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Securities Regulation and Corporate Governance > Posts > Federal Court Rejects Section 16(b) “Short-Swing Profits” Claim Challenging Share Withholding To Satisfy Taxes
Federal Court Rejects Section 16(b) “Short-Swing Profits” Claim Challenging Share Withholding To Satisfy Taxes

A federal court in Oklahoma today issued a precedent-setting decision in favor of Gibson Dunn client WPX Energy, Inc., in Olagues v. Muncrief, No. 17-cv-153 (N.D. Okla. Jan. 26, 2018), ECF No. 42.  In the decision, the court held that pre-approved tax withholding dispositions made in connection with the vesting of equity grants are exempt from Section 16(b)’s prohibition on short-swing profits under Exchange Act Rule 16b-3(e)—even when an employee otherwise subject to the short-swing trading restrictions purchased the company’s shares during the six-month period preceding or following the tax withholding disposition.  This is the first time that a federal court has substantively addressed these types of short-swing trading claims, which have been serially raised by a small group of investors—first in the form of litigation demands and then, absent a payout to the investors, in litigation—during the last sixteen months.  A number of companies have refused the investors’ settlement demands, which has resulted in Section 16(b) cases against the companies’ executives in federal courts in California, Colorado, Delaware, Florida, Massachusetts, North Carolina, Ohio, Oklahoma, Tennessee, Texas, and Washington state. 

In Olagues v. Muncrief, the plaintiff alleged that dispositions of shares that WPX Energy performed on behalf of two covered officers to settle the officers’ tax withholding obligations associated with the vesting of restricted stock units constituted “sales” that could be matched with the officers’ unrelated open-market stock purchases, thereby resulting in short-swing profits in violation of Section 16(b).  In June 2017, the court dismissed the plaintiff’s claims as procedurally improper because the plaintiff had filed his complaint pro se and was not entitled to pursue Section 16(b) claims on behalf of the company in a pro se capacity.  Slip Op. at 5.  The plaintiff subsequently retained counsel and filed an amended complaint.  Id.  The defendants moved to dismiss the amended complaint, arguing that the tax withholding dispositions could not be “matched” with the officers’ open-market purchases because, among other reasons, the tax withholding dispositions were exempt from Section 16(b)’s prohibition on short-swing profits under Exchange Act Rule 16b-3(e).

The court today granted judgment in the defendants’ favor, holding that “plaintiff cannot show that defendants violated §16(b)” because “the tax withholding transactions are exempt [from coverage under Section 16(b)] and cannot be used to show that a prohibited short-swing transaction occurred.”  Id. at 14.   The court explained that under SEC Rule 16b-3, transactions with the issuer—including withholding transactions like the ones at issue in the case—are exempt from Section 16(b) if they are pre-approved by the issuer’s board of directors or a committee of independent directors.  Id. at 8.  The court expressly rejected the plaintiff’s argument that the Rule 16b-3 exemption does not apply because, under the terms of the equity grants, WPX Energy allegedly had “discretion” either to withhold a portion of the equity award or require a cash payment from the officers to satisfy their tax withholding obligations.  The court explained that “[t]he committee was not required to separately approve tax withholding transactions”  because the withholding transactions were “specifically contemplated” and approved in the award agreements.  Id. at 13.

The court also expressly rejected the plaintiff’s argument that one of the tax withholding dispositions did not qualify for the Rule 16b-3 exemption because, under the plaintiff’s interpretation of Section 83(c) of the Internal Revenue Code, taxes on the equity grant were not due until the expiration of the six-month period following the “matching” open-market purchase.  Under Section 83(c), “property transferred to a person for the performance of services must be included as part of that person’s gross income unless it is subject to a substantial risk of forfeiture,” including under Section 16(b).  The court held that “[t]he issue of whether payment of taxes can be deferred depends on the status of a transaction as exempt or non-exempt under § 16(b), and resolving the status of the tax withholding transactions as exempt or non-exempt . . . necessarily dispose[s] of plaintiff’s argument that [defendants] could have deferred payment of taxes.”  Id. at 1112.

Finally, the court questioned whether any tax withholding disposition of stock to an issuer may properly be considered within the scope of Section 16(b) without regard to whether the Rule 16b-3 exemption applies because it is “unclear that [the insiders] actually realized a profit from the withholding of shares” and such dispositions do not present “a situation where [the insiders] purchased shares on the open market and used inside information to sell their shares at a profit.”  Id. at 9–10.  On the contrary, the court recognized that “issuer-insider transactions are ‘not comprehended within’ the purpose of Section 16(b) because they typically lack the information asymmetry associated with market transactions between insiders and ordinary investors.”  Id. at 8 (internal citation omitted).

Today’s decision will be valuable authority for directors and officers in existing or threatened cases that are based on tax withholding transactions.  The decision may also prove to be the death knell for the plaintiff’s campaign of seeking “consulting fees” in exchange for agreement not to pursue litigation. 

Special thanks to Paul Collins and Wesley Sze, who represented WPX Energy in this litigation, for their assistance with this update.

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