Chechele v. Elsztain et al

Filing 19

OPINION AND ORDER: Because Chechele's complaint plausibly states a claim upon which relief can be granted, defendants' motion to dismiss is denied. The Clerk of the Court is ordered to close this motion [Docket No. 12]. A conference is scheduled for March 5, 2012 at 4:00 p.m. (Signed by Judge Shira A. Scheindlin on 2/24/2012) (ft)

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK

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DONNA ANN GABRIELE CHECHELE,

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Plaintiff,

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EDUARDO S. ELSTAIN; CONSULTORES
ASSETS MANAGEMENT S.A.;
CONSULTORES VENTURE CAPITAL
URUGUAY S.A.; AGROINVESTMENT
S.A.; CONSULTORES VENTURE
CAPITAL LIMITED; IFIS LIMITED;
INVERSIONES FINANCIERAS DEL SUR
S.A.; CRESUD SOCIEDAD ANONIMA
COMERCIAL,INMOBILIARIA,
FINANCIERA Y AGROPECUARIA;
AGROLOGY S.A.; IRSA INVERSIONES Y
REPRESENTACIONES SOCIEDAD
ANONIMA; TYRUS S.A.; JIWIN S.A.;
IDALGIR S.A.; REAL ESTATE
INVESTMENT GROUP L.P.; REAL
ESTATE INVESTMENT GROUP II L.P.;
and REAL ESTATE INVESTMENT
GROUP III L.P.,

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Defendants,

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HERSHA HOSPITALITY TRUST,

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Nominal Defendant.

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SHIRA A. SCHEINDLIN, U.S.D.J.:
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OPINION AND ORDER

11 Civ. 3320 (SAS)

I.

INTRODUCTION
Donna Ann Gabriele Chechele owns shares in Hersha Hospitality

Trust (“Hersha”), a Maryland real estate investment trust.1 She has brought a
shareholder derivative suit against Eduardo S. Elstain, one of Hersha’s trustees
who at all relevant times owned more than ten percent of Hersha’s outstanding
Class A common shares, and against fifteen corporate entities controlled by
Elstain, each of which also controlled, either directly or indirectly, at least ten
percent of Hersha’s stock.2 Chechele claims that defendants violated Section 16(b)
of the Securities and Exchange Act of 1934 (“the Act”) by purchasing
approximately $17 million of Hersha stock from Hersha’s underwriters at its
October 29, 2010 public offering and then selling that stock between December
2010 and March 2011 for a total profit of approximately $1.31 million.3 Chechele
claims that these profits should be disgorged from defendants and returned to
Hersha. Defendants have moved to dismiss Chechele’s claim, arguing that their
purchase of Hersha stock was exempted from the prohibition on short swing

1

See Complaint (“Compl.”) ¶¶ 3-4. Unless otherwise indicated, all
factual statements are taken from the Complaint and assumed to be true for the
purpose of adjudicating this motion to dismiss.
2

See id. ¶¶ 5-13.

3

See id. ¶¶ 14-19.
2

insider profits because it was authorized by the Hersha Board and thus permissible
under Rule 16b-3 (“the Rule”) of the Securities and Exchange Commission
(“SEC”).4 Because defendants’ purchase is not covered by the terms of Rule 16b3, which exempts in relevant part only “acquisitions from the issuer” and not
acquisitions from intermediaries such as underwriters, and because there are no
compelling reasons to depart from the plain language of the Rule, their motion to
dismiss is denied.
II.

LEGAL STANDARD
In deciding a motion to dismiss pursuant to Federal Rule of Civil

Procedure 12(b)(6), the court may disregard “[t]hreadbare recitals of the elements
of a cause of action, supported by mere conclusory statements.”5 In contrast,
“[w]hen there are well-pleaded factual allegations, a court should assume their
veracity and then determine whether they plausibly give rise to an entitlement for
relief.”6

4

See Memorandum of Law in Support of Defendants’ Motion to
Dismiss the Complaint Pursuant to Rule 12(b)(6) of the Federal Rules of Civil
Procedure (“Def. Mem.”) at 1.
5

Ashcroft v. Iqbal, 556 U.S. 662, ___, 129 S.Ct. 1937, 1949 (2009)
(citing Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007)).
6

Id. at 1950. Accord Den Hollander v. Copacabana Nightclub, 624
F.3d 30, 32 (2d Cir. 2010).
3

To survive a Rule 12(b)(6) motion to dismiss, the allegations in the
complaint must meet a standard of “plausibility.”7 A claim is facially plausible
“when the plaintiff pleads factual content that allows the court to draw the
reasonable inference that the defendant is liable for the misconduct alleged.”8
“[A] district court may consider the facts alleged in the complaint, documents
attached to the complaint as exhibits, and documents incorporated by reference in
the complaint.”9 “Where public records that are integral to a . . . complaint are not
attached to it, the court, in considering a Rule 12(b)(6) motion, is permitted to take
judicial notice of those records.”10 However, “[i]f the court takes judicial notice, it
does so in order to determine what statements they contained . . . not for the truth
of the matters asserted.”11
III.

APPLICABLE LAW
Section 16(b) of the Act provides for the disgorgement of certain

profits earned through insider trading, regardless of the insider’s intention when

7

Twombly, 550 U.S. at 564.

8

Iqbal, 129 S. Ct. at 1949 (quotation marks omitted).

9

DiFolco v. MSNBC Cable LLC, 622 F.3d 104, 111 (2d Cir. 2010)
(citing Chambers v. Time Warner, Inc., 282 F.3d 147, 153 (2d Cir. 2002)).
10

11

Roth v. Jennings, 489 F.3d 499, 509 (2d Cir. 2007).
Id. (quotation, citation, and emphasis omitted).
4

making the trades:
For the purpose of preventing the unfair use of information which
may have been obtained by such beneficial owner, director, or
officer by reason of his relationship to the issuer, any profit
realized by him from any purchase and sale, or any sale and
purchase, of any equity security of such issuer (other than an
exempted security) or a security-based swap agreement involving
any such equity security within any period of less than six months,
unless such security or security-based swap agreement was
acquired in good faith in connection with a debt previously
contracted, shall inure to and be recoverable by the issuer
irrespective of any intention on the part of such beneficial owner,
director, or officer in entering into such transaction . . .12
Section 16(b) explicitly empowers the SEC to exempt from the law’s
ambit any transactions that the agency determines are “not comprehended within
the purpose” of the law, and the SEC has done so in Rule 16b. The Rule exempts
“[t]ransactions between an issuer and its officers or directors,” that meet certain
conditions.13 Acquisitions from the issuer are exempt if the transaction is approved
by the issuer’s board of directors (or by an independent committee of the board) or
approved by the issuer’s shareholders, or if the security is held for more than six
months.14
IV.

DISCUSSION

12

15 U.S.C. § 78p(b).

13

See 17 C.F.R. § 240.16b-3.

14

See id. § 240.16b-3(d).
5

The issue presented by this motion is discrete and surprisingly novel.15
Defendants were insiders who made their purchase of Hersha stock from
underwriters who had been hired by the company to conduct a public offering.16
Rule 16b-3 exempts from the insider trading rules certain “[t]ransactions between
an issuer and its officers or directors” (emphasis added). Defendants argue that
this exemption properly extends to transactions between an underwriter and a
director when “the material terms” of the transaction were negotiated between the
insider and the issuer, approved by the issuer’s Board of Directors, and then
dictated to the underwriter by the issuer.17 Chechele argues that the plain text of
the rule forecloses defendants’ argument and that guidance from the SEC confirms
the plain meaning.18

15

Neither the parties nor the Court are aware of any prior cases
addressing this question. One possible reason for the novelty of the issue may be
that no defendant has previously attempted to take refuge in Rule 16b-3 for
purchases made from an underwriter at a public offering.
16

See Def. Mem. at 1, acknowledging that “as a technical matter,”
defendants purchased their shares “from underwriters in a public offering at the
offering price rather than directly from the issuer.”
17

See id. at 2.

18

See Plaintiff’s Memorandum of Law in Opposition to the Motion to
Dismiss the Complaint (“Pl. Mem.”) at 5. Chechele also argues, in the alternative,
that even if defendants’ purchases were eligible for exemption under Rule 16b-3,
questions of fact remain regarding whether Hersha’s board complied with the Rule
when it approved of the transaction.
6

When interpreting a statute, the well-established rules of statutory
construction instruct that “the inquiry begins with the plain language of the statute
and ‘where the statutory language provides a clear answer, it ends there as well.’”19
A court must determine “‘whether the language at issue has a plain and
unambiguous meaning with regard to the particular dispute in the case.’”20 The
provision at issue must be read in conjunction with the rest of the statute, but “as
long as the statutory scheme is coherent and consistent, there generally is no need
for a court to inquire beyond the plain language of the statute.”21 Nonetheless, a
court may depart from the plain language “if literal application of the statute will
produce a result demonstrably at odds with the intentions of [the statute’s]
drafters.”22 The same principle applies to the interpretation of a regulation: “The
plain language in a regulation governs unless that meaning would lead to absurd
results.”23

19

Peralta-Taveras v. Gonzales, 488 F.3d 580, 584 (2d Cir. 2007)
(quoting Hughes Aircraft Co. v. Jacobson, 525 U.S. 432, 438 (1999)).
20

In re Caldor, 303 F.3d 161, 168 (2d Cir. 2002) (quoting Robinson v.
Shell Oil Co., 519 U.S. 337, 340 (1997)).
21

United States v. Ron Pair Enters., 489 U.S. 235, 240-41 (1989).

22

Id. at 242.

23

Zhen Nan Lin v. United States Dep’t of Justice, 459 F.3d 255, 262 (2d
Cir. 2006) (quotation and citation omitted).
7

The plain language of Rule 16b-3 exempts transactions between
issuers and their officers and directors, not between underwriters and the issuer’s
insiders and directors. Defendants do not argue that this plain meaning leads to
absurd results. Instead, they argue that the Rule’s purpose is best served by
reading it to exempt their purchase of Hersha stock from the underwriters.24
Defendants argue that because their transaction with the underwriters was strictly
limited by the terms laid out by Hersha’s Board of Trustees, it “falls squarely
within the types of transactions that, according to the SEC, ‘do not appear to
present the same opportunities for insider profit on the basis of non-public
information as do market transactions by officers and directors.’”25 “Because
Section 16(b) is a strict liability rule and can subject insiders to liability regardless
of their actual access to inside information,”26 defendants argue, and because “the
prevailing view is to apply the statute only when its application would serve its
goals,”27 the Rule’s plain meaning should be extended to include the transaction at

24

See Def. Mem. at 7-10.

25

Id. at 7 (quoting Ownership Reports and Trading by Officers,
Directors and Principal Security Holders, Exchange Act Release No. 34-37260, 61
Fed. Reg. 30,376, 30,377 (June 14, 1996) (“1996 Release”).
26

Id. at 5.

27

Kern Cnty. Land Co. v. Occidental Petroleum Co., 411 U.S. 582, 596

(1973).
8

issue.
There are four reasons why defendants’ motion fails. First, although
the underwriting agreement appears to have been written based on the assumption
that the underwriters would sell the shares to the defendants, it did not bind the
underwriters to do so: they were free to do what they wished with the stock.28 That
is to say, they were independent actors not synonymous with the issuer itself.
Second, and more importantly, the transaction occurred on the open market as part
of a public offering. Through the market, it altered the prices at which other shares
were sold and thus impacted other buyers. The 1996 Release exempted
transactions that posed little risk of insider trading because those transactions were
fundamentally different from “market transactions by officers and directors.”29 But
this transaction was a market transaction by officers and directors.
Third, the SEC has provided the following guidance: “Rule 16b-3
would not exempt an officer’s or director’s purchase of the issuer’s stock in a
public offering pursuant to a ‘friends and family’ allocation.”30 Chechele argues
that the transaction in question was a classic “friends and family” or “directed

28

See Pl. Mem. at 12-13.

29

1996 Release at 30,377.

30

Compliance and Disclosure Interpretation No. 123.17 (May 23, 2007),
available at http://www.sec.gov/divisions/corpfin/guidance/sec16interp.htm.
9

share” purchase. Defendants contend that the reasoning behind the SEC’s
interpretation does not apply here, because the issuer dictated the quantity,31 price,
and date terms to both the underwriter and the defendants. Even if true, however,
it is unclear how this fact would distinguish the transaction from a classic directed
share or friends and family program, in which certain individuals are given the
right to buy a certain quantity of shares at the initial offering price at the time of
the initial offering.32 Even though the SEC’s guidance is not entitled to any
deference beyond its power to persuade, it confirms the plain meaning of the Rule
and undercuts defendants’ argument that the SEC intended the Rule to exempt such
transactions.
Fourth and finally, defendants have provided no powerful reason to
depart from the plain language of the Rule. They have not even posited any
important public policy reasons to permit insiders to make short swing profits by

31

Chechele argues that Hersha did not fix the quantity of shares that had
to be sold to defendants by the issuer. She argues that Hersha set the number of
shares that the defendants were permitted to buy, but did not obligate the
underwriters to sell any particular quantity of shares to defendants. This appears to
be an accurate reading of the underwriting agreement. See Pl. Mem. at 12-13.
32

“Contrary to [defendants’] claim, there is no special class of ‘friends
and family’ programs in which someone other than the issuer directs to whom
shares are sold. When the staff [of the SEC] said that the exemption would not
reach a ‘public offering pursuant to a ‘friends and family’ allocation,’ it was
addressing the same fact pattern now before the Court.” Pl. Mem. at 12.
10

selling securities that they previously purchased from underwriters at public
offerings pursuant to terms (largely) set by the issuer. In the absence of some
compelling argument, this Court has neither the power nor the inclination to
expand the scope of permissible insider trading in contravention of the plain
language of the Securities Act and the SEC's duly promulgated regulations.

v.

CONCLUSION

Because Chechele's complaint plausibly states a claim upon which
relief can be granted, defendants' motion to dismiss is denied. The Clerk of the
Court is ordered to close this motion [Docket No. 12]. A conference is scheduled
for March 5, 2012 at 4:00 p.m.

Dated:

New York, New York
February 24,2012

11

-AppearancesFor Plaintiff:
James A. Hunter, Esq.
Hunter & Kmiec
150 East 44th Street, No. 9A
New York, New York 10017
[phone]
For Defendants:
Robert Houck, Esq.
Alejandra de Urioste, Esq.
Alexander Feldman, Esq.
Clifford Chance US, LLP
31 West 52nd Street
New York, New York 10019
[phone]
For Hersha Hospitality Trust:
Joseph J. Saltarelli, Esq.
Hunton & Williams, LLP
200 Park Avenue, 52nd Floor
New York, New York 10166
[phone]

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