United States District Court, S.D. New York
August 26, 2005.
MARC BRUH, Plaintiff,
BESSEMER VENTURE PARTNERS III L.P., and VISTACARE, INC., Defendants.
The opinion of the court was delivered by: GEORGE DANIELS, District Judge
MEMORANDUM DECISION AND ORDER
This action arises out of the automatic conversion of Preferred
Stock to Common Stock at the closing of VistaCare, Inc.'s
("VistaCare") initial public offering and the subsequent sale of
such stock within six months by Defendant, Bessemer Venture
Partners III L.P. ("Bessemer"). Plaintiff, a VistaCare
shareholder, sued VistaCare and Bessemer, seeking disgorgement of
short-swing profits pursuant to Section 16(b) of the Securities
Exchange Act of 1934, 15 U.S.C. § 78p(b) ("Exchange Act").
Defendants counterclaimed, seeking declaratory judgment that the
transactions were not subject to Section 16(b) liability, or
alternatively, that their transactions were subject to two
exceptions that waived liability under Section 16(b). Both
Plaintiff and Defendants move for summary judgment pursuant to
Federal Rule of Civil Procedure 56. Plaintiff's motion for
summary judgment is DENIED. Defendants' motion for summary
judgment is GRANTED.
VistaCare is a publiclytraded company whose common stock is
registered with the Securities and Exchange Commission ("SEC").
Plaintiff is a shareholder of VistaCare. Bessemer, a long-term
investor in VistaCare, entered into a Stock Purchase Agreement
with Vista Hospice Care, Inc. ("VHS"), pursuant to which Bessemer
purchased and acquired 305,292 shares of VHS Series A-1 Preferred
Stock in 1995.*fn1 At the time of this purchase, the
Preferred Stock was not convertible to common stock. In 1998, as part of a recapitalization, VHS became
a wholly owned subsidiary of VistaCare, Inc., and VHS Series A-1
Preferred Stock became VistaCare, Inc. A-1 Preferred Stock.
On December 23, 1999, VistaCare filed a Third Amended and
Restated Certificate of Incorporation ("Restated Certificate").
Under the terms of the Restated Certificate, upon closing of an
initial public offering of VistaCare Common Stock (the "IPO"),
VistaCare Series A-1 Preferred Stock would automatically convert
to shares of VistaCare Common Stock. The Restated Certificate set
forth a specific ratio under which the preferred stock would be
converted to common stock:*fn2
Upon the closing of a Qualified Initial Public
Offering, each outstanding share of Series A-1
Preferred Stock shall automatically be converted into
a number of shares of Class A Common Stock equal to
(i) the Original Issue Price of the Series A-1
Preferred Stock (as adjusted for any stock splits,
stock dividends, recapitalizations and similar
events), plus all accrued but unpaid dividends on
such shares of Series A-1 Preferred Stock, divided by
(ii) the per share price at which the Common Stock is
sold to the public in the Qualified Initial Public
Offering (the "IPO Price").
(June 4, 2004, Twersky Decl., Ex. 2).
Bessemer argues that because the ratio was fixed and set at the
time of the Restated Certificate, even if it were privy to
insider information, it would be unable to alter the ratio to
take advantage of the information. It is further undisputed that
the value of Bessemer's holding was the same after the conversion
because under the formula set forth, an increase in the IPO price
per share would lead to an offsetting decrease in the number of common shares Bessemer
would received in the conversion. Bessemer argues, therefore,
that the conversion was not a new investment by Bessemer in
VistaCare. The conversion's sole effect on Bessemer's holdings
was to change its preferred stock into an equivalent value of
On December 23, 2002, VistaCare completed the IPO of its common
stock at a price of $12.00 per share. Pursuant to the terms of
the 1999 Restated Certificate, Bessemer's Preferred Stock was
converted to 251,865 shares of Common Stock. On May 13, 2003,
VistaCare conducted a secondary offering in which certain selling
shareholders, including Bessemer, sold additional shares of
VistaCare Common Stock to the public at $20.00 per share (the
"Secondary Offering"). At all relevant times, Bessemer held ten
percent or more of the stock of VHS or VistaCare. Bessemer did
not have a position on VistaCare's Board of Directors. Bessemer
had no control over the board or management of VistaCare
concerning the timing, form, or occurrence of the IPO, or the
per-share price to the public of VistaCare common stock.*fn3
On June 24, 2003, counsel for Plaintiff demanded VistaCare
bring suit against Bessemer seeking disgorgement of the profits
Bessemer made from their sale in the Secondary Offering.
Plaintiff's counsel asserted that Bessemer's acquisition of
Common Stock by conversion of its Preferred Stock at the closing
of the IPO constituted a "purchase" for purposes of Section 16(b)
liability. By letter dated July 2, 2003, VistaCare asked Bessemer
to advise why VistaCare should not be entitled to disgorgement of
On July 31, 2003, Bessemer filed a complaint in the United
States District Court for the Southern District of New York
seeking a declaratory judgment that Bessemer has no Section 16(b)
liability because, among other things, the conversion of
VistaCare Common Stock pursuant to the closing of the IPO, should not be considered a "purchase" under
the SEC's rules. On September 18, 2003, Plaintiff filed the
instant Complaint, seeking "disgorgement of short-swing insider
trading profits" allegedly realized by Bessemer. Plaintiff seeks
disgorgement of short-swing profits in the amount of
$1,725,275.25. On October 9, 2003, Bessemer dismissed its
separate declaratory judgment action. Bessemer filed an Answer
and Counterclaim in Plaintiff's action on October 17, 2003.
STANDARD OF REVIEW
Summary judgment is proper "if the pleadings, depositions,
answers to interrogatories, and admissions on file, together with
the affidavits, if any, show that there is no genuine issue of
material fact and the moving party is entitled to judgment as a
matter of law." Fed.R.Civ.P. 56(c); Nebraska v. Wyoming,
507 U.S. 584, 590, 113 S. Ct. 1689, 1694, 123 L. Ed. 2d 317 (1993).
The burden of demonstrating that no factual dispute exists is on
the moving party. Celotex Corp. v. Catrett, 477 U.S. 317, 323,
106 S. Ct. 2548, 91 L. Ed. 2d 265 (1986). Once the moving party
has met this burden, the nonmoving party "must set forth specific
facts showing that there is a genuine issue for trial."
Fed.R.Civ.P. 56 (e). In deciding a motion for summary judgment, a
court must resolve all ambiguities and draw all reasonable
inferences in favor of the party opposing the motion. Anderson
v. Liberty Lobby, Inc., 477 U.S. 242, 255, 106 S. Ct. 2505,
91 L. Ed. 2d 202 (1986). Summary judgment should be granted only
when no reasonable trier of fact could find in favor of the
nonmoving party. Gallo v. Prudential Residential Services,
Ltd., 22 F.3d 1219, 1224 (2d. Cir. 1994).
SECTION 16(b) LIABILITY
Section 16(b) of the Securities Exchange Act of 1934,
15 U.S.C. § 78p(b), which imposes liability for "short-swing" profits,
forbids an insider's speculative short-term trading based upon
insider information. Its purpose is to prevent corporate insiders
from exploiting material information about the issuer to have an
advantage over others with whom they trade. Gwozdsinsky v.
Zell/Chilmark Fund, L.P., 156 F.3d 305, 308 (2d Cir. 1998).
Section 16(b) provides, in pertinent part:
For the purposes of preventing the unfair use of
information which may have been obtained by such
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 . . .
involving any such equity 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. . . .
15 U.S.C. § 78p(b).
Thus, a claim for disgorgement of profits under Section 16(b)
requires that Plaintiff prove that there was (1) a purchase (2)
and a sale of securities (3) by a statutory insider*fn4 (4)
within a six-month period.*fn5 See Feder v. Frost,
220 F.3d 29, 32 (2d Cir. 2000) (quoting Gwozdsinsky v. Zell/Chilmark
Fund, L.P., 156 F.3d 305, 308 (2d Cir. 1998)). Section 16(b) is
a strict liability statute which applies "irrespective of any
intention on the part of such beneficial owner. . . ."
15 U.S.C. § 78p(b); see also Magna Power Co. v. Dow Chem. Co.,
136 F.3d 316, 320-21 (2d Cir. 1998) ("Section 16(b) operates mechanically,
and makes no moral distinctions, penalizing technical violators
of pure heart, and bypassing corrupt insiders who skirt the
letter of the prohibition."); Schaffer v. CC Invs, et al.,
280 F. Supp. 2d 128, 133 (S.D.N.Y. 2003) (stating that Section 16(b)
"not only prohibited all short-swing trading by an insider within
a period of less than six months but did so regardless of whether
the insider actually used or even knew of inside information when
engaging in the transaction."). Plaintiff argues that Bessemer
"purchased" the Common Stock on December 23, 2002, the date of
the initial public offering, when Bessemer's Preferred Stock was
converted to Common Stock.
Under the Securities Act, the term "`purchase' include[s] any
contract to buy, purchase, or otherwise acquire."
15 U.S.C. § 78c(a)(13). The Supreme Court has recognized that the definition of "purchase" applicable to Section 16(b)
[is] broad, and, at least arguably, reach[es] many
transactions not ordinarily deemed a . . . purchase.
In deciding whether borderline transactions are
within the reach of the statute, the courts have come
to inquire whether the transaction may serve as a
vehicle for the evil which Congress sought to prevent
the realization of short-swing profits based upon
access to inside information thereby endeavoring to
implement congressional objectives without extending
the reach of the statute beyond its intended
limits. . . . Thus, "in interpreting the term?
`purchase' . . ., courts have properly asked whether
the particular type of transaction involved is one
that gives rise to speculative abuse."
Kern County Land Co. v. Occidental Petroleum Corp.,
411 U.S. 582
, 593-95, 93 S.Ct. 1376
, 36 L.Ed.2d 503 (1973) (quoting
Reliance Elec. Co. v. Emerson Elec. Co., 404 U.S. 418
, 424 n.
4, 92 S.Ct. 596, 30 L.Ed.2d 575 (1972)). The "indices" of
speculative abuse require a determination of whether there was
access to inside information (distinguishable from the possession
of it) and whether the defendant could influence the timing and
circumstances of the transactions at issue. See Donoghue v.
Casual Male Retail Group, Inc., 375 F. Supp. 2d 226, 231-32
(S.D.N.Y. 2005); Makofsky v. Ultra Dynamics Corp.,
383 F. Supp. 631, 638 (S.D.N.Y. 1974) (citing Kern, 411 U.S. at 597-600).
In 1991, the SEC adopted amended rules which considered a
"derivative security" as a Section 16(b) purchase. A derivative
security is "any option, warrant, convertible security, stock
appreciation right, or similar right with an exercise or
conversion privilege at a price related to an equity security, or
similar securities with a value derived from the value of an
equity security." 17 C.F.R. § 240.16a-1. However, "[r]ights with
an exercise or conversion privilege at a price that is not fixed"
are expressly excluded from the definition of a derivative
security. 17 C.F.R. § 240.16a-1-(c)(6). Further,
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.
The profit that can be realized on short-swing
transactions, whether accomplished through derivative securities, the underlying equity
security or a combination of both, depends upon the
price of the underlying security. While the amount of
the profit may vary given factors such as the time
value of money and volatility of the underlying stock
evidenced in the option premium, the exercise does
not change the opportunity to realize a profit. As
the price of the underlying common stock increases,
so does the value of a call option or similar
derivative security with a fixed exercise or
conversion price related to the common stock.
Ownership Reports and Trading by Officers, Directors and
Principal SecurityHolders, Exchange Act Release No. 28,869,
56 Fed. Reg. 7242, 7249 (Feb. 21, 1991) ("SEC Release").
A derivative security and its underlying equity security are
functionally equivalent. See SEC Release at 7248. Moreover, "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. . . ." 17 C.F.R. § 240.16b-6(a). A call
equivalent position is "a derivative security position that
increases in value as the value of the underlying equity
increases, including but not limited to, a long convertible
security, a long call option, and a short put option position."
17 C.F.R. § 240.16a-1(b).
In the instant matter, Plaintiff argues that "Bessemer did not
own a derivative security in 1999, because the conversion price
was not yet fixed, and convertible securities with conversion
prices that are not fixed are specifically excluded from the
definition of derivative securities. However, once the conversion
price became fixed, the Preferred Stock became a derivative
security. . . ." (Pl. Mem Supp. Mot. Summ. J. at 11-12) (emphasis
in original). Therefore, Plaintiff contends that the IPO provided
Bessemer with a derivative security as of that date, and
established a call equivalent position.
Plaintiff's argument is unavailing. Before December 23, 2002,
Bessemer's Preferred Stock had its own independent value. It did
not derive its value from any then existing VistaCare common
stock. Before the IPO Bessemer held non-derivative Preferred
Stock. After the IPO, Bessemer's Preferred Stock became Common
Stock. Thus, Bessemer no longer held Preferred Stock, but now
held Common Stock equal to its prior Preferred Stock holdings.
Consequently, when the conversion occurred on December 23, 2002,
no derivative or call equivalent position was established. The "purchase" in the instant matter occurred at the time
Bessemer contracted, by signing the Stock Purchase Agreement in
1995, to acquire VistaCare Preferred Stock. That is when
Bessemer's rights and obligations became fixed and irrevocable.
See T-bar Inc. v. Chatterjee, 693 F. Supp. 1, 5-6 (S.D.N.Y.
1988) (defining a purchase as "when the purchaser `ha[d] incurred
an irrevocable liability to take and pay for the stock and his
rights and obligations have become fixed."); Prager v.
Sylvestri, 449 F. Supp. 425, 432-33 (S.D.N.Y. 1978) (stating
that a purchase is made when the "investor becomes irrevocably
committed to the transaction and, in addition, no longer has
control over the transaction in any way that could be turned to a
speculative advantage by the investor."); Blau v. Ogsbury,
210 F.2d 426, 427 (2d Cir. 1954) (stating that purchase occurred when
there is "an irrevocable liability to take and pay for the
In 1999, Bessemer re-negotiated the nature of its holdings from
Preferred Stock to Common Stock. While the price of Common Stock
was not yet fixed, the conversion ratio negotiated was set to
ensure that when the IPO took place the value of the Common Stock
would equal the current value of Bessemer's Preferred Stock.
Bessemer had no control over the board or management of
VistaCare, and thus could not alter the conversion rate
previously established in 1999. Further, neither Bessemer, nor
any of its partners, officers or agents, had any control over the
board or management of VistaCare concerning the timing, form or
occurrence of the IPO or the Secondary Offering. In fact,
Bessemer urged that the Secondary Offering be delayed, but
VistaCare refused. The fact that Bessemer realized a profit from
the sale of its Common Stock in 2003 is of no consequence here.
There is no indication that Bessemer knew in 1999 the actual date
of the IPO, and thus when their Preferred Stock would convert to
Common Stock. Even if Bessemer was aware in 1999 the eventual
date of the IPO, Section 16(b) "does not strip the insider of all
advantage. He may increase or decrease his holdings according to
the dictates of his special knowledge. It is only the short-swing
transaction which must yield profits to the company alone."
Roberts v. Eaton, 212 F.2d 82, 85 (2d Cir. 1954). Moreover, the Second Circuit has found problematic and rejected
the argument, implicitly advanced here by Plaintiff, that "[o]ne
can, as a matter of language, describe the conversion of a
company's preferred stock into an equivalent amount of common
stock as . . . an `acquisition' or `purchase' of another. . . ."
Blau v. Lamb, 363 F.2d 507, 517 (2d Cir. 1966); see also
Occidental Petroleum Corp. v. Mukamal, 450 F.2d 157, 162 (2d
Cir. 1971) aff'd 411 U.S. 582, 590-91 (1973) (discussing dictum
in Park & Tilford, Inc. v. Schulte, 160 F.2d 984 (2d Cir.
1947)). The Second Circuit has stated that putting aside the
intimations in Park & Tilford, "in deciding whether a certain
transaction is a Section 16(b) `purchase' or a `sale' it is
relevant to first consider whether the transaction in any way
makes possible the unfair insider trading that Section 16(b) was
designed to prevent." Lamb, 363 F.2d at 518.
In Roberts v. Eaton, 119 F. Supp. 362 (S.D.N.Y. 1953),
insiders owned over 45 percent of their company's single class of
common stock which was reclassified into a new class of preferred
and a new class of common stock. Within six months of the
reclassification, the insiders sold their new securities at a
profit. In finding that there was no purchase for section 16(b)
liability, the District Court stated that "the defendants had
owned their stock for several years. The sale cannot possibly
come within the provisions of Section 16(b) unless it can be
found that they `purchased' their holdings anew upon
reclassification." Id. at 365. The District Court further
stated that the "corporate shareholders acquired no additional
interest in the corporation as a result of the reclassification.
It was merely a division of their existing interest. Each
stockholder retained what he had held, all the while, in the same
proportion, but in a somewhat different form." Id. In affirming
the District Court's holding, the Second Circuit reasoned that
the "cumulative effect" of different factors rendered the
reclassification of the securities as not speculative abuse and
therefore was not a purchase under Section 16(b). See Roberts
v. Eaton, 212 F.2d 82, 85-86 (2d Cir. 1954) (cited in Lamb,
363 F.2d at 518) (stating that additional factors included the
fact that defendants' interests continued in the same company and
proportionally unchanged, other factors included the fact that "time consuming ratification by the stockholders was
required, and that the acquisition and proposed sale, was fully
disclosed."). In the case at bar, and using the standard
articulated in Lamb, none of the possible unfair trading
activities that Section 16(b) was designed to prevent is present.
Therefore, Plaintiff's contention that the conversion price
became fixed on the date of the IPO, and thus that is when
Bessemer purchased it's Common Stock, is therefore without merit
and must be rejected.
Plaintiff's motion for summary judgment is DENIED. Defendants'
motion for summary judgment is GRANTED.*fn6 This action is
dismissed in its entirety.
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