Levy v. Sterling Holding Co., LLC

• Decision Date: 19 December 2002
• Docket Number: No. 02-1698.,02-1698.
• Citation: 314 F.3d 106
• Parties: Mark LEVY, Appellant v. STERLING HOLDING COMPANY, LLC.; National Semiconductor Corporation; Fairchild Semiconductor International, Inc.
• Court: U.S. Court of Appeals — Third Circuit

314 F.3d 106

Mark LEVY, Appellant v. STERLING HOLDING COMPANY, LLC.; National Semiconductor Corporation; Fairchild Semiconductor International, Inc.

No. 02-1698.

United States Court of Appeals, Third Circuit.

Argued October 29, 2002.

Filed December 19, 2002.

Mitchell M. Twersky, Fruchter & Twersky, New York, NY, Jeffrey S. Abraham (argued), Abraham & Associates, New York, NY, for Appellant.

Steven B. Feirson (argued), Carolyn H. Feeney, Thomas L. Kenyon, Dechert Price & Rhoads, Philadelphia, PA, for Appellee Sterling Holding Company, LLC.

Paul Vizcarrondo, Jr. (argued), Michael A. Charish, Wachtell, Lipton, Rosen & Katz, New York, NY, for Appellee National Semiconductor Corporation.

Kenneth J. Nachbar, Morris, Nichols, Arsht & Tunnell, Wilmington, DE, for Fairchild Semiconductor International, Inc.

BEFORE: NYGAARD, GREENBERG, and MICHEL,^* Circuit Judges.

OPINION OF THE COURT

GREENBERG, Circuit Judge.

I. INTRODUCTION

This matter comes on before this court on an appeal from an order granting a motion to dismiss for failure to state a claim on which relief may be granted entered in the district court on February 5, 2002. Plaintiff-appellant, Mark Levy, a shareholder in Fairchild Semiconductor International, Inc. ("Fairchild"), a nominal defendant-appellee not participating in this appeal, brought this shareholder derivative action on November 28, 2000, against defendants-appellees Sterling Holding Co. ("Sterling") and National Semiconductor Corp. ("National") after Fairchild declined to initiate a lawsuit seeking relief for the matters of which Levy complains. Levy by this action seeks a judgment requiring Sterling and National to disgorge what he alleges were "short-swing insider trading profits of more than $72 million" in Fairchild stock. Levy predicates the action on section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b), which deprives specified insiders from profiting from certain offsetting purchase and sale securities transactions completed within less than a six-month period. The district court had jurisdiction under section 27 of the Exchange Act, 15 U.S.C. § 78aa, and we have jurisdiction under 28 U.S.C. § 1291. We exercise plenary review on this appeal. See Gallo v. City of Philadelphia, 161 F.3d 217, 221 (3d Cir.1998).

II. HISTORY

In view of the procedural posture of the case we take the facts from Levy's allegations. On March 11, 1997, National spun off Fairchild pursuant to an Agreement and Plan of Recapitalization. At that time National retained in Fairchild 4,380,000 shares of Class A common stock, 5,243,621 shares of Class B common stock (as measured after a four-for-one common stock split on April 29, 1998), and 11,667 shares of 12% Series A cumulative compounding preferred stock. Sterling, on or around the same date, purchased for $58.5 million approximately 3,553,000 shares of Class A common stock, 7,099,000 shares of Class B common stock (as measured after the split), and 53,113 shares of 12% Series A cumulative compounding preferred stock in Fairchild.

On July 1, 1999, a majority of Fairchild's common and preferred shareholders voted to convert all shares of its preferred stock into Class A common stock "automatically" upon completion of a contemplated Initial Public Offering (IPO). Inasmuch as the preferred shares previously had not been convertible into common stock, an amendment of Fairchild's certificate of incorporation was required to effectuate the conversion.¹ On July 26, 1999, a majority of the shareholders of all three classes of Fairchild stock approved by written consent a restatement of Fairchild's certificate of incorporation containing an amendment authorizing the conversion. In accordance with a formula in the amendment each share of preferred stock was worth 75.714571 shares of class A common stock. Upon completion of the IPO on August 9, 1999, Sterling and National respectively acquired 4,021,428 and 888,362 shares of Class A common stock. Levy alleges that the conversion of preferred stock into common stock constituted a non-exempt "purchase" by National and Sterling within the meaning of section 16(b) of the Exchange Act.

On January 19, 2000, within six months after the alleged purchase (the conversion), Sterling sold 11,115,000 shares of class A common stock for a profit of $58,511,777, and National sold 7,243,360 shares of class A common stock for a profit of $14,124,958. Levy's complaint alleges that "[t]hese sales are matchable against the purchases [conversions] alleged." While we have some difficulty understanding why there is a matchable situation here in view of Sterling's and National's earlier ownership of class A common stock, we nevertheless at this time accept the allegation as true.

National and Sterling have or had officers who sat on Fairchild's seven-member board of directors pursuant to a Stockholder's Agreement. The agreement, dated March 11, 1997, provided that Sterling would designate two of Fairchild's directors and two of Fairchild's independent directors (subject to the veto of Fairchild's chief executive officer), and that National, if it continued to hold stock in Fairchild, would designate one director who was an executive officer of National. At the times relevant to this action, Fairchild's directors included Sterling's chairman and chief executive officer, the president of Citicorp Venture Capital Ltd. which, Levy alleges, owns an interest in Sterling,² and a managing director of Citicorp Venture Capital. In addition, an individual who served as the president, chief executive officer and chairman of National, was on the Fairchild board.

According to a Fairchild prospectus filed on August 4, 1999, National owned 14.8% of Fairchild's class A common stock and 14.9% of class B common stock and Sterling owned 48.0% of its class A common stock and 85.1% of its class B common stock. For this and other reasons, Levy made the uncontroverted allegation that National and Sterling were beneficial owners of more than 10% of Fairchild's outstanding stock.

III. DISCUSSION

A. Was the reclassification exempted by Rule 16b-7 from section 16(b) or otherwise not included in the section?

1. Statutory Background

Section 16(b) of the Securities Exchange Act of 1934 requires that any profits earned by insiders through "short-swing" trading must be disgorged, or returned to the issuer of the security. The section provides:

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 (other than an exempted security) or a security-based swap agreement ... involving any such equity security within any period of less than six months, unless such security or security-based swap agreement was acquired in good faith in connection with a debt previously contracted, shall inure to and be recoverable by the issuer, irrespective of any intention on the part of such beneficial owner, director, or officer in entering into such transaction of holding the security or security-based swap agreement purchased or of not repurchasing the security or security-based swap agreement sold for a period exceeding six months. Suit to recover such profit may be instituted at law or in equity in any court of competent jurisdiction by the issuer, or by the owner of any security of the issuer in the name and in behalf of the issuer if the issuer shall fail or refuse to bring such suit within sixty days after request or shall fail diligently to prosecute the same thereafter; but no such suit shall be brought more than two years after the date such profit was realized. This subsection shall not be construed to cover any transaction where such beneficial owner was not such both at the time of the purchase and sale, or the sale and purchase, of the security or security-based swap agreement ... or any transaction or transactions which the Commission by rules and regulations may exempt as not comprehended within the purpose of this subsection.

15 U.S.C. § 78p(b).

The Supreme Court has explained the purpose of section 16(b):

The general purpose of Congress in enacting S 16(b) is well known.... Congress recognized that insiders may have access to information about their corporations not available to the rest of the investing public. By trading on this information, these persons could reap profits at the expense of less well informed investors. In § 16(b) Congress sought to `curb the evils of insider trading (by) ... taking the profits out of a class of transactions in which the possibility of abuse was believed to be intolerably great.' ... It accomplished this by defining directors, officers, and beneficial owners as those presumed to have access to inside information and enacting a flat rule that a corporation could recover the profits these insiders made on a pair of security transactions within six months.

Foremost-McKesson Inc. v. Provident Sec. Co., 423 U.S. 232, 243-44, 96 S.Ct. 508, 516, 46 L.Ed.2d 464 (1976) (citing Kern County Land Co. v. Occidental Petroleum Corp., 411 U.S. 582, 591-92, 93 S.Ct. 1736, 1742-43, 36 L.Ed.2d 503 (1973), and citing and quoting Reliance Elec. Co. v. Emerson Elec. Co., 404 U.S. 418, 422, 92 S.Ct. 596, 599, 30 L.Ed.2d 575 (1972)) (footnote omitted).

Section 3(a)(13) of the Securities Exchange Act provides that "[t]he terms `buy' and `purchase' each include any contract to buy, purchase, or otherwise acquire" any equity security. 15 U.S.C. § 78c(a)(13) (emphasis added). In applying this definition in the section 16(b) context, the Supreme Court has said, "[t]he statutory definitions of `purchase' and `sale' are broad and, at least arguably, reach many transactions not ordinarily deemed a sale or purchase." Kern County Land Co., 411 U.S. at 593-94, 93 S.Ct. at 1744.

Thus, section 16(b)...