Securities Regulation Daily Wrap Up, FRAUD AND MANIPULATION—S.D.N.Y.: Client of investment adviser did not agree to short-swing trades, (Feb 6, 2019)

By Lene Powell, J.D.

Mere delegation of investment authority to the adviser did not imply agreement to join the adviser’s ‘control group’ for purposes of short-swing trading.

A federal district court in the Southern District of New York dismissed a shareholder’s complaint seeking disgorgement of profits by an unidentified client of an investment advisor, contending that the client had acted together with the adviser and related defendants to make short-swing trades in the client’s account. Without more, the fact that the client gave the adviser discretion to manage his money was not enough to show that he became part of a control ‘group’ for purposes of the short-swing statute (Rubinstein v. International Value Advisers, LLC, February 5, 2019, Engelmayer, P.).

Short-swing trades. A corporate shareholder of AdTalem Global Education Services, formerly known as DeVry Global Education Group, Inc., sought disgorgement by "John Doe" of the profit he made on trades in his account involving the company. John Doe was an unidentified account-holder at International Value Advisers, LLC (IVA), an investment adviser. The shareholder alleged that John Doe, IVA, and IVA portfolio managers were insiders of DeVry because their combined beneficial ownership of DeVry was more than 10 percent, and that together they acted as a ‘control group’ that executed short-swing trades in Doe’s account under Section 16(b) of the Exchange Act. The trading at issue took place in Doe’s account alone.

No agreement shown. The definition of beneficial owner under Section 16(b) exempts certain classes of securities holders, such as registered investment advisers like IVA, from being treated as the beneficial owner of shares held "for the benefit of third parties or in customer or fiduciary accounts in the ordinary course of business." However, this exemption only holds if those shares are acquired without the purpose or effect of influencing control of the issuer.

The court observed that in light of the statute’s strict liability, which imposes a blanket ban on short-term trading by insiders without regard to whether the insiders acted on inside information, the Supreme Court has cautioned against interpreting the statute to exceed its "narrowly-drawn limits." Here, the court boiled down the question to whether Doe agreed to act together with the IVA defendants for the purpose of acquiring, holding, voting, or disposing of the DeVry’s stock. If Doe did, then the IVA group’s 19.5 percent stake and admitted control purpose would render Doe an "insider" as part of the IVA "group."

The court rejected the shareholder’s argument that Doe’s delegation of authority to IVA’s to manage his account supported the inference that he agreed to trade DeVry shares as a group within the meaning of Section 13(d) and Rule 13d-5(b)(1). The complaint alleged only that IVA had authorization from Doe to manage the account, that is, to make investment and voting decisions for it. This did not support a claim of a "common objective" between Doe and the holders of other accounts that had an investment stake in DeVry, nor an intent to pool the account’s voting or other interests in any particular security, such as DeVry stock. The allegations did not show that Doe was even aware of IVA’s decision to invest his account in DeVry.

Examining the limited case law involving whether the delegation of investment authority to an investment manager alone suffices to create a "group" within the meaning of Section 13(d), the court found that it was largely in accord with its holding. Two cases in the Northern District of California reasoned:

"This theory would necessarily lead to the result that anyone who enters into an investment advisory agreement with an RIA would form a Rule 13(d) group with the RIA and any other clients of the RIA who purchased shares of the company’s stock. This is plainly not what is set forth in §13(d) or Rule 13d-5."

Control purpose. Turning to the shareholder’s remaining argument, that an agreement was formed between Doe and the IVA defendants because IVA disclosed its control purpose and Doe did not object, the court found that this could be "quickly interred." The allegation that Doe "agreed to" or "authorized IVA’s strategy" was unsupported and conclusory, and the court did not accept it as fact. The complaint did not allege that Doe was aware of the IVA defendants’ control purpose by reading the Schedule 13D or other means, or that the IVA defendants notified Doe of their control purpose regarding DeVry.

Complaint dismissed. Accordingly, because Doe was not part of a "control group" with IVA, the court dismissed the complaint in entirety.

The case is No. 1:18-cv-00081-PAE.

Attorneys: David Lopez (Law Office of David Lopez) for Aaron Rubenstein. Dennis H. Tracey, III (Hogan Lovells) for International Value Advisers, LLC.

Companies: International Value Advisers, LLC

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