Gibbons v. Malone: Section 16(b) of the Securities Exchange Act Applies only where Stocks are Part of the Same Equity Security Class

In Gibbons v. Malone, No. 10 CV 8640(BSJ), 2011 WL 3516065 (S.D.N.Y. Aug. 8, 2011), the district court granted the defendant’s motion to dismiss the plaintiff’s action alleging a violation of Section 16(b) of the Securities Exchange Act of 1934. 

Discovery Communications (“Discovery”) has three classes of common stock, including Series A and C, both publicly traded on the NASDAQ.  Each class of stock possessed distinct characteristics.  Series A stock had voting rights, was not controvertible into other classes of stock, and could receive stock dividends.  Series C stock lacked voting rights, was not controvertible into other classes of stock, and could not receive stock dividends. At the time of the alleged insider trading, an options market existed only for Series A stock.

Defendant John Malone (“Malone”), a Discovery director and Chairman of Liberty Media Corp. and Liberty Global Inc., engaged in ten purchases of Series A stock and nine sales of Series C stock between December 5, 2008 and December 17, 2008.  At the time these transactions occurred, Malone was the owner of over ten percent of a class of the company’s stock.

Plaintiff Michael Gibbons (“Gibbons”) alleged that Malone realized an illegal profit of at least $313,573 under Section 16(b) of the Exchange Act because “for each share of Series A Stock purchased by Malone, a corresponding sale of Series C Stock was made at a higher price by Malone.”

Section 16(b) is intended to prevent directors from profiting from insider information.  The provision provides that “profit realized by [a director] from any purchase and sale, or any sale and purchase, of any equity security of such issuer…within any period of less than six months…shall inure to and be recoverable by the issuer…”  15 U.S.C. 78p(b).

Defendants argued that the transactions in Series A and C shares were not the same equity security.  The court agreed.  The court noted that Section 16(b) groups “purchase and sale” and “sale and purchase” together, indicating that they are each “directed at the same prepositional object—i.e. the same equity security.”  The phrase “any equity security” refers to the fact that the law applies to any of the different types of equity securities, not that the law applies when an individual buys one type of equity security and sells another type.

Discovery Series A stock and Series C stock were not convertible into each other, and they were not debentures or derivatives which fell into the same class; they were separate equity securities.  Because Series A and C had different characteristics, they belonged in separate classes of equity securities.  The Second Circuit noted that if Section 16(b) applied to a situation in which one class of stock was purchased and a different class was sold, this would be “beyond the realm of judicial fantasy.”  Smolowe v. Delendo, 136 F.2d 231, 237 n.13 (2d Cir. 1943).  Because an application of Section 16(b) under the plaintiff’s argument would eliminate the statute’s bright-line rule, the court granted the defendants’ motion to dismiss. 

The primary materials for this case may be found at the DU Corporate Governance website.