Gryl ex rel. Shire Pharmaceuticals Group PLC v. Shire Pharmaceuticals Group PLC

Citations: 298 F.3d 136; 2002 WL 1788054Docket: No. 01-9139

Court: Court of Appeals for the Second Circuit; August 5, 2002; Federal Appellate Court

SummaryOriginalCytator Case TreatmentBackward CitatorAnalysis

EnglishEspañolSimplified EnglishEspañol Fácil

Plaintiffs Frank and Barbara Gryl, on behalf of Nominal Defendant Shire Pharmaceuticals Group PLC, seek to compel the disgorgement of short-swing profits made by Defendants Zola Horovitz, Ronald Nordmann, and John Spitznagel, who are individual defendants and directors of Shire. This derivative action is based on Section 16(b) of the 1934 Securities Exchange Act, which mandates that profits from the purchase and sale of an issuer's securities by a director within six months be returned to the issuer to prevent misuse of insider information. The U.S. District Court for the Southern District of New York dismissed the complaint, finding that the defendants' transactions fell under exemptions to the prohibition against short-swing profit taking. The court affirmed this dismissal based on Rule 16b-3(d)(1), which allows issuer-to-insider transactions approved by the issuer's board.

The relevant transactions arose from a merger between Roberts Pharmaceutical Corporation and Shire, which occurred on December 23, 1999. Before the merger, the individual defendants were directors and stock option holders of Roberts. Post-merger, they became directors of Shire, and their Roberts options were converted to Shire options. Less than six months after the merger, the defendants exercised their Shire options and sold the shares for profit. The plaintiffs filed the derivative action on December 4, 2000.

Plaintiffs sought to compel individual defendants to disgorge profits from short-swing sales of Shire shares under Section 16(b) of the 1934 Securities Exchange Act. The defendants moved to dismiss the complaint, claiming exemptions based on three rules: Rule 16a-2(a) for pre-officer transactions, Rule 3a12-3(b) for transactions involving foreign private issuers, and Rule 16b-3(d) for issuer-to-insider transactions approved by the board. They also argued that receiving converted stock options in a merger did not constitute a "purchase" under Section 16(b). The District Court, in its August 30, 2001 decision, agreed that all three exemptions applied but did not resolve the "purchase" issue regarding converted stock options. Plaintiffs appealed the ruling on the exemptions, while defendants reiterated their position on the meaning of "purchase." The court affirmed the dismissal based solely on Rule 16b-3(d)(1), stating that the board’s approval exempted the defendants from Section 16(b) liability. The court did not address the other two exemptions or the "purchase" question. The appeal focused on whether the defendants' transactions were exempt under Rule 16b-3(d)(1), which requires board approval for issuer-to-insider transactions to be exempt from liability.

The transaction must meet three criteria to qualify for the Board Approval Exemption: (1) the defendant must acquire issuer equity securities from the issuer; (2) the defendant must be a director or officer of the issuer at the time of the transaction; and (3) the transaction must receive prior approval from the issuer’s board of directors. 

1. **Acquisition of Issuer Equity Securities**: All individual defendants received stock options from Shire as part of a merger. Under Section 16(b) rules, acquiring a securities option is treated as acquiring the underlying security.

2. **Issuer-to-Insider Transaction**: The plaintiffs allege that the individual defendants became directors at the same time they received their options. This is crucial for establishing liability under Section 16(b), which generally does not apply to individuals who are not directors or insiders at the time of acquiring issuer equity securities.

3. **Approval by the Issuer’s Board**: For transactions involving multiple securities, Rule 16b-3(d)(1) does not require separate approval for each transaction. A board's approval of an overall plan suffices, provided the plan establishes fixed terms and conditions for the transactions in advance, such as through a formula plan.

   - **Formula Plan**: The SEC defines a formula plan as one that specifies the amount, price, and timing of securities transactions using objective criteria. Such a plan must be prescriptive enough to prevent insiders from controlling the terms of their awards, thus minimizing the risk of insider trading. The SEC emphasizes that the board's approval should reflect accountability for its decisions regarding the securities transactions that will arise from the formula plan.

The adequacy of the formulae in a securities grant plan is contingent upon the corporate context of the award. If securities are provided as special compensation to a few insiders, there is a heightened scrutiny for specificity. Conversely, if they are granted broadly to all eligible option holders in the context of a significant corporate event, such as a merger, the need for detailed specificity is reduced. In this case, Article VI, Paragraph 6.1(a) of the Merger Agreement encapsulated a formula plan that met the criteria for the Board Approval Exemption. This provision fixed the relevant terms for converting Roberts options into Shire options, specifying the recipients (all holders of Roberts options), the timing (at the Merger's Effective Time without action from option holders), the quantity (based on the number of Roberts options held and a stipulated exchange ratio), and the exercise price (calculated from the old Roberts option price divided by the exchange ratio). The terms governing the converted Shire options would mirror those of the Roberts options, ensuring no discretion for holders to alter the conversion terms. 

Plaintiffs argued that the Merger Agreement lacked detailed information, such as the names and exact quantities of individuals holding Roberts options. While acknowledging that such details could enhance the plan's clarity, the court noted that strict precision is not mandatory, especially since the missing information did not allow for manipulation by beneficiaries. All holders of Roberts options would receive Shire options, and the Shire board was aware of these provisions. 

Additionally, the court confirmed that the full Shire board had approved the Merger Agreement, as evidenced by a public document referenced by the plaintiffs in their complaint.

On November 22, 1999, Shire submitted its Form F-4 Registration Statement to the SEC, which included the executed Merger Agreement and a summary of its key components, notably the option conversion plan. The Registration Statement indicated that the Shire board discussed and conditionally approved the Merger Agreement on July 22, 1999, pending further approval from a special committee and Shire's shareholders. All of Shire's directors signed the Registration Statement. The plaintiffs did not dispute the accuracy of this document or the board's approval but argued that the conditional nature of the approval did not meet the legal requirements for the Board Approval Exemption under Section 16(b). They contended that the board's failure to explicitly indicate that its approval of the option conversion was intended to invoke this exemption constituted a legal deficiency. However, it was noted that the Board Approval Exemption does not necessitate that board approval be the final step in granting securities, and the plaintiffs' interpretation was undermined by the SEC's amicus brief, which clarified that the exemption could apply even if further approvals were needed. The court distinguished between the multiple approvals required for the Merger itself and the singular board approval needed for the exemption, concluding that the latter was satisfied. The plaintiffs' argument for a specific approval intention was also dismissed, as the SEC's current stance advised against requiring such explicit designation, and previous no-action letters did not warrant deference in this context.

The imposition of purpose-specific approval on the Board Approval Exemption is deemed unpersuasive, aligning with the District Court's conclusion and the ruling in Atlantic Tele-Network v. Prosser. The Skadden No-Action Letter fails to provide justification for such a requirement, and the rule itself focuses solely on whether the transaction's terms received board approval, without regard to the approving body’s motivations. The Board Approval Exemption was designed to simplify and provide flexibility for transactions between issuers and their directors or officers, recognizing that these transactions generally do not present the same insider profit risks as market transactions. The SEC indicated that transactions meeting objective conditions are not prone to the speculative abuses Section 16(b) aims to prevent. Therefore, as long as a transaction is between an issuer and an insider and receives advance board approval, it is sufficiently protected from unfair market manipulation, negating the need for purpose-specific approval to qualify for the Board Approval Exemption under Rule 16b-3(d)(1). The court affirms that the individual defendants' acquisition and sale of Shire securities are exempt from liability under Section 16(b) of the 1934 Securities Exchange Act. The merger involved a stock swap, converting Roberts stock into Shire stock. Rule 16b-3(d)(1) allows approval by a committee of two or more Non-Employee Directors, which is not contested in this appeal. Rule 16a-2(a) specifies conditions under which individuals can be liable for short-swing transactions executed before they became officers or directors, provided such transactions occurred within six months of the relevant Form 4 filing obligation.

Plaintiffs' argument regarding the possibility of a Roberts option holder exercising options before the Merger's effective date does not impact the option conversion plan, as the maximum number of options to be converted was predetermined in the Merger Agreement. Until the effective time, Roberts is prohibited from issuing any equity equivalents. The option conversion plan stipulates that Shire will assume Roberts' stock option plans, adjusting the number of options and exercise prices based on an exchange ratio. The terms of the options post-effective time will mirror those in effect prior. The Shire board's delegation of final approval to a committee was limited to administrative tasks, and the plaintiffs' argument regarding Board Approval Exemption is dismissed; compliance with Rule 16b-3(d)(1) is met as the transaction occurs between the issuer and its directors or officers. The court emphasizes the validity of legislative regulations over non-binding SEC no-action letters, which are merely staff interpretations and not formal Commission actions, thus holding less weight in legal considerations.