On November 23, 2020, the United States Court of Appeals for the Second Circuit vacated a grant of summary judgment to the plaintiff in a derivative action seeking disgorgement of alleged "short-swing profits" in an action under Section 16(b) of the Securities Exchange Act of 1934 against a registered investment advisor, its customer, and the individual defendant who held positions at both entities. Packer v. Raging Cap. Mgmt., LLC, —F.3d—, 2020 WL 6844063 (2d Cir. 2020). Plaintiff alleged that the customer was the "beneficial owner" of more than ten percent of a certain company's shares and, therefore, was required to return profits it earned from buying and selling the company's shares within a six-month period. The district court granted summary judgment in plaintiff's favor, but the Second Circuit vacated the judgment. The Court held that factual issues remained regarding whether the customer was the beneficial owner of the shares in question and therefore remanded the matter for further proceedings.
Defendants made two arguments disputing the customer's status as a beneficial owner. First, they argued that, because the investment advisor was exempt from the beneficial ownership of shares it held on behalf of its customers, the customer was also exempt. The district court rejected this argument. The Second Circuit agreed, holding that the investment advisor's exempt status did not "automatically extend to exempt all members of a group from beneficial ownership." Id. at *3.
Second, defendants contended that, pursuant to an investment agreement delegating the customer's investment and voting authority to the advisor, beneficial ownership had also been delegated to the (exempt) investment advisor. Id. The district court held that this delegation was ineffective and should be disregarded, in light of the fact that the same individual defendant signed on behalf of all parties to the agreement—the investment advisor, the customer, and two feeder funds of the customer—and the individual defendant therefore "could, presumably, revise, amend, or abrogate that agreement with a few strokes of a pen." Id. at *5. However, the Second Circuit held that the district court erred in determining, on the factual record before it, that the customer had not delegated investment and voting authority with respect to the company shares at issue. Id.
Whereas the district court pointed to the "intertwined" relationship among defendants as a reason to reject the effectiveness of the delegation, the Second Circuit explained that Section 16(b) imposes a form of strict liability and should therefore be applied "narrowly" and "cautiously," and that imposing liability based on a finding that entities are "intertwined" would extend liability "beyond the text of both the statute and rule." Id. Moreover, the Second Circuit rejected the district court's reliance on Analytical Surveys, Inc. v. Tonga Partners, L.P., 684 F.3d 36 (2d Cir. 2012), and Huppe v. WPCS International, Inc., 670 F.3d 214 (2d Cir. 2012), which imposed Section 16(b) liability based on state-law principles of agency law. Packer, 2020 WL 6844063, at *5. The Second Circuit emphasized that the present case involved no comparable state-law-based agency relationship, and the district court had not determined that defendants' corporate veils could be pierced. Id.
Finally, the district court had concluded that the individual defendant had the authority to amend the investment agreement, based on the fact that he had signed the agreement on behalf of all parties to the agreement. Id. While the Second Circuit agreed that the individual defendant had the authority to sign the agreement, the Court reasoned that "[a]uthority for an individual to sign a document on behalf of an entity ... does not necessarily carry with it authority to commit those entities to making changes in, or terminating, that document." Id. The Second Circuit concluded that the record was not clear regarding whether the individual defendant himself—without receiving further authorization—could commit the customer or its feeder funds to terminate the agreement. Id. at *5–6. The Court thus vacated the judgment and remanded for further proceedings to consider whether that determination could be made on a renewed motion for summary judgment or would require expansion of the factual record or a trial. Id. at *7.
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