Issuer’s “Fraud” Inducing Insider to Trade is not a Defense to 16(b) Liability
A few months ago I blogged about a case, Microbot Medical v. Alliance Investment Management, in which an investment adviser mistakenly filed a Form 3 reporting that it was a ten percent owner and a Form 4 reporting short-swing transactions when in fact the transactions occurred in a customer account controlled by the customer, leading the court to dismiss the complaint against the adviser but not as to the customer, who was added as a defendant and filed his own Section 16 reports after the complaint was filed. A magistrate judge has now issued a report recommending that the district court grant the plaintiff’s motion for judgment on the pleadings and order the defendant to disgorge short-swing profits of $484,614.
The defendant, Joseph Mona, raised three defenses and also asserted a counterclaim alleging that Microbot had made various fraudulent misrepresentations, in SEC filings and direct communications with him, which led him to make his initial purchases of Microbot stock and then effectively forced him to sell his stock by announcing a dilutive offering which would have diminished the value of his holdings.
As his first defense, Mona argued that his sales were involuntary because Microbot’s conduct left him no choice but to sell, exempting the sales under the “unorthodox transaction” exemption. The magistrate said that open market transactions are “garden variety” transactions and therefore are not unorthodox.
Second, Mona raised the equitable defense that MicroBot had “unclean hands” and therefore was not entitled to a recovery. The magistrate cited case law holding that an action under Section 16(b) is not subject to equitable defenses.
Third, Mona argued that disgorgement would constitute a “windfall” to MicroBot in contradiction of Section 28(a) of the Exchange Act, which provides that no person may recover more than “actual damages” for an alleged violation of the Exchange Act. The magistrate concluded that Section 16(b) profits are not “damages” suffered by the issuer, but are a profit subject to “disgorgement.”
The magistrate also addressed the timing of a ten percent owner’s cessation of ten percent owner status. Most of Mona’s matchable sales were executed on January 14, 2019 and settled on January 17. Microbot’s public offering closed on January 15. Mona argued that his sales occurred on January 17, reducing significantly the number of shares sold while he was still a ten percent owner. The magistrate held that Mona’s sales occurred on the trade date, not the settlement date, and therefore occurred before the dilutive issuance.
-Alan Dye, Section16.net February 1, 2021
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