Analytical Surveys, Inc. v. Tonga Partners, L.P.

Citation684 F.3d 36
Decision Date13 July 2012
Docket NumberNo. 09–2622–cv.,09–2622–cv.
PartiesANALYTICAL SURVEYS, INC., Plaintiff–Appellee, v. TONGA PARTNERS, L.P., Cannell Capital, LLC, J. Carlo Cannell, Defendants–Appellants.
CourtUnited States Courts of Appeals. United States Court of Appeals (2nd Circuit)

OPINION TEXT STARTS HERE

Jack Fruchter (Mitchell M.Z. Twersky and Ximena R. Skovron, on the brief), Abraham, Fruchter & Twersky, LLP, New York, NY, for PlaintiffAppellee.

Steven M. Hecht (Sally J. Mulligan and Michael J. Hampson, on the brief), Lowenstein Sandler PC, Roseland, NJ, for DefendantsAppellants.

Before: HALL, LIVINGSTON, and CHIN *, Circuit Judges.

LIVINGSTON, Circuit Judge:

DefendantsAppellants Tonga Partners, L.P. (Tonga), Cannell Capital, LLC (Cannell Capital), and J. Carlo Cannell (Cannell) (collectively, Defendants), appeal from a judgment of the United States District Court for the Southern District of New York (Wood, J.), entered June 10, 2009, holding Defendants liable to PlaintiffAppellee Analytical Surveys, Inc. (ASI) in the total amount of $4,965,898.95, and from a May 29, 2009 opinion and order denying Defendants' motion for reconsideration. The matter requires us, among other things, to consider the rarely-construed “debt exception” to liability under § 16(b) of the Securities Exchange Act of 1934 (Exchange Act), 15 U.S.C. § 78p(b) (2006), and to address the unsettled issue of the treatment of “hybrid” derivative securities under § 16(b).

Tonga, having previously invested in ASI through the purchase of a $1.7 million promissory note in 2003, exchanged that note in June 2004 for another note from ASI, with the same $1.7 million face value but somewhat different terms. Both notes could be converted into shares of ASI stock at either a pre-set price-per-share or a floating price that depended on ASI's share price over a defined period prior to conversion. In November 2004, Tonga converted that note into shares of ASI stock, all of which it sold in the week following conversion. ASI, seeking to recoup the profits earned by Tonga on the sale of ASI shares, brought suit under § 16(b), which prohibits statutory insiders such as Tonga from profiting on the trade of securities on a short-swing basis (that is, from a purchase-and-sale, or sale-and-purchase, of a security in a six month period).1

The district court held that the note issued in 2004 was sufficiently different from the note issued in 2003 to be considered a new, rather than amended note, and thus that Tonga's acquisition of the 2004 note was a § 16(b) purchase; it further held that the conversion of that note into ASI shares five months later was also a purchase under the statute, and that both of these purchases could be matched to the ensuing sale of ASI stock for purposes of disgorgement of profits earned on transactions prohibited by § 16(b). The court rejected Defendants' argument that regardless whether its transactions were covered by the § 16(b) prohibition, Defendants were shielded from § 16(b) liability by the statute's exceptions for acquisitions of securities in connection with a “debt previously contracted” and for certain “borderline transactions.” The court further held that all Defendants, not merely Cannell, were liable for the profits earned on the transactions at issue.

Defendants moved for reconsideration, arguing that the district court's decision had overlooked new controlling precedent of this Court, pursuant to which their actions were sheltered by an exemption from § 16(b) liability contained in regulations issued by the Securities and Exchange Commission (“SEC”). The district court, noting that Defendants could have advanced that argument prior to the court's decision, but did not do so, denied the motion for reconsideration.

We affirm the judgment of the district court on liability, and its denial of the motion for reconsideration.2

Background

The events culminating in the present case began in 2002, when Tonga made a $2 million investment in ASI. ASI, at that time, was a provider of digital mapping services; at all times relevant to the action, it was publicly traded, and its common stock was registered pursuant to § 12 of the Exchange Act. Tonga is and was a limited partnership, created by DefendantAppellant Cannell as an investment vehicle for himself and other private investors. At all relevant times, Tonga's sole general partner was DefendantAppellant Cannell Capital; Cannell was the sole managing member of Cannell Capital, and, working through Cannell Capital, he in turn directed and controlled the operation of Tonga.

In April 2002, Tonga paid ASI $2 million to acquire a senior secured convertible promissory note with a maturity date in April 2005 (the 2002 Note”). Under the 2002 Note's terms, at any time prior to the maturity date, Tonga could convert part or all of the Note's principal (and accrued interest) into shares of ASI common stock; the number of shares received for a given amount of principal-and-interest depended on the price per share, as determined by a conversion formula in the Note. That formula, in turn, defined the conversion price per share as the least of a fixed price (either $0.40 or $2.00, depending on the timing of the conversion) and two possible floating prices (each based on ASI's average stock price in certain defined periods prior to conversion).3 Section 3.5 of the Note provided that, at maturity, the outstanding balance of the Note would automatically be converted into shares, based on the conversion price on the maturity date. 4

Simultaneous to the acquisition of the 2002 Note, Tonga and ASI also entered into an agreement (the “Registration Rights Agreement”) by which ASI was obligated to file a registration statement with the SEC for the shares acquirable by conversion of the Note, and then to have that statement declared effective, within a certain period of time.5 Failure to have the statement declared effective within the specified period (150 days after its filing with the SEC) constituted an Event of Default under § 2.1(c) of the Note.

As relevant here, if a § 2.1(c) default occurred, § 2.2 of the Note gave Tonga the option to, at a time of its choosing, (1) accelerate the entire unpaid principal balance of the Note (rendering that balance immediately due and payable); or (2) demand prepayment of at least 130% of the principal amount of the Note; or (3) demand that the outstanding principal (and accrued interest) be converted into shares, with the default date serving as the date of conversion for purposes of the conversion price. Alternatively, if Tonga did not wish to exercise one of these options, it was free to ignore the Event of Default and proceed as otherwise provided for by the terms of the Note.

In October 2003 Tonga converted $300,000 of the 2002 Note into approximately 260,000 shares of ASI common stock, at a price, determined under one of the floating-price provisions of the Note, of $1.24 per share.6 At the same time, ASI issued an amended convertible note to Tonga on the same terms as before, now in the amount of $1.7 million (the 2003 Note”). By the time the 2003 Note issued, the deadline for ASI to file a registration statement had been moved back, under various amendments to the Registration Rights Agreement, to December 31, 2003; 7 ASI was therefore obligated under the Note to have said statement declared effective by the SEC by the end of May 2004.

No declaration of effectiveness issued, however. On May 28, 2004, 150 days having passed after the filing of ASI's registration statement with the SEC, an Event of Default was triggered under § 2.1(c) of the 2003 Note. Tonga did not, however, exercise any of the remedies available to it under § 2.2. 8 Rather, following negotiations between ASI and Tonga, ASI issued another note to Tonga in the amount of $1.7 million on June 30, 2004 (the 2004 Note”).9 The 2004 Note carried a maturity date of January 2, 2006 (rather than the previous maturity date of April 2, 2005). The 2004 Note also eliminated the mandatory conversion required by the 2002 and 2003 Notes; at maturity, Tonga now had the option to convert the principal balance into shares, but could, if it wished, insist on payment in full in cash.10

On November 10, 2004, Tonga converted the outstanding principal of the 2004 Note ($1.7 million) into 1,701,341 shares of common stock at the applicable floating price of $1.05 per share. Between November 10 and November 15, 2004, Tonga sold all 1,701,341 shares of that stock in the open market, at prices ranging from $3.52 to $6.62 per share.

On April 6, 2006, ASI filed an action in the United States District Court for the Southern District of New York, seeking disgorgement under § 16(b) of the Exchange Act of the profits earned by Tonga on its November 2004 sale of ASI shares. In response, Tonga argued that its acquisition of the 2004 Note in June 2004, and its conversion of that Note in November 2004, did not constitute purchases of stock such that the ensuing sale of shares came within the prohibition of § 16(b). Tonga also argued that the November 2004 sale fell within § 16(b)'s “debt previously contracted” exemption from liability, and the “borderline transaction” exception to liability of Kern County Land Co. v. Occidental Petroleum Corp., 411 U.S. 582, 93 S.Ct. 1736, 36 L.Ed.2d 503 (1973). Finally, Tonga maintained that even if liability were appropriate, ASI could obtain disgorgement only to the extent of Cannell's personal interest in the profits earned in November 2004, and not any additional profits realized by Cannell Capital and Tonga.

On opposing motions for summary judgment, the district court (Wood, J.) rejected each of these arguments and denied Tonga's motion in its entirety. Instead, on September 26, 2008, the district court granted summary judgment in part to ASI, and ordered Tonga to disgorge $4,965,898.95 in profits, with Cannell and Cannell Capital jointly and severally liable for their...

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