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District Court Holds that Price Adjustment for Conversion of Preferred Stock was not "Purchase" of Corporation's Common Stock

Morrison v. Madison Dearborn Capital Partners III, LP, 389 F. Supp. 2d 596 (D.Del. 2005). A shareholder brought a derivative action to recover profits from short-swing insider trading of stock. The defendants moved to dismiss under Federal Rule 12(b)(6). Plaintiff, a shareholder of XM Satellite Radio Holdings, Inc. brought a derivative action to recover profits from short-swing insider trading of XM Radio stock by Defendants. Plaintiff argued that an adjustment of the conversion price of Preferred Stock comprised a "purchase" of stock under Section 16(b) of the Securities Exchange Act of 1934, and thus made a written demand that defendants disgorge all profits earned as a result of said adjustment. Plaintiff argued that the conversion privilege operated like a call option covering the underlying XM Radio stock and that the preferred stock was, therefore, a "call equivalent position." Notably, no allegation was made that Defendant had exercised its conversion rights. With reference to an SEC Release issued in 1991, when Rule 16(b)(6) was promulgated, the Court noted that (1) Securities like the preferred stock would be treated as if they had a fixed conversion price; (2) that such securities would be derivative securities under Rule 16a-1(c); (3) that adjusting the conversion price or preferred shares woyld not be an acquisition of additional stock; and (4) the under Rule 16(b)(6), the event for a finding of improper insider trading would be the purchase of the Preferred Stock, not the change in the conversion price. The Court found that, as a matter of law, where conversion prices are adjusted for prespecified events, the preferred shares were treated as though they had a fixed price. Thus, the Court found, a conversion price adjustment was not a "purchase" for purposes of the ban on short-swing insider trading. Accordingly, the Court granted Defendants' Motion to Dismiss. Share


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