Petition — Ross v. Morales

oa ae oe oe —— oe ae a a —

IN THE

SUPREME COURT OF THE UNITED STATES

nv. 76-728

OCTOBER TERM, 1976

DONALD B. ROSS, Petitioner

vs.

RICHARD MORALES, Respondent

PETITION FOR WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS FOR

THE TENTH CIRCUIT

DICKSON M. SAUNDERS

R. THOMAS SEYMOUR

LAWRENCE T. CHAMBERS, JR.

DOERNER, STUART, SAUNDERS,

DANIEL & LANGENKAMP

1200 Atlas Life Building

Tulsa, Oklahoma 74103

Attorneys for Petitioner

INDEX

eee re 2

r „ inne 2

Question Presented for Re vie 2

eren 3

eee 4

1 7

een eee 13

Appendix A — Opinion of the United States

Court of Appeals for the Tenth Circuit............. Al

Appendix B — Opinion of the United States District

Court for the Northern District of Oklahoma....... A8

ii

CITATIONS

Cases: Page

Ferraiolo v. Newman, 259 F.2d 342 (6th Cir. 1958),

cert. denied, 359 U.S. 927 (1959)............... 8

Kern County Land Co. v. Occidental Petroleum

n SE OI, occ veddabéarececss 7

Morales v. Arlen Realty & Development Corp.,

352 F.Supp. 941 (S.D.N.Y. 1973))-ů 12

Petteys v. Butler, 367 F.2d 528 (8th Cir. 1966),

cert. denied, 385 U.S. 1006 (1967).............. 9

United States Statutes:

BP Se MO UED oc ci ndcdedcctovessdésceuens 3, 10

D 0. os dtc b 660000 sus 606 n06ae ean 3

Miscellaneous:

Senate Report No. 792, 73d Cong.

fF kh 7

OCTOBER TERM, 1976

DONALD B. ROSS, Petitioner

vs.

RICHARD MORALES, Respondent

PETITION FOR WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS FOR

THE TENTH CIRCUIT

The petitioner Donald B. Ross respectfully prays that a

writ of certiorari issue to review the judgment and opinion

of the United States Court of Appeals for the Tenth Circuit

entered in this proceeding on August 27, 1976.

OPINIONS BELOW

The opinion of the court of appeals is reported at 541

F.2d 233, and is reproduced in Appendix A hereto. The

opinion of the United States District Court for the Northern

District of Oklahoma is unreported and is reproduced in

Appendix B hereto.

JURISDICTION

The judgment of the Court of Appeals for the Tenth

Circuit was entered on August 27, 1976. No petition for

rehearing was filed. This Court’s jurisdiction is invoked

under 28 U.S.C. § 1254(1).

QUESTION PRESENTED FOR REVIEW

Is the giving of 3,416 warrants and $9.00 for each war-

rant in exchange for 3,416 shares of comon stock a “pur-

chase” within the meaning of § 16(b) of the Securities Ex-

change Act of 1934 (15 U.S.C. § 78p) when:

(1) All warrantholders possess the right to ex-

change one warrant and $9.00 for one share of

common stock anytime prior to the expiration

date;

(2) The holders of 98% of such warrants do exer-

cise their warrants;

(3) Warrants are being traded over-the-counter at

a price equal to the price of the common stock,

minus $9.00; and

(4) The exchange occurs within one month of the

expiration date of the warrants, at which time

all warrants, unless previously exchanged, are

to be automatically converted into one-half

share of common stock?

STATUTORY PROVISIONS INVOLVED

United States Code, Title 15, Section 78 (4) (11):

(11) The term “equity security” means any

stock or similer security; or any security conver-

tible, with or without consideration, into such a

security, or carrying any warrant or right to sub-

scribe to or purchase such a security; or any such

warrant or right; or any other security which the

Commission shall deem to be of similar nature and

consider necessary or appropriate, by such rules

and regulations as it may prescribe in the public

interest or for the protection of investors, to treat

as an equity security.

United States Code, Title 15, Section 78p(b):

security was acquired in good faith in connection

with a debt previously contracted, shall inure to

and be recoverable by the issuer, irrespective of any

intention on the part of such beneficial owner, di-

rector, or officer in entering into such transaction

of holding the security purchased or of not repur-

chasing the security sold for a period exceeding six

months. Suit to recover such profit may be insti-

tuted at law or in equity in any court of competent

jurisdiction by the issuer, or by the owner of any

security of the issuer in the name and in behalf of

the issuer if the issuer shall fail or refuse to bring

such suit within sixty days after request or shall

fail diligently to prosecute the same thereafter; but

no such suit shall be brought more than two years

after the date such profit was realized. This sub-

section shall not be construed to cover any trans-

action 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 trans-

action or transactions which the Commicsion by

rules and regulations may exempt as not compre-

hended within the purpose of this subsection.

STATEMENT OF THE CASE

At all times relevant to this action, petitioner was Finan-

cial Vice-President of MAPCO, Inc. (“MAPCO”). Under a

prospectus dated March 17, 1964, MAPCO issued 306,450

warrants. By the terms of the issuance one warrant plus

$9.00 could be exchanged for one full share of MAPCO

common stock through March 31, 1972. Any warrants not so

exchanged were to be automatically converted into one-half

share of MAPCO common on April 1, 1972, the date of

expiration of the warrants. Out of the total issuance all war-

rants except 5,486 (1.79%) were exercised by the holders

thereof prior to the expiration date.

MAPCO was at all times from 1964 forward a listed

stock on the New York Stock Exchange. The warrants had

an anti-dilution clause whereby the warrantholders were

protected against the issuance of MAPCO common stock at

a consideration of less than $18.00 per share. At all times

pertinent hereto, warrants were traded in the over-the-

counter market at a price equal to the price of the common

stock, minus $9.00.

During the period from March 1964, the date of initial

issuance of the warrants, to a time six months prior to Jan-

uary 1, 1972, the petitioner acquired 3,616 warrants of

MAPCO. In February and March, 1972, petitioner disposed

of his warrants in the following manner:

Date — mird Part) Received Sold

Feb. 28 200 200 200

Feb. 29 100 100 100

Mar. 6 200 200 200

Mar. 9 400 400 400

Mar. 23 200

Mar. 24 2,516 2,516

Totals 3,416 200 3,416 900

On February 28, 1972, MAPCO common stock closed at

$41.00, and on March 24, 1972, the last day of the subject

transactions, MAPCO common closed at $43.25. To effect

the conversion of the 3,416 warrants into common stock,

petitioner either furnished his broker the required $9.00 per

warrant or drew upon the balance in his brokerage account.

The 900 shares of common stock obtained through the first

four transactions went to the broker in its street name and

were sold through the New York Stock Exchange.

Thereafter, plaintiff, Richard Morales, brought this

action against petitioner and the nominal defendant,

MAPCO, Inc., pursuant to the provisions of § 16(b) of the

Securities Exchange Act of 1934, 15 U.S.C. § 78p (1964).

The complaint alleged that the petitioner’s selling of the 900

shares’ of MAPCO common stock and the subsequent acqui-

sition of 2,516 shares of common stock was a “sale and pur-

chase” within six months, at a profit, in violation of § 16(b).

Applying a “pragmatic” test, the district court granted

petitioner’s motion for summary judgment, holding that the

'The action was originally filed on February 22, 1974, in the United States

District Court for the Southern District of New York. On June 11, 1974,

the case was transferred to the Northern District of Oklahoma on the stip-

ulation and agreement of all the parties.

The original complaint actually alleged the sale of 1100 shares of common

stock. After discovering that the transaction of March 23, 1972, was, in fact,

a sale of warrants and not common stock, the plaintiff consented to the

entry of partial summary judgment deleting the March 23 transaction from

those at issue. The number of shares of MAPCO common claimed by plain-

tiff to have been sold by petitioner was thereby reduced to 900.

transfer of one warrant plus $9.00 was not a “purchase”

within the meaning of § 16(b) because, inter alia, the war-

rants were the economic equivalents of the common stock,

all warrantholders stood in an equal position, there was no

possibility of speculative abuse of “inside” information, and

the transactions were of an involuntary nature.

The court of appeals reversed, holding that under either

an “objective” or “pragmatic” test, the transactions were

within the purview of § 16(b).

ARGUMENT

The decision below presents a clear conflict in principle

with the decisions of other courts of appeals and of this Court

as to the proper interpretation of § 16(b) of the Securities

Exchange Act of 1934.

The purpose of § 16(b) is to protect the public “by pre-

venting directors, officers, and principal stockholders of a

corporation . . from speculating in the stock on the basis of

information not available to others. Senate Report No. 792,

73d Cong., 2d Session, 9 (1934). In Kern County Land Co. v.

Occidental Petroleum Corp., 411 U.S. 582 (1973), this Court

stated tht in deciding whether borderline or “unorthodox”

transactions are within the reach of the statute, courts should

follow a “pragmatic” approach. The inquiry under this ap-

proach is whether or not the transaction could possibly lend

itself to the types of speculative abuse that the statute was

designed to prevent. Petitioner contends that the transaction

in question — the conversion of warrants into common stock

— was not one that could possibly have given rise to specula-

tive abuse, that the court of apeals did not follow a “prag-

matic” approach in reaching its conclusion to the contrary,

and that the court of appeals’ decision is in direct conflict in

principle with Ferraiolo v. Newman, 259 F.2d 342 (6th Cir.

1958), cert. denied, 359 U.S. 927 (1959), and Petteys v.

Butler, 367 F.2d 528 (8th Cir. 1966), cert. denied, 385 US.

1006 (1967).

In Ferraiolo, one of the “pragmatic” approach cases re-

ferred to in Kern County, supra, 411 U.S. at 594 n.26, the

Court of Appeals for the Sixth Circuit held that a director

had not made a “purchase” within § 16(b) by converting

preferred stock into common stock, and was therefore not

liable for the profits realized by the sale of the common stock

within six months. As in the instant case, the preferred stock

had an anti-dilution clause to protect against dilution of the

value of the preferred. Both the preferred and the common

were listed on the New York Stock Exchange, and, because

of its undilutable conversion privilege, the preferred had

been selling at a price equivalent to the common. When the

preferred was called for redemption the director was faced

with a choice of permitting his preferred shares to be re-

deemed at $27.00 a share or converting them into common

shares selling for $36.00. In the vourt’s words, the director

“naturally took the latter course as did the holders of more

than 99 percent of the outstanding preferred shares.” 259

F.2d at 345. While it was true that the director could have

sold the preferred shares on the open market instead of con-

verting them, the court said “it can hardly be said that a

failure to sell is tantamount to a purchase.” 259 F.2d at 346.

In finding that the conversion of preferred into common

was not a transaction that could have lent itself to the prac-

tices which § 16(b) was enacted to prevent, the court em-

phasized the following facts: all of the preferred sharehold-

ers were treated alike, full disclosure was made to them, the

conversion worked no material change in proportional equity

ownership, the transaction was in a very real sense involun-

tary, the preferred and common were economically equiva-

lent, the conversion had none of the economic indicia of a

purchase, and the conversion created no opportunity for

profit which had not existed since the date of initial issuance

of the convertible preferred.

The facts of Petteys v. Butler, 367 F.2d 528 (8th Cir.

1966), cert. denied, 385 U.S. 1006 (1967), another of the

cases cited by this Court in Kern County as taking the cor-

rect “pragmatic” approach to § 16(b), are quite similar to

the situation in Ferraiolo. The holding is identical. The direc-

tors therein converted preferred stock into common, and sold

10

the common stock within six months of the conversion. The

preferred stock was fully marketable and listed on the New

York Stock Exchange. It was protected against dilution, was

fully convertible, and at all times maintained a market value

equivalent to the common. Redemption of the preferred was

called at a price below the market, and the holders of over

99% of the preferred stock converted to common. Following

Ferraiolo, the Court of Appeals for the Eighth Circuit found

that since the transaction could not possibly have lent itself

to the speculation encompassed within the purposes of

§ 16(b), the conversion was not a “purchase” within the pur-

view of the Act’s provisions.

In all principal respects, Ferraiolo and Petteys are iden-

tical to the instant case. That those situations involved pre-

ferred stock as the underlying security is of no consequence,

for a warrant is also an “equity security” within the meaning

of § 16(b). 15 U.S.C. S 78c(a)(11). Just as the defendants

in Ferraiolo and Petteys could have disposed of their pre-

ferred stock as preferred stock, it is uncontroverted that

petitioner, having held his underlying security for more than

six months, could have disposed of the 3,416 warrants as

warrants without any question of § 16(b) liability whatso-

ever (see note 2, supra). But, to paraphrase the court in

Ferraiolo, it can hardly be said that petitioner's failure to

sell the warrants on the open market was tantamount to a

purchase. The courts in Ferraiolo and Petteys looked through

11

form to substance. Here, as in those cases, petitioner's con-

version of warrants into common stock was also in a very

real sense involuntary. Faced with the possibility of sub-

stantial economic loss had he allowed the warrants to expire,

petitioner “naturally” chose to convert the warrants into

common stock, as did the holders of over 98% of all the

warrants. Here there was no call for redemption, but there

is certainly no substantive difference between the stone wall

of redemption and that of expiration of the warrants.

In the instant case, the Court of Appeals for the Tenth

Circuit distinguished Ferraiolo and Petteys on grounds that

are completely irrelevant to the inquiry of whether the con-

version of the warrants into common stock could possibly

have given rise to speculative abuse. For example, the court

noted that the transaction in Ferraiolo did not require the

payment of money while here $9.00 had to be paid with each

warrant to obtain a share of common. Petitioner submits this

is a distinction without a difference. The $9.00 per warrant

payment was established in 1964 and remained constant.

There was no “purchase” possible in the sense of the ordi-

nary market purchases which § 16(b) was designed to cover.

Most importantly, this distinction ignores the key find-

ing in Ferraiolo, i.e., that the conversion created no oppor-

tunity for profit which had not existed since the date of

initial issuance. The district court below found, as a matter

12

of uncontroverted fact, that the market value of the warrants

was $9.00 less than the market value of the common stock

on the dates of the exchanges, and at least one year prior

thereto. Since the petitioner received the same number of

dollars from the sale of the stock as he would have received

had he sold the warrants as warrants, the warrants and the

common stock were economically equivalent. The court of

appeals utterly ignored the fact that the conversion of the

warrants into common stock created no opportunity for

profit which had not existed since March 17, 1964, the date of

initial issuance. Petitioner contends that the Ferraiolo court’s

reference to “economic indicia” was in fact a reference to

the possibility of speculative profit. The following language

in Morales v. Arlen Realty & Development Corp., 352

F.Supp. 941, 945 (S.D.N.Y. 1973), supports this interpreta-

tion: The question is whether the acquisition of stock under

these circumstances has the indicia of a “purchase”

under § 16(b); viz., whether it entailed the possibility

of speculation.”

Here, and in Ferraiolo and Petteys, all holders of the

underlying “equity security” were in an equal position, as

evidenced by the fact that in all three cases the holders of

over 98% of the respective securities exchanged for common

stock. It was impossible for any warrantholder to have been

vulnerable to an unfair advantage simply because petitioner

may have had access to “inside” information. And it is the

13

absence of unfair advantage that is the gravamen of a

“pragmatic” inquiry into the possibility of speculative abuse.

This the court of appeals completely misperceived. Although

the court correctly labeled the conversion of warrants as an

“unorthodox transaction,” it did not follow a pragmatic

approach in determining whether the exchange constituted

a “purchase” within the meaning of § 16(b), as it was re-

quired to do in accordance with this Court’s decision in Kern

County. It merely concluded that the transaction had the

possibility of speculative abuse of inside information with-

out giving an explanation of the basis for its conclusion.

The reason the court of appeals failed to explain its conclu-

sion is because there was no possibility of abuse. As the

district court stated in the penultimate paragraph of its

opinion:

It is difficult for this Court under the circumstances

of this case to determine in any manner how inside

information could possibly have lent itself to the

speculative abuse prohibited by § 16(b). To find

otherwise would penalize a holder of securities for

following sound economic principles merely because

he serves the corporation in an official capacity, and

thereby has access to inside information.

CONCLUSION

The decision of the Court of Appeals for the Tenth Cir-

cuit is in direct and irreconcilable conflict in principle with

the Ferraiolo and Petteys decisions from the Sixth and

14

Eighth Circuits. This Court should grant certiorari, and the

judgment of the court of appeals should be reversed with

direction to reinstate the judgment of the district court.

Respectfully submitted, |

DICKSON M. SAUNDERS

R. THOMAS SEYMOUR |

LAWRENCE T. CHAMBERS, JR.

DOERNER, STUART, SAUNDERS,

DANIEL & LANGENKAMP

1200 Atlas Life Building

Tulsa, Oklahoma 74103

Attorneys for Petitioner A P P EN D IX

Al

APPENDIX A

UNITES STATES COURT OF APPEALS

TENTH CIRCUIT

No. 75-1414

RICHARD MORALES,

Plaintiff-Appellant,

V.

MAPCO, INC., and DONALD B. ROSS,

Defendants-Appellees.

APPEAL FROM THE UNITED STATES DISTRICT

COURT FOR THE NORTHERN DISTRICT OF

OKLAHOMA

(D.C. No. 74-C-271)

David Lopez for Plaintiff-Appellant.

R. Thomas Seymour (Lawrence T. Chambers, Jr.,

Doerner, Stuart, Saunders, Daniel & Langenkamp,

on the brief) for Defendant-Appellee Ross.

Before McWILLIAMS, BREITENSTEIN and DOYLE,

Circuit Judges.

BREITENSTEIN, Circuit Judge.

This is a stockholder's derivative action to recover for

defendant Mapco short-swing profits said to have been made

by defendant Ross, the financial vice president of Mapco.

Suit was brought under § 16(b) of the Securities Exchange

Act of 1934, 15 U.S.C. S 78p(b). The district court granted

Kw a

summary judgment for Mapco and Ross. The stockholder

| appeals. We reverse.

A2

So far as material, § 16(b) provides:

“For the purpose of preventing the unfair use of

information which may have been obtained by * * * (an)

officer by reason of his relationship to the issuer, any

profit realized by him from any purchase and sale, or

any sale and purchase * * * within any period of less

than six months, * * * shall inure to and be recoverable

by the issuer, irrespective of any intention on the part

of such“ officer in entering into such transaction?

The section specifically authorizes a stockholder's derivative

action.

The facts are uncontested. In 1964 Mapco issued war-

rants which were automatically converted into one-half

share of Mapco common stock each on April 1, 1972. Alter-

natively, one warrant plus $9.00 could be exchanged for one

full share of Mapco stock prior to the expiration date. The

warrants had an anti-dilution clause whereby the warrant

holders were protected against the issuance of Mapco com-

mon stock at a consideration of less than $18.00 per share.

Ross acquired 3,616 Mapco warrants, and held them

for more than six months. Through his broker Ross dis-

posed of the following warrants on the dates shown:

Quantity Date

200 February 28, 1972

100 February 29, 1972

200 March 6, 1972

400 March 9, 1972

Additionally, in March Ross sold 200 warrants to a third

person and by the payment of $9.00 per warrant, secured

2,516 shares of Mapco common himself.

A3

Mapec common was a listed stock on the New York

Stock Exchange. Warrants were sold and bought in the

over-the-counter market. On February 28, the date of the

first transaction in question, Mapco common closed at $41.00,

and on March 24 at $43.25. The stock reached a high of

$52.25 on June 20, 1972.

The stock obtained by the 900 warrants in issue went

to the broker in its street name and was sold through the

New York Stock Exchange. On the first two transactions,

representing a total of 300 warrants, Ross paid to the broker

the $9.00 needed to convert each warrant into a full share

of common. On the last two transactions, Ross’ balance with

the broker sufficed to furnish the needed cash. The broker

furnished Ross with statements showing the transactions.

Ross filed with the Securities and Exchange Commission

its Form 4, “Statement of Changes in Beneficial Ownership

of Securities,” for the months of February and March, 1972.

These listed the security as “Warrants: Exercised and Sold

as Common,” gave the transaction date, and stated the

“Amount Sold or otherwise disposed of”, as a total of 1100.

Section 16(b) declares its purpose to be the prevention

of “the unfair use of information” by a statutory insider

obtained “by reason of his relationship to the issuer.” Re-

liance Electric Co. v. Emerson Electric Co., 404 U.S. 418, 422,

says that “the only method Congress deemed effective to

curb the evils of insider trading was a flat rule taking the

profits out of a class of transactions in which the possibility

of abuse was believed to be intolerably great. ‘(C)onsid-

erations of intent, lack of motive, or improper conduct’ * * *

are irrelevant in § 16(b) suits.” Ibid. at 424 n. 4. See also

Ernst & Ernst v. Hochfelder. US. 44 LW 4445,

A4

4459 n. 28; and Kern County Land Co. v. Occidental Petro-

leum Corp., 411 U.S. 582, 595.

Kern County notes, 411 U.S. at 593, that traditional

cash-for-stock transactions within the six-month period are

within the purview of § 16(b) and comments that “the courts

have wrestled with the question of inclusion or exclusion of

certain ‘unorthodox’ transactions.” The court lists, Ibid. at

n. 24, as unorthodox transactions those “dealings in options,

rights, and warrants.” We have here an unorthodox trans-

action.

In applying § 16(b) the courts have fluctuated from an

objective test to a pragmatic test. Under the objective test

a mechanical determination is made of whether the type of

transaction or class of investor is wholly within or wholly

without the purview of § 16(b). The pragmatic test requires

examination of each transaction to determine whether an

insider has used an opportunity to profit by undisclosed in-

formation. A discussion of the two tests is found in Kern

County, 411 U.S. at 594 n. 26. Kern County applied the

pragmatic test to a merger situation and said that the invol-

untary nature of the transaction coupled with the absence

of speculative abuse resulted in a situation beyond the pur-

view of § 16(b). 411 U.S. at 600. Reliance Insurance applied

the statute mechanically. It was concerned with a two-step

sale, one step of which was without the six months period.

404 U.S. at 424-425.

Ferraiolo v. Newman, 6 Cir., 259 F.2d 342, cert. denied

359 U.S. 927, involved the conversion of preferred into

common stock and, adopting the pragmatic approach, the

court held that the transaction was not within § 16(b). The

court pointed out equality of treatment, full disclosure, and

A5

no material change in proportional equity ownership. Ibid.

at 346. It said that the transaction was involuntary because

of the possibility of monetary loss, that the transaction had

none of the “economic indicia of a purchase”, and that the

transaction could not have lent itself “to the practices which

Section 16(b) was enacted to prevent.” Ibid. In Ferraiolo

the transaction did not require the payment of any money by

the holder. Here $9.00 had to be paid with each warrant to

get a share of common. The preferred stockholder in Fer-

raiolo had an equity ownership. A Mapco warrant holder

had a right to purchase. If the right was not exercised, he

received one-half share of common on the expiration of the

warrant. A right to purchase is not the equivalent of owner-

ship of the property subject to the right. The warrant did not

give ownership until exercised or terminated.

Petteys v. Butler, 8 Cir., 367 F.2d 528, cert. denied, 385

U.S. 1006, was also concerned with conversion of preferred

into common and like Ferraiolo is factually distinguishable

from the case at bar. Neither Blau v. Max Factor & Com-

pany, 9 Cir., 342 F.2d 304, cert. denied 382 U.S. 892, nor Blau

v. Lamb, 2 Cir., 363 F.2d 507, cert. denied 385 U.S. 1002, had

anything to do with transactions in warrants.

Bershad v. McDonough, 7 Cir., 428 F.2d 693, cert. denied

400 U.S. 992, was concerned with a stock option which was

executed, but not exercised, within the six month period.

The court held that the date of execution, rather than the

date of exercise, controlled and that the transaction was

within the purview of § 16(b). In Bershad the parties to the

option controlled its terms. The court said that in the cir-

cumstances presented “the stock was effectively transferred,

for all practical purposes, long before the exercise of the

option.” Ibid. at 698. In the case at bar, Mapco issued the

A6

warrants and controlled the terms. A warrant holder did not

have a right to stock before warrant expiration unless he

surrendered his warrant and paid $9.00.

Booth v. Varian Associates, 1 Cir., 334 F.2d 1, cert.

denied 379 U.S. 961, was concerned with a transaction in

which insiders agreed to exchange or sell stock in one com-

pany for stock in another. The transaction was closed in

1962 and within less than six months of the closing date, the

insiders sold the stock which they had acquired. The court

held the transaction to be within § 16(b). In so doing, it

noted that transaction price was the market quotation a day

prior to the closing, and said that this feature of the trans-

action made it “as much as possible like a market purchase

at the time of the closing.” Ibid. at 4. In the instant case the

warrant holder could exercise a warrant and pay $9.00 with

full awareness of the current market quotations on Mapco

stock.

Kern County points out, 411 U.S. at 593-594, that the

statutory definitions of purchase and of “sale” are broad

“and, at least arguably, reach many transactions not ordi-

narily deemed a sale or purchase. See also definitions found

at 15 U.S.C. § 78c(a)(13) and (14). Section 16(b) covers

either “purchase and sale, or sale and purchase” by an in-

sider within a six-month period. Ross sold stock. Before the

sale Ross had purchased the stock by surrendering a war-

rant and paying $9.00. The stock was held in his broker's

street name and sold on the exchange. After the sale he

acquired more shares in his own name through the use of

the warrants and the payment of $9.00 per share, an event

constituting another purchase of stock. The sale also was of

stock, not of warrants. It makes no difference whether the

A7

purchase occurred before or after the sale. All of the trans-

actions were within the six-month period.

Applying the objective test, the result is the same

whether the transactions be considered a purchase and sale

or a sale and purchase. Ross was an insider and the trans-

actions were within the statutory period. Section 16 (b) was

enacted to remedy a congressionally recognized abuse of

inside information. It should be liberally construed. The

statute removes intent from consideration. Ross’ protesta-

tions of good faith avail nothing. Speculation as to how the

transactions might have been handled to avoid the effect

of § 16(b) is of no relevance.

The pragmatic test produces the same result. We do not

have an exchange of one security for another. The transac-

tions required Ross to make cash payments. The warrants

were not the economic equivalent of the stock because the

warrants carried no equity ownership but the stock did.

Ross was the financial vice-president of Mapco. The trans-

actions had the possibility of speculative abuse of inside

information. Cf. Kern County, 411 U.S. 602. That is enough

to bring them within § 16(b).

Reversed and remanded for the entry of an appropriate

judgment in the light of this opinion.

FILED

AUG 27 1976

HOWARD K. PHILLIPS

CLERK, UNITED STATES

COURT OF APPEALS

TENTH CIRCUIT

A8

APPENDIX B

IN THE UNITED STATES DISTRICT COURT FOR

THE NORTHERN DISTRICT OF OKLAHOMA

NO. 74-C-271

RICHARD MORALES,

Plaintiff,

-VS-

MAPCO, INC., and

DONALD B. ROSS,

Defendants.

David Lopez, New York, New York, and James G.

Davidson, Tulsa, Oklahoma, Attorneys for Plaintiff,

Richard Morales.

R. Thomas Seymour and Lawrence T. Chambers, Jr.,

Tulsa, Oklahoma, Attorneys for Defendant, Donald B. Ross;

and Eugene G. Bell, Tulsa, Oklahoma,

Attorney for Defendant, Mapco, Inc.

MEMORANDUM OPINION

Before H. DALE COOK, United States District Judge

Pursuant to the provisions of §16(b) of the Securities

and Exchange Act of 1934, 15 U.S.C. §78(p) (1964), this

action was brought as a derivative suit initiated by a share-

holder of the nominal Defendant, Mapco, Inc. Section 16(b)

prohibits the unfair use of information obtained by a direc-

tor, officer or principal shareholder as an “insider” of the

issuing corporation. Where an insider has gained “short

swing profits by a sale or purchase or purchase or sale of

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any equity security of the corporate issuer within a period

of less than six months, the profits from such unauthorized

use of inside information are recoverable by the issuing

corporation and inure to its benefit.

This action was filed on February 22, 1974, in the United

States District Court for the Southern District of New York.

The Defendants filed a Motion to Dismiss or Motion to

Transfer. On June 11, 1974, without ruling on the Motion to

Dismiss, the New York Court transferred the case to the

Northern District of Oklahoma on the stipulation and agree-

ment of all the parties.

The pre-trial order filed on October 31, 1974, granted

leave to the Defendants to enlarge their Motion to Dismiss

into a Motion for Summary Judgment. Pursuant to Rule 56,

Federal Rules of Civil Procedure, the Defendants have

moved for summary judgment. One of the grounds now

asserted by the Defendants in support of their motion is that

the two-year Statute of Limitations expired prior to the

transfer of the case from the Southern District of New York

to this Court. The Defendants assert that the action was

wrongfully brought in New York because no venue existed

and that the Defendants’ motion must be sustained since the

Statute of Limitations now bars this action. The expanded

Motion for Summary Judgment also asserts that the De-

fendant, Donald B. Ross, did not dispose of the securities

issued to him by Mapco, Inc., in a manner which constituted

transactions prohibited by §16(b).

The Complaint alleges that the Defendant, Donald B.

Ross, purchased 2,516 shares of Mapco common stock on

March 24, 1972, and that he sold 100 shares of Mapco com-

mon stock on February 29, 1972, 200 shares on February 28,

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1972, 200 shares on March 6, 1972, 400 shares on March 9,

1972, and 200 shares on March 23, 1972, while serving as

Financial Vice-President of Mapco, Inc. In support of their

Motion for Summary Judgment the Defendants admit that

the transactions alleged in the Complaint are true except

that the transactions alleged do not constitute a sale and

purchase as proscribed by §16(b).

The Plaintiff responded to the Defendants’ Motion for

Summary Judgment with a brief wherein the Plaintiff con-

sents to a partial summary judgment as to the transaction

of March 23, 1972, concerning the disposition of 200 war-

rants. The Plaintiff stands on the position that the remaining

transactions constitute a sale and purchase” and that the

Defendant, Ross, is indebted to the issuing corporation for

the unauthorized profits which he gained as an “insider”.

The Plaintiff asserts that the record will support summary

judgment in favor of the Plaintiff as to the remaining issues

before the Court. (Pages 2 and 34 of Plaintiff's Memorandum

in Opposition to Motion for Summary Judgment).

On April 3, 1975, hearing was held before the Court.

Counsel for the parties presented arguments on all issues

pending in the case. By agreement of the parties the deposi-

tion of Donald B. Ross was admitted into the record to be

considered as evidence by the Court in resolving the ques-

tions presented. Both Plaintiff and Defendants declared an

intent to rest upon the facts in the record. In addition to the

consideration of counsels’ statements of resting on the rec-

ord, the Court has determined that this cause is properly

before the Court on a Motion for Summary Judgment since

no dispute exists as to the material facts provided in the

record. Frey v. Frankel, 361 F2d 437 (10th Cir. 1966);

Norton v. Lindsay, 350 F.2d 46 (10th Cir. 1965); Singer v.

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Rehm, 334 F.2d 240 (10th Cir. 1964). The Court has care-

fully considered both the oral and written arguments of

counsel, and has reviewed the entire record and is fully

advised in the premises. Each Motion for Summary Judg-

ment has been cautiously evaluated. For the following rea-

sons the Court is convinced that summary judgment should

be granted:

1). The parties have expressly declared an intent to

rest entirely on the record.

2). Both parties have stipulated that they have no

evidence to controvert issues which normally con-

stitute triable fact issues, H. B. Zachry Co. v.

O’Brien, 378 F.2d 423 (10th Cir. 1967).

3). The Plaintiff has no evidence to dispute the De-

fendants’ contention that the value of the warrants

exchanged by the Defendant, Ross, is the value of

Mapco Common Stock on the date of the exchange.

When the statements of value are viewed in a light

most favorable to the position of the Plaintiff no

issue of fact is raised to controvert the value as

established by the affidavit and deposition filed in

the record. United States v. Diebold, 369 U.S. 654

1962); American Mfrs. Mut. Ins. Co. v. American

Broadcasting — Paramount Theatres, Inc., 388 F.2d

272 (2nd Cir. 1967).

4). The interpretation of the terms “sale and purchase”

is a proper determination of the Court. Kern County

Land Co. v. Occidental Petroleum Corp. 411 US.

582 (1973).

The legal issues before the Court arise from the follow-

ing facts. During the period from March 17, 1964, the date

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of the initial issue of the warrants, to a time six months prior

to January 1, 1972, the Defendant, Donald B. Ross, purchas-

ed 3616 warrants of Mapco, Inc. Under the terms of the

initial issue the warrants were automatically converted into

one-half share of Mapco common stock on April 1, 1972, the

date of expiration. As an alternative one warrant plus $9.00

could be exchanged for one full share of Mapco common

stock prior to the expiration day. The warrants had an anti-

dilution clause whereby the warrantholders were protected

against the issuance of Mapco common stock at a considera-

tion of less than $18.00 per share. During the period of

February 29, 1972, and March 23, 1972, the Defendant, Ross,

while serving as Financial Vice-President of Mapco, Inc.,

exercised 1100 warrants and sold 900 shares of Mapco com-

mon stock through the New York Stock Exchange. On March

24, 1972, Ross exercised 2516 warrants and received 2516

shares of Mapco common stock. These facts are undisputed.

The Court must first consider whether this action was

brought within the period allowed by the Statute of Limita-

tions. In order to resolve this question a determination as to

proper venue in the New York Court must be made. The

Complaint was filed in the New York Court on February

22, 1974. The transaction last complained of by the Plaintiff

occurred on March 9, 1972. The case was transferred to the

Northern District of Oklahoma on the 11th day of June, 1974.

Since the case was transferred after the Statute of Limita-

tions had run, the question of whether the cause was prop-

erly brought within the statutory period is dependent upon

the New York venue. If venue did not lie in the New York

Court then the application of §16(b) to these facts is a futile

engagement.

Section 27 of the Securities and Exchange Act of 1934

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(15 U.S.C. §78aa) provides in part:

“The district courts of the United States, and the United

States courts of any Territory or other place subject to

the jurisdiction of the United States shall have exclusive

jurisdiction of violations of this chapter. Any crim-

inal proceeding may be brought in the district wherein

any act or transaction constituting the violation occur-

red. Any suit or action to enforce any liability or duty

created by this chapter or rules and regulations there-

under, or to enjoin any violation of such chapter or

rules and regulations, may be brought in any such dis-

trict or in the di riet wherein the defendant is found or

is an inhabitant or transacts business, and process in

such cases may be served in any other district of which

the defendant is an inhabitant or wherever the defend-

ant may be found.”

In Blau v. Lamb, 20 F.R.D. 411 (S.D.N.Y. 1957) the court

overruled the defendant's motion to dismiss for lack of

jurisdiction over the person or the subject matter in an

alleged 16(b) violation though none of the defendants were

found or were inhabitants or transacted business in the

Southern District of New York. The plaintiff was a Dela-

ware Corporation with the principal place of business in

Ohio and all of the defendants were domiciled in Ohio. The

court founded jurisdiction on the clause of §78aa which

states act or transaction constituting the violation

occurred,” and concluded that transactions on the New York

Stock Exchange were enough contacf to provide the New

York court with jurisdiction.

In an action for attorney's fees for recovery of short

swing profits in Blau v. Tool Research & Engr. Corp., 330 F.

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Supp. 1374 (S.D.N.Y. 1971), the court said in the following

language that this action could be maintained in the district

where the transactions were effectuated and where the claim

arose:

“The salient fact.. is that the unlawful insider short-

swing transactions were effectuated over the American

Stock Exchange, located in the Southern District. Al-

though trading over a national exchange is insufficient

to satisfy the transaction of business clause of §78aa,

„it appears settled that the consummation of an

illegal short-swing transaction over a national exchange

satisfies the act or transaction constituting the violation

clause of §78aa.”

Numerous cases have held that if such an act is committed

venue lies. See, e.g, Peyser v. Meehan Fund, Inc., 264

F.Supp. 1 (S.D.N.Y. 1966); Sher v. Johnston, 216 F Supp.

123 (S.D.N.Y. 1963); Blau v. Lamb, supra. In authorizing

the brokerage firm of Harris, Upham & Co. to dispose of

the warrants, the defendant, Ross, clearly set in motion the

events which resulted in the acts and transactions through

the New York Stock Exchange which resulted in the dis-

position of the defendant’s stock. In authorizing his agent,

Harris, Upham & Co., to dispose of his warrants, Ross sub-

jected himself to the contacts with New York incurred by

his agents in effecting the transactions. (Exhibit A of the

Answers to Interrogatories Addressed to Defendant Donald

B. Ross; Page 7 of The Deposition of Donald B. Ross).

It is the finding of the Court that this action was prop-

erly brought in the Southern District of New York, that the

New York Court had proper venue over this cause, and,

therefore, that this Court has appropriate jurisdiction over

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the subject matter and the parties since the action was in-

stituted prior to the expiration of the Statute of Limitations

and the Defendants have been properly served with process.

Having determined that venue was proper in New York

and that the Court has jurisdiction over this matter, the

Court next considers the question of whether these trans-

actions constitute a violation of §16(b). The latest teaching

from the United States Supreme Court on the application

of §16(b) is Kern County Land Co. v. Occidental Petroleum

Corp., 411 U.S. 582 (1973) where Mr. Justice White dis-

tinguished the application of §16(b) when the transaction

is “traditional” from those transactions which are unor-

thodox.

“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 with-

in the purview of §16(b) the courts have wrestled with

the question of inclusion or exclusion of certain un-

orthodox’ transactions.” Kern at 593.

In the facts before the Court and upon which facts the par-

ties have rested, the Defendant, Ross, submitted $9.00 plus

one warrant to his broker who exercised rights conferred

by the warrant and received a share of Mapco common stock.

The common stock was then sold and the proceeds applied to

the Ross account. This transaction does not fall under the

traditional cash-for-stock purchase. The Defendant owned

the warrant at least six months prior to any of the exchanges

which are the subject of this lawsuit. He did not tender the

purchase price in cash in order to acquire the common stock

but rather tendered $9.00 plus one warrant as the terms of

the issue dictated and received one share of Mapco common

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stock. Upon receiving the stock the broker sold it and cred-

ited the proceeds to the account of Ross. Clearly this trans-

action falls within the classification of “unorthodox” as

provided in Kern and requires that the pragmatic test be

utilized to determine whether these transactions are pro-

hibited. The pragmatic test directs the Court to look at all

of the circumstances in determining whether §16(b) applies.

Roberts v. Eaton, 212 F.2d 82 (2nd Cir. 1954), cert. denied.

348 U.S. 827 (1954); Ferraiolo v. Newman, 259 F.2d 342

(6th Cir. 1958), cert. denied, 359 U.S. 927 (1959); Blau v. Max

Factor Co., 342 F.2d 304 (9th Cir. 1965), cert. denied, 382

U.S. 892 (1965); Blau v. Lamb, 363 F.2d 507 (2nd Cir. 1966),

cert. denied, 385 U.S. 1002 (1967); Petteys v. Butler, 367

F.2d 528 (8th Cir. 1966), cert. denied, 385 U.S. 1006 (1967).

The facts of each case must be set in the context of the

guidelines of Kern.

“In deciding whether borderline transactions are within

the reach of the statute, the courts have come to inquire

whether the transaction may serve as a vehicle for the

evil which Congress sought to prevent-the realization of

short-swing profits based upon access to inside informa-

tion—thereby endeavoring to implement congressional

objectives without extending the reach of the statute

beyond its intended limits. Kern at 594-595.

The terms “sale and purchase” must be interpreted in light

of the activity which may provide the speculative abuse

which the Congress intended to prevent. Reliance Electric

Co. v. Emerson Electric Co., 404 U.S. 418 (1972). In apply-

ing the terms “sale and purchase” to the facts, the Court

must consider the standard espoused in Ferraiolo, supra,

which states:

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“Every transaction which can reasonably be defined as

a purchase will be so defined, if the transaction is of a

kind which can possibly lend itself to speculation en-

compassed by Section 16(b).” Ferraiolo at 345.

The Court must now apply the lew as set out above to

the facts of this case. The warrants held by the Defendant,

Ross, were convertible at any time prior to April 1, 1°72 for

one share of Mapco common stock. The convertibility of

the warrants was protected against dilution by a provision

which prevented the issuance of Mapco common stock at a

consideration of less than $18.00 per share. The uncontro-

verted affidavit of Alan C. Greenberg, a general partner of

Bear, Stearns & Co., the principal underwriters of these

warrants, supports the premise that the value of the war-

rants plus $9.00 equaled the value of Mapco common stock

on the dates of the exchanges and at least one year prior to

these dates when the affiant states that the firm of Bear,

Stearns & Co. would have exchanged the warrants or paid

cash for the warrants on the basis of the market value of

the Mapco, Inc., common stock. (Exhibit A of Defendant

Donald B. Ross’ Brief in Support of Expanded Motion to

Dismiss). The deposition of Donald B. Ross supports the

conclusion that the value of the warrants was equal to the

value of the common stock on the date of the exchange when

the witness states that he would have received the same

number of dollars from Bear, Stearns & Co. that he received

from Harris, Upham & Co. if he had sold only warrants as

warrants to Bear, Stearns & Co. (Page 12 of The Deposition

of Donald B. Ross). Ross held the economic equivalent of

the Mapco common stock. A transfer of the warrant plus

$9.00 for one share of Mapco common stock cannot be con-

sidered a “purchase” where the securities involved were

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economic equivalents. The conversion did not result in a

material change in the proportional equity ownership of

Mapco or in an opportunity for profit which had not existed

since March 17, 1964. Ferraiolo, supra, at 346.

The exchange of the warrant for Mapco common stock

and the subsequent sale of common stock was a simultaneous

transaction. The brokerage firm of Harris, Upham & Co. held

the warrant as cover for the equivalent of the securities sold.

Though the warrants were held in street name, the broker-

age firm was in a position to order them out in street name

or the name of the purchaser. (Page 14 of The Deposition of

Donald B. Ross). In the transactions subject to this suit the

warrants were ordered out in street name, the common

stock credited to the street name and then sold with the

proceeds credited to the account of Ross as if he had sold

warrants. The transaction in exchanging warrants for stock

was simultaneous with the sale of stock so that no opportu-

nity to speculate between the exchange of the warrant and

the sale of the equivalent stock presented itself. It is the

simultaneous nature of this transaction that takes it out

from under the speculative abuse which Congress intended

to prevent in enacting §16(b). Had Ross held the stock for

any period of time after the exchange, a strong presumption

of speculative abuse would immediately exist. With the ex-

change and sale occurring in one unified transaction such

as is present here, there exists no possibility for speculative

abuse. It is interesting to note that Mapco common stock

closed at $41.00 on February 28, 1972, the first day of the

subject transactions. On March 24, 1972, the last day of the

subject transactions, the stock had gained 2-1/2 points in

closing at 43-1/4. The stock reached a high of 52-1/4 on June

20, 1972, and on September 25, 1972, six months after the

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last of the subject transactions, the stock closed at 24-3/8

with a stock split having occurred on September 14, 1972.

(Defendants’ Exhibit 3 of The Deposition of Donald B.

Ross). These listings show that Ross would have gained sub-

stantially by holding his common stock until June of 1972

where he would have gained more than ten points over his

first sale of common stock. If he had held the stock until six

months after the final exchange of warrants, he stood to

gain more than seven points over his first exchange. The use

of “inside” information would appear under these facts to

have prompted Ross to hold for higher gain. These condi-

tions strongly suggest that no speculative abuse existed in

the exercise of the warrants and simultaneous sale of the

stock.

Each warrantholder held the power to receive the mar-

ket value of the Mapco common stock at least one year prior

to the expiration date. (Affidavit of Alan C. Greenberg).

There was no opportunity for speculative abuse where all

warrantholders were subject to market fluctuations. Ross

held slightly in excess of 1% of all the warrants which were

issued. (Exhibit B of Defendant B. Ross’ Brief in Support

of Expanded Motion to Dismiss). Any “inside” information

gained by Ross because of his position as Financial Vice-

President would have been ineffectual under these circum-

stances to control the market for his own advantage.

According to the uncontroverted affidavit of G. Dean

Cosgrove, Treasurer of Mapco, Inc., less than 2% of those

warrants issued remained unexercised as of March 31, 1972.

(Exhibit B, supra). All warrantholders were thus in the

same position as Ross. Substantially all of the warranthold-

ers converted rather than to suffer a considerable and need-

less loss. No warrantholder was vulnerable to an unfair

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advantage because Ross may have had access to “inside”

information. At the time during which Ross converted his

warrants he had little choice to prevent a substantial eco-

nomic loss. He began his conversion within a month of the

expiration date. The exchange was involuntary as the «xer-

cise of nearly all of the issued warrants indicates. Pecteys,

supra. Since all of the warrantholders stood in an equal

position, no advantage was taken of them by the conversion

of the warrants held by Ross. Shaw v. Dreyfus, 172 F.2d 140

(2nd Cir. 1949) cert. denied, 337 U.S. 907 (1949). To have

waited beyond the expiration date would have rendered the

warrant economically unequal to the common stock and

resulted in a considerable loss to the holder. It is difficult for

the Court under the circumstances of this case to determine

in any manner how inside information could possibly have

lent itself to the speculative abuse prohibited by §16(b). To

find otherwise would penalize a holder of securities for

following sound economic principles merely because he

serves the corporation in an official capacity, and thereby

has access to inside information.

Where there is no possibility of speculative abuse of

“inside” information, an involuntary nature to the trans-

action, a simultaneous transfer of warrants for stock and

sale of stock, and an economic equivalent between the war-

rant and the stock received in the exchange such as exists

in this case, §16(b) should not be applied to render an in-

justice to the defendant. The Motion of Mapco, Ing., and

Donald B. Ross for Summary Judgment should be and is

hereby sustained.

It is so Ordered this 10th day of April, 1975.

/s/ H. Dale Cook

United States District Judge