Ninth Circuit Relies on State Law in Determining Insider Trading Exemption

Ninth Circuit Relies on State Law in Determining Insider Trading Exemption

Case: Alpha Venture Capital Partners LP, et al. v. Pourhassan, et al., No. 21-35274

Ninth Circuit Panel Composition: Bybee (Bush); Bea (Bush); and Christen (Obama).

Result: Affirming the district court's dismissal for failure to state a claim.


In a case touching on securities law and insider trading, the Ninth Circuit was recently asked to examine Section 16(b) of the Securities Exchange Act of 1934 (the "Exchange Act") and analyze one of its related exemptions. Appellee Nader Pourhassan, CytoDyn, Inc.'s Chief Executive Officer and board member, was granted by board approval, options and warrants to purchase millions of CytoDyn's shares. Pourhassan subsequently exercised those options and warrants and then quickly sold his shares within a six-month period resulting in significant profits. Appellants, shareholders of CytoDyn, brought suit against Pourhassan alleging that he needed to disgorge the profits derived from these "short-swing" transactions because he violated Section 16(b) of the Exchange Act.

In the district court, Pourhassan moved to dismiss the case asserting that the short-swing transactions were exempted under Rule 16b-3(d)(1), which permits short-swing transactions if the transactions were approved by the issuing company’s board of directors. The shareholders contended that approval never occurred here because the corporation's full board of directors never approved. Instead, as they pointed out, only four of the five directors had been present at the meeting in which these short-swing transactions had been discussed and, moreover, only three of the four directors present voted to approve. The district court rejected this argument and dismissed the complaint, ruling that the short-swing transactions fell within the Rule 16b-3(d)(1) exemption. The shareholders appealed to the Ninth Circuit.

Statutory Interpretation of Board Approval in Instances of Insider Trading

The statutory interpretation of Section 16(b) of the Exchange Act lies at the heart of this case, which governs and regulates securities transactions in the secondary market. The panel reviewed Section 16(b)’s statutory contours and observed that the law is aimed at preventing corporate executives, namely officers and directors, from utilizing information that is not generally known to the public to secure quick profits (i.e., insider trading) by requiring such insiders to return to the corporation any profits made from short-swing transactions.

However, there are exemptions to Section16(b), including the one at issue here, which negates an insider’s obligation to return profits to the issuing company if the swing transactions are approved by the corporation's board of directors.

On appeal, the parties disputed whether the phrase "approved by the board of directors" in Rule 16b-3(d)(1) requires the full approval of the board of directors. The shareholders argued that the affirmative vote of just three out of the five CytoDyn directors—at a meeting where only four were present—did not constitute a full board approval, and therefore the short-swing transactions did not qualify for the exemption. Pourhassan disagreed, contending that a majority vote, in compliance with CytoDyn's bylaws, was sufficient for purposes of Rule 16b-3(d)(1).

The Court ultimately affirmed the lower court, finding that Rule 16b-3(d)(1) exempted Pourhassan's short-swing transactions from Section 16(b). In making this decision, the Court held that, by its plain terms, Rule 16b-3(d)(1) does not set forth any specific procedure as to how a board approves an insider securities acquisition. Indeed, board approval for purposes of Rule 16b-3(d)(1) doesn’t require “unanimity, a supermajority, a particular quorum, or any other specific steps.”

Relying on Supreme Court precedent, the panel explained that where, as was the case here, such procedural gaps in a federal law exist, they must be filled with state law.

CytoDyn is a Delaware corporation, and so the Court looked to Delaware's corporate law for guidance. Under Delaware corporate law, a quorum is deemed a "majority of the total number of directors," and a vote made with a quorum present constitutes an act of the board. The Court reasoned that since the CytoDyn director vote occurred at a meeting in which a quorum of directors was present—as opposed to happening by a written consent where unanimous board approval would have been required by the Delaware General Corporation Law—CytoDyn’s simple majority vote complied with both Delaware corporate law and CytoDyn's bylaws. As a result, Pourhassan's swing transactions fell squarely within the Rule 16b-3(d)(1) exemption.

Finally, the panel rejected the shareholders’ alternative arguments, namely their contention that certain SEC rulemaking documents—specifically, preamble language that mentioned approval requiring full board consent for these swing transactions—mandated a different interpretation of the exemption, concluding that such language was tenuous and not controlling.

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