A 2nd Circuit panel held that the Exchange Act Rule 16b-3(d) exemption applies to so-called "directors by deputization." (Roth v. Perseus, L.L.C.) In reaching this result, the appellate panel found persuasive the SEC's interpretation of Rule 16b-3(d) that such directors, even if they were also 10 percent holders, were protected by the rule. The court also found that the adoption of Rule 16b-3(d) was within the agency's exemptive authority under Section 16(b).
Rule 16b-3(d) exempts directors and officers, but not 10 percent holders, from Section 16(b) liability with regard to certain transactions with the issuer. As in effect at the time of the transactions in question, the rule applied to a grant, award or other acquisition from the issuer that 1) was approved by the board, or a board committee composed solely of at least two non-employee directors, 2) was approved or ratified by a majority vote of the shareholders or 3) involved the acquisition of securities held by the officer or director for a period of six months following the date of such acquisition.
In this case, Perseus, a private equity fund management firm (and its affiliates) acquired more than 10 percent of the common stock of Beacon Power Corp. Subsequently, two senior officers of Perseus were named to serve as Beacon directors. Perseus distributed 7.5 million Beacon shares to its members, pursuant to an investment agreement with Beacon which Beacon’s board approved. The members, in turn, sold the shares. A Beacon shareholder filed a derivative action claiming that the acquisition of the Beacon shares by Perseus, allegedly a director by deputization, could be matched with the member sales for Section 16(b) purposes.
The U.S. Supreme Court recognized the doctrine of directors by deputization in the 1962 decision, Blau v. Lehman. The high court found that a shareholder, such as a partnership or corporation, could be a director for Section 16 purposes "if the investor actually functioned as a director" and "had been deputized to perform a director's duties not for himself" but for the firm. In subsequent rulemaking, the SEC did not include deputization in its definition of a director. According to the Commission in 1988, it did not
propose to codify case law relating to deputization. Under that theory, a corporation, partnership, trust or other person can be deemed a director for purposes of Section 16 where it has expressly or impliedly "deputized" an individual to serve as its representative on a company's board of directors. In determining whether a person has been deputized for purposes of Section 16, the courts have looked at a variety of factors, focusing primarily on the alleged deputy's position of control within the deputizing entity and the deputy's independent qualifications to serve on the board of the issuing corporation. This fact-intensive analysis appears best left to a case-by-case determination.However, in its amicus brief, the Commission argued that "the rationale underlying Rule 16b-3(d), as set forth in the 1996 adopting release, applies not just to named directors but also to directors by deputization. Like named directors, in transactions exempted by the rule the director by deputization deals with the issuer and not in the market, and thus there generally is no informational disadvantage as there might be in market transactions."
The court also rejected the plaintiff's contention that the Rule 16b-3(d) exemption is inapplicable to a director by deputization that is also a 10 percent holder. The court noted that "the Commission’s adopting release, however, specifically addresses the rule’s application to ten percent holders who are directors, and it does so without drawing a distinction between named directors and directors by deputization." In that release, the SEC stated that Rule 16b-3 does not provide an exemption for persons who are subject to section 16 solely because they beneficially own greater than ten percent of a class of an issuer’s equity securities. Officers and directors owe certain fiduciary duties to a corporation. Such duties, according to the SEC, act as an independent constraint on self-dealing, and may not extend to 10 percent holders. The Commission emphasized that Rule 16b-3 is available "to such a person who is also subject to Section 16 by virtue of being an officer or director with respect to transactions with the issuer."
The court reasoned that the rule’s gatekeeping procedures...are no less effective simply because an officer or director also happens to be a ten percent holder, and that the fact that a person is both a ten percent holder and a director by deputization does not undermine the basis for the exemption. The same policies underlying Rule 16b-3(d) that support application of the rule to a 10 percent holder who is a named director apply to a 10 percent holder who is a director by deputization.
Finally, the panel deferred to the SEC’s opinion on whether the transactions exempted by Rule 16b-3(d) were comprehended within the purpose of Section 16(b). According to the court, a focus on preventing insiders from taking advantage of “information not available to others” supports the SEC’s contention that issuer-insider transactions, where both parties have the benefit of `insider' information, are not comprehended within the purpose of Section 16(b)."