Feder v. Frost

• Decision Date: 01 August 1999
• Docket Number: FROST-NEVAD,Docket No. 99-7478,L
• Citation: 220 F.3d 29
• Parties: (2nd Cir. 2000) MARK FEDER, Derivatively on behalf of Ivax Corporation, Plaintiff-Appellant, v. PHILIP FROST,imited Partnership, Defendants-Appellees
• Court: U.S. Court of Appeals — Second Circuit

Page 29

220 F.3d 29 (2nd Cir. 2000)

MARK FEDER, Derivatively on behalf of Ivax Corporation, Plaintiff-Appellant, v. PHILIP FROST, FROST-NEVADA, Limited Partnership, Defendants-Appellees.

Docket No. 99-7478

August Term, 1999

UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

(Argued: November 9, 1999)

(Decided: August 07, 2000)

Appeal from a dismissal by the District Court for the Southern District of New York (Richard Owen, Judge) of a complaint alleging a violation of Section 16(b) of the Securities Exchange Act. Because the complaint sufficiently alleges beneficial ownership of the stock at issue, we reverse.

JEFFREY S. ABRAHAM, Law Offices of Jeffrey S. Abraham (Mitchell M.Z. Twersky, Fruchter & Twersky, of counsel), New York, New York, for Plaintiff-Appellant.

GARY W. KUBEK, Debevoise & Plimpton, New York, New York (Peter W. Homer, Homer, Bonner & Delgado, P.A., Miami, Florida, of counsel, for Defendant-Appellee Frost-Nevada, Limited Partnership), for Defendants-Appellees.

David M. Becker, General Counsel, Jacob H. Stillman, Solicitor, Susan S. McDonald, Senior Litigation Counsel, Angel Yang, Attorney (Meyer Eisenberg, Deputy General Counsel, of counsel), Securities and Exchange Commission, Washington, D.C., filed an amicus curiae brief on behalf of the Securities and Exchange Commission.

Before: WINTER, Chief Judge, CARDAMONE, and STRAUB, Circuit Judges.

WINTER, Chief Judge:

Mark Feder appeals from Judge Owen's dismissal of his complaint, which alleged a violation of Section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b). Feder is a shareholder of IVAX Corporation and brought the suit derivatively on its behalf. His complaint alleged that appellee Philip Frost is a statutory insider of IVAX and that Frost and Frost-Nevada Limited Partnership ("FNLP"), a firm controlled by Frost, are controlling shareholders of North American Vaccine, Inc. ("NAVI"). He claims that Frost/FNLP must disgorge short-swing profits under Section 16(b) as a result of sales by NAVI of IVAX common stock and purchases by Frost/FNLP of IVAX stock.

The district court concluded as a matter of law that Frost/FNLP did not "realize" any profits from NAVI's sale of IVAX stock. Feder v. Frost, No. 98 CV 4744 1999 WL 163174, at *2-3 (S.D.N.Y. Mar. 24, 1999). We disagree and reverse.

BACKGROUND

Because the district court dismissed the complaint on the pleadings, we take as true the allegations in the complaint. See, e.g.,, Boyd v. Nationwide Mut. Ins. Co., 208 F.3d 406, 408 (2d Cir. 2000). Those allegations were as follows.

Frost is Chairman and CEO of IVAX, a publicly owned corporation. The sole general partner of FNLP is a corporation, all of whose shares are owned by Frost. Frost, with FNLP, is the beneficial owner of 12.8% of IVAX's stock. Frost is also a director of NAVI, whose stock is publicly traded as well. Frost, with FNLP, owns 17.3% of NAVI's common stock.

In addition, Frost and FNLP are parties to a shareholders' agreement. The combined holdings of the parties to this agreement amount to 50.8% of NAVI's common stock. The parties nominate individuals to NAVI's board of directors and have "effective control" over NAVI. The complaint states, "As a result of these contractual arrangements and . . . rights at law, Frost . . . ha[s]: (1) Voting power which includes the power to vote, or to direct the voting of, NAVI securities; and/or (2) Investment power which includes the power to dispose, or to direct the disposition, of NAVI securities."

During various times in late 1995 and early 1996, Frost and FNLP purchased IVAX shares and NAVI sold IVAX shares. Appellant claims that Frost/FNLP were beneficial owners of the IVAX shares sold by NAVI for purposes of Section 16(b). He also contends that all purchases and sales by Frost, FNLP, and NAVI within six months of each other can be matched to determine profits, if any, by the standards applicable under Section 16(b). When matched, he alleges, they disclose substantial short-swing profits. Although these profits accrued to NAVI, appellant claims that they are attributable to Frost/FNLP on a pro rata basis as a result of the increase in value of their NAVI holdings.

Frost/FNLP moved to dismiss under Fed. R. Civ. P. 12(b)(6) on the ground that he did not "realize" any profit from the transactions within the meaning of Section 16(b). Appellant countered that NAVI's stock sales are attributable to Frost/FNLP because, by virtue of the shareholder agreement, Frost/FNLP had control over NAVI's portfolio of securities and was therefore a "beneficial owner" of the IVAX shares held by NAVI pursuant to Rule 16a-1, 17 C.F.R. § 240.16a-1, adopted by the SEC in 1991.

The district court dismissed the complaint because it concluded that Frost/FNLP did not "realize" any profits from NAVI's sales of IVAX stock. Conceding that the transactions increased the value of NAVI -- and that Frost/FNLP may have benefitted from this increased value, see Feder, 1999 WL 163174, at *2 -- the court held that "[i]n a traditional section 16(b) case, the defendant would have cash in hand which the court might require him to disgorge. It is not entirely clear to me how this defendant could be required to disgorge this 'economic effect.'" Id.

The district court also rejected appellant's argument that Rule 16a-1(a)(2)'s definition of "beneficial owner" applies to the determination of whether profits from various purchases and sales have been realized for purposes of Section 16(b). Id. at *2 n.6. The district court held that the Rule 16a-1(a)(2) definition "is to be used solely for determining whether a person" is a statutory insider and, because there was no dispute that Frost/FNLP is a statutory insider of NAVI, that definition was irrelevant.

This appeal followed. After oral argument, we asked the Securities and Exchange Commission (the "SEC" or "the Commission") to file an amicus curiae brief. In that brief, the SEC argued that the district court "misread[]" Rule 16a-1(a)(2) and mistakenly concluded that it did not apply. The SEC also contended that, pursuant to the rule, the complaint sufficiently alleges a Section 16(b) violation. We agree.

DISCUSSION

We of course review de novo a district court's dismissal of a complaint on the pleadings. See, e.g., Boyd, 208 F.3d at 409. Dismissal is "appropriate only if 'it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief.'" Harris v. City of New York, 186 F.3d 243, 250 (2d Cir. 1999) (quoting Conley v. Gibson, 355 U.S. 41, 45-46 (1957)). We address only the narrow issue of whether Rule 16a-1(a)(2) validly renders Frost/FNLP a beneficial owner of the IVAX stock sold by NAVI who might "realize" a profit from the sale.

Section 16(b) of the Exchange Act seeks to prevent corporate insiders from making short-swing profits from transactions in the corporation's stock. Titled "Profits from purchase and sale of security within six months," it provides in relevant part:

For the purpose of preventing the unfair use of information which may have been obtained by such beneficial owner, director, or officer by reason of his relationship to the issuer, any profit realized by him from any purchase and sale, or any sale and purchase, of any equity security of such issuer . . . within any period of less than six months . . . shall inure to and be recoverable by the issuer . . . .

15 U.S.C. § 78p(b). "[L]iability under Section 16(b) does not attach unless the plaintiff proves that there was (1) a purchase and (2) a sale of securities (3) by an officer or director of the issuer or by a shareholder who owns more than ten percent of any one class of the issuer's securities (4) within a six-month period." Gwozdzinsky v. Zell/Chilmark Fund, L.P., 156 F.3d 305, 308 (2d Cir. 1998).

"The statute requires disgorgement to the company of any profit derived from the matching of any purchase and any sale of an 'equity security' . . . within a six-month period by a statutory insider, irrespective of intent or whether overall trading during that six months (i.e., all sales and purchases combined) resulted in a loss." Id. at 308; see also Gollust v. Mendell, 501 U.S. 115, 121 (1991) (quoting Section 16(b)). "No showing of actual misuse of inside information or of unlawful intent is necessary to compel disgorgement." Magma Power Co. v. Dow Chem. Co., 136 F.3d 316, 320 (2d Cir. 1998) (citing Foremost-McKesson, Inc. v. Provident Sec. Co., 423 U.S. 232, 251 (1976); Reliance Elec. Co. v. Emerson Elec. Co., 404 U.S. 418, 424 n.4 (1972)). Rather, Section 16(b) "operates mechanically, and makes no moral distinctions, penalizing technical violators of pure heart, and bypassing corrupt insiders who skirt the letter of the prohibition." Id. at 320-21. The statute, therefore, "imposes liability without fault . . . within its narrowly drawn limits." Id. at 321 (internal quotations omitted); accord Gollust, 501 U.S. at 122 (explaining that Section 16(b) is strict-liability provision).

a) Rule 16a-1

The Exchange Act does not define the term "beneficial owner." However, in 1988, the SEC proposed rules under Section 16 that, inter alia, contained such a definition. See Ownership Reports and Trading by Officers, Directors and Principal Stockholders, Exchange Act Release No. 34-26333, 53 Fed. Reg. 49997, 50001 (Dec. 13, 1988). The accompanying SEC release explained that the rules were being proposed in part because "[u]ncertainty as to the status of indirect interests in securities of the issuer, such as ownership of derivative securities and holdings of the immediate family, trusts, corporations, and partnerships, has raised requests for a definition." Id. Two definitions of "beneficial owner" were deemed necessary by the Commission because of the different uses to which the term is put in Section 16. The first use is to determine who is a ten-percent beneficial owner and therefore a statutory insider. The...