On October 19, 2017, the United States Court of Appeals for the Second Circuit, in a summary order, affirmed dismissal of an action seeking disgorgement of alleged short-swing profits realized by Defendants Eminence Partners II, L.P. and related entities in connection with their sale of common stock in The Men’s Wearhouse, Inc. (“Men’s Wearhouse”) under Section 16(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), 15 U.S.C. § 78p(b). Morrison v. Eminence Partners II, LP, No. 17-843 (2d Cir. Oct. 19, 2017). The Second Circuit held that plaintiff lacked standing under Section 16(b) because his shares of Men’s Wearhouse stock were exchanged for shares in its parent company, Tailored Brands, Inc. (“Tailored Brands”), in a corporate reorganization that was completed before the lawsuit was filed.
Section 16(b) aims to prevent corporate insiders from earning short-swing profits from buying and selling securities within a six-month period because they are presumed to possess material information about the company. Claims under Section 16(b) can be filed either by “the issuer, or by the owner of any security of the issuer.” 15 U.S.C. § 78p(b). The district court dismissed the action because the plaintiff no longer held stock in Men’s Wearhouse, which was the “issuer” of the securities involved in the short-swing trades at the time the complaint was filed, but instead held shares in the issuer’s parent, Tailored Brands, as a result of the reorganization.
In affirming dismissal, the Second Circuit, citing Gollust v. Mendell, 501 U.S. 115, 123-24 (1991), observed that “the security must be held in the ‘issuer’ to whom the short-swing profits would accrue” when a Section 16(b) action is instituted. The panel clarified that the meaning of “issuer” in this context includes only the corporation that “actually issued” the security, and “does not include parent or subsidiary corporations of the issuer.” (emphasis supplied). Plaintiff argued on appeal that (i) his claim was an “asset” that transferred from Men’s Wearhouse to Tailored Brands in the reorganization pursuant to Rule 414(b) promulgated under the Exchange Act and he therefore had standing as a stockholder of Tailored Brands, and (ii) the standing requirement of Section 16(b) should be excused because the corporate reorganization was a fraudulent attempt to deprive him of standing.
The Second Circuit rejected both arguments. First, the Second Circuit held that Rule 414(b), which provides that an issuer succeeds to another company’s Exchange Act filing obligations, was unrelated to Section 16(b). The Second Circuit considered it significant that the SEC had proposed other rules that would have authorized Section 16(b) suits by holders of the securities of a successor issuer but withdrew them. Moreover, the panel distinguished precedent for a “successor-in-interest exception” that sometimes allows Section 16(b) claims to proceed under limited circumstances where an issuer has been “merged out of existence” before a claim could be filed on the ground that, here, Men’s Wearhouse remains a viable corporate entity. Finally, the panel rejected plaintiff’s argument that he had been fraudulently deprived of standing as insufficiently pleaded and in any event implausible because the reorganization was announced before the plaintiff’s Section 16(b) demand.
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