No. 08-35095 N THE UNTED STATES COURT OF APPEALS FOR THE NNTH CRCUT Thomas R. Drelng, a shareholder of NFOSPACE, NC., Plantff-Appellant, VS. AMERCA ONLNE, NC., a Delaware corporaton, Defendant-Appellee, and nfospace, Nomnal nc., Defendant. On Appeal from the Unted States Dstrct Court for the Western Dstrct of Washngton The Honorable James L. Robart, U.S. Dstrct Judge (Seattle, No. C05-1339JLR) APPELLANT THOMAS DRELNG'S REPLY BREF Rchard E. Spoonemore (WSBA #21833) Stephen J. Srann (WSBA#6957) SRANN YOUTZ MEER & SPOONEMORE 719 Second Avenue, Sute 1100 Seattle, WA 98104 Telephone: (206) 223-0303 Facsmle: (206) 223-0246 FLED AU6 2 2008 MOLLY O. DWYER, CLERK U.8. COURTOFAPPEAL8 Davd M. Smmonds (WSBA #6994) 6128-204 _ Drve N.E. Redmond, WA 98053 Attorneys for Appellant Drelng Telephone: (425) 417-5414 Facsmle: (425) 898-9279
TABLE OF CONTENTS l NTRODUCTON... 1 ARGUMENT... 3.. A SECTON 13(D) GROUP S FORMED BY AN AGREEMENT TO ACT TOGETHER FOR THE PURPOSE OF ACQURNG, HOLDNG, VOTNG OR DSPOSNG OF SSUER SECURTES. "POOLNG" OF SHARES, OR A GROUP PURPOSE BEYOND THE LSTED OBJECTVES, S NOT REQURED... 3 A The Dstrct Court mproperly Requred the Objectves of Acqurng, Holdng, Votng or Dsposng to Serve Some Larger Goal... 3 B, Plantff Need Not Prove that AOL and Jan "Acted" as Benefcal Owners of Each Others' Shares. All That s Requred s An Agreement To Act Together for the Purpose of "Acqurng, Holdng, Votng or Dsposng of" ssuer Securtes... 4 AOL AND JAN MANPULATED NFOSPACE'S ACCOUNTNG... 8 A JURYCOULD FND THAT JAN AND AOL AGREED TO ACT TOGETHER TO ACQURE NFOSPACE SECURTES... 10 A. A Plantff s Not Requred to State Every Theory of Recovery n a Complant... 10 A Group s Formed f Persons "Act Together" to Acqure ssuer Securtes Through Accountng Manpulaton... 11 Conduct Evdencng Jont Coordnaton n 1998 s Relevant to Later Secton 13(d) Group Status... 12
1. Evdence of Group Conduct May Pre- Date Regstraton... 12 2. Evdence of Group Conduct May Pre- Date Benefcal Ownershp... 14 Do f a Group s Formed to Acqure Securtes, the Group s Subject to Secton 16(b) Throughout the Perod that Group Members Collectvely Own o More than 10 go... 16 V. A JURYCOULD FND THAT AOL AND JAN HAD AN AGREEMENT TO HOLD AND DSPOSE OF NFOSPACE SECURTES... 18 Vo ADVERSE NFERENCES SHOULD HAVE BEEN DRAWN FROM THE REFUSAL OF AOL's FORMER EXECUTVES TO TESTFY... 20 A. There s Substantal Evdence Corroboratng the nferences to be Drawn From Keller and Colburn's Ffth Amendment Pleas... 20 B. Plantff has No Duty to Demonstrate Ongong Loyalty Between AOL and ts Former Executves.... 21 V. DRELNG'S SECTON 16(B) ACTON AGANST AOL S NETHER AN "EXPANSON" OF THE STATUTE NOR AN "END RUN" AROUND CENTRAL BANK... 23 CONCLUSON... 27
TABLE OF AUTHORTES Cases Amercan Tmber & Tradng Co. v. Frst Nat. Bank of Oregon, 690 F.2d 781 (9 th Cr. 1982)... 11 Arrow Dst. Comp. v. Baumgartner, 783 F.2d 1274 (5th Cr. 1986)... 26 Bennett v. Schmdt, 153 F.3d 516 (7th Cr. 1998)... 11 Brnk's nc. v. Cty of New York, 717 F.2d 700 (2a Cr. 1983)... 22 Central Bank v. Frst nterstate Bank, 511 U.S. 164 (1994)... 24 Cutter & Buck nc. v. Geness ns. Co., 306 F.Supp.2d 988 (W.D. Wash. 2004)... 22 FDC v. Fdelty & Depost Co. of Md., 45 F.3d 969 (5th Cr. 1995)... 22 n re World Access, nc. Securtes Ltg., 119 F. Supp. 2d 1348 (N.D. Ga. 2000)... 20 Jewelcorp nc. v. Pearlman, 397 F.Supp. 221 (S.D.N.Y. 1975)... 24 Kay v. Scentex Corp., 719 F.2d 1009 (9th Cr. 1983)... 24 Lerner v. Mllenco, L.P., 23 F.Supp.2d 337 (S.D.N.Y. 1998)... 26 LButt v. Unted States, 107 F.3d 110 (2a Cr. 1997)... 22.
1 Morales v. Quntel Entertanment, nc., 249 F.3d 115 (2a Cr. 2001)... passm Mosnee Paper Corp. v. Rondeau, 500 F.2d 1011 (7th Cr. 1974), rev'd on other grounds, 422 U.S. 49 (1975)... 8 RAD Servs., nc. v. Aetna Casualty & Sur. Co., 808 F.2d 271 (3 a Cr. 1986)... 21 Rosenberg v. XM Ventures, 274 F.3d 137 (3 d Cr. 2001)... 14, 15, 16 Roth v. Jennngs, 489 F.3d 499 (2a Cr. 2007)... 14, 16, 21 Schaffer v. CC nvestments, LDC, 2002 WL 31869391, *2, *5-7 (S.D.N.Y. 2002)... 14 Schaffer v. CC nvestments, LDC, 280 F. Supp.2d 128 (S.D.N.Y. 2003)... 14 SEC v. Colello, 139 F.3d 674 (9th Cr. 1998)... 20 Securtes & Exchange Comm" n v. Antar, 15 F. Supp. 2d 477 (D. N.J. 1998)... 20 Warner Commc" ns, nc. v. Murdoch, 581 F.Supp. 1482 (D. Del. 1984)... 23, 24 Statutes 15 U.S.C. 78c(a)(11)... 13 15 U.S.C. 78m(d)(1)... 13 15 U.S.C. 78p(a)(1)... 13 15 U.S.C. 78p(b)... 16 v
1 Regulatons 17 C.F.R. 240.13d-5... passm 17 C.F.R. 240.16a-1(a)(1)... 6 17 C.F.R. 240.16a-l (a) (2)... 6 Other Authortes ETF No. 96-18... 9 L. Loss, FUNDAMENTALSOF SECURTESREGULATON (1983)... 26 Ownershp Reports and Tradng by Offcers, Drectors and Prncpal Stockholders, SEC Release No. 34-26333, 53 Fed. Reg. 49997-02, 1988 WL 268999 (1988)... 27 Peter J. Romeo & Alan L. Dye, SECTON 16(B) TREATSE(3d Ed. 2008)... 6 V
NTRODUCTON Ths case should not have been taken from the jury. The jury could have found that: (a) communcatons between AOL and Jan evdenced an agreement to act together to manpulate nfospace's accountng; and (b) the agreement was desgned to allow AOL to acqure nfospace stock through a warrant agreement, to hold that stock and then to dspose of t n a market artfcally nflated by the manpulaton. f the jury so found, t would follow that Jan and AOL had formed a group under Secton 13(d), as mplemented by Rule 13d-5(b)(1). AOL and the dstrct court, however, mantan that a Secton 13(d) group requres more. The dstrct court requred an 'agreement among group members that serves some dstnct group goal beyond the objectves lsted n the Rule. AOL asserts that a group can only exst f ts members "pool" ther shares or act as f they benefcally own each other's shares. Nether vew can be squared wth Rule 13d-5(b)(1). The sources of these addtonal requrements - common fact patterns n Secton 13(d) cases or the purported purpose behnd Secton 13(d) - do not support a departure from the Rule's plan language. Smply because many cases nvolve groups that seek to exercse control by poolng shares does not mean that control s a legal prerequste to group status. Lkewse, although the ultmate purpose behnd Secton 13(d) s to alert the marketplace to potental shfts n corporate control, the text of the statute demands complance regardless of whether the group members actually pool shares to acheve that, or any other, end.
Moreover, nothng supports the vew that evdence of group actvty whch pre-dates ether regstraton of an ssuer's shares or benefcal ownershp by all group members should be gnored. n fact, many groups make agreements to acqure shares before an ssuer regsters ts shares and before all the group members own shares. That evdence s admssble n determnng whether a Secton 13(d) group exsts after regstraton and after all members have acqured shares. The dstrct court's concluson that Secton 16(b) lablty cannot be predcated on a jont manpulatve scheme (as opposed, presumably, to nadvertence or solo actvty) turns the statute on ts head. Secton 16(b) s an ant-fraud (nsder tradng) statute that, n order to serve ts prophylactc purpose, does not mpose a scenter requrement. t s perverse to conclude that a statute desgned to deter fraud should not extend to cases lke ths one, where there happens to be compellng evdence of ntentonal wrongdong by two jont actors engaged n the very evl that the statute was desgned to combat. Ths case does not crcumvent the prmary lablty requrement of Secton 10(b). Even f Secton 16(b) contaned such a requrement, t s satsfed here. AOL and Jan both drectly profted from the short-swng trades that they drectly made. They were not mere brokers, bankers, lawyers or audtors who helped ther clents to proft. They are prmary actors drectly subject to the prohbtons n Secton 16(b). 2
ARGUMENT o A SECTON 13(D) GROUP S FORMED BY AN AGREEMENT TO ACT TOGETHER FOR THE PURPOSE OF ACQURNG, HOLDNG, VOTNG OR DSPOSNG OF SSUER SECURTES. "POOLNG" OF SHARES, OR A GROUP PURPOSE BEYOND THE LSTED OBJECTVES, S NOT REQURED. ko The Dstrct Court mproperly Requred the Objectves of Acqurng, Holdng, Votng or Dsposng to Serve Some Larger Goal. Contrary to AOL's suggeston, the dstrct court grafted requrements onto Secton 13(d). t requred that n acqurng, holdng and dsposng of ssuer securtes, the specfcally proscrbed objectves must themselves serve some larger end. As t explaned: The cases fndng Secton 16(b) lablty, based on group formaton under Secton 13(d), nvolve fact patterns where the defendants attempted to captalze n some way, ether by takng control of the company, preventng ts sale, or otherwse nfluencng stock prce, by agreeng to pool ther shares and votng, dsposng or holdng them to effectuate ther common purpose. ER 14, ns. 19-23 (emphass added). t contnued: Global ntellcom s a good example of a plantff pleadng suffcently a Secton 13(d) group wheren the underlyng "common objectve" was to manpulate stock, but also allegng suffcent facts that the defendants acqured, held, voted or sold stock n furtherance of ths common objectve. Absent the latter allegatons there s no Secton 13(d) group. ER 20, ns. 13-19 (emphass added).
From the dstrct court's perspectve, the agreement to act together to acqure, hold, vote or dspose of securtes must be the means to some ultmately dstnct group end. Ths was error. As the Morales court held n drectly addressng ths ssue: Nether provson [Secton13(d)(3) nor Rule 13d- 5(b)(1)] mandates that the narrow object of acqurng, holdng, votng, or dsposng of securtes must tself serve a broader purpose of seekng corporate control or otherwse exertng nfluence over corporate affars. Morales v. Quntel Entertanment, nc., 249 F.3d 115, 124-25 (2d Cr. 2001). B. Plantff Need Not Prove that AOL and Jan "Acted" as Benefcal Owners of Each Others' Shares. All That s Requred s An Agreement To Act Together for the Purpose of "Acqurng, Holdng, Votng or Dsposng of" ssuer Securtes. Accordng to AOL, an agreement to act together to acqure, hold, vote or dspose of shares s not enough to establsh a group. AOL argues that a plantff s addtonally requred to show that group members "pooled" ther shares or otherwse acted n a manner suggestng that they benefcally owned each other's shares. Ths theme underles AOL's bref. AOL Br., p. 37 ("Absent evdence that AOL and Mr. Jan acted as benefcal owners of one another's nfospace stock, plantff's Secton 16(b) clam fals as a matter of law.") (emphass added); p. 38 (Plantff's evdence "dd nothng to establsh any benefcal ownershp by AOL of Mr. Jan's nfospace stock (or vce versa)."); p. 41 ("Secton 13(d) requres that group members act together wth respect to the acquston of stock, 4
such that each s properly consdered the benefcal owner of the other's shares."). AOL mproperly reads addtonal language nto Rule 13d-5(b)(1), argung that the relevant test s whether AOL and Jan "'agree[d] to act together for the purpose of acqurng, holdng, votng or dsposng of nfospace securtes' such that 'the group formed thereby [s] deemed to have acqured benefcal ownershp,... as of the date of such agreement, of all equty securtes of that ssuer benefcally owned by any such persons.'" AOL Br., p. 26 (emphass added). Under AOL's re-wrte of Rule 13d-5(b)(1), the lsted purposes must further be of a type "such that" group members receve an ownershp beneft from each other's shares. 1 To advance ts argument AOL blends the defnton of benefcal ownershp under Rule 16a-1(a)(1) wth the separate - and napplcable - defnton under Rule 16a-l(a)(2). Under Rule 16a-1(a)(2), a benefcal owner of securtes s "any person who, drectly or ndrectly, through any. contract, arrangement, understandng, relatonshp or otherwse, has or 1 AOL argues ths requrement stems from cases fndng groups n whch members pooled ther ownershp nterests. AOL Br., pp. 27-28. t does not follow, however, that poolng s a legal requrement for group status. For example, most cases nvolve facts ndcatng that group members were seekng to exert control over the ssuer. Morales, 249 F.3d at 124. That does not mean that ntent to control the ssuer s a prerequste to exstence of a group. d. The statute and regulaton determne group exstence, not the fact patterns n AOL's cases. d. at 124-25. ("The plan language of 13(d)(3) demands only an agreement 'for the purpose of acqurng, holdng, or dsposng of securtes... ").
shares a drect or ndrect pecunary nterest n the equty securtes." 17 C.F.R. 240.16a-l(a)(2). Ths defnton, lnked to pecunary nterests n securtes, does not apply here. d. (Rule 16a-1(a)(2) apples "other than for purposes of determnng whether a person s a benefcal owner of more than ten percent of any class of equty securtes... "). Rather than usng the foregong defnton for all purposes under Secton 16, the SEC set forth a dfferent test for nsder status wth respect to 10 % group ownershp. n that area, "the term benefcal owner shall mean any person who s deemed a benefcal owner pursuant to Secton 13(d) of the Act and rules thereunder... " 17 C.F.R. 240.16a- 1(a)(1). Ths dstncton has been n effect snce 1991, when the SEC dvorced the concept of a pecunary beneft from the defnton of benefcal ownershp for purposes of determnng group status: Pror to the Commsson's 1991 rule changes, courts generally held that a member of a Secton13(d) group was not requred to aggregate the securtes holdng of all group members when determnng hs or her status as a ten percent owner, absent a showng that group members receved a drect pecunary beneft from other member's securtes. These decsons were effectvely overturned by the Commsson's adopton n 1991 of Rute 16a-l(a)(1), whch ncorporated the Secton 13(d) standards of benefcal ownershp for purposes of determnng ten percent owner status. Peter J. Romeo & Alan L. Dye, SECTON 16(B) TREATSE, 2.0316], p. 159 (3 d Ed. 2008) (emphass added). 6
Snce 1991, under Secton 13(d) and Rule 13d-5(b)(1), f there s an agreement to act together related to one of the lsted purposes, then the partes are automatcally "deemed" to benefcally own each other shares. No addtonal showng or "fndng" s necessary: When two or more persons agree to act together for the purpose of acqurng, holdng, votng or dsposng of equty securtes of an ssuer, the group formed thereby shall be deemed to have acqured benefcal ownershp, for purposes of Secton 13(d) and (g) of the Act, as of the date of such agreement, of all equty shares of that ssuer benefcally owned by any such persons. 17 C.F.R. 240.13d-5(b)(1) (emphass added). The queston presented here s whether the Drelng has shown an agreement to act together, between AOL and Jan, "for the purpose of acqurng, holdng, votng or dsposng of equty securtes." The plan language of the Rule requres nothng more. Morales, 249 F.3d at 124-25. Ths constructon s consstent wth the legslatve and regulatory hstory. Secton 13(d)(3) was desgned to "prevent a group of persons who seek to pool ther votng or other nterests n the securtes of an ssuer from evadng the provsons of the statute." However, t (and the mplementng regulaton) were drafted n a prophylactc manner that requred flng by any group regardless of whether they were, n fact, poolng ther shares. Morales, 249 F.3d at 124. The reportng requrement s trggered by accumulaton tself, wthout regard to the purpose of the acquston of shares: 7
l To ths observaton we add what s self-evdent from the language and legslatve hstory of the Wllams Act, the reportng requrements of Secton 13(d) apply regardless of the purchaser's purpose n acqurng the shares. Mosnee Paper Corp. v. Rondeau, 500 F.2d 1011, 1016 (7th Cr. 1974), rev'd on other grounds, 422 U.S. 49 (1975) (emphass added). Lack of control-related poolng s no defense under Secton 13(d)(3). Under Rule 13d-5(b)(1), an agreement to act together to acqure, hold or dspose of shares creates a group and reportng s requred regardless of the ultmate ntent (or lack thereof) of the members.. AOL AND JAN MANPULATED NFOSPACE'S ACCOUNTNG. The dstrct court concluded that "there s evdence to support Mr. Drelng's frst allegaton of concerted actvty,.e., to secretly nfluence the corporate affars of nfospace by creatng artfcal revenues and earnngs... " ER 16, ns. 8-11. There are a raft of emals between Jan and AOL dscussng a scheme to "front-load" AOL's payments to nfospace to create the lluson of a penalty so that AOL's warrants could be expensed n 1998. See e.g. ER 242 ("The whole dea of accelerated payment was to take care of penalty that you wll end up payng us n case you termnated the contract for any busness reason."); ER 181; ER 240; ER 379. Jan even admtted that "part of the thng s tryng to mtgate" the effect of a penalty. ER 352-53. AOL argues that there was no mproprety. AOL Br., pp. 15-17. t asserts that because the payments n the fnal verson of the Agreement were not guaranteed, AOL was subject to a penalty. AOL Br., p. 16. t then 8
argues that the contractual penalty was suffcent under the relevant accountng standard because there was a hypothetcal crcumstance under whch AOL would be subject to a "real" $2 mllon penalty. AOL Br., pp. 16-17. AOL's argument rests on the erroneous assumpton that the performance hurdles n the fnal Agreement were real. t also gnores the requrements of the relevant accountng standard. AOL's performance hurdles were set so low as to be meanngless. ER 328 (Jan to AOL: "you can pck the number of searches to be small enough that you wll meet them for sure...'); ER 324 ("we would use a lower search guarantee...'); ER 326 (concernng "lowerng warrant vestng levels" n connecton wth penalty provson). As part of the scheme, Jan and AOL created performance hurdles that were llusory. AOL was never, n realty, at "rsk" for meetng any of the performance targets. n any event, t s rrelevant whether the payments were "guaranteed" or not. Whether the cash payments were contngent upon reachng performance goals has nothng to do wth whether there s a suffcent penalty n the Agreement as defned by ETF No. 96-18. The accountng standard makes t clear that the loss of cash payments and warrants s not suffcent to create a suffcent penalty for nonperformance. ER 230 (Example 6); ER 901 ("Forfeture of the consderaton receved or to be receved does not represent a suffcently large dsncentve under the rule."); ER 217. There must be a substantal freestandng penalty, beyond forfeture of performance-based cash or warrants, before the warrant can 9
be expensed at the tme of contractng rather than at the tme of performance. ER 230; ER 901; ER 888-89. Fnally, AOL argues that there s a sngle hypothetcal crcumstance under whch t would have been subject to a real penalty. The crcumstance t posts, however, could never occur because, n fact, the hurdles were manpulated. Moreover, the relevant test s whether a counterparty s always subject to a penalty for non-performance. ER 224; ER 229-30; ER 888. That was not the case here. ER 889-91.. A JURY COULD FND THAT JAN AND AOL AGREED TO ACT TOGETHER TO ACQURE NFOSPACE SECURTES. A. A Plantff s Not Requred to State Every Theory of Recovery n a Complant. AOL argues that "the frst tme plantff presented a theory that AOL and Mr. Jan formed a group to allow AOL to acqure nfospace securtes was n plantff's opposton to AOL's summary judgment moton." AOL Br., p. 39. t then asserts that t was "surprsed" by Drelng's theory, whch t clams contradcts hs verson of the facts. AOL s wrong. The dstrct court, over two years before enterng summary judgment, recognzed that Drelng's Secton 16(b) allegatons ncluded jont actvty to acqure nfospace shares. ER 61 ("Construed n the lght most favorable to Mr. Drelng, t s reasonable to nfer from the facts alleged that AOL and Jan had an agreement to acqure and hold nfospace securtes and then sell those same securtes at a proft.") (emphass added). The detals of the agreement between AOL and Jan 10
were also set forth n exactng detal n answers to AOL's dscovery. SER 204-6; SER 215-17. AOL s not, as t clams, "enttled to summary judgment on the 'acqure' theory because t was not alleged n the Complant." AOL Br., p. 38. A complant s not requred to allege all, or any, of the facts entaled by a clam. Nor must a complant set forth every legal theory of recovery. Bennett v. Schmdt, 153 F.3d 516, 518 (7th Cr. 1998). Ths ssue s one of far notce - notce that AOL ndsputably receved. Amercan Tmber & Tradng Co. v. Frst Nat. Bank'ofOregon, 690 F.2d 781, 786"(9th Cr. 1982) ("A party need not plead specfc legal theores n the complant, so long as the other sde receves notce as to what s at ssue n the case."); ER 61; SER 204-6; SER 215-7. B. A Group s Formed f Persons "Act Together" to Acqure ssuer Securtes Through Accountng Manpulaton. AOL argues that "alleged accountng manpulaton s nsuffcent to state a Secton 16(b) clam." AOL Br., p. 39. Accountng manpulaton, standng alone, may not create a group under Rule 13d-5(b)(1). However, an agreement to "act together" by manpulatng the accountng of an ssuer n order to allow one, or both, partcpants to acqure securtes creates a cognzable group. Rule 13d-5(b)(1) prescrbes an agreement to "act together for the purpose Of acqurng.., equty securtes of an ssuer... " 17 C.F.R. 240.13d-5(b)(1) (emphass added). Here, the agreement to act together was the agreement between AOL and Jan to create the lluson of a penalty so that nfospace could expense the warrants at 1998 prces. No 11
deal would have been entered nto unless the warrants could be expensed n that manner. ER 6, ns 12-18; ER 344; ER 356-57. Moreover, a key component of the Whte Pages Agreement was AOL's rght to acqure 5% of nfospace under a warrant agreement. ER 290-311. See also ER 284; ER 109; ER 328; ER 324. A reasonable jury could conclude that a purpose of the "agreement to act together" - to manpulate nfospace's accountng - was to allow AOL to acqure nfospace shares under the warrant agreement. The dstrct court erred by not sendng ths ssue to the jury. C. Conduct Evdencng Jont Coordnaton n 1998 s Relevant to Later Secton 13(d) Group Status. AOL mscharacterzes Drelng's clam as to when AOL and Jan formed a group under Secton 13(d). The ssue s not, as AOL argues, whether AOL and Jan were a Secton 13(d) group n August of 1998. AOL Br., pp. 43-44, 48. The matchng trades at ssue occurred from November 1999 through May 2000. Thus, the relevant ssue s whether AOL and Jan were a group pror to those trades. Drelng reles on evdence of coordnaton n 1998 between AOL and Jan to show that a Secton 13(d) group came nto exstence once AOL began to acqure nfospace securtes. That evdence s properly consdered despte the fact that t occurred pror to nfospace's regstraton of ts securtes and pror to AOL's February 1999 acquston of shares. 1. Evdence of Group Conduct May PreDate Regstraton. AOL argues that Secton 16(b) only apples to persons who are benefcal owners of more than 10% of any class of shares regstered 12
pursuant to Secton 12 of the Act. AOL Br., p. 42. Ths s true, but t.msses the pont. There s no dspute that nfospace's shares were regstered, and that Jan and AOL owned, collectvely, more than 10% of nfospace's common stock, when AOL engaged n short-swng transactons between November 1999 and May 2000. The ssue s whether pre-regstraton agreements between AOL and Jan s evdence of group exstence. The dstrct court sad no. ER 18, fn. 11. Ths was error. A group can exst under Rule 13d-5(b)(1) pror to regstraton. The Rule uses the unqualfed term "equty securtes of an ssuer." 17 C.F.R. 240.13d-5(b)(1). Ths term s defned by statute to nclude all "stock or smlar securty" of a company. t s not lmted to securtes regstered under Secton 12. See 15 U.S.C. 78c(a)(11). A group s formed under the Rule f there s an agreement to act together to acqure, hold, vote or dspose of equty securtes rrespectve of whether those securtes are regstered. See generally, Drelng Br., p. 39-40. However, untl regstraton, there s no oblgaton for a group to fle under Secton 13(d). 15 U.S.C. 78m(d)(1). Secton 16(b) s smlar. Once regstraton occurs, a group ownng more than 10% of those securtes s requred to fle under Secton 16(a) and s prohbted from tradng on the short-swng under Secton 16(b). 15 U.S.C. 78p(a)(1), (b). Sectons 13 and 16 would be undermned f pre-regstraton group actvty was gnored. Shareholders groups could coordnate postregstraton purchases and sales just pror to regstraton and then clam 13
that no flngs were necessary (and short-swng tradng-was allowed wth mpunty), because all of the plannng took place just pror to regstraton. That s what occurred here. nfospace was on the cusp of gong publc when AOL and Jan coordnated ther actvtes. ER 340-42. The coordnaton was desgned to (and dd) (1) allow AOL to acqure nfospace shares n the post-regstraton perod, and (2) artfcally drve up nfospace's share prce after regstraton so that AOL and Jan could hold and then sell nto an nflated market. That evdence cannot be gnored. 2. Evdence of Group Conduct May Pre-Date BeneJcfal Ownershp. Relyng on Rosenberg v. XM Ventures, 274 F.3d 137 (3d Cr. 2001), AOL argues that each member of a group must hold benefcal ownershp of ssuer securtes before ts entry nto that group. AOL Br., pp. 43-44. AOL then jumps to the concluson that evdence of group formaton s rrelevant f t predates the pont at whch all group members have acqured benefcal ownershp. Were AOL correct, courts could never, as a matter of law, consder group formaton evdence that predated the acquston of benefcal ownershp by all group members. However, courts can and do consder such evdence. See Roth v. Jennngs, 489 F.3d 499, 512 (2d Cr. 2007); Morales, 249 F.3d at 125-126; Schaffer v. CC nvestments, LDC, 2002 WL 31869391, *2, *5-7 (S.D.N.Y. 2002) (court consders letter, memoranda, tme records, and other communcatons that occurred before any alleged group member purchased ssuer stock); Schaffer v. CC nvestments, LDC, 280 F. Supp.2d 128, 133 (S.D.N.Y. 2003) (clarfyng that no alleged group member n Schaffer owned ssuer stock pror to ntal purchase). 14
Each of these cases nvolves the same-fact pattern: alleged group members communcated wth each other, and engaged n conduct relevant to group status, before all group members acqured benefcal ownershp of ssuer stock. That s our fact pattern, and wll often be the case when the group s formed to acqure securtes. One can easly magne stuatons n whch a non-benefcal owner plots for months wth benefcal owners, all n advance of (1) the regstraton of the ssuer's securtes, and (2) subsequent purchases and sales that take advantage of nsde nformaton. Why should ths conduct be gnored? And why shouldn't the 1998 conduct of AOL and Jan "form the bass" for Drelng's allegatons of group actvty here? The only authorty cted by AOL, Rosenberg, s napposte. The plantff n Rosenberg dd not allege that any group conduct occurred before ts members acqured benefcal ownershp. Rather, the alleged group formed on the same day as the ntal purchase by ts members. (One of the group actors dd not even exst untl that day.) Rosenberg, 274 F.3d at 147. The ssue, as framed by the Rosenberg court, was whether ether alleged group member was a benefcal owner (and therefore a potental group member and statutory nsder under Secton 16(b)) before the frst "transacton n ssue." d. at 147. Because nether alleged group member was a benefcal owner of stock pror to the ntal short-swng trade, plantff's clam faled. Here, AOL admts that t was a benefcal owner as of February 1, 1999, when t frst acqured nfospace securtes. The "frst transacton n 15
ssue" --.e., the frst short-swrtg trade-occurred after that acquston. Under Rosenberg, AOL was elgble to become a group member any tme after February 1, 1999-well before ts frst short-swng trade. Rosenberg does not address, and has nothng to say about, whether to dsregard Drelng's evdence that a group was n the process of formng n the summer of 1998. D. f a Group s Formed to Acqure Securtes, the Group s Subject to Secton 16(b) Throughout the Perod that Group Members Collectvely Own More than 10%. Quotng the fnal sentence of Secton 16(b), AOL argues that "[p]lantff must show that AOL was a more than 10 % owner of nfospace stock by vrtue of ts purposed 'group' membershp 'both at the tme of the purchase and sale, or the sale and purchase of the securty.'" AOL Br., p. 46. From ths t argues that t has no lablty f plantff cannot show that AOL-Jan group actvty contnued for the entre duraton of the relevant short-swng trades (.e., from November 1, 1999 to May 10, 2000). AOL's argument was specfcally rejected n Roth. As the Second Crcut explaned, "Secton 16(b) tself contans no provson as to who s an nsder." Roth, 489 F.3d at 513. t mposes lablty upon a "benefcal owner" who volates ts provsons. 15 U.S.C. 78p(b). t s Sectons 16(a) and Rule 16a-l(a)(1) that ndcate the term "benefcal owner" n Secton 16(b) can nclude a group that collectvely owns more than 10%. d. Whether a group exsts, and ts duraton, are ultmately defned by Secton 13(d) and Rule 13d-5(b)(1), not by Secton 16(b). d. Under Secton 13(d) and Rule 13d-5(b)(1), a group exsts f there s an agreement 16
to act together for the purpose of acqurng, holdng, or dsposng of ssuer shares. The use of the dsjunctve s sgnfcant and ndcates, for example, that a group can be formed solely through an agreement to act together to acqure shares. d. Under Secton 13(d), that group does not somehow cease to exst upon completon of ts share acquston. As the Second Crcut correctly noted, to conclude otherwse would gnore the dsjunctve "or" n Rule 13d-5(b)(1). d. at 514. As a result, once a group s formed under Secton 13(d), ts ndvdual members are subject to Secton 16(b)'s short-swng prohbton as long as they collectvely own more that 10% of the ssuer's shares. d. Ths approach s requred by the statutory scheme. t also serves the purpose behnd Secton 16(b). f a defendant ntally acqured stock whle actng as a group member, hs later sales of stock could easly be based on nsde nformaton-regardless of whether the acquston-related group actvty contnued to exst. d. ("These provsons approprately address the Congressonal concern that such short-swng sales may have been based on access to nsde nformaton."). Applyng ths reasonng, AOL and Jan: (1) "acted together" n 1998 for one or more of the purposes found n Rule 13d-5(b)(1) - acqurng, holdng, or dsposng of nfospace securtes; (2) collectvely owned more than 10% of nfospace stock before the frst short-swng transacton on November 1, 1999; and (3) contnued to collectvely own more than 10% of nfospace stock "at the tme of the matchng short-swng transacton[s],".e., durng the sx months followng November 1, 1999. There s no 17
requrement that plantff adduce addtonal evdence of group actvty durng the sx-month perod of short-swng tradng. t s suffcent that plantff presents evdence that a group was ntally formed for the purpose of acqurng, holdng or dsposng of securtes. Once a group s formed and the 10% collectve ownershp requrement satsfed, group members are deemed nsders subject to Secton 16(b) as long as they contnue to collectvely own 10% of ssuer securtes, regardless of whether there s any contnung group actvty. V. A JURY COULD FND THAT AOL AND JAN HAD AN AGREEMENT TO HOLD AND DSPOSE OF NFOSPACE SECURTES. As noted above, a jury could conclude that one of the purposes of AOL and Jan's agreement to act together was to enable AOL to acqure rdospace stock. See Secton, B, above. That, however, was not the only purpose. AOL, n nternal emals, concedes that ts "sole" concern was drvng LrdoSpace's stock prce. ER 794 ("Do you have thoughts on who nternally mght understand the best means of affectng [rdospace's] stock prce n ths space, snce that's the sole goal... "); ER 796 (AOL admts to "fshng" for ways to do busness wth nfospace because "[]f ther stock rses we get more dough"); ER 74 (attemptng to do a deal "to generate analyst/nvestor nterest n rdospace"). t s not surprsng that AOL was very nterested n obtanng a "beneft from [nfospace's] stock prce" when Jan proposed the accountng scheme. ER 182. Nor s t surprsng that AOL would agree to enter nto "Amendment 1" - an amendment whch provded AOL wth no econornc 18
beneft other than to prop up nfospace stock prce when nfospace was at rsk for not meetng analysts' expectatons. ER 219; ER 393; ER 390-91; ER 788-90; See Drelng Br., pp. 22-25. AOL could only obtan the "beneft from our stock prce," however, f t held ts nfospace securtes, and later d_sposed of them n a market that was unaware of what AOL and Jan both knew: that nfospace's purported proftablty was an lluson.2 Under the plan language of Rule 13d-5(b)(1), an agreement to pump up nfospace's stock prce wth the purpose of then sellng when the stock prce s nflated s an agreement "to act together for the purpose of... holdng.., or dsposng of equty securtes of an ssuer." AOL and the dstrct court suggest that absent an agreement to sell on a specfc day, or wthn a very narrow tme perod, there can be no agreement to act together for the purpose of dsposng of securtes. ER 10-11; AOL Br., p. 51. Nothng n Rule 13d-5(b)(1) demands that the agreement to act together have, as ts purpose, the dsposton of shares on a specfc day or a wthn a narrow tme perod. nsder tradng, whch Secton 16(b) s ultmately desgned to prevent, can occur n two ways. nsders may know of a specfc event, 2 AOL and Jan held and then each dsposed of approxmately $200 mllon worth of shares n the frst sx months of 2000. Ths was precsely when nfospace's expenses were underreported due to the manpulaton. $68 mllon - the amount nfospace's expenses were understated durng that tme - was no small matter. t eclpsed nfospace's reported revenues of $43.6 mllon for the same perod. ER 518; ER 110; ER 121-35; ER 812; ER 817; ER 889. 19
such as the lack of FDA approval for a new drug, whch when publcly known wll mmedately move the stock prce. Courts and the SEC also recognze, however, that nsder tradng may occur through a systematc, mult-faceted fraud desgned to artfcally nflate the prce of a company's stock over a perod of years. See e.g. Securtes & Exchange Comm'n v. Antar, 15 F. Supp. 2d 477 (D. N.J. 1998) (defendants lable n $27 mllon nsder tradng scheme over nearly three-year perod); n re World Access, nc. Securtes Ltg., 119 F. Supp. 2d 1348, 1356 (N.D. Ga. 2000) (nsders sellng $38 mllon over 21-month perod states clam for nsder tradng when nsders were aware of ongong msrepresentatons to the market). That type of prolonged and systemc manpulaton does not requre sales on a specfc day, just durng a specfc perod when the market s manpulated. A jury could conclude that happened here. V. ADVERSE NFERENCES SHOULD HAVE BEEN DRAWN FROM THE REFUSAL OF AOL's FORMER EXECUTVES TO TESTFY. A. There s Substantal Evdence Corroboratng the nferences to be Drawn From Keller and Colburn's Ffth Amendment Pleas. A dstrct court n a cvl case may draw adverse nferences when a wtness nvokes the Ffth Amendment. SECv. Colello, 139 F.3d 674, 677 (9th Cr. 1998). An nference of mproprety s proper when "evdence n addton to the adverse nference" supports the concluson. d. at 678. AOL admts that Drelng "ctes to ndependent evdence purportedly supportng hs clam that AOL asssted Mr. Jan n accountng mpropretes." AOL Br., p. 55. The dstrct court concluded that "there s 20
evdence to support Mr. Drelng's frst allegaton of concerted actvty,.e., to secretly nfluence the corporate affars of nfospace by creatng artfcal revenues and earnngs... " ER 16, lns. 8-11. The Ffth Amendment nference Drelng seeks flows drectly from these facts. An agreement under Secton 13(d) may be nothng more than an nformal understandng (whch may be nferred from crcumstantal evdence). Roth, 489 F.3d at 508; Morales, 249 F.3d at 124. A fact fnder may nfer here that there was an agreement to manpulate nfospace's accountng and that the purpose of the accountng manpulaton - or the nformal understandng between AOL and Jan - was so that AOL could acqure nfospace securtes, and then hold and dspose of securtes nto a market artfcally nflated by the manpulaton. Explct communcatons dentfyng these goals s not necessary. There s plenty of collaboratng evdence to support adverse nferences from the falure of Keller and Colburn to testfy on these same subjects. B. Plantff has No Duty to Demonstrate Ongong Loyalty Between AOL and ts Former Executves. AOL argues that plantff s requred to demonstrate a relatonshp of loyalty between AOL, and Keller and Colburn. AOL Br., pp. 54, 57. AOL ctes no authorty from ths crcut n support of ts argument. The dstrct court dd not requre such proof. A plantff does not have the burden of provng loyalty between a wtness and an opposng party before a negatve nference aganst that party can be drawn. See RAD Servs., nc. v. Aetna Casualty & Sur. Co., 808 F.2d 271, 276 (3a Cr. 1986) (falure of party to demonstrate contnung 21
loyalty between wtness and former employer dd not prevent drawng of adverse nference aganst employer); FDC v. Fdelty & Depost Co. of Md., 45 F.3d 969, 978 (5th Cr. 1995) (non-party wtness Ffth Amendment nvocaton s admssble as an adverse nference aganst party wth whch t has no specal relatonshp); Brnk's nc. v. Cty of New York, 717 F.2d 700, 710 (2d Cr. 1983) (fact that nvokers of the prvlege are no longer employees of the defendant and are, n part, adverse to the employer defendant does not bar usng ther refusals to testfy as vcarous admssons of ther former employer). Dstrct courts n ths dstrct have followed ths approach. Cutter & Buck nc. v. Geness ns. Co., 306 F.Supp.2d 988, 1005 (W.D. Wash. 2004). The only crcut court case cted by AOL, LButt v. Unted States, 107 F.3d 110 (2d Cr. 1997), does not requre, as AOL clams, that the "party seekng the adverse nference must demonstrate a relatonshp of loyalty between the non-party and the party aganst whom the nference s to be mputed." AOL Br., p. 55. Rather, the court lsted a number of "nonexclusve factors whch should gude [a] tral court." LButt, 107 F.3d at 123. One of those factors was whether t would be "lkely" that "the nonparty wtness would.., render testmony n order to damage the relatonshp.'3 d. 3 Another factor, not mentoned by AOL, was "whether the non-party wtness was a key fgure n the ltgaton and played a controllng role n respect to any of ts underlyng aspects." LButt, 107 F.3d at 123-24. 22
There s no evdence that Keller and Colburn would havepersonally benefted from testmony adverse to AOL. AOL's lablty s based on Keller's and Colburn's actons. Thus, t s reasonable for a jury to nfer that, were they to answer truthfully rather than nvokng the prvlege, the answers would beneft plantff, not AOL. Regardless of any ongong loyalty between these wtnesses and ther former employer, Keller and Colburn have no ncentve to testfy n a way that would favor plantff to the detrment of AOL. VL DRELNG'S SECTON 16(B) ACTON AGANST AOL S NETHER AN "EXPANSON" OF THE STATUTE NOR AN "END RUN" AROUND CENTRAL BANK. AOL offers a parade of horrbles to suggest that Drelng's theory, f vable, wll "dscourage busness partners from acceptng stock as form of payment" and "mperl" the "survval" of start-up companes. AOL Br., pp. 32, 40. A legtmate busness transton between two companes does not nvolve an agreement between an outsde entty and an ssuers' CEO to manpulate the ssuers' accountng. t s that fact that sets ths case apart. A busness deal between an outsde entty and an ssuer Wll not generally create a group under Rule 13d-5(b)(1). That s because an ssuer cannot be a member of a group. Warner Commc'ns, nc. v. Murdoch, 581 F.Supp. 1482, 1499 (D. Del. 1984). Nor wll communcatons wth an nsder of the ssuer (even one wth large holdngs) to further a legtmate busness deal subject the outsde entty to Secton 16(b). d. However, an nsder of an ssuer can form a group wth an outsde entty f the nsder acts aganst the nterests of the ssuer wth an ntent to 23
personally beneft hmself. d. at 1499-1500; Jewelcorp nc. v. Pearlman, 397 F.Supp. 221, 250 (S.D.N.Y. 1975). f an outsde entty enters nto an agreement to act wth that nsder to further that personal beneft, then Rule 13d-5(b)(1) can - and should - apply. Warner Commc'ns, 581 F.Supp at 1499-1500; Jewelcorp, 397 F.Supp. at 250. Here, a jury could conclude that Jan was actng for hmself, not nfospace, n proposng and then mplementng the accountng scheme. See generally Drelng Br., pp. 52-6. (For example, concealng the scheme from nfospace's "damn accountant" s not ndcatve of an ntent to further nfospace's legtmate busness nterests. ER 181; ER 354-55; ER 468; ER 472-76; ER 438-40.) A jury could fnd, based on the emals alone (e.g. ER 181-82; ER 242; ER 240; ER 379; ER 381), that AOL knew of the scheme and agreed to act wth Jan to mplement t. AOL had more than the mere potental to trade on nsde nformaton. See Kay v. Scentex Corp., 719 F.2d 1009, 1013 (9th Cr. 1983). t actually traded, knowng that nfospace was vastly unreportng ts expenses and that ts proftablty was llusory. AOL also knew that Jan was a sgnfcant shareholder of nfospace, and that Jan beleved that the scheme would boost nfospace's stock prce. ER 182. f AOL had not agreed to work wth Jan to manpulate nfospace's accountng so t could acqure, hold and dspose of nfospace securtes, AOL would not be subject to Secton 16(b). AOL asserts that Drelng s usng Secton 16(b) to "end-run" Central Bank v. Frst nterstate Bank, 511 U.S. 164 (1994) (no Secton 10(b) ader and abettor lablty). AOL Br., p. 32. Smlarly, the dstrct court concluded 24
that "[t]he purpose of Secton 13(d) was not to provde another means of ltgatng securtes fraud... " ER 15, lns. 22-23. See also ER 20, ns 17-19 ("The court s not persuaded that two partes actng together to manpulate stock prce by utlzng questonable accountng methods and other smlar actvtes, gve rse to a Secton 13(d) group.") These assertons fal for two reasons. Frst, the evdence shows that AOL s a prmary volator, not a mere ader and abettor. AOL wll not be held lable for trades made by Jan- t wll be held lable for ts own conduct and ts own trades. See Drelng Br., p. 35 fn. 110. AOL acted as a prmary volator n: (a) reachng understandngs wth Jan to form a group and manpulate the ssuer's stock; (b) drectly acqurng, holdng and dsposng of that stock consstent wth that agreement; and (c) drectly proftng from that scheme. Second, the dstrct court's poston, taken to ts logcal concluson, s that Secton 16(b) groups who work together to acqure, hold or dspose of an ssuers stock through llegtmate means should be exempt, whle groups workng together n legtmate ways should be subject to the statute. Ths undermnes the ntent of Secton 16(b). The Ffth Crcut rejected the noton that modern economc realty requres restrctng the scope of Secton 16(b) n derogaton of Congress's orgnal purpose. t noted that the proponents of ths approach... dsplay apparent scorn for the [orgnally ntended] moral and poltcal opnon factor.' 'Why should the publc enter nto the market,' Professor Loss wrtes, 'f the rules of the game make t perfectly legtmate for nsders (and ther frends 25
and busness assocates) to play wth marked cards?' Arrow Dst. Comp. v. Baumgartner, 783 F.2d 1274, 1282 (5th Cr. 1986) (quotng L. Loss, FUNDAMENTALS OF SECURTESREGULATON, 607 n.8 & 9, 608 (1983)). Professor Loss's metaphor s apt. At the card game here at ssue, both AOL and Jan sat at the table. Both entered the game. Both used marked cards. Both won lots of money n so dong. AOL dd not merely mark the cards for others, provde for the card table or serve the drnks. t was a key player and profteer-a prmary volator. At ts core, the premse that jont fraudulent conduct cannot gve rse to a group s an attack on group theory tself. t s beyond cavl that fraudulent actvty can form the bass for a group's common objectve. See, e.g., Lerner v. Mltenco, L.P., 23 F.Supp.2d 337, 338, 344 (S.D.N.Y. 1998) (defendant allegedly partcpated n group "for the purpose of artfcally mantanng the market prce" of ssuer's securtes and to evade reportng requrements; group had formed smlar allances to manpulate stock prce of other companes; allegatons were suffcent). t s not surprsng that Secton 16 group members sometmes engage n fraudulent behavor. Congress was concerned about varous forms of fraud when t enacted Secton 16: n some cases, nsders manpulated the market prce of ther stock and caused the company to follow fnancal polces calculated to produce sudden changes n market prces. To combat these abuses, Congress enacted secton16 to requre 26
reports of securtes transactons by nsders and to provde for the recovery of any short-swng profts. Ownershp Reports and Tradng by Offcers, Drectors and Prncpal Stockholders, SEC Release No. 34-26333, 53 Fed. Reg. 49997-02 at 49998, 1988 WL 268999 (1988) (emphass added). AOL nevertheless asks ths court to adopt the dstrct court's judcal excepton to longstandng group theory: that thrd partes who work wth nsders n a group capacty (.e., who meet the statutory 10% ownershp threshold and agree to act together for a common purpose of acqurng, holdng or dsposng of ssuer stock) should be exempt f the group conduct s manpulatve. Ths putatve excepton s both dangerous and wrong. CONCLUSON For the reasons stated above, ths Court should: (1) reverse the dstrct court's grant of summary judgment; and (2) remand for tral. RESPECTFULLY SUBMTTED ths 11 th day of August, 2008. SRANN YAOUTZ "_'cc/hdx,6_'e.spoonemore, WSBA #21833 Stephen J. Srann, WSBA #6957 and Davd M. Smmonds (WSBA #6994) Attorneys for Appellant Drelng 27
CERTFCATE OF COMPLANCE PURSUANT TO CRCUT RULE 32-1 certfy that: The bref s: Proportonately spaced, has a typeface of 14 ponts or more and contans 6,964 words. or s D contans words or lnes of text. or s D Monospaced, has 10.5 or fewer characters per nch and n conformance wth the type specfcatons set forth at Fed. R. App. P. 32(a)(5) and does not exceed pages. DATED: August 11, 2008. E. Spoonemore
1 CERTFCATE OF SERVCE, Rchard E. Spoonemore, hereby certfy that am a member of the bar of ths Court, and that on August 11, 2008, caused APPELLANT THOMAS DRELNG'S REPLYBREFto be served pursuant to Rule 25(b), F.R.A.P., by malng copes of same to the followng counsel: Mchael D Hunsnger THE HUNSNGER LAW FRM 100 S. Kng Street, Sute 400 Seattle, WA 98104 Counsel for Amerca Onlne, nc. George A. Borden, J. Andrew Keyes, Amanda MacDonald, Marce R. Zegler, and Dane H. Butswnkas WLLAMS & CONNOLLY, 725-12th Street, N.W. LLP Washngton, DC 20005 Counsel for Amerca Onlne, nc. Douglas W. Greene WLSON SONSN GOODRCH & ROSAT, PC 701 Ffth Avenue, Sute 5100 Seattle, WA 98104 Counsel for nfospace, nc. [x] [x] [x] [x] By Unted States Mal By Emal mke hunsngerlawyers@yahoo.com camlle hunsngerlawyers@yahoo.com By Unted States Mal By Emal gborden@wc.com, akeyes@wc.eom, amacdonald@we.eom, mzegler@we.eom, [x] By Unted States Mal [x] By Emal dgreene@wsgr.com dbutswnkas@we.eom n addton, have caused the orgnal and ffteen copes of the APPELLANT THOMAS DRELNG'S REPLY BREF to be forwarded by Federal Express (Prorty Overnght) ths day to the Clerk of the Court addressed as follows: Offce of the Clerk U.S. COURT OF APPEALSt NNTH CRCUT 95 Seventh Street San Francsco, CA 94103 DATED:August 11, 2008, at Seattle; _//gton....._ ////$/_ Y l_cchard E. Spoonemore f