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From Securities Regulation Daily, January 29, 2014

Goldman Sachs not liable as a statutory insider when call options expired

By John M. Jascob, J.D.

The Second Circuit Court of Appeals has held that The Goldman Sachs Group, Inc., (Goldman Sachs) was not required to disgorge short-swing profits where the company was a statutory insider only when the call options at issue were written, but not when they expired. Although ruling that the expiration of a call option within six months of its writing constitutes a “purchase” by the option writer, and thus must be matched against a “sale” occurring when the option was written, the appellate court ruled that Goldman Sachs lacked insider status at the time of purchase because the firm no longer held 10 percent of the issuer’s shares when the options expired. Accordingly, the Second Circuit panel affirmed the dismissal of the plaintiff’s derivative action (Roth v. Goldman Sachs Group, Inc., January 29, 2014, Winter, R.).

Background and allegations. The plaintiff, a shareholder in Leap Wireless International, Inc., (Leap) had filed a derivative suit seeking to hold Goldman Sachs and a subsidiary liable under Exchange Act Sec. 16(b) and Rule 16b-6(d) for their failure to disgorge “short-swing profits” derived from writing call options on Leap stock. Although Goldman Sachs owned over 10 percent of Leap’s equity shares when it wrote the call options, and thus was a statutory insider under Sec. 16(b), Goldman Sachs owned less than 10 percent when the unexercised options expired less than six months later. Concluding that the expiration was a “purchase,” but that the defendants were not statutory insiders at the time of the “purchase,” the district court held that Goldman Sachs was not required to disgorge any profits and dismissed the suit.

“Purchase” under Sec. 16(b). The plaintiff had argued that Goldman Sachs’s writing of a short call option constituted a simultaneous sale and purchase under the statute, based on a theory that the writer commits to a subsequent purchase of the underlying stock at the instant it takes a short position on a call option. Because Goldman Sachs was a statutory insider when the options were written, the plaintiff contended, the fact that Goldman Sachs was not a statutory insider at the time of the option’s expiration was of no consequence.

The appellate court, however, granted deference to the SEC’s interpretation of Sec. 16(b). The appellate court observed that the SEC had adopted Rule 16b-6(d) to eliminate the potential that an insider writing options could generate profits by knowing, by virtue of inside information, that the option would not be exercised within six months. For this reason, the SEC determined that in the case of an expiration of a short option position, the expiration will be treated as the purchase of the option. Accordingly, the court held that, for purposes of Sec. 16(b), the expiration of a call option within six months of its writing is to be deemed a “purchase” by the option writer to be matched against the “sale” deemed to occur when that option was written. Because Goldman Sachs was no longer a statutory insider at the time the options expired, the company was not liable to disgorge short-swing profits under the statute.

The case is No. 12-2509-CV.

Attorneys: Glenn F. Ostrager (Ostrager Chong Flaherty & Broitman P.C.) for Andrew E. Roth. Daniel H. Tabak (Cohen & Gresser LLP) for The Goldman Sachs Group, Inc. and Goldman, Sachs & Co. Christopher R. Harris (Latham & Watkins LLP) for Leap Wireless International, Inc.

Companies: The Goldman Sachs Group, Inc.; Goldman, Sachs & Co.; Leap Wireless International, Inc.

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