Rubenstein v. Int'l Value Advisers, LLC

959 F.3d 541

Aaron RUBENSTEIN, Plaintiff-Appellant,

v.INTERNATIONAL VALUE ADVISERS, LLC, Charles de Vaulx, Charles de Lardemelle, Defendants-Appellees,Adtalem Global Education Services (f/k/a DeVry Education Group, Inc.), Nominal Defendant-Appellee,John Doe, an unidentified IVA client, Defendant.

No. 19-560-cv

August Term 2019

United States Court of Appeals, Second Circuit.

Argued October 23, 2019

Decided May 20, 2020

Miriam Tauber (David Lopez, Law Office of David Lopez, Southampton, NY, on the brief), Miriam Tauber Law PLLC, New York, NY, for Plaintiff-Appellant.

Dennis Henry Tracey, III (Robin Muir, on the brief), Hogan Lovells US LLP, New York, NY, for Defendants-Appellees.

Susan Saltzstein, Skadden, Arps, Slate, Meagher & Flom LLP, New York, NY, for Nominal Defendant-Appellee.

Before: KEARSE, PARKER, and SULLIVAN, Circuit Judges.

BARRINGTON D. PARKER, Circuit Judge:

Plaintiff-Appellant Aaron Rubenstein appeals from an order of the United States District Court for the Southern District of New York (Engelmayer, J. ) dismissing, under Rule 12(b)(6), his complaint alleging violations of Section 16(b) of the Securities Exchange Act of 1934 (the " ‘34 Act"). The issue presented is whether a client of an investment advisor became a member of a Section 13(d) group with his investment advisor and the advisor’s other clients merely because he and the other clients had delegated discretionary investment authority to the advisor and the advisor had purchased for the client’s account shares of the same issuer that was the subject of the advisor’s Schedule 13D filing. We agree with the court below that the client did not thereby become a member of a group and that the client was not obliged to disgorge his short-swing profits. Accordingly, we affirm the order of the district court.

To prevent insiders of a securities issuer from trading on material non-public information, Section 16(b) of the Securities Exchange Act of 1934 imposes strict liability on certain insiders of an issuer, requiring them to disgorge to the issuer any profits they realize from short-swing trading in the issuer’s securities. As defined by Section 16(b), short-swing trading is "any purchase and sale, or any sale and purchase, of any equity security of such issuer ... within any period of less than six months ... irrespective of any intention on the part of [the insider]." 15 U.S.C. § 78p(b). Among the insiders subject to the rule are directors and officers of the issuer, as well as "[e]very person who is directly or indirectly the beneficial owner of more than 10 percent of any class of any equity security" of the issuer. Id.¹ Section 16(b) is known as the "short-swing profit rule."

In addition to requiring individual statutory insiders to disgorge short-swing profits, the ’34 Act provides for "group" liability. Section 13(d)(3) provides that "[w]hen two or more persons act as a ... group for the purpose of acquiring, holding, or disposing of securities of an issuer," the group shall be deemed a "person" subject to Section 16(b). Id. § 78m(d)(3).² A group is formed "[w]hen two or more persons agree to act together for the purpose of acquiring, holding, voting or disposing of equity securities of an issuer." 17 C.F.R. § 240.13d-5(b)(1). The group is then "deemed to have acquired beneficial ownership ... of all equity securities of that issuer beneficially owned by any [group members]." Id. Consequently, if members of a group collectively hold more than 10% of any class of equity securities of an issuer, each member of the group is subject to the short-swing profit rule. See id. § 240.16a-1(a)(3). The dispositive issue on this appeal is whether John Doe, an anonymous defendant, became a member of such a group.

Defendant International Value Advisers ("IVA") is an investment advisor registered under Section 203 of the Investment Advisers Act of 1940. Defendants Charles de Vaulx and Charles de Lardemelle are the managing members of IVA, as well as portfolio managers for IVA-managed funds and separately managed client accounts. Rubenstein holds shares in Adtalem Global Education Services, formerly known as DeVry Education Group ("DeVry"). The "John Doe" defendant is the owner of a brokerage trading account managed by IVA, and IVA exercises discretionary authority over that account. That account holds shares of DeVry selected and purchased for it by IVA acting as its investment manager. Although that account does not hold more than 10% of DeVry shares, John Doe, the IVA defendants, and IVA’s other clients collectively owned 19.5% of DeVry’s outstanding common stock.

Between June and December 2016, the IVA defendants reported on ownership reports filed under Section 13(d) and Section 16(a) of the ’34 Act that they beneficially owned, through their voting and investment power over their advisee-clients, more than 10% of DeVry’s outstanding common stock. Specifically, at various times in 2016, the IVA defendants filed Schedule 13Ds with the SEC indicating that, in accumulating their position in DeVry, they had formed a "control purpose" with respect to DeVry and that they sought the appointment of IVA’s managing partner to the DeVry board to represent the investment interests of IVA and its clients who held DeVry shares.

No one disputes that, at this point, the IVA defendants were subject to Section 16(b)’s short-swing profit rule. In July 2016, IVA, as investment manager for John Doe’s account, purchased 31,847 shares of DeVry and within six months sold DeVry shares at a profit. If John Doe were a member of a group with the IVA defendants and their other clients, he would have been a statutory insider subject to the short-swing profit rule because the IVA defendants were insiders and their clients collectively owned more than 10% of DeVry common stock. If not, he would not have been subject to the rule. Accordingly, what the parties contest is whether John Doe was a member of an insider group with IVA and its clients and consequently obligated to return the short-swing profits.

Rubenstein sued, alleging that John Doe was a member of a group with the IVA defendants and IVA’s other clients. He contended that John Doe’s investment management agreement with IVA qualified as an agreement to trade in the securities of an issuer under Section 13(d). He further theorized that the IVA defendants’ filing of a Schedule 13D automatically caused John Doe to become a member of a group by "silent acquiescence." In other words, Rubenstein alleged that the filing of the Schedule 13D put an owner of DeVry shares in a managed account (such as John Doe) on notice of the IVA defendants’ control purpose and that the owner thereby "agreed" to become part of the group by failing to terminate the IVA defendants’ control of the managed account.

Defendants moved to dismiss the complaint and the district court granted the motion. The court observed that the touchstone of a group under Section 13(d) is that its members combined in furtherance of a common objective. The court held that the complaint did not plausibly allege a common objective between the IVA defendants, who had a control purpose, and John Doe, whose DeVry shares had been purchased for his account on a discretionary basis by his investment manager. In other words, the court held that Rubenstein had not plausibly pled the existence of a Section 13(d) agreement. Rubenstein v. Int’l Value Advisers, LLC , 363 F. Supp. 3d 379, 394-95 (S.D.N.Y. 2019).

The court further concluded that the applicable Section 13(d) rule, in addition to requiring an agreement, required its members to have acted together for the purpose of acquiring not just any security but the securities of "an issuer," meaning a particular issuer. Because the complaint did not plausibly allege that this had occurred, the court determined that John Doe did not become a member of a 13(d) group and could not be required to return his DeVry profits. Id. at 392.

This appeal followed. "We review a district court’s grant of a motion to dismiss under Rule 12(b)(6) de novo ." Edwards v. Sequoia Fund, Inc. , 938 F.3d 8, 12 (2d Cir. 2019) ; see also Ashcroft v. Iqbal , 556 U.S. 662, 678, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009) ; Bell Atl. Corp. v. Twombly , 550 U.S. 544, 555-56, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007).

DISCUSSION

Resolution of this appeal turns on whether John Doe was a member of an insider group. We hold that he was not. Our holding follows from the text and structure of the ’34 Act and its implementing regulations, as well as the legislative purpose behind the short-swing profit rule. Moreover, we are unmoved by Rubenstein’s arguments to the contrary, which are based either on a misunderstanding of certain regulatory exemptions or on erroneous legal positions.

I.

A Section 13(d) group is formed "[w]hen two or more persons agree to act together for the purpose of acquiring, holding, voting or disposing of equity securities of an issuer." 17 C.F.R. § 240.13d-5(b)(1). The group is then deemed to have acquired beneficial ownership of all equity securities of that issuer beneficially owned by any group members. If the group’s collective holdings exceed 10% of any class of the issuer’s outstanding equity securities, then each group member is subject to the short-swing profit rule. See id. § 240.16a-1(a)(3).

Rubenstein does not allege that any defendants are liable for short-swing profits except John Doe, who realized the profits in an account managed for him by IVA. It is not disputed that the other defendants were statutory insiders who would have been obligated to return short-swing profits had they realized them. They were required to file, and did file, Schedule 13Ds.

Rubenstein relies principally on the theory that IVA’s clients became members of a group with their investment advisor and its other clients when they signed investment management agreements delegating discretionary trading authority to IVA. We do not agree. Rubenstein’s theory is incompatible with the...