SWEET, District Judge.
This case arises out of the litigations stemming from the May 18, 2012 initial public offering ("IPO") of Facebook, Inc. ("Facebook"). Pursuant to the transfer order from the United States Judicial Panel on Multidistrict Litigation (the "MDL Panel"), entered on October 4, 2012, 41 actions relating to this underlying event are presently before this Court.
In the instant motion, Defendants Morgan Stanley & Co. LLC ("Morgan Stanley"), J.P. Morgan Securities LLC ("J.P. Morgan"), and Goldman Sachs & Co. ("Goldman") (collectively, the "Lead Underwriters") move pursuant to Rule 12(b)(6) to dismiss the complaint (the "Complaint") filed by Plaintiff Robert Lowinger ("Plaintiff" or "Lowinger"), which seeks disgorgement of "short-swing" profits allegedly earned by the Defendants from underwriting activities performed in connection with the IPO under Section 16(b) of the Securities Exchange Act of 1934.
For the reasons set forth below, the motion is granted.
The procedural history of this litigation has been detailed extensively in various opinions by this Court. See, e.g., In re Facebook, Inc., IPO Sec. & Deriv. Litig., 922 F.Supp.2d 475, 484-85 & 485 n. 4 (S.D.N.Y.2013).
With respect to the instant motion, Plaintiff alleges that he is a Facebook shareholder and that, on September 12, 2012, he made a demand on Facebook that it seek disgorgement of the profits obtained by the Lead Underwriters based on the facts alleged in the Complaint. (Compl. ¶ 47.)
When Facebook declined to bring suit, the instant action was filed on June 12, 2013. (Compl. ¶ 49.)
On October 16, 2013, the Leader Underwriters moved to dismiss Plaintiff's Complaint. This motion was heard and marked fully submitted on April 9, 2014.
Familiarity with the general background of this case is assumed. Certain allegations and facts are repeated in part as relevant to the issues presented by the instant motion.
On May 18, 2012, Facebook made a registered initial public offering of approximately 421 million shares of Class A common stock to investors at $38.00 per share. See In re Facebook, Inc., IPO Sec. & Deriv. Litig., 922 F.Supp.2d 475, 484-85 & 485 n. 4 (S.D.N.Y.2013).
Prior to the IPO, the Lead Underwriters entered into "lock-up" agreements with each of the Selling Shareholders, who together allegedly held greater than ten percent of Facebook's common stock. (Compl. ¶¶ 15, 17.) The lock-up agreements committed the Selling Shareholders "not to sell or otherwise dispose" of any Facebook common stock for periods of time following the IPO without Morgan Stanley's prior consent. (Compl. ¶ 15.) Plaintiff alleges that the "common purpose" of these lock-up agreements was "to control the supply of Facebook shares available to the market, which, in turn, was expected to provide support for the trading price of Facebook common stock." (Compl. ¶ 16.) Plaintiff further contends that the Lead Underwriters and the Selling Shareholders agreed to "act together" to achieve this common purpose, and that the Lead Underwriters were therefore beneficial owners of the Facebook shares
In April 2012, Facebook purportedly shared internal revenue projections with the Lead Underwriters of this agreement which were incorporated into research reports prepared by the underwriters and also shared at road shows marketing Facebook's IPO. (Compl. ¶¶ 20-21.) On May 7, 2012, Facebook allegedly revised its internal revenue projections and noted a continued trend of daily active users increasing more rapidly than the number of ads delivered, which Facebook attributed to increasing mobile usage among users and certain product decisions. (Compl. ¶ 22.) Facebook purportedly shared this concern with Morgan Stanley. (Compl. ¶¶ 22, 26.)
On May 9, 2012, Facebook amended its Registration Statement, informing investors of the continuing trend that Facebook had identified:
(Compl. ¶ 25.)
Similar to the consolidated complaint filed in the securities class action, Plaintiff alleges that this disclosure was false and misleading because it failed to sufficiently disclose "that these factors had already materially impaired Facebook's revenue." (Compl. ¶ 26; see also Consol. Class Action Compl. ("Securities Compl."), In re Facebook, Inc., IPO Sec. & Derivative Litig., MDL No. 12-2389(RWS), Dkt. No. 71, ¶¶ 129-30, 194.)
In addition, after filing the May 9 amendment, the Complaint alleges that Facebook called "select investment bankers and their securities analysts" to discuss Facebook's revision to its revenue projections. (Compl. ¶¶ 27, 29.) These calls purportedly followed a script prepared by Morgan Stanley and advised the analysts that Facebook believed that its second-quarter revenue would be at the "lower end of our $1.1 to $1.2 [billion] range ... based upon the trends [] described in the disclosure." (Compl. ¶ 30 (emphasis omitted).) Following the calls, the Complaint alleges that analysts for the Lead Underwriters then revised their second-quarter and full-year revenue estimates downward in response, but told "only a few `major clients'" of the changes. (Compl. ¶¶ 31-32, 38.)
According to Plaintiff, retail investors, not knowing these facts, purchased an unusually large proportion of the shares sold in the IPO driving up the price of Facebook's stock to as high as $45 on May 18, 2012, the first day of trading
Independently, the Complaint alleges additional violations against J.P. Morgan and Goldman Sachs, and against Goldman individually.
First, Plaintiff maintains that J.P. Morgan and Goldman purportedly obtained fees by lending out Facebook shares to short-selling clients "at the very same time" that they were acting as underwriters for the IPO
Second, the Complaint alleges that as of June 30, 2012, Goldman owned 9,507,859 shares of Facebook common stock, all purportedly purchased in May 2012 following the IPO, and that as of September 30, 2012, Goldman had sold 5,591,649 of those shares at prices higher than those at which they were acquired. (Compl. ¶¶ 43-45.) The Complaint also asserts that Goldman transacted in call and put options during this same period. (Id.) Plaintiff uses this activity to support the inference that Goldman engaged in short-swing profits. (Id.)
In turn, Defendants maintain that their actions regarding sales of stock prior to, during and following the IPO were commercially standard practice and in accordance with the relevant agreements and statutes.
The offering's Registration Statement and Prospectus, which are referenced in the Complaint, each explain that, in addition to the 421 million shares being sold to investors through the underwriting syndicate, Facebook and the Selling Shareholders had granted the underwriters "an option, exercisable for 30 days from the date of [the] prospectus, to purchase up to 63,185,042 additional shares of common stock at the public offering price ... for the purpose of covering over-allotments, if any, made in connection with the offering ...." (James P. Rouhandeh Declaration, "Rouhandeh Decl."; Ex. A (Facebook, Inc., Registration Statement (Form S-1/A) (May 16, 2012) ("Final S-1")) at 164; Ex. B (Facebook, Inc., Prospectus (May 17, 2012) ("Prospectus")) at 163); see also Amendments to Regulation M: Anti-Manipulation Rules Concerning Securities Offerings, Release No. 33-8511, 69 Fed.Reg. 75774, 75780 (Dec. 17, 2004) ("Amendments to Regulation M") ("In the typical offering, the syndicate agreement allows the managing underwriter to `oversell' the offering, i.e., establish a short position beyond the number of shares to which the underwriting commitment relates."); id. at n. 65 ("Underwriters requently receive an over-allotment option (`Green Show'), which is the right, but not the obligation,
Under the Prospectus, short positions created by over-allotments could also "be covered by exercising the [over-allotment] option or by purchasing shares in the market once secondary trading begins." Amendments to Regulation M, 69 Fed. Reg. at 75780. According to Defendants, this option of covering the short sales with market purchases enables the lead manager to stabilize and support an offering. "If the stock price declines immediately after the offering, the stabilization agent purchases shares in the aftermarket in order to cover the syndicate short position, and these purchases generate market demand and help support the price." Westenberg, Initial Public Offerings § 19:3.4. If the share price does not decline below the offering price, the lead manager can "exercise the over-allotment option (at the IPO price) ... and cover the syndicate short position with the additional shares purchased from the company." Id.
The Registration Statement similarly advised that "the underwriters may engage in transactions that stabilize, maintain or otherwise affect the price of the Class A common stock." (Rouhandeh Decl. Ex. A (Final S-1) at 166.) It explained that the underwriters could "sell more shares than they are obligated to purchase under the underwriting agreement, creating a short position" that they could cover either by exercising the over-allotment option and purchasing additional shares from Facebook and the Selling Shareholders at the fixed option price, or by purchasing additional shares from Facebook and the Selling Shareholders at the fixed option price, or by purchasing shares in the open market at the market trading price. Id.
Facebook advised investors that the underwriters' decision whether to cover their short position by exercising the over-allotment option or by purchasing in the market would be based on, among other things, "the open market price of shares compared to the price available under the over-allotment option." Id. It further explained that open-market purchases to cover over-allotment short positions, together with other transactions available to the underwriters, "may raise or maintain the market price of the Class A common stock above independent market levels or prevent or retard a decline in market price of the common stock." Id.
The Defendants maintain that their sales and purchases during the the relevant periods, and in particular during the distribution, were in compliance with such principles and regulations. (See Defendants' Memorandum in Support of Motion to Dismiss, "Def. Mem."; at 7-8 ("Nothing in the complaint disputes that a bona fide distribution in fact occurred.").)
In considering a motion to dismiss pursuant to Rule 12(b)(6), the Court construes the complaint liberally, accepting all factual allegations as true and drawing all reasonable inferences in the plaintiff's favor. SEC v. Gruss, 859 F.Supp.2d 653, 659 (S.D.N.Y.2012) (citations omitted); see also Anderson News, L.L.C. v. Am. Media, Inc., 680 F.3d 162, 168 (2d Cir.2012) (all conflicts and ambiguities are to be resolved in plaintiff's favor). The issue is not whether "a plaintiff will ultimately prevail but whether the claimant is entitled to offer evidence to support the claims." Gruss, 859 F.Supp.2d at 659.
Section 16 imposes obligations on specified insiders relating to their ownership of an issuer's equity securities registered pursuant to Section 12 of the Securities Exchange Act. See 15 U.S.C. § 78p.
Section 16(a) mandates that any director, officer or "beneficial owner of more than 10 percent of any class of any equity security (other than an exempted security)" of a company must report to the SEC the amount of all equity securities beneficially owned and must disclose any changes in such ownership. See id. § 78p(a); Roth ex rel. Leap Wireless Int'l, Inc. v. Goldman Sachs Grp., Inc., 873 F.Supp.2d 524, 529 (S.D.N.Y.2012), appeal docketed, Roth v. The Goldman Sachs Grp., Inc., No. 12-2509 (2d Cir. June 25, 2012).
Section 16(b) polices trading of securities by statutorily defined insiders. It provides in relevant part:
15 U.S.C. § 78p(b).
As the Second Circuit has explained, Section 16(b) serves to "deter `insiders,' who are presumed to possess material information about the issuer, from using such information as a basis for purchasing or selling the issuer's equity securities at an advantage over persons with whom they trade." Gwozdzinsky v. Zell/Chilmark Fund, L.P., 156 F.3d 305, 308 (2d Cir.1998) (footnote omitted).
To state a claim for disgorgement of short-swing profits under Section 16(b), a plaintiff must allege: (1) a non-exempt purchase and subsequent non-exempt sale (or a non-exempt sale and subsequent non-exempt purchase) of a class of an issuer's equity securities (2) within a six-month period (3) by a statutory insider. See id.
Congress designed Section 16(b) to be "`capable of easy administration'" and "to create rules that can be mechanically applied." Gibbons v. Malone, 703 F.3d 595, 603 (2d Cir.2013) (quoting Reliance Elec. Co. v. Emerson Elec. Co., 404 U.S. 418, 422, 92 S.Ct. 596, 30 L.Ed.2d 575 (1972)). To further that design, the statute "`imposes a form of strict liability' and requires insiders to disgorge these `short-swing' profits `even if they did not trade on inside information or intend to profit on the basis of such information.'" Credit Suisse Sec. (USA) LLC v. Simmonds, ___ U.S. ___, 132 S.Ct. 1414, 1417, 182 L.Ed.2d 446 (2012) (quoting Gollust v. Mendell, 501 U.S. 115, 122, 111 S.Ct. 2173, 115 L.Ed.2d 109 (1991)); see Gibbons, 703
The Complaint alleges both that (1) the Lead Underwriters, acting as a "group" with the Selling Shareholders, violated Section 16 and (2) Goldman individually, as a beneficial owner, engaged in short-swing profits prohibited under the statute. Each assertion will be addressed in turn.
Under the SEC's rules, the determinative inquiry in deciding whether a person is subject to reporting and disgorgement under Section 16 is whether the person is "a beneficial owner of more than ten percent of any class of equity securities" under Section 13(d) of the Securities Exchange Act and the rules thereunder. 17 C.F.R. § 240.16a-1; see also Levy v. Southbrook Int'l Invs., Ltd., 263 F.3d 10, 14-15 (2d Cir.2001). Any person who has voting or investment power over securities is deemed the beneficial owner of those securities. See 17 C.F.R. § 240.13d-3(a).
Section 13(d) also provides that:
15 U.S.C. § 78m(d)(3); see also 17 C.F.R. § 240.13d-5(b)(1) (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"). Each group member is deemed to beneficially own all equity securities owned by all other members of the group. See 17 C.F.R. § 240.13d-5(b)(1); Litzler v. CC Invs., L.D.C., 411 F.Supp.2d 411, 414 (S.D.N.Y.2006).
Morgan Stanley and J.P. Morgan as individual parties are not alleged to have owned the more than ten percent of Facebook's Class A stock required to qualify as "beneficial owners" for purposes of Section 16 during the relevant period
According to Plaintiff, because the purpose of the lock-up agreements, which required that a specified amount of Facebook securities be held by the Selling Shareholders for specified periods of time (see Compl. ¶ 15), was to facilitate the successful sale of Facebook stock in the IPO, the Lead Underwriters "combined" with
As noted, the statute and the implementing rule are both concerned with groups formed for the purpose of acquiring shares of an issuer. See 15 U.S.C. § 78m(d)(3); 17 C.F.R. § 240.13d-5(b)(1). Whether a group exists under section 13(d)(3) "turns on `whether there is sufficient direct or circumstantial evidence to support the inference of a formal or informal understanding between [members] for the purpose of acquiring, holding, or disposing of securities.'" CSX Corp. v. Children's Inv. Fund Mgmt. (UK) LLP, 562 F.Supp.2d 511, 552 (S.D.N.Y.2008) (quoting Hallwood Realty Partners, L.P. v. Gotham Partners, L.P., 286 F.3d 613, 617 (2d Cir.2002)) (emphasis added).
Plaintiff's allegations establish that both the Lead Underwriter and the Selling Shareholders shared the intent of the lockup agreements, namely to protect the stability of the stock and the investing public
To the contrary, the lock-up agreements did not bind the two groups as to either their roles and interests during the IPO, or with respect to their conduct in relation to the Facebook shares. Though the lockup agreements did commit each Selling Shareholder "not to sell or otherwise dispose of" any Facebook common stock for periods of time following the IPO, (Compl. ¶ 15), the Lead Underwriters were under no reciprocal agreement. Instead, Goldman directly sold stock during the restricted periods, and J.P. Morgan and Morgan Stanley neither owned pre-IPO stock which they were required to hold nor took any action that would limit the supply of Facebook stock in conjunction with the shareholders. See Roth v. Jennings, 489 F.3d 499, 508 (2d Cir.2007). The lock-up agreements themselves also did not confer any combined benefit on the parties, but rather were a standard structural feature that assisted marketability by assuring investors that the Selling Shareholders' remaining holdings would not be immediately
In short, the lock-up agreements did not create any kind of "single unit": The Selling Shareholders were sellers and holders of Facebook stock, whereas the Lead Underwriters functioned as distributors, and the two groups acted entirely independently in relation to the acquiring or selling the Facebook stock prior to, during and following the IPO.
Regardless, the lock-up agreements by themselves are not sufficient to create joined liability under the statute. Because lock-up agreements are standard industry practice
Even presuming all of Plaintiff's allegations as true, here, no such comparable commonalities exist. The Complaint alleges that the Lead Underwriters and Selling Shareholders had a common intent governing the lock-up agreement, but not that the agreement coordinated the two parties in any way with respect to their conduct regarding
Whether, if beneficial owners, the Lead Underwriters would be exempt from Section 16 liability under Rule 16a-7 presents certain complex and unprecedented issues, for instance, whether Defendants' creation of informational disparities accompanied by unusually high levels of short selling, though compliant with the letter of the law, may still be "indecent" or "dishonest" for purposes of determining "good faith." The Court declines to reach these issues at this time, because even if the Lead Underwriters are not exempt under the statute, they lack the prerequisite "beneficial owner" status for Section 16 to apply. See U.S. v. Bulluck, 556 Fed.Appx. 18, 2014 WL 684992 (2d Cir. Feb. 24, 2014) (declining to reach an unprecedented issue of the case because the outcome could be disposed of on alternate grounds); see also Segura v. United States, 468 U.S. 796, 104 S.Ct. 3380, 82 L.Ed.2d 599 (1984) (seven Justices decline to address this issue because case does not require its resolution).
Plaintiff contends that even if the Lead Underwriters are not a "group" under Section 16, Goldman was a beneficial owner of 10% of Facebook's stock on May 17, 2012 and made additional short-swing profits between May 17, 2012 and September 30, 2012. (See Compl. ¶¶ 43-45.) More specifically, Plaintiff alleges that Goldman sold 5,591,649 shares of Facebook stock between June 30, 2012 and September 30, 2012 (Compl. ¶ 45), and that some selling occurred at prices higher than paid for purchases causing Goldman to earn additional short-swing profits from trading Facebook securities. (Compl. ¶ 45.) According to Plaintiff, because Goldman sold 5,243,185 shares of Facebook stock at $37,582 per share, (see Prospectus at 143 fn. 23(I); see also Goldman Form 4 (Abraham Decl. Ex. D)), in order for Goldman to have owned 9,507,859 shares of Facebook
Section 16 does not cover any transaction where the defendant was not a beneficial owner "both at the time of the purchase and sale, or the sale and purchase, of the security involved ...." Foremost-McKesson, Inc. v. Provident Securities Co., 423 U.S. 232, 234, 96 S.Ct. 508, 46 L.Ed.2d 464 (1976). As such, for Goldman to be a "beneficial owner" subject to liability under the statute, it would have to have been a 10% beneficial owner both at the time of the May 17 sale, and at the time of at least one subsequent purchase during the June through September time period.
Goldman's Form 4 signed May 17, 2012
Though Plaintiff alleges that Goldman was a 10% beneficial owner on May 17, 2012, there is no allegation in the Complaint as to Goldman's ownership status during the subsequent activity — and in fact the Form 4 indicates that as of May 17, 2012, Goldman was no longer a beneficial owner. Because the statute requires that the entity be a 10% owner both at the time of the sale and subsequent purchase of the security, Plaintiff has not adequately alleged that Goldman was a beneficial owner subject to liability under the statute. Accordingly, dismissal is also appropriate as to Goldman individually.
Because Goldman is not subject to Section 16 liability, the Court need not address whether Plaintiff's allegations as to short-swing profits are adequate.
Based on the conclusions set forth above, Defendants' motion to dismiss the Complaint is granted.