Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca2-14-03800/USCOURTS-ca2-14-03800-0/pdf.json

Nature of Suit Code: 360
Nature of Suit: Other Personal Injury
Cause of Action: 

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14-3800-cv

Lowinger v. Morgan Stanley

1 UNITED STATES COURT OF APPEALS

2

3 FOR THE SECOND CIRCUIT

4

5 August Term, 2014

6

7 (Argued: May 15, 2015 Decided: November 3, 2016)

8

9 Docket No. 14-3800-cv 

10 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

11

12 ROBERT LOWINGER, 

13

14 Plaintiff-Appellant,

15

16 THOMAS E. NELSON, individually and on behalf of all others

17 similarly situated, ROCK SOUTHWARD, derivatively on behalf of

18 himself and all others similarly situated, AVATAR SECURITIES,

19 LLC, MEREDITH BAILEY, on behalf of themselves and all others

20 similarly situated, DMITRI BOUGAKOV, on behalf of themselves and

21 all others similarly situated, RYAN CEFALU, on behalf of

22 themselves and all others similarly situated, LORRAIN CHIN, FIRST

23 NEW YORK SECURITIES L.L.C., ATISH GANDHI, on behalf of themselves

24 and all others similarly situated, PHILLIP GOLDBERG, on behalf of

25 themselves and all others similarly situated, ERIC HAMRICK, on

26 behalf of themselves and all others similarly situated, STEVE

27 JARVIS, JOE JOHNSON, on behalf of themselves and all others

28 similarly situated, NUHKET KAYAHAN, on behalf of themselves and

29 all others similarly situated, DAVID KENTON, on behalf of

30 themselves and all others similarly situated, DENNIS KUHN, on

31 behalf of themselves and all others similarly situated, BENJAMIN

32 LEVINE, on behalf of themselves and all others similarly

33 situated, KATHERINE LOIACONO, on behalf of themselves and all

34 others similarly situated, CRYSTAL MCMAHON, on behalf of

35 themselves and all others similarly situated, GEORGE

36 MICHALITSIANOS, on behalf of themselves and all others similarly

37 situated, RANDY TERESA MIELKE, on behalf of themselves and all

38 others similarly situated, JACINTO RIVERA, on behalf of

39 themselves and all others similarly situated, FAISAL SAMI, on

40 behalf of themselves and all others similarly situated, SANJEEV

41 SHARMA, on behalf of themselves and all others similarly

42 situated, COLIN SUZMAN, on behalf of themselves and all others

43 similarly situated, T3 TRADING GROUP, LLC, VIJAY AKKARAJU, ALEXIS

44 ALEXANDER, as custodian for Chloe Sophie Alexander, BRIAN ROFFE

45 PROFIT SHARING PLAN, individually and on behalf of all others

1

Case 14-3800, Document 104-1, 11/03/2016, 1898994, Page1 of 20
1 similarly situated, JOSE GALVAN, MARY GALVAN, ROBERT HERPST,

2 individually and on behalf of all others similarly situated,

3 SANJAY ISRANI, on behalf of themselves and all others similarly

4 situated, KBC ASSET MANAGEMENT N.V., and the EMPLOYEES’

5 RETIREMENT SYSTEM OF THE GOVERNMENT OF THE VIRGIN ISLANDS

6 (Collectively, the INSTITUTIONAL INVESTORS), DOUGLAS M. LIGHTMAN,

7 individually and on behalf of all others similarly situated,

8 DENNIS PALKON, individually and on behalf of all others similarly

9 situated, RICK POND, JACOB SALZMANN, individually and on behalf

10 of all others similarly situated, MICHAEL SPATZ, MAREN TWINING,

11 individually and on behalf of all others similarly situated,

12 GOLDRICH COUSINS P.C. 401(k) PROFIT SHARING PLAN & TRUST, IRVING

13 S. BRAUN, individually, EDWARD CHILDS, derivately on behalf of

14 himself and all others similarly situated, KATHY REICHENBAUM,

15 individually and on behalf of all others similarly situated, JUN

16 YAN, on behalf of herself and all others similarly situated,

17 ELBITA ALFONSO, VICKY JONES, PHYLLIS PETERSON, JERRY RAYBORN, on

18 behalf of themselves and all others similarly situated, EDWARD

19 VERNOFF, JUSTIN F. LAZARD, on behalf of himself and all others

20 similarly situated, SYLVIA GREGORCYZK, on behalf of herself and

21 all others similarly situated, PETER BRINCKERHOFF, GARRETT

22 GARRISON, DAVID GOLDBER, individually and on behalf of all others

23 similarly situated, KEVIN HYMS, individually and on behalf of all

24 others similarly situated, RICHARD P. EANNARINO, individually and

25 on behalf of all others similarly situated, PETER MAMULA,

26 individually and on behalf of all others similarly situated,

27 KHODAYAR AMIN, on behalf of himself and all others similarly

28 situated, ELLIOT LEITNER, individually and on behalf of all

29 others similarly situated, BARBARA STEINMAN, on behalf of herself

30 and all others similarly situated, HOWARD SAVITT, on behalf of

31 himself and all others similarly situated, CHAD RODERICK, EUGENE

32 STRICKER, individually and on behalf of all others similarly

33 situated, STEVE SEXTON, individually and on behalf of all others

34 similarly situated, KEITH WISE, individually and on behalf of all

35 others similarly situated, JONATHAN R. SIMON, JAMES CHANG,

36 individually and on behalf of all others similarly situated,

37 SAMEER ANSARI, individually and on behalf of all others similarly

38 situated, DARRYL LAZAR, individually and on behalf of all others

39 similarly situated, MICHAEL LIEBER, individually and on behalf of

40 other similarly situated, THOMAS J. AHRENDTSEN, AARON M. LEVINE,

41 individually and on behalf of all others similarly situated,

42 KAREN CUKER, individually and on behalf of all others similarly

43 situated, BRIAN GRALNICK, individually and on behalf of all

44 others similarly situated, JENNIFER STOKES, individually and on

45 behalf of all others similarly situated, VERNON R. DeMOIS, Jr.,

46 individually and on behalf of all others similarly situated, HAL

47 HUBUSCHMAN, derivately on behalf of Facebook, Inc., EDWARD

48 SHIERRY, individually and on behalf of all others similarly

2

Case 14-3800, Document 104-1, 11/03/2016, 1898994, Page2 of 20
1 situated, JANIS FLEMING, WILLIAM COLE, derivatively on behalf of

2 Facebook, Inc., STEVE GRIFFIS, HOLLY McCONNAUGHEY, derivatively

3 on behalf of Facebook Inc., GAYE JONES, derivatively on behalf of

4 Facebook Inc., LIDIA LEVY, on behalf of herself and all others

5 similarly situated, 

6

7 Plaintiffs,

8

9 v.

10

11 MORGAN STANLEY & CO. LLC, J.P. MORGAN SECURITIES LLC, GOLDMAN

12 SACHS & CO., and FACEBOOK, INC., a Delaware corporation, 

13

14 Defendants-Appellees,

15

16 BARCLAYS CAPITAL INC., MERRILL LYNCH, PIERCE, FENNER & SMITH

17 INCORPORATED, ERSKINE B. BOWLES, JAMES W. BREYER, DAVID SPILLANE,

18 DAVID A. EBERSMAN, ALLEN & COMPANY LLC, BMO CAPITAL MARKETS

19 CORP., BLAYLOCK ROBERT VAN LLC, DONALD E. GRAHAM, C.L. KING &

20 ASSOCIATES, INC., REED HASTINGS, CABRERA CAPITAL MARKETS, LLC,

21 CASTLEOAK SECURITIES, L.P., PETER A. THIEL, CITIGROUP GLOBAL

22 MARKET, INC., MARK E. ZUCKERBERG, COWEN AND COMPANY, LLC, CREDIT

23 SUISSE SECURITES (USA) LLC, SHERYL K. SANDBERG, DEUTSCHE BANK

24 SECURITIES INC., CIPORA HERMAN, E TRADE SECURITIES LLC, ITAU BBA

25 USA SECURITIES, INC., LAZARD CAPITAL MARKETS LLC, LEBENTHAL &

26 CO., LLC, LOOP CAPITAL MARKETS LLC, M.R. BEAL & COMPANY,

27 MACQUARIE CAPITAL (USA) INC., MURIEL SIEBERT & CO., INC.,

28 OPPENHEIMER & CO., INCORPORATED, PACIFIC CREST SECURITIES LLC,

29 PIPER JAFFRAY & CO., RBC CAPITAL MARKETS, LLC, RAYMOND JAMES &

30 ASSOCIATES, INC., SAMUEL A. RAMIREZ & COMPANY, INC., STIFEL,

31 NICOLAUS & COMPANY, INC., THE WILLIAMS CAPITAL GROUP, L.P., WELLS

32 FARGO SECURITIES, LLC, WILLIAM BLAIR & COMPANY, L.L.C., NASDAQOMX

33 GROUP, INCORPORATED, LAWRENCE CORNECK, individually and on behalf

34 of all others similarly situated, JILL D. SIMON, CITIGROUP GLOBAL

35 MARKETS INC., ALLEN & FACEBOOK (sic) LLC, WILLIAM BLAIR &

36 FACEBOOK (sic) LLC, M.R. BEAL & FACEBOOK (sic) INCORPORATED,

37 COWEN AND FACEBOOK (sic) LLC, STIFEL NICHOLAS & FACEBOOK (sic)

38 INCORPORATED, SAMUEL A. RAMIREZ & FACEBOOK (sic) INC, KEVIN

39 HICKS, individually and on behalf of all others similarly

40 situated, LINH LUU, individually and on behalf of all others

41 similarly situated, HARVEY LAPIN, individually and on behalf of

42 all others similarly situated, KING & ASSOCIATES, INC., DAVID E.

43 (sic) EBERSMAN, NICK E. TRAN, THE NASDAQ STOCK MARKET L.L.C., a

44 Foreign Limited Liability Company, NASDAQ STOCK MARKET,

3

Case 14-3800, Document 104-1, 11/03/2016, 1898994, Page3 of 20
1 INCORPORATED, NASDAQ OMX GROUP, INCORPORATED, UMA M. SWAMINATHAN,

2 ROBERT GREIFELD, ANNA M. EWING, MARC L. ANDREESSEN, 

3

Defendants.* 4

5

6

7 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 

8

9 B e f o r e: WINTER, LOHIER, and CARNEY, Circuit Judges.

10

11 Appeal from a grant by the United States District Court for

12 the Southern District of New York (Robert W. Sweet, Judge) of a

13 Rule 12(b)(6) motion dismissing appellant's complaint. The

14 principal issue is whether standard lock-up agreements in an IPO

15 between lead underwriters and certain pre-IPO shareholders are

16 alone sufficient to render those parties a "group" under Section

17 13(d) and subject to Section 16(b) disgorgement under the

18 Securities Exchange Act of 1934. We hold that they are not. We,

19 therefore, affirm.

20 JEFFREY S. ABRAHAM (Mitchell M.Z.

21 Twersky & Philip T. Taylor on the

22 brief), Abraham, Fruchter &

23 Twersky, LLP, New York, NY, for

24 Plaintiff-Appellant.

25

26 JAMES P. ROUHANDEH (Charles S.

27 Duggan & Andrew Ditchfield on the

28 brief), Davis Polk & Wardwell LLP,

29 New York, NY, for Defendants30 Appellees Lead Underwriters.

31

32 Andrew B. Clubok, Kirkland & Ellis

33 LLP, New York, NY, for Defendant34 Appellee Facebook, Inc.

35

* The Clerk is directed to amend the caption as above.

4

Case 14-3800, Document 104-1, 11/03/2016, 1898994, Page4 of 20
1 Michael A. Conley, John W. Avery,

2 Nicholas J. Bronni, Securities and

3 Exchange Commission, Washington,

4 DC, for Amicus Curiae Securities

5 and Exchange Commission.

6

7 WINTER, Circuit Judge:

8 Robert Lowinger appeals from Judge Sweet's dismissal of his

9 complaint pursuant to Fed. R. Civ. P. 12(b)(6). The complaint

10 asserted claims under the Securities Exchange Act of 1934, 15

11 U.S.C. § 78p(b), against, inter alia, appellees Goldman Sachs &

12 Co., Morgan Stanley & Co., LLC, and J.P. Morgan Securities LLC

13 (collectively "Lead Underwriters"). It sought to hold them

14 liable under Section 16(b) for disgorgement of short-swing

15 profits received in connection with their sales and purchases of

16 shares in the course of Facebook, Inc.'s initial public offering

17 (“IPO”).

18 Section 16(b) requires a "beneficial owner" of ten percent

19 or more of an issuer's stock to disgorge all profits realized

20 from short sales or purchases of that security within a six-month

21 period. See 15 U.S.C. § 78p(b). The Lead Underwriters alone did

22 not meet the ten-percent threshold. However, "beneficial owner,"

23 as defined in Section 13(d) of the Exchange Act, includes

24 “groups.” Appellant contends that the Lead Underwriters and

25 certain pre-IPO shareholders together formed a group under

26 Section 13(d).

27

5

Case 14-3800, Document 104-1, 11/03/2016, 1898994, Page5 of 20
1 The group was allegedly formed by lock-up agreements between

2 the Lead Underwriters and pre-IPO Shareholders (“Shareholders”). 

3 The lock-up agreements prevented the Shareholders from selling

4 their stock for a specified period of time except as permitted by

5 the Lead Underwriters. The district court dismissed the

6 complaint on the grounds that the lock-up agreements alone did

7 not render the Lead Underwriters beneficial owners of the

8 aggregated shares held by the Shareholders under Section 13(d).

9 Because we agree that this standard form lock-up agreement is

10 insufficient, on its own, to establish a group under Section

11 13(d), we affirm.

12 BACKGROUND

13 Upon review of a dismissal of a complaint under Fed. R. Civ.

14 P. 12(b)(6), the facts, and inferences to be drawn from those

15 facts, are viewed in the light most favorable to the plaintiff. 

16 Chambers v. Time Warner, Inc., 282 F.3d 147, 152 (2d Cir. 2002).

17 This appeal arises from the May 18, 2012 IPO by Facebook,

18 Inc. ("Facebook"). The offering was underwritten by a syndicate

19 of thirty-three financial firms (collectively, “Underwriters”),

20 including the three Lead Underwriters. Goldman was a Lead

21 Underwriter, and some Goldman subsidiaries owned Facebook shares. 

22 As part of the IPO process, each of the Shareholders (who, in the

23 aggregate, owned more than ten percent of Facebook's common

24 stock) entered into lock-up agreements with the Lead Underwriters

6

Case 14-3800, Document 104-1, 11/03/2016, 1898994, Page6 of 20
1 in order to "induce the Underwriters that may participate in the

2 Public Offering to continue their efforts in connection with the

3 Public Offering." J. App'x at 73. Appellant makes no claim that

4 these lock-up agreements departed from standard underwriting

5 practices.

6 The lock-up agreements generally provided that the

7 Shareholders would not sell or otherwise dispose of Facebook

8 stock for periods ranging from 91 days to 211 days after the date

9 of the Prospectus without the consent of Morgan Stanley as agent

10 for the Lead Underwriters. The agreements were disclosed in

Facebook's Prospectus and Registration Statement.1 11 

12 As is common in IPOs, the Registration Statement and

13 Prospectus alerted investors that the Underwriters might

14 "over-allot," i.e., sell more than the 421 million shares

15 earmarked for the IPO. Permitting such sales allows underwriters

16 to stabilize fluctuating share prices during an offering by

17 increasing the supply of shares after the offering price has been

18 determined. This ensures (and assures investors) that the entire

19 underwritten amount is sold. Underwriters generally hedge this

20 extra allotment by establishing a short position on oversold

21 shares while simultaneously holding the shares long. 

1 We may consider Facebook's Registration Statement and Prospectus as

documents integral to the complaint. See Chambers, 282 F.3d at 152-53; see

also San Leandro Emergency Med. Grp. Profit Sharing Plan v. Philip Morris

Cos., Inc., 75 F.3d 801, 808-09 (2d Cir. 1996).

7

Case 14-3800, Document 104-1, 11/03/2016, 1898994, Page7 of 20
1 Underwriters are thus protected against upward or downward

2 movements in the stock's price. The Facebook IPO permitted the

3 Underwriters to cover this short position either by purchasing

4 the requisite additional shares directly from Facebook and the

5 Shareholders at a fixed price (per the terms of a so-called

6 "over-allotment option," or "Green Shoe"), or by purchasing

7 shares directly from the open market once secondary trading had

commenced.2 8

9 Because of their role in the IPO, the Lead Underwriters were

10 necessarily granted access to nonpublic financial information

11 concerning Facebook. In March and April 2012, Facebook shared

12 its internal forecasts with the Lead Underwriters for both the

13 second quarter of 2012 and for fiscal year 2012. These forecasts

14 estimated revenue between $1.1 and $1.2 billion and approximately

15 $5 billion, respectively. That information was "incorporated

16 into materials used by the Underwriters to market the Facebook

17 IPO to investors in a road show commenced on May 7, 2012." J.

18 App'x at 20.

2 Facebook’s Registration Statement disclosed that “the underwriters may

engage in transactions that stabilize, maintain or otherwise affect the price

of the Class A common stock.” J. App’x at 43. This gave leeway to the IPO

underwriters by allowing them to “sell more shares than they are obligated to

purchase under the underwriting agreement, creating a short position” that

they could cover by exercising a Green Shoe option or “by purchasing shares in

the open market.” Such open-market purchases “may raise or maintain the

market price of the Class A common stock above independent market levels or

prevent or retard a decline in the market price of the common stock.” 

8

Case 14-3800, Document 104-1, 11/03/2016, 1898994, Page8 of 20
1 That same day, May 7, however, the complaint alleges,

2 Facebook revised its revenue estimates downward for the second

3 quarter to the low end of the $1.1 to $1.2 billion range and

4 projected the 2012 fiscal year estimate to be 3% to 3.5% lower

5 than the previously forecasted $5 billion. Facebook shared those

6 concerns with Morgan Stanley. On May 9, Facebook amended its

7 Registration Statement to advise potential investors of its

8 revised estimates. 

9 On May 17 and 18, 2012, the Underwriters sold 484,418,657

10 shares of Facebook common stock to the public at prices ranging

11 from $38.00 to $42.05 per share. Facebook received $37.582 for

12 each share sold and the Underwriters received discounts and

13 commissions amounting to $0.418 per share. Over 310 million of

14 these shares were sold by the Lead Underwriters, which generated

15 $129,000,000 in discounts and commissions for appellees. 

16 Stating that the amendment to the Registration Statement did

17 not adequately disclose the revised estimates, the complaint

18 alleges that only after trading closed on May 18, 2012, did the

19 investors become aware that the Underwriters had already cut

their estimates for Facebook ahead of the IPO.3 20 On May 21, the

21 first trading day thereafter, Facebook's stock price declined to

3 Because this appeal raises only a claim under Section 16, which

imposes a strict-liability rule, as discussed infra, the adequacy of

disclosure and the misuse of material, nonpublic information are not before

us.

9

Case 14-3800, Document 104-1, 11/03/2016, 1898994, Page9 of 20
1 "$34.03 on extremely high volume reflecting a decline of more

2 than 10%" from the IPO price. J. App'x at 25. On May 22, 2012,

3 a report by Reuters further divulged that the revised projections

4 had been revealed by the Underwriters to select clients in a

5 manner that avoided a general and direct disclosure of the

6 relevant material information. The decline continued and on May

7 22, Facebook's stock closed at $31 per share -- 18.42% below the

8 IPO price -- on high trading volume. 

9 During that period, the Underwriters declined to exercise

10 their Green Shoe option to cover their short positions, choosing

11 instead to purchase the over-allotted shares directly on the

12 secondary market, at prices lower than the Green Shoe fixed price

13 of $38.00 per share. As a result, the Underwriters "made a

14 profit of about $100 million with the bulk of that profit [having

15 been] made on" May 21. J. App'x at 26 (internal citation and

16 quotation marks omitted).

17 On September 12, 2012, appellant, a Facebook shareholder,

18 made a demand on Facebook that it compel J.P. Morgan, Morgan

19 Stanley, and Goldman to disgorge their profits –- as explained

20 infra, calculated under Section 16(b) by subtracting the sales

21 prices of May 17 from the purchase prices during the following

22 four days. Facebook declined to bring suit, and appellant filed

10

Case 14-3800, Document 104-1, 11/03/2016, 1898994, Page10 of 20
his complaint on June 12, 2013.4 1

2 On May 2, 2014, the district court granted appellees' motion

3 to dismiss the complaint. It held that because appellant's

4 Section 13(d) group allegation was based entirely on the lock-up

5 agreements, it was insufficient to state a claim under Section

6 16(b). The district court noted that "[b]ecause lock-up

7 agreements are standard industry practice," they are, without

8 more, "insufficient to establish a Section 16(b) group." In re

9 Facebook, Inc., IPO Sec. & Derivative Litig., 986 F. Supp. 2d

10 544, 553 (S.D.N.Y. 2014). The district court declined to reach

11 the alternative argument that the Underwriters' transactions were

12 exempt under SEC Rule 16a-7 as part of a good faith

underwriting.5 13

14

4 The Facebook IPO has spawned multiple lawsuits that have been

consolidated in the district court. See In re Facebook, Inc., IPO Sec. &

Derivative Litig., 922 F. Supp. 2d 475, 477 (S.D.N.Y. 2013). Only the Section

16 issues are before us.

5 With regard to the Rule 16a-7 issue, the court stated, “Whether, if

beneficial owners, the Lead Underwriters would be exempt from Section 16

liability under Rule 16a–7 presents certain complex and unprecedented issues,

for instance, whether Defendants' creation of informational disparities

accompanied by unusually high levels of short selling, though compliant with

the letter of the law, may still be ‘indecent’ or ‘dishonest’ for purposes of

determining ‘good faith.’ The Court declines to reach these issues at this

time, because even if the Lead Underwriters are not exempt under the statute,

they lack the prerequisite ‘beneficial owner’ status for Section 16 to apply.” 

In re Facebook, Inc., 986 F. Supp. at 554 (internal citations omitted). In

view of our disposition of this matter, we also do not address this Rule 16a-7

issue.

11

Case 14-3800, Document 104-1, 11/03/2016, 1898994, Page11 of 20
1 This appeal followed. We solicited, and received, the views

2 of the SEC, as amicus curiae, relevant to the disposition of this

3 appeal. 

4 DISCUSSION

5 We review de novo a district court's dismissal of a

6 complaint pursuant to Rule 12(b)(6). See Chambers, 282 F.3d at

7 152. To survive dismissal, a complaint must plead "enough facts

8 to state a claim to relief that is plausible on its face." Bell

9 Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007).

10 Section 16(a) of the Exchange Act provides that any

11 director, officer, or "beneficial owner of more than 10 percent

12 of" a firm’s securities, commonly called "statutory insiders,"

13 must report to the SEC the amount owned and must disclose changes

14 in ownership. 15 U.S.C. § 78p(a). Section 16(b), intended to

15 prevent the defined insiders from profiting from short-swing

16 variations in share price, imposes a strict-liability rule for

17 disgorgement of profits. It states:

18 For the purpose of preventing the unfair use

19 of information which may have been obtained

20 by such beneficial owner . . . by reason of

21 his relationship to the issuer, any profit

22 realized by him from any purchase and sale 

23 . . . of any equity security of such issuer 

24 . . . within any period of less than six

25 months . . . shall inure to and be

26 recoverable by the issuer, irrespective of

27 any intention on the part of such beneficial

28 owner . . . in entering into such

29 transaction.

30

12

Case 14-3800, Document 104-1, 11/03/2016, 1898994, Page12 of 20
1 15 U.S.C. § 78p(b). A disgorgement action may be brought by the

2 issuer or on behalf of the issuer by a security holder, like

3 appellant. Because Section 16(b) operates regardless of intent

and calculates “profits” in an automatic and non-intuitive way,6 4

5 we have cautioned that Section 16(b) is a "blunt instrument" to

6 be confined within "narrowly drawn limits." Magma Power Co. v.

7 Dow Chem. Co., 136 F.3d 316, 321 (2d Cir. 1998) (internal

8 quotation marks omitted).

9 To state a claim, the complaint here must allege facts

10 demonstrating that appellees were at relevant times statutory

11 insiders, i.e., as pertinent here, beneficial owners of more than

12 ten percent of Facebook's stock. Congress did not explicitly

13 define the term "beneficial owner," see Levy v. Southbrook Int'l

14 Invs., Ltd., 263 F.3d 10, 14 (2d Cir. 2001), but the SEC has

15 adopted Exchange Act Rule 16a-1, defining beneficial owner to

16 mean "any person who is deemed a beneficial owner pursuant to

17 Section 13(d) of the [Exchange] Act and the rules thereunder," 

6 Section 16(b), long recognized by this court as a “crude,”

“arbitrary,” and “Draconian” mechanism for curbing insider trading, see Blau

v. Lamb, 363 F.2d 507, 515 (2d Cir. 1966), is especially so with respect to

calculating the amount of “profit realized” from short-swing trading, see

Smolowe v. Delendo Corp., 136 F.2d 231, 239 (2d Cir. 1943) (setting forth the

general procedure for calculating disgorgement under Section 16(b)). Under

the established method of calculating disgorgeable “profit” for Section 16(b)

purposes, an individual may be charged with a Section 16(b) “profit” even when

his or her relevant trading actually resulted in a substantial financial loss. 

See Feder v. Frost, 220 F.3d 29, 32 (2d Cir. 2000); Adler v. Klawans, 267 F.2d

840, 847-48 (2d Cir. 1959). For example, imagine a statutory insider who

purchases 100 shares at $100 per share on January 1, sells 100 shares at $50

per share on February 1, purchases 100 shares at $150 per share on March 1,

and sells 100 shares for $125 per share on April 1. This trader has lost

$7,500 in real terms, but he has a profit of $2,500 for Section 16(b)

purposes. See Smolowe, 136 F.2d at 239.

13

Case 14-3800, Document 104-1, 11/03/2016, 1898994, Page13 of 20
1 17 C.F.R. § 240 16a-1(a); see also Ownership Reports and Trading

2 by Officers, Directors and Principal Security Holders, Exchange

3 Act Release No. 34-28869, 56 Fed. Reg. 7242, 7244 (Feb. 21,

4 1991). Section 13(d) requires any person acquiring beneficial

5 ownership of five percent or more of a corporation's common stock

6 to disclose certain information. See 15 U.S.C. § 78m(d). 

7 Section 13(d)’s purpose is to compel disclosure of certain events

8 that may portend changes in corporate control. Wellman v

9 Dickinson, 682 F.2d 355, 365 (2d Cir. 1982).

10 Exchange Act Rule 13d-3(a) describes a beneficial owner as

11 "any person who, directly or indirectly, through any contract,

12 arrangement, understanding, relationship, or otherwise has or

13 shares: (1) Voting power . . . ; and/or, (2) Investment power

14 which includes the power to dispose, or to direct the disposition

15 of, such security." 17 C.F.R. § 240.13d-3(a). Additionally,

16 according to Section 13(d)(3), "[w]hen two or more persons act as

17 a partnership, limited partnership, syndicate, or other group for

18 the purpose of acquiring, holding, or disposing of securities of

19 an issuer, such syndicate or group shall be deemed a 'person' for

20 the purposes of this subsection." 15 U.S.C. § 78m(d)(3); see

21 also 17 C.F.R. § 240.16a-1(a)(1). Ultimately, according to

22 Exchange Act Rule 13d-5(b)(1), "[w]hen two or more persons agree

23 to act together for the purpose of acquiring, holding, voting or

24 disposing of equity securities of an issuer, the group formed

14

Case 14-3800, Document 104-1, 11/03/2016, 1898994, Page14 of 20
1 thereby shall be deemed to have acquired beneficial ownership,

2 for purposes of section [] 13(d) . . . of all equity securities

3 of that issuer beneficially owned by any such persons." 17

4 C.F.R. § 240.13d-5(b)(1). This Rule tracks the language of

5 Section 13(d), except for its addition of “voting” to the acts

6 that trigger a “group” finding.

7 It is agreed that the Underwriters themselves did not hold

8 ten percent of Facebook’s stock. Rather, appellant alleges that

9 the Underwriters were members of a group that in the aggregate

10 held ten percent of Facebook shares. This group was allegedly

11 formed by the lock-up agreements between the Lead Underwriters

12 and Shareholders, which prevented the Shareholders from selling

13 (“disposing,” in statutory language) their pre-IPO shares of

14 Facebook stock for a specified period of time after the IPO

15 without the Lead Underwriters’ consent. 

16 A plain language argument suggests application of Section

17 13(d), but we have explicitly avoided holding that such an

18 agreement, without more, forms a group under Section 13(d). 

19 Rather, we have stated only that a lock-up agreement "may bear

20 upon" the question of whether a group exists or that evidence of

21 coordination in acquiring, holding, or disposing of securities

22 may demonstrate the existence of a group. Morales v. Quintel

23 Entm’t, Inc., 249 F.3d 115, 127 (2d Cir. 2001); see also CSX

24 Corp. v. Children’s Inv. Fund Mgmt. (UK) LLP, 654 F.3d 276, 283

15

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1 (2d Cir. 2011) (noting that the "touchstone" of the court's

2 finding of a group is that "the members combined in furtherance

3 of a common objective" to acquire, hold, vote or dispose of

4 securities) (internal quotation marks omitted).

5 Our reluctance to recognize the existence of a “group,”

6 notwithstanding a contractual arrangement explicitly limiting the

7 disposal of shares, reflects the fact that lock-up agreements,

8 rather than being agreements “to act together,” are generally

9 one-way streets keeping certain shareholders out of the IPO

10 market for a specified period of time or without compliance with

11 other restrictions, as discussed immediately below. 

12 However, we cannot avoid a larger, legitimate concern

13 emphasized in the SEC’s amicus brief over applying Section 13(d)

14 literally in the context of standard lock-up agreements. As the

15 brief notes, a lock-up agreement is common, Brief of the SEC as

16 Amicus Curiae, at 19 (citing NYSE/NASD IPO Advisory Comm., Report

17 & Recommendations of a committee convened by the NYSE, Inc. &

18 NASD at the request of the U.S. Securities and Exchange

19 Commission (May 2003), at p.16, available at

20 http://www.finra.org/sites/default/files/Industry/p010373.pdf),

21 even essential, to the typical IPO, and some other public

22 offerings as well, id. at 19-22. Such an agreement assures

23 potential buyers of securities in the IPO “that shares owned [by

24 pre-IPO shareholders of the issuer will not] enter the public

16

Case 14-3800, Document 104-1, 11/03/2016, 1898994, Page16 of 20
1 market too soon after the offering.” Initial Public Offerings:

2 Lockup Agreements, Fast Answers, U.S. Securities & Exchange

3 Commission, available at http://www.sec.gov/answers/lockup.htm

4 (last visited Oct. 17, 2016); see also In re Facebook, Inc., 986

5 F. Supp. 2d at 553. These assurances lead investors reasonably

6 to expect an orderly market free of the danger of large sales of

7 pre-owned shares depressing the share price before the pricing of

8 the newly offered shares has settled in the market.

9 Applying Section 16(b) to underwriters engaged in lock-up

10 agreements as facilitators of a public offering would impair the

11 market for public offerings by complicating the role of

12 underwriters –- adding tens of millions of dollars in legal

13 exposure to the underwriters’ costs. As parties to lock-up

14 agreements, the underwriters are not acting as investors seeking

15 to buy low and sell high. Rather, they are conduits for the

16 distribution of securities in an offering to the public in which

17 their participation begins and ends with the offering. A central

18 role of the standard lock-up agreement is to limit the investment

19 decisions of large shareholders in order to bring about an

20 orderly, and successful, offering.

21 Public offerings are heavily regulated. See, e.g., In re

22 Public Offering Fee Antitrust Litig., 98-cv-7890 (LLM), 2003 WL

23 21496795, at *2 (S.D.N.Y. June 27, 2003); David A. Westenberg,

24 Initial Public Offerings: A Practical Guide to Going Public,

17

Case 14-3800, Document 104-1, 11/03/2016, 1898994, Page17 of 20
1 § 18:12 (1st ed. 2011). Among the most heavily regulated are

2 IPOs. See Adoption of Integrated Disclosure System, Securities

3 Act Release No. 33-6383, 47 Fed. Reg. 11380 (Mar. 16, 1982).

4 Disclosure to the public of relevant facts is extensive and, in

5 this case, included all of the pertinent facts asserted in the

6 complaint. IPOs contemplate the sharing of confidential

7 financial information with underwriters, agreements between

8 underwriters and large pre-IPO shareholders limiting disposal of

9 their shares, and trading by underwriters in the course of the

10 offering. Far from being nefarious, these actions benefit

11 existing shareholders and new public investors. For example, one

12 purpose of the regulation of public offerings is to enhance

13 relatively accurate pricing of the offering’s shares by

14 disclosure before sales of an offering to the public are allowed. 

15 See 15 U.S.C. § 77h. Achieving that purpose requires assurances

16 of control over the disposition of blocs of shares owned by large

17 pre-IPO investors, and lock-up agreements provide that control. 

18 (One effect of a lock-up agreement in an IPO is to prevent pre19 IPO insiders from using nonpublic information to trade in a

20 nascent public market.) The purpose also requires stabilization

21 efforts by underwriters, as discussed above. Lock-up agreements

22 are, therefore, essential to the regulation of public offerings.

23 As amicus, the SEC advises us that ordinary lock-up

24 agreements do not implicate the purposes of Section 13(d) and its

18

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1 definition of a “group.” Section 13(d) is intended to alert

2 investors about possible changes in control and provide

3 information about possible parties to those changes. See, e.g.,

4 Brief of the SEC, Amicus Curiae, Morales v. Quintel Entm't, Inc.,

5 249 F.3d 115 (2d Cir. 2001), at 20–21 ("There is no doubt that

6 the purpose of Section 13(d) is to require disclosure of

7 information by persons who have acquired a substantial interest,

8 or increased their interest in equity securities of a company by

9 a substantial amount . . . so that investors might assess the

10 potential for changes in corporate control and adequately

11 evaluate the company's worth.") (internal quotation marks

12 omitted). To that end, the beneficial ownership rule seeks to

13 "prevent a group of persons who seek to pool their voting or

14 other interests . . . from evading" Section 13(d)'s disclosure

15 requirements. Wellman, 682 F.2d at 366 (quoting S. Rep. No. 550,

16 90th Cong., 1st Sess. 8 (1967)).

17 While appellant is correct that both the Underwriters and

18 Shareholders hoped to profit from the IPO -- the Underwriters

19 profiting according to the underwriting agreement and the

20 Shareholders profiting from a newly established public market for

21 their shares -- this common objective creates no need for

22 information about potential changes in control beyond that

23 inherent in a public offering. Using Section 13(d) to create a

24 “group” subject to Section 16(b) would impose large damages on

19

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1 transitory conduits of a public offering of shares. This

2 imposition of damages would have nothing to do with the allaying

3 of concerns about changes in control but would greatly raise the

4 costs, and reduce the number, of IPOs. 

5 To be sure, our analysis applies only to standard lock-up

6 agreements like those at issue here. As the SEC’s amicus brief

7 states, “[a]typical language in the lock-up agreement, or other

8 facts and circumstances outside of the lock-up agreement,” may

9 trigger a Section 13(d) “group” finding. Brief of the SEC as

10 Amicus Curiae, at 22. Our cases, discussed supra, have clearly

11 indicated that coordination between underwriters and the other

12 parties to a lock-up agreement with implications for control

13 changes beyond those inherent in an IPO might trigger such a

14 finding. But no facts alleged in this matter, in the petition

15 for reconsideration in the district court, or in the request to

amend persuade us that such a trigger exists.7 16

17 We, therefore, affirm.

7 Appellant also advances an argument based on the fact that Goldman

subsidiaries owned some pre-IPO Facebook shares. The substance of appellant’s

argument is rendered rather murky by issues related to how it was raised in

the district court. Goldman’s subsidiaries’ ownership of pre-IPO Facebook

shares was disclosed in the documents filed with the SEC that accompanied the

IPO and its underwriting. J. App’x at 106. These documents were before the

district court on the motion to dismiss, but appellant raised the stock

ownership issues as relevant only in its motion for reconsideration in the

district court. It comes before us as a claim of error by that court either

in its decision on the merits or in the court’s declining to allow the

complaint to be amended. We hold that these allegations do not render the

lock-up agreements here as atypical in a way pertinent to our refusal to apply

Section 13(d). No facts that might be alleged by plaintiff suggest, whether

the lock-up agreements covered the Goldman shares or not, any implications

regarding control changes as contemplated by Section 13(d) as is fully

explained in the text.

20

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