Second Circuit Affirms Dismissal of Shareholder’s Claims against Corporate Insider Seeking Disgorgement of "Short-Swing" Profits

In Olagues v. Icahn, 866 F.3d 70 (2d Cir. 2017), the United States Court of Appeals for the Second Circuit affirmed the lower court’s holding that shareholder John Olagues (“Plaintiff”) failed to state a claim upon which relief could be granted in actions against corporate insider Carl C. Icahn (“Defendant”) seeking disgorgement of "short-swing" profits.  The court determined that Plaintiff had failed to plausibly allege the Defendant obtained additional profits that required disgorgement.

Plaintiff, a shareholder in three companies, Herbalife, Ltd., Hologic Inc., and Nuance Communications Inc. (the “Companies”), alleged that Defendant wrote "European Style" put options allowing the counterparty to exercise the option on a specific date. The Plaintiff further alleged the Defendant bought "American Style" call options allowing him to exercise the option at any time until the expiration date. The complaint asserted that Defendant set the expiration date in both transactions for the same day and included in the contract that the exercise of a call option would terminate the corresponding put option.

Defendant disgorged the amount of the premiums to the Companies when the put options were cancelled unexercised within six months of their sale.  See Rule 16b-6. Plaintiff, however, argued Defendant should also have disgorged the value of the discounts received on the premiums paid for the call options in exchange for charging lower premiums on the put options. Plaintiff further argued the premiums associated with the open market option contract show Defendant charged too low of an amount for the put options and paid too low of a price for the call options.

Under Rule 16(b) of the Securities and Exchange Act of 1934, liability attaches if the plaintiff proves (1) purchase of a security (2) sale of a security (3) carried out by an insider (4) in a six-month period. A strict liability provision, the seller need not have engaged in the transactions on the basis of inside information.  Rule 16b-6(d) specifies that profits must be recovered whenever an option is cancelled or has expired within six months of writing.  Profits include “the entire premium actually ‘received for writing the option[s’” at issue, not just the amount reported to the SEC.” (citation omitted). 

The court held Plaintiff did not plausibly allege Defendant failed to disgorge all premiums received. First, the court reasoned the open market option contracts did not provide a meaningful comparison to Defendant’s transactions. Plaintiff did not allege the structure of these transactions was fraudulent. Additionally, the court stated the complaint did not allege facts to support the inference that there were additional short-term swing profits. The fact that the Defendant exercised a fixed-price call option did not support this inference and was “a non-event under Rule 16(b).” Finally, the court held the events described in the complaint do not fall within the policy reasons for stopping insiders from receiving and keeping premiums from options. The Court qualified its holding, noting the complaint did not state a claim for relief because it solely relied on incomparable transactions that did not have meaningful similarities to the transactions at issue in the case.

For the above reasons, the court affirmed the lower court’s dismissal of the complaint, holding that Plaintiff failed to state a claim.

The primary materials for this case may be found on the DU Corporate Governance Page.