Levy v. Sterling Holding Co., LLC, 07-1849.

• Decision Date: 01 October 2008
• Docket Number: No. 07-1849.,07-1849.
• Citation: 544 F.3d 493
• Court: U.S. Court of Appeals — Third Circuit
• Parties: Mark LEVY, Appellant v. STERLING HOLDING COMPANY, LLC; National Semiconductor Corporation; Fairchild Semiconductor International, Inc.

544 F.3d 493

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

No. 07-1849.

United States Court of Appeals, Third Circuit.

Argued March 24, 2008.

Filed: October 1, 2008.

Jeffrey S. Abraham, Esq. [Argued], Abraham, Fruchter & Twersky, New York, NY, for Plaintiff-Appellant Mark Levy.

Carolyn H. Feeney, Esq., Steven B. Feirson, Esq. [Argued], Philadelphia, PA, for Defendant-Appellee Sterling Holding Company, LLC.

Paul Vizcarrondo, Jr., Esq., Wachtell, Lipton, Rosen & Katz, New York, NY, for Defendant-Appellee National Semiconductor Corporation.

Megan W. Casio, Esq., Morris, Nichols, Arsht & Tunnell, Wilmington, DE, for Defendant-Non-Participating Fairchild Semiconductor International, Inc.

Allan A. Capute, Esq. [Argued], Securities & Exchange Commission, Washington, DC, for Securities and Exchange Commission Amicus Appellee.

Before: McKEE, RENDELL, and TASHIMA,^* Circuit Judges.

OPINION OF THE COURT

RENDELL, Circuit Judge.

Mark Levy filed a shareholder derivative suit on behalf of Fairchild Semiconductor International, Inc. ("Fairchild") against Sterling Holding Company, LLC ("Sterling") and National Semiconductor Corporation ("National") for disgorgement of short-swing profits, pursuant to section 16(b) of the Exchange Act of 1934. National and Sterling contend that two separate SEC Rules, 16b-3 and 16b-7, exempt them from section 16(b) liability. When this case was before us previously, at the motion-to-dismiss stage, we ruled that neither exemption applied here. Levy v. Sterling Holding Co. (Levy I), 314 F.3d 106 (3d Cir.2002). Thereafter, however, the SEC amended Rules 16b-3 and 16b-7 to, as it put it, "clarify the exemptive scope" of these two Rules, making clear that both apply to the instant fact pattern. Ownership Reports and Trading by Officers, Directors and Principal Security Holders, Exchange Act Release No. 52,202 ("2005 Amendments Release"), 70 Fed. Reg. 46,080, 46,080 (Aug. 9, 2005). The District Court then ruled in favor of National and Sterling and against Levy on cross motions for summary judgment. We must decide whether our rulings in Levy I, or the SEC's more-recent Rule amendments, govern the case at this stage. For the reasons that follow, we conclude that at least one of the amendments is controlling and, therefore, we will affirm the District Court's grant of summary judgment to National and Sterling, and its denial of summary judgment to Levy.

I.

A.

In 1997, Fairchild was spun off from National as a new company. Three classes of Fairchild stock were created: (1) Class A common stock; (2) Class B common stock, which differed from Class A common because it did not entail voting rights; and (3) preferred stock, which offered a cumulative 12% dividend. Class A common and Class B common were freely convertible into each another, but preferred stock was not convertible into either Class of common. National received a mix of all three classes of stock and, in exchange for its $58.5 million investment in the new company, so did Sterling. The only other initial investors were a number of National employees slated to become key Fairchild employees. The governing shareholder agreement gave National the power to designate one of Fairchild's seven directors and gave Sterling the power to designate two.

In 1999, Fairchild decided to undertake an initial public offering ("IPO") to raise additional capital and was told by a number of underwriters that it should eliminate its preferred stock in order for the IPO to be successful. Consistent with this advice, a majority of Fairchild's board voted that, as part of the IPO, all of the company's outstanding shares of preferred stock would automatically be reclassified as shares of Class A common stock. A majority of each of the three classes of shareholders subsequently approved the reclassification by written consent. Preferred shares were to be valued at their contractual liquidation value—the original price plus accumulated unpaid dividends— and Class A common shares were to be valued at the price at which the Class A shares would be offered to the public in the IPO, less underwriting fees and commissions. Dividing the former by the latter yielded a 76-to-1 conversion ratio, meaning that each share of preferred stock would become 76 shares of Class A common.¹ Prior to the execution of the IPO, according to the IPO prospectus, Sterling owned 48% of the outstanding Class A common, 85.1% of the outstanding Class B common, and 75.9% of the outstanding preferred, while National owned 14.8%, 14.9%, and 16.7%, respectively.

On August 9, 1999, the IPO was completed and the shares of preferred stock owned by Sterling and National were reclassified as 4 million and 900,000 shares of Class A common, respectively. On January 19, 2000—less than six months later— with Fairchild undertaking a secondary offering of Class A common stock, Sterling sold 11 million shares of Class A common and National sold 7 million shares of Class A common. The share price of Class A common had increased 84% since the reclassification.

B.

In November 2000, Levy, a Fairchild shareholder, filed a derivative suit against National and Sterling, pursuant to section 16(b) of the Securities and Exchange Act of 1934, which generally provides for the disgorgement of any profits earned by statutory insiders from short-swing trading. See 15 U.S.C. § 78p(b).² The four elements required for section 16(b) liability are (1) a purchase of a security and (2) a sale of that security (3) by a director or officer of the issuer or by a beneficial owner of 10% of any Class of the issuer's securities (4) within a six-month period. See id.; Levy I, 314 F.3d at 111. As a general rule, any profits earned through transactions that meet these elements rightfully belong to the issuer. There is no mens rea requirement—section 16(b) creates a strict liability regime.

According to the statute itself, the purpose of section 16(b) is "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." 15 U.S.C. § 78p(b). The statute authorizes the SEC to promulgate rules and regulations exempting from liability transactions that are "not comprehended within [this] purpose." Id.; see Levy I, 314 F.3d at 112. Exercising this authority, the SEC has established a number of section 16(b) exemptions. See 17 C.F.R. §§ 240.16b-1, .16b-3, .16b-5 to .16b-8 (codifying SEC Rules 16b-1, 16b-3, and 16b-5 to 16b-8).

Levy claimed that the reclassification of National's and Sterling's preferred stock holdings constituted a "purchase" of Class A common stock so that the profits that National and Sterling earned from their sale of Class A common less than six months later belong to Fairchild. National and Sterling filed motions to dismiss, contending that two separate exemptions—Rule 16b-3 and Rule 16b-7—shielded them from section 16(b) liability.³

Adopted in 1996, the version of Rule 16b-3 that was in effect until 2005 provided, in pertinent part:

Transactions between an issuer and its officers or directors.

(a) General. A transaction between the issuer (including an employee benefit plan sponsored by the issuer) and an officer or director of the issuer that involves issuer equity securities shall be exempt from section 16(b) of the Act if the transaction satisfies the applicable conditions set forth in this section.

....

(d) Grants, awards and other acquisitions from the issuer. Any transaction involving a grant, award or other acquisition from the issuer (other than a Discretionary Transaction) shall be exempt if:

(1) The transaction is approved by the board of directors of the issuer ...;

(2) The transaction is approved or ratified by ... the written consent of the holders of a majority of the securities of the issuer entitled to vote ...; or

(3) The issuer equity securities so acquired are held by the officer or director for a period of six months following the date of such acquisition....

17 C.F.R. § 240.16b-3 (amended 2005).

The 1991 version of Rule 16b-7, which remained in effect until 2005, provided, in pertinent part:

Mergers, reclassifications, and consolidations.

(a) The following transactions shall be exempt from the provisions of section 16(b) of the Act:

(1) The acquisition of a security of a company, pursuant to a merger or consolidation, in exchange for a security of a company which, prior to the merger or consolidation, owned 85 percent or more of either:

(i) The equity securities of all other companies involved in the merger or consolidation, or in the case of a consolidation, the resulting company; or

(ii) The combined assets of all the companies involved in the merger or consolidation.. ..

17 C.F.R. § 240.16b-7 (amended 2005). Even though the SEC added the word "reclassifications" to the Rule's title in 1991, the Rule's text did not specifically refer to them.

National and Sterling argued that Rule 16b-3(d) exempted them from any liability related to the reclassification because the reclassification fit within the category of a "grant, award, or other acquisition from the issuer"—as an "other acquisition"— and was approved by a majority of Fairchild's board and a majority of the voting shareholders (even though approval by either of the two would have sufficed). They maintained that Rule 16b-7's exemption applied as well because they acquired the disputed Class A common stock as part of a "reclassification" that met the Rule's 85% cross-ownership requirement.

The District Court granted National's and Sterling's motions to dismiss, finding that the reclassification fell within the scope of Rule 16b-7 and that Levy's section 16(b) suit thus necessarily failed. The Court did not rule on the applicability of Rule 16b-3(d). Levy then appealed to our Court.

C.

In an opinion filed December 19, 2002, we reversed,...