Petition — Allis-Chalmers Manufacturing Co. v. Gulf & Western Industries, Inc.
Supreme Court brief1976
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75-580 | i.
-
a
j OCT 4G his,
IN THE MICHAEL RODAK
Supreme Couwt of the United States :
Octrosper TERM, 1975
’ 25
———
Auuis-CHAaLMERS Manuracturine CoMPAny,
Petitioner,
—V.-—
Guutr & Western Inpvustrizs, Inc.,
Respondent.
PETITION FOR WRIT OF CERTIORARI TO THE
UNITED STATES COURT OF APPEALS
FOR THE SEVENTH CIRCUIT
=
———
S. Hazarp GILLESPIE
Counsel for Allis-Chalmers
Manufacturing Company
1 Chase Manhattan Plaza
New York, New York 10005
Tel. No.: (212) 422-3400
=~ oe eee
TABLE OF CONTENTS
PAGE
Opinions Below 1
Jurisdiction 2
Statute Involved 2
Question Presented 3
Statement of the Case 4
The Decision of the District Court 6
_ The Decision of the Court of Appeals ......... 7
Reasons for Granting a Writ of Certiorari 8
ConcLusIONn 15
APPENDICES:
I i a la
REISER Smee NOME att apo na HOE aI eo Oe 35a
F _ RGRERSIER Res aso fe nto SO Rg OR 75a
TaBLE OF AUTHORITIES
Cases:
Adler v. Klawans, 267 F.2d 840 (2d Cir. 1959) —...00.00...... 11
Kern County Land Co. v. Occidental Petroleum Corp.,
411 U.S. 582 (1973) .............
PAGE
Newmark vy. RKO General, Inc., 425 F.2d 348, cert.
Se ee Se GD cenicciscirteeenccatnieneerainscenicinion 11
Perine vy. William Norton & Co., 509 F.2d 114 (2d Cir.
ERS SRTIR SenAA Ce ey ote hr alin er bree ar OEE 11
Provident Securities Co. v. Foremost-McKesson, Inc.,
506 F.2d 601 (9th Cir. 1974), cert. granted, 420 U.S.
I a ca eens calacieaiiaasaaaanenin 7,9, 12
Reliance Electric Co. vy. Emerson Electric Co., 434
F.2d 918 (8th Cir. 1970), aff'd, 404 U.S. 418 (1972) .. 10,
11-12, 13
Stella v. Graham-Paige Motors Corp., 104 F.Supp. 957
(S.D.N.Y. 1952), aff'd in part, remanded in part,
232 F.2d 299 (2d Cir.), cert. denied, 352 U.S. 831
I dele ia geese ala el Ad 10
Statutes:
Securities Exchange Act of 1934, 15 U.S.C. et seq.
ee ee aa Ss TPO sisstesnhiieicsiacalshetilachhliestichishebalianciaiceiialncsian 4
§16(b), 15 U.S.C. § 78p(b) ...................... 2-3, 6, 7, 9, 10,
12, 13, 14
es Te A TIMI: ‘ciinseshicisescithalemsipinainnibinaniihltaiaiaintabbiats 6
Miscellaneous:
L. Loss, Securities Reauiation (2d ed. 1961) .............. 10
In THE
Supreme Court of the United States
Octoser Term, 1975
No. 75-.
i
Au.is-CHaLMers Manuracturine Company,
Petitioner,
—_—vV—
Gutr & Western Inpvusrtuiss, Inc.,
Respondent.
— >
PETITION FOR WRIT OF CERTIORARI TO THE
UNITED STATES COURT OF APPEALS
FOR THE SEVENTH CIRCUIT
Petitioner Allis-Chalmers Manufacturing Company
(“Allis-Chalmers”) prays that a writ of certiorari issue
to review the judgment of the United States Court of
Appeals for the Seventh Circuit entered on September 29,
1975.
Opinions Below
The opinion of the United States Court of Appeals for
the Seventh Circuit, rendered on September 29, 1975 and
as yet unreported, is set forth in Appendix A hereto. The
opinion of the United States District Court for the North-
ern District of Illinois is reported at 372 F.Supp. 570 (N.D.
Ill. 1974), and is set forth in Appendix B hereto.
Jurisdiction
The judgment of the Court of Appeals was entered on
September 29, 1975. Prior to the entry of judgment, the
Court of Appeals sua sponte circulated the opinion among
all the active judges of that court because, as was candidly
acknowledged, the court “adopt[ed] a position on an issue
as to which a conflict between circuits exists”. 6a n.5.*
A majority of the active judges did not request rehearing
en banc, Chief Judge Fairchild and Judge Cummings vot-
ing for rehearing. This Court has jurisdiction pursuant to
28 U.S.C. § 1254(1).
Statute Involved
Section 16(b) of the Securities Exchange Act of 1934,
48 Stat. 896, 15 U.S.C. § 78p(b), provides:
“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,
f 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, irre-
spective of any intention on the part of such bene-
ficial owner, director, or officer in entering into such
transaction of holding the security purchased or of
* Citations to “a” are to the Appendices attached hereto.
not repurchasing the security sold for a period ex-
ceeding six months. Suit to recover such profit may
be instituted at iaw or in equity in any court of com-
petent 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.”
Question Presented
Is the purchaser of approximately 29% of the registered
equity securities of an issuer, who prior thereto owned
no such securities but who within six months after the
purchase “voluntarily disposes of” the securities, liable
under Section 16(b) of the Securities Exchange Act of
1934, 48 Stat. 896, 15 U.S.C. §78p(b), to the issuer for
all short-term profits realized?
Statement of the Case
Petitioner Allis-Chalmers is a Delaware corporation
whose common stock was at all relevant times registered
pursuant to the provisions of Section 12 of the Securities
Exchange Act of 1934 (the “1934 Act”), 15 U.S.C. §781.
Respondent Gulf & Western Industries, Inc. (“Gulf &
Western”), also a Delaware corporation, is a conglomerate
which “had bought and sold controlling interests in a
number of corporations” prior to its initial purchase of
Allis-Chalmers stock. 2a n.1.
In May 1968 Gulf & Western was interested in acquiring
a substantial portion of the outstanding common stock of
Allis-Chalmers. Respondent’s chairman, Mr. Bludhorn, and
president, Mr. Judelson, notified the chairman of Allis-
Chalmers, Mr. Stevenson, that respondent was considering
acquiring stock in petitioner by means of an exchange, and
the next day informed petitioner that Gulf & Western
would seek to effect the purchase of 3,000,000 shares of
Allis-Chalmers stock by means of an exchange offer.
On July 1, 1968 respondent formally offered to purchase
3,000,000 shares of Allis-Chalmers common stock for a
package of cash, subordinated debentures and warrants.
These 3,000,000 shares represented approximately 29% of
the then outstanding Allis-Chalmers common stock. The
exchange offer was fully subscribed to on July 19, 1968,
and respondent’s shareholders approved the offer on July
29, 1968. Prior to its purchase of these 3,000,000 shares
of Allis-Chalmers, Gulf & Western owned none of peti-
tioner’s common stock.
5
Subsequent to the purchase of this 29% block of Allis-
Chalmers common stock, respondent entered into an
agreement in August 1968 with Oppenheimer Fund, Inc.
(“Oppenheimer”) whereby respondent would acquire an
additional 248,000 shares of Allis-Chalmers common stock
held by Oppenheimer. Gulf & Western’s purchase of this
block of stock occurred on September 30, 1968.
In the period subsequent to its agreement to acquire
the second block of Allis-Chalmers common stock, respon-
dent underwent a change of heart as to the attractiveness
of owning 3,248,000 shares of Allis-Chalmers stock. The
Court of Appeals wrote:
“On September 13, 1968 Allis-Chalmers chairman
Stevenson had on his own initiative met with Bludhorn
and Judelson of Gulf & Western and had, according
to his recollection at trial, told them that things did
not look good for Allis-Chalmers. He refused to quan-
tify the bad news for the Gulf & Western representa-
tives in response to their specific questions, but he
clearly disclosed to them his personal negative evalu-
ation of the situation at Allis-Chalmers. Stevenson’s
notes for this meeting reflected his belief at that time
that the Gulf & Western people were ‘getting nervous’
about their block of stock in Allis-Chalmers. At trial,
Stevenson testified that he ‘had the feeling right then
[at the September 13, 1968 meeting] that they were
thinking about disposing of it.” 4a n.4.
On the very day of its purchase of the block of Allis-
Chalmers stock from Oppenheimer, Gulf & Western com-
menced negotiations with White Consolidated Industries,
Inc. (“White”) for the sale to White of the entire block
of 3,248,000 Allis-Chalmers shares owned by respondent.
On October 31, 1968 respondent and White reached agree-
ment, and on December 6, 1968 Gulf & Western sold its
entire block of 3,248,000 shares of Allis-Chalmers stock
to White. Therefore, within a period of less than six
months, Gulf & Western had first purchased in two large
blocks and then, after apparently “getting nervous” over
the prospects of Allis-Chalmers, sold in a single transaction
3,248,000 shares of Allis-Chalmers registered common
stock. :
The Decision of the District Court
On January 6, 1969 petitioner commenced suit against
Gulf & Western, pursuant to Section 27 of the 1934 Act,
to recover pursuant to Section 16(b) the short-swing profits
that Gulf & Western realized on the two purchases and
single sale within less than six months of 3,248,000 shares
of Allis-Chalmers common stock. A non-jury trial resulted
in a judgment against Gulf & Western in the amount of
$1,135,858, the amount the District Court calculated to have
been Gulf & Western’s profits on the two purchases and
single sale of all 3,248,000 shares of Allis-Chalmers stock.
The District Court held that respondent was a “beneficial
owner” within the meaning of Section 16(b) when it made
its initial exchange offer purchase of approximately 29%
of petitioner’s common stock, and, in accord with rulings
of the Courts of Appeals for the Second and Eighth Cir-
cuits and decisions of this Court, construed the proviso of
Section 16(b) exempting “any transaction where such bene-
ficial owner was not such both at the time of purchase and
sale” as not applying to Gulf & Western’s initial purchase
of more than 10% of the listed equity securities of Allis-
Chalmers.
The Decision of the Court of Appeals
Both petitioner and respondent appealed to the Court of
Appeals for the Seventh Circuit. Prior to the decision
of the Court of Appeals for the Ninth Circuit in Provident
Securities Co. v. Foremost-McKesson, Inc., 506 F.2d 601
(9th Cir. 1974), cert. granted, 420 U.S. 923 (1975), Gulf
& Western principally argued that Section 16(b) did not
apply to the purchases and sale involved in this case,
relying on the decision of this Court in Kern County Land
Co. v. Occidental Petroleum Corp., 411 U.S. 582 (1973).
After the decision of the Ninth Circuit, Gulf & Western
contended that it was not liable under Section 16(b) for
profits realized on the sale of the initial 3,000,000 shares
of Allis-Chalmers stock it purchased in July and sold in
December 1968. Gulf & Western’s position was that be-
cause it owned no such stock prior to its exchange offer
purchase, it was not a beneficial owner “both at the time
of the purchase and sale” and therefore was exempt under
the proviso of Section 16(b) from liability for the short-
swing profits that it had realized.
The Court of Appeals for the Seventh Circuit relied heav-
ily on the decision of the Ninth Circuit in Provident Securi-
ties Co. v. Foremost-McK esson, Inc., 506 F.2d 601 (9th Cir.
1974), cert. granted, 420 U.S. 923 (1975), as well as the
language of a Senate bill that was left aside in favor of
the present Section 16(b). The Seventh Circuit held that
Section 16(b) only applies to “beneficial owners” who,
after already owning 10% of the securities of an issuer,
thereafter realize profits from the purchase and sale
within six months of additional shares. The Court, as
noted above, candidly acknowledged “that a contrary view
8
has been taken in the Second and Fighth Circuits” and
that “a conflict between circuits exists.” 6a n.5.
Respondent further argued to the Seventh Circuit ‘iat
its second purchase of stock (from Oppenheimer) on Sep-
tember 30, 1968 was such an integral part of the original
exchange offer that the test utilized by this Court in Kern
County Land Co. v. Occidental Petroleum Corp., 411 U.S.
582 (1973), must be applied and that respondent should
not be liable for the short-swing profits realized from the
purchase and sale of that block of stock. The Court of
Appeals rejected this contention, holding that the Oppen-
heimer transaction was neither “an unorthodox transac-
tion” nor devoid of the possibility of speculative abuse.
Petitioner Allis-Chalmers appealed to the Seventh Cir-
cuit on the ground that the District Court had improperly
calculated the extent of respondent’s short-swing profits.
The Court of Appeals agreed, holding after detailed anal-
vsis of the evidence that respondent had in fact realized
profits of $2,465,680.47 from the purchase from Oppen-
heimer and sale to White of the block of 248,000 shares
of Allis-Chalmers stock.
Reasons for Granting a Writ of Certiorari
A writ of certiorari should issue to review the judgment
of the Court of Appeals for the Seventh Circuit because
that court has rendered a decision which conflicts with
decisions of the Courts of Appeals for the Second and
Eighth Cireuits. The importance of this federal question,
concerning the applicability or inapplicability of this re-
medial statute to far from unusual circumstances, cannot
be contested in view of the grant of a writ of certiorari in
9
Foremost-McKesson, Inc. v. Provident Securities, Inc., 420
U.S. 923 (1975).
Prior to the decision of the Court of Appeals herein, both
Allis-Chalmers and Gulf & Western moved for and were
granted leave by this Court to file briefs amici curiae in
support, respectively, of petitioner’s petition for certiorari
and respondent’s opposition thereto in l’oremost-McKesson,
Inc. v. Provident Securities Co., Docket No. 74-742. While
the question presented by the instant petition is likely to be
decided in Foremost-McKesson, that case may involve the
resoiution of additional questions not here presented. Allis-
Chalmers’ motion for leave to file an amicns brief is in-
cluded herein as Appendix C.
The narrow question presented here is the construction
of the phrase “at the time of” in the exemption for “bene-
ficial owners” provided in Section 16(b). Simpiy stated,
the question is whether a person must first own 10% of the
securities of an issuer and then purchase and sell additional
shares within six months before short-swing profits must
be disgorged. The plain statement of this discrete question
completely conceals, however, the profoundly broad prac-
tical impact that its resolution encompasses. Does this “pro-
phylactic” statute preclude an issuer from recovering ap-
proximately $10,000,000 of short-swing profits realized
from the purchase and sale within six months of 29% of
the listed securities for the calculated or fortuitous reason
that the beneficial owner purchased all such stock in one
transaction?
If there is any concern as to what Congress did mean
when it limited the coverage of the statute to situations
- where the beneficial owner is a 10% owner “both at the time
of the purchase and sale, or the sale and purchase”, Allis-
Chalmers suggests that this Court supplied the answer in
10
Reliance Electric Co. v. Emerson Electric Co., 404 U.S. 418,
423 n.3 (1972). There this Court cites with approval 2
L. Loss, Securities Recutation 1060 (2d ed., 1961) with
respect to step sales. Professor Loss’ <ull text covers both
step purchases and step sales.
“A substantial ‘out’ nevertheless remains for the 10
percent holder: If a person who is not an insider wants
to acquire up to, say, 15 percent, he should buy up to
just under 10 percent in one transaction (which will
be exempted even under the court’s construction [in
Stella v. Graham-Paige Motors Corp.,infra]) and then
buy the remaining 5-plus percent in a separate trans-
action. Conversely, a person who owns 15 percent and
wants to sell down to 5 percent should sell 5-plus per-
cent in one transaction and then, after he becomes a
holder of slightly less than 10 percent, sell out the
remainder.”
As recognized by the Court of Appeals in the instant
case, the Second Circuit consistently has held for 19 years
that “at the time of” does not mean “prior to” but “simul-
taneously with”, and that a person is a “beneficial owner”
“at the time of” the purchase if more than 10% of a class
of registered equity securities are purchased. This con-
struction was first applied in Stella v. Graham-Paige Motors
Corp., 104 F.Supp. 957 (S.D.N.Y. 1952), aff’d on this point,
232 F.2d 299 (2d Cir.), cert. denied, 352 U.S. 831 (1956).
To construe “at the time of” as meaning “prior to” would
permit exactly the type of “in and out” profit-taking See-
tion 16(b) was intended to prevent and that has oceurred
in this case.
The reasons favoring such a construction of Section
16(b) obviously promote the purpose of the 1934 Act. As
11
stated by the Chief Justice in Adler v. Klawans, 267 F.2d
840 (2d Cir. 1959):
“Most recently in Stella v. Graham-Paige Motors
Corp., supra, this court gave approval to the District
Court’s holding that the purchase which makes a per-
son a 10% beneficial owner may be included notwith-
standing the express proviso. All three of these cases
underscored, either expressly or impliedly, Judge
Clark’s statement in the Smolowe case that:
‘The statute is broadly remedial. Cf. Wright v.
Securities and Exchange Commission, 2 Cir., 112
F.2d 89. Recovery runs not to the stockholder, but
to the corporation. We must suppose that the statute
was intended to be thoroughgoing, to squeeze all
possible profits out of stock transactions, and thus
to establish a standard so high as to prevent any
conflict between the selfish interest of a fiduciary
officer, director, or stockholder and the faithful per-
formance of his duty.’” 267 F.2d at 846 (footnote
omitted).
The Second Circuit has consistently followed this construc-
tion of the phrase “at the time of”. Perine v. William
Norton & Co., 509 F.2d 114, 118 (2d Cir. 1974); Newmark
v. RKO General, Inc., 425 F.2d 348, 355-56 (2d Cir.),
cert, denied, 400 U.S. 854 (1970).
The holding of Stella was adopted by the Eighth Circuit
in Emerson Electric Co. v. Reliance Electric Co., 434 F.2d
918 (8th Cir. 1970), aff'd on other grounds, 404 U.S. 418
(1972). The Court of Appeals there observed that:
“[a]ny other view [of the meaning of the phrase ‘at the
time of’] has the weakness of impracticability of appli-
é
12
cation of the statute, a result we should not lightly
attribute to a Congress striving to prevent what it
considered to be highly undesirable speculations by
certain security owners who are in position to obtain
or to be exposed to that kind of inside information
lending itself to speculative use to the possible detri-
ment of the public.” 434 F.2d at 924.
Despite this Court’s observation that “the legislative
history [of Section 16(b)] affords no explanation of the
purpose of the proviso”, Reliance Electric Co. v. Emerson
Electric Co., 404 U.S. 418, 424 (1972), the Ninth Circuit
in Provident Securities Co. v. Foremost-McKesson, Inc.,
506 F.2d 601 (9th Cir. 1974), cert. granted, 420 US. 923
(1975), purported to find legislative history supporting .
construction of “at the time of” as meaning “prior to ;
As set forth fully in Allis-Chalmers’ brief as amicus curiae
in support of Foremost-McKesson, Inc.’s petition for a writ
of certiorari, reproduced in Appendix C hereto, the Ninth
Circuit reached this conclusion on the basis of language
contained in a Senate bill which was never enacted. As
shown in Allis-Chalmers’ amicus brief, the legislative his-
tory of the House bill, which was the lineal prececessor
of Section 16(b), supports petitioner’s position. The House
bill was introduced almost a month after the hearings on
a Senate bill upon which the Ninth Circuit erroneously
relied in reaching its construction of the proviso of Sec-
tion 16(b). See 87a-92a.
In the present case, the Seventh Circuit stated that it
agreed with much of the Ninth Cireuit’s analysis of pen
legislative history, thereby perpetuating that Court's
erroneous construction of Section 16(b). 15a-19a. Allis-
Chalmers submits that, to the extent relevant legislative
sr ge 2 be
13
history exists, it supports the position of the Second and
Eighth Circuits that Congress intended to bar an insider
from retaining the tyne of short-swing profits realized
here by Gulf & Western.
As is obvious from the facts of this ease, Gulf &
Western’s reliance on Kern County Land Co. v. Occidental
Petroleum Corp., 411 U.S. 582 (1973), is entirely misplaced.
That the decision therein, involving an involuntary, forced
disposition of the shares as part of a corporate reorgani-
zation, is inapposite requires no extended comment. Even
the Court of Appeals for the Seventh Cireuit, in the
present case pointed out that Gulf & Western
“voluntarily disposed of the [Allis-Chalmers] shares
within six months, after obtaining an indication from
Allis-Chalmers’ chairman that the future of that com-
pany did not look any too bright. The possibility
clearly existed, therefore, that Gulf & Western’s early
disposition of its Allis-Chalmers shares was an at-
tempt to avoid the effect of the predicted weakening
of Allis-Chalmers’ common stock, a prediction gained
as an insider of that company.” 24a (emphasis in
original).
This Court stated in Reliance Electric Co. v. Emerson
Electric Co., 404 U.S. 418, 424 (1972) :
“To be sure, where alternative constructions of the
terms of §16(b) are possible, those terms are to be
given the construction that best serves the congres-
sional purpose of curbing short-swing speculation by
corporate insiders”. (Footnote omitted.)
Clearly the situation in which a corporation makes an
initial purchase of almost 29% of the common stock of
14
another and sells the entire block within six months at
a handsome profit constitutes exactly the opportunity for
short-term speculation Congress intended to prevent by
enacting Section 16(b). The applicability of Section 16(b)
would be severely if not fatally curtailed with respect
to a variety of situations in which Congress attempted
by means of a flat rule to prevent the possibility of “the
unfair use of information”. The construction of Section
16(b) adopted by the Courts of Appeals for the Seventh
and Ninth Circuits not only does plain violence to the
Congressional purpose underlying Section 16(b) but can-
not logically be found in the statute or gleaned from the
legislative history. The conflict among the Courts of Ap-
peals over the construction of a statute prescribing
important national policy must, and can only be, resolved
by this Court.
ete et BU ees ees
15
CONCLUSION
For the reasons set forth above, petitioner Allis-Chalmers
Manufacturing Company prays that a writ of certiorari
issue to review the judgment of the Court of Appeals for
the Seventh Circuit, or, in the alternative, that this Court
withhold action on this petition pending the decision of
this Court in Foremost-McK esson, Inc. v. Provident Securi-
ties Co., Docket No. 74-742, and thereafter dispose of this
petition in accordance with any decision therein which may
control the issue presented by this petition.
Dated: October 16, 1975
Respectfully submitted,
S. Hazarp GILLEsPIE
Counsel for Allis-Chalmers
Manufacturing Company
1 Chase Manhattan Plaza
New York, New York 10005
Tel. No.: (212) 422-3400
———— = ra
la
APPENDIX A
Opinion of the United States Court of Appeals
for the Seventh Circuit
In the
inited States Court of Appeals
For the Seventh Circuit
Nos. 74-1266 and 74-1267
Auuis-CHaLMens Manvuracturinc Comraxy,
a Delaware Corporation,
Plaintiff-A ppellant,
v.
Gutr & Western Inpvstaiss, Ixc.,
a Delaware Corporation,
Defendant-A ppellee.
“— from the United States District Court for the
orthern District of Illinois, Eastern Division—
No. 70 C 513
James B. Parsons, Judge.
ArGuep January 14, 1975 — Decivep SEPTEMBER 29, 1975
Before CiarK, Associate Justice (Retired),*° Swycert
and Pe.., Circuit Judges.
Swycert, Circuit Judge. This appeal presents several
issues concerning the proper construction of section 16(b)
of the Securities Exchange Act of 1934, 15 U.S.C.
§ 78p(b). The section, which seeks to prevent misuse of
internal corporate information, requires certain statutorily
defined corporate insiders to remit to their corporation
any profits realized as a result of any transaction con-
sisting of a purchase and subsequent sale, or sale and
*The Honorable Tom C. Clark, Associate Justice (Retired) of the
Supreme Court of the United States, is sitting by designation.
74-1266, 74-1267 2a
repurchase, which is completed within six months. Included
among the insiders covered by the section are owners
of more than ten percent of any class of equity security
_registered under the provisions of section 12 of the
Act, 15 U.S.C. § 78(l). In this case we must determine
whether the section applies to an initial purchase of
more than ten percent of a covered security by one who
was an outsider until that purchase was consummated.
In addition we must decide whether the facts in this
case so completely preclude the possibility of misuse
of inside information that application of the section to
this type of transaction could serve no purpose. Finally,
uestions exist as to the proper method of determining
the profits realized where a violation is found.
In May of 1968, Gulf & Western Industries, Inc.' began
actively to contemplate the acquisition of a substantial
interest in Allis-Chalmers Manufacturing Company.’ In
this connection, Charles G. Bludhorn, chairman of the
board of Gulf & Western, and David N. Judelson, its
president, contacted Robert S. Stevenson, the chairman of
the board at Allis-Chalmers. First contact was made on
~~ 6, 1968. Bludhorn and Judelson indicated that Gulf
& Western was considering an exchange offer and that
they would keep Stevenson advised as these plans
developed. On the following day Stevenson was informed
that an exchange offer would immediately be announced
by Gulf & Western, pursuant to which Gulf & Western
would seek to acquire 3,000,000 shares of Allis-Chalmers
common stock in return for a per share consideration of
$11.50 cash plus $12.50 principal amount of a Gulf &
Western six percent subordinated debenture due in 1988
plus 9/10 of a ten-year registered Gulf & Western war-
rant to purchase Gulf & Western common stock at fifty-
five dollars per share.
The offer was formally made through a prospectus
dated July 1, 1968. By its terms, Gulf & Western agreed
1Gulf & Western is a Delaware corporation engaged in diversified
pursuits including manufacturing, distribution, mining, agricultural, and
other operations. The record indicates that prior to the transaction here
involved, Gulf had bought and sold controlling interests in a number of
* Allis-Chalmers is a Delaware corporation whose common stock is,
and was at all relevant times, registered on the New York Stock Ex-
change pursuant to 15 US.C. § 78(1).
3a 74-1266, 74-1267
to accept Allis-Chalmers shares tendered prior to July
19, 1968 on a pro-rata basis up to a total of 3,000,000
shares accepted. If less than 3,000,000 shares were ten-
dered by July 19th, then Guif & Western further agreed
te accept additional shares thereafter on a “first-come,
first-served hasis,” up to the 3,000,000 limit. The offer
was subject to the approval of the Gulf & Western stock-
holders at a meeting to be held on July 29, 1968, and
was to expire in any event on July 30, 1968 unless ex-
tended prior thereto by Gulf & Western. All tenders of
Allis-Chalmers stock were to be irrevocable by the tender-
ing party. The offer was fully subscribed by July 19, 1968
so that no shares tendered thereafter could be accepted
under the terms of the offer, no extension having been
made by Gulf & Western. The shareholders of Gulf &
Western approved the offer on July 29, 1968.
After this initial acquisition, on August 28, 1968, Gulf
& Western entered into an agreement with Oppenheimer
Fund, Inc. whereby they would acquire 248,000 additional
shares of Allis-Chalmers stock owned by Oppenheimer
in return for 496,000 warrants for the purchase of Gulf
& Western common stock. The closing date for the agreed
exchange was to be September 30, 1968. The warrants
were not to be registered initially, but according to the
agreement Gulf & Western was to file a registration state-
ment for these warrants and for the shares of Gulf &
Western stock to be issued thereunder on or before
April 30, 1969. Iw addition, Gulf & Western agreed that
if the registration statement became effective later than
December 31, 1968, it would guarantee an average ‘per
warrant price of $13.50 for anv warrants sold by Oppen-
heimer within ninety days after actual registration. This
was to be accomplished either by a payment from Gulf
& Western of the difference between the average sale
price and $13.50, or by Gulf & Western supplying a pur-
chaser willing to take the warrants at the guarantee price
or better.’ This exchange was carried out, the closing being
held on September 30, 1968. The registration statement
*The agreement provided that if the guarantee were invoked Gulf &
Western would have three business days during which to find a pur-
chaser willing to pay a higher price than the price at which Oppenheimer
intended to sell the warrants. If no such purchaser was found, then
Oppenheimer would be free to sell and to seck a cash payment under
the guarantee for all shares sold during the ninety-day period.
- _
a ”
——
*
74-1266, 74-1267 4a
did not become effective until after December 31, 1968,
and after an agreed extension of the guarantee period,
Oppenheimer in fact sold 487,500 warrants subject to the
guarantee and obtained a payment thereunder from Gulf
& Western in the amount of $2,154,437.50 on June 5, 1969.
One month after the Oppenheimer acquisition, on
October 31, 1968, Gulf & Western reached an agreement
with White Consolidated Industries, Inc. whereby White
would purchase Gulf & Western’s entire holding in Allis-
Chalmers, which at this point consisted of 3,248,000 shares
of Allis-Chalmers common stock. This agreement was the
' result of negotiations between Gulf & Western and White
which had commenced with a meeting between Mr. Bludhorn
and White representatives on September 30, 1968, the very
day that the Oppenheimer exchange was closed.‘ The White
acquisition was consummated on December 6, 1968. Gulf
& Western received in return for its Allis-Chalmers stock
250,000 unregistered shares of White common stock plus
$20,000,000 in cash plus a 180-day promissory note at
8.5 percent interest in the face amount of $93,680,000. The
promissory note was given in lien of cash pursuant to
& payment option in the October 31, 1968 agreement with
Gulf & Western and was in fact redeemed with interest
by White on March 20, 1969.
On January 6, 1969 this action was commenced by
Allis-Chalmers in the Eastern District of Wisconsin.
On motion of Gulf & Western the cause was transferred
to the Northern District of Illinois. 309 F. Supp. 75 (1.D.
Wis. 1970). A trial was conducted without a jury, and
Gulf & Western ‘was held liable to Allis-Chalmers for all
profits realized as a result of the purchase and sale of
all 3,248,000 shares of Allis-Chalmers stock. Profits were
found by the district judge in the amount of $1,135,838.00
and judgment was entered against Gulf & Western and in
*On September 13, 1968 Allis-Chalmers chairman Stevenson had on his
own initative met with Bludhorn and Judelson of Gulf & Western and
had, according to his recollection at trial, told them that things did not
look £ for Allis-Chalmers. He refused to quantify the bad news for
the lf & Western representatives in response to their specific ques-
tions, but he clearly disclosed to them his personal negative evaluation
of the situation at Allis-Chalmers. Stevenson's notes for this meeting
reflected his belief at that time that the Gulf & Western ple were
nervous” about their block of stock in Allis-Chalmers. At
trial, Stevenson testified that he “had the feeling right then [at the
~ eed 13, 1968 meeting) that they were thinking about disposing
5a 74-1266, 74-1267
favor of Allis-Chalmers in this amount. 372 F.Supp 570
(N.D. Ill. 1974). Both parties appeal from this judgment.
I
The first question we must resolve is whether the
transaction consisting of initial acquisition of 3,000,000
shares of Allis-Chalmers common stock and its subsequent
sale by Gulf & Western falls within that class of
transactions subject to section 16(b) of the Securities
Exchange Act. Tha? section provides in relevant part:
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 pur-
chase, of any equity security of such issuer (other
than an exempted security) within any period of
less than six months . .. sliall inure to and be re-
coverable by the issuer, irrespective of any inten-
tion on the part of such beneficial owner, director,
or officer in entering into such transaction of hold-
ing the security purchased or of not repurchasing
the security sold for a period exceeding six montlis.
. 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 vr transactions which the Com-
mission by rules and ~gulations may exempt as not
comprehended within the purpose of this subsection.
The term “beneficial owner” is defined in section 16(a)
and includes “[e]very person who is directly or indirectly
the beneficial owner of more than 10 per centum of any
class of any equity security . . . registered pursuant to
[15 U.S.C. § 78(1l)}.” ,
There is nothing in the record to indicate that prior
to the July 1968 exchange offer Gulf & Western had any
legally significant relationship with Allis-Chalmers. Only
when the July acquisition was completed did Gulf & West-
ern become a “bencficial owner” within the meaning of sec-
tion 16(b). Thus, there is no possibility under the facts
of this case that Guif & Western could have made “unfair
use of information . .. obtained . . . by reason of [its]
74-1266, 74-1267 6a
relationship to [Allis-Chalmers]” until after the initial ac-
quisition. The precise question is therefore whether section
16(b) applies to a purchase/sale short-swing transaction
where the decision to initiate the transaction (1.c., purchase
the stock) could not have been premised on use of infor-
mation obtained through a section 16(a) insider relation-
ship with the issuing company. We are mindful, how-
ever, that the intent and purpose of legislation “must
[be] glean[ed} from the statute as a whole rather than
from isolated parts.” Adler v. Alawans, 267 Ic S40,
$44 (2d Cir. 1959). We therefore have examined the
language of section 16(}) in its totality. This exaimmation,
and a consideration of the legislative development of
section 16(b) convinces us that the statute was never
intended to reach such a transaction.
A
We realize that a contrary view has been taken in the
Second and Eighth Circuits. On the other hand, the Ninth
Circuit has recently decided this issue consistent with our
interpretation, based on a thorough review of the legisla-
tive history of section 16(b).* A diseussion of these con-
flicting precedents is pertinent.
SSince Part I of this opinion adopts a Fs agape on an issue as to
which a conflict between circuits exists, is opinion has_ been cir-
culated to all the active judges of the court. A majority of the
active judges have not requested a rehearing en banc, and no re-
hearing will be held, pursuant to Internal Rule 2.
Judge Philip W. Tone has disqualified himself from any considera-
tion of this case and has asked that this fact be noted.
Chief Judge Thomas E. Fairchild and Judge Walter J. Cummings
have asked that their votes in favor of rehearing be noted.
Judge John Paul Stevens has asked that his separate views be noted:
STEVENS, Circuit Judge. Although I voted against a rehearing en
banc because I agree with Judge Swygert’s basic conclusion that
the fact of critical importance is the controlling person's presumed
access to inside information at the time of his decision either to
buy or to sell, I do not agree with his reading of the clause
making §16(b) inapplicable to “any transaction where such bene-
ficial owner was not such both at the time of the purchase and
sale, or the sale and purchase, of the security involved... .” I
think the word “both” refers to both times, that is, the time of
purchase and the time of sale, rather than to both a purchase-sale
and a sale-purchase. The word “or” in the clause, as well as the
Supreme Court’s holding in Reliance Electric Co. v. Emerson
Electric Co., 404 U.S. 418, require this reading. This reading is not
contrary to Judge Swygert’s holding because Gulf & Western
was a controlling person both at the time of its purchase of the
348,000 shares and also at the time of its sale of those shares.
Ta 74-1266, 74-1267
In Stella v. Graham-Paige Motors Corp., 104 F. Supp.
957 (S.D.N.Y. 1952), recognized as law of the case, 132
F.Supp. 100 (S.D.N.Y. 1955), aff'd in part, remanded in
part on other grounds, 232 V.2d 299 (2d Cir. 1956), cert.
denied, 302 US. 831 (1956), District Judge Samuel 11.
Kaufman was confronted with the following facts. In 1945
the Kaiser-Il'razer Corporation was organized. Its capital
structure consisted of 500,000 shares of common stock, half
of which were owned by Graham-Paige Motors Corpora-
tion. In that same year Kaiser-Frazer issued 1,700,000 new
shares of common stock, bringing the proportional Graham-
Paige interest down from fifty percent to 11.34 percent.
On January 23, 1946 IXaizer-l'razer issued 1,800,000 ad-
ditional shares. This cut the Graham-Paige interest down
to 6.25 percent, or well below the level constituting section
16 (b) beneficial ownership. About a year later, on Feb-
ruary 10, 1947, Graham-Paige purchased 750,000 additional
shares of Kaiser-Frvazer stock. With the completion of this
acquisition, Graham-Paige was once again a beneficial
owner, with holdings constituting twenty-one percent of
Kaizer-Frazer stock. One dav less than six months later,
on August 9, 1947 Graham-Paige sold 155,000 shares of
Kaiser-Frazer common stock. A stockholder of {Kaiser-
Frazer brought suit on behalf of that corporation to recov-
er any profit from that sale. —
Judge Kaufman held that the purchase on February 10,
1947 by which defendant Graham-Paige resumed its bene-
ficial owner status could be matched with the sale of
August 9, 1917 to constitute a section 16 (b) transaction
even though Grahain-Paige was not a beneficial owner im-
mediately prior to the February purchase. He based this
determination on an “ambiguity” in the exemption lan-
guage contained in section 16 (b). That language reads:
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. .. .
Judge Kaufman saw two reasonable interpretation; of
the words “at the time of” as used in this passage. He
noted that these words coull mean “prior to” as defen-
dant contended, or “simultancousty with” as urged by the
74-1266, 74-1267 8a
plaintiff and the Securities and Exchange Comission, as
amicus. Recognizing that the Congressional purpose behind
section 16 (b) was “to protect the outside stockholders
against at least short-swing speculation by insiders with
advance information” 104 I’. Supp. at 959 [citations omit-
tedjJ, he adopted the “simultaneously with” construction
and held Graham-Paige lable. Judge Kaufman based his
holding in part on the fear that the “prior to” interpreta-
tion would aliow “a person to purchase a large block of
stock, sell it out until his ownership was reduced to less
than ten percent, and then repeat the process, ad
infinitum.” /d. at 959. This construction was accepted as
the law of the case by District Judge Dimock in a sub-
sequent district court opinion and was affirmed without
analysis by the Second Cireuit, Judge Ilinks dissenting.
Judge Hinks reasoned in part:
{TJhe basi¢ rationale of the Act was such that only
completed swing transactions gave rise to the pre-
sumption of unethical use of advance information: if
one purchased stock on one day, became a director on
the next, and sold some of his stock on the next, any
resulting prolit was not recoverable by the corporation
apparently because a sale alone was thought to be
insufficient basis for a drastic presumption that it had
been made in violation of a fiduciary duty. In prin-
ciple, the same rationale is equally applicable to
beneficial owners who do not become such until a given
purchase is consummated. Under that rationale, the
presumption will arise only when both the purchase
and the sale were made by one who at the time was a
fiduciary.
232 F.2d at 305.
Judge IXaufman’s construction continues to be authori-
tative in the Second Circuit.*
In the Eighth Circuit, the Stella v. Graham-Paice Motors
Corporation construction of section 16 (b) was expressly
adopted in Emerson Electric Co. v. Reliance Electric Uo.,
434 bi2d 91S (Sth Cir. 1970), afd, 404 U.S. 418 (1972).
The Supreme Court’s affirmance in Lmerson, however,
* Newmark v. RKO General, Inc., 425 F.2d 348, 355-56 (2d Cir. 1970);
Perine v. William Norton & Co., Inc., 509 F.2d 114, 118 (2d Cir. 1974).
9a 74-1266, 74-1267
never reached this question. 404 U.S. at 421.’ Looking then
to the Eighth Circuit opinion, we find the following factual
situation. Emerson Electric became interested in acquiring
Dodge of Mishawaka, Indiana, a small manufacturer of
electric transmission equipment. merson initiated merger
negotiations. Dodge rejected the idea of merger, and Miner-
son then made a tender offer tor Dodge common stock.
Through this offer, Kmerson acquired 13.2 percent of
Dodge common stock. Dodge, however, was at the same
time negotiating a defensive merger with Reliance Elec-
tric, a competitor of Emerson. A proxy fight ensued, and
Reliance was the victor, the proposed defensive merger
being approved by the Dodge shareholders. Shortly there-
after linerson decided to liquidate its position in Dodge
prior to final director approval of the Dodge/Reliance
merger. Recognizing the possible section 16 (b) problem in
doing so within six months of the original acquisition,
Emerson liquidated in two steps, the first sale bringing its
Dodge holdings down to 9.9 percent and the second sale
disposing of this balance. Both steps of the liquidation
were carried out within six months of the original acqui-
sition.
In determining that Emerson was liable for the profits
gained in the first step of the two-step sale of Dodge stock,
the Eighth Circuit reasoned that the phrase “at the time
of” was ambiguous. The court saw three possible mean-
ings attributable to the phrase in the context of section
16 (b): (1) “immediately before.” (2) “simultaneously
with,” or (3) “immediately after.”* Next, the court noted
that in its opinion it was “doubtful that Congress intended
it to have one of those meanings in every situation.” 434
F.2d at 923. This suggestion was necessary to the-court’s
™The Supreme Court concentrated its analysis exclusively on the
“second e” by which Emerson disposed of its remai 9.96%
interest in Dodge stock. Its decision was founded on the fact t this
sale was made when Emerson was no longer a “beneficial owner”
within the terms of the statute, and on the fact that SEC Rule 16a-10,
17 C.F.R. §240.16a-10, exempts from 16(b) any transaction involv a sale
made during a month in which the s older never o more
than a 10% interest. But see 404 US. at 440-41 (Douglas, J. dissenting).
*We are unable to see any practical difference between “simul-
taneously with” and “immediately after” as used in Emerson, unless
“simultaneously with” merely means either before or after depending
on which construction best suits the De ~ of the statute as per-
ceived by the judge applying it. See Note, Stockholder Acquiring 10%
74-1266, 74-1267 10a
decision to follow the Stella rationale because the Eighth
Circuit recognized the logical anomaly of the Stella rule
nunely, that if “at the time of” is uniformly construed
to mean “simultaneously with” the execution of the pur-
chase or sale, then in every buy/sell transaction in which
the sale reduces the defendant’s holdings to below ten per-
cent of the issuing corporation, as was the ease in the first
sale in the Emerson liquidation, that sale would eall into
effect the exemption provision. That is, “at the time of”
such a sale (the instant it became eifective) the defendant
would no longer be a benelicial owner. Maced with this leeal
puzzle, the Lmerson court was forced to detine “sinmulta-
neously with” to mean both “before” and “after” depend-
ing on whieh end of the short-swing transaction is being
analyzed: “a 10 percent stockholder need only be such
simultaneously with each transaction: that is, just after a
purchase or just before a sale.” -
omitted).’ e.” 434 F.2d at 923 (footnote
. pas ;
I poe nea a ee ane recognized that
lem nterpretation is difficult and not free of
all doubt.” Nonetheless, the court was persuaded that the
Congressional intent to stop the possible use of inside
information hy directors, officers and beneficial owners in
connection with short-swing transactions demanded this
construction to avoid “impracticability of application.”
Illustrative of the problems perceived by the Emerson
® (Continued)
Ownership on Purchase Held Liable i
of ;, - Securities Exchange Act, 57 aa om a ase
tc po A pp A. onl ——— in oa egy In this light, it is interesting
a Emerson tM ormulation of the issue, and its answer, in
Wje are convinced that “at the time of purchase” i
time simultaneously with” the purchase, so that a -E.. ~
yy ‘subject to the provisions of Section 16(b) immediately upon
t is, at the very moment of) his acquisition of more than 10
= = \ he ee stock.” Emerson Electric Co. v. Reli-
~ emphasis) ™ - Supp. 588, 589 (E.D.Mo. 1969) (original
e use of the verb “includes” would imply tha istrict j
perceived the phrase | “at the time of” i ae both mag Fe
Pemeens nape gd pew and it is clear from the result reached that his
Smadterel® an taneously with” is virtually indistinguishable from
*The quoted words were used by the Ei ircui
. * . . ghth C t i
wy of the Second Circuit in Stella. In deciding the yy Pe
t, the Eighth Circuit avoided restating this inconsistency by focusi
age wd on the facts presented, but it is clear that the court did otek
dual-meaning construction of “at the time of.” .
~emestesaee
ila 74-1266, 74-1267
court was the possibility that one might purchase a block of
stock as large as fifty-one percent and then sell within six
months with section 16 (b) impunity even though after the
purchase of this block such an investor would be in a
position to obtain inside information and exercise influence
over corporate transactions.
The Ninth Circuit, in the recent case of Provident Secu-
rities Co. v. Foremost-McKesson, Inc., 506 F.2d 601 (9th
Cir. 1974), cert. granted, 42 U.S.L.W. 5446 (U.S. Feb. 18,
1975), rejected the application of section 16 (b) to an initial
ten percent acquisition. In doing so, the court expressly
recognized the contrary decisions of the Second and Kighth
Circuits, but declined to follow them. This decision was
based in part on an analysis of dicta contained in the Su-
preme Court’s opinions in Reliance Electric Uo. v. Emer-
son Electric Co., 404 U.S. 418 (1972) and Aern County
Land Co. v. Occidental Petroleum Corp., 411 U.S. 582
(1973), and in part on a review of the legislative history
of section 16 ()).
The court in Provident began its discussion of the initial
purchase issue by noting that in Reliance the Supreme
Court placed great emphasis on the requirement that a sec-
tion 16 (b) beneficial owner/defendant be such a beneficial
owner “both at the time of purchase and sale. . . .” 506
F.2d at 608. Turning to the subsequent Kern opinion, the
court quoted the initial formulation of issues by the Su-
preme Court in that case:
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 exercl-
sable within the statutory six-month period!
411 U.S. at 584.
Recognizing the ambiguity in the first sentence of this pas-
sage, the Provident court opined that the reference to “one
or more statutory purchases” may have indicated that
statutory purchases occur only after the purchaser has
74-1266, 74-1267 12a
acquired an initial ten percent.’® The court pointed out that
this interpretation would be consistent with the following
additional language in Kern:
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 speculuative 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 sub-
stantial stuckholdings 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, we nevertheless fail to perceive
how the fruition of such anticipated events would re-
quire, or in any way depend upon, the receipt and use
of inside information. If there are evils to he redressed
by way of deterring those who would make tender
offers, § 16 (b) does not appear to us to have been
designed for this task. 411 U.S. at 597 (footnote
omitted)."
Turning to the legislative history of section 16 (b), the
Provident court noted that early drafts of the section
focused on the intention of a corporate insider in making
a purchase of his company’s stock, not to change his invest-
ment relationship to the corporation, but to capitalize on
inside information by entering into a short-swing pur-
chase/sale transaction in an upward market. According to
the court in Provident, part of the design of this scheme
would be for the insider to come out of the. transaction
with “exactly the same interest in the corporation as he
owned before he began his speculative venture.” 506 F.2d
at 609. These drafts, however, did not cover the converse
situation: the sale by an insider of his corporation’s stock
1°The original offer in Kern was made on a first-come, first-served
basis, so in all probability a number of the separate purchase trans-
actions involved in the original offer were consumenated,
ticular purchase which put Occidental over the 10% ownership level.
Two additional factors undercut any attempt to characterize Kern
as an approval of the Stella rationale, as suggested by defendants in
this case: first, Stella was never cited in the Kern opinion, and second,
the Court poe noted elsewhere in the opinion that the dccision
to extend the original offer to encompass an additional 500,000 shares
was made after the acquisition of a 1C% interest Occidental.
US. at 584-85, n, 7. ” ” -
13a 74-1266, 74-1267
in a downward market with the intent of replacing it at a
lower price over a short temn. To remedy this omission,
the operative language was modified in part. Where the
early drafts had read:
[A]ny profit made by such person on any transaction
in such a registered security extending over a period
of less than six monthis shall inure to and be recover-
able by the issuer. 506 F.2d at 609 (emphasis added),
the later drafts read:
{AJny profit realized by [such person] from any pur-
chase and sale, or any sale and purchase, of any equity
security of such issues . . . within any period of less
than six months . .. shall inure to and be recover-
able by the issuer. 506 F.2d at 610 (emphasis added).
The Provident court saw no indication that this change
was intended to alter the original intent of focusing on
insider status at the time of entering into the short-swing
transaction. Moreover, it reasoned that the presumptions
created by the statute necessarily assume this premise:
The drafters recognized, however, the difficulty of
proving that the insider actually intended a short-
swing transaction when he made his original dect-
sion.... In order to ameliorate this difficulty of prov-
ing intention or expectation, the section created a
statutory presumption that a person with access to
inside information who purchases and sells, or sells
and repurchases, within a six-month period does so
with the intent to speculate rather than to invest. That
the drafters intended for the presumption to be
conclusive is clear... .
Since the presumption of intention or expectation
is conclusive, it is necessary that it be narrowly
construed so as to apply only to the class of persons
who can reasonably be expected to have access to
inside information. The hearings. demonstrated that
Congress intended that the class not be defined too
broadly ....
As the Committee testimony indicates, the section
also creates a presumption that officers, directors and
10-percent shareholders fall within the class of per-
sons who may reasonably be expected to have access
to inside information (statutory insiders). It does not
74-1266, 74-1267 l4a
appear, however, that this presumption (as distin-
ished from the presumption of intent to speculate)
is always conclusive, since the Supreme Court has held
that at least in some situations it may be rebutted.
- Kern County Land Co. v. Occidental Petroleum Corp.,
411 U.S. 582, 93 S.Ct. 1736, 36 L.Ed.2d 503 (1973).
Nevertheless, the legislative history demonstrates
that the class was not intended to include outsid-
ers....
Since a person who decides to purchase enough stock
to increase his holdings to 10 percent of a corpora-
tion’s outstanding shares is an outsider at the time he
makes his investment decision, he does not fall within
the class of persons to which the conclusive presump-
tion was intended to apply. He may have made that
decision on the basis of inside information, but such
inside information could not have been acquired, in
the language of the statute, “by reason of his rela-
tionship to the issuer,” or in the language of the Su-
preme Court, “from substantial stockholdings that did
not yet exist.” Kern County Land Co., 411 U.S. at 597.
We hold that the initial purchase by which a person
increases his holdings to 10 percent of a corporation’s
outstanding stock is not a section 16 (hb) transaction
and that the conclusive presumption imputing an intent
to speculate does not apply to such a person who sells
within six months. The statutory language “at the time
of,” in order to be consistent with the rationale of
the statutory presumption, must be construed to mean
prior to the time when the decision to purchase is made.
906 F.2d at 610-14 (footnote omitted).
Finally, the court in Provident felt compelled to address
another context in which section 16 (b) might he ayplied.
In doing so, it created its own modified version of the
Kighth Circuit’s dual-meaning theory:
This construction, however, should not be applied
to a transaction that is not an initial purchase but in
reality is a repurchase or a closing transaction. It
would be inconsistent with the rationale of the pre-
sumption and with the legislative history to allow a
principal shareholder to sell his holdings below the 10
percent level and then repurchase at a profit within
six months. Where a shareholder was within a class
of persons who had access to inside information by
15a 74-1266, 74-1267
reason of their relationship to the issuer prior to
making his initial decision to speculate, the conclusive
presumption should be applied if simultaneously with
the conclusion of the closing transaction he is the
owner of 10 percent of the issuer’s stock. Although
this conclusion mandates that the language “at the
time of” means prior to in the case of an initial trans-
action and simultaneously with in the case of a closing
transaction, we do not believe that this “inconsistency”
is inconsistent with the rationale of the section. In
order for the statutory presumption of intention or
expectation to deter speculation rather than to impose
an arbitrary hardship on a good faith investor, it must
apply only to shareholders who, at the time they make
the decision to purchase or to sell, are within the class
of persons who can reasonably be expected to have
access to inside information by reason of their rela-
tionship to the corporation. This conclusion does not
provide a consistent construction of the language “at
the time of” for both the initial and the closing trans-
actions, but it is consistent with the rationale of sec-
tion 16 (b)—a consistency that we believe is much
more important than the consistency of terms. 506
F.2d at 614-15 (footnote omitted).
B
While we agree with much of the analysis in the Ninth
Cireuit decision in Provident, we are convinced that a
fundamenta! conceptual error, initiated in the Stella deci-
sion, has survived even the careful analysis in Provident.
It is our view that the legislative history of section 16 (b)
provides ample support for a construction of that section
which obviates any necessity, under any circumstances, to
attribute to Congress an intent to utilize a chameleonic
definition of the simple phrase “at the time of.” We adopt
this simplified construction with full recognition that see-
tion 16 (b) is a remedial statute which has a wholesome
purpose. Emerson Llectric, supra, 434 F.2d at 923 and
n. 14. This, of course, begs the real question: what is that
purpose? Our review of the history of the statute
convinces us that in enacting section 16 (b) Congress had
in mind a specifie type of two-part transaction consisting
either of a purchase and subsequent sale, or a sale and
subsequent repurchase, and did not intend section 16 (b)
74-1266, 74-1267 l6a
to apply to every separate purchase or sale as to which
some use of inside information is a theoretical possibility.
As Judge Wallace pointed out in Provident, the early
draft of section 16 (b) did not address the problem of a
sale/purchase insider scheme. This apparently was an
oversight. The language of the early draft is instructive,
however, since it makes clear that Congress originally
treated the purchase/sale procedure as a conceptual unit:
(b) It shal! be unlawful for any [beneficial owner]
(1) To purchase any such registered security with
the intention or expectation of selling the »4me securi-
ty within six months; and any profit mace by such
person on any transaction in such a registered security
extending over a period of less than six months shall
inure to and be recoverable by the issuer, irrespective
of any intention or expectation on his part in entering
into such transaction of holding the security purchased
for a period exceeding six months. Hearings on S. Res.
56 and S. Res. 97, Before the Senate Comm. on Bank-
ing & Currencu, 73d Cong., Ist Sess., Pt. 15, at 6430
(1934) (emphasis added).
As used in the initial draft, the term “transaction” obvious-
ly included both purchase and sale. The critical point for
measuring insider status (/.c., beneficial ownership) was
prior to the opening purchase of stock. Thus the section
focused on purchases made “with the intention or expecta-
tion of selling” within six months, but obviated the need
for proof of such intention or expectation “in entering
into such transaction.” Given the fact that the section was
aimed at preventing speculation based on abuse of inside
information, the section must have contemplated a pre-ex-
isting hencficial interest: unless the opening purchase was
motivated by an insider's anticipation of an upward mar-
ket, the full .purchase/sale transaction could hardly be
characterized as “speculative” from .the standpoint of in-
sider abuse. Kern Cownty Land Co. v. Occidental Fetro-
‘leum Corp., 411 U.S. at 597.
When the section was revised to include a sale/repur-
chase transaction, the term “transaction” was replaced at
one point with words describing the two types of insider
schemes to he covered by section 16 (b):
Ali Be Pell
17a 74-1266, 74-1267
(b) For the purpose of preventing the unfair use
of information which may have been obtained by such
beneficial owner, director, or oflicer 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, ir-
respective of any intention on the part of such benefi-
cial 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).
Nothing in this portion of the restricted version would
indicate that Congress had abandoned the unitary “trans-
action” concept. Moreover, retention of specific language
obviating the need for independent proof of the insider’s
intention “in entering into such transaction” would indicate
that Congress still meant to focus on insider status “prior
to” the unitary transaction in question and not “simulta-
neous with” the initial step in that transaction, as sug-
gested in Siclia and later cases.
This construction offers a simple method of determin-
ing the application of section 16 (b) to a given situation.
The question is whether one in a position of presumed
access to inside information, that is, a director, officer, or
a 10 percent stockholder of a corporation, combined a pur-
chase and a sale of his company’s stock, in any order, with-
in a period of six months, thereby producing a profit. If the
answer to this question is yes, the profit attributable to the
short-swing transaction must be returned to the corpora-
tion. The logic of this test is clear: the position of di-
rector, officer, or beneficial owner results in a presumption
of access to inside information, and the short-term nature
of the transaction results in a presumption that this infor-
mation motivated a coordinated short-terin turn-over. Dif-
ficulties in proving either access or motivation justify the
conclusiveness of these presumptions.
74-1266, 74-1267 18a
The final question is whether the language of the exemp-
tion clause precludes our construction of section 16(b).
The exemption clause provides in pertinent part:
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... .
Having in mind the purpose of the section as first drafted,
there is little reason to believe that this clause was meant
to extend coverage to situations where the purchase/sale
or sale/repurchase could not have been motivated at the
beginning of the transaction by inside information. The
language of the clause is that of limitation and not of
expansion.
More difficult is the question of whether the exemption
clause requires a determination of beneficial ownership
relative to each component of a short-swing transaction,
that is, relative to the purchase and to the sale, regardless
of which comes first."* The use of the word “both” is con-
fusing in this regard. It is possible to read the word to
refer to the separate components of the two types of
short-swing transactions; this has been the prevailing view.
It is also possi xe to read this word to refer to the two
types of transactions as transactions. Neither construc-
tion is absolutely apparent. If Congress had intended the
first construction it could easily have said “both at the
time of the purchase and at the time of the sale.”
Similarly, if Congress had intended the second construc-
tion it could have said “both at the time of the purchase
12 We are aware that the Supreme Court’s opinion in Reliance Electric
relies in large part on the fact that Emerson was not a beneficial owner
at the time of the second sale, when it disposed of its remaining 96%
interest in Dodge Manufacturing Company. We also note, however,
that the Court in Reliance purposefully avoided a full analysis of the
exemption clause, and in particular its application to the initial pur-
chase in that case. 404 US. at 420-21. r proposed construction of
section 16(b) is in full harmony with the “congressional design of
predicating liability upon an ‘objective measure of proof’” 404 U.S. at
425, and would in every purchase/sale transaction yield the same re-
sult as that reached by the Court in Reliance. This is because in
every purchase/sale transaction the “last” 10% held by a 16(b) de-
fendant will have pre-ezisted any short-swing transaction, and thus
will not be part of any 16(b) transaction for profit computation pur-
— Under these circumstances we do not believe that Reliance
orecloses our further analysis of the exemption clause or our develop-
ment of an alternative construction thereof.
et ee ne oe
a .
19a 74-1266, 74-1267
and sale transaction, or the sale and purchase transaction.”
It did neither, however, and we are left with the task of
determining what construction will best serve the in-
tended purposes of the statute. Given the legislative
history of section 16(b) and the apparent logic of focusing
al] insider status inquiries on the period prior to thie
initiation of the short-swing transaction, we believe Con-
gress intended by the language in question merely to
indicate that in. the ease of both types of short-swing
transactions, a person, to be charged with a section 1(i(b)
violation, must only have had insider status prior to the
initial purchase or sale."
Since Gulf & Western did not oceupy any section 16())
insider position prior to the initial purchase of 3,000,000
shares of Allis-Chalmers common stock, its subsequent sale
of this stock within six months did not trigger that see-
tion’s conclusive presumption that a coordinated short-
oes transaction based on inside information had taken
place.
Il
Turning to the September 30, 1968 acquisition of 248,000
shares of Allis-Chalmers common stock, it is not disputed
that this purchase was executed at a time when Gulf &
Western was a beneficial owner within the meaning of
13 Nothing in the legislative history or the generally accepted pu
of section 16(b) would suggest a reason for requiring a beneficial
interest at the time immedately before or after the closing component
of a short-swing transaction. Possession of more than a 10% in-
terest at this late stage could in no way relate to the possibility of
speculative abuse, since any bey plan would be formulated prior
to the opening urchase or sale, as we have indicated. Furthermore, re-
quiring a beneficial interest in connection with the closing component
encourages a dual-meaning approach to the words “at the time of,” as
evidenced by the opinion of the Ninth Circuit in Provident. 506 F.2d at
614. Such a dual-meaning EO ny ~ defies rational justification in ter +s
of legislative intent, and es the words themselves almost mea. ‘ng-
less. Moreover, in a limited class of cases, such a requirement wuld
allow a careful insider to speculate with 16(b) impunity. Thus, where a
cial owner anticipated a downward market, he could sell his entire
interest and buy back only 9.9% within six months. With regard to this
transaction he would never have been a beneficial owner at the time of
the repurchase regardless of how the words “at the time of” might
be construed, and yet as to that transaction he would have satisfied
both section 16(b) presumptions: a) he initiated the transaction when
he was an insider, giving rise to a presumption of access to inside
information; b) he completed the transaction within six months, giving
rise to a presumption that he used inside information to coordinate
the sale and repurchase.
74-1266, 74-1267 20a
section 16(b).** The defendant contends, however, that
the Oppenheimer purchase was so much a part of the
original take-over bid by Gulf & Western, and so pro-
foundly influenced by alleged resistance to the take-over
bid by Allis-Chalmers, that a “pragmatic” approach to
the application of section 16(b) is required. It is also
contended that pragmatic analysis of the facts in this
case compels a finding of nonliability since Gulf & West-
ern was never in fact a functional insider of Allis-
Chalmers, and did not, as a factual matter, obtain any
inside information in connection with the purchase and
sale of the 248,000 shares.
This argument is based on the decision of the Supreme
Court in Kern County Land Co. v. Occidental Petroleum
Corp., 411 U.S. 582 (1973). Gulf & Western urges that
Kern is precedent for the proposition that section 16(b)
should be applied only in those situations in which the
transaction in question “may serve as a vehicle for the
evil which Congress sought to prevent—the realization
of short-swing profits based on access to inside informa-
tion.” 411 U.S. at 594. (emphasis added). In our view,
the district judge properly determined that the rationale
of the Kern case does not preclude liability under 16(b)
for any profits realized by Gulf & Western as a result of
the purchase and sale of the 248,000 shares obtained from
Oppenheimer.
In Kern, defendant Occidental Petroleum Corporation
had sought to initiate a merger with Kern County Land
Company. This proved impossible, however, and Oc-
cidental decided to attempt a take-over of Kern through
a tender offer to the Kern shareholders. In the course
of the tender offer Occidental acquired well over ten
percent of the outstanding shares of the target corpora-
1#Under the construction of section 16(b) adopted in section I of
this opinion, we need not pause to assess the significance of the fact
that upon the execution of the sale of these shares to White Industries,
Gulf & Western was no longer a beneficial owner within the meaning
of the statute. It is interesting to note, however, that language in
Provident would indicate that under the Ninth Circuit's view, liability
would be avoided where, as here, one is not a beneficial owner
“simultaneously with” the closing component of a section 16(b) trans-
action. 506 F.2d at 614-15 (quoted at pages 14-15 of this opinion).
Rati wee wwe nt ne
21a 74-1266, 74-1267
tion. While the offer was in effect, Kern engineered a
defensive merger with Tenneco, Inc., involving an ex-
change of all shares of IXern stock for shares of Tenneco
stock. Prior to the closing of the defensive Kern/
Tenneco merger, Occidental executed a call option agree-
ment with Tenneco whereby Tenneco acquired the right:
to purchase from Occidental all Tenneco shares which
would be acquired by Occidental in return for its shares of
Kern stock under the proposed defensive Kern/T'enneco
merger. By its terms, this option was not exercisable
until six months after the last acquisition of Kern stock
by Occidental.
Subsequently, but within six months of the original
acquisition of Kern stock by Occidental, the Kern/‘l'en-
neco defensive merger was closed. At this point Occidental
becaine irrevocably~ entitled to receive ‘'enneco shares
in exchange for its Kern stock. Occidental purposely
did not exercise this right until Tenneco exercised its
call option more than six months after the last acquisition
of Kern stock by Occidental. Immediately upon the exer-
cise of Tenneco’s option, Occidental tendered its Kern
shares and disposed of its newly acquired Tenneco
shares by transferring them to Tenneco pursuant to the
option agreement.
In holding that Occidental was not liable to Kern under
section 16(b), the Supreme Court determined that neither
the pe mg of the irrevocable right to exchange its
Kern shares for Tenneco shares pursuant to the defensive
merger, nor the execution of the option agreement with
Tenneco in reaction to that merger constituted a “sale”
by Occidental within the meaning of the statute. The
Court pointed out that the exchange of shares was required
by the terms of the defensive merger and thus was not
a voluntary act attributable to Occidental. No evidence
existed to indicate that Occidental had in any way par-
ticipated in the merger negotiations between Kern and
Tenneco, and the continuous, short-term nature of the
tender offer precluded any reasonable opportunity for
Occidental to have premised its decision to acquire
shares in excess of ten percent on insider’s knowledge of
74-1266, 74-1267 22a
the Kern/Tenneco merger negotiations.** Once the defen-
sive merger “crystallized” Occidental was left with no real
option regarding the conversion of its Kern shares
into Tenneco shares. Had Occidental decided to avoid
the conversion of its shares under the merger by dis-
posing of the shares to an outside purchaser prior to
consummation of the merger, this sale would have fallen
clearly within the section 16(b) “sale” concept and “would
have left Occidental with a prima facie § 16(b) liability.
411 U.S. at 600. In light of these facts the Court held
that the involuntary conversion of Occidental’s Kern
shares into those of Tenneco did not constitute a section
16(b) “sale” of the IXern stock.
With respect to the option agreement, the Court initially
observed that “the mere execution of an option to sell is
not generally regarded as a ‘sale’.” 411 U.S. at 601. The
Court then proceeded to examine the particular option
agreement at issue to determine whether this agreement
amounted to a “sale” within the meaning of section 16(b)
in terms of its potential for speculative abuse in connection
with the prior acquisition of more than ten percent of
the stock of Kern Company. In its analysis the Court
noted that the option was not on Kern stock at all, but on
Tenneco stock which might be received in exchange for
Kern stock in the event that the defensive Kern/‘Tenneco
merger was approved. Implicit in this observation was the
recognition that Occidental never intended to sell its
Kern holdings so long as Kern County Land Company
retained its separate corporate identity. In addition, the
facts showed that Occidental had worked diligently to
prevent this merger from proceeding to consummation.
The option agreement was further limited by the fact that
18The Occidental tender offer was on a first-come, first-served
basis. Originally the offer was for a total of 500,000 shares, and this
ofier was announced on May 8, 1967. By May 10, this original offer
was fully subscribed. On the following day the offer was extended
to encompass an additional 500,000 shares. The offer expired on June
8, 1967 with Occidental owning a total of 887,549 shares of Kern
stock. Occidental achieved 10% ownership when it acquired 432,800
shares. Since the decision to extend the offer was made on May 11, one
day after the original offer for 500,000 shares was subscribed—and
in all probability one day after Occidental first became a beneficial
owner—the possibility that Occidental used information gained as an
insider as a basis for its extension of the tender offer was virtually
non-existent. 411 U.S. at 584-85 & note 6.
De ee
. PAS ISAS amet mbd
ie mw
23a 74-1266, 74-1267
it was a call option and therefore unenforceable by Oc-
cidental even if the defensive merger were in fact closed
and shares exchanged. Given these facts the Court con-
cluded that the execution of the option agreement was
also not a section 16(b) “sale” of Occidental’s Kern in-
terests.
The purchase and sale of the 248,000 shares of Allis-
Chalmers stock acquired from Oppenheimer is not even
remotely comparable to the transaction in Kern. The
question in Aern was whether the term “sale” as used
in the statute should be construed to apply to two very
unorthodox transactions. In resolving this question the
Court pierced the form of the two transactions to deter-
mine whether in substance either of the transactions
amounted to a sale. The Court did not suggest that or-
dinary, voluntary transactions commonly recognized as
purchases and sales would not automatically trigger the
application of section 16(b) in future cases as_ they
uniformly have in the past. Indeed the Court specifically
recognized that:
[t]he 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 informa-
tion. 411 U.S. at 595.
In order to avoid this automatic rule under the Kern
rationale, it would have to be shown 1) that either the
gp weg or the sale was an unorthodox transaction, and
) that an analysis of the unorthodox transaction discloses
no possibility of short-term speculative abuse."* The Op-
penheimer purchase/sale transaction satisfies neither of
these tests. The purchase of the Oppenheimer shares in
Allis-Chalmers was a simple, voluntary purchase on the
eert of Gulf & Western. Certainly the fact that Gulf &
Vestern used its own warrants rather than cash as con-
sideration in this bargain does not render the purchase
16 a , J aovgme Court —y yo >
veluntary nature of Occidental’s ex e, when led
with the absence of the possibility of de ny abuse of inside
information, convinces us that section 16(b) should not apply to
transactions such as this one. 411 US. at 600.
74-1266, 74-1267 24a
unorthodox, and we do not understand Gulf & Western
so to contend. Similarly, the sale of Gulf & Western’s
total interest in Allis-Chalmers to White was a simple,
orthodox sale, albeit involving a rather complicated con-
sideration element. Unlike the situation in Kern, there 1s
nothing in the nature of these transactions which requires
a judicial construction of the terms “purchase” or “sale,”
beyond giving these terms their commonly accepted mean-
ings.
Moreover, even were we to assuinc that these transac-
tions met the “unorthodox” test, nothing in the nature
of these transactions precludes, or even reduces, the possi-
bility of speculative abuse. The purchase from Oppen-
heimer was a planned business transaction, presumabiy
undertaken as a profitable venture. Similarly, the sale
to White was not involuntary, as in the case of a con-
version into shares of another corporation pursuant to
a defensive merger, nor was it conditional in any respect
or tied to the future value of stock in a different cor-
poration. On the contrary, at the time that Gulf & Western
made its decision to purchase the 248,000 shares of Allis-
Chalmers stock from Oppenheimer it was in a position to
anticipate and control its future disposition of those
shares. It voluntarily disposed of the shares within six
months, after obtaining an indication from Allis-Chalmers’
chairman that the future of that company did not look any
too bright. The possibility certainly existed, therefore, that
Gulf & Western’s early disposition of its Allis-Chalmers
shares was an attempt to avoid the effect of the predicted
weakening of Allis-Chalmers’ common stock, a prediction
gained as an insider of that company. The application of
‘section 16(b) is therefore automatic, and not in any way
affected by a failure to prove up actual access to inside
information, or improper use of such information.
Il
Having found Gulf & Western liable for any profits
realized from its purchase and sale within six months of
the 248,000 shares of Allis-Chalmers stock obtained from
. Oppenheimer, we must determine whether the district
court properly evaluated these profits. Allis-Chalmers
contends that the district judge erred in his calculation of
each element of damages thereby greatly reducing the
liability of Gulf & Western.
ee a
A me
eters
25a 74-1266, 74-1267
A
With respect to the acquisition of the shares from
Oppenheimer, the district court determined that the un-
registered Gulf & Western warrants covered by that
transaction should be evaluated at a per unit price of
$15.92. This figure resulted in a total purchase price evalu-
ation of $7,896,520.00 ($15.92 x 496,000 = $7,896,320.00).
Allis-Chalmers points out that experts of both the defen-
dant and the plaintiff evaluated the unregistered warrants
at a much lower figure,’’ and that nothing in the record will
support the $15.92 per share figure used by the district
ju ge. It contends, therefore, that the value determination
y the district court was clearly erroneous and should be
set aside. We agree.
The district court’s evaluation was the result of an
erroneous assumption, namely, that a discount factor of
fifteen percent which was recommended by two of the
three expert witnesses did not reflect a full appraisal
of the market value to be attributed to the guarantce
by Gulf & Western relating to future registration of
the 496,000 warrants. Gulf provided in its agreement
with Oppenheimer that it would file a registration state-
ment for the warrants (and related stock) on or before
April 30, 1969, and in addition, that if it did not make
effective a registration statement for these securities
before December 31, 1968, it would guarantee Oppen-
heimer an average gross price per warrant of $13.50 for
any warrants sold during the ninety days following the
effective date of the registration statement. Also included
in the agreement was a provision that in the event Op-
penheimer should decide to sell the warrants under the
guarantee, Gulf & Western would be given notice of the
proposed sale and an opportunity for three business days
to provide a buyer who would purchase the warrants
from Oppenheimer at a higher price than the price to
1% Plaintiffs’ expert witnesses were Robert N. Hampton and Fred
D. Stone. Hampton testified that considering all factors involved in
the purchase agreement, a valuation per warrant of $14.25 would be
proper, ,-~y- a discount of 95% from the low market trade
on the date for identical registered warrants. Stone, also
ae the entire ent between the parties, testified that a
range of from $12.92 to $13.70 would be accurate, representing a dis-
count from low market of from 13% to 18%. Defendants’ expert, Gabriel
fl Danihel, on a similar basis, testified that a discount of 15% would
proper.
74-1266, 74-1267 26a
be obtained by Oppenheimer in its proposed sale. Each
of the experts who iestified on the subject of valuation
of the unregistered warrants expressly indicated that his
evaluation was based in part on the provisions of this
guarantee. Each also expressed his final valuation in
terms of a discount to be applied to the low market price
for comparable registered Gulf & Western warrants bein
sold on the American Stock Exchange on the date o
closing.
The district judge adopted a discount figure of fifteen
percent as representative of the opinions of the experts
and as realistic,** and applied this discount to the volume-
weighted average price,’® rather than the low price for
registered. warrants on the date of closing as urged by
plaintiffs. Tle thereby arrived at a fair value per un-
registered warrant of $13.69. Ilad the judge adopted
$13.69 as the section 16(b) purchase price we would have
no trouble affirming” as to this element of his calculation
of damages.
18We find no substantial disagreement between the parties as to
the propriety of this figure.
1*The volume-weighted average price is determined for a given day
by breaking the day’s transactions into groups according to the price
at which the security was traded, and then multiplying each price times
the number of shares traded at that price, and dividing the total of
these products by the total number of shares traded for the day. We
the propriety of using the volume-weighted average price in sec-
tion III B, infra, in connection with the valuation of certain unregistered
shares of White Consolidated Industries. That discussion applies to the
use of the volume-weighted average price here, as well, since of a total
of 29,600 warrants traded on the date of closing, only 700 (2.3%)
were traded at the low market figure of $15%.
20 Although Gulf & Western argues that the fact of non-registration
does not or should not affect the cost to it of the warrants, and that the
September 30, 1968 valuation should therefore equal the market value
of registered warrants on that date, this argument ignores the value of
money as a commodity. Gulf & Western elected not to purchase the
Oppenheimer shares in Allis-Chalmers for cash. If it had possessed
496,000 registered warrants on September 30, 1968 it could have used
these warrants and relied on their market value as reflected on the
American Stock Exchange. It apparently had neither cash nor registered
warrants, however, and therefore determined to use unregistered
warrants. To Oppenheimer these warrants represented an allocation
of capital to a non-liquid, speculative investment which would remain
essentially non-liquid until registration on the American Stock Ex-
a. _ oy - the Xo. A. oR. to O
attributable to the fact of non- tion. See W. tcher, lopedia
of the Law o. Private Corporations § 8907, vol. 19, p. 67 (1959 ed.) On
the other hand, Gulf & Western realized an immediate return for the
non-registered warrants in the form of freely marketable Allis-
Chalmers stock without the necessity of waiting the uncertain period
en ee a ee
abs
i
27a 74-1266, 74-1267
The district judge went on, however, to add to this
“fair value” figure an increment of $2.23 as representing
the value of the guarantee to register within three months,
thereby attaining a final per unit valuation of the un-
registered warrants of $15.92, or $.15 more than the low
market transaction for registered warrants on the closing
date and only $.19 less than the volume-weighted average
price for that day for identical registered warrants.
This was clearly error. Aside from the fact that the
experts were nearly unanimous in their lower valuation
of the unregistered warrants with the guarantee “for
16(b) purposes,” and aside from the fact that Oppen-
heimer independently evaluated the warrants at $15.63 per
warrant in a filing with the Securities and Exchange
Commission, the addition of $2.23 to the conceded fair
value of $13.69 per warrant does not withstand logical
examination. ;
The effect of the guarantee as to Oppenheimer was two-
fold. First, it provided an incentive for Gulf & Western to
make its best efforts to attain early registration, thereby
reducing the period of non-liquidity for Oppenheimer. Sec-
ond, it provided a limited hedge against significant loss on
Oppenheimer’s investment in the event Oppenheimer deter-
mined to sell its warrants within a period of ninety days
after the effective date of registration in the event the
December 3), 1968 registration date was not inet. It did
not remove all risk, however, since if the early registration
date was met, no guarantee would he effective, and
sinilarly, if the market in the warrants remained rela-
20 (Continued)
required for registration of its warrants. By doing this Gulf & Western
was able to shift to penheimer and avoid for itself any tie-up of
capital during the period of non-registration. To use an analogy, Gulf &
Western was able to obtain immed’ ‘te payment for an unfinished product
coupled with a promise to complete the production process. By doing so
it avoided the cost of financing the Oppenheimer purchase during the
interim between September 30, 1968 and the date of registration. It can-
not be denied that the true cost of producing a marketable warrant is
less when one is paid early in the production process rather than
after the process is completed. Given an assumed constant market
value for the completed product, one who is paid prior to completion
need only receive an amount sufficient to produce, through investment,
the actual market value of the product as of the date of completion.
A discount for non-registration was therefore appropriate. Cf. Security
— Corp. v. Devilliers Nuclear Corp., 472 F2d 844, 846 (2d Cir.
1972).
74-1266, 74-1267 28a
tively constant or increased from September 30, 1968
through the ninety days after effective registration, Op-
nheimer, if it retained its warrants, would no longer
- protected by the guarantee.
Turning to Gulf & Western, the guarantee has other,
more significant features. On its face, it gave Gulf & West-
ern a choice between early registration and possible lia-
bility under the $13.50 guarantee provision. More impor-
tantly, however, it gave Gulf & Western an opportunity
to limit its own costs in the event the $13.50 guarantee was
invoked, by giving Gulf & Wes*ern a three-day period
during which it could itself repurchase the warrants at the
guarantee price.” If it elected to do so, Gulf & Western
could have effectively converted its stock acquisition to a
cash purchase with the payment of the purchase price de-
layed for a period of several months after delivery of
the Allis-Chalmers stock. If this:were to happen, Gulf’s
“cost” would have been limited to the cost of preparin
the unregistered warrants (negligible), plus the cost 0
registration, plus the purchase price of $13.50 per warrant,
minus the market value of the use of the $13.50 per un-
registered warrant during the interim between the Sep-
tember 30, 1968 closing and the purchase back of the
warrants.
This analysis makes it clear that the guarantee could
not have eliminated the disparity between the market
value of the registered warrants being traded on the
American Stock Iixchange and the fair value of the un-
registered warrants used in the Oppenheimer transaction,
and that far from presenting an additional and costly
risk to Gulf & Western, the guarantee actually presented
a method to limit the “cost” of the warrants to well
below the volume-weighted market value of $16.1144 for
similar registered warrants as reflected on the date of
closing.** ‘The record in this case clearly supports the
71There is no express limitation on sepeaese by a corpora
< * . ae in the corporate law Delaware. Det. Cope Ane.
t. 8, > .
22Gulf & Western voluntarily extended the guarantee period on
March 18, 1969 when Oppenheimer gave notice of its intent to sell its
warrants. The extension did not avoid liability under the guarantee,
however, since during the extension Oppenheimer sold pursuant to
proper notice. Gulf & Western made payment under the guarantee
in the sum of $2,154,437.50 on June 5, 1969. Apparently Gulf & Western
believed this the better alternative to simply purchasing the warrants
themselves at the $13.50 figure.
29a 74-1266, 74-1267
$13.69 figure drawn from the opinions of the experts,
and we therefore adopt this evaluation as properly
reflecting the section 16(b) purchase price of the Allis-
Chalmers shares obtained from Oppenheimer. The full
purchase price of these shares is therefore $6,790,240.00
($13.69 x 496,000).
B
Turning to the December 6, 1968 sale by Gulf & West-
ern of its entire holding 3,248,000 shares of Allis-Chal-
mers common stock to White, we must determine the
section iS({b) vaiue of the total consideration received
from White and the proportional amount of this total
consideration attributable te the 248,000 shares obtained
from Oppenheimer. The total consideration received from
White consisted of $20,000,000 in cash, 250,000 unregis-
tered shares of White common stock, and an unsecured
six month promissory note from White in the face amount
of $93,680,000 at an interest rate of eight and one-half
percent. The district court valued the 250,000 unregis-
tered shares of White stock at seventy-five percent of
the volume-weighted average price of identical registered
shares being traded on the New York Stock Exchange
on December 6, 1968. The White note was valued at
ninety-five percent of its face amount. Allis-Chalmers
says that the district court erred in both determinations.
Regarding the unregistered White common stock, Allis-
Chalmers contends that the twenty-five percent discount,
even if proper in amount, should have been applied to the
high market price for identical registered shares traded on
‘December 6, 1968 rather than to the volume-weighted aver-
age price for that day. The high price was $42.50 while the
volume-weighted average price was $40.3458.”* It is urged
28 Curiously, Allis-Chalmers seems to contend at one point in its
brief that a discount of 28% rather than 25% should have been em-
. Thus, in its table of computations it figures on the basis of
50 discounted by 28% times 250,000 shares. The table shows a
correct product of $7,650,000 for these figures which is then compared
to the district court’s figure of $7,613,493 ‘to arrive at an eged
jw amg diminution in profit of $36,507 as a result of the judge's
to use the $42.50 rather than the volume-weighted average price.
But more significant is the district judge’s use of a discount of 25%
rather than the 28% shown in the Allis-Chalmers table. Had Allis-
Chalmers used the 25% figure in its table, it would have reflected a
74-1266, 74-1267 30a
that use of the higher valuation was required under the
rationale of Bershad v. McDonough, 428 F.2d 693 (7th
Cir. 1970), cert. denied, 400 U.S. 992 (1971), and Srnolowe
v. Delendo Corp., 136 F.2d 231 (2d Cir. 1943), cert. denied,
320 U.S. 751 (1943), in order “to squeeze all possible
profits” from the transaction. 136 F.2d at 239. While we
agree with the underlying principle of the Bershad and
Smolowe cases,** we are unable to agree that use of the
volume-weighted average price in this case offended that
principle.
Smolowe was a case involving the problem of trade-
matching. A section 16 (b) insider had engaged in nuner-
ous purchases and sales within a six month period and the
question there was which purchase to mateh with which
sales in order to compute section 16 (}) profits. After
rejecting the possibility of using an “identity” test or the
related “first-in, first-out’ rule as being ineffective in the
ease of a large stockholder who could choose his oppor-
tunities to sell specific certilicates and avoid section 16 (b)
liability altogether, and after rejecting the notion of aver-
aging all purchases and all sales within a six month period
as effectively allowing a set-off of losses within the period
in contravention of the provision in section 16 (b) that
“any” profit be recovered, the court concluded:
The statute is broadly remedial . . . . Recovery
runs not to the seacihalies. but to the corporation.
We must suppose that the statute was intended to be
thoroughgoing, to squeeze all possible profits out of
stock transactions, and thus to establish a standard so
high as to prevent any conflict between the selfish
interest of a fiduciary officer, director, or stockholder
and the faithful performance of his duty .... The only
rule whereby all possible profits can be surely recov-
ered is that of lowest price in, highest price out—
within six months—as applied by the district court.
23 (Continued)
diminution in “profits realized” resulting from the use of the volume-
weighted average price (rather than the high market price) of $355,257
rather than the $36,507 figure. In the conclusion of its brief Allis-
Chalmers in fact does combine the 25% discount with the $42.50 figure
to reflect the true impact of the court’s use of the volume-weighted
average price.
24 Plaintiffs also cite Anderson v. Commissioner, 480 F.2d 1034, 1037
(ith Cir. 1973), in support of their position, but this tax case adds
ing more than a general citation with approval of the Bershad and
Smolowe cases.
_e
Se eee We ed
he ee Le ee eee
3la 74-1266, 74-1267
We affirm it here, defendants having failed to suggest
another more reasonable rule. 136 F.2d at 239.
(footnote omitted).
Nothing in this language suggests that the “lowest price in,
highest price out” rule was meant to have application in
cases where only one purchase or one sale has taken place
so that trade-matching is not a problem, and the last
sentence of the passage clearly indicates that even in trade-
matching situations the rule is not absolute if a more
reasonable method is suggested.”
Bershad did not involve valuation at all, but revolved
around the question of whether the granting of a certain
“option” to purchase stock amounted to a sale of that stock
for section 16 (b) purposes. In determining that it did, this
court noted the broad purpose of the section:
Section 16 (b) was designed to prevent speculation
in corporate securities by “insiders” such as directors,
officers and large stockholders. Congress intended the
statute to curb manipulative and unethical practices
which result from the misuse of important corporate
information for the personal aggrandizement or unfair
profit of the insider. Congress hoped to insure the
strict observance of the insider’s fiduciary duties to
outside shareholders and the corporation by removing
the profit from short-swing dealings in corporate secu-
rities. Conversely, Congress sought to avoid unduly
discouraging bona fide long-term contributions to cor-
' porate capital....
In order to achieve its goals, Congress chose a rela-
tively arbitrary rule capable of easy administration.
The objective standard of Section 16 (b) imposes strict
liability upon substantially all transactions ocenrring
within the statutory time period, regardless of the
intent of the insider or the existence of actual specu-
lation. This approach maximized the ability of the rule
to eradicate speculative abuses by reducing difficultics
2° Plaintiffs contend that Newmark v. RKO General, Inc., 305 F. Supp.
310, 314 (S.D.N.Y. 1969), aff'd, 425 F.2d 348 (2d Cir. 1970), cert. denied,
400 U.S. 854 (1970), represents an application of the “general rule” in a
non-trade matching situation. While it is true that the rule of “highest
in a — ry it is — pi A ‘Se Lo in” valuation
was not objected on appeal, at 357, extensive anal
of the use of this figure was never urged. =
74-1266, 74-1267 32a
in proof. Such arbitrary and sweeping coverage was
deemed necessary to insure the optimum prophylactic
effect. 428 I°.2d at 696.
Though the court cited Smolowe in support of these state-
ments, it cannot be argued that this general statement of
purpose somehow enshrined in the law of this circuit a flat
rule of lowest price in, highest price out for all valuation
problems under section 16 (b). Valuation simply was not
in issue in Bershad.
In this case, authenticated copies of the Fitch Report for
December 6, 1968 trading in White common stock on the
New York Stock Exchange disclosed that of a market
volume of 31,300 shares traded for the day, only four
hundred shares were traded at the market high price of
$42.50. This represents a scant 1.277 percent of the market
in White shares. By far the largest single sale on De-
cember 6, 1968, a trade of 7600 shares, reflected a price of
$40.00—significantly less than the volume-weighted average
price of $40.3458. In addition, Allis-Chalmers’ own expert
testified that normal accounting procedure was “to figure
... in terms of the average of the high and low price in a
iven day rather than one end or the other,” and that he
had made his discount computations from the high market
figure in this instance only at the instruction of counsel for
Allis-Chalmers.
We have held that the goal of squeezing out all profits
“does not require a court to adopt a completely unrealistic
interpretation of the market.” Mueller v. Korholz, 449 F.2d
82, 87 (7th Cir. 1971), cert. denied, 405 U.S. 922 (1972).
We find no error in the determination of the district court
that it would be unreasonable and unrealistic here to at-
tribute a market value of $42.50 per share to a block of
250,000 shares of White common stock acquired on Decein-
ber 6, 1968. On the basis of the Fitch Report alone it would
be difficult to reach a different conclusion. Section 16 (b),
while it was intended to be thoroughgoing, was surely not
intended to reject accuracy in favor of punitiveness.
Looking finally to the district court’s valuation of the
unsecured White note, we must determine whether the
discount of five percent of the face amount of the note was
properly applied. This discount was intended to account
for the risk factors involved in a note of this size and to
_
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33a 74-1266, 74-1267
produce a value reflecting what “the disinterested but
available third party investor” would pay for the note on
December 6, 1968. In adopting the ninety-five percent
valuation figure the court rejected undisputed evidence
that the note was in fact paid in full with interest by White
three and one-half months after closing. The question
therefore becomes whether the difference between the
market value of the note and the actual value the note
produced for Gulf & Western falls within the statutory
phrase “any profit realized.” We have no hesitation in hold-
ing that it does.
As we have previously noted, section 16 (b) was designed
to curb misuse of inside information by removing profit
from a class of transactions deemed by Congress to present
an into!erable invitation for such abuse. Reliance Electric
Co. v. Emerson Electric Co., 404 U.S. 418, 422 (1972). All
transactions within the class are tainted with a presump-
tion that inside information has been misused, and the pre-
sumption precludes any defense based on the showing of
a “clean heart” by the section 16 (b) defendant. Jd, at 424
n. 4; Newmark v. RNO General, Inc., 425 F.2d 348, 353
(2d Cir. 1970), cert. denied, 400 U.S. 854 (1970). It should
be noted, however, that the statute does no more than
remove the profit from such transactions. It does not inflict
an affirmative fine or penalty. Thus, one who is forced by
personal circumstances into a section 16 (b) transaction
does not face financia! ruination, but merely the prospect
that his short-term investment of capital has not produced
& positive gain.
_ Given the broad remedial purpose of section 16 ()h), its
limited impact, and the intent of Congress in drafting this
section to “eradicate speculative abuses by reducing dif-
ficultics in proof,” Bershad v. McDonough, 428 F.2d at 696,
we hold that in transactions involving debt obligations of
an amount certain, evidence of payment in full, if avail-
able at the time of trial, should control the determination
of “profit realized.”** We cannot help but wonder whether
76The evidence showed that the prime rate of interest at the time
of this transaction was 6%%. Expert testimony indicated that the
nature of the note and the circumstances surrounding the sale to
White justified the higher 8%% rate agreed to by the parties. There
has mn no contention that the increment over the prime rate was
of the note, P y artifcially reducing the face amount
74-1266, 74-1267 34a : 35a
APPENDIX B
Opinion of the United States District Court
for the Northern District of [Illinois
Gulf & Western's present belief that estimated market
value at the time of closing is the only proper measure of
16 (b) liability could have withstood the strains of a situa-
tion where White had in fact defaulted on the note com-
pletely. In any event, a rule of evaluation which looks to
Fd LD advemd! Meee 2 piel eat:
the realities in such situations will avoid the possibility IN THE
that real profits will escape the reach of the statute or that ;
non-existent profits will he ‘‘recovered.” We believe this to : UNITED STATES DISTRICT COURT
be no more nor less than the language of the section re-
quires. . FoR THE NORTHERN DISTRICT OF ILLINOIS
IV
, , ; ;, , "er EASTERN DIVISION
To summarize, the consideration received from White
Industries is properly evaluated as follows: $20,000,000
in cash, plus $7,564,837.50 in unregistered White comnon
No. 70 C 513 and No. 69 C 627
stock (250,000 x $40,3458 x .75 discount factor), plus +
$93,680,000 in the form of the White promissory note, for |
a total consideration of $121,244,837.50. This figure must ALLIS-CHALMERS MANUFACTURING COMPANY,
be prorated to reflect the portion attributable to the Op-
a oration
penheimer purchase. A simple method of doing this is to a Delaware corp ’
divide the total consideration by the total number of shares | Pisinus,
sold ($121,244,837.50 — 3,248,000 — $37.3291) and then v.
multiply the resulting per-share figure by 248,000. Using
this method a proportional consideration for the 248,000 GULF & WESTERN INDUSTRIES, INC.,
shares of $9,257,616.80 is produced. Substracting tu. »equi-
sition price of $6,790,240.00 from this figure yields a gross a Delaware corporation,
profit allocable to the Oppenheimer transaction of $2,467,- Defendant.
376.80. From this figure must be deducted the stipulated . -
expenses incurred by Gulf in connection with the Op-
penheimer purchase in the amount $1,696.23. The resulting
net profit for section 16 (b) purposes is $2,465,680.47. This action was commenced on January 6, 1969 in the
_ The judgment of the district court is therefore reversed | United States District Court for the Eastern District of
in part and remanded for entry of judgment in favor of | Wisconsin by plaintiff, Allis~-Chalmers Manufacturing Com-
Allis-Chalmers in the amount of $2,465,680.47. Mach party | pany, now Allis-Chalmers Corporation (hereinafter re-
oh ee ee a | ferred to as “Allis”). Plaintiff seeks to recover alleged
A true Copy: ) short-swing profits from Gulf & Western Industries, Inc.
(hereinafter referred to as “G&W”) under Section 16(b)
of the Securities Exchange Act of 1934 (15 U.S.C. § 78
p (b)) alleged by plaintiff to have been realized by G&W
Teste:
Clerk of the United States Court of : as a result of two purchases in July and September of
Appeals for the Seventh Circuit 1968 aggregating 3,248,000 shares of Allis common stock
and the subsequent sale of these shares on December 6,
: 1968.
;
HT OP ae
36a
Pursuant to a motion by G&W under 28 U.S.C. § 1406 (a)
that venue was improper in the Eastern District of Wis-
consin the case was transferred to this District. Allis-
Chalmers Mfg. Co. v. Gulf & Western Industries, Inc., 309
F. Supp. 75 (E.D. Wis. 1970). At the same time G&W
commenced an action in this Court for declaratory judg-
ment. Gulf & Western Industries, Inc. v. Allis-Chalmers
Manufacturing Company, (69 C 627). On March 23, 1970
the two actions were consolidated and this Court ordered
the consolidated action to proceed on the basis of Allis’
Amended Complaint which was originally filed on February
19, 1970 in the Eastern District of Wisconsin.
Allis, a corporation organized under the laws of the State
of Delaware, having its principal office in West Allis, Wis-
consin, is a manufacturing company engaged in the manu-
facture of agricultural, construction, industrial and elec-
trical machinery and related equipment.
G&W, a corporation organized under the laws of Dela-
ware, having its principal office in the City and State of
New York, is a diversified company engaged in a variety
of businesses, including manufacturing, distribution, lei-
sure time operations and the production of minerals, metals
and certain agricultural and consumer products.
During the period June 30, 1968 and December 31, 1968
there were between 10,364,102 and 10,410,292 shares of
Allis common stock issued and outstanding. 3,000,000 of
these shares were purchased by G&W through an Exchange
Offer made to all Allis shareholders, and 248,000 shares
of them were bought from the Oppenheimer Fund, Inc.
On May 7, 1968 G&W publicly announced to all Allis
shareholders that it would make an Exchange Offer in ac-
cordance with a registration statement and prospectus filed
and published as required by the Securities Act of 1933.
G&W proposed to purchase on a pro-rata basis up to
— a
AR Ra cE OOS GAA eb AAD AB AOE NAA ETL ites NAT ls
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hrf, Bi i Sa haat >.
37a
3,000,000 such shares. Under the proposed offer Allis
shareholders would receive for each share of Allis com-
mon stock: (a) $11.50 in cash, (b) $12.50 principal
amount of a 6% subordinated 20-year nonconvertible de-
benture (“the G&W 6% Debenture”), and (c) 9/10 of a
10-year registered warrant to purchase G&W common
stock at $55 per share (“the G&@W Warrant’).
There is a major dispute as to the date on which the
purchase of the 3,000,000 shares of Allis common stock
occurred. G&W contends that the date was July 29, 1968;
Allis contends the date was July 31, 1968. Both parties
agree that G&W’s purchase of the additional 248,000 shares
of Allis’ common from the Oppenheimer Fund took place
later on September 30, 1968. In exchange for these 248,000
shares G&W gave Oppenheimer 496,000 unregistered G&W
warrants.
On December 6, 1968 G&W sold its entire block of
3,248,000 shares of Allis’ common stock to White Consoli-
dated Industries, Inc. (hereinafter referred to as ““White’’)
in exchange for: (a) 250,000 unregistered shares of White
common stock, (b) White’s unsecured 842% promissory
note in the face amount of $93,680,000 payable in six
months, and (c) $20,000,000 in cash.
Allis now seeks to recover what it alleges are short-swing
profits of $16,305,251 which it contends G&W realized from
its two purchases in July and September 1968 and its subse-
quent sale in December of 1968 of the 3,248,000 shares of
Allis common stock. The total sales price is alleged to have
been $121,330,000. Allis’ position is that the purchases and
the sale both occurred within less than six months. Allis
claims that the amount of the sale together with the divi-
dends received by G&W during this less than six month
period, minus its stipulated cost of acquiring and selling the
3,248,000 shares constitute the amount of profit. Allis also
38a
seeks to recover interest at 6% on G&W’s profits from the
date of sale, December 6, 1968, to the date of entry of judg-
ment.
G&W’s Answer to the Amended Complaint denies all ma-
terial allegations of the Complaint, and specifically alleges,
inter alia, that G&W was not a beneficial owner of more
than 10% of Allis’ stock at the time of its acquiring through
the Exchange Offer the 3,000,000 Allis shares, and that this
is required by Section 16(b). G&W contends that since its
acquisition of the 3,000,000 Allis shares was pursuant to an
Exchange Offer regulated by the Securities Act of 1933 the
transaction would be excluded from the purpose of Section
16(b). G&W further charges that the sale of its 3,248,000
Allis shares was induced by “duress and hostility” to G&W,
originating with Allis and inflamed through Allis’ encour-
agement of Federal Trade Commission proceedings against
G&W. G&W thus denies liability. But then, going further,
G&W claims that even if there is liability, it realized no
profit from the transactions and there would be no money
due to Allis as a result of this action.
LIABILITY
_The jurisdiction of this Court is asserted under Section 27
of the Securities Exchange Act of 1934 (15 U.S.C. 78aa).
Section 16(b) of the Act states as follows:
“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 pur-
chase, of any equity security of such issuer (other
than an exempted security) within any period of
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39a
less than six months, unless such security was ac-
quired in good faith in connection with a debt previ-
ously 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 secu-
rity purchased or of not repurchasing the security
sold for a period exceeding six months. Suit to re-
cover 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 prose-
cute 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 con-
strued 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.”
Section 16(b), thus, provides that liability attaches to
10% beneficial owners who are such: “. .. both at the time
of the purchase and sale, or the sale and purchase of the
security involved. .. .”
G&W contends in one of its affirmative defenses that as
to the 3,000,000 shares of plaintiff’s common stock acquired
by G&W pursuant to the Exchange Offer, G&W is not liable
to Allis for any profits that may have been realized upon
40a
the sale to White since at that point in time when G&W
acquired the 3,000,000 shares G&W was not a beneficial
owner of more than 10% of Allis’ equity security within
the terms of the statute. This would mean that it then
became the owner of more than 10%, and only a subsequent
acquisition would bring the statute into play.
Allis, however, contends that on an initial purchase of
more than 10% one becomes such a holder of more than
10% of the stock of a company as to trigger the applicabil-
ity of Section 16(b). To bolster its contention that one
becomes subject to Section 16(b) at the time of the purchase
which turns one into a 10% beneficial owner irrespective of
the percentage of his prior holdings, if any, Allis quotes
from the recent decision in Kern County Land Co. v. Occi-
dental Petroleum Corp., 411 U.S. 582, 584 (May 7, 1973):
“Unquestionably, one or more statutory purchases
occurs 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.”
In the Kern County case defendant, Occidental Petroleum
Corporation, made a tender offer for shares of the Kern
County Land Company ‘hereinafter referred to as “Old
Kern”). That offer became effective on May 8, 1967 and
by May 10 more than 10% of the shares had been tendered.
The Court found 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.
G&W relies upon Kern County also. This is because in
that case a tender offer was involved, which like the ex-
change offer here, raised the question of whether or not the
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nature of the purchase was reached by the statutory
definition.’
A careful analysis of the case law including Kern County
leads me to the conclusion that G&W by its initial purchase,
became a beneficial owner of more than 10% of Allis’ stock.
In construing the words “at the time” as used in the statute
the Court in Stella v. Graham-Paige Motors Corp., 104
F.Supp. 957 (S.D.N.Y. 1952), aff'd in part, remanded in
part, 232 F.2d 299 (2d. Cir.), cert. denied, 352 U.S. 831
(1956) said as follows at 960:
1 Pertinent language in the decision includes the following from
593-595:
“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 encompassed within the
purview of § 16(b), the courts have wrestled with the question
of inclusion or exclusion of certain ‘unorthodox’ transactions.
The statutory definitions of ‘purchase’ and ‘sale’ are broad
and, at least arguably, reach many transactions not ordinarily
deemed a sale or purchase. In deciding whether borderline
transactions are within the reach of the statute, the courts
have come to inquire whether the transactions may serve as
a vehicle for the evil which Congress sought to prevent—the
realization of short-swing profits based upon access to inside
information—thereby endeavoring to implement congressional
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 alterna-
tive constructions of the terms of §16(b) are possible, those
terms are to be given the construction that best serves the
congressional | mgr of curbing short-swing speculation by
corporate insiders. Reliance Electric Co. v. Emerson Electric
Co., supra, at 424. See Blau v. Lamb, 363 F.2d 507 (CA2
1966), cert. denicd, 383 U.S. 1002 (1967). * * * [Thus]
“{iJn, interpreting the terms ‘purchase’ and ‘sale’, courts have
properly asked whether the particular type of transaction in-
volved is one that gives rise to speculative abuse.”
42a
“. .. if the words ‘at the time’ are construed to mean
‘simultaneously with’ a shareholder would become
subject to the provisions of §16(b) as soon as his
ownership exceeded 10% of the outstanding shares.
This construction wouid be consistent with the de-
clared purpose of the statute to prevent the unfair
use of inside information by officers, directors, or
—— owning more than 10% of the equity
s Oe
Through the years since the Stella decision the Courts
have followed its thinking in construing the words “at the
time of the purchase and sale” to apply to shareholders
immediately upon their acquisition of more than 10% of a
corporation’s securities. In Bershad v. McDonough, 300
F.Supp. 1051 (N.D.IIl. 1969) aff'd, 428 F.2d 698 (7th Cir.
1970), cert. denied, 400 U.S. 992 (1971), asin Kern County,
supra, the Court was concerned with whether the granting
of an option was a sale (the back end of the transaction)
within the confines of Section 16(b). However, it is clear
that the Courts would not have concerned themselves with
that issue had they first not reasoned that Section 16(b)
liability turned on an initial acquisition exceeding 10%
serving to set in motion the 6 month period. In accord with
these cases are the holdings in Emerson Electric Co. v.
Reliance Electric Co., 434 F.2d 918 (8th Cir. 1970), aff'd
on other grounds, 404 U.S. 418 (1972); Blau v. Lamb, 363
F.2d 507 (1966), cert. denied, 385 U.S. 1002 (1967); and
Newmark v. RKO General, Inc., 425 F.2d 348 (1970), cert.
denied, 400 U.S. 854 (1970).
On the facts before me, I conclude that G&W became a
beneficial owner of more than 10% of Allis’ common stock
at the time of its purchase, by tender offer, of the 3,000,000
shares of Allis’ stock. However, G&W argues that even if
7
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th ne OL Na OP ON et BY tO ee Neg
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43a
it became a 10% owner of Allis’ common stock at the time
it acquired by tender offer almost a third of Allis’ equitable
ownership and sold the whole of it within six months, it
is exempt from the operation of Section 16(b) because the
purchase was “unorthodox” and “unorthodox” transactions
do not involve the type of abuse Section 16(b) was enacted
to prevent.
G&W presents a strong argument for the proposition that
its initial acquisition of the Allis shares by an Exchange
Offer was not the traditional cash-for-stock purchase that
Congress considered in passing Section 16(b). Rather,
G&W contends, it was a hybrid type of transaction with
unique characteristics closely resembling a merger. G&W
says that it would be erroneous to consider the legal
consequences of G&W’s acquisition of the stock apart from
the disclosure process with which it alleges “it was inex-
tricably connected.” The argument is that Exchange Offers
(as distinct from cash transactions) are surrounded by
numerous legal safeguards which are designed to guarantee
full disclosure to all shareholders and thus by their very
nature are unsuited to short-swing speculation based on
inside information.
'n effect, the argument is that since the acquisition was
conducted in accordance with the methods established by
the Securities and Exchange Commission and Congress,
i.e, pursuant to a registered Exchange Offer and by a
Prospectus, G&W was not automatically an insider nor was
there any possibility of abuse as a result of the nature
of the transaction. Its offer, G&W contends, was subject
to the prohibition against the use of any Prospectus (or
Registration Statement) which contained “any untrue
statement of fact or omission of a material fact required
to be stated * * * or necessary to make the statements
therein not misleading.” Such prohibition appears in a
44a
number of sections of the Securities Act of 1933, 15 U.S.C.
§§ 77k, 771, 77q, 77x. Accordingly, G&W maintains, it
caused all material information regarding Allis to be
released to the public and placed in the hands of each Allis
shareholder and that these actions afforded all parties to
the proposed exchange an equal informational footing, elimi-
nating thereby any advantage to G&W.
In opposition to this contention Allis ignores certain
words of Kern County, “unorthodox sale—not a sale within
the meaning of 16(b)”, and argues that an unfettered read-
ing of the language of Section 16(b) makes it clear that
the statute does not require any showing that an insider
had inside information in order for liability to attach. The
suggestion that full and truthful disclosure of what is
known is required by some other necessary proceedings,
according to Allis, creates no defense to the charge that
there was an actionable purchase.
It is true that the court in Kern County found that an
unsuccessful takeover bidder who converted shares of the
target company into the merged entity’s shares was not
liable for short-swing profits when it was found that there
had been no opportunity for speculative abuse. The target
corporation, Old Kern, had vigorously opposed Occidental’s
takeover bid and to thwart such a takeover had arranged
a “defensive merger” with Tenneco. Due to the merger
of Old Kern and Tenneco, Occidental was virtually forced
to exchange the Old Kern shares that it had acquired by
its tender offer for those of Tenneco. The successor cor-
poration to Old Kern brought suit to recover the alleged
Section 16(b) profits realized by Occidental. The court
concluded that the transaction having been forced upon
Occidental did not constitute a “sale” within the purview
of Section 16(b). The court noted that the merger left
Occidental with no appraisal rights under California laws;
. aba VAdeae acre ppittebs ally Dow
45a
but that any other sale of Old Kern shares for cash before
the merger closed “‘would have left Occidental with a prima
facie § 16(b) liability.” Supra at 600.
I am convinced that with these words the Supreme Court
recognized that where, for example, a purchase carries suf-
ficent indicia of full disclosure of aii information available
to the purchaser, and its sale is an economically or legally
coerced involuntary act the transaction is not intended
by Congress to be unlawful; but that when the sale is
clearly voluntary a prima facie Section 16(b) violation
would exist. When we on the trial bench try to facilitate
our determination by limiting liability to simple categories,
such as “orthodox” and “unorthodox”, we may easily blind
ourselves to the kinds of abuses to which Congress directed
16(b). The 1934 Senate Report on Stock Exchange Prac-
tices (Senate Comm. on Banking and Currency), Stock
Exchange Practices, S. Rep. No. 1455, 73rd Congress, 73
Cong. 2d Sess. 55 (1934) stated:
“Among the most vicious practices unearthed at the
hearings before this subcommittee was the flagrant
betrayal of their fiduciary duties by directors and
officers of corporations * * *. Closely allied to this
type of abuse was the unscrupulous employment of
inside information by large stockholders who, while
not directors or officers, exercise sufficient control
over the destinies of their companies to enable them
to acquire and profit by information not available
to others.”
Even though Kern County is a clear repudiation of the
“cold turkey” application of statutory liability in 16(b)
cases, nowhere in Kern County does the Supreme Court take
out of 16(b) its application to a short-swing transaction
just because there was in fact no access to inside informa-
46a
tion. It leaves the statute applicable to types of transactions
that give “rise to speculative abuse”. (Kern County at 595. )
Under Kern County (594 fn. 26) the language of this Cir-
cuit in Bershad v. McDonough, 428 F.2d 693 (7th Cir.
1970), was confirmed. Then it went one step further. It
announced a flexible “possibility of abuse” test to be applied
to each case on the facts regarding its questioned transac-
tion. The specific transaction itself must permit the possi-
bility of or potential for abuse. (Kern County at 595.)
The question is whether or not an outsider becoming a
prima facie insider, such as defendant, by virtue of a tender
offer to purchase one third of plaintiff’s common stock,
under the circumstances of this case, engages in that type
of transaction which Congress determined gives rise to the
possibility of or potential for speculative abuses. By virtue
of the nature and amount of the purchase, such purchaser
generally places himself or itself in a position to at least ex-
ercise substantial influence over the decisions of the corpo-
ration, if not control. From this position information can
be acquired not otherwise available to the public. Stock
value changes can be reliably anticipated if not maneuvered.
The desirable speculative character of a free market can be
wrecked by the cumulative effect of a substantial amount of
such piracy. The danger, of course, in each instance, is not
easily established by evidence of actual manipulation or
intent to manipulate.
Some corporations have as their primary occupation deal-
ing in the stock of other corporations. Some buy and sell
units of corporate control for profit. It seems to me that
irrespective of whether the purchase under these circum-
stances is handled in an “orthodox” or an “unorthodox”
manner, it can constitute one of the types of conduct which
Section 16(b) was intended to reach.
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47a
This does not mean that Congress sought by this !aw to
stop or even dissuade corporations from using their equity
for moving in and out of positions of control or effective
influence in other corporations, either for the purpose of in-
vestment or the purpose of acquiring on a trial and error
basis absorbable corporate operations. The statute does in-
tend to include corporate conduct out of which buying and
selling for profit from an insider’s perspective can occur.
The evidence in the case before me shows defendant, G&W,
as having engaged in a substantial number of transactions
involving the purchase and sale of controlling interests in
other corporations. There is nothing in the evidence to
establish that G&W’s acquisitions and dispositions were for
the purpose of gaining inside information to be used selling
stock positions in corporations for profit, or that it actually
did have inside information when it bought or sold. I am
confident that the greater weight of the evidence presented
to me does not establish that G&W had inside information
of the character contemplated by Section 16(b) either be-
fore or after its purchase of Allis. But I am convinced that
its position both at the time of the purchase and at the time
of the sale was such as would, in many such situations, per-
* Its chief executive officer, when asked to confirm or reject a
Statement appearing in the February 15, 1973 edition of the Wall
Street Journal, stated that he “would not reject the statement.” The
statement was that, from 1958 through 1968:
“* * * G&W acquired about 130 companies, usually using its
own securities or packages of its securities and warrants to
buy the companies. At first the acquisitions were complemen-
tary with G&W’s main lines of business, but later it branched
out in all directions. The big year was 1968 when 23 acquisi-
tions came under G&W’s wing. * * * G&W that year similarly
withdrew from stock positions in other large companies—
Armour and Co., Allis-Chalmers Manfg. Co., and Sinclair
Oil Corp. In fact over the years, G&W has bought in and out
of companies both for investment reasons and for the purpose
of acquisition and complete control.”
48a
mit access to information not otherwise available to the
general public.
Allis failed to establish that G&W did have inside infor-
mation both at the time of the purchase and at the time of
the sale. What was shown was that in May of 1968 G&W’s
president was told by the head of a California investment
firm that he had encouraged an investment firm to seek a
merger with Allis; that Allis had been interested in being a
part of a profitable merger; that the investment company
and Allis had entered into a preliminary agreement to
merge, but that the plan fell through because the investment
firm believed a heavy manufacturing business inherently
risky. This cannot be considered the type of inside informa-
tion to which the statute refers. In addition, what was
shown was that in September of 1968, before G&W sold its
Allis stock, Allis’ president told G&W’s president that Allis’
performance during that quarter of the year was extremely
poor and that its earnings had declined sharply, but the in-
ference to be drawn from this was that Allis sought to dis-
courage G&W’s retention of its stock position in Allis. Other
information given G&W by Allis was almost contemporane-
ously made public.
G&W asserted as an affirmative defense the absence of
inside information; but here again I find the facts insuffi-
cient. A fact does not exist here which is found in other
cases in which this affirmative defense has succeeded. The
missing fact is that plaintiff’s conduct locked the defendant
outside so effectively that the defendant could not have
acquired inside information had it wanted to. This is what
happened in Kern County, and in Gold v. Sloan, 486 F.2d
340 (4th Cir. 1973).
I further find the facts insufficient to establish as an
affirmative defense that G&W was compelled to sell its stock
in Allis before the expiration of the statutory period. Occi-
dental was not only locked out in Kern County, but under
49a
the circumstances was left no realistic alternative to dis-
posing of its stock in Old Kern. Its only alternative would
have left it with a prima facie 16(b) liability. Of the same
order was the circumstance which compelled Scurlock in
Gold v. Sloan to acquire the Susquehanna stock, part of
which he sold within six months. G&W was here not caught
in a merger. The one clear-cut defensive tactic of Allis,
slashing its quarterly dividend in half after G&W had
acquired one third of its common stock, as offensive as G&W
may have felt it, was nevertheless not an act which com-
pelled a sale some fifty odd days before the end of the
statutory period.
VALUATION
Section 16(b) of the Securities Exchange Act of 1934 (15
U.S.C. 78(b) ), provides that “for the purpose of preventing
the unfair use of [inside] information,” the beneficial
owner shall pay over to the complaining corporation any
profit realized by the purchase and sale. What then is the
amount, if any, Allis is entitled to be paid by G&W is the
remaining question. Allis contends that the amount is
$16,305,251, with additional interest to the datc of the entry
of judgment. G&W contends that there was no profit, but
rather a loss, and that Allis would be entitled to nothing.
The issue of the amount of profits to be accounted for
where there is a 16(b) liability calls into play, when the
consideration given or received is other than cash, certain
principles of valuation. Were the consideration given and
received cash only, the problem would be a simple one; but
in most of these cases it usually is not just cash. Most of the
cases under 16(b) cited by the parties in their briefs, in
which liability had been found, involved consideration other
than cash.
50a
In this case the purchases were made with some cash, but
principally with G&W warrants and debentures; and the
sale was made for some cash, but principally for certain un-
registered shares of common stock of White, and an un-
secured six month corporate promissory note. Valuations
of these other-than-cash considerations was the matter te
which both sides were requested to and did direct much of
their attention in testimony, exhibits and argument. The
testimony and opinions of expert witnesses was presented
at great length by both sides. Were the position of the plain-
tiff and its experts accepted completely, the defendant would
be accountable for $12,741,788 in profits, for dividends and
for interest from the date of the sale to the date of this deci-
sion. Were the position of the defendant and its experts
accepted completely, it would be found that the defendant,
through no fault of its own, lost $11,545,566 (if not $13,-
699,993) in the purchase and sale. The differences of more
than 30 million dollars between the positions of the parties
and their experts must be resolved by applying to the facts
basic principles of valuation derived from authorities in the
field of securities and accounting, and from cases interpret-
ing valuations in 16(b) cases.
The Court itself must determine the fair market value or
the fair value (in the absence of a market) of the considera-
tion given up and received in a 16(b) case. Real or actual
values, as in other cases, may require investigation of the
affairs of the corporations and businesses involved; but the
situs of the 16{b) valuation is the actual or presumed mar-
ket place. Park & Tilford, Inc. v. Schulte, 160 F.2d 984,
990 (2nd Cir.) cert. denied 332 U.S. 761 (1947).
Where in determining valuation two or more interpreta-
tions may equally be drawn from the same facts, the Court
may adopt the one least favorable or most favorable to the
defendant as the relative equities of the parties dictate; but
5la
in doing so the Court is not required to adopt a completely
unrealistic interpretation of the market. Mueller v. Korholz,
449 F.2d 82, 87 (7th Cir. 1971). One of the major disagree-
ments between the parties in this case is the plaintiff’s
insistence that in 16(b) cases, valuations always must be
read in the light least favorable to the defendant or most
favorable to the plaintiff.
The concept of maximizing profit by using such theories
as “lowest in and highest out” as espoused in the 1943
decision of the 2nd Circuit in Smolowe v. Delendo Corpora-
tion, 136 F.2d 231, 239, is not the law in this (7th) Circuit.
In Mueller, supra at 87, we are admonished not to adopt
a completely unrealistic interpretation in the name of ad-
vancing the Congressional purpose. In that case the Seventh
Circuit was confronted with the problem of valuing the
defendant Korholz’s holdings of “Gypsum” stock traded in
the over-the-counter market. No evidence was presented
of actual trades on the date in question, but there was
evidence of dealers “making a market” in Gypsum stock.
Their quotations ranged from 6 to 634 on the “bid” side
and from 714 to 74% on the “asked” side. This meant that
the best bid Korholz could have received from his shares
was 634. As the Seventh Circuit explained, the plaintiff
contended :
‘st & *
as a matter of law that the low bid price of
$6.00 was the only acceptable evidence of value
because the policy of § 16(b) requires the Court to
adopt an interpretation of the facts that will
‘squeeze out all possible profit.’ Cf. Smolowe v.
Delendo Corp., 186 F.2d 231 (2 Cir. 1943).”
Then explaining away the language of the Second Circuit,
the court in Mueller went on to say at 87:
52a
“The comment in that case [Smolowe; supra] may
guide a court’s choice between two reasonable inter-
pretations of the facts. Jt does not require a court
to adopt a completely unrealistic interpretation of
the market.” (Emphasis added. )
The court thereafter proceeded to affirm a valuation
based not on $6.00 the low bid, nor even on the $6.75 best
bid, but on a $6.875 “average price or value” on the relevant
date.
There are numerous cases in which courts have chosen
either the high or low figure for what appeared to be
punitive purposes. Blau v. Lamb, 242 F.Supp. 151 (S.D.
N.Y. 1965), rev’d and aff’d in part, 363 F.2d 507 (2 Cir.
1966), cert. denied 385 U.S. 1002 (1967); Marquette
Cement Mfg. Co. v. Andreas, 239 F.Supp. 962 (S.D.N.Y.
1965) ; Gratz v. Claughton, 187 F.2d 46 (2d Cir.), cert.
denied, 341 U.S. 920 (1951); Heli-Coil Corp. v. Webster,
222 F.Supp. 831 (D.N.J. 1963), aff’d as modified, 352 F.2d
156 (3d Cir. 1965); Blaw v. Lehman, 173 F.Supp. 590
(S.D.N.Y. 1959), aff’d 286 F.2d 786 (2 Cir. 1960), aff’d,
368 U.S. 403 (1962). But it appears to me that in those
eases the trial courts must have been without evidence
from which realistic values might have been computed.
As a result of evidentiary default, and faced with a deci-
sional necessity, they resolved the issue through “stop-gap”
application of Congressional purpose. Mueller’s under-
standing of Smolowe would apply also to them. Even so,
Mueller’s admonition to the trier of fact to seek from the
evidence, if at all possible, a basis upon which a realistic
interpretation of fair market value can be made, is to me
a highly responsible mandate.
53a
THE PURCHASE
During the six month period involved in this case there
were between 10,363,102 and 10,410,292 shares of Allis’
common stock issued and outstanding. G&W opened it by
buying 3,000,000 shares through an exchange offer and
later acquired directly from the Oppenheimer Fund, Inc.,
an additional 248,000 shares. Before the end of the period
G&W sold all 3,248,000 to a single purchaser, White Con-
solidated Industries, Inc.
The parties disagree as to the date upon which G&W
acquired the 3,000,000 shares, not because it was the day
that began the six month countdown, but because of the
substantial difference in value of the stock on the different
dates assertec by the parties to be the date of purchase.
The exchange offer was publicly noticed through the press
by G&W on May 7, 1968. There is no evidence as to whether
or not there was any awareness of G&W’s intentions prior
to that date. The offer was to purchase from all Allis
shareholders on a pro-rata basis up to 3,000,000 shares,
offering in exchange for each share: $11.50 in cash; 9/10
of a warrant to expire January 31, 1978 to acquire a share
of G&W common at $55; and a $12.50 principal amount of -
a 6% G&W Subordinate Debenture to be due July 1, 1988.
According to the proxy statement the exchange offer was
conditioned on approval of G&W shareholders on July 29,
1968. If this approval were forthcoming, G&W would ac-
cept all Allis shares tendered up to 3,000,000. If more than
3,000,000 would have been tendered by July 19, 1968, all
would be accepted on a pro-rata basis. If fewer than
3,000,000 would have been tendered by July 19, G&W would
accept all shares tendered after that date in their order
of receipt up to 3,000,000 shares. Ali tenders were
irrevocable.
d4a
Before July 29, 1968, more than 3,000,000 Allis shares
had been tendered, and on that date G&W’s shareholders
approved the Exchange Offer. Thereafter, in the “Initial
Statement of Beneficial Ownership of Securities” required
by Section 16(a) of the Securities Exchange Act of 1934
to be filed with the SEC, it was stated that G&W acquired
3,000,000 shares of Allis’ common on July 31, 1968.
In G&W’s monthly report to the SEC for the month of
July, 1968, it was stated that “Registrant, on July 31,
1968, acquired 3,000,000 shares of common stock of Allis-
Chalmers.” In a document called “Welcome to Gulf &
Western” sent out to the new G&W warrant holders under
the exchange offer, it was stated that “The effective date
of the Exchange was July 31, 1973.”” G&W’s warrant agent
dated all warrants given in exchange for Allis common, on
the date July 31, 1968, and an answer by G&W to one of
Allis’ interrogations filed in these proceedings contained
sufficient reference to July 31, 1968, to generate a con-
tention by Allis that G&W judicially admitted July 31st
to be the acquisition date; but the certainty of that answer
as an admission is clouded by the nature of the answer and
the context within which it was given.
Using July 29, 1968 as the valuation date itself, G&W
comes out with a gross purchase price per Allis share of
$37.93. Using July 31 as a controlling date, Allis comes
out with a gross purchase price per Allis share of $35.37.
This difference, crudely stated, of $2.56 per share, places
- the parties initially seven million dollars apart in their
computations.
Allis contends that the court is bound by the manner in
which G&W handled the exchange offer in its accounting,
public and judicial records, and statements. Allis con-
tends that as far as possible the court must resolve issues
in favor of the plaintiff, because 16(b) is “remedial”. Thus
55a
Allis, by holding G&W to the July 31st date, a day on
which the stock market was closed, acquires August Ist as
the valuation date, a day which, over July 29th, substan-
tially maximizes profit. On August lst nothing happened
between the parties. On July 29th G&W itself became irre-
vocably bound to Allis’ shareholders who in reliance on the
terms of the exchange offer had irrevocably tendered their
stock for securities that in turn had a remote equitable
interest in Allis. To use estoppel here to argue against a
contractually relied upon date as the day for valuation that
will “squeeze out” all possible profit is almost to manufac-
ture profit and to render the statute punitive and not
remedial.
As indicated above, in 16(b) determinations, the manner
in which a corporation handles its financial records and
statements for its own or public purposes, and its state-
ments in courts may, like admissions against interest, weigh
heavily against such corporation, but the court may not
use these facts to abandon its duty of determining the
market value. Estoppel will not intervene to bind a party
to what otherwise under the facts would be an erroneous
determination of artificial profit. Mueller v. Korholz, supra;
Park & Tilford, Inc. v. Schulte, supra; Champion v. Jeffress,
352 F.Supp. 1081, 1084 (E.D.Mich. 1973).
Earlier in this case, when it was before the District
Court for the Eastern District of Wisconsin (the case was
later transferred to this district), Judge Reynolds of that
court announced that the date of purchase is that on which
the “insider” becomes bound and by the act of shareholder
approval entitled to acquire the tendered shares. Allis-
Chalmers Mfg. Co. v. Gulf & Western Industries, Inc., 309
F.Supp. 75, 80-81 (E.D.Wis. 1970). I conclude with him,
from all the evidence that July 29, 1968 was for purposes
of valuation the date of purchase.
56a
Plaintiff contends that the value of 9/10ths of a G&W
warrant expiring in 1978 to acquire a share of G&W’s
common stock at $55 must be merely 9/10ths of the low
at which those warrants were traded on the exchange on
the valuation date. When we use the date Allis chose—
August 1, 1968—and that day’s low—13.875, we come out
with a figure of $37,462,500.° When we use the date of
the rule of this case—July 29, 1968—and that day’s low of
15.0, we come out with a figure of $40,500,000.* I disagree
with both. If an investor is to be ordered to turn over his
“profit”, without proof of wrongdoing, it should be real
and not manufactured profit. The research and reporting
services relied upon by the public in the market recite lows
and highs to reflect trends, but when reflecting an isolated
day in a single figure they use an average. A quick average
is half the sum of the high and low. A refined average
would be the volume-weighted average for the day. We
should use neither the high nor the low if we have the
facts from which to make a realistic determination. Muel-
ler v. Korholz, supra; Volk v. Zlotoff, 318 F.Supp. 864,
866 (S.D.N.Y. 1970).
Defendant contends that as to its warrants, we at least
should consider their volume-weighted average on July
29th. This average was 15.56301. When we use that
average we come out with the figure of $42,020,127.°
With this I agree. But then, the defendant goes further
and urges that a realistic valuation of the warrants would
recognize the effect of arbitrage upon the value of the
°9/i0ths of 13.875 x 3,000,000; or 9/10ths of 3,000,000
(2,700,000) x 13.875. .
‘9/10ths of 15.0 x 3,000,000; or 9/10ths of 3,000,000
(2,700,000) x 15.0.
59/10ths of 15.56301 x 3,000,000; or 9/10ths of 3,000,000
(2,700,000) x 15.56301. Defendant rounded this figure for the
average at 15.56, and came out with the lesser amount of 42,012,000.
57a
warrants. This, according to G&W, would require using
the weighted-average in the trading of the warrants over
the period of May 7, 1968, when public notice was given
of the intent to follow through on the exchange offer, and
July 29, 1968, the acquisition date. This average was
18.93. Were that average used, we would come out with
the figure of $51,120,000; the amount G&W claims to be
the proper valuation. With this I do not agree. I am of
the opinion that to apply arbitrage would be unrealistic and
artificial.
® | learn from the witnesses that quite commonly during exchange
and tender offers specialized ea comes into play and affects the
market price of one or the other of the securities involved, from the
time of a market awareness of a proposed exchange or tender offer
until the consummation of the transaction.
Generally the proponent of the exchange, the seller, in order to
insure the success of his proposal, places in the package he offers
as consideration things that would add up to a higher market value
than that of the securities sought. This, | am taught by the witnesses,
attracts arbitrageurs whose dealing in these securities causes their
market prices to be unrepresentative of what they would be even
when they reflect the offer. Fair market value thus should reflect an
averaging out of the difference between the down pressure of arbitrage
activity and the resistance of the security to that pressure.
The defendant strongly urges that statistics show that arbitrage did
occur here and that the value of the warrants should take it into
account. But the reports of Investment Statistics Laboratory show
no changes in the trading and prices of the warrants, at least during
the first two months of the exchange offer which could not be at-
tributed to the ofier itself. Were arbitrage applicable in this case, it
seems to me that to strike an average over the entire period of
awareness of the offer when no serious drop in the prices of the
warrants occurred until a few weeks before the uisition date,
would give excessive weight to the high as against low. This
indeed would be manufacturing a valuation.
On the other hand, the evidence shows that without any dramatic
increase in warrants outstanding from April through July, there was
a dramatic increase in short interest over the period of the exchange.
The percentage of short interest to outstanding warrants increased
from .4 in April to 13.4 in May, and then to 14.7 in June and 18.9
in July. In August it returned to 8.0, in September to 4.5 i
October and November back to .4. When this fact is placed along
side the daily trading and closings of the warrants over the same
58a
In 16(b) valuations of the consideration given through
exchange offers in payment for the stock of the plaintiff
corporations, making adjustments of market value to
reflect the impact of arbitrage activities upon securities of
one side would deprive the parties of fundamental fairness.
G&W would have a windfall of at least $4,981,500.
I find no case law to guide me on this issue, but when
I analyse carefully the testimony of the expert witnesses
I conclude that in any case in which the purchase is effected
through a security for security exchange offer, adjusting
the market value of the securities given as consideration
for the target securities to reflect the impact upon the
market of arbitrage would be improper. To allow G&W
an additional cost amount reflecting arbitrage, would be
y give G&W compensation for having made the exchange
offer.
The effect of the exchange offer itself on the market
price, as from day to day while it is open and information
and rumors about it change, is as substantial an unknown
period of time, it becomes clear that there was arbit i
this exchange offer. But it becomes equally clear that yn f
effect upon the market of the warrants until on or after July 12th
on which day they traded dramatically low and closed at 19.25.
Prior to then its closings described no pattern. During the 42 market
days from May 7 to July 12, the movements were not unusual.
There was a lowest closing at 17.25 on June 28th, and a highest
closing at 20.75 on July 8th. But after the 19.25 closing of July
hy _ a a} —— decline to an all time low
of 13.875 on August Ist. It is this decline whi i -
“= the ry of thn activity. wahsscetienedes
‘ere I to give a fair value to the im of arbitrage
market price of the warrants on the date as rchase, I would ae
an average between the closing on July 12, 1568, as explained above
and the weighted-average of the trading on July 29, 1968. With that
in mind, | would find the fair market valuation of the G&W warrants
given as part of the consideration for the Allis common at the time
of the purchase to be $46,993.500. (Half the sum of 19.25 and
15.56 is 17.405. 9/10ths of 17.405 x 3,000,000 (or 17.405 x
9 10ths of 3,000,000) (2,700,000) comes out to be $46,993,500. )
59a
as is arbitrage. Both are that speculative in nature that
when the proponent of an exchange offer, as here, puts
together his package of considerations to pay for the
target security, as he is deemed to have placed in it what
will insure the success of the exchange, so he must be
deemed to have withheld from it what he calculates will be
necessary to cover for the aberrations of the market, in-
cluding arbitrage. Were he, hypothetically, buying up his
own package at the time of the exchange, and in the market
place, and were he allowed an adjustment for arbitrage,
he would benefit from it twice. Just as the court will not
construct a valuation to manufacture a higher profit, so
it will not permit considerations which, though perfectly
fair and proper in other valuations, have the effect of
manufacturing an undeserved deduction from profit.
In view of the foregoing, I conclude that the value to be
assessed the warrants given as part consideration for the
3,000,000 Allis common shares on July 29, 1968, is
$42,020,127.
The third item of the consideration given for each of the
3,000,000 shares of Allis’ common stock was a $12.50 prin-
ciple amount of a G&W 6% subordinated debenture.’ The
debentures were issued in denominations of $100 and for
each Allis share one eighth of a debenture was given. There
thus were 375,000 of such debentures issued and all were
given in the 3,000,000 share exchange. They were new
debentures due in 1988. On the date of purchase controlling
in this case, July 29, 1968, none of these debentures were
traded on the stock exchange. As far as that is concerned,
even the August Ist date claimed by Allis to be the proper
date of purchase would not serve to give a fair market value
to them because there were too few traded upon which a
7 The first item was $11.50 cash per share. 3,000,000 x $11.50 =
$34,500,000.
60a
fair valuation could be based. On July 29th there were
outstanding and being traded in substantial amounts sim-
ilar debentures due in 1987. On that day $87,000 of them
were traded with an average between the high and low
of 80.875.
The new debentures were first admitted to trading on the
New York Stock Exchange on August 8, 1968. On that
day, 332 one thousand dollar units were traded. They
opened at 75, closed at 75, had a high of 76, a low of 74,
and a volume-weighted average of 75.15023. Both Allis
and G&W refer to August 8th for a meaningful valuation.
Allis claims the amount should be the low of $74 because,
it asserts, “Section 16(b) case law the lowest price of a
security on the date of purchase governs.” G&W claims
that the amount should be the volume-weighted average
of the August 8th trading, $75.15 each. None of the ex-
perts were able to place a hypothetical or real valuation
on the debentures, either as of July 29th or August lst,
based upon knowledge existing as of that day.
To choose the low of August 8th’s trading, as requested
by Allis, just to “squeeze out all possible profits”, is to
manufacture valuation. Since similar debentures were
trading with a high-low average of 80.875, and since our
debentures themselves finished out the rest of August with
an average closing of 76.47, the volume-weighted average
of the first trading day, August 8th, $75.15 is quite realistic
of what would have been the fair market value on July
29th, had there been a market. Accordingly, I find the
value of the debentures given up in the exchange offer to be
$28,181,336 ($75.15023 x 275,000).
In addition to the 3,000,000 shares of Allis’ common
acquired by G&W through the Exchange Offer, G&W later
purchased 248,000 shares from Oppenheimer Fund, Inc.
Their agreement of August 28, 1968, provided that in
6la
exchange itor the Allis stock Oppenheimer Fund, Inc. would
receive 496,000 G&W warrants. Because the consumma-
tion of this agreement depended upon, among other things,
the listing of the G&W warrants and underlying common
stock to their respective stock exchanges (subject to official
notification of the issuance), the agreement called for a
closing date three days after such listing but not later than
September 30, 1968; and G&W would receive all dividends
paid on the Allis shares after the agreement date, August
28th.
Although the G&W warrants would be listed without
SEC registration and thus were not freely tradable, G&2W
agreed to file a registration on or before April 30, 1969.
G&W also agreed that if the registration statement did not
become effective by December 31, 1968, and if Oppenheimer
chose to sell any warrant in the ninety days following
the effective date of registration, G&W would guarantee
or pay Oppenheimer an average gross price of $13.50 for
each warrant Oppenheimer sold. The agreement was closed
on September 30th. G&W did not cause the registration
statement for the warrants to become effective until Janu-
ary 13, 1969, thus bringing into effect the agreement’s
price guarantee. On March 18, 1969, Oppenheimer in-
formed G&W of its sale of 8,500 warrants and its plan
to sell the remaining warrants beginning after March 21,
1969. The parties however reached an agreement wherein
Oppenheimer would defer the immediate sale of the war-
rants, and G&W would extend the guarantee until October
of 1969. On April 18 Oppenheimer invoked the extended
guarantee and a week later made its demand upon G&W
for $2,154,450. G&W paid it on June 5, 1969.
The parties have agreed that the valuation date of these
496,000 warrants was September 30, 1968. The agreement
is realistic and I approve it. These warrants were un-
62a
registered at the time of purchase and their valuation must
reflect that fact. On that date registered warrants were
trade
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