This week, the Ninth Circuit addresses the requirements for invoking a regulatory exemption to liability under Section 16(b) of the Securities Exchange Act of 1934.

ROTH v. FORIS VENTURES, LLC

The Court holds that Rule 16b-3 exempts securities transactions approved by the issuer’s board of directors from liability under Section 16(b) of the Exchange Act regardless of whether the board approved the transaction specifically to exempt it from liability.

The panel: Judges Wardlaw, M. Smith, and Rayes (D. Ariz.), with Judge Smith writing the opinion.

Key highlight: “The text of Rule 16b-3 does not include a purpose-specific approval requirement. The Rule states, in relevant part, that ‘[a]ny transaction . . . involving an acquisition from the issuer . . . shall be exempt if . . . [t]he transaction is approved by the board of directors of the issuer.’ 17 C.F.R. § 240.16b-3(d)(1). Simply put, nothing in the regulation indicates that the board must approve the transaction for the specific purpose of exempting it from Section 16(b) liability.”

Background: Section 16(b) of the Exchange Act imposes strict liability for sales and purchases of securities between the issuer of the securities and its beneficial owner, director, or officer if the transactions occur within six months of each other and realize a profit. The Exchange Act authorizes the SEC to establish regulatory exemptions to liability under Section 16(b). Rule 16b-3 establishes such an exemption for transactions approved by the issuer’s board of directors.

John and Ann Doerr are members of Amyris’s board of directors. John Doerr also indirectly owns all membership interests in Foris Ventures, LLC, which owns over 10% of Amyris common stock and related derivative securities (making it a beneficial owner of Amyris within the meaning of Section 16(b)). Foris and Amyris entered into various profitable transactions involving Amyris stock, warrants, and debt. Amyris’s board of directors approved those transactions.

Amyris shareholder Andrew Roth filed a derivative lawsuit on Amyris’s behalf alleging that those transactions violated Section 16(b). The district court denied defendants’ motion to dismiss, holding that the relevant transactions were not exempt under Rule 16(b)(3) because the board did not approve them for the specific purpose of exempting the transactions from liability. The district court granted a certificate of interlocutory appealability, and the Ninth Circuit granted defendants’ petition to appeal and Roth’s petition to conditionally cross-appeal.

Result: The Ninth Circuit reversed in part and remanded for further proceedings. It held that Rule 16b-3 does not require that board approval be for the specific purpose of exempting the transaction from liability. The district court derived that requirement from an SEC no-action letter, but no-action letters are not entitled to judicial deference and in any event the SEC had subsequently repudiated that position. The Ninth Circuit rejected a purpose-specific approval requirement because no such requirement appeared in the text of Rule 16b-3. That result was also supported by a persuasive Second Circuit decision addressing the same issue.

The Ninth Circuit rejected Roth’s argument that remand was required to determine whether the board was aware of Doerr’s pecuniary interest in the challenged transactions. The district court had found that it was, and that finding was adequately supported by SEC filings and the complaint’s recognition that Doerr indirectly owns all membership interests in Foris. 

However, the Court concluded that remand was necessary to determine whether Foris was eligible for the exemption, which applies only to directors and officers but not beneficial owners. A corporation may nonetheless qualify for the exemption if it is a director by deputization (meaning it has deputized a natural person to perform its duties on the board). Whether Foris was a director by deputization was a question of fact for the district court to determine in the first instance. The Ninth Circuit also declined to address in the first instance the related question whether Rule 16b-3 exempts from liability entire transactions rather than specific defendants.

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