Rule 16b-3’s Board Approval Exemption Does Not Require the Affirmative Vote of Every Director
A district judge in the W.D. of Washington has dismissed a complaint filed against the CEO of CytoDyn, Inc. alleging that the CEO’s receipt of an employee stock option was not exempt under Rule 16b-3(d)(1) because it was not approved by all five members of CytoDyn’s board.
The option grant was approved in December 2019 at a duly convened meeting of the board of directors which was attended by four of the five directors, including the CEO. The CEO recused himself from the vote, and the grant was approved by the other three directors. Less than six months later, the CEO sold common stock on the open market.
A group of CytoDyn shareholders represented by Seattle-based Foster Garvey PC filed a complaint seeking to match the option grant with the CEO’s sales of common stock. The CEO filed a motion to dismiss the complaint, arguing that the option grant was exempt under Rule 16b-3(d)(1), which exempts a transaction between the issuer and an officer or director if “the transaction is approved by the board of directors of the issuer.” The plaintiffs argued that the exemption is available only if every member of the board approves the transaction, meaning in this case that all five directors needed to have attended the meeting, and that all five, including the CEO, needed to have voted in favor of the grant.
Plaintiffs based their argument on the SEC’s reference to the exemption, in the releases proposing and adopting the current version of Rule 16b-3, as the “full board” exemption. The court was skeptical that the SEC would impose a “full board” requirement without doing so in the rule itself and without defining “full board,” and also concluded that the SEC’s reference to the “full board” was merely a shorthand means of distinguishing the board approval exemption from the alternative board-level exemption in Rule 16b-3(d)(1) for transactions approved by “a committee of the board of directors that is composed solely of two or more Non-Employee Directors,” which the SEC referred to as the “non-employee director exemption.”
The court held that, because the CEO’s option grant was approved at a duly convened meeting of CytoDyn’s board in accordance with state law and CytoDyn’s bylaws, the grant was approved by the board of directors within the meaning of Rule 16b-3(d)(1).
Any other outcome could have called into question a significant number of past board-approved transactions approved by fewer than all directors, particularly in merger transactions, where interested directors often recuse themselves. As just one example, in its 2019 decision dismissing a 16(b) complaint challenging Elon Musk’s reliance on the board approval exemption to exempt his receipt of Tesla stock in Tesla’s merger with Solar City, the court noted in its recitation of the facts that Musk and another interested director recused themselves from the vote on the merger. (The plaintiff in that case did not make the “full board” argument.)
-Alan Dye, Section16.net March 16, 2021
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