A lingering uncertainty under Section 16 is when an investment fund will be deemed to have divested itself of beneficial ownership of its portfolio securities by entering into an investment management agreement which delegates voting and investment power to a registered investment adviser (particularly where the manager is an affiliate of the fund), and the fund may not revoke the delegation within 60 days. In a recent decision, Revive Investing v. Armistice Capital Master Fund, a district judge held that a fund’s entry into an IMA did not divest the fund of beneficial ownership, not because the manager may have been an affiliate of the fund, but because, as a factual matter, the IMA did not delegate voting power to the manager or divest the fund of shared investment power. In the same opinion, the court declined to reach a conclusion regarding whether the fund was a director by deputization.
The fund in question is managed by Armistice Capital LLC, which is controlled by Steve Boyd, who also serves as one of three directors of the fund. In early 2019, the fund acquired more than 10% of the common stock of Aytu BioPharma, causing the fund, the manager and Boyd to file a joint Form 3 as ten percent owners. Shortly afterward, Aytu’s CEO invited Boyd to join the board. In October 2019, the fund purchased more securities directly from Aytu, taking the fund over 40%. The defendants jointly reported the purchase, checking the ten percent owner box and using transaction code “P.” In December 2019, the reporting persons reported two small open market purchases by the fund. In March 2020, after a run-up in Aytu’s stock price, the fund sold almost all of its Aytu securities. The Form 4 reporting the sales checked only the director box and disclosed in a footnote that the reporting persons had agreed to disgorge $92,879 based on a matching of the fund’s March 2020 sales with the two December 2019 open market purchases.
The Fund as Beneficial Owner
The defendants argued that the fund was not a ten percent owner because it had divested itself of investment and voting power over its Aytu stock, based on the IMA’s provision that “all investment decisions . . . will be made by” the manager. The court rejected the argument, saying the provision did not address “voting power” and also did not say that the fund itself could not also exercise investment power. The court contrasted the IMA with the one addressed in Packer v. Raging Capital, in which the Second Circuit held that a fund may divest itself of beneficial ownership through an IMA. The IMA in Packer, the court said, did more than delegate to the manager “all investment decisions,” by also providing that the manager had “exclusive control and discretion” over investment decisions and “sole authority” to exercise incidents of ownership, including “voting power.” Noting also that the defendants’ Schedule 13D said they all shared voting and investment power, the court granted summary judgment to the plaintiffs on the question of beneficial ownership.
The Fund’s Status as Director by Deputization
The defendants also argued that the fund was a director by deputization, making its purchases from the issuer exempt under Rule 16b-3. Both sides moved for summary judgment on the issue, but the court denied both motions, holding that deputization is a question of fact and that genuine issues of material fact remained to be resolved. The court cited the Romeo & Dye treatise for five factors that courts generally consider in determining whether deputization occurred but then listed six specific questions the court wants answered before those factors are applied. The list expands on what courts have typically required in deputization cases, but it remains to be seen how the answers affect the ultimate resolution of the issue.
Settlement
The defendants also argued that their settlement with the issuer, which released them from further liability, barred the plaintiffs’ action. The court rejected the argument, holding that reliance on a settlement is an affirmative defense and that the defense was waived because it wasn’t pleaded. Even if the defense wasn’t waived, the court said, the settlement agreement didn’t bind “all shareholders” and in any case didn’t take into account the transactions between the issuer and the fund.
– Alan Dye, Section16.net, September 7, 2023
