Second Circuit Agrees that Investment Fund Ceased to be Ten Percent Owner Before Call Option Expired

I’ve blogged about Olagues v. Perceptive Advisers LLC twice before, most recently a year ago when the SDNY dismissed the complaint. As explained in my first blog, Perceptive, a ten percent owner of Repros Therapeutics, decided in January 2013 to “collar” most of its position by writing calls having an above-market exercise price and simultaneously purchasing puts having a below-market exercise price, with all of the options having an expiration date of March 16, 2013 (a Saturday). Repros’s stock price declined to less than the exercise price of the puts, so, on the expiration date, the puts were exercised, and the calls expired out of the money. As a result of Perceptive’s exercise of its put options, Perceptive ceased to be a ten percent owner.

Two shareholders sued Perceptive, alleging that the premium Perceptive received for writing the call options ($1.7 million) was recoverable under Rule 16b-6(d), since the options expired less than six months after they were written. The SDNY dismissed the complaint, holding that, under the rules of the Options Clearing Corporation, the put options were exercised before the call options expired, and therefore Perceptive was no longer a ten percent owner when the call options expired (meaning that the expiration was not subject to Section 16). The court based this conclusion on two OCC rules. First, OCC Rule 1000(b)(21) provides that an out of the money option expires at “11:59 p.m. Eastern Time, the Saturday immediately following the third Friday of the expiration month of such option contract.” Under this rule, the call options written by Perceptive expired at 11:59 p.m. on Saturday, March 16. Second, OCC Rule 805(d) provides that an unexercised in-the-money option does not expire, and instead its holder is “deemed to have properly and irrevocably tendered” an exercise notice “immediately prior to the expiration time.” Accordingly, Perceptive exercised its puts “immediately prior” to 11:59 p.m. on March 16, 2013, and therefore was no longer a ten percent owner when the calls expired at 11:59 p.m.

On appeal, the plaintiffs made two arguments. First, they argued that the purchase resulting from the expiration of the call options occurred on Friday, March 15, because at that time the parties became irrevocably committed to an expiration. The plaintiffs based their argument on NYSE Rule 2360(b)(23)(A)(iii), which provides that an option scheduled to expire on a non-business day (here, Saturday March 16) will expire at its scheduled expiration time if not exercised by 5:30 p.m. Eastern Time on the business day immediately prior to the expiration date (here, Friday March 15). Because the call options could no longer be exercised after 5:30 p.m. on Friday March 15, the plaintiffs argued, the parties became irrevocably committed to the expirations at that time, resulting in a purchase. The court rejected the argument, holding that the unambiguous language of Rule 16b-6(d) provides that a purchase occurs “upon” the expiration of an option.

The plaintiffs also argued that the exercise of the put options did not immediately divest Perceptive of beneficial ownership of the shares subject to the put options, because Perceptive retained voting and investment power over the shares until the trade settled on March 20. The court rejected that argument as well, citing the SEC’s 1981 Q&A release on Section 16 (34-18114, Q. 16), in which the Commission said that “an insider . . . divests himself of . . . beneficial ownership at the time he makes a firm commitment for its sale.” There probably were better reasons for the court to reject the argument, given that the Q&A release was issued before the SEC amended the rules in 1991 to define “beneficial owner,” for the purpose of determining ten percent owner status, on the Section 13(d) standards of beneficial ownership.