A judge in the SDNY had denied a motion to dismiss a complaint alleging that an investment fund, Standard General Master Fund L.P., remained the beneficial owner of common stock of TEGNA, Inc. it sold just after the record date for TEGNA’s April 30, 2020 annual meeting, making the fund a ten percent owner at the time of subsequent short-swing trades. See Chechele v. Standard General L.P.
The case arose in the context of a proxy contest waged by Standard to replace four members of TEGNA’s board. As of March 16, before TEGNA announced the record date for the annual meeting, Standard owned 21,124,315 shares of TEGNA common stock, representing 9.7% of the class outstanding. On March 25, TEGNA announced the record date and made it retroactive to March 20. Also on March 25, and on each of the next four trading days (i.e., March 25-31), Standard sold $1 million of its shares of common stock and entered into physically-settleable swaps for the same number of shares (for a total of $5 million shares sold and $5 million swaps purchased). TEGNA publicly criticized Standard for selling stock before the annual meeting, leading Standard to purchase another 4.5 million shares of common stock on April 2.
The plaintiff (represented by James Hunter, David Lopez and Miriam Tauber) alleged that Standard remained the beneficial owner of the 5 million shares it sold March 25-31 because Standard owned the shares on the record date and therefore retained the right to vote the shares at the annual meeting. Because Standard remained the beneficial owner of those shares, the plaintiff argued, each purchase of a 1 million share swap during the March 25-31 period increased the 21,124,315 shares Standard beneficially owned by 1 million. Once the total number owned exceeded 10% of the class, subsequent sales during the March 25-31 period were subject to Section 16, as was Standard’s purchase of 4.5 million shares at a lower price on April 2. Matching those transactions yielded an alleged short-swing profit of almost $5 million.
Beneficial Ownership. The defendants (Standard, its investment manager and the individual who controlled both entities) moved to dismiss the complaint. First, they argued that the “vestigial” right to vote shares already sold, at a single annual meeting, is insufficient to constitute the “right to vote” within the meaning of Rule 13d-3. The court rejected the argument and agreed with the SEC staff’s position, expressed in a 13(d) Compliance and Disclosure Interpretation, that a person will remain the beneficial owner of shares sold after the record date for a meeting of shareholders if the person retains the right to vote the shares at the meeting.
Change in Form of Beneficial Ownership. The defendants also argued that, even if they were 10 percent owners, their sales of stock and same-day purchases of swaps were exempted by Rule 16a-13 as mere changes in the form of beneficial ownership. The court disagreed, noting that each day’s transactions were not a unified exchange with a single counterparty, but instead were open market sales and independently acquired swaps. Each transaction was, therefore, a separate transaction for purposes of Section 16(b). The court also noted that the price differential between the purchases and sales resulting from the transactions evidenced a change in the defendants’ pecuniary interest.
Statutory Purpose. Citing cases applying the “unorthodox transaction” exemption, defendants argued that applying Section 16(b) to an entity that is clearly an “outsider” with no access to inside information would be inconsistent with the purposes of Section 16(b). The court noted that the unorthodox transaction analysis applies only to involuntary transactions, where it may be appropriate to assess whether application of Section 16(b) would further the purposes of the statute. Voluntary transactions like the defendants’, in contrast, do not warrant a similar analysis, and in any case the defendants’ transactions did present an opportunity for speculative abuse.
Profit Calculation. The defendants also challenged the application of the “lowest price in, highest price out” methodology for calculating profits, arguing that the methodology is inconsistent with the Supreme Court’s holding in Liu v. SEC that the SEC’s right to seek disgorgement in civil enforcement actions is limited to the “wrongdoer’s” net profits. The court noted that Liu involved a different statute and also was based on equitable remedies which aren’t applicable in an action under Section 16(b).
-Alan Dye, Section16.net July 12, 2021
