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99-9374

THE UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

RICHARD MORALES,

Plaintiff-Appellant,

QUINTEL ENTERTAINMENT, INC. AND PETER STOLZ,

Defendants-Appellees.

On Appeal from the United States District Court

for the Southern District ofNew York

BRIEF OF THE

.SECURITIES AND EXCHANGE COMMISSION, AMICUS CURIAE,

IN SUPPORT OF APPELLANT ON ISSUES ADDRESSED

DAVID M. BECKER

General Counsel

JACOB H.STILLMAN

Solicitor

ERIC SUMMERGRAD

Deputy Solicitor

Of Counsel

MEYER EISENBERG

Deputy General Counsel

ALLAN A. CAPUTE

Special Counsel to the Solicitor

Securities and Exchange Commission

Washington, D.C. 20549-0606

(202) 942-0837

TABLE OF CONTENTS

Page

TABLE OF AUTHORITIES

INTEREST OF THE SECURITIES AND EXCHANGE

COMMISSION AND SUMMARY OF ITS POSITION

~ .'

ISSUES ADDRESSED BY THE COMMISSION

STATEMENT OF THE CASE

Factual Background . . . . . . . . ~ . . . . . . . . . . . . . . .... ., . ~ . . . . . . . 7

The Proceedings Below . ~

ARGUMENT

II.

III.

IV.

THE DISTRICT COURT IMPROPERLY RELIED

ON THE GOLDMAN SACHS LETTER, WHICH

WAS RESTRICTED TO A NARROW SET OF

CIRCUMSTANCES NOT PRESENT IN THIS

CASE. .

~ .. 14

A SECTION 13(d) BENEFICIAL OWNERSHIP

GROUP MAY EXIST EVEN IF IT DOES NOT

HAVE A COMMON OBJECTIVE THAT IS

RELATED TO CORPORATECQNTROL

AN AGREEMENT TO EXCHANGE AN ASSET

FOR SECURITIES MAY MANIFEST A PURPOSE

TO ACQUIRE THE SECURITIES. .

LOCK-UP PROVISIONS, IN APPROPRIATE

CIRCUMSTANCES, MAY DEMONSTRATE AN AGREEMENT

TO HOLD AND/OR DISPOSE OF SECURITIES. .

CONCLUSION

-\.

TABLE OF AUTHORITIES

CASES

Page

. Bateman Eichler, Hill Richards, Inc. v. Berner,

472 U.S. 299 (1985)

Bath Industries, Inc. v. Blot,

427 F.2d 97 (7thCir. 1970)

;

Blue Chip Stamps v. Manor Drug Stores,

421 U.S. 723 (1975) .. "

Foremost-McKesson, Inc. v. Provident Securities Co.,

423 U.S. 232 (1976)

GAF Corp. v.Milstein, 453 F.2d 709 (2d Cir. 1971),

cert. denied, 406 U.S. 916 (1972)

11,20,22 passim

Global Intellicom v. Thomson Kernaghan & Co.,

[1999 Transfer Binder] Fed. Sec. L. Rep. (CCH)

90,534 (July 27 1999)

Gollustv. Mendell, 501 U.S. 115 (1991)

1.1. Case Co. v. Borak,

377 U.S. 426 (1964)

Lemerv. Millenco, 23 F. Supp.2d 337(S.D.N.Y. 1998)

Morales v. Freund,

136 F.3d 763 (2d Cir. 1999)

9,21

NYCERS v. SEC, 45 F.3d 7 (2d Cir. 1995)

Reliance Electric Co. v. Emerson Electric Co.,

404 U.S. 418 (1972)

, 2

Table of Authorities (continued)

STATUTES AND RULES (cont'd)

SEC v. Savoy Indus.,

587 F.2d 1149 (D.C. Cir. 1978),

cert. denied, 440 U.S. 913 (1979)

11',21

Wellman v. Dickinson,

682 F.2d 355 (2d Cir. 1982), cert. denied,

460 U.S. 1069 (1983)

11,21 passim

STATUTES AND RULES

Securities Exchange Act of 1934, 15 U.S.C. 78a, et seq.

Section 13(d), 15 U.S.C. § 78m(d)

3,4,5 passim

Section 13(d)(l), 15 U.S.C. § 78m(d)(1)

Section 13(d)(3), 15 U.S.C~ § 78m(d)(3)

Section 16(b), 15U.S.C. § 78p(b)

1,2,3 passim

Commission Rule

17 C.F.R. 202.1(d) .. , . . . . . . . . . . . . . . . . . . . . . . . ... . . . . . . . . . . . . . . . . . . . 15

Rules under the Securities Exchange Act 17 C.F.R. 240.01, et seq.

Rule 13d-5(a), 17 C.F.R. 240.13d-5(a)

Rule 13d-5(b)(I), 17 C.F~R. 240.13d-5(b)(I)

III

3,8, 10 passim

STATUTES AND RULES (cont'd)

Rules under the Securities Exchange Act. 17 C.F.R. 240.01, et seq. (cont'd)

Rule 16a-l(a)(I), 17 C.F.R. 240.l6a-l(a)(I)

3,4,9 passim

Rule 16a-l(a)(2), 17 C.F.R. 240.l6a-l(a)(2)

MISCELLANEOUS

S. Rep. No. 550, 90th Cong., 1st Sess (1967)

P. Romeo & A. Dye, Section 16 Updates Vol. IX, No.4 (Dec. 1999) .... 20,26

The Goldman Sachs Group, Inc., No Action Letter [1999 Transfer Binder] Fed.

Sec. L. Rep. (CCH) '77,552(April 30, 1999)

Morgan Stanley Group, Inc., SEC No Action Letter [1991 Transfer Binder] Fed.

Sec. L. Rep. CCH 79,681 (April 30, 1991)

Alex Brown Inc., SEC No Action Letter [1991 Transfer Binder] Fed. Sec. L. Rep.

~ . 15

CCH 79, 725 (July 22, 1991)

'.'

Adoption of Beneficial Ownership Disclosure Requirements,

Exchange Act Release No. 13291, 13 SEC Docket 1779 (Feb. 24, 1977) 22

Amendment to Beneficial Ownership Ownershjp Reporting Requirements,

Exchange Act Release No. 39538,66 SEC Docket 902 (Jan. 12, 1998) .23

No. 99-9374

UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

RICHARD MORALES,

Plaintiff-Appellant,

QUINTEL ENTERTAINMENT, INC. and PETER STOLZ,

Defendants-Appellees.

On Appeal from the United States District Court

for the Southern District ofNew York

BRIEF OF THE SECURITIES AND EXCHANGE COMMISSION,

AMICUS CURIAE, IN SUPPORT OF APPELLANT ON ISSUES ADDRESSED

INTEREST OF THE SECURITIES AND EXCHANGE

COMMISSION AND SUMMARY OF ITS POSITION

T~e Securities and Exchange Commission, the agency responsible for the

administration and enforcemept ofthe federal securities laws, submits this brief as

amicus curiae to address important issues relating to the "short-swing" trading

. provisionin Section 16(b) ofthe Securities Exchange Act of 1934, 15 U.S.C. §

78p(b).

-2

The objective of Section 16(b) is to deter corporate insiders from trading in

their companies; securities on the basis of inside information to which they have

access by virtue of their positions. Congress determined that such persons should

not be allowedto profit from short-swing trading -- purchases and sales occurring

within a period of less than six months -- which it viewed as a type of trading that

posed a particular risk of misuse of inside infonnation . J / Although Section 16(b)

is enforced in private actions only, and not in Commission enforcement actions, the

Commission 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' of the securities laws and are 'a necessary

supplement to Commission action.'" Bateman Eichler, Hill Richards, Inc. v.

Berner, 472 U.S. 299, 310 (1985), quoting 1.1. Case Co. v. Borak, 377 U.S. 426,

11.

In enacting Section 16(b) "Congress recognized that insiders may

have access to infonnation 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 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. 418,422 (1972). Congress presumed

that persons owning more than ten percent of a class of an issuer's

registered equity securities would have access to inside information.

Id. at 424. See also Gollust v. Mendell, 501 U.S. 115, 121 (1991).

-3

432 (1964); see Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 730

(1975).

Congress concluded that the persons who should be subject to the

constraint of Section 16(b) include not only corporate officers and directors, but

also the beneficial owners of more than ten percent of a class of an issuer's

registered equity securities. Section 16 of the Act, however, contains no definition

of beneficial owner. Accordingly, in 1991 the Commission promulgated Rule 16a

l(a)(l),-17 C.F.R. 240.16a-l(a)(I), for the purposed of determining who is a ten

percent beneficial owner. The rule generally adopts the defmition of beneficial

owner applied under Section 13(d) ofthe Act, 15 U.S.C. § 78m(d), and rules

thereunder. Under Rule 13d-5(b)(I), 17 C.F.R. 240. 13d-:5(b)(1), a group of

shareholders is deemed the beneficial owner of the securities owned by each

member of the group if the group acts with the- purpose ofacquiring, voting,

holding, or disposing of the securities of an issuer.

In this case the plaintiff, a shareholder of Quintel Entertainment Inc. who is

.suing on under Section 16(b) on company's behalf, claims that defendant Peter

Stolz was a member of a group whose members beneficially owned in excess of

10% of the stock of Quintel, and seeks recovery of profits realized on short-swing

trades in Quintel stock engaged in by Stolz. The district court rejected that claim,

-4

holding that Stolz was not part of a Section 13(d) beneficial ownership group and

thus not liable as a statutory insider under Section 16(b). The court granted .

summary judgment for Stolz.

The Commission expresses no view on that result. As a generalmatter, the

question whether shareholders are acting as a Section 13(d) group depends on

,whether the facts and circumstances demonstrate that they were acting for the

common purpose of acquiring, disposing, or holding securities. In some cases this

can be resolved on summary judgment because there is no genuine factual dispute

as to the presence, or lack, of such a common purpose. In other cases, where the

motivations and relations among the shareholders are less clear, summary judgment

may not be appropriate. The Commission expresses no view as to whether, based

on these facts, summary judgment was properly granted.

The Commission, however, has serious concerns about portions of the

district court's analysis in which the court appeared to draw, or atleast imply,

incorrect legal conclusions. First, the court relied in'part on an iriterpretive letter

issued by the Commission's Division of Corporation.Finance in connection with a

different transaction, interpreting certain aspects of Rule 16a-l(a)(1). Although the

Commission's staff concluded that on the facts of that tranSaction no Section 16

concerns were raised, the facts and circumstances of that transaction were very

-5

different from those presented here. The district court, however, drew from that

Jetter overbroad and incorrect conclusions that Section 16 concerns may not be

present here. The district court should not have relied on the letter.

. Second, the 'decision of the district court is susceptible to being construed,

and has been construed by some commentators, as holding that a Section 13(d)

group cannot exist unless the alleged group members have a common objective

related to corporate control of the issuer. We do not believe that the district court

intended its decision to so hold, and such a holding would be incorrect.

Accordingly, this Court should make clear that a Section 13(d) group is not limited

in that manner.

Finally, we believe that the district court unduly restricted the circumstances'

under ,which an acquisition of stock in exchange for the sale of assets can manifest

a Section 13(d) group purpose to acquire securities, and also improperly restricted

the circumstances:in which a contractual agreement to restrict the sale of a security

(a "lock-up" provision) can manifest a group purpose to hold securities. The

district court incorrectly J;'elied on the fact that the alleged group members were

selling an asset as precluding a purpose by them to acquire securities, and on the

fact that the buyer ofthe asset insisted on the lock-up as ruling out a purpose by

the alleged group to hold securities. While we take no position on the factual

-6

question whether the alleged group in this case had these purposes, such purposed

cannot be ruled out as a matter of law on the bases relied on by the court.

ISSUES ADDRESSED BY THE COMMISSION

The Commission's brief addresses the following questions:

Whether the district court properly relied on a staff letter relating to

The Goldman Sachs Group, Inc., No-Action Letter [1999 Transfer Binder] Fed.

Sec. L. Rep. (CCH) '77,552 (April 30, 1999), in concluding that the defendant was

not a more than ten percent beneficial owner for Section 16(b) purposes.

Whether shareholders must have a common objective related to

corporate control in order to constitute a beneficial ownership group under Section

13(d) of the Exchange Act.'

Whether an agreement to acquire securities in exchange for the sale of

an asset necessarily manifests only a purpose to the sell the asset, and precludes

finding a purpose to acquire securities.

Whether a lock-up agreement restricting'the sale of securities may,

depending on the circumstances, demonstrate art agreement by the alleged group to

hold and/or dispose of securities within the meaning of Section 13(d) and Rule.

13d-5(b)(1).

-7

STATEMENT OF THE CASE

Factual Background

Defendant Stolz was an eleven percent shareholder of Psychic Reader's

Network ("PRN"),a,privately held company. The other shareholders, Steve Feder

and Thomas Lindsey, each owned 44.5 percent ofPRN's shares. In 1996, Feder,

Lindsey, and Stolz agreed to sell to Quintel PRN's interest in New Lauderdale LLC

("New Lauderdale"), ajoint venture between PRN and QuinteL Pursuant to an

agreement executed in September 1996 ("PRN/Quintel Agreement" or

"Agreement"), Feder and Lindsey each received 7.7 percent, or more, of Quintel's

shares, and Stolz received 352,000 shares or about 2~5 percent of Quintel's shares

(AI75, 511). Feder was, under the Agreement, employed by Quintel to operate

New Lauderdale (A262).

The PRN/Quintel Agreement contained lock-up provisions restricting the

three PRN shareholders from selling the Quintel stock they received as

consideration for tl].eir interest in New Lauderdale. 2/

The first lock-up provision prevented the PRN shareholders from

selling Quintel stock for two· years unless a principal of Quintel sold

shares. In the event that a Quintel principal did sell shares, each PRN

shareholder had the right to sell a number of Quintel shares in

accordance with a set formula. The second lock-up provision

(continued...)

-8

In December 1996, Stolz, Feder, and Lindsey jointly filed with the

Commission, pursuant to Section 13(d), a Schedule 13D reporting their acquisition

of Quintel stock (A30) and stating that "[t]he Reporting Persons may be deemed to

be a 'group' within the meaning of Rule 13d-5(b)(I)." Subsequently, Stolz, Feder,

and Lindsey jointly filed four amendments to their Schedule 13D containing

statements to the same effect (A78-80, 85-87, 92-94, 99-101).J/ Stolz also filed,

pursuant to the reporting provisions in Section 16(a), six Fonns 4 and one Form 5,

with the Commission between February 1997 and September 1998 in which he

stated that his relationship to Quintel was that of a "Member of 13(d) group owning

more than 10%" (AI 10, 112, 116, 120, 124, 128, 132).3/

Between November 1996 and August 1998, Stolz made forty purchases and

fifty-one sales of Quintel stock (A21-23).

2/(.. ~continued)

restricted the number ofshares the PRN shareholders could sell within .

any given quarter (A50-52, 177-80).

Stolz, Feder, and Lindsey had the opportunity to disclaim group

membership when they jointly filed their Schedule 13D and

amendments, but they did not do so. See Schedule 13D, item 2.

Stolz contends that he acted on the advice of counsel when he signed

.documents prepared for him by his attorney, who also represented

Feder and Lindsey.

-9

The Proceedings Below

Plaintiff Morales, a Quintel shareholder, brought this action on behalf of

Quintel against Stolz seeking, under Section 16(b), to recover profits Stolz realized

on those purchasescand sales of Quintel stock that occurred within six months of

each other.

The parties cross-moved for summary judgment. On October27, 1999, the

district court granted summary judgment for the defendant. The court recognized

that since Stolz admitted to having profited from the purchase and sale of Quintel

stock within a six-month period, the only question is whether he is a beneficial

owner of more than 10 percent of Quintel's stock, and thus subject to Section

16(b). ~/ Since Stolz personally acquired only 2.5 percent of the Quintel shares, he

could only be the beneficial owner of more than 10% if his shares were aggregated

with those acquired by Feder and/or Lindsey. Under Rule 16a-1(a)(1), this would

be appropriate only if Stolz, Feder, and Lindsey were deemed, the beneficial owners

of each other's:shares under the Section 13(d} ~oupprinciple. See,g., Morales

v. Freund, 163 F.3d 763, 766-76 (2d Cir. 1999) (applying Rule 16a-l(a)(1)'s

. 1t is undisputed that Stolz was not an officer or director ofQuintel,

positions that would independently have made him subject to Section

16(b).

-10

definition of beneficial owner within the group context).

Commission Rule 13d-5(b)(I) provides that "[w]hen two or more persons

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 * * * of all equity securities of that issuer beneficially owned

by any such persons." Thus, the district court correctly pointed out that "if

defendant Stolz acted with Feder and Lindsey 'as a group for the purpose of

acquiring, holding or disposing of' Quintel securities, their stock holdings would be

aggregated to" more than 18% and Stolz would be a beneficial owner of more than

10% percent of Qumtel stock under §16(b)." 72 F. Supp. 2d at 347 (quoting

Section 13(d)(3)). 6/

In order to determine whether Stolz, Feder, and Lindsey acted as a group

within the meaning of Rule 13d-5(b)(I), the district court looked to the purpose of

Section f3(d). That provision, the district court stated, was enacted '''to alert the

marketplace t(levery large, rapid aggregation or accwnulation of securities,

Although it may be appropriate to aggregate shareholders' interests to

determine if they cross the ten percent threshold, that does not render

them liable for each others' short-swing trades. They are only liable

for the trading of securities in which they have a pecuniary interest.

See Rule 16a-l(a)(2), 17 C.F.R. 240. 16a-l(a)(2).

-11

regardless of technique employed, which might represent a potential shift in

corporate controL'" Id. (quoting GAP Corp. v. Milstein, 453 F.2d 709, 717 (2d

Cir. 1971), cert. denied, 406 U.S. 916 (1972)). It logically follows that "[i]n order

to fonn a group under §13(d), the defendants must have 'combined i:p. support ofa

common objective.'" Id. (quoting SEC v. Savoy Indus., 587 F.2d 1149, 1162

(D.C. Cir. 1978), cert. denied, 440 U.S. 913 (1979)). See also Wellman v.

Dickinson, 682 F.2d355, 362-63 (2d Cir. 1982), cert. denied, 460 U.S. 1069

(1983). The court concluded, "[t]hus, we must consider whether, as a matter of

law, the PRN/QuinteI Agreement was an agreement between Stolz, Feder and

. Lindsey to act as a group with the purpose of acquiring, holding, or disposing of

Quintel Securities." Id. at 348.

The PRN/Quintel Agreement did not, in the district court's judgment,

constitute an agreement for the purpose ofacquiring, holding, or disposing of

Quintel securities.:The court observed that "[t]here is no evidence that Stolz, Feder

and Lindsey were trying to effectuate a shift in corporate control through the

disposition of Quintel stock." Id. The court further reasoned,that the agreement

was not one for the purpose of acquiring Quintel shares because "the only

common objective that Stolz, Feder and Lindsey shared was to sell PRN's .

holdings in New 'Lauderdale LLC." Id.

-12

The district court then held that the lock-up provisions "do not reflect the

objectives of Stolz, Feder and Lindsey" to hold and dispose of Quintel shares

because those provisions "exist to protect Quintel and Quintel shareholders" from

a decline in the price of Quintel stock. Id. The court further stressed that neither

Stolz nor the group would be able to exert substantial influence over Quintel

because Stolz owned less than 2.5 percent of Quintel shares and the group as a

whole owned only about 18 percent. Id. at 349.

To buttress its conclusion, the district court relied on an interpretive letter

issued by the Commission's Division of Corporation Finance to The Goldman

Sachs Group, Inc., SEC No-Action Letter [1999 Transfer Binder] Fed. Sec. L.

Rep. CCH ~77,553 (April 30, 1999). That letter addressed whether the 550

managing directors of Goldman Sachs, who received stock upon the firm's

becoming a public company; would be subject to the provisions of Section 16 by

virtue of aggregating the collective stockholdings of the managing direqtors as a

group. The question presented was whether aggregation would be required as a

result of the managing· directors' entry into an agreement restricting the sale oftheir

shares and directing the voting of the shares. In that letter, the Division of

Corporation Finance expressed the view that each managing director of Goldman

Sachs who was iricluded in ajoint report of beneficial ownership on Schedule 13D

-13

solely because ofhis or her participation in that shareholders' agreement, need not

include the shares of Goldman Sachs owned by other parties to the shareholders'

agreement for purposes of detennining whether the managing director was a ten

percent beneficial owner under Rule 16a-l(a)(1). 1/

The district court stated that the "SEC has ruled" that Goldman .Sachs,

partners were not subject to aggregation of their stock for the purpose of

determining whether they were ten percent beneficial owners under Section 16(b),

even though the shareholders' agreement !pey signed as a condition for receiving

stock included lock-up provisions and votm.g agreements. 72 F.Supp. at 349. The

court emphasized that the· staff based its letter partly on the fact that the Goldman

Sachs shareholders would be unable to control the frrm because of their large

The staff s interpretive advice addressed Rule16a-l(a)(1), which

applies the Section 13(d) defmition of beneficial owner for purposes

of both the reporting provision in Section 16(a).and the short-swing

profits provision in Section 16(b). The staff expressed an interpretive

rather than a no-action position: The staff does not issue no-action

letterS with resp~ct to the Section .16 rules as a ~atter of policy

. because the Commission does not have statutory authority to enforce

Section 16(b). However, the staffdoes respond to interpretive letter

requests that raise novel issues under the Section 16 rules.

The staff also stated in the letter that it would not recommend

enforcement action under Section 13(d) so long as the·directors

followed certain modified procedures for filing disclosure documents

under that provision.

-14

numbers and their small indiv idual holdi ngs. The court also found relev

involuntary nature of the share holde rs' agree ment . Here too, the court

the lock-up was an invol untar y condition of sale imposed by Quintel,

ant the

concl uded,

and the

shareholders each held only small amou nts of Quintel stock. Id; at"34

ARG UME NT

1."

tHE DISTRICT COU RT IMPR OPER LY RELIED ON THE GOL DMA N

SET

SACHS LETTER, WHI CH WAS REST RICT ED TO A NAR ROW

OF CIRC UMS TAN CES NOT PRES ENT IN THIS CASE .

In the Goldman Sach s letter, the Comm ission staff stated that a mana

director of the firm did not need to inclu de the shares held by other

ging

partie s to the

shareholders' agreement for the purpo se of determining the direc tor's

status as a

ten percent beneficial owne r unde r Rule 16a-l (a)(l) . Construing-that

letter , the

district court here stated that the staff

based its ruling in part on the share holde rs' lack of abilit y

to control Gold man Sachs beca use ofthe large numb er "

of Shareholders 'and their smal l individual holdings~

Similarly, each individual share holde r here owns a small

perce niage ()fQu intel stock . Altho ugh there are only three

shareholders in the alleged-group, there is no indic ation

that Stolz, Fede r and Linds ey had the ability, or comm on

objective, to exert influe nce over Quintel.

The court stated that

[a]ls() relev ant is wheth erthe PRN/ Quin tel Agre emen t was

voluntary. In the Gold man Sach s No-A ction Letter, the

-15

SEC also based its ruling on the involuntariness of the

shareholder agreement. * * * The partners and

employees at Goldman Sachs had to agree to the lock-up

and voting provisi~ns, or they could not receive their

shares of Goldman Sachs stQck. Similarly, the sale of

PRN's holding in New Lauderdale LLC would not have

occurred unless Stolz, Feder and Lindsey agreed to the

lock-up provisions.

72 F. Supp. 2d at 349.

The district court's reliance on the Goldman Sachs letter is overly broad and

misplaced. ~/

The staff viewed the facts presented to it as highly unusual, and

carefully limited the interpretive advice it gave Goldman Sachs to the facts

presented. 9/ Specifically, the staff was willing to advise Goldman Sachs that

The staff previously expressed similar interpretive views in letters to

two other investment banking firms under virtually the same facts

presented by Goldman- Sachs. See Morgan Stanley Group, Inc.,

SEC No-Action Letter [1991 Transfer Binder] Fed. Sec. L. Rep. CCH

79,681 (April 30, 1991); Alex Brown Inc., SEC No-Action Letter

[1991 Transfer Binder] Fed. Sec. L. Rep; CCH 79, 725 (July 22,

1991)." .

Comrriission no-action and interpretive letters are not official

expressions of the Commission's views and do not have the force of

law. See NYCERS v. SEC, 45 F.3d 7, 12-13 (2d Cir. 1995) .

(discussing nature and effects of no-action letters). These letters do,

however, "represent the views of persons who are continuously

working with the provisions of the statute involved," 17 C.F.R.

202.1 (d), and as such they are frequently relied on by interested

persons to provide guidance on the application ofthe securities laws

and rules thereunder.

-16

those persons covered by the shareholders' agreement need not aggregate their

shares to detennine their ten percent status under Section 16 because (1) the

participation of a party in the shareholders' agreement "is solely because of his or

her status as an employee" and, therefore, "essentially involuntary"; and (2) the

covered persons will be "too numerous" and their individual "holdings will be too

small, to permit any single Covered Person to exercise control" over the firm

through the shareholders' agreement. Goldman Sachs also represented to the staff

that information baiTiers would prevent the misuse of confidential information for

personal. trading.

The conditions imposed on the managing directors in Goldman Sachs were

essentially conditions of their employment. If they wished to continue in their

capacity as managing directors, they had to agree to the conditions on their stock

ownership. There was no collective investment motive for the conditions.

. Moreover, it was represented that virtually all the directors would each own one

percent or less ofthe shares covered by the shareholders' agreement and that none

ofthe directors would own more than one percent of the outstanding shares not

covered by the agreement. There were approximately 550 persons covered by the

agreement. Even though the shareholders' agreementrendered the shareholders a

beneficial ownership group for Section 13(d) purposes (which was not disputed),

-17

the circumstances made it clear that they were not, solely by virtue of their

participation in the shareholders' agreement, in a position to have access to inside

information about the company for Section 16 purposes. Accordingly, the staff

concluded that, in this very narrow situation, it was not necessary to apply the

Section 13(d) group test in determining whether a person was, solely by virtue of

participation in the shareholders' agreement, a ten percent beneficial owner for

purposes of Section 16.l.Q/

The facts of this case are very different. Unlike Goldman Sachs, here the

lock-up agreement was entered into in an investment transaction, rather than as a

condition to employment. Moreover, in contrast to the more than 500 shareholders

at issue in the Goldman Sachs letter, this cases involves only three shareholders

who together acquired 18 percent of the company's stock (A256). That scenario

presents a greater likelihood that the shareholders might collectively have access to,

and improperly use" inside. information.

10/

Reflecting the narrow scope of the staff's interpretation, the Goldman

Sachs letter added that the staff's position "does not extend to any

situation outside the Shareholders' Agreement where a [shareholder]

agreesto act together with any other person for the purpose of

acquiring, holding, voting, or disposing of shares of Common Stock."

Thus,the interpretive letter clearly intended that the Section 13(d) test

would apply to other agreements that a shareholder hador could enter

into.

-18

This is not to say that Stolz, Feder, and Lindsey necessarily·should be

treated as Section 16 insiders..But neither can it be concluded, merely on the basis

of the size of their holdings or on whether Quintel insisted on the lock-up provision,

that they were not. Unlike the Goldman Sachs situation, the facts here do not

. necessarily demonstrate that the shareholders would not be in a position to engage

in the activity with which Section 16 is concerned.

II.

A SECTION 13(d) BENEFICIAL OWNERSHIP GROUP MAY EXIST

EVEN IF IT DOES NOT HAVB A COMMON OBJECTIVE THAT IS

RELATED TO CORPORATE CONTROL.

The district court's decision focuses on whether Stolz, Feder, and Lindsey

had a purpose related to control of Quintel and can be construed as holding that a

Section 13(d) group must have as its purpose to take over an issuer or influence

corporate control. At the outset of its analysis the court recognized that members

of a Section 13(d) group might join together for purposes not related to corporate

control. The court noted that, in addition to a purpose to control the company or.,

influence its control, "courts have considered [the] common[] objective[] to control

the stock price * ** ." 72 F. Supp. 2d at 348.1.1/ The court, nevertheless, relied

ill

The district court also describes two cases where a Section 13(d)

group was found to exist without a purpose of corporate control. 72

F. Supp. 2d at 348. (discussing Lerner v. Millenco, 23 F. Supp.2d

(continued.. ~ )

-19

heavily on the absence of a·corporate control purpose in deciding that a Section

13(d) group did not exist. The courtwrote generally that "[t]here is no evidence

that Stolz, Feder and Idndsey were trying to effectuate a shift in corporate control

through the disposition of Quintel stock." Id. With regard to the acquisition of

Quintel shares specifically, the court stated that "although the sale ~as in exchange

for Quintel stock, the purpose of the agreement was not to acquire control of

Quintel." Id. ''Nor,'''the court continued, "is there any other evidence of an

agreement to attempt a corporate takeover."· Id. The court also emphasized that

the group did not seek to "influence" control:

Defendant Stolz did not agree with Feder and Lindsey to

use their stock to exert influence over Quintet * * * Even

combining Stolz's interest with the holdings of Feder and

Lindsey, the alleged group would own about 18% of

Quintel, and would be unable to exert substantial

influence over Quintel. Further, there is no evidence that

Stolz has attempted to exert influence over or get

involved in the management of Quintet

72 F. Supp. 2d at 348-49.

ll/(...continued)

337,344 (S.D.N.Y. 01998) (finding a group purpose to artificially .

maintain the price of the stock); Global Intellicom v. Thomson

Kernaghan & Co., [1999 Transfer Binder] Fed. Sec. L. Rep. CCH

90,534 (July 27 1999) (fmding a group purpose to decrease the value

of the stock).

-20

The district coures extensive reliance on the absence ofa control purpose

has caused its opinion to be interpreted as holding that a Section 13(d) group may

exist only where the group seeks corporate control or to influence corporate

control. 12/

'There is no doubt that ''the purpose of Section 13(d) is to require disclosure

of information by persons who have acquired a substantial interest, or increased

their interest in equitY securities of a company by a substantial amount, within a

relatively short time," S. Rep. No. 550, 90th Cong., 1st Sess 4 (1967), so that

investors might "assess the potential for changes in corporate control and

adequately evaluate the company's worth." GAF Corp. v. Milstein, 453 F.2d. 709,

717 (2d Cir. 1971), cert. denied, 406 U.S. 910 (1972). Nothing, however, in

12/

Two widely read commentators on Section 16 summarized the district

court's holding, in part, by stating:

[T]he'court indicated that a Section 13(d) group can exist only

where the parties have a common objective that may involve a

potential shift in corporate control. Because there was no

evidence that the three purported group members had a

COrnmon object.ive to effectuate a shift in corporate control

through the disposition of the issuer's stock, the court felt there

was no'basis under 13(d) to find the existence ofa group.

P. Romeo & A. Dye, Section 16 Updates Vol. IX, No.4 at 6 (Dec.

1999).

-21

Section 13(d) or the rules thereunder limits the defmition of beneficial owner to

persons who have a purpose of influencing control.

In specifically describing when a group of shareholders is the beneficial

owner of each group member's shares such that they should be aggregated, neither

Congress nor the Commission made any mention in Section 13(d) or Regulation

13D ofany requirement that shareholders come together for ~e purpose of

influencing control.;Rule 13d-5(b)(I) specifically provides that "[w]hen two or

more persons agree to· act together for purposes of acquiring, holding, voting or

disposing of equity securities of an issuer, the group formed thereby shall be

deemed to have acquired beneficial ownership * * * of all equity securities of that

issuer beneficially owned by any such persons ." The "touchstone of a group

within the meaning of Section 13(d)" as described by this Court is not control, but

"that the members combined in furtherance of a common objective." Wellman v.

Dickinson, 682 F.2d at 363. See also SEC v. Savoy, 587 F.2d 1149, 1162 (D.C.

Cir.), cert. denied,

440 U.S~913 (1978); Bath Industries. Inc. v. Blot, 427 F.2d 97,

111 (7th Cir. 1970). "All that is required is that the members of the group have

combined to further'a common objective with regard to" acquiring, holding, voting,

or disposing of securities. Moralesv. Freund, 163 F.3d at 767.

Moreover, 'Congress made it clear that Section 13(d) applies regardless of a

-22

control purpose, when it gave the Commission the authority to exempt from the

section acquisitions of stock "not entered into for the purpose of, and nothaving

the effect of, changing or influencing the control ofthe issuer or otherwise as not

comprehended within the purposes ofthis subsection." Thus, absent a

Commission exemption, transactions are within the scope of Section 13(d) even if

they do not involve a control purpose. SeeGAF Corp. v. Milstein, 453 F.2d 709,

719 n.20 (2d Cir. 1971) (recognizing the Commission's prerogative to exempt

persons not having a control purpose).

The Commission, however, has not adopted any such exemption. At most,

the Commission has only made it easier for certain persons not seeking control to

comply with the filing requirements ofthe Act. For example, when the

Commission adopted Regulation 13D, it allowed certain persons who are beneficial

owners of securities under Section 13(d) to file a short-form notice so long as the

person "acquired such securities in the ordinary course of his business and not

with the purpose or with the effect ofchanging or influencing the control of an

issuer." See Adoption of Beneficial Ownership Disclosure Requirements,

ExchangeAct Release No. 13291, 13 SEC Docket 1779 (Feb. 24, 1977). The

Commission expanded use 'ofthe short form (Schedule 13G) in 1998 to include

"paSsive investors" who are "not seeking to acquire influence or control of the

-23

issuer and who own less than 20 percent of the class of securities." Amendment to

Beneficial Ownership Reporting Requirements, Exchange Act Release No. 39538,

66 SEC Docket 902 (Jan. 12, 1998).

III.

AN AGREEMENT TO EXCHANGE AN ASSET FOR SECURITIES·

MAY MANIFEST A PURPOSE TO ACQUIRE THE SECURITIES.

The district court held that the PRN/Quintel Agreement was not an agreement

by the alleged group to acquire Quintel securities. In the court's view, Feder,

Lindsey, and Stolz acted for the purpose of selling New Lauderdale alone and not

for the purpose of acquiring Quintel shares. The court reasoned that ''the

PRN/Quintel Agreement was an agreement between two corporations to effectuate

a sale ofPRN's holdings in another company." 72 F. Supp. 2d at 348. And

"although the sale was in exchange for Quintel stock * * * [t]he only common

objective that Stolz, Feder and Lindsey shared was to sell PRN's holdings in New

Lauderdale LLC" Id.

...

:~.~

There is nothing in the record excerpts submitted to this Court, (which

apparently include all the papers put before the district court), to support the

conclusion that PRN's shareholders acted only for the purpose of selling New

Lauderdale. This is not a case where the evidence shows that the sole purpose was

to sell the asset and that acquiring Quintel stock was not even a partial purpose.

-24

The district court, rather, appears to have determined that as a matter oflaw a

group's acquisition of stock through a merger or a sale of an asset cannot

manifest an intention by the group to acquire securities and therefore (absent

another group purpose) it falls outside the scope ofSection 13(d). Yet, there is

nothing in Section 13(d) or the rules thereunder to support such a broad statement

of law. In fact, Rule 13d-5(a) is at odds with any such notion. That rule provides

that "[a] person who becomes a beneficial owner of securities shall be deemed to

have acquired such securities for ~e purposes of Section 13(d)( 1) of the Act,

whether such acquisition was through purchase or otherwise" (emphasis added).

That Stolz and the other two sellers may have been motivated in part by an

objective of selling their interest in New Lauderdale does not preclude their also

having as a common objective the acquisition of stock in Quintel. The two

objectives are not mutually inconsistent. We believe that the district court erred in

concludi~g that, as a matter of law, the agreement could never have rendered the

shareholders a Section 13(d) beneficial ownership group~

IV.

LOCK-UP PROVISIONS, IN APPROPRIATE CIRCUMSTANCES,

.MAY DEMONSTRATE AN AGREEMENT TO HOLD AND/OR

.DISPOSE OF SECURITIES.

The district court decided that the lock-up provisions in the PRN/Quintel

agreement did not constitute an agreement by Stolz, Feder and Lindsey to hold

-25

and/or dispose ofQuintel securities. In this regard, the court wrote that "[t]he

lock-up provisions here do not reflect the.objectives of Stolz, Feder, and Lindsey,

rather they· exist to protect Quintel and Quintel shareholders." Quintel, "not

defendant Stolz and the alleged group, was trying to affect -- i.e., protect -- the .

price of Quintel stock." 72 F.Supp. 2d at 348.

One reading ofthe district court's decision is that lock-up provisions when

insisted on by oneparty do not serve as a basis for fmding a Section 13(d) group·

purpose by those who do not initiate the provisions. Even this statement would be

overbroad. The mere fact that athitd-party insists on a lock-up provision does not

mean that the provision does not also manifest a common purpose among those

subject to its terms to hold securities. The fact that the lock-up was insisted on by

athird party may be a piece of evidence suggesting the absence of a group

purpose, but it will rarely be conclusive evidence.

In his briefbefore the districtcourt, h9wever, Stolz argues that "[p]laintiff's

suggestion that a lock-up agreementimposed on shareholders by an issller of

securities cause the shareholders to be beneficial owners of each other's shares is

also contrary to the longstanding practice of both the securities Bar and the SEC

with respect to such lock-ups." (Defendant's Memoran~um of Law In Ppposition

to Plaintiff's Motion for Summary,Judgment, p. 10)~ Stolz supports this statement

-26

· with an affidavit from Carl W. Schneider, Esq., who states that "[i]t is generally

understood that multiple stockholders who agree to * * * lock-ups do not, as a

consequence of such agreement, constitute a Section 13(d) 'group. '" Indeed, after

publication of the district court's decision in this case, two widely read

commentators on Section 16 stated even more broadly that the ''judgment that a

lock-up agreement does not result in the creation of a Section 13(d) group is

consistent with the SEC staffs longstanding position that such an agreement does

not give rise to Section 13(d) reporting obligation." P. Romeo & A. Dye, Section

· 16 Updates, Vol. IX, No.4 at 6 (Dec. 1999). Stolz, Schneider, and the

commentators appear to· assume that cilliock-up agreements proposed by a third

party are involuntarily imposed and that there is a Commission policy that such

· lock-up agreements can never create a Section 13(d) group. Id.; A184.

There is, however, no Commission policy that lock-up agreements cannot

lead to the creation of Section 13(d) groups. Nor could there be such a policy,

. .

because whether a lock-up provision creates a Section 13(d) group depends on the

specific facts and circumstances of any given case. There are situations where a .

lock-up agreement might constitute an ~greement by a group of shareholders to act

together for the purposes of acquiring, holding, or disposing of securities. For

example, lock-up' agreements e~tered into by an issuer and a group of shareholders

-27

.might serve to support the price of securities by keeping stock off the market at a

time when positive infol1Ilation about the issuer is circulating inthe media, thereby

benefitting both the-issuer and the shareholder group. Furthermore, lock-up

provisions also have the effect of making shares unavailable for sale to those who

might seek to compete for or to influence corporate control, an effect that could be

desired both by the issuer seeking to ward off unfriendly bids and by a shareholder

group seeking to ward off competitors.

While the district court's decision that the PRN/Quintel Agreement's lock-up

provisions did not constitute an agreement to act as a Section 13(d) group may be

correct, the purported Commission policy regarding lock-ups, as described in the

record in this case and by commentators, does not exist. It would be incorrect to

conclude that a lock-up agreement can never create a Section 13(d) group. Whether

a lock-up provision constitutes an agreement for the purposes of creating a Section

13(d) group depenqs on the facts and circumstances of any given case.

...

-28

CONCLUSION

The Commission urges the Court to correct the district court's reliance on

the Goldman Sachs no-action letter and to correct the analysis put forward by th~

district court as set forth above.

Respectfully submitted,

DAVID M. BECKER

General Counsel

ERIC SUMMERGRAD

Dep

olicit

Of Counsel

MEYER EISENBERG

Deputy General Counsel

March 2000

Securities and Exchange Commission

Washington, D.C. 20549-0606

(202) 942-0837

No. 99-9374

UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

RICHARD MORALES,

Plaintiff-Appellant,

QUINTEL ENTERTAINMENT, INC. and PETER STOLZ,

Defendants-Appellees.

On Appeal from the United States District Court

for

Southern District ofNew York

the

CERTIFICATE OF COMPLIANCE

I certify that the Brief of the Securities and Exchange Commission, Amicus

Curiae in Support of Appellants on Issue Addressed complies with the type volume

limitations of Federal Rule of Appellate Procedure 32(a)(7), and contains 6301

words in 14 point Times New Roman.

~.'

/&~~

Allan A. Capute

No. 99~9374

UNIT ED STAT ES COURT OF APPEALS

FOR THE SECOND CIRC UIT

RICHARD MOR ALE S,

Plain tiff-Appellant,

QUINTEL ENTE RTA INME NT, INC. and PETE R STOLZ,

Defendants-Appellees.

On Appe al from the United States District Court

for the Southern District ofNe w York

CERT IFICA TE OF SERVICE

ict of

I, Allan A. Capute, am a mem ber of the bars of Maryland and the Distr

served three

Columbia, and I hereby certif y that on March 24, 2000 I caused to be

us Curiae, In

copies of the Brief of the Securities and Exchange, Commission, Amic

ss to:

Support of Appellant on Issue s Addressed by ovem ightF edera l Expre

David Lopez, Esq.

171 Edge of the Woods Road

P.G.B ox 323

Southampton, New York 1196 8

Roger L. Waldman, Esq.

Moses & Singe r

1301 Avenue ofthe Amer icas

New York, New York 1001 9-607 6

Jay D. Lukowski, Esq.

Feder, Kaszovitz, Isaacson, Webber & Skala

450 Seventh Avenue

New York, New York 16123

A~u~

./. (202) 942-0837

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.