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An investment group that signed an agreement capping the amount of shares it was allowed to trade in a biotechnology company cannot be sued for disgorgement of short-swing profits, the 2nd U.S. Circuit Court of Appeals ruled Thursday. Upholding the dismissal of a shareholder derivative suit, the 2nd Circuit agreed with the Securities and Exchange Commission that a large stockholder of ImmunoGen Inc. is not a “beneficial owner” of more than 10 percent of the company’s stock. Because the stockholder has a valid conversion cap agreement keeping it from holding more than 4.9 percent — less than half of the 10 percent required to qualify as a beneficial owner — it is thus shielded from short-swing liability, the court said. In Levy v. Southbrook International Investments Ltd., 00-7630, the 2nd Circuit upheld and clarified an SEC interpretation of the beneficial ownership rule, a companion to restrictions on insider trading that is designed to inform investors about stock sales that could affect ownership or control of a corporation. Under �16(b) of the Securities and Exchange Act of 1934, 10 percent stock ownership, or “beneficial ownership,” is the threshold for short-swing trader liability. If a party acquires more than 10 percent of a company’s stock, it must publicly disclose the transaction to the SEC, or risk a lawsuit for disgorgement of profits by shareholders. Investor Mark Levy had claimed that, even though Southbrook International Investments Ltd.’s conversion cap agreement limited it to owning 4.9 percent of ImmunoGen stock, Southbrook violated the law on three occasions by acquiring common shares through conversion and selling them at a profit. Cumulatively, Levy alleged, Southbrook’s acquisitions amounted to more than a 10 percent ownership in the company as of February 1997. In December 1998, Levy demanded that ImmunoGen’s board of directors bring an action against Southbrook. When the board refused, Levy filed suit in the Southern District. In addition to arguing that beneficial ownership should be measured by totaling the number of shares owned by Southbrook during the relevant period, Levy charged the conversion cap agreement was a “sham transaction,” because Southbrook still had the freedom to make limited conversions and sales to circumvent the cap. Southbrook countered that the cap agreement was lawful, that the sales and conversions it made in 1997 did not violate the agreement, and that it could not be considered a beneficial owner within the meaning of SEC rules. Federal Judge Naomi Reice Buchwald of the U.S. District Court for the Southern District of New York granted Southbrook’s motion to dismiss, finding, in part, that “it is clear that only those holders of derivative securities, who could acquire ownership, by conversion or otherwise, of more than 10 percent of the common stock at one time, are subject to Section 16(b) liability.” Buchwald also rejected Levy’s contention that the conversion cap agreement was a sham transaction. DIRECTION FROM SEC On the appeal, when the 2nd Circuit asked the SEC to submit an amicus curiae brief, the commission came down squarely on the side of Southbrook’s view of the law. Southbrook, Judge Fred I. Parker said, argued that “beneficial ownership depends on its right, at a given point, rather than cumulatively over a 60-day period, to acquire through conversion more than 10 percent of ImmunoGen’s common stock.” Judge Parker said �13(d) of the act and rules promulgated under that section are “reporting requirements intended to provide investors with early warning of potential changes in control.” “The beneficial ownership threshold established for disclosure of shareholder control under Section 13(d) is based on, at least in part, the power over corporate affairs associated with significant equity ownership,” Parker said. “This power also implicates access to inside information and the potential for insider trading.” At issue, he said, is the SEC’s interpretation of Rule 13d-3(d)(1)(i), which speaks of the “right to acquire” stock within a 60-day period. That right, the SEC argued, is, at all times, subject to the conversion cap. “Only when the investor divests itself of sufficient shares of common stock to reduce holdings below the cap does any additional ‘right to acquire’ come into being,” Parker said. “At that point the investor does not have voting power, investment power, or the ‘right to acquire’ those powers, with respect to the divested shares. Nor does it have the ‘right to acquire’ those powers by virtue of its conversion rights because the cap prohibits conversion so as not to exceed holdings in excess of 4.9 percent of the common stock.” Therefore, he said, the SEC believed that the “calculation of beneficial ownership is not cumulative.” “Viewing Rule 13d-3(d)(1)(i) in the context of its purpose, and operation, we find reasonable the SEC’s reading of the Rule’s ‘right to acquire’ language,” he said. “The SEC’s use of ‘within 60 days’ in Rule 13d-3(d)(1)(i) directs us not to look to the percentage of common shares cumulatively, beneficially owned during the 60-day period as plaintiff-appellant argues, but rather, to whether the ‘right to acquire’ inures at some point within 60 days of the acquisition.” Not only does this interpretation comport with U.S. Supreme Court precedent, Judge Parker said, it also “limits Section 16(b) short swing liability to those persons in a position to influence the value of stocks because they hold or have the ‘right to acquire,’ at any one time, more than 10 percent of the issuer’s common stock.” The court also found that the conversion cap agreement signed by Southbrook was valid. Senior Judge Wilfred Feinberg and Alfred V. Covello, Chief Judge of the U.S. District Court for the District of Connecticut, sitting by designation, joined in the opinion. Jeffrey S. Abraham represented Levy. Herbert Teitelbaum, Peter Sapanoff and Noah Weissman, of Robinson Silverman Pearce Aronsohn & Berman, represented Southbrook. Allan A. Capute, Eric Summergrad, Meyer Eisenberg and David M. Becker represented the Securities and Exchange Commission.

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