Opinion
99 Civ. 1480 (NRB)
May 8, 2000
Jeffrey S. Abraham, Esq., Mitchell M.Z. Twersky, Esq., Herbert Teitelbaum, Esq., New York, New York.
OPINION ORDER
Plaintiff Mark Levy ("Levy"), derivatively on behalf of Immunogen, Inc., brings this action for disgorgement pursuant to Section 16(b) of the Securities and Exchange Act of 1934, as amended, 15 U.S.C. § 78p(b) ("Exchange Act"), claiming that Southbrook International Investments, Ltd. ("Southbrook") improperly profited from its investment in ImmunoGen, Inc. ("ImmunoGen" or the "Company") by virtue of being a "beneficial owner of more than 10%" of ImmunoGen's common stock. Compl. ¶ 16. Now pending is Southbrook's motion to dismiss, pursuant to Fed.R.Civ. p. 12(b)(6), for failure to state a claim, on the ground that it was not a beneficial owner of that amount. For the reasons set forth below, defendant's motion to dismiss is granted.
BACKGROUND
As this Opinion is addressed to defendants' motion to dismiss, we rely exclusively on plaintiff's complaint for our recitation of the following facts. On October 16, 1996, Southbrook and ImmunoGen entered into a Convertible Preferred Stock Purchase Agreement ("the Agreement") by which Southbrook acquired various series of ImmunoGen preferred stock, yielding 9% per year, that were convertible into shares of common stock, under varying conversion formulas. Compl. ¶ 7. Plaintiff asserts that, pursuant to the Agreement, Southbrook acquired the right to own more than 10% of ImmunoGen common stock, thereby beneficially owning that amount for purposes of § 16(b) short-swing trading liability, and proceeded to trade in the Company's stock. Compl. ¶¶ 11-19.
However, the same Agreement contains a provision that prevents Southbrook from owning more than 4.9% of ImmunoGen's common stock at any time. The relevant provision, article III, paragraph 3.10 ("the conversion cap"), reads as follows:
3.10 Purchaser Ownership of Common Stock. The Purchaser may not use its ability to convert Shares hereunder or under the terms of the Vote Certificates or to exercise its right to acquire shares of common stock under the Warrants to the extent that such conversion or exercise would result in the Purchaser owning more than 4.9% of the outstanding shares of the Common Stock.See Aff. of Kenneth Henderson ("Henderson Aff."), dated Oct. 19, 1999, Ex. 2 ("Agreement") at 13. Plaintiff does not in any way assert that Southbrook ever violated the conversion cap, but rather, that the cap did not prevent defendant from beneficially owning more than 10% of Immunogen's common stock. See Pl.'s Mem. at 7.
Plaintiff calculates that by February 21, 1997, Southbrook had the right to acquire, by exercising its conversion rights under the Agreement, a total of 2,673,742 shares of ImmunoGen common stock, nearly 15% of the 17,933,328 shares then outstanding. Compl. ¶ 11. Plaintiff claims, based on Southbrook's ownership of convertible preferred stock, that between January 1 and February 4, 1997, while beneficially owning more than 10%, Southbrook acquired 1, 384, 823 common shares by conversion, and then sold them presumably at a profit. Id. ¶ 12. Southbrook allegedly repeated this process — trading in ImmunoGen common stock while owning the right to acquire more than 10% of it — between January 27, 1997 and August 4, 1997. and again in October 1997. Id. ¶¶ 16, 17.
A cursory reading of the complaint might lead the reader to believe that Southbrook actually owned more than 10% of ImmunoGen's outstanding common stock. See, e.g., Compl. ¶ 17. However, a closer examination reveals that plaintiff's calculations are based on the number of convertible preferred shares, not common shares, that Southbrook owned. For example, in reliance on a Proxy Statement filed by ImunoGen on October 9, 1997, see Henderson Aff. Ex. 7, Levy alleges that Southbrook "owned 2,617,709 shares of [c]ommon [s]tock, which was more than the 10% of the 23,981,264 shares [outstanding]." Compl. ¶ 17. However, a review of note 4 of the Proxy Statement makes clear that the 2,617,709 shares are in fact the convertible preferred shares owned pursuant to the Agreement; indeed, the note makes specific reference to the Agreement as well as to its conversion cap of 4.9%. See Henderson Aff. Ex. 7 at 4.
On December 28, 1998, plaintiff demanded that ImmunoGen's Board of Directors bring an action to disgorge Southbrook of its alleged, short-swing profits. Compl. ¶ 21. By letter dated February 18, 1999, the Board refused, and this derivative suit followed. Compl. ¶ 22.
DISCUSSION
A. Fed.R.Civ.P. 12(b)(6) Standard
Dismissal of a complaint pursuant to Fed.R.Civ.P. 12(b)(6) is warranted if "it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." See Cooper v. Parsky, 140 F.3d 433, 440 (2d Cir. 1998) (quoting Conley v. Gibson, 355 U.S. 41, 45-46 (1957)). In ruling on a Rule 12(b)(6) motion, a court is required "merely to assess the legal feasibility of the complaint, not to assay the weight of the evidence which might be offered in support thereof." Geisler v. Petrocelli, 616 F.2d 636, 639 (2d Cir. 1980). Further, a court must accept all factual allegations in the complaint as true, and draw all inferences in the plaintiff's favor. See Sheppard v. Beerman, 18 F.3d 147, 150 (2d Cir. 1994), cert. denied, 513 U.S. 816 (1994).
B. Section 16(b) of the Exchange Act
Section 16(b) of the Exchange Act provides that "a beneficial owner of more than ten percent of any class of equity security must turn over any profits earned, regardless of intent, from a purchase and sale of the securities occurring within six months." Global Intellicom, Inc. v. Thomson Kernaghan Co., 1999 WL 544708, *13 (S.D.N.Y. July 27, 1999). The purpose of the statute is to "prevent the unfair use of information" which such beneficial owners, as well as officers and directors, are presumed to possess "by reason of [their] relationship to the issuer." 15 U.S.C. § 78p(b). Nevertheless, because such presumptive insiders are subject to strict liability, regardless of their actual access to or use of inside information, section 16(b) should be narrowly construed. See Gollust v. Mendell, 501 U.S. 115, 122 (1991) Courts should avoid "literal, `mechanical' application of the statutory text in determining who may be subject to liability," and should look instead to the "evil that Congress sought to correct through § 16(b)." Id. (quoting Reliance Electric Co. v. Emerson Electric Co., 404 U.S. 418, 425 (1972)).
Section 16(b) reads in pertinent part:
For the purpose of preventing the unfair use of information which may have been obtained by such beneficial owner . . . any profit realized by him from any purchase and sale, or any sale and purchase, of any equity security of such issuer . . . within any period of less than six months . . . shall inure to and be recoverable by the issuer, irrespective of any intention on the part of such beneficial owner . . . in entering into such transaction or holding the security purchased or of not repurchasing the security sold for a period exceeding six months.15 U.S.C. § 78p(b). "Such beneficial owner" refers to "[e]very person who is directly or indirectly the beneficial owner of more than 10 per centum of any class of equity security" in Section 16(a). 15 U.S.C. § 78p(a). See Global Intellicom, 1999 WL 544708, at *12 n. 7.
"Beneficial ownership" for purposes of § 16(b) liability is defined in § 13 of the Exchange Act and regulations promulgated thereunder. 17 C.F.R. § 240.16a-1 (a). Specifically, Rule 13-d defines the "beneficial owner" of a security as:
[A]ny person who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise has or shares:
(1) Voting power which includes the power to vote, or to direct the voting of, such security; and/or
(2) Investment power which includes the power to dispose, or to direct the disposition of such security.17 C.F.R. § 240.13d-3 (a). A provision of the Rule, central to the facts of this case, further states that:
Levy concedes that because the convertible preferred shares it acquired were non-voting, only the "investment power" prong of Rule 13d-3 (a) is at issue. See Pl.'s Mem. at 7.
[a] person shall be deemed to be the beneficial owner of a security . . . if that person has the right to acquire beneficial ownership of such security . . . within sixty days, including but not limited to any right to acquire: (A) [t]hrough the exercise of any option, warrant or right; [or] (B) through the conversion of a security; . . .17 C.F.R. § 240.13d-3 (d)(1)(i).
C. Levy's Theory of Beneficial Ownership
The issue to be decided on this motion is whether Southbrook, despite the existence of the conversion limitation of 4.9%, had the right to acquire voting or investment power over more than 10% of ImmunoGen's common stock within 60 days. Plaintiff's theory is that the conversion cap only prevented Southbrook from owning more than 4.9% of ImmunoGen's common stock at any one time; the provision did not prevent defendant from owning, in blocks of 4.9%, cumulatively more than 10%, at different times during a sixty day period. See Pl.'s Mem. at 6-7 (alleging that Southbrook could exceed the statutory threshold "by seriatim converting, selling and then converting its [p]referred [s]tock into more shares of the [c]ommon [s]tock"). We reject plaintiff's theory for several reasons.
We note, incidentally, that three separate transactions must take place in order for defendant to actually own more than 10% of the issuer's equity: it would first have to convert preferred stock equivalent to 4.9% common stock, at which point it would own 4.9% of the common stock and beneficially own another 4.9% block of readily convertible preferred stock, a total of only 9.8% (step 1); it would then have to sell some converted common stock (step 2), because of the contractual limitation, in order to pave the way for the final step, conversion of additional preferred stock (step 3). of course, the last transaction would result in a violation of the conversion cap.
First, contrary to plaintiff's contention that conversion caps are invalid, see infra, several courts in the Second Circuit have upheld conversion caps, such as the one present here, in the context of § 16(b). See Levner v. Saud, 903 F. Supp. 452 (S.D.N Y 1994), aff'd, Levner v. Prince Alwaleed, 61 F.3d 8 (2d Cir. 1995) ("Levner II"); Global Intellicom, 1999 WL 544708, at *16; but see Schaffer v. Capital Ventures Int'l, 98 Civ. 3900, slip op. (S.D.N.Y. Sept. 13, 1999). In Global Intellicom, a case involving the sale of convertible debentures, the relevant agreement provided that:
[t]he Purchaser agrees not to convert Debentures . . . to the extent such conversion or exercise would result in the Purchaser beneficially owning (as determined in accordance with Section 13(d) of the Exchange Act and the rules thereunder) in excess of 4.999% of the then issued and outstanding shares of Common Stock . . .Id. at 16. In dismissing both § 13(d) and § 16(b) claims against the defendant, Judge Cote found that "this restriction is a sufficient restraint such that [the defendant-purchaser] is not the beneficial owner of more than 5% [of the issuer's] common stock." Id. As the Court reasoned, "holders of freely convertible securities are generally deemed to be beneficial owners of the underlying common stock. Where conversion rights are limited, however, a holder of a convertible security may not be deemed the beneficial owner of the underlying common stock." Id. at 15.
Plaintiff's effort to distinguish Judge Cote's decision based on that case's conversion cap's specific reference to "beneficial ownership," Pl.'s Mem. at 9 (emphasis added), is unavailing as it is clear that Judge Cote's opinion did not turn on that specific language.
Similarly in Levner, where an owner of 4.8% of Citicorp common stock purchased convertible preferred stock equal to an additional 10% common stock, Judge Preska relied in part on a conversion cap of 10% in finding that the defendant was not the beneficial owner of more than the cap amount. 903 F. Supp. at 461. Narrowly construing § 16(b) and considering the purpose and policy underlying the statute, the District Court found that the preferred stock was not "presently convertible" to more than 10% as a matter of law, and accordingly, the defendant was not a beneficial owner of more than 10%. Id. at 462. On appeal, the Second Circuit affirmed "the carefully reasoned opinion of Judge Preska," agreeing that the relevant purchase agreement prevented the defendant from "convert[ing] his preferred shares in sufficient quantity, together with the common shares he already held, to render him the beneficial owner of more than 10 percent of Citicorp common stock." Levner II, 61 F.3d at 9.
Second, based on our independent analysis of Rule 13-d's provisions, we reject plaintiff's theory of beneficial ownership. Reading the Rule within the broader statutory framework, it is clear that only those holders of derivative securities, who could acquire ownership, by conversion or otherwise, of more than 10% of the common stock, at one time, are subject to § 16(b) liability. Notwithstanding the extremely strained interpretation of Rule 13d-3(1)(i) that plaintiff asks this Court to adopt, we believe Congress intended to impose presumptive insider status and strict liability only under those circumstances. See, e.g., Morales v. Freund, 163 F.3d 763, 766 (2nd Cir. 1999) ("core object of § 16(b) [is] the avoidance of short-swing profit[s] by investors who trade in stocks whose value they may be able to influence"). Thus we note, once again, that Southbrook was restricted by the Agreement's conversion cap from owning more than 4.9% of the outstanding common stock, at any one time, and thus was never a beneficial owner of more than the triggering amount.
According to plaintiff's construction, the "Agreement only prevented Southbrook from owning more than 4.9% of [common stock] at any one time. However, Rule 13d-3(1)(i) . . . speaks in terms of the shares which could be acquired within sixty days. As such, the particular number of shares of common stock owned on any one day is irrelevant to the analysis of determining the beneficial ownership for purposes of Section 16(b)." Pl.'s Mem. at 7 (emphasis in original). We simply cannot accept plaintiff's suggestion that the number of shares a person could own at a single time is irrelevant.
Third, we consider plaintiff's theory to be extremely far reaching and overly broad. Taken to its logical extreme, the theory would seem to reach virtually any person who has the capacity (i.e., wherewithal) to successively purchase and sell sufficient quantities of stock in a relatively short period of time. One might imagine a wealthy speculator who buys 1% of a company's common stock (or an equivalent amount of derivative securities), sells it shortly thereafter for a profit, and repeats this process ten or more times over a period of sixty days. Under plaintiff's theory, the person's mere ability to acquire more than 10% at different times within sixty days, while never resulting in his owning 10% at one time, would make him the beneficial owner of more than 10%. However, our confidence that § 16(b) was not intended to reach this hypothetical investor, causes us to be wary of plaintiff's theory, since if accepted, it would extend the statute's sweep beyond those with insider power and information.
In sum, plaintiff's argument as to beneficial ownership fails because it is inconsistent with clear precedent in this Circuit, requires an improperly broad construction of § 16(b) and its accompanying regulations, and would not serve the statute's underlying purposes. Accordingly, we find that in the absence of a violation of the conversion cap, Southbrook did not beneficially own more than 4.9% of ImmunoGen's common stock.
D. Conversion Cap is Valid and Enforceable
Alternatively, Levy argues that the Agreement's conversion cap, ¶ 3.10, is void and unenforceable pursuant to (1) the sham transaction doctrine, (2) Rule 13d-3(b), and (3) § 29(a) of the Exchange Act.See Pl.'s Mem. at 10-19. These arguments are without merit. First, the sham transaction doctrine, see Bershad v. McDonough, 428 F.2d 693, 697 (7th Cir. 1970), cert. denied, 400 U.S. 992 (1971) ("[t]he commercial substance of the transaction rather than its form, must be considered, and the courts should guard against sham transactions . . ."), is inapplicable here, given that conversion caps have been upheld as a legitimate means of structuring a transaction to avoid § 16(b) liability. See Global Intellicom, 1999 WL 544708, at *1; see also Reliance, 404 U.S. at 422 ("liability cannot be imposed simply because the investor structured his transaction with the intent of avoiding liability under Section 16(b)").
Plaintiff's argument under Rule 13d-3(b), which prohibits "contract[s], arrangement[s] or device[s]" that are "part of a plan or scheme to evade the [applicable] reporting requirements," similarly fails as there is no factual basis to support the existence of such a plan or scheme to evade, here. There is no allegation in plaintiff's complaint that Southbrook failed to disclose any aspects of the ImmunoGen transaction in applicable regulatory filings, or that defendant ever attempted to conceal any matter for the purpose of avoiding its reporting obligations.
Rule 13d-3(b), 17 C.F.R. § 240.13d-3 (b), states, in relevant part:
Any person who, directly or indirectly, creates or uses a . . . contract, arrangement or device with the purpose or effect of divesting such person of beneficial ownership of a security or preventing the vesting of such beneficial ownership as part of a plan or scheme to evade the reporting requirements of section 13(d) . . . shall be deemed for purposes of such Sections to be the beneficial owner of such security.
Finally, plaintiff's § 29(a) argument, raised for the first time in plaintiff's opposition brief, also fails, as the statute applies only to parties' express waivers of non-compliance with the securities laws. No such waiver is pled here. Rather, the parties entered into a transaction that has been specifically sanctioned by the courts under the securities laws.
Accordingly, plaintiff's contentions, that the conversion cap present here is invalid and unenforceable, fail.
CONCLUSION
For the foregoing reasons, defendant's motion to dismiss is granted, and plaintiff's complaint is dismissed. The Clerk of the Court is directed to close the above captioned case.
IT IS SO ORDERED.