If I told you that all 10% owners owe a fiduciary duty to the corporation, I’d be surprised if you weren’t surprised. However, that was, in fact, the holding of the Second Circuit Court of Appeals last October in Donoghue v. Bulldog Investors General Partnership, 696 F.3d 170 (2d Cir. 2012):
Thus, pursuant to § 16(b), when a stock purchaser chooses to acquire a 10% beneficial ownership stake in an issuer, he becomes a corporate insider and thereby accepts “the limitation” that attaches to his fiduciary status: not to engage in any short-swing trading in the issuer’s stock.
Id. at 177 (footnote omitted). The Second Circuit, in an opinion by Judge Reena Raggi, reached this remarkable conclusion in rejecting a constitutional challenge to Section 16(b) of the Securities Exchange Act of 1934 by Phil Goldstein’s Bulldog Investors investment fund.
Mr. Goldstein’s fund admitted violating Section 16(b) but argued that the plaintiff had failed to demonstrate that the proscribed short-swing trading caused the issuer an actual injury. An actual injury is needed to satisfy the standing requirement of Article III of the U.S. Constitution. As the students in my Administrative Law class have learned, there are three legs to the constitutional standing stool – injury-in-fact, causation, and redressability. Mr. Goldstein focused on the first leg of the stool, arguing that the issuer was not injured by the Section 16(b) violation. Judge Raggi addressed this very fundamental problem by finding a violation of a fiduciary duty owned by Bulldog Investors to the issuer.
The Second Circuit’s opinion is troubling for several reasons. First, Section 16(b) doesn’t use the word “fiduciary duty”. Second, the Court’s opinion reads “in-fact” out of the injury requirement. As Justice Antonin Scalia stated in Lujan v. Defenders of Wildlife, 504 U.S. 555, 578 (1993), “broadening the categories of injury that may be alleged in support of standing is a different matter from abandoning the requirement that the party seeking review must himself have suffered an injury” (emphasis added). I have yet to see a corporation conclude that it has been injured by a Section 16(b) violation (other than by the legal fees incurred in dealing with alleged violations). In my view, the Court of Appeals got it backwards – corporations are injured in fact by the existence of Section 16, not by any breach of a judicially imagined fiduciary duty. Finally, plaintiffs’ attorneys may seize on this discovery of fiduciary duties to create even more causes of action.
Although Mr. Goldstein failed to persuade the Second Circuit, he’s hoping that the Supreme Court will be more receptive. On January 2, 2013, he filed this Petition for Writ of Certiorari. This case has implications far beyond the rather narrow field of short-swing profit liability. The petition (footnote 4) refers to numerous other statutes in which Congress has conferred a private right of action.