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Corporate & Securities Law

: Jim Hamilton's World of Securities Regulation

By Jim Hamilton

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3rd Circuit Changes Course, Finds Reclassification Exempt from Section 16(b)

Revisiting a case that prompted the SEC to amend its short-swing trading rules, a 3rd Circuit panel found that a reclassification of preferred stock to common shares was not a Section 16 purchase (Levy v.Sterling Holding Co.) under Exchange Act Rule 16b-3. In a previous ruling, the court held in 2002 that the transaction was not exempt under Rules 16b-3 and 16b-7. With regard to Rule 16b-3, the court limited the exemption to transactions with a compensatory purpose, and found also that Rule 16b-7 did not apply to all reclassifications.

In response, the SEC adopted amendments to the rules in 2005 to clarify that the exemptions applied to the kind of transactions at issue in the first Levy case. The question before the 3rd Circuit was the impact of their amendments on their previous ruling and to the transactions involved.
The plaintiff claimed that the earlier decision should stand because 1) the doctrine of stare decisis, 2) the amendments exceeded the SEC's authority and 3) applying the 2005 rules to the 1999 reclassification would have an impermissible retroactive effect. With regard to stare decisis, the court found that a previous holding by the court did not foreclose consideration of a subsequent agency interpretation.

On the question of SEC authority, the court found that the SEC rationale, that the purchase of securities from, or sale of securities to, the issuer by a director or officer did not present the same opportunity for speculative abuse targeted by Congress as transactions with unrelated parties. Because the SEC's rulemaking rationale was reasonable, the court concluded that new Rule 16b-3 was a valid exercise of the SEC?s congressionally delegated authority.

Finally, the court found that the case did not present retroactivity concerns. The rule changes, stated the court, were clarifications rather than new substantive provisions.

[Note: The court ruled on the basis of Rule 16b-3 and did not fully reach the Rule 16b-7 question.]

Full post as published by Jim Hamilton's World of Securities Regulation on October 06, 2008 (boomark / email).