Satisfaction of Condition to Exercise of Derivative Security Is Not a “Purchase”
A judge in the SDNY has issued an opinion in Chechele v. Dundon which appears to hold that an insider’s exercise of an option, subject to regulatory approval of the exercise, is a purchase as of the date of exercise, not the date on which regulators approve the exercise.
The case and its history are complicated, but the allegations relevant to the court’s holding are:
Option Grants. In connection with the January 2014 IPO of Santander Consumer USA Holdings, Santander granted three options to its CEO, Thomas Dundon, who also was chairman of the board and a ten percent owner. (The only option relevant to the litigation entitled Dundon to purchase 759,773 shares at a price of $24 a share.) At the same time, Dundon entered into an agreement with Santander’s majority owner (Parent) giving Parent the right to buy all of Dundon’s stock upon termination of his employment at the average trading price of the stock over the ten days prior to Parent’s exercise of the right.
Conditional Exercises. Dundon resigned as chairman and CEO on July 2, 2015, and the parties entered into a separation agreement under which Dundon’s options would remain outstanding for three years, he could elect to settle them for cash, and Parent would buy Dundon’s stock at the highest intraday price over the preceding ten days. The next day, when the stock was trading at $26.48 a share, Dundon exercised his options for cash, and Parent exercised its right to purchase all 34,598,506 shares of Dundon’s stock for $26.83 a share. Both exercises were subject to approval by bank regulators.
Settlement upon Regulatory Approval. While the parties were waiting for regulatory approval, Dundon left the board, Santander’s stock price dropped to $9 a share, and the parties renegotiated some of the terms of settlement, including a return to the prior formula for Parent’s payment to Dundon (back to $26.17 a share). The bank regulators approved the transactions on November 15, 2017, at which time the parties executed a previously negotiated final settlement agreement, and the transactions closed.
The plaintiff sought to match Dundon’s purchase of the shares underlying his $24 a share option with his same-day sale of shares to Parent at $26.17 a share. Plaintiff’s argument was based on the theory that, because Dundon’s option could not be exercised on the negotiated terms without regulatory approval, the exercisability of the option, like the exercise itself, was subject to a material condition beyond Dundon’s control, and therefore the option was not a derivative security until the condition was satisfied. So, the plaintiff argued, Dundon acquired the option when he was no longer an officer or director eligible to Rely on Rule 16b-3. And, because the exercise also did not occur until the condition was satisfied, the option was out of the money when exercised, making the resulting purchase ineligible for the Rule 16b-6(b) exemption and matchable with Dundon’s sale of stock to Parent.
The court rejected the plaintiff’s argument without addressing the effect of the conditionality of the exercise, and held that a purchase occurs when an insider acquires an option, and the subsequent exercise and settlement of the option are not purchases subject to matching.
-Alan Dye, Section16.net September 3, 2020
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