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ALLAIRE CORPORATION v. OKUMUS

United States District Court, S.D. New York


March 31, 2004.

ALLAIRE CORPORATION, Plaintiff, -against- 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, Defendants

The opinion of the court was delivered by: THOMAS GRIESA, Senior District Judge

Opinion

This is an action by plaintiff Allaire Corporation brought against various shareholders for failure to comply with the forfeiture provision of Section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq. Allaire is a public company whose common stock was traded on the Nasdaq National Market during all relevant times. Defendant Ahmet H. Okumus is alleged to have directly or indirectly controlled each of the other defendant corporations. Okumus is the managing member of defendants Okumus Capital, LLC ("OC"), Okumus Advisors, LLC ("OA"), and Okumus Technology Advisors, LLC ("OTA"). Defendant OC in turn is the investment manager of defendants Okumus Opportunity Fund, Ltd. and Okumus Technology Value Fund, Ltd. OA is a general partner and investment advisor of defendant Okumus Page 2 Technology Value Partners, LP. OTA is the general partner and investment advisor of defendant Okumus Technology Value Partners, LP.

In sum, plaintiff alleges that defendants, while owners of sufficient Allaire stock to be considered statutory "insiders," made, within six months, a purchase and sale of Allaire stock. Plaintiff alleges that this purchase and sale resulted in profits that, under Rule 16(b) of the Exchange Act, must be disgorged to plaintiff.

  Defendants move to dismiss the complaint for failure to state a claim. The motion is granted.

  THE COMPLAINT

  The following facts, taken from the complaint, are undisputed unless otherwise noted.

  The complaint alleges that on November 17, 2000 defendants sold one or more call options in Allaire stock at a price of $7.50, set to expire on December 16, 2000. Call options give the buyer of the option the ability to purchase the underlying stock at a specified price until the expiration date. Call options are a type of "derivative security," so named because the value of the option is derived from the price of the underlying stock. The buyer of a call option holds a "call equivalent position," which increases in value as the value of the underlying equity increases. The seller of a call option holds a corollary "put Page 3 equivalent position," which increases in value as the value of the underlying security falls. As will be explained in greater detail below, the Exchange Act applies special rules to the purchase and sale of derivative securities by statutory insiders.

  The complaint alleges that on November 30, 2000 defendants filed a Schedule 13G with the Securities and Exchange Commission ("SEC"). The 13G stated that as of November 20, 2000 defendants were collectively the beneficial owners of 16.1% of the 27, 411, 078 shares of Allaire common stock outstanding on November 20. Thus, as will be explained in greater detail below, the complaint alleges that as of November 20 defendants were statutory insiders with respect to their Allaire holdings, pursuant to Section 16(b) of the Exchange Act.

  On December 16, 2000 the call options expired unexercised. The complaint alleges that this event constituted a purchase of stock by defendants. Defendants dispute this characterization.

  The complaint alleges that on January 16, 2001 defendants again sold one or more call options exercisable immediately at a strike price of $7.50, with an expiration date of February 16, 2001. The complaint alleges that this event constituted a sale of stock that may be paired, pursuant to the Exchange Act, with the expiration of the prior call option, in order to constitute a purchase and sale of Allaire stock within six months. Defendants dispute this characterization. Page 4

  The call options were exercised on February 16, 2001.

  On February 28, 2001 defendants filed with the SEC an amendment to the Schedule 13G filed in November, stating that defendants beneficially owned no shares of Allaire Common Stock.

  DISCUSSION

  Section 16(b) of the Exchange Act provides:

For the purpose of preventing the unfair use of information which may have been obtained by [a] beneficial owner, director, or officer by reason of his relationship to the issuer, any profit realized by him from any purchase and sale, or any sale and purchase, of any equity security of such issuer (other than an exempted security) within any period of less than six months . . . shall inure to and be recoverable by the issuer, irrespective of any intention on the part of such beneficial owner, director, or officer in entering into such transaction of holding the security purchased or of not repurchasing the security sold for a period exceeding six months. . . . This subsection shall not be construed to cover any transaction where such beneficial owner was not such both at the time of the purchase and sale, or the sale and purchase, of the security involved . . . .
15 U.S.C. § 78p(b). Section 16(a) of the Exchange Act defines "beneficial owner," as referred to in Section 16(b), as any person "who is directly or indirectly the beneficial owner of more than 10 per centum of any class of any equity security (other than an exempted security) which is registered pursuant to section 781 of this title." Id. § 78p(a). Thus, Section 16 creates a class of statutory "insiders" who are prevented from reaping "short-swing profits based on access to inside information." Kern County Land Co. v. Occidental Petroleum Page 5 Corp., 411 U.S. 582, 594 (1973). The statute is a no-fault, strict liability provision with respect to transactions that fall "within its narrowly drawn limits." Foremost-McKesson. Inc. v. Provident Securities Co., 423 U.S. 232, 251 (1976); see also, Gwozdzinsky v. Zell/Chilmark Fund, L.P., 156 F.3d 305, 310 (2d Cir. 1998).

  In 1991 the SEC amended its rules to clarify the applicability of Section 16(b) to derivative securities. Rule 16a-4 specifies that, except for reporting purposes, "[f]or purposes of section 16 of the Act, both derivative securities and the underlying securities to which they relate shall be deemed to be the same class of equity securities." 17 C.F.R. § 240.16a-4. Rule 16b-4 sets forth a fairly complex scheme for how purchases or sales of derivative securities are to be counted under Rule 16(b), which is relevant to set forth in some detail:

(a) The establishment of or increase in a call equivalent position or liquidation of or decrease in a put equivalent position shall be deemed a purchase of the underlying security for purposes of section 16(b) of the Act, and the establishment of or increase in a put equivalent position or liquidation of or decrease in a call equivalent position shall be deemed a sale of the underlying securities for purposes of section 16(b) of the Act. . . .
  (b) The closing of a derivative security position as a result of its exercise or conversion shall be exempt from the operation of section 16(b) of the Act, and the acquisition of underlying securities at a fixed exercise price due to the exercise or conversion of a call equivalent position or the disposition of underlying securities at a fixed exercise price due to the exercise of a put equivalent position shall be exempt from the operation of section 16(b) of the Act. Page 6 . . .

 

(d) Upon cancellation or expiration of an option within six months of writing of the option, any profit derived from writing the option shall be recoverable under section 16(b) of the Act. The profit shall not exceed the premium received for writing the option. The disposition or closing of a long derivative security position, as a result of cancellation or expiration, shall be exempt from section 16(b) of the Act where no value is received from the cancellation or expiration.
17 C.F.R. § 240.16b-6.

  Contemporaneous commentary by the SEC on these amendments clarified that the Rules require that the acquisition or disposition, rather than the exercise, of a derivative security be deemed the significant event under 16(b). See Ownership Reports and Trading by Officers, Directors and Principal Security Holders, Final Rules and Solicitation of Comments, 56 Fed. Reg. 7242, 7248-49, 7253 (Feb. 21, 1991). This is because:

the exercise of a derivative security, much like the conversion of a convertible security, essentially changes the form of beneficial ownership from indirect to direct. Since the exercise represents neither the acquisition nor the disposition of a right affording the opportunity to profit, it should not be an event that is matched against another transaction in the equity securities for purposes of section 16(b) short-swing profit recovery.
Id. at 7249. The Second Circuit reaffirmed this rationale in Magma Power Co. v. Dow Chemical Co., 136 F.3d 316 (2d Cir. 1998), explaining that "the acquisition or disposition of the option is the point at which the inside information may be advantageous, [so] the SEC's regime regards it as the triggering event under Page 7 Section 16(b)." Id. at 322. By contrast, "the exercise of a fixed-price option is a non-event for 16(b) purposes . . . . because the insider by then is already bound by the terms of the option, [so] the potential for abuse of inside information is minimal." Id. Thus, Rule 16b-6(a)'s reference to the establishment or liquidation of call or put positions designates acquisition or disposition of an option as the relevant events under Section 16(b). This is clarified by the express language of Rule 16b-6(b), which exempts from Section 16(b) the disposition of a derivative position based on the exercise or conversion of such position. See id.

  It is clear from the above discussion that plaintiff's interpretation of Rule 16b-6 misconstrues its applicability to the instant transaction. Plaintiff argues that the December 16 expiration of the call option must be construed as a "purchase" by defendants, because it was a "liquidation of . . . a put equivalent position" within the meaning of Rule 16b-6(a). However, only the November 17 sale of the call option, not its December 16 expiration, can come within Rule 16b-6(a). This is because it was the November 17 sale that bound defendants to the terms of the option, and therefore was the point at which any inside information possessed by the defendants might have been advantageous. Under the reasoning of the Magma Power case, if those options had been exercised on December 16 it would have Page 8 been a "non-event" because the exercise itself could not be driven by inside information possessed by the defendants. This logic is equally applicable to the expiration of the call options in this case.

  Of course, as noted above, the defendants were not in fact insiders on November 17, because they did not acquire sufficient Allaire stock until November 20. Therefore, the November 17 call option sale was not a sale covered by Section 16(b). A fortiorari, the expiration of the call options on December 16 was also irrelevant under Section 16(b).

  Therefore, the December 16 expiration cannot be matched with the writing of the January 16 call option for purposes of recovering defendants' profits from that transaction. For this reason, plaintiff fails to state a claim under Section 16(b).

  CONCLUSION

  For the reasons set forth, defendants' motion to dismiss for failure to state a claim is granted.

  SO ORDERED. Page 1

20040331

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