On August 3, 2017, the United States Court of Appeals for the Second Circuit affirmed the dismissal of a “short-swing” trading suit brought by a shareholder in Herbalife, Ltd., Hologic Inc., and Nuance Communications, Inc. (the “Companies”), against investment entities controlled by Carl C. Icahn (“Icahn” and the “Icahn Entities”), that sought disgorgement of certain consideration the Icahn Entities allegedly received in violation of Section 16(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and regulations promulgated thereunder. Olagues v. Icahn et al., No. 16‐1255‐cv (2d Cir. Aug. 3, 2017). Plaintiff acknowledged that the Icahn Entities disgorged premiums on certain put options that were cancelled unexercised within six months of their sale, as required by Section 16(b), but alleged that the Icahn Entities should have also disgorged the “value” of alleged discounts that Icahn received on purchases of related call options. In affirming the district court’s decision, the Second Circuit ruled that plaintiff failed to state a plausible claim for additional disgorgement by the Icahn Entities.
Section 16(b) of the Exchange Act aims to prevent corporate insiders, who are presumed to possess material information about the corporation, from earning short‐swing profits by buying and selling securities within a six‐month period. Rule 16b-6(d), which was promulgated by the Securities and Exchange Commission, applies where an insider receives a premium for writing (that is, selling) an option that is cancelled or expires unexercised within six months. 17 C.F.R. § 240.16b‐6(d).
According to the complaint, the Icahn Entities exercised the call options on the Companies and, as required by the governing contracts, the put options automatically cancelled. Because the cancellation of the put options occurred within six months after their writing, Icahn was required to (and did) disgorge the premiums received for writing them. Plaintiff alleges that, in addition to the premiums the Icahn Entities disgorged on the put options, they also received certain undeclared consideration in the form of discounts on premiums they paid to buy the corresponding call options. Plaintiff alleges that the Icahn Entities agreed to charge counterparties lower premiums for the put option contracts in exchange for paying the counterparties lower premiums for the call option contracts and the “value” of the discounts had to be disgorged under Rule 16b-6(d). In support, plaintiff pointed to premiums associated with similar option contracts that were allegedly available on the open market when the Icahn transactions occurred.
In affirming dismissal of the complaint, the Second Circuit focused on the plaintiff’s exclusive reliance on comparisons to options traded on the open market. The panel found that these open-market options had “no meaningful similarities to the options at issue here” and therefore concluded that plaintiff failed to allege that the Icahn Entities disgorged less than the total amount of premiums they actually received. In issuing this ruling, the Second Circuit emphasized the “limited nature” of its holding, as its conclusion that the complaint did not state a claim for relief reflected plaintiff’s exclusive reliance upon open market options that were not truly comparable to the options at issue in this case.
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