Fifth Circuit Affirms Dismissal Of Shareholder's Claim To Recover Alleged Short-Swing Profits Because Equity Dispositions Were Exempt Under Rule 16(b)-3(e)

by Shearman & Sterling LLP

On March 12, 2018, the United States Court of Appeals for the Fifth Circuit affirmed the dismissal of a shareholder’s claims to recover on behalf of Dynegy, Inc. (“Dynegy”) alleged short-swing profits from insiders in violation of Section 16(b) of the Securities Exchange Act of 1934 (“Exchange Act”).  Jordan v. Flexton, et al., No. 17-20346 (5th Cir. Mar. 12, 2018).  Plaintiff alleged that defendants, Dynegy’s officers, received short-swing insider trading profits from a series of dispositions of equity securities that violated Section 16(b) because the dispositions occurred less than six months after they received the equity securities.  Plaintiff maintained that the purchases were not exempt under SEC Rule 16b-3(e) because they were neither pre-approved nor automatic.  The district court dismissed the action and held that the transactions were exempt under Rule 16b-3(e).  On appeal, the Fifth Circuit affirmed the dismissal on the ground that plaintiff failed to allege facts showing that the dispositions were discretionary or were not pre-approved.
Section 16(b) of the Exchange Act allows a shareholder to bring an action against officers, directors, and certain beneficial owners of a corporation who realize any profits from the purchase or sale, or sale and purchase of the corporation’s securities within a six-month period.  To state a claim for disgorgement, a plaintiff must allege a non-exempt purchase and subsequent non-exempt sale of equity securities by an insider within six months.  Here, plaintiff alleged that officers of Dynegy made short-swing insider trading profits because they sold equity securities they received from Dynegy for a profit less than six months after they received the securities.  In response, defendants moved to dismiss the action on the ground that the dispositions were exempt under Rule 16b-3(e), which exempts from disgorgement any disposition of equity securities where the transaction is not discretionary and pre-approved.  To qualify as discretionary under Rule 16b-3(e), a transaction must be “at the volition of a plan participant.”
The district court dismissed the action and the Fifth Circuit affirmed, finding that plaintiff failed to plead facts demonstrating that the dispositions were discretionary or not pre-approved in accordance with Rule 16b-3.  The Fifth Circuit ruled the dispositions were discretionary because, as plaintiff conceded, the transactions were used to pay tax liabilities and the officers “did not have any control over the timing of the transactions, the amount of the tax payment made to Dynegy, or the price at which the restricted stock units were disposed.”  The Fifth Circuit also ruled that plaintiff failed to allege facts showing that the dispositions were not pre-approved by Dynegy.  The court noted that the transactions at issue were pre-approved under the company’s long-term incentive compensation plan, and in any event, plaintiff waived the argument that they were not pre-approved by failing to raise it in his opening brief.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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