# UNITED STATES DISTRICT COURT > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/agency%3Asec%3Aa574db0888203c30 ## Record - **Collection:** Agency decision - **Document type:** Agency decision ## Text UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK Barbara Schaffer, Derivatively On behalf of LaserSight Incorporated, Plaintiff, v. No. 99 Civ. 2821 (VM) CC Investments, LDC, et aI., Defendants. MEMORANDUM OF THE SECURITIES AND EXCHANGE COMMISSION, AMICUS CURIAE DAVIDM. BECKER (DB-4904) General Counsel ERIC SUMMERGRAD (ES-3628) Deputy Solicitor Of Counsel MEYER EISENBERG (ME-5871) Deputy General Counsel ' ALLAN A. CAPUTE (AC-3578) Special Counsel to the Solicitor Securities and Exchange Commission 450 Fifth Street,N.W. Washington, D.C. 20549-0606 (202) 942-0837 (Capute) TABLE OF CONTENTS ii TABLE OF AUTHORITIES ~ .. 3 BACKGROUND ., A. The Regulatory Scheme of Section 16 and Rule 16a-l(a)(I) .. :':- 3 B. Facts 6 .ARGUl\1ENT 1. THE COMMISSION ACTED WITHIN ITS AUTHORITY IN ADOPTING RULE 16a-l(a)(1). . A. The Commission Had the Power to Define "Beneficial Owner" Under Its Rulemaking and Definiti~nal Authority in Sections 3(b) and23(a) ofthe Exchange Act. I. ~ 9 9 10 The Commission Had Authority to Promulgate Rule 16a-l(a)(I) Under Section 3(b). . ; 12 The Commission Did Not Need A Special Grant of Rulemaking Authority in Section 16(b) Itself. 13 Rule 16a-l(a)(1) Is Necessary or Appropriate to Carrying Out, and Is Consistent with the Provisions and Purposes of, Section 16(b) 15 3. B. 9 The Commission Had Authority to Promulgate Rule 16a-l(a)(I) Under Section 23(a). . 2. ll. ' THE APPLICATION OF A GROUP CONCEPT OF BENEFICIAL OWNERSHIP UNDER SECTION 16 IS 'CONSISTENT WITH THE LEGISLATIVE HISTORY OF THAT PROVISION. . CONCLUSION 23 29 -1­ TABLE OF AUTHORITIES Cases ~ 2 ~ . . . . . . .. 20 Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299(1985) CBI Inc. v. Horton, 682 F.2d 643 (7th Cir. 1982) .; Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., ." 467 U.S. 837 (1984) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 16, 17 . Continental Oil Co. v. Perlitz, 176 F. Supp. 219 (S.D. Tex. 1959) 10, 16 C.R.A. Realty Corp. v. Goodyear Tire & Rubber Co., 705 F. Supp. 972 (S.D.N.Y.), affd without opinion, 888 F.2d 125 (2d Cir. 1989) ~ . 20 Falcon Trading v. SEC, 102 F.3d 579 (D.C. Cir. 1996) 9 FDA v. Brown & Williams Tobacco Corporation, _ U.S. _, 120 S. Ct. 1291 (2000) 17 Foremost-McKesson, Inc~ v. Provident Securities Co., 423 U.S. 232 (1976) 4,21 GAP Corp. v. Milstein, 453 F.2d 709 (2d Cir. 1971) 18 Gollust v. Mendell, 501 U.S. 115 (1991) 4 J.1. Case Co. v. Borak, 377 U.S. 426 (1964) ~ 2 Lerner v. Millenco, 23 F; Supp. 337(S.D.N.Y. 1998) ..... C • • • • • • • • • • • • • • • • • • • • 21 Lockheed Aircraft Corp. v. Rathman, ·106 F. Supp. 810 (S~D. Cal. 1952) 10 Manessor Southwestern Railway Co. v. Morgan, 486 U.S. 330 (1988) 28 Meyer v. Chesapeake Ins. Co., Ltd., 877 F.2d 1154 (2d. Cir. 1989), cert denied, 493 U.S. 1021 (1990) 21 -11­ TABLE OF AUTHORITIES (CONTINUED) Cases (Continued) Mendell v. Gollust, 793 F. Supp. 474 (S.D.N.Y.), affd without opinion, 983 F.2d 1048 (1992) Morales v. Freund, 163 F.3d 763 (2d. Cir. 1999) 4,20 : 21 . '. Mourning v. Family Publications, Inc., 411 U.S. 356 (1973) ....................• 16 Nationsbank ofNorth Carolina v. Variable Annuity Life Ins. Co., 513 U.S. 251 (1995) 16, 17 NLRB v. Bell Aerospace Co., 416 U.S. 267 (1974) 28 ~ Reliance Electric Co. v. Emerson Electric Co., 404 U.S. 418 (1972) .. , ." Rothenberg v. Jacobs, [1989 Transfer Binder] Fed. Sec. L. Rep. (CCH) ~94,199 (S.D.N.Y. Jan. 11, 1989), affd. without opinion, 888 F.2d 126 (2d Cir. 1989) Securities Industry Assoc. v. Board of Governors of the Federal Reserve System, 468 U.S. 207 (1984) Schaffer v. Soros, No. 92 Civ. 1233 (LMM), 1994 WL 381442 (S~D.N~Y. July 20, 1994), vacated in part on other grounds, " 1994 WL 592891 (S.D.N.Y. Oct. 31, 1994) ; 4 20 17 5,22 StrauSs v. American Holdings, Inc., 902 F. Supp.475 (S.D.N.Y. 1995) 22 " Strauss v. Kopp Investment Advisors Inc., [1999 Transfer Binder] Fed. Sec. L. Rep. (CCH) ~90,666, 1999 WL 787818 (S.D.N.Y. " Sept. 20, 1999) 21 Thorpe v. Housing Authority of the City ofDurham, 393 U.S. 268 (1969) 16 -lll­ TABLE OF AUTHORITIES (CONTINUED) Cases (Continued) ~ Touche Ross & Co., Inc. v. SEC, 609 F.2d 570 (2d Cir. 1979) United States v. Correll, 389 U.S. 299 (1967) ~ .: 13, 15 passim 28 '" Statutes and Rules . Securities Exchange Act of 1934, 15 U.S.C. 78a. et seq. Section 3(a)(9), 15 U.S.C. 78c(a)(9) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . .. 27 Section 3(a)(34), 15 U.S.C. 78c(a)(34) . . . • . . .. . .. .. . . . . . . .. . . . . . .. . . ... 11 Se~tion 3(b), 15 U.S.C. 78c(b) 9, 10, 12 passim Section 10, 15 U.S.C. 78j 27 ~ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 3,4 Section 12, 15 U.S.C. 781 Section 12(h), 15 U.S.C. 781(h) :................. 13 Section 13(d), 15 U.S.C. 78m(d) ~ 4,5,6 passim Section 13(d)(3), 15 U.S.C. 78m(d)(3) 2,5, 7 passim Section 16, 15 U.S.C. 78p 3,4, 11 passim Section 16(a), 15 U.S.C. 78p(a) 3,6, 14 passim Section 16(b), 15 U.S.C. 78p(b) . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . .. 1,2,3 passim Section 16(e), 15 U.S.C~ 78p(e) II' Section 23(a), 15 U.S.C. 78w(a) 9, 10, 11 passim -lV­ TABLE OF AUTHORITIES (CONTINUED) Statutes and Rules (Continued) . Rules Under the Securities Exchange Act of 1934, 17 C.F.R. 240.01, et seq. Rule 2(e), 17 C.F.R. 240.2(e) Rule 13d-3(a), 17 C.F.R. 240J3d-3(a) Rule 13d-5(b)(1), 17 C.F.R. 240.13d-5(b)(I) Rule 16a-l, 17 C.F.R. 240.16a;..1 Rule 16a-l(a)(I), 17 C.F.R. 240.16a-l(a)(1) Rule 16a-l(a)(2), 17 C.F.R. 240. 16a-l(a)(2) ; . . . . . . . . . . . .. 10, 13 5, 7 ~':' 5 9 ;. 1,2,3 passim 6,8 Federal Rules of Civil Procedure Rule 12(b)(6) 8 Miscellaneous 112 Congo Rec. 19003 (August 11, 1966) 26,27 J. Seligman, The Transfonnation of Wall Street: A History ofthe Securities and Exchange Commission and Modem Corporate Finance, (rev'd ed. 1995) 25, 26 Morgan Stanley Group, Inc., SEC No-Action Letter, 1991 WL 178730 (April 30, 1991) 19 .Ownership Reports and Trading by Officers, Directors and Principal . Securities Holders, Exchange Act Release No. 288~9, . 48 SEC Docket 234 (Feb: 21, 1991) 9 P. Romeo and A. Dye, Section 16 Treatise and Reporting Guide, §4.02 .; '.' -v­ 22, 23 TABLE OF AUTHORITIES (CONTINUED) Miscellaneous (Continued) ~ . . . .. S. 2731, 89th Congress, 1st Session (1965) 26 S. Rep. No. 73-792 (1934) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . .. 24 S. Rep: No. 94-75 (1975) 13 S. Rep. No. 93-14451 (1934) ':'" 25 23 S. Rep. No. 3420 Service Merchandise Company, No-Action Letter, 1988 WL 233569 (January 11, 1988) -Vl­ 15 UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK Barbara Schaffer, Derivatively On behalf of LaserSight Incorporated, Plaintiff, '" v. No. 99 Civ. 2821 (VM) CC Investments, LDC,et aI., .Defendants. MEMORANDUM OF THE SECURITIES AND EXCHANGE COMMISSION, AMICUS CURIAE By order dated February 15,2000, the Court invited the Commission to file an amicus curiae brief in this case, in which the defendants have moved to dismiss plaintiff's action brought under Section 16(b) ofthe Securities Exchange Act of 1934, 15 U.S.C. 78p(b) ("the Exchange Act" or "the Act"). The Court's order notes that defendants CC Investments, LDC ("eCI") and Castle Creek Partners, LLC ("Castle Creek") have argued that the Commission "exceeded the authority conferred on it by Congress when the Commission adopted its Rule 16a-l(a)(l) as such rule pertains to liability wider Section 16(b) ofthe Securities Exchange Act" (February 15,2000 Order, p. 1). This argument has been adopted by the other defendants. The Court's order continues: In view ofthe significance ofthis issue to the disposition-of the motions and ofthe vital interest the Commission has in any determination affecting the validity of its rules, the Court invites, sua sponte, the Commission to submit an amicus curiae brief limited to the application of SEC Rule 16a-l(a)(I) and the concept of"group" liability under Section 13(d)(3) of the Act to Section 16(b) ofthe Act * * *. " . '. (Order, p. 1). As the Court noted, the Commission has a strong interest in this issue. Although Section 16(b) ofthe Exchange Act is enforced in private actions, and not in Commission enforcement actions, the Commission, nevertheless, has an interest in assuring that proper private actions can be brought. As the Supreme Court has repeatedly recognized, such actions "provide 'a most effective weapon in the enforcement' ofthe securities laws and are 'a necessary supplement to Commission action. '" Bateman Eichler. Hill Richards. Inc. v. Berner, 472 U.S. 299, 310 (1985) (quoting].!. Case Co. v. Borak, 377 U.S. 426, 432 (1964». Section 16(b) ofthe Exchange Act is intended to curb the abuse of inside information by officers, directors and beneficial owners of more than ten percent of an .issuer's registered equity securities. The rule at issue, by defining who is a beneficial owner of securities for purposes of Section 16(b), seeks to assure that the section is enforceable in private actions against the full range of shareholders to whom it should apply. Moreover, the rule also applies in determining beneficial ownership ofsecurities -2­ : .. for purposes ofthe reporting requirement in Section I6(a) of the Exch~ge Act, IS.U.S.C. 78p(a), a provision which the Commission does enforce. The Commission construes the Court's order as requesting its views only on the issue of the Commission's authority to promulgate Rule 16a-l(a)(l). AccQrdingly, this . '. brief is limited to that issue. BACKGROUND A. The Regulatoty Scheme of Section 16 and Rule 16a-I(a)Cl) Section 16 of the Act, 15 U.S.C. 78p, contains two provisions directed at curbing the misuse of inside information by corporate insiders. Under Section 16(a) ofthe Act, . 15 U.S.C. 78p(a), those insiders - - who are identified as officers and directors ofan issuer of securities and also the "beneficial owner" of more than ten percent of any class . of registered equity securities of the issuer - - must report, at the time of registration ofthe securities under Section 12 ofthe Exchange Act or at the time the insider becomes an officer, director, or greater than ten percent benefiCial owner, the amount of all securities such insider beneficially owns. Section 16(b) ofthe Act provides that the issuer or a shareholder ofthe issuer may bring an action to recover short..swing profits (Le., profits from the purchase and sale of the issuer's equity securities within a period of less than six months) realized by an officer, director or "such beneficial owner" as identified in Section 16(a». -3­ In enacting Section 16(b) "C()ngress recognized that insiders may have access to information about their corporations not available to the rest ofthe investing public." Foremost-McKesson, Inc. v. Provident Securities Co., 423 U.S. 232, 243 (1976). The provision was designed to "curb the evils of insider trading [by] * * * taking the profits out ofa class oftransactions in which the possibility of abuse was believed to be intolerably great." Reliance Electric Co. v. Emerson Electric Co., 404 U.S. 418, 422 •(1972). Congress concluded that corporate officers, directors, and the beneficial owners of more than ten percent ofa class ofan issuer's registered equity securities may be presumed to have access to inside information. Reliance Electric Co. v. Emerson Electric Co., 404 U.S. at 424. See also Gollust v. Mendell, 501 U.S. 115, 121 (1991). Section 16 ofthe Act, however, contains no definition of beneficial owner. In order to bring clarity to the term "beneficial owner," in 1991 the Commission amended its definitional rule under the section, Rule 16a-l, to add a new Rule 16a-l(a)(I). For purposes of determining who is a beneficial owner of securities under Section 16, that rule adopts the definition of "beneficial owner" found in Sectioh 13(d) ofthe Exchange Act, 15.U .S~C. 78m(d), and the rules promulgated under that se~tion. Rule 16a-l(a)(I), provides, in pertinent part, that Solely for purposes of determining whether a person is a beneficial owner of more than ten percent of any class of equity securities registered pursuant to Section 12 ofthe Act, the term "beneficial owner" shall mean any person who is -4­ " . deemed a beneficial owner pursuant to Section 13(d) ofthe Act and the rules thereunder * * * ." A beneficial owner under Section 13(d) includes "any person who, directly or indirectly, . through any contract, arrangement, understanding, relationship, or otherwise has or shares" "voting power" or "investment power." See Rule 13d-3(a), 17 C.F.R. 240.13d­ '" 3(a). Rule 13d-5(b)(l), 17 C.F.R. 240.13d-5(b)(l), provides that when such shareholders agree to act together for the purpose of acquiring, holding, voting or disposing of equity securities of an issuer, the group formed thereby shall be deemed to have acquired beneficial ownership, * * * as ofthe date of such agreement, of all equity securities ofthat issuer beneficially owned by any such persons.) Thus, if a defendant "even 'indirectly' 'shared' voting or investment power, including the power to direct the disposition of[an issuer's] shares, [he] must be found to be a beneficial owner" of all ofthe shares ofthe group. Schaffer v. Soros, No. 92 Civ. 1233 (LMM), 1994 WL 381442 at *5 (S.D.N.Y. July 20, 1994), vacated in part on other grounds, 1994 WL 592891 (S.D.N.Y. Oct. 31, 1994). As applied under Section B(d), this means that where a gro~p holds more than 5% of an issuer's registered equity securities, the group must file a statement on Schedule ) Rule 13d-5(b)(I) was promulgated, in part, under Section 13(d)(3) o~the Act, 15 U.S.C. 78m(d)(3), which provides that "[w]hen two or more persons act as a * * * group for the purpose of acquiring, holding, or disposing of securities of an issuer, such * * * group shall be deemed a 'person' for the purposes ofthis subsection." -5­ 13D. As imported to Section 16, this means that where aSection 13(d) group holds more than ten percent of an issuer's equity securities, the members ofthe group are subject to ·the reporting requirements of Section 16(a) and are liable under Section 16(b) for recovery of short-swing profits realized from transactions involving their shares. This does not mean, however, that each member ofthe group ne'cessarily is liable for short-swing profits realized from transactions involving the shares held by all members ofthe group. While Rule 16a-l(a)(l) uses the Section 13(d) standard for . purposes of determining whether a person has crossed the ten percent beneficial ownership threshold, Rule 16a-l(a)(2), 17 C.F.R. 240. 16a-l(a)(2), applies a "pecuniary interest" test for all other purposes of Section 16, including the determination ofthe shares from which the defendant may be held liable for short-swing profits. A person thus is liable only for profits realized on those shares in which he has a pecuniary interest. 2 B. Facts The plaintiff, Barbara Schaffer, a shareholdet:, in LaserSight Incorporated ("LaserSight"),brought this action on behalf ofLaserSight under Section 16(b) to recover short-swing profits against CCI, Castle Creek, Societe Generale, Shepherd Investments 2 Rule 16a-l(a)(2) provides, in pertinent part, that "[o]ther than for purposes of determining whether a person is a beneficial owner ofmore than ten . percent ofany class ofequity securities * * *, the term 'beneficial owner' shall mean any person who, directly or indirectly, * * * has or shares a direct or indirect pecuniary interest in the equity securities. * * *." -6­ • International, Ltd. ("Shepherd Investments"), Stark International, arid two investment managers, Michael Roth and Brian Stark, who are alleged to have controlled the investment decisions of Shepherd Investments' and Stark International (Complaint at 1-3). The defendants purchased preferred stock that was convertible to common stock an4 warrants to purchase common stock in LaserSight under a private plac~ment agreement. Thereafter, they are alleged to have bought and sold LaserSight securities within a period '. of less than six months. Schaffer alleges that, of the defendants, only CCI was individually a beneficial owner of more than ten percent ofLaserSight common stock (Complaint at 5). Schaffer alleges, however, that Castle Creek, Societe Generale, Shepherd Investments and Stark International are also liable for short-swing profits under' Rule 16a-l(a)(1) because they were members of a Section 13(d) group with CCI (Complaint at 4-5). Accordingly, although only CCI is alleged individually to have beneficially'owned more than ten percent ofLaserSight common stock, Schaffer employs the group concept ofbeneficia1 ownership of Section 13(d)(3) of the Exchange Act and Rule 13d-5(b)(I) to aggregate the shares ofcommon stock beneficially owned by Castle Creek, Societe Generale, Shepherd Investments, Stark International, Stark, and Roth with those of cel in order to reach the ten percent threshold for application of Section 16(b). Schaffer also alleges that Shepherd Investments and Stark International together beneficially owned more than ten percent ofLaserSight common stock and that they . -7­ fonned a second Section 13(d) group, apart from the larger group that also includes CCI, Castle Creek, and Societe Generale (Complaint at 5). In a brief filed in support oftheir motion to dismiss, Shepherd Inves~ments and Stark International, whose investment decisions were controlled by Roth and Stark, concede that they "constitute a group under Section 16." They do contest, however, that they are members ofthe iarger group (Stark Defendants R.Br. at II n.3).3 Schaffer seeks to recover a total of$7,091,975 in short-swing profits: $1,935,540 from CCI; $721,600 from Societe Generale; and $4,434,835 from Shepherd Investments .and Stark International (Complaint at 13).4 Under Rule 16a-l(a)(2) the defendants are ·liable for only their individual profits and not those of the other members of the group. Defendants moved to dismiss Schaffer's complaint for failure to state a claim pursuant to Fed. R. Civ. P. 12(b)(6). Among the arguments made by CCI and Castle Creek, and adopted by the other defendants, is their assertion that the Commission exceeded the authority delegated to it by Congress when it promulgated Rule 16a-l(a)(1). 3 "_ Br. at _" refers to a brief of one ofthe parties in support or opposition to summary judgmentand the page number ofthe brief. "_ R.Br. _". refers to a reply brief filed by one ofthe defendants in response to plaintiffs brief in opposition to summary judgment. 4 Schaffer also seeks additional undetennined profits, if any, and prejudgment interest. -8­ ARGUMENT, I. TIIE COMMISSION ACTED WITHIN ITS AUTHORITY IN ADOPTING RULE 16a-l(a)(1). The Commission had the authority, under its rulemaking grant in Section 23(a) of the Exchange Act, 15 U.S.C. 78w(a) and under its definitional authori!y in Section 3(b), .'. ofthe Act, 15 U.S.C. 78c(b), to define the term "beneficial owner." The definition it . chose is necessary or appropriate to carrying out the purposes of Section 16(b), as required by Section 23(a), and is consistent with the provisions and purposes of Section 16(b), as required by Section 3(b). A. The Commission Had the Power to Define "Beneficial Owner" Under Its Rulemaking and Definitional Authority in Sections 3Cb) and 23(a) ofthe Exchange Act. The principal statutory authorities for applying the Section 13(d) defmition of beneficial owner to Section 16 are the Commission's authority to define terms under Section 3(b) of the Exchange Act and its general rulemaking authority under Section 23(a) ofthe Act. The Commission relied on both ofthese provisions in adopting Rule 16a-l. See Ownership Reports and Trading by Officers, Directors and Principal Securities Holders, Exchange Act Release No. 28869,48 SEC Docket 234,257 (Feb. iI, 1991). As a general matter; courts have broadly construed the Commission's rulemaking authority under both ofthese provisions. See,·~ Falcon Trading v. SEC, 102 F.3d 579, 582 (D.C. Cir. ·1996) (finding the Commission's quorum rule valid under -9­ Section 23(a»; Touche Ross & Co., Inc. v. SEC, 609 F.2d 570, 581-82 (2d Cir. 1979) (finding fonner Rule 2(e) valid under Section 23(a»; Continental Oil Co. v. Pertitz, 176 .' F. Supp. 219, 221, 227 (S.D. Tex. 1959) (finding a Section 16(b) rule promulgated ... pUrSuant to Section 23(a) valid); Lockheed Aircraft Corp. v. Rathman, 106 F. Supp. 810, 813-14 (S.D. Cal. 1952) (finding a Section 16(b) rule promulgated putsuant to Section 3(b) valid). . I. . The Commission Had Authority to Promulgate Rule 16a-l(a)Cl) Under Section 23(a). The defendants argue that the CommIssion's general rulemaking authority under Section 23(a) does not empower it to adopt a rule under Section 16(b). They claim that the section only empowers the Commission to make such rules and regulations as may be necessary or appropriate to implement the provisions of [the Exchange Act]for which they are responsible orfor the execution ofthe functions vested in them by the [Exchange Act]. * * *. (omissions and italics in original) (CCI Br. at 24, quoting Section 23(a». The defendants assert that because the Commission is not empowered to enforce Section 16(b) it . therefore has no "responsibility" or "function vested in them" with respect to the section (other than the expressly conferred power to grant exemptions). . -10 ­ This argument rests on a very selective and misleading editing of Section 23(a). The pertinent portion of Section 23(a) reads in full as follows: The Commission, the Board of Governors of the Federal Reserve System, and the other agencies enumerated in Section 3(a)(34) of this title shall each have power to make such rules and regulations as may be necessary or appropriate to implement the provisions ofthis title for which they ilre responsible or for the execution of the functions vested in them by this title, and may for such purposes classify persons, securities, transactions, statements, applications, reportS, and other matters within their respective jurisdictions, and prescribe greater, lesser, or different requirements for different classes thereof. * * * Read in context, it is clear that the terms "responsibility" and "functions" are used in Section 23(a) only to differentiate the scope ofthe Commission's power from that of the Federal Reserve Board and other agencies that share responsibility for administration of the Act. Under Section 23(a), the only substantive limitation placed on the Commission's general rulemaking power by Section 23(a) is that the Commission must not make a rule in an area delegated to another agency, and those rules must be "necessary or appropriate" to implement the Exchange Act. 5 5 Another part of Section 16 supports this interpretation. Section 16(e), 15 U.S.C. 78p(e), provides that Section 16, including Section 16(b), does not apply to "foreign or domestic arbitrage transactions unless made in contravention of such rules and regulations as the Commission may adopt in order to carry out the purposes ofthis section." By exempting arbitrage. transactions "unless made in contravention of such rules and regulations as the Commission may adopt in order to carry out the purposes" of Section 16, Congress necessarily recognized that the Commission has·the authority (continued...) -11­ 2. The Commission Had Authority to Promulgate Rule 16a-l(a)(1) Under Section 3(b). The defendants similarly argue that the Commission's authority under Section 3(b) to defme terms contained within the Exchange Act is inapplicable to Section 16(b). They .quote Section 3(b) as limiting the Commission "as to matters within their * * * ." jurisdiction, the power by rules and regulations to define technical, trade, accounting, and other terms used in [the Exchange ActJ* * * " (omissions in original) (CCI Br. at 24, quoting Section 3(b». The defendants then assert that "the application of [the beneficial' ownership] definition to Section 16(b) is not'a matter within their jurisdiction' * * * " (CCI Br. 24). Once again, the defendants selectively quote the section. The full text of Section 3(b) provides: The Commission and the Board of Governors ofthe Federal Reserve System, as to matters within their respective jurisdictions, shall have power by rules and regulations to define technical, trade, accounting, and other terms used in this title, consistently with the provisions and purposes ofthis ·title.6 S(...continued) to make rules that would have the effect ofmaking Section 16(b) applicable to arbitrage transactions~ In other words, Congress contemplated that the Commission·has the power to make affirmative rules defming the reach of Section 16(b),not merely exemptive rules. 6 Section 3(b) was amended in 1975 to add the words "and other terms" in order "to broaden the authority ofthe Commission and the Board of (continued...) - 12­ As with Section 23(a), the purported limitation is merely a means of distinguishing those areas under the Exchange Act in which the Commission may regulate from those in .., which other agencies have authority. 3. The Commission Did Not Need A Special Grant of Rulemaking Authority in Section 16(b) Itself. . '. The defendants place significant weight on the fact that the text of Section 16(b) expressly provides the Commission only the authority to make rules exempting transactions from its operation, and does not expressly provide other rulemaking authority.? "[A]n express grant of authority is not necessary to sustain the validity ofthe challenged rule or regulation." Touche Ross & Co. v. SEC, 609 F.2d 570,580-81 (2d eire 1979) (finding fonner Rule 2(e), allowing the Commission to sanction attorneys and accountants whopractice before it, valid under Section 23(a». There was no reason to provide the Commission with special rulemaking authority in Section 16(b) itself, when it already had general rulemaking authority under Section 23(a) and definitional authority under Section 3(b). 6(...continued) Governors ofthe Federal Reserve System to make clear that they may defme any tenn used in the Exchange Act, whether or not it is already defined in the title." S. Rep. No. 94-75, at 94 (1975).. 7 Section 12(h) ofthe Act, 15 U.S.C. 781(h), also authorizes the Commissiop, by rule or order, to exempt certain securities and any officer,director, or beneficial owner from Section 16, if the Commission finds such an exemption is "not inconsistentwith the public interestand/or protection of investors." - 13­ There are many provisions in the Exchange Act that the Commission enforces and under which it may adopt rules, even under defendants' pinched reading, but which ,.. provide no special·grant of rulemaking authority. To take just the most pertinent example, the reporting provisions in Section 16(a) are enforced by the Commission, yet contain no express rulemaking authority. The defendants do not dispiite that the Commission had the power to adopt Rule 16a-l(a)(l) for the purpose of defining the term . "beneficial owner" in that section. Indeed, the fact that the Commission has the power to define the term "beneficial owner" for purposes of Section 16(a) necessarily means it has the power to do the same for Section 16(b). Section 16(b) specifies to whom it applies by referring back to Section 16(a).8 Congress intended the tenn "beneficial owner" to have the same meaning in both subsections. It is inconceivable that the Commission could define the term for purposes 8 Section 16(a) provides that "[e]veryperson who is directly or indirectly the beneficial owner of more than 10 per centuin of any class of any equity security * * * or who isa director or an officer ofthe issuer" shall report the amount of securities he owns to the Commission (emphasis added). Section 16(b) then refers back to Section 16(a) stating that "[f]or the purpose ofpreventing 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 or sale, * * * ofany equity security ofsuch issuer * * * within any period of less than six months * * * shall * * * be recoverable by the issuer· * * *." -14 ­ of Section 16(a), but that the term, when incorporated by reference into Section l6(b), would somehow acquire a different meaning. 9 B. Rule 16a-l(a)(1) Is N~cessary or Appropriate to Carrying Out, and Is Consistent with the Provisions and Purposes of, Section l6(b). Once it is established that the Commission possesses the requisitc{authority to make rules under Section 16(b), the next question is whether Rule l6a-l(a)(1) is "consistent[] with the provisions and purposes" of the section, as required by Section 3(b) or "necessary or appropriate" to carrying out the purposes of Section l6(b), as required by Section 23(a).10 9 Defendants also argue that the Commission "has recognized that its role with respect to Section 16(b) is extremely limited" (CCI Br. at 23). As support for this assertion defendants cite a no-action letter in which the staff wrote that "[b]ecause the Commission does not have enforcement power under Section l6(b) ofthe Securities Exchange of 1934, the Division [of Corporation Finance] can express no view outside the context ofthe exemptive rules promulgated by the Commission." Service Merchandise Company, No-Action Letter, 1988 WL 233569 (January 11, 1988). This misapprehends the context in which the sta,tement was made. A no­ action request is a request that the staff stateit will not, on the facts as .represented by the requestor, recommend enforcement action. Since the .. Commission does not enforce Section 16(b), the staffobviously could not give a position regarding prospective enforcement action. However, the staff does issue interpretive letters addressing its rules under Section 16(b). None ofthis has anything to do with the Commission's rulemaking authority. 10 When itconstrued Section 23(a) in a different context in Touche Ross & .. Co. v. SEC, 609 F.2d 570,579 (2d Cir. 1979), the Second Circuit quoted (continued...) - 15­ The first step in those inquiries'is whether the language of Section 16 is clear on its face, since "[i]fthe intent of Congress is clear, that is the end of the matter; for the court, as well as the agency, must give .effect to the unambiguously expressed intent of .Congress." Chevron. U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. .". 837,842-43 (1984). But Congress'intent in using the term "beneficial owner" is not clear. Section 16 . does not purport to define the term "beneficial owner" and it is a term that plainly can have more than one meaning. Under these circumstances, where Congress "is silent or ambiguous with respect to the specific issue, the question for the court is whether the agency's answer is based on a permissible construction ofthe statute." Chevron, 467 U.S. at 843. 11 See also Nationsbank ofNorth Carolina v. Variable Annuity Life Ins. Co., IO(...contmued) . • the Supreme Court's guidance that "[w]here the empowering provision ofa statute states simply that the agency may 'make * * * such rules and regulations as may be necessary to carry out the provisions ofthe Act,' * * * the validity ofthe regulation promulgated thereunder will be sustained so long as it is 'reasonably related to the purposes ofthe enabling legislation.'" Mourning v. Family Publications, Inc., 411 U.S. 356, 369 (1973) . (omissions in original) (quoting Thorpe v. Housing Authority ofthe City of Durham, 393 U.S. 268, 280-81 (1969)). Thus, Rule 16a..;l(a)(l) is valid so long as it is "necessary or appropriate" to carry out the purposes ofSection 16(b) or "reasonably related" to the purposes of Section 16(b).. See, e.g., Continental Oil Co. v. Perlitz, 176 F.Supp. 219, 223-27(S.D. Tex. 1959). 11 "Deference under Chevron to an agency's construction of a statute that it administers is premised on the theory that a statute's ambiguity constitutes an implicit delegation from Congress to the agen~y to fill in the statutory (continued...) - 16­ ; .. 513 U.S. 251, 257 (1995). An agency's interpretation ofa statute'it administers is to be accorded substantial deference "whenever its interpretation provides a reasonable construction ofthe statutory language and is consistent with legislative intent." Securities Industty Assoc. v. Board of Govemors ofthe Federal Reserve Syst~m, 468 U.S. 207,217 (1984). See also Nationsbank v. Variable Annuity Life Ins. Co., 513 Q.S. at 256-57. Two things are readily apparent about Congress' intent when it enacted Section 16. The first is that Section 16 was intended to deter the misuse of inside information. The second is that Congress presumed that a person with an investment in more than ten percent ofthe equity securities of an issuer is likely to have access to inside information about the issuer and was determined to suppress the abuse of inside information by such large stockholders. The Commission had this Congressional intent in mind in 1991 when it adopted the definition of beneficial owner in Section 13(d) for purposes of determining ten percent beneficial owner status under Section 16(b). The Commission stated: 1I(...continue . . d·) gaps." FDA v.Brown & Williamson Tobacco C01:poration, _ U.S. _, 120 KCt. 1291, 1314 (2000). Where Congress is silent, the Supreme Court recently noted, only in "extraordinary cases" should a court hesitate before concluding that Congress intended such a delegation. Id. The Court found that Brown and Williamson, ~ was such an extraordinary case, in part, .. because the regulation oftobacco was an especially politically sensitive area and because Congress had enacted several pieces of legislation regulating tobacco on its own, thereby, inthe Court's view, indicating its intent not to delegate regulation oftobacco to an administrative agency. Id. at 1315. -17 ­ Section 16, as applied to ten percent holders, is intended to reach those persons who can be presumed to have access to inside information because they can influence or control the issuer as a result oftheir equity ownership. Section 13(d) of the Exchange Act specifically addresses such relationships. As proposed, the rules adopted today define ten percent holders under Section 16 as persons deemed ten percent holders under Section 13(d) ofthe Exchange Act and the rules thereunder. The Section 13(d) analysis * * * [is] importeo into the ten percent holder determination for Section 16 purposes. • Ownership Reports and Trading by Officers, Directors and Principal Security Holders, Exchange Act Release No. 28869,48 SEC Docket 234,236 (Feb. 21, 1991). The objective of Section 13(d) is to provide notice ofthe rapid accumulation of securities in an issuer. Although filings are required regardless of whether the investors have a control purpose, Section 13(d) was adopted as part of the Williams Act and is intended to provide an early warning of accretions ofstock ownership that could potentially affect or influence control. See,~, GAF Com. v. Milstein, 453 F.2d 709, 717 (2d Cir. 1971). Ifa group ofpersons that beneficially owns more than five percent of an issuer under Section 13(d) standards can be presumed to have the potential to influence corporate control, then it reasonably may also be concluded that a group that beneficially owns more than ten percent of an issuer may have access to inside information. Furthermore, ifan individual who owns more than ten percent of an issuer can be presumed to have access to inside information, that presumption can alsohold true for a - 18­ group that owns more than ten percent of an issuer and is acting in concert for thepurpose of acquiring, holding, voting, or disposing ofsecurities of the issuer. 12 The defendants suggest that a shareholder should be found to be a member of a Section l3(d) group only when the shareholder has a pecuniary interest in the shares of the group. That would be too narrow an approach. Where shareholders· act in concert for the purpose of acquiring, holding, voting, or disposing of securities, they can reasonably be expected to have collective voting strength which will give them presumptive access to inside information. This is so regardless of whether each member of the group has a economic interest in the securities of the other members. Nevertheless, the defendants express concern that a group member might be found liable for profits derived from the securities transactions ofanother member ofthe group, even though the group member had realized no gain on the transaction. This was a primary concern expressed in several pre-Rule 16a-l(a)(I) cases that rejected applying 12 While such a presumption is appropriate, there are some, relatively rare, circumstances where it may be concluded that a Section l3(d) group does not in fact have access to inside information and its members should not be subject to Section 16(b). In these rare instances, which have involved . group membership that was·an involuntary condition to employment, where group members were numerous and individually rarely owned more than one percent of outstanding securities, the Commission staffhas provided interpretive relief stating its view that Section 16 does not apply. See, ~ Morgan Stanley Group Inc., SEC No-Action Letter, 1991 WL 178730 (April 30, 1991). -19 ­ Section B(d) beneficial ownership concepts to Section 16.J3 These cases were primarily concerned that, since Section 16(b) provides for the recovery of short-swing profits, wholesale application ofthe Section 13(d) beneficial ownership concept to Section 16(b) • would mean that a member ofa group is liable for profits from transactions in securities in which he or she had no pecuniary interest. ·0. This concern has been addressed in the rule. Rule 16a-l(a)(2) provides that a : person is not the beneficial owner of securities for purposes other than determining his status as a ten percent owner, unless he has a "pecuniary interest" in those securities. Rule 16a-l(a)(2) defines pecuniary interest as "the opportunity, directly or indirectly, to profit or share in any profit derived from a transaction in the subject securities." Accordingly, while a shareholder may be subject to suit under Section 16(b) because of his membership in a Section B(d) group, his liability in that suitis limited to the profits he directly or indirectly realized. 13 See Meyer v. Chesapeake Ins~ Co., Ltd., 877 F.2d 1154, 1162 (2d Cir.· 1989), cert. denie