During a tender offer campaign, respondent bought more than 10%
of the outstanding stock of petitioner's predecessor (Old Kern).
Respondent was blocked in its takeover efforts by a defensive
merger between Old Kern and Tenneco, in which Old Kern stockholders
were to receive new Tenneco stock on a share-for-share basis. Less
than a month after its initial tender offer, respondent thereupon
negotiated a binding option to sell to Tenneco at a date over six
months after the tender offer expired all the new Tenneco stock to
which respondent would be entitled when the merger took place. Sale
of the post-merger stock yielded respondent a profit of some $19
million, which petitioner sought to recover by a suit under § 16(b)
of the Securities Exchange Act of 1934, prohibiting profitable
short-swing speculation by statutory insiders. The District Court's
summary judgment for petitioner was reversed by the Court of
Appeals.
Held: The transactions, which were not based on a
statutory insider's information and were not susceptible of the
speculative abuse that § 16(b) was designed to prevent, did not
constitute "sales" within the meaning of that provision. Pp.
411 U. S.
591-604.
(a) There was nothing in connection with respondent's tender
offer acquisition of Old Kern stock or the exchange thereof for the
Tenneco stock that gave respondent "inside information," and once
the merger, which respondent did not engineer, was approved, the
Old Kern-Tenneco stock exchange was involuntary. Pp.
411 U. S.
596-600.
(b) The option agreement was not of itself a "sale"; the option
was grounded on the mutual advantages to respondent as a minority
stockholder that wanted to terminate an investment it had not
chosen to make and Tenneco, whose management did not want a
potentially troublesome minority stockholder; and the option was
not a source of potential speculative abuse, since respondent had
no inside information about Tenneco or its new stock. Pp.
411 U. S.
601-604.
450 F.2d 157, affirmed.
Page 411 U. S. 583
WHITE, J., delivered the opinion of the Court, in which BURGER,
C.J., and MARSHALL, BLACKMUN, POWELL, and REHNQUIST, JJ., joined.
DOUGLAS, J., filed a dissenting opinion, in which BRENNAN and
STEWART, JJ., joined,
post, p.
411 U. S.
605.
MR. JUSTICE WHITE delivered the opinion of the Court.
Section 16(b) of the Securities Exchange Act of 1934, 48 Stat.
896, 15 U.S.C. § 78p(b), [
Footnote
1] provides that officers,
Page 411 U. S. 584
directors, and holders of more than 10% of the listed stock of
any company shall be liable to the company for any profits realized
from any purchase and sale or sale and purchase of such stock
occurring within a period of six months. Unquestionably, one or
more statutory purchases occur when one company, seeking to gain
control of another, acquires more than 10% of the stock of the
latter through a tender offer made to its shareholders. But is it a
§ 16(b) "sale" when the target of the tender offer defends itself
by merging into a third company and the tender offeror then
exchanges his stock for the stock of the surviving company and also
grants an option to purchase the latter stock that is not
exercisable within the statutory six-month period? This is the
question before us in this case.
I
On May 8, 1967, after unsuccessfully seeking to merge with Kern
County Land Co. (Old Kern), [
Footnote 2] Occidental Petroleum Corp. (Occidental)
[
Footnote 3] announced an
offer, to expire on June 8, 1967, to purchase on a first-come,
first-served basis 500,000 shares of Old Kern common stock
[
Footnote 4] at a price of
$83.50 per share plus a brokerage
Page 411 U. S. 585
commission of $1.50 per share. [
Footnote 5] By May 10, 1967, 500,000 shares, more than 10%
of the outstanding shares of Old Kern, [
Footnote 6] had been tendered. On Mar 11, Occidental
extended its offer to encompass an additional 500,000 shares. At
the close of the tender offer, on June 8, 1967, Occidental owned
887,549 shares of Old Kern. [
Footnote 7]
Immediately upon the announcement of Occidental's tender offer,
the Old Kern management undertook to frustrate Occidental's
takeover attempt. A management letter to all stockholders cautioned
against tender and indicated that Occidental's offer might not be
the best available, since the management was engaged in merger
discussions with several companies. When Occidental extended its
tender offer, the president of Old Kern sent a telegram to all
stockholders again advising against tender. In addition, Old Kern
undertook merger discussions
Page 411 U. S. 586
with Tenneco, Inc. (Tenneco), [
Footnote 8] and, on May 19, 1967, the Board of Directors
of Old Kern announced that it had approved a merger proposal
advanced by Tenneco. [
Footnote
9] Under the terms of the merger, Tenneco would acquire the
assets, property, and goodwill of Old Kern subject to its
liabilities, through "Kern County Land Co." (New Kern), [
Footnote 10] a new corporation to be
formed by Tenneco to receive the assets and carry on the business
of Old Kern. The shareholders of Old Kern would receive a share of
Tenneco cumulative convertible preference stock in exchange for
each share of Old Kern common stock which they owned. On the same
day, May 19, Occidental, in a quarterly report to stockholders,
appraised the value of the new Tenneco stock at $105 per share.
[
Footnote 11]
Page 411 U. S. 587
Occidental, seeing its tender offer and takeover attempt being
blocked by the Old Kern-Tenneco "defensive" merger, countered on
May 25 and 31 with two mandamus actions in the California courts
seeking to obtain extensive inspection of Old Kern books and
records. [
Footnote 12]
Realizing that, if the Old Kern-Tenneco merger were approved and
successfully closed, Occidental would have to exchange its Old Kern
shares for Tenneco stock, and would be locked into a minority
position in Tenneco, Occidental took other steps to protect itself.
Between May 30 and June 2, it negotiated an arrangement with
Tenneco whereby Occidental granted Tenneco Corp., a subsidiary of
Tenneco, an option to purchase at $105 per share all of the Tenneco
preference stock to which Occidental would be entitled in exchange
for its Old Kern stock when and if the Old Kern-Tenneco merger was
closed. [
Footnote 13] The
premium to secure the option, at $10 per share, totaled $8,866,230,
and was to be paid immediately upon the signing of the option
agreement. [
Footnote 14] If
the option were exercised, the premium was to be applied to the
purchase price. By the terms of the option agreement, the option
could not be exercised prior to December
Page 411 U. S. 588
9, 1967, a date six months and one day after expiration of
Occidental's tender offer. On June 2, 1967, within six months of
the acquisition by Occidental of more than 10% ownership of Old
Kern, Occidental and Tenneco Corp. executed the option. [
Footnote 15] Soon thereafter,
Occidental announced that it would not oppose the Old Kern-Tenneco
merger, and dismissed its state court suits against Old Kern.
[
Footnote 16]
The Old Kern-Tenneco merger plan was presented to and approved
by Old Kern shareholders at their meeting on July 17, 1967.
Occidental refrained from voting its Old Kern shares, but, in a
letter read at the meeting, Occidental stated that it had
determined prior to June 2 not to oppose the merger and that it did
not consider the plan unfair or inequitable. [
Footnote 17] Indeed, Occidental indicated that,
had it been voting, it would have voted in favor of the merger.
Meanwhile, the Securities and Exchange Commission had refused
Occidental's request to exempt from possible § 16(b) liability
Occidental's exchange of its Old Kern stock for the Tenneco
preference shares that would take
Page 411 U. S. 589
place when and if the merger transaction were closed. Various
Old Kern stockholders, with Occidental's interests in mind,
thereupon sought to delay consummation of the merger by instituting
various lawsuits in the state and federal courts. [
Footnote 18] These attempts were
unsuccessful, however, and preparations for the merger neared
completion with an Internal Revenue Service ruling that
consummation of the plan would result in a tax-free exchange with
no taxable gain or loss to Old Kern shareholders, and with the
issuance of the necessary approval of the merger closing by the
California Commissioner of Corporations.
The Old Kern-Tenneco merger transaction was closed on August 30.
Old Kern shareholders thereupon became irrevocably entitled to
receive Tenneco preference stock, share for share in exchange for
their Old Kern stock. Old Kern was dissolved, and all of its
assets, including "all claims, demands, rights and choses in action
accrued or to accrue under and by virtue of the Securities Exchange
Act of 1934 . . . ," were transferred to New Kern.
The option granted by Occidental on June 2, 1967, was exercised
on December 11, 1967. Occidental, not having previously availed
itself of its right, exchanged certificates representing 887,549
shares of Old Kern stock for a certificate representing a like
number of shares of Tenneco preference stock. The certificate was
then endorsed over to the optionee-purchaser and, in return,
$84,229,185 was credited to Occidental's accounts at various banks.
Adding to this amount the $8,886,230 premium paid in June,
Occidental received $93,905,415 for its Old Kern stock (including
the 1,900 shares acquired prior to issuance of its tender offer).
In addition, Occidental received dividends totaling $1,793,439.22.
Occidental's
Page 411 U. S. 590
total profit was $19,506,419.22 on the shares obtained through
its tender offer.
On October 17, 1967, New Kern instituted a suit under § 16(b)
against Occidental to recover the profits which Occidental had
realized as a result of its dealings in Old Kern stock. The
complaint alleged that the execution of the Occidental-Tenneco
option on June 2, 1967, and the exchange of Old Kern shares for
shares of Tenneco to which Occidental became entitled pursuant to
the merger closed on August 30, 1967, were both "sales" within the
coverage of § 16(b). Since both acts took place within six months
of the date on which Occidental became the owner of more than 10%
of the stock of Old Kern, New Kern asserted that § 16(b) required
surrender of the profits realized by Occidental. [
Footnote 19] New Kern eventually moved for
summary judgment, and, on December 27, 1970, the District Court
granted summary judgment in favor of New Kern.
Abrams v.
Occidental Petroleum Corp., 323 F.
Supp. 570 (SDNY 1970). The District Court held that the
execution of the option on June 2, 1967, and the exchange of Old
Kern shares for shares of Tenneco on August 30, 1967, were "sales"
under § 16(b). The Court ordered Occidental to disgorge its profits
plus interest. In a supplemental opinion, Occidental was also
ordered to refund the dividends which it had received plus
interest.
On appeal, the Court of Appeals reversed and ordered summary
judgment entered in favor of Occidental.
Abrams v. Occidental
Petroleum Corp., 450 F.2d 157 (CA2 1971). The Court held that
neither the option nor the exchange constituted a "sale" within the
purview of
Page 411 U. S. 591
§ 16(b). [
Footnote 20] We
granted certiorari. 405 U.S. 1064 (1972). We affirm.
II
Section 16(b) provides,
inter alia, that a statutory
insider [
Footnote 21] must
surrender to the issuing corporation
"any profit realized by him from any purchase and sale, or any
sale and purchase, of any equity security [
Footnote 22] of such issuer . . . within any
period of less than six months."
As specified in its introductory clause, § 16(b) was enacted
"[f]or the purpose of preventing the unfair use of information
which may have been obtained by [a statutory insider] . . . by
reason of his relationship to the issuer."
Congress recognized that short-swing speculation by stockholders
with advance, inside information would threaten the goal of the
Securities Exchange Act to "insure the maintenance of fair and
honest markets."
Page 411 U. S. 592
15 U.S.C. § 78b. Insiders could exploit information not
generally available to others to secure quick profits. As we have
noted,
"the only method Congress deemed effective to curb the evils of
insider trading was a flat rule taking the profits out of a class
of transactions in which the possibility of abuse was believed to
be intolerably great."
Reliance Electric Co. v. Emerson Electric Co.,
404 U. S. 418,
404 U. S. 422
(1972). As stated in the report of the Senate Committee, the bill
aimed at protecting the public
"by preventing directors, officers, and principal stockholders
of a corporation . . . from speculating in the stock on the basis
of information not available to others."
S.Rep. No. 792, 73d Cong., 2d Sess., 9 (1934). [
Footnote 23]
Page 411 U. S. 593
Although traditional cash-for-stock transactions that result in
a purchase and sale or a sale and purchase within the six-month
statutory period are clearly within the purview of § 16(b), the
courts have wrestled with the question of inclusion or exclusion of
certain "unorthodox" transactions. [
Footnote 24] The statutory definitions of "purchase"
Page 411 U. S. 594
and "sale" are broad and, at least arguably, reach many
transactions not ordinarily deemed a sale or purchase. [
Footnote 25] In deciding whether
borderline transactions are within the reach of the statute, the
court have come to inquire whether the transaction may serve as a
vehicle for the evil which Congress sought to prevent realization
of short-swing profits based upon access to inside information
[
Footnote 26] -- thereby
endeavoring to implement congressional
Page 411 U. S. 595
objectives without extending the reach of the statute beyond its
intended limits. The statute requires the inside, short-swing
trader to disgorge all profits realized on all "purchases" and
"sales" within the specified time period, without proof of actual
abuse of insider information, and without proof of intent to profit
on the basis of such information. Under these strict terms, the
prevailing view is to apply the statute only when its application
would serve its goals.
"[W]here alternative constructions of the terms of § 16(b) are
possible, those terms are to be given the construction that best
serves the congressional purpose of curbing short-swing speculation
by corporate insiders."
Reliance Electric Co. v. Emerson Electric Co., 404 U.S.
at
404 U. S. 424.
See Blau v. Lamb, 363 F.2d 507 (CA2 196),
cert.
denied, 385 U.S. 1002 (1967). Thus,
"[i]n interpreting the terms 'purchase' and 'sale,' courts have
properly asked whether the particular type of transaction involved
is one that gives rise to speculative abuse."
Reliance Electric Co. v. Emerson Electric Co., supra,
at
404 U. S. 424
n. 4. [
Footnote 27]
In the present case, it is undisputed that Occidental became a
"beneficial owner" within the terms of § 16(b) when, pursuant to
its tender offer, it "purchased" more than 10% of the outstanding
shares of Old Kern. We must decide, however, whether a "sale"
within the ambit of the statute took place either when Occidental
became irrevocably bound to exchange its shares of Old Kern for
shares of Tenneco pursuant to the terms of the merger agreement
between Old Kern and Tenneco or
Page 411 U. S. 596
when Occidental gave an option to Tenneco to purchase from
Occidental the Tenneco shares so acquired. [
Footnote 28]
III
On August 30, 1967, the Old Kern-Tenneco merger agreement was
signed, and Occidental became irrevocably entitled to exchange its
shares of Old Kern stock for shares of Tenneco preference stock.
Concededly, the transaction must be viewed as though Occidental had
made the exchange on that day. But, even so, did the exchange
involve a "sale" of Old Kern shares within the meaning of § 16(b)?
We agree with the Court of Appeals that it did not, for we think it
totally unrealistic to assume or infer from the facts before us
that Occidental either had or was likely to have access to inside
information by reason of its ownership of more than 10% of the
outstanding shares of Old Kern, so as to afford it an opportunity
to reap speculative, short-swing profits from its disposition
within six months of its tender offer purchases.
It cannot be contended that Occidental was an insider when, on
May 8, 1967, it made an irrevocable offer to purchase 500,000
shares of Old Kern stock at a price substantially above market. At
that time, it owned only 1,900 shares of Old Kern stock, far fewer
than the 432,000 shares needed to constitute the 10% ownership
required by the statute. There is no basis for finding
Page 411 U. S. 597
that, at the time the tender offer was commenced, Occidental
enjoyed an insider's opportunity to acquire information about Old
Kern's affairs.
It is also wide of the mark to assert that Occidental, as a
sophisticated corporation knowledgeable in matters of corporate
affairs and finance, knew that its tender offer would either
succeed or would be met with a "defensive merger." If its takeover
efforts failed, it is argued, Occidental knew it could sell its
stock to the target company's merger partner at a substantial
profit. Calculations of this sort, however, whether speculative or
not and whether fair or unfair to other stockholders or to Old
Kern, do not represent the kind of speculative abuse at which the
statute is aimed, for they could not have been based on inside
information obtained from substantial stockholdings that did not
yet exist. Accepting both that Occidental made this very prediction
and that it would recurringly be an accurate forecast in tender
offer situations, [
Footnote
29] we nevertheless fail to perceive how the fruition of such
anticipated events would require, or in any way depend upon, the
receipt and use of inside information. If there are evils to be
redressed by way of deterring those who would make tender
offers,
Page 411 U. S. 598
§ 16(b) does not appear to us to have been designed for this
task.
By May 10, 1967, Occidental had acquired more than 10% of the
outstanding shares of old Kern. It was thus a statutory insider
when, on May 11, it extended its tender offer to include another
500,000 shares. We are quite unconvinced, however, that the
situation had changed materially with respect to the possibilities
of speculative abuse of inside information by Occidental. Perhaps
Occidental anticipated that extending its offer would increase the
likelihood of the ultimate success of its takeover attempt or the
occurrence of a defensive merger. But, again, the expectation of
such benefits was unrelated to the use of information unavailable
to other stockholders or members of the public with sufficient
funds and the intention to make the purchases Occidental had
offered to make before June 8, 1967.
The possibility that Occidental had, or had the opportunity to
have, any confidential information about Old Kern before or after
May 11, 1967, seems extremely remote. Occidental was, after all, a
tender offeror, threatening to seize control of Old Kern, displace
its management, and use the company for its own ends. The Old Kern
management vigorously and immediately opposed Occidental's efforts.
Twice it communicated with its stockholders, advising against
acceptance of Occidental's offer and indicating, prior to May 11
and prior to Occidental's extension of its offer, that there was a
possibility of an imminent merger and a more profitable exchange.
Old Kern's management refused to discuss with Occidental officials
the subject of an Old Kern-Occidental merger. Instead, it undertook
negotiations with Tenneco and forthwith concluded an agreement,
announcing the merger terms on May 19. Requests by Occidental for
inspection of Old Kern records were sufficiently frustrated
Page 411 U. S. 599
by Old Kern's management to force Occidental to litigate to
secure the information it desired.
There is, therefore, nothing in connection with Occidental's
acquisition of Old Kern stock pursuant to its tender offer to
indicate either the possibility of inside information's being
available to Occidental by virtue of its stock ownership or the
potential for speculative abuse of such inside information by
Occidental. Much the same can be said of the events leading to the
exchange of Occidental's Old Kern stock for Tenneco preferred,
which is one of the transactions that is sought to be classified a
"sale" under § 16(b). The critical fact is that the exchange took
place and was required pursuant to a merger between Old Kern and
Tenneco. That merger was not engineered by Occidental, but was
sought by Old Kern to frustrate the attempts of Occidental to gain
control of Old Kern. Occidental obviously did not participate in or
control the negotiations or the agreement between Old Kern and
Tenneco.
Cf. Newmark v. RKO General, 425 F.2d 348 (CA2),
cert. denied, 400 U.S. 854 (1970);
Park & Tilford
v. Schulte, 160 F.2d 984 (CA2),
cert. denied, 332
U.S. 761 (1947). Once agreement between those two companies
crystalized, the course of subsequent events was out of
Occidental's hands. Old Kern needed the consent of its
stockholders, but, as it turned out, Old Kern's management had the
necessary votes without the affirmative vote of Occidental. The
merger agreement was approved by a majority of the stockholders of
Old Kern, excluding the votes to which Occidental was entitled by
virtue of its ownership of Old Kern shares.
See generally
Ferraiolo v. Newman, 259 F.2d 342 (CA6 1958),
cert.
denied, 359 U.S. 927 (1959);
Roberts v. Eaton, 212
F.2d 82 (CA2 1954). Occidental, although registering its opinion
that the merger would be beneficial to Old Kern shareholders, did
not in fact, vote at the
Page 411 U. S. 600
stockholders' meeting at which merger approval was obtained.
Under California law, its abstention was tantamount to a vote
against approval of the merger. Moreover, at the time of
stockholder ratification of the merger, Occidental's previous
dealing in Old Kern stock was, as it had always been, fully
disclosed.
Once the merger and exchange were approved, Occidental was left
with no real choice with respect to the future of its shares of Old
Kern. Occidental was in no position to prevent the issuance of a
ruling by the Internal Revenue Service that the exchange of Old
Kern stock for Tenneco preferred would be tax-free; and, although
various lawsuits were begun in state and federal courts seeking to
postpone the merger closing beyond the statutory six-month period,
those efforts were futile. The California Corporation Commissioner
issued the necessary permits for the closing that took place on
August 30, 1967. The merger left no right in dissenters to secure
appraisal of their stock. Occidental could, of course, have
disposed of its shares of Old Kern for cash before the merger was
closed. Such an act would have been a § 16 sale, and would have
left Occidental with a
prima facie § 16(b) liability. It
was not, therefore, a realistic alternative for Occidental as long
as it felt that it could successfully defend a suit like the
present one.
See generally Petteys v. Butler, 367 F.2d 528
(CA8 1966);
cert denied, 385 U.S. 1006 (1967);
Ferraiolo v. Newman, supra; Lynam v.
Livingston, 276 F.
Supp. 104 (Del. 1967);
Blau v.
Hodgkinson, 100 F.
Supp. 361 (SDNY 1951). We do not suggest that an exchange of
stock pursuant to a merger may never result in § 16(b) liability.
But the involuntary nature of Occidental's exchange, when coupled
with the absence of the possibility of speculative abuse of inside
information, convinces us that § 16(b) should not apply to
transactions such as this one.
Page 411 U. S. 601
IV
Petitioner also claims that the Occidental-Tenneco option
agreement should itself be considered a sale, either because it was
the kind of transaction the statute was designed to prevent or
because the agreement was an option in form but a sale in fact. But
the mere execution of an option to sell is not generally regarded
as a "sale."
See Booth v. Varian Associates, 334 F.2d 1
(CA1 1964),
cert. denied, 379 U.S. 961 (1965);
Allis-Chalmers Mfg. Co. v. Gulf & Western
Industries, 309 F. Supp.
75 (ED Wis.1970);
Marquette Cement Mfg. Co. v.
Andreas, 239 F.
Supp. 962 (SDNY 1965). And we do not find in the execution of
the Occidental-Tenneco option agreement a sufficient possibility
for the speculative abuse of inside information with respect to Old
Kern's affairs to warrant holding that the option agreement was
itself a "sale" within the meaning of § 16(b). The mutual
advantages of the arrangement appear quite clear. As the District
Court found, Occidental wanted to avoid the position of a minority
stockholder with a huge investment in a company over which it had
no control and in which it had not chosen to invest. On the other
hand, Tenneco did not want a potentially troublesome minority
stockholder that had just been vanquished in a fight for the
control of Old Kern. Motivations like these do not smack of insider
trading, and it is not clear to us, as it was not to the Court of
Appeals, how the negotiation and execution of the option agreement
gave Occidental any possible opportunity to trade on inside
information it might have obtained from its position as a major
stockholder of Old Kern. Occidental wanted to get out, but only at
a date more than six months thence. It was willing to get out at a
price of $105 per share, a price at which it had publicly valued
Tenneco preferred on May 19 when the Tenneco-Old Kern agreement was
announced.
Page 411 U. S. 602
In any event, Occidental was dealing with the putative new
owners of Old Kern, who undoubtedly knew more about Old Kern and
Tenneco' affairs than did Occidental. If Occidental had leverage in
dealing with Tenneco, it is incredible that its source was inside
information, rather than the fact of its large stock ownership
itself.
Neither does it appear that the option agreement, as drafted and
executed by the parties, offered measurable possibilities for
speculative abuse. What Occidental granted was a "call" option.
Tenneco had the right to buy after six months, but Occidental could
not force Tenneco to buy. The price was fixed at $105 for each
share of Tenneco preferred. Occidental could not share in a rising
market for the Tenneco stock.
See Silverman v. Landa, 306
F.2d 422 (CA2 1962). If the stock fell more than $10 per share, the
option might not be exercised, and Occidental might suffer a loss
if the market further deteriorated to a point where Occidental was
forced to sell. Thus, the option, by its very form, left Occidental
with no choice but to sell if Tenneco exercised the option, which
it was almost sure to do if the value of Tenneco stock remained
relatively steady. On the other hand, it is difficult to perceive
any speculative value to Occidental if the stock declined and
Tenneco chose not to exercise its option.
See generally
Note, Put and Call Options Under Section 16 of the Securities
Exchange Act, 69 Yale L.J. 868 (1960); H. Filer, Understanding Put
and Call Options 96-111 (1959); G. Leffler, The Stock Market
363-378 (2d ed.1957).
The option, therefore, does not appear to have been an
instrument with potential for speculative abuse, whether or not
Occidental possessed inside information about the affairs of Old
Kern. In addition, the option covered Tenneco preference stock, a
stock as yet unissued, unregistered, and untraded. It was the value
of this
Page 411 U. S. 603
stock that underlay the option and that determined whether the
option would be exercised, whether Occidental would be able to
profit from the exercise, and whether there was any real likelihood
of the exploitation of inside information. If Occidental had inside
information when it negotiated and signed the option agreement, it
was inside information with respect to Old Kern. Whatever it may
have known or expected as to the future value of Old Kern stock,
Occidental had no ownership position in Tenneco giving it any
actual or presumed insights into the future value of Tenneco stock.
That was the critical item of intelligence if Occidental was to use
the option for purposes of speculation. Also, the date for exercise
of the option was over six months in the future, a period that,
under the statute itself, is assumed to dissipate whatever trading
advantage might be imputed to a major stockholder with inside
information.
See Comment, Stock Exchanges Pursuant to
Corporate Consolidation: A Section 16(b) "Purchase or Sale?," 117
U.Pa.L.Rev. 1034, 1054 (1969);
Silverman v. Landa, supra.
By enshrining the statutory period into the option, Occidental
also, at least if the statutory period is taken to accomplish its
intended purpose, limited its speculative possibilities. Nor should
it be forgotten that there was no absolute assurance that the
merger, which was not controlled by Occidental, would be
consummated. In the event the merger did not close, the option
itself would become null and void.
Nor can we agree that we must reverse the Court of Appeals on
the ground that the option agreement was, in fact, a sale because
the premium paid was so large as to make the exercise of the option
almost inevitable, particularly when coupled with Tenneco's desire
to rid itself of a potentially troublesome stockholder. The
argument has force, but resolution of the question is very much a
matter of judgment, economic and otherwise, and the
Page 411 U. S. 604
Court of Appeals rejected the argument. That court emphasized
that the premium paid was what experts had said the option was
worth, the possibility that the market might drop sufficiently in
the six months following execution of the option to make exercise
unlikely, and the fact that here, unlike the situation in
Bershad v. McDonough, 428 F.2d 693 (CA7 1970), the
optionor did not surrender practically all emoluments of ownership
by executing the option. Nor did any other special circumstances
indicate that the parties understood and intended that the option
was in fact, a sale. [
Footnote
30] We see no satisfactory basis or reason for disagreeing with
the judgment of the Court of Appeals in this respect. [
Footnote 31]
The judgment of the Court of Appeals is affirmed.
So ordered.
Page 411 U. S. 605
[
Footnote 1]
"For the purpose of preventing the unfair use of information
which may have been obtained by such beneficial owner, director, or
officer by reason of his relationship to the issuer, any profit
realized by him from any purchase and sale, or any sale and
purchase, of any equity security of such issuer (other than an
exempted security) within any period of less than six months,
unless such security was acquired in good faith in connection with
a debt previously contracted, shall inure to and be recoverable by
the issuer, irrespective of any intention on the part of such
beneficial owner, director, or officer in entering into such
transaction of holding the security purchased or of not
repurchasing the security sold for a period exceeding six months.
Suit to recover such profit may be instituted at law or in equity
in any court of competent jurisdiction by the issuer, or by the
owner of any security of the issuer in the name and in behalf of
the issuer if the issuer shall fail or refuse to bring such suit
within sixty days after request or shall fail diligently to
prosecute the same thereafter; but no such suit shall be brought
more than two years after the date such profit was realized. This
subsection shall not be construed to cover any transaction where
such beneficial owner was not such both at the time of the purchase
and sale, or the sale and purchase, of the security involved, or
any transaction or transactions which the Commission by rules and
regulations may exempt as not comprehended within the purpose of
this subsection."
15 U.S.C. § 78p(b).
[
Footnote 2]
Old Kern was a California corporation having substantial real
estate holdings, including oil-producing lands, oil-exploration
activities, cattle ranching, cattle feeding operations, and
interests in the manufacture of automotive parts, electronic
systems and devices, and farm machinery and construction equipment.
After the reorganization described in the text, Old Kern became
known as the 600 California Corporation until its eventual
dissolution under California law on October 6, 1967.
[
Footnote 3]
Occidental is the respondent in this Court. A California
corporation with its principal place of business in California,
Occidental is engaged in the production and sale of oil, gas, coal,
sulphur, and fertilizers.
[
Footnote 4]
The Old Kern stock was registered pursuant to § 12 of the
Securities Exchange Act of 1934, as amended, 15 U.S.C. §
78
l. The stock was a nonexempt, equity security for
purposes of § 16(b).
[
Footnote 5]
The Old Kern stock closed at 63 5/8 on Friday, May 8, 1967, the
last trading day prior to the announcement of the tender offer. It
had reached a high of 64 7/8 and a low of 57 3/8 in 1967, a high of
76 1/4 and a low of 51 3/4 in 1966, a high of 71 5/8 and a low of
56 in 1965, and a high of 70 3/8 and a low of 56 5/8 in 1964. Thus,
the $85 per share tender offer price represented a substantial
profit for shareholders of Old Kern.
[
Footnote 6]
On May 10, Old Kern had 4,328,000 shares outstanding.
[
Footnote 7]
On May 18, 1967, Occidental filed a Form 3, Initial Statement of
Beneficial Ownership of Securities, with the Securities and
Exchange Commission indicating direct ownership of 507,055 shares
of Old Kern stock; on June 9, 1967, Occidental filed a Form 4,
Statement of Changes in Beneficial Ownership of Securities, for the
month of May, indicating the purchase of an additional 376,326
shares of Old Kern stock, for a total ownership as of May 31, 1967,
of 883,381 shares. An additional 4,168 shares were purchased by
June 8, 1967, so that, as of June 30, 1967, Occidental held 887,549
shares of Old Kern stock. This figure included 1,900 shares which
Occidental purchased on the open market in April, 1967. Section
16(b) liability is not asserted with respect to these shares
because these purchases did not make Occidental a "beneficial
owner" for purposes of § 16(b).
[
Footnote 8]
Tenneco, a Delaware corporation, is a diversified industrial
company with operations in natural gas transmission, oil and gas,
chemicals, packaging, manufacturing, and shipbuilding. Tenneco is
not a party to this litigation.
[
Footnote 9]
Although technically a sale of assets, the corporate combination
has been consistently referred to by the parties as a "merger," and
will be similarly denominated in this opinion. The only
significance of the characterization is the fact that a sale of
assets required, under California law, approval of only a majority
of the Old Kern shareholders, and provided no appraisal rights for
dissenters.
[
Footnote 10]
New Kern, a Delaware corporation with its principal place of
business in California, is the petitioner in this Court, and is a
wholly owned subsidiary of Tenneco Corp. Tenneco Corp. is, in turn,
a wholly owned subsidiary of Tenneco, and owns all of the capital
stock or controlling interests in most of Tenneco's nonpipeline
operating subsidiaries. When first incorporated, New Kern was known
as KCL Corp.
[
Footnote 11]
The annual dividend of $5.50 per share on the new Tenneco stock
would be more than double the current annual dividend of $2.60 per
share on the Old Kern stock. Each share of the new Tenneco
preference stock was convertible into 3.6 shares of Tenneco common
stock. During 1967, Tenneco common stock had sold at a high of 32
1/2 and a low of 20 7/8. Moreover, in contrast to Occidental's cash
offer, the Tenneco exchange was expected to be, and was ultimately
approved by the Internal Revenue Service as, free of capital gains
tax.
[
Footnote 12]
Prior to any court ruling on Occidental's mandamus petitions,
Old Kern voluntarily permitted inspection of Old Kern's general
ledger, consolidated financial statements, consolidated journal
entries, details of cash receipts from oil operations, supporting
trial balances, and other records over a six-day period. A list of
stockholders, however, was withheld.
[
Footnote 13]
The agreement covered 886,623 shares. This figure is 926 shares
less than the number of Old Kern shares ultimately owned by
Occidental. This discrepancy apparently results from uncertainty as
to the number of shares tendered.
[
Footnote 14]
An outside investment banking firm in New York had determined
that between $9 and $12 per share was a fair premium on an option
on the Old Kern stock.
[
Footnote 15]
On that date, and on the date of the exercise of the option, Old
Kern common stock was selling at approximately $95 per share.
[
Footnote 16]
Seeking to prevent its acquisition of Tenneco shares pursuant to
the merger from being matched with the sale of those shares upon
exercise of the option for purposes of establishing § 16(b)
liability, Occidental asked that the new Tenneco stock not be
immediately registered pursuant to § 12 of the Securities Exchange
Act of 1934, 15 U.S.C. § 78
l.
See 450 F.2d 157,
160 n. 6.
[
Footnote 17]
The letter indicated that Occidental
"did not consider it to be in its best interest, or the best
interest of its shareholders, or the best interest of KCL
Shareholders generally for it to [oppose] the transaction."
However, Occidental stated that,
"[i]n view of the fact that we would rather have worked out our
own transaction with KCL, we shall not vote our KCL shares at the
KCL Shareholder's Meeting on July 17, 1967."
Under applicable California law, the abstention from voting was
tantamount to opposing the merger.
[
Footnote 18]
This history of this litigation is reviewed in
600
California Corp. v. Harjean Co., 284 F.
Supp. 843 (ND Tex.1968).
[
Footnote 19]
Occidental answered asserting various affirmative defenses and
shareholders, and one was subsequently begun. The four suits were
counterclaims. Two suits had already been instituted by Old Kern
consolidated.
[
Footnote 20]
In view of its disposition, the Court of Appeals did not reach
Occidental's contentions that only the purchases in excess of 10%
of Old Kern's stock, rather than all purchases made pursuant to the
tender offer, should be included in calculating liability, and that
the awards of prejudgment interest and dividends were improper.
Occidental also appealed from the dismissal of its counterclaims.
The Court of Appeals dismissed Occidental's appeal as moot.
[
Footnote 21]
For purposes of § 16(b), a statutory insider includes a
"beneficial owner, director, or officer." 15 U.S.C. § 78p(b). The
term "beneficial owner" refers to one who owns
"more than 10 per centum of any class of any equity security
(other than an exempted security) which is registered pursuant to
section 78
l [§ 12] of this title."
15 U.S.C. § 78p(a).
[
Footnote 22]
The term "equity security" is defined to include
"any stock or similar security; or any security convertible,
with or without consideration, into such a security, or carrying
any warrant or right to subscribe to or purchase such a security;
or any such warrant or right; or any other security which the
Commission shall deem to be of similar nature and consider
necessary or appropriate, by such rules and regulations as it may
prescribe in the public interest or for the protection of
investors, to treat as an equity security."
15 U.S.C. § 78c(a)(11).
[
Footnote 23]
The legislative history of § 16(b) reveals a congressional
effort to curb short-swing trading by insiders whose position gives
them access to information not available to the investing public
and the ability to influence corporate policy.
"Among the most vicious practices unearthed at the hearings
before the subcommittee was the flagrant betrayal of their
fiduciary duties by directors and officers of corporations who used
their positions of trust and the confidential information which
came to them in such positions to aid them in their market
activities. Closely allied to this type of abuse was the
unscrupulous employment of inside information by large stockholders
who, while not directors and officers, exercised sufficient control
over the destinies of their companies to enable them to acquire and
profit by information not available to others."
S.Rep. No. 1455, 73d Cong., 2d Sess., 55 (1934).
See
also 10 S.E.C. Ann.Rep. 50 (1944); S.Rep. No. 792, 73d Cong.,
2d Sess., 9 (1934).
"The Securities Exchange Act of 1934 aims to protect the
interests of the public against the predatory operations of
directors, officers, and principal stockholders of corporations by
preventing them from speculating in the stock of the corporations
to which they owe a fiduciary duty. . . . By this section [16(b)],
it is rendered unlawful for persons intrusted with the
administration of corporate affairs or vested with substantial
control over corporations to use inside information for their own
advantage."
S.Rep. No. 1455, 73d Cong., 2d Sess., 68 (1934).
The purpose and operation of § 16(b) were explained as follows
by one of its draftsmen.
"[Section 16(b)] is to prevent directors receiving the benefits
of short-term speculative swings on the securities of their own
companies because of inside information. The profit on such
transaction under the bill would go to the corporation. You hold
the director, irrespective of any intention or expectation to sell
the security within 6 months after, because it will be absolutely
impossible to prove the existence of such intention or expectation,
and you have to have this crude rule of thumb, because you cannot
undertake the burden of having to prove that the director intended,
at the time he bought, to get out on a short swing."
Hearings on Stock Exchange Practices before the Senate Committee
on Banking and Currency, 73d Cong., 2d Sess., pt. 15, p. 6557
(1934).
See generally Hearings on H.R. 7852 and H.R. 8720
before the House Committee on Interstate and Foreign Commerce, 73d
Cong., 2d Sess., 85 (1934); Hearings on Stock Exchange Practices,
supra, at 6463-6581 (1934); S.Rep. No. 792, 73d Cong., 2d
Sess., 7-9 (1934); S.Rep. No. 1455, 73d Cong., 2d Sess., 55-68
(1934); H.R.Rep. No. 1383, 73d Cong., 2d Sess., 13-14 (1934).
See also Blau v. Lamb, 363 F.2d 507 (CA2 1966),
cert.
denied, 385 U.S. 1002 (1967);
Smolowe v. Delendo
Corp., 136 F.2d 231 (CA2),
cert. denied, 320 U.S. 751
(1943); Yourd, Trading in Securities by Directors, Officers and
Stockholders: Section 16 of the Securities Exchange Act, 38
Mich.L.Rev. 133 (1939); Meeker & Cooney, The Problem of
Definition in Determining Insider Liabilities Under Section 16(b),
45 Va.L.Rev. 949 (1959); Comment, Stock Exchanges Pursuant to
Corporate Consolidation: A Section 16(b) "Purchase or Sale?," 117
U.Pa.L.Rev. 1034 (1969).
[
Footnote 24]
The term,
see 2 L. Loss, Securities Regulation 1069 (2d
ed.1961), has been applied to stock conversions, exchanges pursuant
to mergers and other corporate reorganizations, stock
reclassifications, and dealings in options, rights, and
warrants.
[
Footnote 25]
"When used in this chapter, unless the context otherwise
requires --"
"
* * * *"
"(13) The terms 'buy' and 'purchase' each include any contract
to buy, purchase, or otherwise acquire."
"(14) The terms 'sale' and 'sell' each include any contract to
sell or otherwise dispose of."
16 U.S.C. §§ 78c(a)(13), (14).
[
Footnote 26]
Several decisions have been read as to apply a so-called
"objective" test in interpreting and applying § 16(b).
See,
e.g., Smolowe v. Delendo Corp., supra; Park & Tilford v.
Schulte, 160 F.2d 984 (CA2),
cert. denied, 332 U.S.
761 (1947);
Heli-Coil Corp. v. Webster, 352 F.2d 156 (CA3
1965). Under some broad language in those decisions, § 16(b) is
said to be applicable whether or not the transaction in question
could possibly lend itself to the types of speculative abuse that
the statute was designed to prevent. By far the greater weight of
authority is to the effect that a "pragmatic" approach to § 16(b)
will best serve the statutory goals.
See, e.g., Roberts v.
Eaton, 212 F.2d 82 (CA2),
cert. denied, 348 U.S. 827
(1954);
Ferraiolo v. Newman, 259 F.2d 342 (CA6 1958),
cert. denied, 359 U.S. 927 (1959);
Blau v. Max Factor
& Co., 342 F.2d 304 (CA9),
cert. denied, 382 U.S.
892 (1965);
Blau v. Lamb, supra; Petteys v. Butler, 367
F.2d 528 (CA8 1966),
cert. denied, 385 U.S. 1006 (1967).
For a discussion and critical appraisal of the various "approaches"
to the interpretation and application of § 16(b),
see
Lowenfels, Section 16(b): A New Trend in Regulating Insider
Trading, 54 Cornell L.Q. 45 (1968); Comment, Stock Exchanges
Pursuant to Corporate Consolidation: A Section 16(b) "Purchase or
Sale?," 117 U.Pa.L.Rev. 1034 (1969); Note,
Reliance
Electric and 16(b) Litigation: A Return to the Objective
Approach?, 58 Va.L.Rev. 907 (1972); Gadsby & Treadway, Recent
Developments Under Section 16(b) of the Securities Exchange Act of
1934, 17 N.Y.L.F. 687 (1971).
[
Footnote 27]
Our differences with the dissent as to the reach and scope of
congressional intent and purpose are clear. If we are mistaken, or
if Congress would now mandate a different result, the statutory
remedy would not be difficult to fashion.
[
Footnote 28]
Both events occurred within six months of Occidental's first
acquisition of Old Kern shares pursuant to its tender offer.
Although Occidental did not exchange its Old Kern shares until
December 11, 1967, it is not contended that that date, rather than
the date on which Occidental became irrevocably bound to do so,
should control. Similarly, although the option was not exercised
until December 11, 1967, no liability is asserted with respect to
that event, because it occurred more than six months after
Occidental's last acquisition of Old Kern stock.
[
Footnote 29]
Although a "defensive merger" is one tactic available to
incumbent management in its arsenal of anti-tender offer weapons,
it is by no means a foregone conclusion that it is the response
that will be most often, much less invariably, employed. Incumbent
management might, for instance, choose to exhort shareholders not
to tender, employ various techniques to elevate the market price of
the company's stock in order to make the tender offer less
attractive, institute legal proceedings, or increase the company's
outstanding stock. Any one of these devices might prove more
attractive to incumbent management than a defensive merger which
could prove to be highly detrimental to the enterprise.
See Note, Defensive Tactics Employed by Incumbent
Managements in Contesting Tender Offers, 21 Stan.L.Rev. 1104
(1969).
[
Footnote 30]
In
Bershad v. McDonough, 428 F.2d 693 (CA7 1970), the
defendants were directors and greater than ten percent stockholders
of Cudahy Co. The defendants, within six months of their
acquisition of beneficial ownership of Cudahy, granted an option to
Smelting Refining & Mining Co. to purchase their Cudahy stock.
The Seventh Circuit held that the grant of the option was a § 16(b)
"sale" of the Cudahy stock. The Court of Appeals in the present
case distinguished
Bershad as follows:
"That case came before the court of appeals on a finding by the
district court that, under the circumstances there presented, the
stock had in fact, been sold within the six months period, although
the option was not formally exercised until later. The district
court had relied on a number of circumstances, the most significant
being that the optionor gave the optionee an irrevocable proxy to
vote the shares and that the optionor and one of his associate
directors resigned as directors within a few days after the grant
of the option and were replaced by officers of the optionee. In
other words, the district court found, in effect, that the 'option'
was accompanied by a wink of the eye, and the court of appeals
sustained this. Here, there is no such finding, and no basis for
one."
450 F.2d at 165.
[
Footnote 31]
With respect to entering judgment for Occidental, the dissent
simply has a different, but insufficiently persuasive, view of the
facts from that of Judge Friendly and his colleagues.
MR. JUSTICE DOUGLAS, with whom MR. JUSTICE BRENNAN and MR.
JUSTICE STEWART concur, dissenting.
The Court, in resorting to an
ad hoc analysis of the
"possibility for the speculative abuse of inside information,"
charts a course for the interpretation of § 16(b) of the Securities
Exchange Act of 1934, 15 U.S.C. § 78p(b), that, in my mind,
undermines the congressional purpose. I respectfully dissent.
I
"The statute is written broadly, and the liability it imposes is
strict."
Reliance Electric Co. v. Emerson Electric Co.,
404 U. S. 418,
404 U. S. 431
(DOUGLAS, J., dissenting). Except for narrowly drawn exceptions, it
is all-inclusive. [
Footnote 2/1]
The operative language provides:
"[A]ny profit realized by [a beneficial owner, director, or
officer] from
any purchase and sale, or
Page 411 U. S. 606
any sale and purchase, of any equity security of such issuer
(other than an exempted security)
within any period of less
than six months, unless such security was acquired in good
faith in connection with a debt previously contracted, shall inure
to and be recoverable by the issuer,
irrespective of any
intention on the part of such beneficial owner, director, or
officer in entering into such transaction of holding the security
purchased or of not repurchasing the security sold for a period
exceeding six months."
(Emphasis added.) By its own terms, the section subsumes all
transactions that are technically purchases and sales, and applies
irrespective of any actual or potential use of inside information
to gain a trading advantage.
See Feder v. Martin MaMetta
Corp., 406 F.2d 260, 262 (CA2 1969). The conclusion seems
inescapable that Occidental Petroleum Corp. (Occidental) purchased
and sold shares of Kern County Land Co. (Old Kern) within a
six-month period, and that this "round trip" in Old Kern stock is
covered by the literal terms of § 16(b).
Occidental, pursuant to a cash tender offer, acquired in excess
of 880,000 shares of Old Kern during May and June, 1967. It is
undisputed that these acquisitions were purchases within the
meaning of the section. [
Footnote
2/2] On August
Page 411 U. S. 607
30, 1967, Old Kern sold its assets to a newly formed subsidiary
of Tenneco Corp., Kern County Land Co. (New Kern), in exchange for
cumulative convertible preference stock of Tenneco, Inc. (Tenneco),
Tenneco Corp.'s parent. Old Kern was dissolved in October, 1967
(within six months of the tender offer), and each shareholder
became irrevocably entitled to receive, share for share, for his
Old Kern stock the cumulative convertible preference stock of
Tenneco.
The question presented to us is whether this exchange of shares
constituted a "sale" of the Old Kern shares. The term "sale," as
used in the Securities Exchange Act, includes "any contract to sell
or otherwise dispose of." 15 U.S.C. § 78c(a)(14). Clearly,
Occidental "disposed" of its Old Kern shares through the Old
Kern-Tenneco consolidation. Its status as a shareholder of Old Kern
terminated, and it became instead a shareholder of Tenneco, privy
to all the rights conferred by the Tenneco shares. [
Footnote 2/3]
See Newmark v. RKO General,
425 F.2d 348 (CA2 1970);
Park & Tilford v. Schulte,
160 F.2d 984 (CA2 1947). [
Footnote
2/4] In my view, we
Page 411 U. S. 608
need look no further. As my Brother BLACKMUN, then Circuit
Judge, stated in dissent in
Petteys v. Butler, 367 F.2d
528, 538 (CA8 1966):
"My own reaction is that either the statute means what it
literally says or that it does not; that, if the Congress intended
to provide additional exceptions, it would have done so in clear
language; and that the recognized purpose and aim of the statute
are more consistently and protectively to be served if the statute
is construed literally and objectively, rather than non-literally
and subjectively on a case-by-case application. The latter
inevitably is a weakening process."
The majority finesses the literal impact of § 16(b) by examining
Occidental's willfulness and its access to inside information. It
concludes:
"But the involuntary nature of Occidental's exchange, when
coupled with the absence of the possibility of speculative abuse of
inside information, convinces us that § 16(b) should not apply to
transactions such as this one."
Ante at
411 U. S. 600.
This approach is plainly contrary to the legislative purpose.
The purpose of § 16(b) is stated in its preamble:
"preventing the unfair use of information which may have been
obtained by such beneficial owner, director, or officer by reason
of his relationship to the issuer. . . ."
The congressional investigations that led to the enactment of
the Securities Exchange Act revealed widespread use of confidential
information by corporate insiders to gain an unfair advantage in
trading their corporations' securities. [
Footnote 2/5] Unlike other remedial provisions
Page 411 U. S. 609
of the Act, the most noteworthy being § 10(b), 15 U.S.C. §
78j(b), Congress drafted § 16(b) as an objective rule, designed to
have a clearly "prophylactic" effect.
Blau v. Lehman,
368 U. S. 403,
368 U. S. 414.
See Heli-Coil Corp. v. Webster, 352 F.2d 156, 165-166 (CA3
1965);
Smolowe v. Delendo Corp., 136 F.2d 231, 235 (CA2
1943). As Thomas Corcoran, a principal draftsman of the Act,
explained to Congress:
"You hold the director, irrespective of any intention or
expectation to sell the security within 6 months after, because it
will be absolutely impossible to prove the existence of such
intention or expectation, and you have to have this crude rule of
thumb because you cannot undertake the burden of having to prove
that the director intended, at the time he bought, to get out on a
short swing. [
Footnote 2/6]"
In
Reliance Electric, supra, the Court noted that
"the only method Congress deemed effective to curb the evils of
insider trading was a flat rule taking the profits out of a
class of transactions in which the possibility of abuse
was believed to be intolerably great."
404 U.S. at
404 U. S. 422
(emphasis added). Certainly mergers are such a class of
transactions. [
Footnote 2/7] In
Newmark v. RKO General, supra, for example, RKO signed an
option contract to purchase shares of the company which was to be
merged into a subsidiary of RKO. When the merger was approved by
the necessary parties, RKO exercised its option, and the merger was
consummated. The court found that RKO
"not only acquired knowledge of what would transpire
Page 411 U. S. 610
but also could exercise substantial influence over the course of
events."
425 F.2d at 353. "In sum," the court concluded,
"the purchase and subsequent exchange of Central shares were
fraught with opportunities for the kind of speculative abuse
section 16(b) was intended to abort."
Id. at 354.
The Securities and Exchange Commission has resisted a rule that
would exempt mergers as a class from the operation of § 16(b). It
responded as follows to a proposal of the Special Committee on
Securities Regulation of the Association of the Bar of the City of
New York: [
Footnote 2/8]
"We concluded, however, that removing the 'teeth' of Section
16(b) to discourage the use of inside information would allow
insiders to create and take advantage of speculative opportunities
during the time surrounding such significant corporate events which
outweighed this potential conflict. Also, we know that some persons
are unwittingly caught by the section in these as in other
situations falling within the provisions of Section 16(b), but, in
our opinion, the public interest and the interest of investors are
better served in this area by the unrestricted operation of the
section."
It is true that, in some cases, an insider may be required to
disgorge profits even though his transactions do not lend
themselves to the abuses that underlay the enactment of § 16(b).
The draftsmen carefully weighed this eventuality, and opted for a
bright-line rule. As Thomas Corcoran stated:
"You have to have a general rule. In particular transactions, it
might work a hardship, but those transactions that are a hardship
represent the sacrifice to the necessity of having a general rule.
[
Footnote 2/9] "
Page 411 U. S. 611
The very construction of § 16(b) reinforces the conclusion that
the section is based in the first instance [
Footnote 2/10] on a totally objective appraisal of the
relevant transactions. [
Footnote
2/11]
See Smolowe v. Delendo Corp., supra, at 236. Had
the draftsmen intended that the operation of the section hinge on
abuse of access to inside information, it would have been anomalous
to limit the section to purchases and sales occurring within six
months. [
Footnote 2/12] Indeed,
the purpose of the six-month limitation, coupled with the
definition of an insider, was to create a conclusive presumption
that an insider who turns a short-swing profit in the stock of his
corporation had access to inside information and capitalized on
that information by speculating in the stock. But the majority
departs from the benign effects of this presumption when it assumes
that it is "totally unrealistic to assume or infer from the facts
before us that Occidental either had or was likely to have access
to inside information. . . ."
Ante at
411 U. S. 596.
The majority abides by this assumption even for that period after
which Occidental became a 10% shareholder and then extended its
tender offer in order to purchase additional Old Kern shares.
The majority takes heart from those decisions of lower federal
courts which endorse a "pragmatic" approach to
Page 411 U. S. 612
§ 16(b). Many involved the question whether a conversion of one
security of an issuer into another security of the same issuer
constituted a purchase or a sale. [
Footnote 2/13] It would serve no purpose to parse their
holdings because, as Louis Loss describes, they have a
"generalization-defying nature." [
Footnote 2/14] In 1966, the Securities and Exchange
Commission exercised its exemptive power under § 16(b) to adopt
Rule l6b-9, [
Footnote 2/15]
which, under specified conditions, excludes a conversion from the
operation of § 16(b). This rule will relieve the courts of much of
the burden that has developed from
ad hoc analyses in this
narrow area. But, by sanctioning the approach of these cases, the
majority brings to fruition Louis Loss' prophecy that they will
"continue to rule us from their graves," [
Footnote 2/16] for henceforth they certainly will be
applied by analogy to the area of mergers and other
consolidations.
Thus, the courts will be caught up in an
ad hoc
analysis of each transaction, determining both from the economics
of the transaction and the
modus operandi of the insider
whether there exists the possibility of speculative abuse of inside
information. Instead of a section that is easy to administer and,
by its clear-cut terms, discourages litigation, we have a section
that fosters litigation because the Court's decision holds out the
hope for the insider that he may avoid § 16(b) liability. In short,
the majority destroys much of the section's prophylactic effect. I
would be the first to agree that
"[e]very transaction which can reasonably be defined as a
purchase [should] be so defined, if the transaction is of a
kind
Page 411 U. S. 613
which can possibly lend itself to the speculation encompassed by
Section 16(b)."
Ferraiolo v. Newman, 259 F.2d 342, 345 (CA6 1958)
(STEWART, J., then Circuit Judge).
See also Reliance Electric
Co. v. Emerson Electric Co., 404 U.S. at
404 U. S. 424.
Certainly we cannot allow transactions which present the
possibility of abuse but do not fall within the classic conception
of a purchase or sale to escape the confines of § 16(b). It is one
thing to interpret the terms "purchase" and "sale" liberally in
order to include those transactions which evidence the evil
Congress sought to eliminate; it is quite another to abandon the
bright-line test of § 16(b) for those transactions which clearly
fall within its literal bounds. Section 16(b), because of the
six-month limitation, allows some to escape who have abused their
inside information. It should not be surprising, given the
objective nature of the rule, if some are caught unwillingly. In
Reliance Electric, supra, at
404 U. S. 422,
the Court quoted with approval the following language from
Bershad v. McDonough, 428 F.2d 693, 696 (CA7 1970):
"In order to achieve its goals, Congress chose a relatively
arbitrary rule capable of easy administration. The objective
standard of Section 16(b) imposes strict liability upon
substantially all transactions occurring within the statutory time
period, regardless of the intent of the insider or the existence of
actual speculation. This approach maximized the ability of the rule
to eradicate speculative abuses by reducing difficulties in proof.
Such arbitrary and sweeping coverage was deemed necessary to insure
the optimum prophylactic effect."
It is this "objective standard" that the Court hung to so
tenaciously in Reliance Electric, but now apparently would abandon
to a large extent. In my view, the Court
Page 411 U. S. 614
improperly takes upon itself the task of refashioning the
contours of § 16(b) [
Footnote
2/17] and changing its essential thrust.
II
Although I conclude that the judgment below should be reversed
on the grounds that the exchange of shares constituted a sale, I
could not conclude that it was proper for the Court of Appeals to
direct entry of summary judgment in favor of Occidental even if I
accepted the majority approach to § 16(b). It did this
notwithstanding the failure of Occidental to move for summary
judgment in the District Court. To say the least, this is an
extraordinary procedure. [
Footnote
2/18] Even if it can be justified in the most limited
circumstances -- for example, where the record below left no doubt
whatsoever that the nonmoving party was entitled to summary
judgment as a matter of law -- this is not such a case.
The District Court concluded that,
"[i]n consequence of the option agreement, Occidental disposed
of its holdings in Old Kern stock at a profit of about $20 per
share. . . . This profit falls within the meaning and purview of
Section 16(b). . . ."
323 F.
Supp. 570, 579-580. Since the actual sale pursuant to the
exercise of the option did not occur within the six-month period,
the only reasonable interpretation of this conclusion of law is
that the District Court found that the execution of the option was,
in fact and substance, a sale. The majority does not contest that
an option agreement may
Page 411 U. S. 615
be, in economic reality, a sale.
See Bershad v. McDonough,
supra. It distinguishes, but does not reject,
Bershad. Rather, the majority can "see no satisfactory
basis or reason for disagreeing" with the Court of Appeals, which
concluded that there is "no basis" for a finding that Occidental's
Old Kern stock was "sold" upon execution of the option. [
Footnote 2/19] I cannot agree.
In
Bershad, the defendants, who had purchased
approximately 18% of the outstanding shares of Cudahy Co. at $6.75
per share, executed an option obligating themselves to sell the
shares at $9 per share. The market price of the shares was then
$9.125. The optionee paid $350,000 (14% of the purchase price) for
the option, to be applied against the purchase price in the event
of exercise and forfeited in the event of nonexercise. In addition,
defendants gave the optionee an irrevocable proxy with respect to
the optioned stock, and defendant McDonough and his colleagues
resigned from the Cudahy board of directors. The Court of Appeals
also found that
"[t]he circumstances of the transactions clearly indicate that
the stock was effectively transferred, for all practical purposes,
long before the exercise of the option."
428 F.2d at 698.
By comparison, the exercise price here was $105, and the premium
to secure the option was $10 per share, or $8,866,230, also to be
credited against the purchase price if the option were exercised
and forfeited in the event of nonexercise if the merger was
consummated. Thus, the effective exercise price was nearly 10%
below the estimated value of the Tenneco shares to be received
in
Page 411 U. S. 616
the consolidation. [
Footnote
2/20] When the option was executed, Occidental's attorney was
authorized to vote Occidental's Old Kern shares in favor of the
Tenneco acquisition, and it was not until it was apparent that
Occidental's vote was not needed that Occidental's attorney was
relieved of his obligation. Occidental also abandoned its demand
for two seats on Old Kern's board, as well as its litigation for
inspection of Old Kern's books and records.
In concluding that this case was not controlled by
Bershad, the Court of Appeals emphasized the undisputed
testimony [
Footnote 2/21] that
the forfeitable downpayment was a reasonable, noncoercive price.
The basis for this was the deposition of one of Occidental's
vice-presidents stating that a New York investment firm had advised
him that $9 to $12 per share was a reasonable premium for an option
on stock selling at $95. This deposition should not suffice to
support summary judgment. First, it is not clear what assumptions
the investment firm had made in giving this advice. Second, while
it may be that $10 per share premium was a reasonable price for an
option based upon factors available to the general investing
public, it is by no means clear that an option
Page 411 U. S. 617
executed by two parties privy to inside information should be
judged on the same terms. [
Footnote
2/22] It may be that, under the circumstances present here, the
eventual exercise of the option was a "sure thing." In short,
Occidental may have known that it was "locked into" a $17 million
profit. [
Footnote 2/23] Finally,
it has not been determined what effect, if any, the very size of
the down payment -- nearly $9 million -- had on the eventual
exercise. With these uncertainties, and in view of the holding of
the District Court that the option agreement constituted a sale, at
the very least, the case should have been remanded to the District
Court for a hearing on whether the terms of the option "compelled"
its exercise.
See Mourning v. Family Publications Service,
Inc., ante p.
411 U. S. 356, at
411 U. S. 383
(DOUGLAS, J., dissenting);
White Motor Co. v. United
States, 372 U. S. 253,
372 U. S. 263;
6 J. Moore, Federal Practice � 56.12, p. 2243 (2d ed.1972).
[
Footnote 2/1]
Section 16(b) provides in full:
"For the purpose of preventing the unfair use of information.
which may have been obtained by such beneficial owner, director, or
officer by reason of his relationship to the issuer, any profit
realized by him from any purchase and sale, or any sale and
purchase, of any equity security of such issuer (other than an
exempted security) within any period of less than six months,
unless such security was acquired in good faith in connection with
a debt previously contracted, shall inure to and be recoverable by
the issuer, irrespective of any intention on the part of such
beneficial owner, director, or officer in entering into such
transaction of holding the security purchased or of not
repurchasing the security sold for a period exceeding six months.
Suit to recover such profit may be instituted at law or in equity
in any court of competent jurisdiction by the issuer, or by the
owner of any security of the issuer in the name and in behalf of
the issuer if the issuer shall fail or refuse to bring such suit
within sixty days after request or shall fail diligently to
prosecute the same thereafter; but no such suit shall be brought
more than two years after the date such profit was realized. This
subsection shall not be construed to cover any transaction where
such beneficial owner was not such both at the time of the purchase
and sale, or the sale and purchase, of the security involved, or
any transaction or transactions which the Commission by rules and
regulations may exempt as not comprehended within the purpose of
this subsection."
15 U.S.C. § 78p(b).
[
Footnote 2/2]
The term "purchase" includes "any contract to buy, purchase, or
otherwise acquire." 15 U.S.C. § 78c(a)(13). A "beneficial owner" is
one who owns
"more than 10 per centum of any class of any equity security
(other than an exempted security) which is registered pursuant to
section 781 [§ 12] of this title."
15 U.S.C. § 78p(a). The District Court held that
"[t]he tender offer constituted a ingle act of Occidental,
whereby the company became a beneficial owner of more than 10
percent of Old Kern's capital stock."
323 F.
Supp. 570, 579. Thus, the District Court ruled that the profit
made on all stock purchased in the tender offer, not only the
profit on the purchases in excess of 10%, would have to be
surrendered. The Court of Appeals did not reach this issue.
[
Footnote 2/3]
This is not a case where the stock surrendered and the stock
received in the exchange were economic equivalents.
Cf., e.g.,
Blau v. Lamb, 363 F.2d 507, 523-525 (CA2 1966);
Blau v.
Max Factor Co., 342 F.2d 304, 308-309 (CA9 1965).
An exchange of securities in different companies is a "purchase"
or "sale" for purposes of § 10(b).
E.g., SEC v. National
Securities, Inc., 393 U. S. 453;
Dasho v. Susquehanna Corp., 380 F.2d 22 (CA7 1967).
[
Footnote 2/4]
Judge Clark, in
Park & Tilford v. Schulte, adopted
a straightforward approach to defining "acquisition":
"Defendants did not own the common stock in question before they
exercised their option to convert; they did afterward. Therefore,
they acquired the stock, within the meaning of the Act."
160 F.2d 984, 987. The same analysis holds for
"disposition."
[
Footnote 2/5]
Examples of this practice are chronicled elsewhere.
See,
e.g., Reliance Electric Co. v. Emerson Electric Co.,
404 U. S. 418,
404 U. S.
429-430 and nn. 3-6 (DOUGLAS, J., dissenting) and
sources cited therein. It would serve no purpose to recount them
here.
[
Footnote 2/6]
Hearings on Stock Exchange Practices before the Senate Committee
on Banking and Currency, 73d Cong., 2d Sess., pt. 15, p. 6557
(1934).
[
Footnote 2/7]
See Recent Cases, 84 Harv.L.Rev. 1012, 1018 (1971).
[
Footnote 2/8]
Letter of Nov. 24, 1965.
[
Footnote 2/9]
Hearings,
supra, 411
U.S. 582fn2/6|>n. 6, at 6558.
[
Footnote 2/10]
The objective approach may have to yield to a more flexible
interpretation of the terms "purchase" and "sale" to include
transactions which present the evil Congress sought to eliminate or
transactions which are designed to evade § 16(b).
See
discussion
infra at
411 U. S.
612-613.
[
Footnote 2/11]
The preamble of the section, which expresses the purpose of the
section, was intended to aid in establishing the constitutionality
of the section and guiding the Commission's rulemaking authority.
See Smolowe v. Delendo Corp., 136 F.2d 231, 236 (CA2
1943); 2 L. Loss, Securities Regulation 1041 (2d ed.1961).
[
Footnote 2/12]
In addition, there would have been no reason to exempt
transactions wherein the "security was acquired in good faith in
connection with a debt previously contracted. . . ."
[
Footnote 2/13]
See, e.g., Roberts v. Eaton, 212 F.2d 82 (CA2 1954);
Ferraiolo v. Newman, 259 F.2d 342 (CA6 1958);
Blau v.
Max Factor & Co., 342 F.2d 304 (CA9 1965);
Blau v.
Lamb, 363 F.2d 507 (CA2 1966);
Petteys v. Butler, 367
F.2d 528 (CA8 1966).
[
Footnote 2/14]
5 L. Loss, Securities Regulation 3029 (Supp. to 2d ed.1969).
[
Footnote 2/15]
Securities Exchange Act Release 7826.
[
Footnote 2/16]
5 L. Loss, Securities Regulation 3029 (Supp. to 2d ed.1969).
[
Footnote 2/17]
Occidental unsuccessfully sought to have the Securities and
Exchange Commission adopt a rule which would have exempted this
exchange. No inferences should be drawn from this refusal. But I do
believe that, given the structure and policies of § 16(b), any
"exempting" is best left to the Commission and Congress.
See
Heli-Coil Corp. v. Webster, 352 F.2d 156, 165-166 (CA3
1965).
[
Footnote 2/18]
See generally 6 J. Moore, Federal Practice � 56.12 (2d
ed.1972).
[
Footnote 2/19]
The Court of Appeals also concluded that the District Court had
made no such finding. For the reasons indicated above, I do not
agree. In any event, I presume that the Court of Appeals, had it
confronted such a finding, would have determined that it was
clearly erroneous.
[
Footnote 2/20]
Respondent argues that, unlike
Bershad, the effective
exercise price was not below the current market value because the
Old Kern shares never sold for more than $94.75. It contends that
this trading price reflected the Kern board's acceptance of the
proposed consolidation. But it is common for a stock which may be
exchanged to sell at a discount from the stock to be received until
the exchange becomes a certainty. This discount reflects the risk
that the exchange may not be consummated. The option agreement
provided that the premium would be returned if there were no
exchange. Thus, we must appraise this transaction on the assumption
that the consolidation would be approved and accomplished.
[
Footnote 2/21]
Petitioner contends here that it did not believe that it was
necessary to rebut this hearsay testimony in order to prevail on
its motion for summary judgment; moreover, it was not faced with a
cross-motion.
[
Footnote 2/22]
Although Occidental may not have been Tenneco's "ally," as the
majority indicates, it was in their mutual interest to arrange for
a satisfactory option agreement.
[
Footnote 2/23]
Shortly after the option was exercised, Armand Hammer, the
President of Occidental, commented on the profit of $17 million
that Occidental expected. In his mind, it was "not bad for two
weeks' work."