A magistrate judge in the SDNY has issued a report in a Section 16(b) action recommending that the court grant summary judgment to the insider on the ground that, more than a year before the complaint was filed, the insider settled the claim privately.
The defendant is FBC Holdings, which in 2018 was a ten percent owner of Sphere 3D Corporation, owning both common stock and a convertible debenture. In March 2018, FBC and Sphere amended the debenture to extend its maturity date, require Sphere to pay an “extension fee” in return, and allow Sphere to pay the extension fee and interest in either cash or common stock. Over the next three months, Sphere elected on four occasions to pay interest and the extension fee with common stock.
FBC reported these acquisitions on Forms 4, after which Sphere received demand letters from Miriam Tauber (April 18), David Lopez (April 23) and Daniel Doherty (April 24) seeking to match the acquisitions with FBC’s sales of stock within the preceding six months. Sphere investigated the claim and then informed Tauber (presumably because she was first to submit a letter) that the company had determined not to pursue the claim due to possible defenses, the cost of litigation and the amount at issue. Tauber teamed up with Lopez, and on November 8, following three months of negotiations, the parties agreed to settle the claim for $300,000, representing 30% of the alleged profit.
Approximately ten months later, Doherty submitted a second demand letter, and again Sphere didn’t respond. Finally, in January 2020, Doherty filed a 16(b) action, and FBC moved for summary judgment based on the prior settlement. Doherty argued that the settlement was invalid and that FBC should disgorge the remaining amount of the short-swing profit.
The magistrate first noted that Section 29(a) of the 1934 Act, which provides that a waiver of compliance with any provision of the Act is void, has been held not to prohibit a release of securities fraud claims that have “matured.” On that basis, the magistrate concluded that a settlement releasing an insider from further liability based on a matured Section 16(b) claim does not violate Section 29(a).
The magistrate then considered several possible standards for approving a private 16(b) settlement and ultimately applied the standard applicable to settlements of class actions under FRCP 23(e)(2), which requires that the proposed settlement be “fair, reasonable and adequate.” The magistrate concluded that FBC’s settlement met this standard, noting that (1) the settlement was the product of arms-length negotiations involving experienced plaintiffs’ attorneys known to be active in the plaintiffs’ bar and (2) FBC had raised defenses (the “debt previously contracted” exemption and the “forced transaction doctrine”) which were substantial enough to justify the relatively low settlement amount. The magistrate also noted that the case was complex and that the cost of litigating rather than settling would have been significant.
The circumstances under which a private settlement of a contested claim will protect an insider from further exposure to liability has been a longstanding concern of insiders and their counsel. There is very little case law on the subject, partly because multiple claimants usually band together to settle the claim and split any resulting attorneys’ fee, but also because plaintiffs’ attorneys generally would rather settle a case than litigate, and they know that insiders will become unwilling to settle claims privately if plaintiffs’ attorneys start challenging one another’s settlements, forcing insider’s to defend themselves twice. This magistrate’s report, if adopted by the court, together with the decision in Donoghue v. Bohemian, should ease that concern somewhat.
Query whether the litigation could have been avoided if the parties to the settlement had included Doherty in the negotiations.
-Alan Dye, Section16.net January 19, 2021
