Donoghue v. Sinclair Broadcast Group Inc.

Background

This shareholder derivative action concerns Section 16(b) of the Securities Exchange Act of 1934. That provision requires certain corporate insiders to give up profits from matching purchases and sales of the company’s securities occurring within less than six months, without requiring proof that the insider actually used confidential information or acted intentionally.

The plaintiffs alleged that David D. Smith was an officer, director, and beneficial owner of more than ten percent of Sinclair Broadcast Corporation’s common stock. They alleged that Smith acquired Sinclair Class B shares from Grantor Retained Annuity Trusts (GRATs) and later sold Sinclair Class A shares. The alleged acquisitions occurred on July 10, 2019; March 17, November 20, and December 23, 2020. The alleged sales or transfers occurred between November 2019 and March 2021. Using a lowest-in, highest-out calculation, the plaintiffs estimated approximately $5.5 million in short-swing profits.

The GRAT agreements identified Smith as the settlor, or person who established the trusts, and identified Steven A. Thomas and Paul O. Wallace as trustees. The agreements gave the trustees authority to manage and dispose of trust property, while Smith was prohibited from serving as a trustee. The agreements also gave Smith a non-fiduciary right to acquire trust property by substituting other property of equivalent value.

Legal standard

Smith moved to dismiss under Federal Rule of Civil Procedure 12(b)(6), which tests whether a complaint alleges enough facts to state a plausible claim. On such a motion, the court generally accepts the complaint’s factual allegations as true, draws reasonable inferences for the plaintiffs, and may consider documents incorporated into the complaint, including certain Securities and Exchange Commission filings.

Rule 16a-13 exemption

Smith first argued that his acquisitions were exempt under Securities and Exchange Commission Rule 16a-13 because they merely changed the form of his beneficial ownership without changing his financial interest in the shares.

The court rejected dismissal on this ground. The applicable rules attribute trust holdings and transactions to the trust rather than the settlor when the settlor does not exercise or share investment control over the securities. The court did not resolve the parties’ disagreement over the precise meaning of “investment control,” because Smith’s motion failed under either proposed definition.

The complaint and trust agreements did not show that Smith could direct the trustees’ management or disposition of the shares. Instead, the agreements transferred Smith’s rights in the shares to the trustees, gave the trustees authority to sell or otherwise dispose of trust property, and barred Smith from serving as trustee. The court also rejected Smith’s argument that his substitution right gave him a veto over trustee decisions or made him a de facto trustee. At most, the court found, that provision created an ambiguity that had to be resolved in the plaintiffs’ favor on a motion to dismiss.

The court also declined to treat statements in Smith’s SEC Forms 4 as proof that he remained the beneficial owner of the shares. Although the filings could be reviewed to determine what they stated, the court could not rely on Smith’s statements in them for their truth at this stage. The court concluded that Smith had not shown from the complaint and incorporated documents that the Rule 16a-13 exemption applied. His motion to dismiss on that ground was denied.

Whether the transactions were purchases

Smith alternatively argued that his acquisitions from the GRATs were not “purchases” under Section 16(b). The Exchange Act defines “purchase” broadly to include any contract to buy, purchase, or otherwise acquire securities.

The court held that the alleged exchanges of property of equivalent value for the shares fit within that definition. The alleged substitute property matched the range of market prices for Sinclair shares on the relevant dates, and the transactions therefore had the characteristics of ordinary exchanges of value for stock. The court also noted that Smith had referred to some of the transactions as purchases in SEC filings and had called them reacquisitions in his motion papers.

The court further stated that applying Section 16(b) was consistent with the statute’s purpose of preventing insiders from using potentially confidential information to obtain quick profits. The allegations did not support Smith’s assertion that he made all investment decisions for the GRATs; the trust agreements instead indicated that the trustees exercised investment control. The court did not address the statutory exception for certain unusual or involuntary transactions because Smith did not rely on it.

Disposition

The court concluded that the plaintiffs plausibly alleged that Smith’s acquisitions from the GRATs were purchases under Section 16(b) and that Smith could not establish the Rule 16a-13 exemption based on the materials properly considered on the motion. Judge Jesse M. Furman denied Smith’s motion to dismiss in full. The court directed Smith to file an answer within three weeks and rescheduled the initial pretrial conference.