Allaire Corporation v. Ahmet H. Okumus, Okumus Capital, Llc, Okumus Opportunity Fund, Ltd., Okumus Technology Value Fund, Ltd., Okumus Advisors, Llc, Okumus Opportunity Partners, Lp, Okumus Technology Advisors, Llc, and Okumus Technology Value Partners, Lp, Docket No. 04-2149-Cv

Citation: 433 F.3d 248Docket: 248

Court: Court of Appeals for the Second Circuit; January 4, 2006; Federal Appellate Court

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Allaire Corporation, a Delaware corporation whose stock is traded on NASDAQ, filed a lawsuit against Ahmet H. Okumus and associated entities, alleging violations of Section 16(b) of the Securities Exchange Act of 1934. The complaint asserts that Okumus, deemed a "statutory insider," engaged in short-swing trading by writing call options on Allaire stock on November 17, 2000, and subsequently acquiring enough shares to qualify as an insider on November 20, 2000. Allaire contends that the expiration of the November call options on December 16, 2000, constituted a "purchase" of stock, while the writing of new call options on January 16, 2001, represented a "sale." They argue these transactions should be matched for liability under Section 16(b) for profits earned by Okumus. The district court dismissed the case under Rule 12(b)(6), ruling that the expiration of the November calls was not a valid purchase under SEC regulations, leading Allaire to appeal the decision. The appellate court reviews the dismissal de novo, affirming that a complaint can only be dismissed if it is clear that no facts could support a claim for relief.

To prevent the misuse of information potentially acquired by beneficial owners due to their relationship with the issuer, any profit from the purchase and sale, or sale and purchase, of equity securities (excluding exempted securities) within six months must be returned to the issuer, regardless of the owner's intent regarding the duration of holding the security. This rule does not apply to transactions where the beneficial owner was not in that position during both the purchase and sale, nor to transactions exempted by the Commission. An "insider" is defined as anyone who beneficially owns more than 10% of any class of registered equity security. A "short swing" trade refers to transactions occurring within six months of each other. The SEC has defined "equity security" broadly, encompassing any related equity or derivative security. Under relevant case law, broad definitions of 'purchase' and 'sale' can apply to various transactions. In 1991, the SEC introduced regulations for section 16(b) concerning derivative securities, establishing that the creation or increase of a call equivalent position is treated as a purchase, while a put equivalent position is treated as a sale. The main legal question is whether the expiration of a short call option counts as a purchase under Rule 16b-6(a), which could subject the insider to liabilities under section 16(b) if subsequent call options are written within six months.

Allaire interprets Rule 16b-6(a) to assert that the expiration of a call option constitutes a "purchase" under the rule, as it represents a liquidation of a "put equivalent position." A "put equivalent position" is defined as a derivative security that gains value when the underlying equity decreases, which includes short call option positions where the writer is obligated to sell the security at the strike price if the option is exercised. Allaire argues that if the option expires unexercised, the writer’s obligation ceases, thus constituting a purchase that should be matched with previous sales, establishing liability under section 16(b).

However, this interpretation contradicts the statutory intent of section 16(b), which is designed to hold traders accountable only for transactions that enable them to profit from insider information. Previous rulings suggest that the exercise of options by holders is a "non-event" for the writers, as they cannot exploit inside information after agreeing to the option's terms. Therefore, the district court concluded that the terms "establishment" and "liquidation" in Rule 16b-6(a) pertain only to the initial transaction between option writer and holder, not to the expiration of the option. Allaire acknowledges that the exercise of an option is a non-event for the writer but attempts to distinguish this from expiration by noting the writer’s ability to close the position before exercise.

An insider can be liable under section 16(b) without participating in a transaction due to their ability to choose whether to buy or sell stock within a six-month period. The focus is on the insider's actual actions rather than potential actions. Rule 16b-6(d) specifies that if an option is canceled or expires within six months of being written, any profit from writing the option is recoverable under section 16(b), limited to the premium received. This provision establishes that insiders who write a put option are liable for any premium received if the option expires unexercised within six months, qualifying as a "sale" under section 16(b). Allaire's interpretation of Rule 16b-6(a) would make Rule 16b-6(d) redundant, as it would imply that the expiration of a call option is already covered under Rule 16b-6(a). The explicit mention of "expiration" in Rule 16b-6(d) indicates the SEC’s awareness of its significance, suggesting that its omission from Rule 16b-6(a) was intentional. The specific trades in question do not fall under Rule 16b-6(d) since the options written by Okumus relate to different shares than those that expired, thus not triggering liability.

The SEC has indicated that the expiration of a call option more than six months after its writing is considered an exempt closing of a derivative security position for the writer, provided no value is exchanged during the expiration. This position was articulated in a no-action letter to Sullivan & Cromwell, which stated that such an expiration should not be viewed as a purchase by the writer that would trigger liability under Rule 16b-6(a). The letter is persuasive but not binding, and its interpretation aligns with the understanding that while writing an option constitutes a "transaction" under section 16(b), its expiration does not, especially when paired with other transactions. The judgment of the district court is affirmed based on these findings. Additional notes clarify that the relevant law and definitions related to derivative securities and options remain unchanged despite amendments made in 2000. Rule 16b-6(c) further suggests that if the SEC intended for expiring options to incur insider liability when matched with other transactions, it would have provided guidance on calculating profits in such scenarios, which it did not.