## Facts

- An Ivax Corporation shareholder brought a derivative action seeking disgorgement of alleged short-swing profits under § 16(b) of the Securities Exchange Act of 1934.
- Philip Frost was Ivax’s Chairman and CEO and controlled Frost–Nevada Limited Partnership (FNLP).
- North American Vaccine, Inc. (NAVI) held shares of Ivax and sold Ivax stock in late 1995 and early 1996.
- During the same general period, Frost and FNLP purchased Ivax stock, and the complaint alleged NAVI’s sales could be matched with Frost/FNLP’s purchases within six months to show profits.
- The complaint alleged Frost/FNLP were controlling shareholders of NAVI and benefited indirectly because NAVI’s profitable Ivax sales increased the value of Frost/FNLP’s NAVI holdings.
- The district court dismissed under Rule 12(b)(6), holding Frost/FNLP did not “realize” profits from NAVI’s sales.

## Issues

1. Whether a statutory insider can be a § 16(b) “beneficial owner” of issuer securities held and traded by a controlled entity based on an indirect pecuniary interest in those securities.
2. Whether allegations of control over the entity holding the securities are sufficient, at the pleading stage, to avoid Rule 16a-1’s portfolio-securities safe harbor.
3. Whether “realization” of short-swing profits under § 16(b) may be pleaded based on indirect gains (such as appreciation in the insider’s holdings of the controlled entity) rather than direct receipt of trading proceeds.

## Decision

- The Second Circuit reversed the dismissal and remanded.
- The court held the complaint adequately alleged Frost/FNLP were “beneficial owners” of NAVI’s Ivax shares under SEC Rule 16a-1(a)(2) because they had an indirect pecuniary interest in NAVI’s trades.
- The court concluded the Rule 16a-1 safe harbor did not defeat the claim on the pleadings because the complaint alleged Frost/FNLP were controlling shareholders of NAVI and could influence NAVI’s disposition of its Ivax holdings.
- The court rejected the district court’s view that § 16(b) requires direct realization of trading proceeds, holding that an alleged opportunity to profit indirectly can suffice at the pleading stage under the SEC’s definitions.

## Legal Principles

- Section 16(b) imposes strict liability and requires disgorgement of profits from matched purchases and sales (or sales and purchases) of an issuer’s equity securities within six months by statutory insiders.
- Under SEC Rule 16a-1(a)(2), “beneficial owner” includes any person who, directly or indirectly, has or shares a direct or indirect pecuniary interest in the equity securities.
- “Pecuniary interest” includes the opportunity, directly or indirectly, to profit or share in profit derived from a transaction in the subject securities.
- A shareholder’s interest in an entity’s portfolio securities may fall within Rule 16a-1’s safe harbor only where the shareholder is not a controlling shareholder and does not have or share investment control over the portfolio.
- For pleading purposes, alleged control over an entity holding the issuer’s securities may support attribution of the entity’s trading to the insider based on indirect pecuniary benefit, consistent with the SEC’s rule-based definition of beneficial ownership.

## Conclusion

The Second Circuit held that allegations of control over a company holding and trading the issuer’s shares, coupled with an alleged indirect opportunity to profit through increased value of the insider’s holdings in that company, can state a § 16(b) claim and defeat dismissal at the pleading stage.


Feder ex rel. Ivax Corp. v. Frost, 220 F.3d 29 (2d Cir. 2000)