Opinion ID: 3038415
Heading Depth: 2
Heading Rank: 1

Heading: statutory and regulatory framework of insider

Text: TRADING UNDER § 16(b) AND RULE 16b-3(d)
Congress enacted § 16(b) as part of the Securities 2 We review de novo a dismissal under Rule 12(b)(6), Arrington v. Wong, 237 F.3d 1066, 1069 (9th Cir. 2001), and may consider documents referred to in the complaint or any matter subject to judicial notice, such as SEC filings. MGIC Indemnity Corp. v. Weisman, 803 F.2d 500, 504 (9th Cir. 1986). DREILING v. AMERICAN EXPRESS CO. 9571 Exchange Act of 1934 to prevent corporate insiders from exploiting their access to “information not generally available to others.” Kern County Land Co. v. Occidental Petroleum Corp., 411 U.S. 582, 592 (1973). Section 16(b) reads in relevant part: For the purpose of preventing the unfair use of information which may have been obtained by such bene- ficial owner, director, or officer by reason of his relationship to the issuer, any profit realized by him from any purchase and sale . . . of any equity secur- ity of such issuer . . . within any period of less than six months . . . shall . . . be recoverable by the issuer, irrespective of any intention on the part of such beneficial owner, director, or officer in entering into such transaction of holding the security . . . . This subsection shall not be construed to cover . . . any transaction or transactions which the Commission by rules and regulations may exempt as not compre- hended within the purpose of this subsection. 15 U.S.C. § 78p(b) (emphasis added). [1] In passing the statute, “Congress recognized that shortswing speculation by stockholders with advance, inside information would threaten the goal of the Securities Exchange Act to ‘insure the maintenance of fair and honest markets.’ ” Kern County, 411 U.S. at 591 (quoting 15 U.S.C. § 78b). Section 16(b) flatly prohibits a “class of transactions in which the possibility of abuse was believed to be intolerably great,” id. at 592, and does so by “impos[ing] a strict prophylactic rule with respect to insider, short-swing trading.” ForemostMcKesson, Inc. v. Provident Sec. Co., 423 U.S. 232, 251 (1976). The statute identifies three classes of insiders— directors, officers and beneficial owners—and makes them liable, without fault or intended wrongdoing, for trading in their company’s shares. 15 U.S.C. § 78p(b). 9572 DREILING v. AMERICAN EXPRESS CO. [2] Section 16(b) does not, however, reach all insider trading. Foremost-McKesson, 423 U.S. at 253 (“Congress itself limited carefully the liability imposed by § 16(b).”). The statute imposes strict liability on insiders only for “shortswing” trades—specifically, a coupled purchase-and-sale, or sale-and purchase, completed within six months. 15 U.S.C. § 78p(b).3 Courts have recognized that § 16(b) is a blunt instrument, at once both over- and under-inclusive. See Citadel Holding Corp. v. Roven, 26 F.3d 960, 965 (9th Cir. 1994) (“[Section] 16(b) is a relatively arbitrary, ‘flat rule’ . . . .” ) (quoting Reliance Elec. Co. v. Emerson Elec. Co., 404 U.S. 418, 422 (1972)). The statute is over-inclusive in that it imposes strict liability regardless of motive, including trades not actually based on inside information. Kern, 411 U.S. at 595 (noting that § 16(b) requires disgorgement of profits “without proof of actual abuse of insider information, and without proof of intent to profit on the basis of such information”). It is underinclusive in that there is no liability for trades made on inside information if more than six months transpire between purchase and sale. Foremost-McKesson, 423 U.S. at 252 (“Even an insider may trade freely without incurring statutory liability if, for example, he spaces his transactions at intervals greater than six months.”). [3] In response to the statute’s over-inclusiveness, Congress exempted two classes of transactions from the “flat rule” of liability. See 15 U.S.C. § 78p(b) (exempting from liability securities “acquired in good faith in connection with a debt previously contracted” and transactions in which a “beneficial owner was not such both at the time of the purchase and sale, or the sale and purchase”). Aside from these specific transac- 3 See also Allis-Chalmers Mfg. Co. v. Gulf & Western Indus., Inc., 527 F.2d 335, 346 (7th Cir. 1975) cert. denied 96 S.Ct. 1142 (1976) (“Our review of the history of the statute convinces us that in enacting section 16(b) Congress had in mind a specific type of two-part transaction consisting either of a purchase and subsequent sale, or a sale and subsequent repurchase . . . .”). DREILING v. AMERICAN EXPRESS CO. 9573 tion exemptions, Congress provided an open-ended delegation to the SEC, authorizing it to exempt other transactions “not comprehended within the purpose of [§ 16(b)].” Id. § 78p(b).
TRANSACTIONS Before 1996, Rule 16b-3 and its pre-cursor Rule X-16B-3 exempted only insider-issuer transactions, approved by the board of directors, that were related to officer or director compensation. The 1996 revision of Rule 16b-3 exempted all grants or awards of stock or options by an issuer to an insider, compensatory or not, if the transaction was approved by the board or majority of shareholders. 17 C.F.R. § 240.16b-3(d). In relevant part, the rule reads: (d) Acquisitions from the issuer. Any transaction, other than a Discretionary Transaction, involving an acquisition from the issuer (including without limitation a grant or award), whether or not intended for a compensatory or other particular purpose, shall be exempt if:
board of directors of the issuer, or a com- mittee of the board of directors that is com- posed solely of two or more Non-Employee Directors; . . . 17 C.F.R. § 240.16b-3. [4] The SEC adopted the 1996 version of Rule 16b-3(d) as part of a number of amendments to Rule 16b-3 to present a “simplified, flexible approach” to insider transactions. Ownership Reports and Trading by Officers, Directors and Principal Security Holders, 61 Fed. Reg. 30,376, 30,377 (June 14, 1996). The SEC exempted non-compensatory issuer-insider trades because they “do not appear to present the same oppor9574 DREILING v. AMERICAN EXPRESS CO. tunities for insider profit on the basis of non-public information as do market transactions by officers and directors,” id., and “where the issuer, rather than trading markets, is on the other side of an officer or director’s transaction in the issuer’s equity securities, any profit obtained is not at the expense of uninformed shareholders and other market participants of the type contemplated by the statute.” Id. The SEC based these observations “on its experience with the Section 16 rules,” and concluded that short-swing transactions between an insider and an issuer that “satisfy . . . objective gate-keeping conditions[ ] are not vehicles for the speculative abuse that section 16(b) was designed to prevent.” Id. Thus, the SEC enacted Rule 16b-3(d) because board or shareholder-approved insider-issuer transactions were “not contemplated within the purpose” of § 16(b). The SEC’s decision to revise Rule 16b-3(d) in 1996 was founded not just on its years of experience making rules under § 16 rules, 61 Fed. Reg. at 30,377, but also, according to the SEC’s amicus brief, “careful study, notice and public comment.” The SEC received 38 letters in its solicitation for comments on early versions of Rule 16b-3(d), mostly positive. Id. at 30,377 & 30,380. Rule 16b-3(d) also reconciles competing policies.4 Finally, Rule 16b-3(d) implements certain of the “objective gate-keeping conditions,” such as approval by the issuer’s board of directors or ratification by a majority of shareholders. 17 C.F.R. § 240.16b-3(d)(1) & (2). In identifying these “gate-keeping” conditions, the SEC noted that “[a]lthough the new rule would not prohibit Non-Employee Directors or the full board from awarding themselves grants of issuer equity 4 The SEC noted in its amicus brief that before the 1996 version amendment to Rule 16b-3, the old exemption immunized only “approved written employee benefit plan[s]” which “did not work and actually discouraged some insiders from acquiring issuer securities through employee benefit plans.” DREILING v. AMERICAN EXPRESS CO. 9575 securities, such grants would be subject to state laws governing corporate self-dealing.” 61 Fed. Reg. at 30,381.