By Anne Sherry, J.D.
The Court of Appeals for the Ninth Circuit held that a short-swing transaction is exempt from clawback if it had board approval, even if that approval was not given for the specific purpose of the exemption. The holding agrees with an amicus brief filed by the SEC. The court remanded the case to allow further proceedings on the fact issue of whether the defendant is a “director by deputization” (Roth v. Foris Ventures, LLC, November 13, 2023).
Exchange Act Section 16(b) allows the clawback of profits from securities transactions between an issuer and an insider that occur within a six-month window. But under Rule 16b-3(d)(1), transactions that are “approved by the board of directors of the issuer” are exempt from clawback. Relying on a nonbinding 1999 SEC staff interpretive letter, the district court for the Northern District of California held that defendants must show that the board approved the transaction for purposes of invoking the Rule 16b-3 exemption. The SEC repudiated this position a few years later, and the Second Circuit held that there was no such purpose-specific approval requirement.
The Ninth Circuit did not spend much time coming to its conclusion in this “rare case where all parties involved agree that we must reverse.” As the Second Circuit observed in 2002, the text of the rule does not include a purpose-specific approval requirement or say anything about the board’s motivations. The Ninth Circuit likewise held that Rule 16b-3 does not include such a requirement.
The district court did not err, however, in finding that the board knew of a beneficial owner’s indirect pecuniary interest in the transactions when it approved them. The only remaining fact issue was whether the defendant was entitled to the Rule 16b-3 exemption as a “director by deputization.” Because a company may incur Section 16(b) liability by deputizing a natural person to perform its duties on the board, such a company may also invoke the exemption if the board is aware of the deputization. The record at the motion-to-dismiss stage was insufficient to resolve this question of fact, making remand necessary.
The district court will also have to contend with the related argument that Rule 16b-3 exempts entire transactions rather than specific defendants. This potentially dispositive issue—which would bring the exemption back into play even if the defendant was found not to be a director by deputization—was never squarely addressed by the district court, and the appeals court is “a court of review, not first view.”
The case is No. 22-16632.