## Facts

- Editek, Inc., a public company, brought suit under § 16(b) of the Securities Exchange Act of 1934 to recover alleged short-swing profits.
- In February 1991, Editek issued Morgan Capital, L.L.C. convertible preferred stock that could be converted into Editek common stock after a 60-day period.
- The conversion formula used a floating rate tied to the market price at conversion; based on the instrument’s terms, Morgan Capital allegedly could obtain more than 10% of Editek’s common stock upon conversion.
- On May 1, Morgan Capital converted the preferred stock into common stock and received more than 10% of Editek’s outstanding common stock.
- Morgan Capital then sold the common stock within a short period, and Editek alleged profits exceeding $500,000.
- The district court dismissed under Rule 12(b)(6), reasoning Morgan Capital was not a more-than-10% beneficial owner at the relevant time because it initially held only convertible preferred stock, not common stock.

## Issues

1. Whether a holder of convertible preferred stock can be a “beneficial owner of more than 10 percent” for § 16(b) purposes before conversion, such that the holder is above 10% at the time of the purchase and the sale.
2. Whether, in determining § 16(b) beneficial ownership, a court may consider SEC beneficial-ownership concepts developed under § 13(d), including treatment of derivative or convertible rights.
3. Whether Editek’s allegations were sufficient to survive a Rule 12(b)(6) motion on the timing and extent of Morgan Capital’s beneficial ownership.

## Decision

- The Eighth Circuit reversed the dismissal and remanded for further proceedings.
- The court held the district court misread the regulatory framework by treating record ownership of common stock as the exclusive basis for § 16(b) beneficial ownership.
- The court concluded Editek plausibly alleged Morgan Capital held a position that could confer more than 10% beneficial ownership prior to conversion, making dismissal at the pleading stage improper.

## Legal Principles

- Section 16(b) imposes strict liability disgorgement of short-swing profits on directors, officers, and more-than-10% beneficial owners, without requiring proof of intent or actual misuse of inside information.
- For 10% holders, § 16(b) liability requires the defendant to be above 10% both at the time of the matched purchase and sale; an acquisition that first pushes the holder above 10% cannot itself serve as the matchable “purchase.”
- “Beneficial ownership” is not limited to record title; SEC regulatory concepts may treat holders of convertible or derivative instruments as beneficial owners depending on the rights conveyed (including contingent rights to acquire shares).
- On a Rule 12(b)(6) motion, allegations supporting a plausible inference of >10% beneficial ownership at the relevant times are sufficient; fact-dependent ownership questions involving complex instruments generally require further development.

## Conclusion

The Eighth Circuit reinstated Editek’s § 16(b) claim, holding that convertible preferred stock may support an inference of more-than-10% beneficial ownership before conversion and that the complaint adequately alleged insider status to proceed beyond the pleading stage.


Editek, Inc. v. Morgan Cap., L.L.C., 150 F.3d 830 (8th Cir. 1998)