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Greenfield v. Criterion Capital Management LLC

United States District Court, N.D. California

July 5, 2016



          PHYLLIS J. HAMILTON United States District Judge.

         Defendants’ motion to dismiss the first amended complaint (“FAC”) in the above-entitled action pursuant to Federal Rule of Civil Procedure 12(b)(6) came on for hearing before this court on May 18, 2016. Plaintiffs appeared by their counsel Glenn Ostrager, Paul Wexler, and Willem Jonckheer; and defendants appeared by their counsel Michael Swartz, Randall Adams, Roger Mead, and Steven Shatz. Having read the parties’ papers and carefully considered their arguments and the relevant legal authority, the court hereby GRANTS the motion in part and DENIES it in part.


         Plaintiff Stacey Greenfield brings this action derivatively under § 16(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78p(b), on behalf of nominal defendant Veeva Systems, Inc. ("Veeva"). FAC ¶ 15. Plaintiff seeks disgorgement of "short-swing" profits she alleges were recovered by Criterion Capital Management LLC ("Criterion Capital"), three individual members of Criterion Capital, and certain funds for which Criterion Capital acts as the investment adviser. Id. Plaintiff brought this action after Veeva declined to do so. FAC ¶ 42.

         Criterion Capital is a California limited liability company with its principal place of business in San Francisco. FAC ¶ 3. It is a registered investment adviser ("RIA"). FAC ¶ 22. Named as defendants in addition to Criterion Capital are three individuals and six funds. The individual defendants are Christopher H. Lord ("Lord"), David Riley ("Riley"), and Tomoko Fortune ("Fortune"), each of whom resides in California and is a member and portfolio manager of Criterion Capital. FAC ¶¶ 10-12. Plaintiff asserts that "[t]rusts established by Lord, Riley, and Fortune own Criterion Capital.” FAC ¶ 12.

         The defendant funds are Criterion Capital Partners Master Fund, L.P. ("Partners Master Fund"); Criterion Capital Partners Master Fund GP, Ltd. ("Partners GP"); Criterion Horizons Master Fund, L.P. ("Horizons Master Fund"); Criterion Horizons Master Fund GP, Ltd. ("Horizons GP"); Criterion Vista Master Fund, L.P. ("Vista Master Fund"); and Criterion Vista Master Fund GP, Ltd. ("Vista GP"). FAC ¶¶ 4-9.

         Partners Master Fund, Horizons Master Fund, and Vista Master Fund are Cayman Islands exempted limited partnerships. FAC ¶¶ 4, 6, 8. They are hedge funds (“Criterion Hedge Funds” or “Hedge Funds”) which were allegedly established by Criterion Capital and the individual defendants in order to “manage their investments and generate substantial fees.” FAC ¶ 13. Partners GP, Horizons GP, and Vista GP are Cayman Islands corporations, each serving as the general partner of the corresponding (Partners, Horizons, Vista) limited partnership. FAC ¶¶ 5, 7, 9. Criterion Capital is the investment adviser for each of the defendant limited partnerships, FAC ¶ 14, which hold title to various securities investments. According to plaintiff, however, Criterion Capital "controls" the holdings. FAC ¶ 22.


         Section 16 of the Exchange Act includes two subsections - § 16(a) and § 16(b). Section 16(a) provides that "[e]very person who is directly or indirectly the beneficial owner of more than 10 percent of any class of any equity security . . . which is registered pursuant to" § 12 of the Act, or who is "a director or an officer of the issuer of such security" must file certain statements/reports with the SEC. 15 U.S.C. § 78p(a)(1). Initial ownership statements are filed on SEC Form 3, and statements disclosing changes in beneficial ownership are filed on SEC Form 4. See 17 C.F.R. § 240.16a-3(a), (g). There is no private right of action under § 16(a) to compel the required trading reports, see Scientex Corp. v. Kay, 689 F.2d 879, 884 (9th Cir. 1982), and § 16(a) does not form the basis of the claims asserted here.

         Under § 16(b), any profit realized by "such beneficial owner, director, or officer by reason of his relationship to the issuer . . . from any purchase and sale, or any sale and purchase, of any equity security of such issuer . . . within any period of less than six months . . . shall be . . . recoverable by the issuer." 15 U.S.C. § 78p(b) (emphasis added). Section 16(b) was enacted to prevent the unfair use of information which may have been obtained by a beneficial owner, director, or officer by reason of his relationship to the issuer. Gollust v. Mendell, 501 U.S. 115, 122 (1991); see also Dreiling v. Am. Online, Inc., 578 F.3d 995, 1001 (9th Cir. 2009). Section 16(b) “imposes strict liability regardless of motive, including trades not actually based on inside information.” Dreiling v. Am. Express Co., 458 F.3d 942, 947 (9th Cir. 2006).

         In the present case, none of the defendants is an officer or a director of Veeva, and thus the question of liability under § 16(b) turns in part on defendants’ status as "beneficial owners of more than 10 percent of" a class of Veeva securities. Under SEC Rule 16a-1, 17 C.F.R. § 240.16a-1, in determining whether a person is "a "beneficial owner of more than ten percent of any class of equity securities registered pursuant to section 12 of the Act, " the term "beneficial owner" means "any person who is deemed a beneficial owner pursuant to section 13(d) of the Act and the rules thereunder." 17 C.F.R. § 240.16a-1(a)(1).

         While a "beneficial owner" can be an individual, § 13(d) of the Act also provides that "[w]hen two or more persons act as a . . . group for the purpose of acquiring, holding, or disposing of securities of an issuer, such . . . group shall be deemed a 'person' for the purposes of this subsection." 15 U.S.C. § 78m(d)(3) (emphasis added). SEC Rule 13d-5, which was promulgated to implement and clarify § 13(d), defines beneficial ownership by a "group" as follows:

When two or more persons agree to act together for the purpose of acquiring, holding, voting or disposing of equity securities of an issuer, the group formed thereby shall be deemed to have acquired beneficial ownership, for purposes of sections 13(d) and (g) of the [Exchange] Act, as of the date of such agreement, of all equity securities of that issuer beneficially owned by any such persons.

17 C.F.R. § 240.13d-5(b)(1) (emphasis added).

         The key inquiry in determining whether a group existed such that beneficial ownership could be imputed to certain shareholders is whether the parties “agree[d] to act together for the purpose of acquiring, holding, voting or disposing of” a firm's securities. See Dreiling, 578 F.3d at 1002-03 (citing Morales v. Quintel Entm't, Inc., 249 F.3d 115, 122-23 (2nd Cir. 2001) (citing 17 C.F.R. § 240.13d-5(b)(1))). Generally, courts have concluded that whether such an agreement existed is a question of fact. See Dreiling, 578 F.3d at 1003 (the agreement “may be formal or informal and may be proved by direct or circumstantial evidence") (citing Morales, 249 F.3d at 124).

         Thus, under Rule 13d-5, which is incorporated in § 16(b) and Rule 16a-1, where there is such an agreement, the shares held by persons in such a group are aggregated to determine whether the group has a greater than ten percent beneficial ownership in the issuing corporation. If the aggregate number of shares beneficially owned by the group exceeds ten percent, each member of the group is deemed to be a greater than ten percent beneficial owner and is liable to disgorge profits from transactions by such group member effected within a less than six-month period.

         Finally, while Rule 16a-1 defines “beneficial ownership” for purposes of § 16 by reference to § 13(d), the SEC has also exempted certain categories of institutions and persons who are not deemed to be beneficial owners even if they otherwise would be covered by § 13(d). Specifically, Rule 16a-1 provides that certain persons or entities are exempted from the category "beneficial owner of more than ten percent of any class of equity securities registered pursuant to section 12 of the Act” where the securities of such class are “held for the benefit of third parties or in customer or fiduciary accounts in the ordinary course of business" provided that "such shares are acquired by such institutions or persons without the purpose or effect of changing or influencing control of the issuer . . . ." 17 C.F.R. § 240.16a-1(a)(1) (emphasis added).

         These exempted persons and entities include "[a]ny person registered as an investment adviser under Section 203 of the Investment Advisers Act of 1940 (15 U.S.C. 80b-3) or under the laws of any state" (referred to as "the RIA exemption"); and "[a] . . . control person, provided the aggregate amount held directly by the . . . control person, and directly and indirectly by their subsidiaries or affiliates that are not persons specified in § 240.16a-1(a)(1)(i) through (x), does not exceed one percent of the securities of the subject class" (referred to as "the control-person exemption"). 17 C.F.R. § 240.16a-1(a)(1)(iv), (vii) (emphasis added).

         In promulgating Rule 16a-1, the SEC acknowledged that without such exemptions the listed institutions - which in the ordinary course of their business manage customer and fiduciary accounts - would be subject to liability under § 16(b) if they exercised either their voting or investment power over accounts that when aggregated held over ten percent of a class of equity securities. See Ownership Reports and Trading by Officers, Directors and Principal Security Holders, Exchange Act Release No. 34-27148, 54 Fed. Reg. 35667, at 35670 (Aug. 18, 1989) (the “1989 Release"). Responding to this concern, the SEC stated that “[t]he proposed revision appears necessary to avoid undue interference with the day-to-day business of banks, brokers, dealers, investment advisers and other specified institutional fiduciaries and custodians.” Id.


         Plaintiff alleges that she is the owner of Class A common stock in Veeva. FAC ¶ 1. She asserts further that the ten defendants collectively constitute a "group" (which plaintiff refers to throughout the FAC as "the Criterion Group") for purposes of determining beneficial ownership under § 13(d)(3) and § 16(b) of the Exchange Act. FAC ¶ 21. Plaintiff claims that at all relevant times, the Criterion Group was a greater than ten percent beneficial owner of Veeva's Class A common stock, and that it garnered short- swing profits disgorgeable to Veeva. Id.

         Plaintiff alleges that defendants' membership in the § 13(b) group is shown by the following: (a) Criterion Capital acknowledged in its Form ADV that it manages the three Hedge Funds; (b) Criterion Capital, directly or indirectly, controls the Hedge Funds' holdings in Veeva through a "master feeder structure" as alleged in FAC ¶ 14 - that is, each of the three Hedge Funds act as a "master feeder" through which the other three defendant Funds invest substantially all their assets, and Criterion Capital acts as the general partner of the Hedge Funds; (c) SEC filings were made collectively on behalf of all group members; and (d) Criterion Capital provides the defendant Funds with office space, utilities, and clerical and administrative services, including payment of the salaries of all personnel providing those services. FAC ¶ 22.

         Plaintiff alleges that the Hedge Funds acted together with Criterion Capital, their common investment adviser, and an appointed agent, to manage the Hedge Funds' trading in Veeva's Class A common stock. FAC ¶ 23. She asserts that this "investment structure" establishes that the Hedge Funds were members of a group, and also that the Criterion Group members (i.e., all the defendants) have beneficial ...

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