Packer v. Raging Capital Mgmt., LLC, Docket Nos. 19-2703

981 F.3d 148

Brad PACKER, derivatively on behalf of 1-800-Flowers.com, Inc., Plaintiff - Appellee-Cross-Appellant,

v.RAGING CAPITAL MANAGEMENT, LLC, Raging Capital Master Fund, Ltd., William C. Martin, Defendants - Appellants-Cross-Appellees,1-800-Flowers.com, Inc., Defendant.

Docket Nos. 19-2703

19-2852

August Term 2020

United States Court of Appeals, Second Circuit.

Argued: August 17, 2020

Decided: November 23, 2020

Thomas J. Fleming, Olsham Frome Wolosky LLP, New York, NY (Martin D. Edel, Goulston & Storrs P.C., New York, NY, David M. Zucker, Goulston & Storrs P.C., Boston, MA, on the brief), for Defendants-Appellants-Cross-Appellees William C. Martin, Raging Capital Master Fund, Ltd., and Raging Capital Management, LLC.

Paul D. Wexler, New York, NY (Glenn F. Ostrager, Joshua S. Broitman, Roberto L. Gomez, Ostrager Chong Flaherty & Broitman P.C., New York, NY, on the brief), for Plaintiff-Appellee-Cross-Appellant Brad Packer.

(Douglas A. Rappaport, Akin Gump Strauss Hauer & Feld LLP, New York, NY, Z. W. Julius Chen, Akin Gump Strauss Hauer & Feld LLP, Washington, DC, Alan L. Dye, Hogan Lovells US LLP, Washington, DC, for amicus curiae Managed Funds Association, in support of Defendants-Appellants-Cross-Appellees.)

Before: NEWMAN, POOLER Circuit Judges.¹

JON O. NEWMAN, Circuit Judge:

The issue on this appeal is whether the customer of a regulated investment advisor was the beneficial owner of more than ten percent of the shares of 1-800-Flowers.com, Inc. ("Flowers"), which were bought and sold within an interval of six months² ("trading period"), a transaction for which section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b), requires a beneficial owner to disgorge such short-swing profits. Appellants Raging Capital Management, LLC ("RCM"), Raging Capital Master Fund, Ltd. ("Master Fund"), and William C. Martin appeal from the Aug. 21, 2019, judgment of the District Court for the Eastern District of New York (Gary R. Brown, Magistrate Judge), requiring Master Fund to disgorge $4,909,393 in short-swing profits in a derivative suit brought by Appellee Brad Packer on behalf of 1-800-Flowers.com, Inc. Packer cross-appeals from the denial of prejudgment interest.

We conclude that factual issues remain on the issue of whether Master Fund was the beneficial owner of the shares, and we therefore vacate the judgment against Master Fund and remand for further proceedings. In view of that ruling, we dismiss Packer's cross-appeal as moot.

Background

Understanding the complicated factual background requires identification of four entities and several individuals:

RCM is a Delaware limited liability company, which is a registered investment advisor as defined by the Investment Advisers Act of 1940, 15 U.S.C. § 80b-2(a)(11).³

Master Fund is a Cayman Islands corporation, which is an investment fund and a customer of RCM.

Raging Capital Offshore Fund ("Offshore") is a Cayman Islands corporation, which is also a customer of RCM.

Raging Capital Fund (QP), LP ("QP"), is a Delaware limited partnership, which is also a customer of RCM.

Both Offshore and QP accept investments from the public and funnel these investments to Master Fund.

Offshore and QP are referred to in this litigation as "feeder funds." The feeder funds together own 100 percent of Master Fund's "Common Shares." During the trading period, the feeder funds had about 143 investors and now have about 230 investors.

Martin holds positions in RCM, Master Fund, and Offshore, and indirectly has a role in QP. He is the chairman, chief investment officer, and managing member of RCM, and owns most, and possibly all, of its shares.⁴ Martin is also a member of the three-member board of directors of Master Fund. During the trading period, the other two directors of Master Fund were two Cayman Island LLCs, DMS Fund Governance I Ltd. ("DMS I") and DMS Fund Governance II Ltd. ("DMS II"), characterized by Martin as "directors services firms." Since November 2015, the other two directors of Master Fund have been Don Ebanks and Wade Kenny.⁵

Martin is also a member of the three-member board of Offshore. During the trading period, the other two directors of Offshore were Ebanks and Kenny, although Kenny is no longer a director.

Martin is a limited partner of QP. The general partner of QP is RCM, which is controlled by Martin.

The relationship among RCM, Master Fund, Offshore, and QP is governed by an Investment Management Agreement ("IMA"), which was executed on November 9, 2012. Martin signed the IMA on behalf of all four parties to the agreement. Under the terms of the IMA, RCM makes "[a]ll investment decisions" for Master Fund, Offshore, and QP ("the Funds"), A-29, has "exclusive[ ] ... control and discretion" over purchase or sale of the Funds’ securities, A-30, and has "the sole authority to exercise all rights, powers, privileges, and other incidents of ownership or possession (including but not limited to, voting power) with respect to all such securities and financial instruments held by the Master Fund," A-29-A-30. By these provisions of the IMA, the Defendants contend, Master Fund has delegated beneficial ownership of the Flowers shares to RCM.

Especially relevant to this appeal, the termination provision of the IMA states:

(b) any party may terminate this Agreement effective at the close of business on the last day of any fiscal quarter by giving the other party not less than sixty-one days’ written notice; provided, however, that (i) unanimous consent of shareholders of the Cayman Feeder [Offshore] is required for the Cayman Feeder to terminate this Agreement under (b) of this Section 9 and (ii) unanimous consent of the partners of the U.S. Feeder [QP] is required for the U.S. Feeder to terminate this Agreement under (b) of this section 9.

A-102.

The litigation . In October 2015, Packer filed a complaint derivatively on behalf of Flowers against RCM, Master Fund, and Martin to obtain disgorgement of profits resulting from a short-swing sale of Flowers stock. The Complaint alleged that the three defendants were a group for purposes of determining beneficial ownership and that the group had beneficial ownership of more than ten percent of Flowers Class A common stock.⁶ On consent, the case was referred to Magistrate Judge Brown. In August 2019, with respect to the alleged section 16(b) violation, the District Court granted the Plaintiff's motion for summary judgment, denied the Defendants’ motion for summary judgment, and ordered entry of judgment against Master Fund in the amount of $4,909,395; the District Court denied Packer's claim for prejudgment interest. See Packer v. Raging Capital Management, LLC, No. 15-CV-5933, 2019 WL 3936813 (E.D.N.Y. Aug. 20, 2019).⁷ RCM, Master Fund, and Martin timely appealed. Packer cross-appealed from the denial of prejudgment interest.

Discussion

Section 16(b) of the Exchange Act requires a "beneficial owner" of more than ten percent of a company's shares to disgorge profits obtained from a short-swing sale. 15 U.S.C. § 78p(b). In 1991, the SEC promulgated Rule 16a-1, which—"[s]olely for purposes of determining whether a person is a beneficial owner of more than ten percent [of an issuer's shares]—defined "beneficial owner" as "any person who is deemed a beneficial owner pursuant to section 13(d) of the Act." 17 C.F.R. § 240.16a-1(a)(1). In turn, Rule 13d-3 provides:

(a) For purposes of section 13(d) ... of the Act a beneficial owner of a security includes any 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 direct the disposition, of such security.

17 C.F.R. § 240.13d-3(a). Rule 13d-3 also provides that a person is deemed to be a beneficial owner of a security if that person has the right to acquire beneficial ownership of such security within sixty days. See 17 C.F.R. § 240.13d-3(d)(1)(i).

In 2009, the SEC advised that if a security holder "has delegated all authority to vote and dispose of its stock to an investment advisor" and lacks "the right under the contract to rescind the authority granted ... within 60 days," the security holder does not need to "report beneficial ownership" of the securities. See SEC Division of Corporate Finance, Compliance and Disclosure Interpretations, Exchange Act Sections 13(d) and 13(g) and Regulation 13D-G Beneficial Ownership Reporting, Question 105.04 (Sept 14, 2009).⁸

In this case, the Defendants make two arguments to dispute Packer's contention that Master Fund was a beneficial owner of more ten percent of Flowers shares. The first builds on the undisputed premises that RCM, as a registered investment advisor, is an entity exempt from beneficial ownership of shares it holds on behalf of a customer by virtue of exclusion (v) of Rule 16a-1(a)(1), 17 C.F.R. § 240.161(a)(1),⁹ and that Martin is a control person with respect to RCM and exempt from beneficial ownership by virtue of exclusion (vii) of Rule 16a-1(a)(1), 17 C.F.R. § 240.161(a)(1).¹⁰ Then, the Defendants assert in part II(C) of the brief that RCM's exempt status somehow confers a derivative exempt status on Master Fund. The District Court properly rejected what it termed the Defendants’ "inoculation theory," stating, "There is no authority supporting the notion that an investor [Master Fund] can derivatively benefit from the exemption enjoyed by its registered investment advisor [RCM]." Packer , 2019 WL 3936813, at *2-*3. Nothing in Egghead supports Master Fund's argument that the registered investment advisor exception automatically extends to exempt all members of a group from beneficial ownership.

Master Fund endeavors to enlist Egghead.com, Inc. v. Brookhaven Management Co ., 340 F.3d 79 (2d Cir. 2003), in support of its exemption claims based on RCM's exemption. Egghead does not aid Master Fund. That...