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District Court Applies SEC Rules Amendments to Transaction, Grants Summary Judgment

Levy v. Sterling Holding Co., LLC, 2007 WL 582555 (D.Del. Feb. 13, 2007).

In this shareholder derivative action, the plaintiff shareholder sued two defendants, both of whom occupied board positions with the corporation, for allegedly purchasing stock in the corporation and then selling it at a profit within six months, in violation of Section 16(b) of the Securities and Exchange Act of 1934. After each side filed cross-motions for summary judgment, the SEC adopted Amendments to SEC Rules 16b-3 and 16b-7, which exempt certain transactions from the prohibitions of Section 16(b). Defendants argued that the transaction that formed the basis of Plaintiff’s complaint, whereby Defendant’s preferred stock in the corporation was “automatically” converted to common stock upon completion of an IPO, was an exempt “reclassification” transaction under the SEC Rules. Conversely, Plaintiff argued that the exemption did not apply. The Court found that the SEC had acted within its power in exempting reclassification transactions from Section 16(b), and that as a result of that exemption, Defendants were entitled to judgment as a matter of law. 

The Court first analyzed whether Congress authorized the SEC to designate certain transactions as exempt from Section 16(b) liability. The Court looked to the language of the statute to find that Congress “explicitly afforded the SEC the authority to exempt transactions from the reach of section 16(b).” This authority “requires the SEC to interpret which transactions are exempt from [Section 16(b)’s] application.” The Court then looked to the legislative history and purpose of the statute to find that the SEC’s interpretation excluding reclassification transactions from Section 16(b) liability, as enunciated through the Amendments, was permissible. The Court then analyzed whether the Amendments should be applied retroactively to the transaction at issue in the litigation. The Court found that the Amendments did not “change the legal landscape with respect to exemptions under Section 16(b),” but rather simply clarified what had been the established approach of the SEC to reclassification transactions. Because they did not represent substantive changes in the law, the Amendments applied to the transaction at issue in the litigation, despite the fact that it pre-dated them. As a result of the deference owed to the SEC interpretation of Section 16(b), the Court held that the reclassification transaction was exempt from the purview of the statute, and Defendants were therefore entitled to judgment as a matter of law.



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