BRAD PACKER, DERIVATIVELY ON BEHALF OF 1-800-FLOWERS.COM, INC. v. RAGING CAPITAL MANAGEMENT, LLC, RAGING CAPITAL MASTER FUND, LTD., WILLIAM C. MARTIN, 1-800-FLOWERS.COM, INC.
Docket Nos. 19-2703, 19-2852
United States Court of Appeals, Second Circuit
November 23, 2020
19-2703 (L)
Packer v. Raging Capital Management
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
August Term 2020
Argued: August 17, 2020 Decided: November 23, 2020
Docket Nos. 19-2703, 19-2852
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BRAD PACKER, DERIVATIVELY ON BEHALF OF 1-800-FLOWERS.COM, INC.,
Plaintiff - Appellee-Cross-Appellant,
V.
RAGING CAPITAL MANAGEMENT, LLC, RAGING CAPITAL MASTER FUND, LTD.,
WILLIAM C. MARTIN,
Defendants - Appellants-Cross-Appellees,
1-800-FLOWERS.COM, INC.,
Defendant.
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Before: NEWMAN, POOLER Circuit Judges.1
Aрpeal and cross-appeal from a judgment of the Eastern District of New
York (Gary R. Brown, Magistrate Judge), granting summary judgment in favor of
Brad Packer in a derivative suit on behalf of 1-800-Flowers.com, Inc. against
Raging Capital Master Fund, Ltd. (“Master Fund”). The District Court ruled that
Master Fund was the beneficial owner of more than ten percent of the shares of 1-
800-Flowers, Inc., which were bought and sold within a period of six months. The
judgment requires Master Fund to disgorge $4,909,393 in shоrt-swing profits for
violating section 16(b) of the Securities Exchange Act of 1934,
Master Fund contends in part that factual questions remain as to whether it was a
beneficial owners of the shares.
Packer cross-appeals from the denial of prejudgment interest.
We conclude that factual questions remain on the issue of Master Fund’s
beneficial ownership and therefore remand. In view of that ruling, we dismiss the
cross-appeal as moot.
Thomas J. Fleming, Olsham Frome Wolosky LLP,
New York, NY (Martin D. Edel, Goulston &
Storrs P.C., New York, NY, David M.
Zucker, Goulston & Storrs P.C., Boston, MA,
on the brief), for Defendants-Appellants-
Cross-Appellees William C. Martin, Raging
Capital Master Fund, Ltd., and Raging
Capital Management, LLC.
Paul D. Wexler, New York, NY (Glenn F. Ostrager,
Joshua S. Broitman, Roberto L. Gomez,
Ostrager Chong Flaherty & Broitman P.C.,
New York, NY, on the brief), for Plaintiff-
Appellee-Cross-Appellant Brad Packer.
(Douglas A. Rappaport, Akin Gump Strauss
Hauer & Feld LLP, New York, NY, Z. W.
Julius Chen, Akin Gump Strauss Hauer &
Feld LLP, Washington, DC, Alan L. Dye,
Hogan Lovells US LLP, Washington, DC, for
amicus curiae Managed Funds Association,
in support of Defendants-Appellants-Cross-
Appellees.)
The issue on this appeal is whether the customer of a regulated investment
advisor was the beneficial owner of more than ten percent of the shares of 1-800-
Flowers.com, Inc. (“Flowers”), which were bought and sold within an interval of
six months2 (“trading period”), a transaction for which section 16(b) of the
Securities Exchange Act of 1934,
disgorge such short-swing profits. Appellants Raging Capital Management, LLC
(“RCM”), Raging Capital Master Fund, Ltd. (“Master Fund”), and William C.
Martin appeal from the Aug. 21, 2019, judgment of the District Court for the
Eastern District of New York (Gary R. Brown, Magistrate Judge), requiring Master
Fund to disgorge $4,909,393 in short-swing profits in a derivative suit brought by
Appellee Brad Packer on behalf of 1-800-Flowers.com, Inc. Packer cross-appeals
from the denial of prejudgment interest.
We conclude that factual issues remain on the issue of whether Master Fund
was the beneficial owner of the shares, and we therefore vacate the judgment
against Master Fund and remand for further proceedings. In view of that ruling,
we dismiss Packer’s cross-appeal as moot.
Background
Understanding the complicated factual background requires identification
of four entities and several individuals:
RCM is a Delaware limited liability company, which is a registered
investment advisor as defined by the Investment Advisers Act of 1940,
Master Fund is a Cayman Islands corporation, which is an investment fund
and a customer of RCM.
Raging Capital Offshore Fund (“Offshore”) is a Cayman Islands
corporation, which is also a customer of RCM.
for amicus curiae at 4.
Raging
which is also a customer of RCM.
Both Offshore and QP accept investments from the public and funnel these
investments to Master Fund.
Offshore and QP are referred to in this litigation as “feeder funds.” The
fеeder funds together own 100 percent of Master Fund’s “Common Shares.”
During the trading period, the feeder funds had about 143 investors and now have
about 230 investors.
Martin holds positions in RCM, Master Fund, and Offshore, and indirectly
has a role in QP. He is the chairman, chief investment officer, and managing
member of RCM, and owns most, and possibly all, of its shares.4 Martin is also a
member of the three-member board of directors of Master Fund. During the
trading period, the other two directors of Master Fund were two Cayman Island
LLCs, DMS Fund Governance I Ltd. (“DMS I”) and DMS Fund Governance II Ltd.
(“DMS II”), characterized by Martin as “directors services firms.” Since November
and Martin stated in a deposition, “I am the only owner” of RCM, A-711. However, the Defendants dispute
that Martin is the sole owner of RCM, and contend that he is the “majority owner” of RCM. A-793.
2015, the other two directors of Master Fund have been Don Ebanks and Wade
Kenny.5
Martin is also a member of the three-member board of Offshore. During the
trading period, the other two directors of Offshore were Ebanks and Kenny,
although Kenny is no longer a director.
Martin is a limited partner of QP. The general partner of QP is RCM, which
is controlled by Martin.
The relationship among RCM, Master Fund, Offshore, and QP is governed
by an Investment Management Agreement (”IMA”), which was executed on
November 9, 2012. Martin signed the IMA on behalf of all four parties to the
agreement. Under the terms of the IMA, RCM makes “[a]ll investment decisions”
for Master Fund, Offshore, and QP (“the Funds”), A-29, has “exclusive[] . . . control
аnd discretion” over purchase or sale of the Funds’ securities, A-30, and has “the
sole authority to exercise all rights, powers, privileges, and other incidents of
ownership or possession (including but not limited to, voting power) with respect
to all such securities and financial instruments held by the Master Fund,” A-29-A-
as directors of Master Fund “through” DMS I and DMS II and, since November 2015, served as directors
of Master Fund “in their individual capacities.” A-32.
30. By these provisions of the IMA, the Defendants contend, Master Fund hаs
delegated beneficial ownership of the Flowers shares to RCM.
Especially relevant to this appeal, the termination provision of the IMA
states:
(b) any party may terminate this Agreement effective at the close of
business on the last day of any fiscal quarter by giving the other party
not less than sixty-one days’ written notice; provided, however, that
(i) unanimous consent of shareholders of the Cayman Feeder
[Offshore] is required for the Cayman Feeder to terminate this
Agreement under (b) of this Seсtion 9 and (ii) unanimous consent of
the partners of the U.S. Feeder [QP] is required for the U.S. Feeder to
terminate this Agreement under (b) of this section 9.
A-102.
The litigation. In October 2015, Packer filed a complaint derivatively on
behalf of
of profits resulting from a short-swing sale of Flowers stock. The Complaint
alleged that the three defendants were a group for purposes of determining
beneficial ownership and that the group had beneficial ownership of more than
ten percent of Flowers Class A common stock.6 On consent, the case was referred
to Magistrate Judge Brown. In August 2019, with respect to the alleged section
outstanding Flowers shares during the trading period without any grouping, see Packer, 2019 WL 3936813,
at *1, we need not consider any issue concerning grouping of shares. Whether Master Fund had beneficial
ownership of those shares remains a central issue of this appeal.
16(b) violation, the District Court granted the Plaintiff’s motion for summary
judgment, denied the Defendants’ motion for summary judgment, and ordered
entry of judgment against Master Fund in the amount of $4,909,395; the District
Court denied Packer’s claim for prejudgment interest. See Packer v. Raging Capital
Management, LLC, No. 15-CV-5933, 2019 WL 3936813 (E.D.N.Y. Aug. 20, 2019).7
RCM, Master Fund, and Martin timely appealed. Packer cross-appealed from the
denial of prejudgment interest.
Discussion
Section 16(b) of the Exchange Act requires a “beneficial owner” of more than
ten percent of a company’s shares to disgorge profits obtained from a short-swing
sale.
for purposes of determining whether a person is a beneficial owner of more than
ten percent [of an issuer’s shares]—defined “beneficial owner” as “any person
who is deemed a beneficial owner pursuant to section 13(d) of the Act.”
(a) For purposes of section 13(d) . . . of the Act a beneficial owner of a
security includes any person who, directly or indirectly, through any
contract, arrangement, understanding, relationship, or otherwise has
or shares:
Packer v. Raging Capitаl Management, LLC, 242 F. Supp. 3d 141 (E.D.N.Y. 2017).
(1) Voting power which includes the power to vote, or to direct
the voting of, such security; and/or
(2) Investment power which includes the power to dispose, or
direct the disposition, of such security.
beneficial owner of a security if that person has the right to acquire beneficial
ownership of such security within sixty days. See
In 2009, the SEC advised that if a security holder “has delegated all authority
to vote and dispose of its stock to an investment advisor” and lacks “the right
under the contract to rescind the authority grаnted . . . within 60 days,” the security
holder does not need to “report beneficial ownership” of the securities. See SEC
Division of Corporate Finance, Compliance and Disclosure Interpretations,
Exchange Act Sections 13(d) and 13(g) and Regulation 13D-G Beneficial
Ownership Reporting, Question 105.04 (Sept 14, 2009).8
In this case, the Defendants make two arguments to dispute Packer’s
contention that Master Fund was a beneficial owner of more ten percent of Flowers
shares. The first builds on the undisputed premises
investment advisor, is an entity exempt from beneficial ownership of shares it
holds on behalf of a customer by virtue of exclusion (v) of Rule 16a-1(a)(1), 17
C.F.R. § 240.161(a)(1),9 and that Martin is a control person with respect to RCM
and exempt from beneficial ownership by virtue of exclusion (vii) of Rule 16a-
1(a)(1),
brief that RCM’s exempt status somehow confers a derivative exempt status on
Master Fund. The District Court properly rejected what it termed the Defendants’
“inoculation theory,” stating, “There is no authority supporting the nоtion that an
investor [Master Fund] can derivatively benefit from the exemption enjoyed by its
registered investment advisor [RCM].” Packer, 2019 WL 3936813, at *2-*3. Nothing
in Egghead supports Master Fund‘s argument that the registered investment
advisor exception automatically extends to exempt all members of a group from
beneficial ownership.
Master Fund endeavors to enlist Egghead.com, Inc. v. Brookhaven Management
Co., 340 F.3d 79 (2d Cir. 2003), in support of its exemption claims based on RCM’s
exemption. Egghead does not aid Master Fund. That decision considered a
plaintiff’s argument based on what was then exclusion (x) (now exclusion (xi)) of
held for the benefit of its customers if the shаres were acquired for the purpose or effect of influencing
control of the issuer. See
applicable in this case.
amount held directly by the parent or control person, and directly or indirectly by their subsidiaries or
affiliates that are not persons specific in
securities of the subject class.”
Rule 16a-1(a)(1),
Exclusion (x) exempted from beneficial ownership a group, provided all its
members were exempt from beneficial ownership by virtue of the exclusions in
the first nine of the Rule’s exemptions. See
advisor in that case could not be exempt from beneficial ownership because it was
a member of a group and all group members did not qualify for exemption under
exclusion (x). Our Court rejected the argument, ruling that an investment advisor
did not lose its exclusion (v) exemption just because it did not qualify for
exemption under exclusion (x). See Egghead, 340 F.3d at 85-86. Nothing in Egghead
supports Master Fund‘s argument that the registered investment advisor
exception automatically extends to exempt аll members of a group from beneficial
ownership.
The Defendants’ second argument to avoid Master Fund’s beneficial
ownership is that, by virtue of the IMA, Master Fund delegated to RCM
investment and voting authority with respect to the Flowers shares that RCM
what was then exclusion (x).
holds for its benefit. The District Court ruled that the delegation was not effective
to preclude Master Fund’s beneficial ownership for three reasons.
First, the District Court relied on the relationship among the parties to the
IMA. “Assuming the validity of the delegation theory, the intertwined
relationship of these parties proves fatal,” and “the delegation
because it is undisputed that RCM, Martin, and Master Fund are not unaffiliated
parties.” Packer, 2019 WL 3936813, at *5. Second, the District Court understood the
IMA to make RCM the agent of Master Fund. “[A] review of the express terms of
the [IMA] . . . makes it patent that Master Fund authorized RCM to act as its agent
for all purposes relevant thereto.” Id. at *4 (emphasis added). Third, the District
Court deemed Martin to have the power to amend the IMA, including its
requirement of sixty-one dаys’ notice for termination. “Since nothing prevented
defendants from altering the agreement at will, the facts here cannot be reasonably
construed as an effective delegation.” Id. at *5. In the District Court’s view, Martin,
the person who signed the IMA for all four parties, “could, presumably, revise,
amend, or abrogate that agreement with a few strokes of a pen.” Id. at *4 n.5.
Before considering each of these three reasons, we set forth some basic
principles concerning section 16(b). Sеction 16(b) imposes liability “irrespective of
any intention on the part of such beneficial owner, director, or officer,” in entering
the transaction.
strict liability,” thus serving as “strong medicine for the ill Congress sought to
address.” Olagues v. Perceptive Advisors LLC, 902 F.3d 121, 125-26 (2d Cir. 2018)
(internal quotation marks omitted). “Courts have therefore ‘been reluctant to
exceed a literal, “mechanical” application of the statutory text in determining who
may be subject to liability.’” Id. at 126 (quoting Gollust v. Mendell, 501 U.S. 115, 122
(1991)). “The strict liability remedy should be emplоyed cautiously to avoid unfair
application.” Id. It is to be applied “narrowly.” Foremost-McKesson, Inc. v. Provident
Securities Co., 423 U.S. 232, 251 (1976).
It would not be consistent with these principles to accept the District Court’s
first reason for rejecting Master Fund’s delegation of voting and investing
authority to RCM. Although Rule 13d-3(a) includes within the definition of a
beneficial owner “any person who, directly or indirectly, through any contract,
arrangement, understanding, relationship, or otherwise has” voting or investment
authority,
“intertwined” or “not unaffiliated”12 to bring a person within the coverage of Rule
relation to beneficial ownership. Packer, 2019 WL 3936813, at *5. After stating that “‘an entity is the beneficial
owner of its portfolio securities where voting and investment decisions are made by the persons who .
13d-3(a) would extend the reach of section 16(b) beyond the text of both the statute
and the rule.
The District Court based its second reason for rejecting Master Fund’s
delegation to RCM‒an agency relationship‒on this Court’s decisions in Analytical
Surveys, Inc. v. Tonga Partners, L.P., 684 F.3d 46 (2d Cir. 2012), and Huppe v. WPCS
International, Inc., 670 F.3d 214 (2d Cir. 2012). See Packer, 2019 WL 3936813, at *3-*4. In Tonga,
as relevant here, this Court ruled that, under applicable Delaware law,
of a limited partnership (Tonga), and that an individual (Cannell), who was the
sole managing member of the general partner, was an agent of the limited
partnership’s agent. As a result of these state-law-based agency relationships, both
the limited partnership and the limited partner’s agent were liable for a violation
are charged with making those decisions,’” the treatise adds, “‘The result may be different whеre the entity
delegates voting and investment authority to an unaffiliated third party and does not retain the ability to
revoke that authority within 60 days.’” Id. (quoting Peter J. Romeo & Alan L. Dye, Section 16 Treatise and
Reporting Guide, § 2.03[5][f] at 148 (5th ed. 2020)). The use of the word “may” recognizes that the statement
is only a possibility, and, more important, definitively states the governing rule that “an entity may not
remain a beneficial owner of securities, however, where it delegates voting and investment authority tо a
third party and does not retain the ability to revoke that authority within 60 days.” Romeo & Dye,
§ 2.03[5][f][i]. We note that treatise co-author Dye has signed the amicus curiae brief submitted by the
Managed Fund Association in this appeal, which explains the word “unaffiliated” in the above-quoted
sentence: “[T]he term ‘unaffiliated’ in this context means a distinct legal entity, as opposed to the fund’s
general partner . . . . The Customer Fund [Master Fund] and the RIA [RCM] are ‘unаffiliated’ in the relevant
sense, given that the two are completely distinct corporate entities whose relationship is governed by strict
contractual terms.” Br. for Amicus Curiae at 26.
of section 16(b) by the managing member of the general partner. See Tonga, 684
F.2d at 51-52.
Somewhat similarly, in Huppe, on which Tonga was based, this Court ruled
that, under the same Delaware law, two funds (identified as PE and QP), which
were limited partners, were each agents of general partners (unidentified limited
partnerships), and that two individuals (Marxe and Greenhouse), who were
limited partners of those general partners, were agents of the general partners’
agents. As a result, the funds were liable for section 16(b) violations by the
individuals. 670 F.3d at 221-22.13
In the pending case, there is no comparable state-law-based agency
relationship between Master Fund and RCM. They are both distinct corporations,
and the District Court did not rule that the corporate veil could be pierced.
It is true that, pursuant to provisiоns of the IMA, Master Fund has made
RCM its agent for the specific purpose of exercising voting and investment
authority with respect to the Flowers (and any other) shares that RCM holds on
Master Fund’s behalf. That is the essence of a customer/investment advisor
Notes
held only that an “insider principal cannot shed its insider status by transferring trading authority to a non-
insider agent.” Id. at 550.
relationship. But making an investment advisor a customer’s agent for the
specified purpose of carrying out the advisor’s traditional functions for a customer
does not make the advisor an agent for all purposes. Nеither Tonga nor Huppe, nor
anything in SEC statutes, rules, or guidance, supports such a result.
The District Court’s third reason for rejecting delegation was the Court’s
view that Martin had the power to amend the IMA. Such power, if it existed,
would allow him to eliminate the sixty-one days’ notice requirement in the
termination provision, thereby ending the delegation within sixty days of
acquiring shares and triggering application of Rule 3d-3(a) and section 16(b) to
short-swing profits. The District Court based its view of Martin’s authority to
amend the IMA on the fact that he had signed it on behalf of all four parties to the
agreement. See Packer, 2019 WL 3936813, at *4 n.5, *5.
We do not doubt that Martin had authority to sign the IMA on behalf of all
four parties to it. Martin was the controlling person of RCM. He signed on behalf
of Master Fund pursuant to a resolution adopted by the three directors of Master
Fund explicitly authorizing any one director to sign the IMA for that corporation.
He signed on behalf of Offshore pursuаnt to a similar resolution adopted by
Offshore’s board. He signed on behalf of QP as the controlling person of RCM,
which was QP’s general partner.
Authority for an individual to sign a document on behalf of an entity,
however, does not necessarily carry with it authority to commit those entities to
making changes in, or terminating, that document. We can accept that Martin
could commit RCM to amend the IMA because he was in control of RCM. Whether
he could similarly commit Mastеr Fund and the feeder funds is not clear at this
point. With respect to these three entities, the District Court stated, “Notably
absent from the termination provision of the agreement is a requirement that
termination requires ‘unanimous consent’ of Master Fund’s directors or
shareholders, which is an express requisite for termination of the other entities to
the agreement.” Packer, 2019 WL, at *4 n.5.
The Court’s statement is problematic. First, with respect to Master Fund, the
absence of a unanimous consent requirement in the IMA does not mean that
Master Fund’s board has authorized Martin alone to commit Master Fund to
termination of the agreement. In fact, Martin has averred that the board of Master
Fund “was empowered to act by majority vote only.”14 A-33. Second, with respect
for example, Martin, to make changes to a group of agreements that includes the IMA. Master Fund
to Offshore, the termination provision requires unanimous consent of its
shareholders, but the record to date does not indiсate that such consent to
termination has been given. Third, with respect to QP, the termination provision
does not require unanimous consent of its directors or shareholders; it requires
unanimous consent of its partners,15 and the record to date does not indicate that
such consent to termination has been given.
Packer’s essential argument that Martin could commit Master Fund and the
feeder funds to termination of the IMA is that he had the power to compel all of
the required directors, partners, or shareholders of those entities to do his bidding.
He asserts, for еxample, that Ebanks and Kenny were not independent of Martin.
He points out that Ebanks acknowledged serving on the boards of about 200
entities, had never met Martin, participated in Master Fund’s quarterly board
meetings by telephone, and “provided no independent decision-making on
behalf of Master Fund.” Br. for Appellee at 7. Packer also cites Master Fund’s
Schedule 13G filings in June and July of 2014, stating that Master Fund
responds that this authority was limited tо making changes in the proposed IMA, not the executed
agreement. And Martin has averred that Master Fund’s board can act only by majority vote. To whatever
extent this dispute becomes relevant, it is an issue to be resolved either on a renewed motion for summary
judgment on an expanded record or at trial.
acknowledged that it had shared beneficial ownership of more than ten percent
of Flowers’ common stock with RCM and Martin.
The Defendants have responded by challenging the accuracy or significance
of Packer’s allegations. For example, Martin averred that he has “no affiliation or
relationship” with Ebanks or Kenny, the directors, along with Martin, of Master Fund
and Offshore. A-32. Martin has characterized Ebanks and Kenny as “independent
directors” of Master Fund and Offshore, acting as directors of these entities
“through” two Cayman Island directors services firms. A-32. Martin explained
that “[b]y ‘independent’ I mean directors who had no employment, financial, or
other relationship with me or RCM.” A-31. He also stated, “I have no power to
unilaterally make decisions on behalf of [Master Fund]. Rather, decisions must be
approved, at a minimum, by a majority of the board of directors.” A-33, A-737.
With respect to Master Fund’s 13G Schedules, the Defendants point out that they
disclosed the purchase and sale of the Flowers shares on those schedules, which
they describe аs “reserved for institutional investors who have no plan or intent to
effect control of the issuer. See
Master Fund’s “voting power” and “dispositive power” as “shared.” A-121, A-131, A-140, A-150.
Packer seeks to diminish the persuasive force of some of Martin’s sworn
statements by calling them “self-serving,” Br. for Appellee at 9, which they surely
are. Evidence offered by a party to litigation is usually self-serving. That’s why
the party offers it. Whether it is credible and of sufficient persuasive force to
support a favorable finding is a matter for a fact-finder. See United States v. Scully,
877 F.3d 464, 475 (2d Cir. 2017) (“[The witness] is competent to testify . . .even if
his testimony is one-sided and self-serving.”).
The District Court could not, on a motion for summary judgment, determine
that Martin could alter the IMA on behalf of all four entities with “strokes of a
pen.” Packer, 2019 WL 3936813, at *4 n.5. It remains to be determined as a factual
matter whether, under all the relevant circumstances, Martin is in control of
Master Fund and the feeder funds with authority to commit these entities to
altering or terminating the IMA. Whether that determination can be made on a
renewed motion for summary judgment, after the record has been expanded, or
will require a trial is a matter initially for the District Court on remand.
For these reasons, the judgment in favor of Packer is vacated, and the case
is remanded for further proceedings. In view of this ruling, the cross-appeal from
the denial of prejudgment interest to Packer is dismissed as moot.