The amount of the dividend on the Calissio common stock was more than 25% of the value of the subject security, so Finra set the ex-date as August 19, the first business day after the payable date. Because the ex-date was after the record date, the shares sold by COR were sold with due bills, so DTC debited COR’s account and credited the accounts of the buyers’ clearing brokers with the amount of the dividend (even though the shares sold by COR were not entitled to the dividend under applicable corporate law). As a result, DTC debited COR’s account $3.7 million and credited the accounts of the buyers’ clearing brokers with a corresponding amount, effectively forcing COR to pay the dividend on those 340 million shares (or go after its client and others that had caused the dividend ineligible shares to be deposited with COR and subsequently sold).
COR was able to recover a portion of its loss from the sellers’ introducing broker, which had helped move the shares from the sellers to COR. In an attempt to be made whole, however, COR also sued the buyers’ clearing brokers, claiming conversion of COR property and unjust enrichment. The court denied both claims. On the conversion claim, the court noted that COR has no claim against the buyers who received DTC credits as a result of misconduct by the sellers (in misrepresenting to the market that the shares were entitled to the dividend) on whose behalf COR acted. And the court relied on the same rationale in rejecting the unjust enrichment claim, commenting that the defendants’ account holders, the buyers of the new shares, “were not unjustly enriched by receiving due bill credits to remedy the…sellers’ misconduct.” COR’s losses could have been avoided if it had understood the significance of having shares issued and sold between the record date and the subsequent ex-date.
Occasionally issuers fail to comply with the requirements of giving advance notice of record dates as required by Rule 10b-17, which can also result in costly mistakes. In Gold v. Ford Motor Co., 852 F. Supp. 2d 535 (D. Del., 2012), aff’d Gold v. Ford Motor Co., 2014 U.S. App. LEXIS 15700 (3rd Cir., 2014), a trust associated with Ford had issued a series of trust preferred securities that traded on the NYSE and entitled holders to quarterly distributions. The trust held debt securities issued by Ford, the interest payments on which were used by the trust to make the quarterly distributions. Ford had the right to suspend interest payments on the debt securities for a period of up to 20 consecutive quarters, in which case the trust would suspend distributions on the trust-preferred securities. Ford exercised this right beginning with the quarterly distribution due on April 15, 2009.
A little over a year later, on the morning of June 30, 2010, Ford announced that it would pay the deferred interest and resume quarterly interest payments on July 15, and that the trust would pay the deferred distributions and the current quarterly distribution on July 15 to holders of record as of June 30. In the afternoon of June 30, the NYSE posted an electronic notice that the ex-date for the forthcoming distribution was July 1 (after the June 30 record date), and set a due bill period of June 28, 29 and 30.
The plaintiff in the case sold trust preferred securities on June 30 after Ford had announced resumption of the distributions but before NYSE issued notice of the ex-date. The plaintiff was the record holder of those securities because the trades would not settle until July 6 (the settlement cycle was T+3 at the time). However, because those securities were sold before the July 1 ex-date, the plaintiff was not entitled to the July 15 distribution on those securities. The plaintiff promptly sued Ford and the trust, alleging they had committed securities fraud under Section 10(b) of the Exchange Act by failing to give the NYSE ten days advance notice of the record date as required by Rule 10b-17. The court denied the claim on the basis that one of the required elements of a Section 10(b) claim, loss causation, was not present. The court determined that it was the NYSE’s decision to set a July 1 ex-date, not any action by Ford or the trust, that caused the plaintiff’s losses. The court also denied the plaintiff’s motion to amend its complaint, finding that there is no private right of action under Rule 10b-17. See Gold v. Ford Motor Co., 937 F. Supp. 2d 526 (D. Del., 2013). The district court’s decision was upheld by the Third Circuit, which found that the plaintiff failed to adequately plead scienter (the intent to deceive, manipulate or defraud). This case illustrates the pitfalls of making trading decisions without understanding when the ex-date will occur.
The application of ex-dates to distributions under a confirmed plan of reorganization in bankruptcy also has resulted in misunderstandings and costly mistakes. In Zardinovsky v. Arctic Glacier Income Fund (In re Arctic Glacier Int’l, Inc.), 901 F.3d 162 (3rd Cir., 2018), Arctic Glacier, an income trust based in Canada, entered into a plan of arrangement (overseen by a monitor under Canadian law) under which it would sell its assets and distribute proceeds first to its creditors and then to its unitholders. Its units were listed on the Canadian Securities Exchange and traded in the U.S. over-the-counter market. The plan included broad releases of liability for Arctic Glacier and its trustees, officers, employees and other parties.
In November 2014, the monitor disclosed that it estimated the upcoming unitholder distribution would be $0.153 per unit, in excess of 75% of the value of the units. On December 11, 2014, Arctic Glacier published notices that it would make the distribution to unitholders of record as of December 18. Despite this announcement, Arctic Glacier’s unit price “held steady” after the record date, which the company “found puzzling, as its [units] no longer traded with the [distribution] and should have lost value equal to the [distribution].” But Arctic Glacier did nothing to respond to this anomaly regarding its unit price. In addition, Arctic Glacier did not notify Finra of this distribution or the record date, as required by Rule 10b-17.
It seems clear that at least some investors assumed Finra would set an ex-date after the payable date, so that they would be entitled to the distribution even if they purchased units after the record date. That certainly appears to be the case for the plaintiffs. Between December 16 and January 22, the plaintiffs bought more than 12.6 million units. On January 21, the monitor for the plan announced that it would pay a distribution of $0.15557 per unit on the next day, January 22. The distribution was paid to holders of record as of December 18, as provided for in the plan. On the next day, regulators in Canada and the United States froze trading in Arctic Glacier’s units and, when trading resumed, its unit priced dropped from $0.21 to $0.05, reflecting the value of the distribution that had been paid.
The plaintiffs claimed that Arctic Glacier and the individual defendants committed negligence and fraud by failing to comply with U.S. securities laws and regulations, particularly Rule 10b-17, and Finra regulations. The plaintiffs claimed that if the defendants had complied with these laws and regulations, Finra would have set an ex-date as the next business day following the payable date (because the amount of the distribution was more than 75% of the value of the underlying security), in which case the plaintiffs would have received the distribution on the units they acquired after the record date.
The court denied the plaintiffs’ claims, noting that the plan had detailed distribution provisions and did not incorporate or even refer to Finra’s rules. The court held that the plan, which had been subject to a recognition order in U.S. bankruptcy court, and the releases were res judicata—the plan “bars all challenges to the plan that could have been raised.” As a result, the plaintiffs effectively paid for a distribution that Arctic Glacier paid to someone else (the investors that sold the plaintiffs their units after the record date at a price that assumed the plaintiffs would be entitled to the distribution). See also Karathansis v. THCR/LP, 2007 U.S. Dist. LEXIS 30772, aff’d In re THCR/LP Corp., 2008 U.S. App. LEXIS 23151 (3rd Cir., 2008) (where the court found that stockholders as of the record date that subsequently sold their shares were entitled to the distribution in accordance with the terms of the confirmed plan or reorganization notwithstanding the fact that the NASD had established an ex-date as the next business day after the payable date and DTC had used due bills so that the distribution actually was made based on the holders as of the payable date rather than as of the record date).