Mercer v. Gupta , 712 F.3d 756 ( 2013 )

12-3393
Mercer v. Gupta
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
____________________
August Term, 2012
(Argued: January 8, 2013 Decided: April 5, 2013)
Docket No. 12-3393
____________________
JAMES MERCER,
Plaintiff - Appellant,
v.
RAJAT K. GUPTA,
Defendant - Appellee.
____________________
Before: WINTER, POOLER, and CHIN, Circuit Judges.
Appeal from an order, memorandum order, and judgment of the United States District
Court for the Southern District of New York (Jed S. Rakoff, J.) granting defendant’s motion to
dismiss plaintiff’s claim under Section 16(b) of the Securities Exchange Act, 15 U.S.C. § 78p(b).
Because we find that defendant was not a “beneficial owner” of Goldman Sachs shares under
Section 16 and Rule 16a-1, 17 C.F.R. § 240.16a-1, the judgment of the district court is
AFFIRMED.
____________________
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JEFFREY IVER TILDEN, Gordon Tilden Thomas & Cordell LLP,
Seattle, WA (Mark A. Wilner, Gordon Tilden Thomas & Cordell,
LLP, Davis Steven Preminger, Iran S. Birk, Keller Rohrback LLP,
New York, NY, on the brief), for Plaintiff-Appellant.
GARY P. NAFTALIS, Kramer Levin Naftalis & Frankel LLP,
New York, NY (Michael S. Oberman, Alan Roy Friedman, on the
brief), for Defendant-Appellee.
Per Curiam:
Plaintiff-Appellant James Mercer (“Plaintiff”) appeals from a December 23, 2011 order,
July 28, 2012 memorandum order, and July 31, 2012 judgment of the district court (Rakoff, J.),
which granted Defendant-Appellee Rajat K. Gupta’s (“Defendant”) motion to dismiss pursuant
to Fed. R. Civ. P. 12(b)(6). Plaintiff had brought a derivative suit on behalf of the Goldman
Sachs Group, Inc. (“Goldman Sachs”) under Section 16(b) of the Securities Exchange Act, 15
U.S.C. § 78p(b), seeking to require Defendant to disgorge all profits from short-swing
transactions in Goldman Sachs shares. The district court held that, while Defendant was a
statutory insider for purposes of Section 16(b), Plaintiff had failed to plausibly allege that
Defendant was a “beneficial owner” of Goldman Sachs shares under Section 16(b) and Rule 16a-
1, 17 C.F.R. § 240.16a-1, and it dismissed the action. We agree that Plaintiff failed to plead that
Defendant was a beneficial owner. We also decline to extend the term “beneficial owner” to
encompass, perforce, “tippers” who provide insider information, in exchange for payment, to
another party who engages in the short-swing trading of shares. Accordingly, we affirm the
orders and judgment of the district court.
Affirmed.
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BACKGROUND
Plaintiff brings suit pursuant to Section 16(b), which is designed to prevent statutory
insiders—a securities issuer’s “directors, officers, and principal stockholders”—“from engaging
in speculative transactions on the basis of information not available to others.” Donoghue v.
Bulldog Investors Gen. P’ship, 696 F.3d 170, 173-74 (2d Cir. 2012) (internal quotation marks
omitted). It requires statutory insiders “to disgorge all profits realized from” short-swing
transactions, the “purchase and sale (or sale and purchase) of the same security made within a six
month period.” Analytical Surveys, Inc. v. Tonga Partners, L.P., 684 F.3d 36, 43 (2d Cir. 2012).
“Section 16(b) requires an insider to disgorge any profit realized by him from short-swing
transactions.” Roth v. Jennings, 489 F.3d 499, 516 (2d Cir. 2007) (internal quotation marks
omitted). An insider who does not directly own the securities purchased and sold can
nonetheless “realize profit” for Section 16(b) purposes if he is determined to be a “beneficial
owner of the securities. See Morales v. New Valley Corp., 968 F. Supp. 139, 143 (S.D.N.Y.
1997) (“[A]n insider who is the beneficial owner of another individual's securities can be held
liable under § 16(b) for that individual’s purchase and sale of the security within six months.”).
Rule 16a-1(a)(2) defines beneficial owner as “any person who, directly or indirectly, through any
contract, arrangement, understanding, relationship or otherwise, has or shares a direct or indirect
pecuniary interest in the equity securities.”1 17 C.F.R. § 240.16a-1(a)(2).
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“Under section § 16(b), the concept of ‘beneficial owner’ has two distinct applications.”
Morales, 968 F. Supp. at 143 (S.D.N.Y. 1997). “The first definition is used to determine who
qualifies as an insider of an issuer by virtue of being the beneficial owner of more than ten
percent of any class of equity securities of the issuer.” Id. at 143-44 (citing 17 C.F.R. §
240.16a–1(a)(1)). “The second definition, and the one relevant for this [action], concerns . . .
liability under § 16(b).” Id. at 144 (citing 17 C.F.R. § 240.16a–1(a)(2)).
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Here, Plaintiff alleges that Defendant was a statutory insider of Goldman Sachs who
realized short-swing profits from Goldman Sachs shares. It is uncontested that Defendant was,
at all relevant times, a statutory insider, due to his position as a member of the Goldman Sachs
board of directors. The parties disagree, however, as to whether Plaintiff alleged facts sufficient
to establish that Defendant beneficially owned shares of Goldman Sachs. Plaintiff alleges that
Defendant beneficially owned shares that Raj Rajaratnam traded on the short swing through the
Galleon Group (“Galleon”), a group of hedge funds Rajaratnam founded and formerly
controlled.
Plaintiff alleges that, throughout 2008, Defendant repeatedly called Rajaratnam after
learning information relevant to Goldman Sachs’s share price. After these calls, Galleon would
engage in short-swing trading of Goldman Sachs shares, earning profits or avoiding losses.
Plaintiff also alleges that Defendant was a director of, and had a balance of over $16 million in,
Voyager Multi-Strategy Fund (“Voyager”), a Galleon master fund that invested in other Galleon
hedge funds. Finally, Plaintiff alleges that Defendant knew that Rajaratnam paid another party,
Anil Kumar, in exchange for insider information.
From these factual allegations, Plaintiff asserts three theories for why Defendant is a
beneficial owner of Goldman Sachs shares: (1) Rajaratnam made quid pro quo payments to
Defendant in exchange for insider information; (2) Defendant was a director of, and had a
financial interest in, Voyager; and (3) Defendant had the “opportunity to profit” in Galleon due
to his close business relationship with Rajaratnam.
On December 23, 2011, the district court rejected Plaintiff’s theories and dismissed the
Complaint pursuant to Fed. R. Civ. P. 12(b)(6). The district court reaffirmed the dismissal in a
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July 28, 2012 memorandum order and July 31, 2012 judgment.2
DISCUSSION
“We review de novo a district court’s dismissal of a complaint for failure to state a claim
under Federal Rules of Civil Procedure Rule 12(b)(6), accepting all factual allegations as true,
but giving no effect to legal conclusions couched as factual allegations.” Starr v. Sony BMG
Music Entm’t, 592 F.3d 314, 321 (2d Cir. 2010) (internal quotation marks omitted).
At issue in this case is whether, accepting all of Plaintiff’s factual allegations as true,
Defendant was a beneficial owner of Goldman Sachs shares under Section 16(b) and Rule 16a-1.
The “term beneficial owner shall mean any person who, directly or indirectly, through any
contract, arrangement, understanding, relationship or otherwise, has or shares a direct or
indirect pecuniary interest in the equity securities.” 17 C.F.R. § 240.16a-1(a)(2) (emphasis
added). “The term pecuniary interest in any class of equity securities shall mean the opportunity,
directly or indirectly, to profit or share in any profit derived from a transaction in the subject
securities.” Id. § 240.16a-1(a)(2)(i). Rule 16a-1 includes a non-exhaustive list of “indirect
pecuniary interest[s].” See id. § 240.16a-1(a)(2)(ii).
Plaintiff asserts three theories as to why Defendant had pecuniary interests in and,
therefore, beneficial ownership of, Goldman Sachs shares: (1) Rajaratnam made quid pro quo
payments to Defendant in exchange for insider information; (2) Defendant was a director of, and
had a financial interest in, Voyager, a Galleon master fund; and (3) Defendant had the
“opportunity to profit” in Galleon due to his close business relationship with Rajaratnam.
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In its memorandum order the district court noted that Defendant also moved to dismiss
Plaintiff’s claim as barred by the statute of limitations, but did not address the issue due to its
decision on the merits. Because we affirm the district court, we also decline to address the issue.
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We reject Plaintiff’s assertions for substantially the reasons stated in the district court’s
memorandum order. First, with respect to the quid pro quo payments, the Complaint fails to rise
“above the speculative level.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007). Plaintiff’s
allegation that Defendant knew about Rajaratnam’s payment to Anil Kumar is not an allegation
that Rajaratnam paid Defendant. Moreover, assuming arguendo that Plaintiff adequately
pleaded that Rajaratnam paid Defendant, such payments do not amount to a pecuniary interest.
Section 16(b) requires that the defendant himself “realized profits from short-swing
transactions.” Roth 489 F.3d at 517 (emphasis added); see also 17 C.F.R. § 2410.16a-
1(a)(2)(ii)(C) (stating that a performance-related fee is a pecuniary interest but “a right to a
nonperformance-related fee alone” is not). Plaintiff has failed to adequately allege that
Defendant received profits from Goldman Sachs shares as opposed to payment for insider
information.
Next, Plaintiff alleges that Defendant had a pecuniary interest in Goldman Sachs through
his financial stake in Voyager, a Galleon master fund that owned interests in other Galleon
entities. Because Defendant had the “opportunity[,] indirectly, to profit or share in any profit
derived” by Voyager through its ownership of other Galleon entities that, in turn, owned
Goldman Sachs shares, Defendant’s financial stake is a pecuniary interest. However, Rule 16a-1
creates a “safe harbor” where “a shareholder shall not be deemed to have a pecuniary interest in
the portfolio securities held by a corporation or similar entity in which the person owns securities
if the shareholder is not a controlling shareholder of the entity and does not have or share
investment control over the entity’s portfolio.” 17 C.F.R. § 240.16a-1(a)(2)(iii); see also Feder
v. Frost, 220 F.3d 29, 34 (2d Cir. 2000). The “safe harbor,” as an affirmative defense, may be
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raised on a motion to dismiss if the defense is based on facts appearing on the face of the
complaint. See Official Comm. of Unsecured Creditors of Color Tile, Inc. v. Coopers &
Lybrand, LLP, 322 F.3d 147, 158 (2d Cir. 2003). Plaintiff does not allege that Defendant is a
controlling shareholder but does allege that Defendant had investment control. While the term
“investment control” is not defined in Rule 16a-1, at least one district court within our circuit has
defined “control,” borrowing from Rule 12b-2, as “the possession, direct or indirect, of the
power to direct or cause the direction of the management and policies of a person, whether
through the ownership of voting securities, by contract, or otherwise.” See, e.g., Egghead.com,
Inc. v. Brookhaven Capital Mgmt. Co. Ltd., 194 F. Supp. 2d 232, 243 (S.D.N.Y. 2002) (quoting
17 C.F.R. § 240.12b-2).
Here, Plaintiff alleges that Defendant “knew and intended” that his insider information
would cause Galleon to trade Goldman Sachs shares. However, influence over investment
decisions is not akin to control. Plaintiff also alleges that Defendant had investment control
because he was on the board of Voyager, a Galleon master fund that held interests in other
Galleon hedge funds that owned Goldman Sachs shares. While this may suggest control over
Voyager, it does not allow for an inference that Defendant had investment control over the
Galleon funds that actually traded the Goldman Sachs shares. Plaintiff has failed to adequately
plead that Defendant had investment control.
Finally, Plaintiff alleges that Defendant profited from Galleon’s Goldman Sachs
transactions due to his close business relationship with Rajaratnam. Plaintiff alleges that
Rajaratnam gave Defendant the “opportunity . . . to profit” in the Goldman Sachs transactions by
giving him an interest in Voyager in exchange for insider information. We have held, however,
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that the “presumption” that a defendant “derived some pecuniary benefit” from another’s short-
swing transactions is not enough to establish pecuniary interest. Roth, 489 F.3d at 516-17.
Business dealings alone do not establish beneficial ownership.
Ultimately, the issue in this case is whether the term “beneficial ownership” can
encompass the relationship between Defendant and Rajaratnam, who were, respectively, tipper
and tippee of insider information. It is clear that Section 16(b) does not apply perforce to
tippees. See Blau v. Lehman, 368 U.S. 403, 411-12 & n.12 (1962); Provident Secs. Co. v.
Foremost-McKesson, Inc., 506 F.2d 601, 612 n.6 (9th Cir. 1974), aff’d, 423 U.S. 232 (1976).
Plaintiff’s Complaint requires us to ask whether Section 16(b) applies to tippers, merely because
of the tipper-tippee relationship. The regulations, because they are non-exhaustive, are not
dispositive of the issue. 17 C.F.R. § 240.16a-1(a)(2)(ii) (The “term indirect pecuniary interest in
any class of equity securities shall include, but not be limited to” the listed interests.) (emphasis
added); Id. § 240.12b-2 (“The term ‘control’ . . . means the possession, direct or indirect, of the
power to direct or cause the direction of the management and policies of a person, whether
through the ownership of voting securities, by contract, or otherwise.”) (emphasis added). While
we are not bound by the examples in the regulations, we are mindful that Section 16(b) has
“narrowly drawn limits.” Magma Power Co. v. Dow Chem. Co., 136 F.3d 316, 321 (2d Cir.
1998) (quoting Foremost McKesson, Inc. v. Provident Secs. Co., 423 U.S. 232, 251 (1976)). It is
significant that Congress considered and rejected draft language that would have created a
provision similar to Section 16(b) applicable to tippees. Blau, 368 U.S. at 412 n.12. Plaintiff
may “present persuasive policy arguments that the Act should be broadened in this way to
prevent the unfair use of information more effectively than can be accomplished by leaving the
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Act so as to require forfeiture of profits only by those specifically designated by Congress to
suffer those losses.” Id. at 411 (internal quotation marks omitted). However, we hold that,
absent any indication from Congress to the contrary, Section 16(b) does not apply perforce to
tippers of insider information.
CONCLUSION
Plaintiff has failed to allege that Defendant had “pecuniary interest” in Goldman Sachs
shares that would make him a “beneficial owner” of the shares under Section 16(b) and Rule
16a-1. Accordingly, the judgment of the district court is AFFIRMED.
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