Bruh v. Bessemer Venture Partners III L.P.

• Decision Date: 13 September 2006
• Docket Number: Docket No. 05-5271-cv.
• Citation: 464 F.3d 202
• Parties: Marc BRUH, Plaintiff-Counter-Defendant-Appellant, v. BESSEMER VENTURE PARTNERS III L.P., Defendant-Counterclaimant-Appellee, Vistacare, Inc., Defendant.
• Court: U.S. Court of Appeals — Second Circuit

464 F.3d 202

Marc BRUH, Plaintiff-Counter-Defendant-Appellant, v. BESSEMER VENTURE PARTNERS III L.P., Defendant-Counterclaimant-Appellee Vistacare, Inc., Defendant.

Docket No. 05-5271-cv.

United States Court of Appeals, Second Circuit.

Argued: April 7, 2006.

Decided: September 13, 2006.

Jeffrey S. Abraham (Mitchell M.Z. Twersky and Ximena Skovron, on the brief), Abraham Fruchter & Twersky, LLP, New York, NY, for Plaintiff-Counter-Defendant-Appellant.

Vincent T. Chang (Frederick R. Kessler, on the brief), Wollmuth Maher & Deutsch LLP, New York, NY, for Defendant-Counterclaimant-Appellee.

Before McLAUGHLIN, CABRANES, Circuit Judges, and GLEESON, District Judge.¹

GLEESON, Judge.

Marc Bruh, a shareholder in VistaCare, Inc. ("VistaCare"), brought this action against Bessemer Venture Partners III, L.P. ("Bessemer"), pursuant to § 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b), seeking disgorgement of the profit Bessemer made when it sold shares of VistaCare common stock on May 13, 2003. The question presented on appeal is whether a stock reclassification — converting Bessemer's preferred stock into common — that occurred in December 2002 can properly be matched against that sale and thus give rise to liability for short-swing insider trading under § 16(b). The United States District Court for the Southern District of New York (George B. Daniels, Judge) granted summary judgment for the defendants, and we affirm, though we arrive at that result by a different route.

BACKGROUND

The relevant facts are not in dispute. In 1995 Bessemer purchased 305,292 shares of Series A-1 preferred stock in Vista Hospice Care, Inc. ("VHS") for $9.90 per share. By a recapitalization in 1998, VHS became a wholly-owned subsidiary of VistaCare, and Bessemer's shares in VHS were converted to Series A-1 preferred shares in VistaCare. Bessemer then, and at all times relevant thereafter, owned more than ten percent of VistaCare's stock and was therefore subject to § 16(b) liability as a statutory insider.²

In 1999 the VistaCare shareholders adopted a Third Amended and Restated Certificate of Incorporation, which provided:

Upon the closing of a Qualified Initial Public Offering ["IPO"], each outstanding share of Series A-1 Preferred Stock shall automatically be converted into a number of shares of Class A Common Stock equal to (i) the Original Issue Price of the Series A-1 Preferred Stock (as adjusted for any stock splits, stock dividends, recapitalizations and similar events), plus all accrued but unpaid dividends on such shares . . ., divided by (ii) the per share price at which the Common Stock is sold to the public in the . . . [IPO].

Two aspects of this provision are worthy of note. First, the conversion formula ensured that the aggregate value of Bessemer's investment in VistaCare would remain the same through the conversion: the greater the IPO price relative to the value of each of Bessemer's preferred shares, the fewer common shares Bessemer would receive, and vice versa. Second, the conversion was to be automatic. After negotiating the Third Amended Certificate, Bessemer did not retain the option of keeping its preferred shares in the event of a "[q]ualified" IPO, nor did it have the right to convert its preferred shares to common at any earlier time.

On December 17, 2002, VistaCare announced a Qualified IPO³ and set the price of the offering at $12.00 per share. On December 23, 2002, the deal closed, and Bessemer's preferred stock was converted into 251,865 shares of common stock. Trading opened at $15.90 per share. On May 13, 2003, VistaCare made a secondary offering of stock at $20.00 per share. Although Bessemer had requested that the secondary offering be delayed (perhaps in the hope of avoiding this lawsuit by allowing the six-month time frame in which short-swing trading is prohibited to expire), VistaCare declined, and Bessemer sold anyway. At the net price of $18.95 per share, compared to the $12.00 per share IPO price, Bessemer earned a profit of $1,725,275.25 on the 251,865 shares it acquired by the conversion of its preferred shares.⁴ This action followed.

The district court granted summary judgment for Bessemer, concluding that "[t]he `purchase' in the instant matter occurred at the time Bessemer contracted, ... in 1995, to acquire [VHS] Preferred Stock." That, the district court held, was "when Bessemer's rights and obligations became fixed and irrevocable." [SA 8.] Bruh appealed, and we invited the Securities and Exchange Commission ("SEC") to participate as amicus curiae.

DISCUSSION

We review the district court's grant of summary judgment de novo, see Miller v. Wolpoff & Abramson, L.L.P., 321 F.3d 292, 300 (2d Cir.2003), and we may affirm on any basis for which there is sufficient support in the record, including grounds not relied on by the district court, see Shumway v. United Parcel Service, Inc., 118 F.3d 60, 63 (2d Cir.1997).

Congress enacted § 16(b) "[f]or the purpose of preventing the unfair use of information" by corporate insiders trading securities issued by the company they manage or in which they hold a significant ownership interest. 15 U.S.C. § 78p(b).⁵ The mechanism adopted to that end is "a flat rule taking the profits out of a class of transactions" — so-called "short-swing" transactions involving a stock purchase and sale (or sale and purchase) by an insider within a period of less than six months — "in which the possibility of abuse was believed to be intolerably great," Kern County Land Co., v. Occidental Petroleum Corp., 411 U.S. 582, 592, 93 S.Ct. 1736, 36 L.Ed.2d 503 (1973) (internal quotation marks omitted). Any profit realized from such a transaction is recoverable by the corporation in a suit against the insider, brought either by the corporation itself or, as in this case, on behalf of the corporation by a shareholder.

Congress further provided, however, that § 16(b) "shall not be construed to cover ... any transaction or transactions which the [Securities and Exchange] Commission by rules and regulations may exempt as not comprehended within the purpose of this subsection." 15 U.S.C. § 78p(b). One such exemption, Rule 16b-7, 17 C.F.R. § 240.16b-7, is the focus of the dispute between the parties here. And because that rule was amended by the Commission in 2005, after the transactions giving rise to this case took place, see Ownership Reports and Trading by Officers, Directors and Principal Security Holders, Exchange Act Release No. 52202, 70 Fed.Reg. 46080 (Aug. 9, 2005) (hereinafter "2005 Release"), the case implicates two versions of the Rule 16b-7 exemption.

Bruh contends that under the old Rule 16b-7, as interpreted by the Third Circuit in Levy v. Sterling Holding Company, 314 F.3d 106 (3d Cir.2002), the conversion of Bessemer's preferred stock into common was not exempt. He further contends that to the extent the new Rule 16b-7 would exempt that conversion, it may not be applied retroactively, see Bowen v. Georgetown Univ. Hosp., 488 U.S. 204, 208, 109 S.Ct. 468, 102 L.Ed.2d 493 (1988). Bessemer, with support from the Commission, argues that the new Rule 16b-7 is merely the old Rule properly understood. The Third Circuit's decision in Levy, they contend, was issued only "[i]n the absence of specific SEC guidance" on the question, 314 F.3d at 114, and that guidance having now been supplied, the Commission's reasonable interpretation of its own rule is entitled to deference under Bowles v. Seminole Rock & Sand Company, 325 U.S. 410, 413-14, 65 S.Ct. 1215, 89 L.Ed. 1700 (1945); see also Auer v. Robbins, 519 U.S. 452, 461-62, 117 S.Ct. 905, 137 L.Ed.2d 79 (1997).

We hold that the Commission's construction of the old Rule 16b-7 is not plainly erroneous, and it is therefore controlling.⁶ So construed, the rule relieves Bessemer of liability here.

A. Seminole Rock Deference

We do not examine the Commission's exemptive rules with fresh eyes. Rather, in the "interpretation of an administrative regulation a court must necessarily look to the administrative construction of the regulation if the meaning of the words used is in doubt. . . . [T]he administrative interpretation . . . becomes of controlling weight unless it is plainly erroneous or inconsistent with the regulation." Seminole Rock, 325 U.S. at 413-14, 65 S.Ct. 1215; see also Press v. Quick & Reilly, Inc., 218 F.3d 121, 128 (2d Cir.2000) ("We are bound by the SEC's interpretations of its regulations in its amicus brief, unless they are plainly erroneous or inconsistent with the regulations.") (internal quotation marks omitted); Levy v. Southbrook Int'l Investments, Ltd., 263 F.3d 10, 16 (2d Cir.2001) (deference owed to SEC's interpretation of rules implementing § 16(b) when "neither plainly erroneous nor inconsistent with the regulations"). It is "axiomatic that the [agency's] interpretation need not be the best or most natural one by grammatical or other standards. . . . Rather, the [agency's] view need be only reasonable to warrant deference." Pauley v. BethEnergy Mines, Inc., 501 U.S. 680, 702, 111 S.Ct. 2524, 115 L.Ed.2d 604 (1991). We are thus obligated to accept the Commission's interpretation of Rule 16b-7 — here expressed both by the Commission's amicus brief and by the 2005 amendments to the rule itself — so long as it represents "a plausible construction of the language of the actual regulation," Ehlert v. United States, 402 U.S. 99, 105, 91 S.Ct. 1319, 28 L.Ed.2d 625 (1971); see also Northern Indiana Pub. Serv. Co. v. Porter, 423 U.S. 12, 15, 96 S.Ct. 172, 46 L.Ed.2d 156 (1975) (agency interpretation must "sensibly conform[] to the purpose and wording of the regulations").⁷

We pause briefly to explain the grounds for such deference, which greatly inform our decision here. Like the deference owed under Chevron U.S.A., Inc. v. Natural Resources Defense Council, 467 U.S. 837, 104 S.Ct. 2778, 81 L.Ed.2d 694 (1984), to an agency's reasonable construction of a statute it administers, ...