Amicus Curiae Brief — Landreth Timber Co. v. Landreth

LANDRETH TIMBER COMPANY, PETITIONER

V.

IVAN K. LANDRETH, Er AL., RESPONDENTS

ON WRIT OF CERTIORARI TO THE UNITED STATES

COURT OF APPEALS FOR THE NINTH CIRCUIT

BRIEF FOR THE SECURITIES AND EXCHANGE

COMMISSION AS AMICUS CURIAE

SUPPORTING PETITIONER

REX E. LEE

Solicitor General

Louis F. CLAIBORNE

Deputy Solicitor General

CHRISTOPHER J. WRIGHT

Assistant to the Solicitor General

Department of Justice

Washington, D.C. 20530

(202) 633-2217

DANIEL L. GOELZER

General Counsel

PAUL GONSON

Solicitor

Jacos H. STILLMAN

Associate General Counsel

ROSALIND C. COHEN

Assistant General Counsel

STEPHEN M. DETORE

Attorney

Securities and Exchange

Commission

Washington, D.C. 20549

QUESTION PRESENTED

Whether the sale of all of the stock in a company

is a securities transaction subject 20 the antifraud

provisions of the federal securities laws.

(1)

TABLE OF CONTENTS

Page

Interest of the Securities and Exchange Commission 1

ä 3

Summary of argument 1 5

Argument:

I. In view of the plain language, the structure, and

the legislative history of the federal securities

laws, petitioner’s purchase of conventional com-

mon stock was a securities transaction 7

Il. Prior holdings of this Court support the con-

clusion that petitioner’s purchase of common

stock was a securities transaction 15

III. Important policy considerations also counsel re-

jection of the sale of business doctrine........ 1 21

A 27

TABLE OF AUTHORITIES

Cases:

American Tobacco Co. v. Patterson, 456 U.S. 63 24

Bellah v. First National Bank, 495 F.2d 1109 10, 11

Blue Chip Stamps v. Manor Drug Stores, 421 U.S.

e 7 7

Briggs v. Sterner, 529 F. Supp. 1155 19

Cadiz v. Jimenez, 579 F. Supp. 117 — 2

Chandler v. Kew, Inc., 691 F.2d 448998 Tate 2

C.N.S. Enterprises, Inc. v. G. & G. Enterprises,

Inc., 508 F.2d 1354, cert. denied, 423 U.S. 825 11

Cochise College Park, Inc., In re, 703 F.2d 1339 11

Coffin v. Polishing Machines, Inc., 596 F.2d 1202,

cert. denied, 444 U.S. 868 9 2. 19

Cole v. PPG Industries, Inc., 680 F. 2d 549 2

Colson v. Bertsch, 586 F. Supp. 12892 2

Daily v. Morgan, 701 F.2d 4998 2, 11, 12, 13, 18,

24-25, 26, 27

(m)

IV

Cases—Continued : Page

Dirks v. , 468 UB. 6662 25

Exchange National Bank v. Touche Ross & Co.,

I QA. 10, 20-21, 25

Frederiksen v. Poloway, 637 F.2d 1147, cert. de-

r | ae ee 23

Golden v. Garafalo, 678 F.2d 1199 2, 9, 12, 14, 22

Great Western Bank & Trust Co. v. Kotz, 532 F.2d

TE SL LS See ee NO RES Me eae 10

Hunssinger v. Rockford Business Credit, Inc., 745

r ee Dee nae een be So ee ee = 11, 19

International Brotherhood of Teamsters v. Daniel,

gS REESE RT ae eeme eae 7,18

King v. Winkler, 673 F.2d 3422 2,17

Marine Bank v. Weaver, 455 U.S. 551 6, 8, 12, 13, 19,

20, 21, 24

McClure v. First National Bank, 497 F.2d 490,

~ < f , & ... 11

McGrath v. Zenith Radio Corp., 651 F. 2d 458, cert.

RR ERTIES AEE SS 23

Meason v. Bank of Miami, 652 F.2d 542, cert. de-

e 18-19

Montclair v. Ramsdell, 107 U.S. 14447770404 9

Oakhill Cemetery v. Tri State Bank, 513 F. Supp.

— AA tiated eeetieMiR re 2

Occidental Life Insurance Co. v. Pat Ryan & Asso-

ciates, Inc., 496 F.2d 1255, cert. denied, 419 U.S.

—.ͤ ̃ —ñ—.... . ͤů ů ů— —— ——˙·—ðÜ̃ 03Ü nilaaintina 24, 25

Richards v. United States, 369 U.S. 1 — 14

Ruefenacht v. O’Halloran, Civ. No. 80-1097 (D. N. J.

Apr. 15, 1983), rev’d, 737 F.2d 320, cert. granted

sub nom. Gould v. Ruefenacht, No. 84-165 (Nov.

= —A nensee. 2, 10, 11, 15, 20, 21, 22, 24, 25

Russello v. United States, No. 82-472 (Nov. 1,

—8 . ̃ —%öi x 14

SEC v. C. M. Joiner Leasing Corp., 320 U.S. 344. 8, 9, 10,

18, 23

SEC v. United Benefit Life Ins. Co., 387 U.S. 202.. 18

SEC v. Variable Annuity Life Ins. Co., 359 U.S.

SEC v. W. J. Howey Co., 328 U.S. 29938 4. 5, 9, 13, 15,

18, 19

Cases—Continued : Page

Securities Industry Ass’n v. Board of Governors of

the Federal Reserve System, No. 82-1766 (June

Statutes :

ER, SACL ee ee EL» 14, 15, 23, 24

Superintendent of Insurance v. Bankers Life &

e 12

Sutter v. Groen, 687 F.2d 1999779 2, 19, 23

Tcherepnin v. Knight, 389 U.S. 332 10, 18

United Housing Foundation, Inc. v. Forman, 421

r 4, 6, 15, 16, 17, 18, 19, 27

United States v. Menasche, 348 U.S. 528 9

United States v. Naftalin, 441 U.S. 768 14

Zabriskie v. Lewis, 507 F.2d 54e 11

Banking Act of 1933, § 21 (a) (1), 12 U.S.C. 378

B T 14

Securities Act of 1933, 15 U.S.C. 77a et seg. :

r eee x

§ 2(1), 15 U.S.C. 77 (1) 1 x

§ 4(2), 15 U.S.C. 77d (2) EE ST Ne 12

e .... . 3-4

§ 12(1), 15 U.S.C. 7771 ()) 8 3-4

§ 12(2), 15 U.S.C. 771 (7 8 3

817 (a), 15 U.S.C. 77 (a) 1 3

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

et seq.:

§ 3(a), 15 U.S.C. 78c(a) ...... .

§ 3(a) (10), 15 U.S.C. 78 (a) (1)

§ 10(b), 15 U.S.C. 781 (o)) *

. ———

F eee ae

— —

0

Miscellaneous:

Ballentine’s Law Dictionary (2d ed. 1930)

Black’s Law Dictionary (3d ed. 1933)

77 Cong. Rec. (1933):

p. 2925 1 ä 14

1 — 1 e 14

VI

Miscellaneous—Continued : Page

H.R. Rep. 85, 73d Cong., Ist Sess. (1933) 14, 17

H.R. Rep. 1383, 73d Cong., 2d Sess. (1934) 25

L. Loss, Fundamentals of Securities Regulation

— . . ⏑—ꝙ«¶ R 11, 12

2A N. Singer, Statutes and Statutory Construction

// x.. Gq

S. Rep. 42, 73d Cong., Ist Sess. (1933) — 14

In the Supreme Court of the United States

OCTOBER TERM, 1984

No. 83-1961

LANDRETH TIMBER COMPANY, PETITIONER

v.

IVAN K. LANDRETH, Er AL., RESPONDENTS

ON WRIT OF CERTIORARI TO THE UNITED STATES

COURT OF APPEALS FOR THE NINTH CIRCUIT

BRIEF FOR THE SECURITIES AND EXCHANGE

COMMISSION AS AMICUS CURIAE

SUPPORTING PETITIONER

INTEREST OF THE SECURITIES

AND EXCHANGE COMMISSION

The Securities and Exchange Commission, the

agency principally responsible for the administration

and enforcement of the federal securities laws, sub-

mits this brief as amicus curiae to address the ques-

tion whether the sale of a controlling stock interest

in a corporation is a “securities” transaction subject

to the antifraud »rovisions of the federal securities

laws. The court below held that a purchaser of a

100% stock interest is not entitled to the protections

of those provisions. This ruling conflicts with deci-

sions of the Courts of Appeals for the Second, Third,

(1)

Fourth, and Fifth Circuits.’ Three other circuits

adhere to versions of the “sale of business” doctrine

endorsed by the court below.“ Some lower courts have

expanded this doctrine so far as to deny antifraud

protections to purchasers of a 50% or less stock

interest where the purchaser was found to have a

role in corporate management.* The Court will hear

a companion case, Gould v. Ruefenacht, cert. granted,

No. 84-165 (Nov. 13, 1984), that presents the ques-

tion whether the sale of a 50% stock interest is cov-

ered by the antifraud provisions of the federal secu-

rities laws.

The Commission disagrees with both the analysis

employed and the result reached by the court below in

this case and by other courts that have adopted the

sale of business doctrine. Persons who bargain to

1 Ruefenacht v. O’Halloran, 737 F.2d 320 (3d Cir. 1984),

cert. granted sub nom. Gould v. Ruefenacht, No. 84-165 (Nov.

13, 1984); Daily v. Morgan, 701 F.2d 496 (5th Cir. 1983);

Golden v. Garafalo, 678 F.2d 1139 (2d Cir. 1982); Coffin v.

Polishing Machines, Inc., 596 F.2d 1202 (4th Cir.), cert.

denied, 444 U.S. 868 (1979) ; see also Cole v. PPG Industries,

Inc., 680 F.2d 549 (8th Cir. 1982) (interpreting Arkansas

law by reference to federal securities law).

Sutter v. Groen, 687 F.2d 197 (7th Cir. 1982): King v.

Winkler, 673 F.2d 342 (11th Cir. 1982); Chandler v. Kew,

Inc., 691 F.2d 443 (10th Cir. 1977).

See, e.g., Ruefenacht v. O’Halloran, Civ. No. 80-1097

(D.N.J. Apr. 15, 1983) (50% stock interest), rev'd, 737 F.2d

320 (3d Cir.), cert. granted sub nom. Gould v. Ruefenacht,

No. 84-165 (Nov. 13, 1984) ; Colson v. Bertsch, 586 F. Supp.

1289 (D.N.J. 1984) (35%-49% stock interest) ; Cadiz v. Jimi-

nez, 579 F. Supp. 1176 (D.P.R. 1983) (14% stock interest) ;

Oakhill Cemetery v. Tri-State Bank, 513 F. Supp. 885 (N.D.

Ill. 1981) (50% stock interest not a security if combined with

corporate control).

purchase what is unquestionably stock should have

the protection that investors reasonably expect to be

associated with stock. In addition, adoption of the

analysis underlying the sale of business doctrine

could adversely affect protection for those who pur-

chase instruments other than stock, such as notes

and debt instruments. The resolution of the sale of

business issue will not only affect private litigation

but could also significantly affect enforcement actions

brought by the Commission.

STATEMENT

This action arises out of the sale by respondents

Ivan K. Landreth and his sons of all of the outstand-

ing common stock of a timber company. Petitioner

Landreth Timber Company, the successor to the cor-

poration formed to acquire the common stock from

the Landreth family, was owned by a small investor

group, including Samuel Dennis, a Boston attorney;

his client John Bolten, a retired businessman who

lived in Florida; and several others (Pet. App. 2a).*

Petitioner brought this action against the sellers seek-

ing damages under the antifraud provisions of the

federal securities laws.“ Petitioner alleged that, in

*Samuel Dennis originally executed the sale agreement.

Before the closing on November 17, 1977, Dennis and the

sellers agreed to assign the rights under the agreement to

B & D Company, a corporation formed to complete the pur-

chase (Pet. App. 2a). B & D merged with the timber com-

pany to form Landreth Timber Company (ibid.).

The complaint sought relief under Sections 12 (2) and

17(a) of the Securities Act of 1933, 15 U.S.C. 771(2) and

77q(a), and Section 10(b) of the Securities Exchange Act of

1934, 15 U.S.C. 78j(b), which are antifraud provisions. The

complaint also sought relief for violations of registration

requirements under Sections 5 and 12(1) of the Securities

4

connection with the sale, respondents had misrepre-

sented or had omitted to state material facts concern-

ing the liabilities of the timber company and the

condition, production capacity, and completion cost

of its principal asset, a partially-built sawmill (Sec-

ond Amended Complaint / 9-13, 24-25).

The district court granted respondents’ motion for

summary judgment, ruling that the transaction did

not involve securities within the meaning of the fed-

eral securities laws. The district court acknowledged

that the stock at issue possessed the characteristics

of conventional “stock” (Pet. App. 13a), a term in-

cluded in the statutory definition of a “security.”

Nevertheless, the court held that the stock could not

be a security unless it met the test set forth in SEC

v. W. J. Howey Co., 328 U.S. 293 (1946), for iden-

tifying “investment contracts,” another term included

in the statutory definition of security. In the district

court’s view, this conclusion is mandated by United

Housing Foundation, Inc. v. Forman, 421 U.S. 837

(1975). Because the Howey test requires that antici-

pated profits be derived from the efforts of others, the

court ordered the p irties to submit facts bearing on

roles of the sellers and purchasers, the court found

that the management of the business had passed into

the hands of the purchasers (Pet. App. 19a-20a). On

this basis, the court held that the petitioner did not

satisfy the investment contract test.

The court of appeals affirmed (Pet. App. la-10a).

It reasoned (Pet. App. 7a) that it should look beyond

the statutory language in this case because it had pre-

viously done so in construing “note,” another term in

Act, 15 U.S.C. 77e and 7770), breach of contract, common

law fraud, and violations of various state statutes.

the statutory definition of security. In adopting the

sale of business doctrine, the court stated (Pet App.

8a): [When a person purchases control of a busi-

ness, he does not make an investment from which he

expects profits solely from the efforts of others. Al-

though the transaction involves stock, the economic

realities reflect acquisition of a business, not passive

investment, and the [securities] Acts therefore do not

apply.” Thus, like the district court, the court of ap-

peals held that an instrument that was undeniably

common stock was not a security unless it satisfied

the investment contract test set forth in Howey.

SUMMARY OF ARGUMENT

L

The plain language of the federal securities laws,

the structure of those statutes, and their legislative

history, all support the conclusion that petitioner’s

purchase of ordinary common stock was a securities

transaction. With respect to the status under the

securities laws of ordinary common stock, the statu-

tory language is clear—the term “stock” is expressly

included in the statutory definition of “security.”

Excluding conventional common stock from the cov-

erage of the securities laws because it does not also

meet the test for an “investment contract,” another

specifically enumerated term in the statutory defini-

tion of security, violates established canons of statu-

tory construction. In addition, the structure of tne

federal securities laws refutes respondents’ sugges-

tion that the sale of business doctrine should be

adopted because those laws are not concerned with

private transactions or transactions involving trans-

fer of control; numerous provisions in those laws are

concerned with such matters. Furthermore, nothing

in the legislative history of the securities laws sup-

ports respondents’ position that the sale of a con-

trolling stock interest should be construed to be out-

side the express coverage of those laws. Instead, the

legislative history supports a broad reading of

“security.”

IL

This Court’s decision in United Housing Founda-

tion, Inc. v. Forman, 421 U.S. 837 (1975), warrants

no departure from the plain meaning of the statute.

Forman did not hold that the investment contract test

must be applied to all types of securities, including

ordinary corporate stock; rather, Forman held that

so-called “stock” entitling the purchaser to lease an

apartment was not a security. In reaching its deci-

sion, the Court utilized the investment contract test

only after concluding that the “stock” at issue in that

case did not come within the statutory term “stock”

because it did not possess the characteristics typically

associated with that type of instrument. In contrast

to Forman, the instruments in the present case pos-

sess all of the characteristics of conventional stock.

Nor does this Court’s decision in Marine Bank v.

Weaver, 455 U.S. 551 (1982), support adoption of

the sale of business doctrine. The Court in Weaver

relied on the prefatory clause to the statutory defini-

tions, “unless the context otherwise requires,” to hold

that, in light of the comprehensive scheme under

which federally regulated and insured banks con-

duct business, certificates of deposit of such banks

should not be deemed securities for purposes of the

antifraud provisions of the federal securities laws.

There is no comparable alternative federal compre-

hensive regulatory scheme here.

~

Important policy considerations counsel rejection

of the sale of business doctrine. Application of that

doctrine would require an inquiry into the nebulous

area of corporate control and would create arbitrary

distinctions among transactions and among their par-

ticipants. The only certain result of adopting the

doctrine would be an increased burden on the federal

courts and on litigants. In addition, purchasers of

conventional stock should not be excluded from the

protections of the securities laws simply because they

intend to play a role in the operation of the business.

The possibility of fraud is not eliminated because the

purchaser acquires a controlling stock interest. Fur-

thermore, the alleged fraud in this case related to

the condition of the corporation and value of the

stock at the time of its purchase. At that time peti-

tion was no less a passive investor than one who

buys shares in the market. Finally, contrary to

respondents’ argument, a stock sale is not the same

as an asset sale; the risks and consequences of the

two types of transactions are substantially different.

ARGUMENT

I. IN VIEW OF THE PLAIN LANGUAGE, THE

STRUCTURE, AND THE LEGISLATIVE HISTORY

OF THE FEDERAL SECURITIES LAWS, PETI-

TIONER’S PURCHASE OF CONVENTIONAL COM-

MON STOCK WAS A SECURITIES TRANSACTION

A. “The starting point in every case involving con-

struction of a statute is the language itself.” Inter-

national Brotherhood of Teamsters v. Daniel, 439 U.S.

551, 558 (1979), quoting Blue Chip Stamps v. Manor

Drug Stores, 421 U.S. 723, 756 (1975) (Powell, J.,

concurring). With respect to the status under the

federal securities laws of ordinary common stock, the

statutory language could not be more clear. The term

“security” is defined in both the Securities Act of

1933 and the Securities Exchange Act of 1934 to

include stock.“ Although not defined in the Acts,

“stock” carries a well-defined meaning. SEC v C. M.

Joiner Leasing Corp., 320 U.S. 344, 351 (1943). See

Ballentine’s Law Dictionary 1236 (2d ed. 1930):

“As the term is used in connection with corporations,

it means the capital of the corporation * * *.” By its

nature, stock represents both ownership and control,

conferring the right “to participate in the general

management of the company.” Black's Law Diction-

ary 1660 (3d ed. 1933). The district court voncluded

in this case that the timber company’s stock “pos-

sessed the ordinary characteristics of stock” (Pet.

App. 13a), and it is not disputed that the instru-

ments purchased by petitioner were conventional

common stock.

“Investment contract” is also specifically enumer-

ated in the statutory definition of security. See note

Section 3(a) (10) of the Securities Exchange Act of 1934,

15 U.S.C. 78 (a) (10), provides:

The term “security” means any note, stock, treasury

stock, bond, debenture, certificate of interest or participa-

tion in any profit-sharing agreement, * * * investment

contract, voting-trust certificate, * * * or in general, any

instrument commonly known as a “security” * * *.

Section 2(1) of the Securities Act, 15 U.S.C. 77b(1), is vir-

tually identical. Marine Bank v. Weaver, 455 U.S. 551, 555

n.3 (1982). All 40 definitions in the 1934 Act, 15 U.S.C.

78 (a), and all 15 definitions in the 1933 Act, 15 U.S.C. 77b,

are preceded by the statutory language “When used in this

[chapter], unless the context otherwise requires See

pages 19-21, infra.

6, supra. Unlike “stock,” “investment contract” is

a general term designed to ensure that novel, uncon-

ventional, or irregular instruments that might not be

considered securities in normal parlance are covered

by the securities laws. See SEC v. W.J. Howey Co.,

328 U.S. 293, 298-299 (1946); C.M. Joiner Leasing

Corp., 320 U.S. at 351. Thus, by including the term

“investment contract” in the definition of “security,”

Congress broadened the definition to include more

than ordinary stocks and bonds.

The court of appeals held that the purchase of stock

by petitioner was not a securities transaction because

it did not satisfy the test set forth in SEC v. N..

Howey Co., supra, for determining whether a novel

instrument is an investment contract: that it “in-

volves an investment of money in a common enter-

prise with profits to come solely from the efforts of

others.” 328 U.S. at 301 (see Pet. App. 8a). But

invoking the investment contract test to determine

the status under the securities laws of stock—a sepa-

rate term in the definition of security—violates estab-

lished canons of statutory construction.

A statute should be construed “to give effect, if

possible, to every clause and word of a statute.”

United States v. Menasche, 348 U.S. 528, 538-539

(1955), quoting Montclair v. Ramsdell, 107 U.S. 147,

152 (1882). See also 2A N. Singer, Statutes and

Statutory Construction § 46.06 (4th rev. ed. 1984).

Indeed, It here was little reason for the drafters to

use words such as ‘stock,’ ‘treasury stock,’ or ‘voting-

trust certificate,’ unless their intention was to include

all such instruments as commonly defined.” Golden v.

Garafalo, 678 F.2d at 1144. It is apparent from the

statutory language that investment contracts are

properly viewed as only one of “the several types of

10

instruments designated as securities” under the defini-

tional sections of the securities laws. Tcherepnin v.

Knight, 389 U.S. 332, 338 (1967). Once the court

concluded that the instruments purchased by peti-

tioner were ordinary common stock, it should have

ended its inquiry and held that those instruments

were securities.”

The court of appeals reasoned ( Pet. App. 7a- ga)

tory definitions of security.“ But note“ and stock

are very different sorts of terms. Note“ is a vague

This Court first interpreted the meaning of security in

SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344, 350-351

(1943). That case made clear that Congress did not intend

bonds.

The conclusion of the court below that the general phrase

“investment contract” circumscribes the scope of “stock”

specific term, “turn[s] the history of the Acts * * on their

heads.” Ruefenacht v. O Halloran, 737 F.2d at 329.

* The Ninth Circuit uses a “risk capital” test to determine

whether a note is a security. Great Western Bank & Trust

Co. v. Kotz, 532 F.2d 1252, 1257-1258 (1976). Most other

e.g., Bellah v. First National Bank, 495 F.2d 1109, 1111-

1114 (5th Cir. 1974). The Second Circuit has taken a slightly

different approach. It begins with a presumption that the

statute encompasses any note, but excludes notes bearing a

“family resemblance” to consumer or commercial transac-

tions. See Exchange National Bank v.

544 F.2d 1126, 1137-1138 (1976).

11

term meaning nothing more than a promise to pay

money. In re Cochise College Park, Inc., 703 F. 2d

1339, 1347 (9th Cir. 1983). It includes investment

instruments as well as commercial loan transactions

and consumer payment plans.’ Accordingly, courts

have found it necessary to look at various factors re-

lating to the transaction at issue, rather than just to

the instrument itself, to determine whether a par-

ticular note is covered by the securities laws. See, e.g.,

C.N.S. Enterprises, Inc. v. G. & G. Enterprises, Inc.,

508 F.2d 1354, 1361-1362 (7th Cir.), cert. denied,

423 U.S. 825 (1975) ; McClure v. First National Bank,

497 F.2d 490, 494 (5th Cir. 1974), cert. denied, 420

U.S. 930 (1975). “Stock,” in contrast, is a precise term

denoting an easily recognizable, conventional instru-

ment with common characteristics. Thus, in the case

of ordinary stock, analysis of the transaction at issue

is not required. See Ruefenacht v. O’Halloran, 737 F.2d

at 325. If an instrument is ordinary stock, which has

a traditional and accepted meaning and which “repre-

sents to many people, both trained and untrained in

business matters, the paradigm of a security” (Daily

v. Morgan, 701 F.2d at 500), it is not necessary to

look beyond the instrument to determine whether it

is a security.”

o See, . g., Hunssinger v. Rockford Business Credit, Inc.,

745 F.2d 484 (7th Cir. 1984); Zabriskie v. Lewis, 507 F. 2d

546 (10th Cir. 1974); Bellah v. First National Bank, 495 F. 2d

1109 (Sth Cir. 1974).

10 As Professor Loss has stated in criticizing the sale of bus-

iness doctrine: “It is one thing to say [as was held in Forman]

that the typical cooperative apartment dweller has bought a

home, not a security * * But stock (except for the resi-

dential wrinkle) is so quintessentially a security as to fore-

close further analysis.” L. Loss, Fundamentals of Securities

Regulation 212 (1983) (emphasis in original).

12

B. The statutory scheme of the federal securities

laws supports rejection of the sale of business doc-

trine. Contrary to the suggestion of respondents (Br.

in Opp. 3, 6), the antifraud provisions of the secu-

rities laws apply to private, negotiated transactions.”

While transactions not involving a public offering are

exempt from the registration requirements (see Sec-

tion 4(2) of the Securities Act, 15 U.S.C. 77d(2)),

there is no comparable exemption from antifraud lia-

bility." “Thus, the coverage of the antifraud pro-

visions of the securities laws is not limited to instru-

ments traded at securities exchanges and over-the-

counter markets * * *.” Marine Bank v. Weaver,

455 U.S. 551, 556 (1982). These provisions have “al-

ways been understood to apply to transactions in

shares of close as well as publicly held corporations

and to negotiated as well as market sales and pur-

chases of shares.” Golden v. Garafalo, 678 F.2d at

1146-1147 (citing Superintendent of Insurance v.

Bankers Life & Casualty Co., 404 U.S. 6 (1971)).*

11 Professor Loss has characterized that doctrine as coming

“dangerously close to the heresy of saying that the fraud pro-

visions do not apply to private transactions.” L. Loss, supra,

at 212; see note 10, supra.

2 The Fifth Circuit in Daily v. Morgan emphasized (701

F. ad at 502) :

If Congress had wanted to exempt the privately nego-

tiated sale of a controlling interest of stock in a small

business from [the] antifraud provision [of Section

10(b)] it could have done so. * * * Congress could and

did exempt small, private sales of stock from many of the

requirements of the securities laws, but chose to apply

the section 10(b) antifraud provision to all stock.

18 The analysis of this Court in Weaver, in holding that a

negotiated loan agreement was not a security, does not sug-

gest a contrary conclusion. In reaching the determination

13

Nor do the securities laws exclude transactions

affecting the transfer of controlling stock interests,

as respondents suggest (Br. in Opp. 8). On the con-

trary, the Securities Exchange Act contains provi-

sions specifically covering tender offers, disclosure of

transactions by corporate directors, officers, and prin-

cipal stockholders, and the recovery of short-swing

profits garnered by such persons. See, e.g., Sections

14 and 16 of the Securities Exchange Act of 1934, 15

U.S.C. 78n, 78p. See also Daily v. Morgan, 701 F.2d at

503 (“a rule that turns on the transfer of control

would logically exclude from the reach of Rule 10b-5

many tender offer battles’). Thus, the securities laws

themselves refute the notion that those laws were in-

tended only to cover passive investors purchasing

minority interests.

C. The legislative history provides no justification

for the sale of business doctrine. Rather, it supports

a broad reading of the term “security.” Congress did

not specifically address the sale of business issue, but

that a unique agreement between two families, which included

arrangements for the use of a barn and pasture, was not a

security, that opinion distinguished “those instruments ordi-

narily and commonly considered to be securities in the com-

mercial world”—which the securities laws were plainly in-

tended to cover—from “unusual instruments,” such as the

investment contracts at issue in Howey. 455 U.S. at 559.

As this Court in Weaver explained, It] he wnusual instru-

ments found to constitute securities in prior cases involved

offers to a number of potential investors, not a private trans-

action * , had equivalent values to most people and

could have been traded publicly.” Jd. at 559-560 (emphasis

added). Thus, while the Court recognized (id. at 559-560 &

n.11) that novel instruments are properly subject to trans-

actional analysis in order to determine whether they are in-

vestment contracts, it did not suggest such an analysis for

stock or other conventional instruments.

14

the House Report accompanying what became the

Securities Act explains that the term “security” was

intended to cover the “many types of instruments that

in our commercial world fall within the ordinary con-

cept of a security.” H.R. Rep. 85, 73d Cong., 1st Sess.

11 (1933). This statement supports “the proposition

that instruments ordinarily regarded as ‘stock’ are a

‘security’, notwithstanding that the underlying trans-

action involves a transfer of control. This under-

standing of Congressional intent, moreover, has been

almost universally accepted by the courts, the relevant

agency and the bar for over 40 years.” Golden v.

Garafalo, 678 F.2d at 1144-1145.“ In the face of

legislative silence as to the precise issue presented

here, courts should assume “that the legislative pur-

pose is expressed by the ordinary meaning of the

words used.” Securities Industry Ass’n v. Board

of Governors of the Federal Reserve System, No.

82-1766 (June 28, 1984), slip op. 11 (quoting Rus-

sello v. United States, No. 82-472 (Nov. 1, 1983), slip

op. 4; Richards v. United States, 369 U.S. 1, 9

(1962) ).”

14 This Court has recognized that investor protection is not

the sole purpose of the securities laws. See United States v.

Naftalin, 441 U.S. 768, 776 (1979) (quoting S. Rep. 42, 73d

Cong., Ist Sess. 1 (1933); 77 Cong. Rec. 2925 (1933) (re-

marks of Rep. Kelly); id. at 2935 (remarks of Rep. Chap-

man) (acknowledging congressional concern with protecting

“honest corporate business” and “ethical business men“).

% This Court recently rejected an argument similar to

respondents’ in Securities Industry Ass’n v. Board of Gov-

ernors of the Federal Reserve System, No. 82-1766 (June

28, 1984). In construing the Banking Act of 1933 (the Glass-

Steagall Act), enacted by Congress only weeks after the Secu-

rities Act, this Court held that the terms “notes or other

securities” which appear in Section 21(a)(1) of that Act, 12

U.S.C. 378(a)(1), together with the terms “stocks” and

15

II. PRIOR HOLDINGS OF THIS COURT SUPPORT

THE CONCLUSION THAT PETITIONER’S PUR-

CHASE OF COMMON STOCK WAS A SECURITIES

TRANSACTION

A. This Court’s decision in United Housing Foun-

dation, Inc. v. Forman, 421 U.S. 837 (1975), war-

rants no departure from the plain language of the

statute. Forman did not hold, as respondents (Br.

in Opp. 9) claim, that the investment contract test

formulated in SEC v. W.J. Howey Co., 328 U.S. 293

(1946), is the sine qua non for all securities, includ-

ing ordinary stock in a business corporation. Nor did

that case establish a single “economic reality” test

(Pet. App. 7a-8a). Indeed, the two-part analysis that

the Court used in Forman bolsters the conclusion that

the investment contract test is not applicable to in-

struments that come within one of the specific statu-

tory terms in the definition of security. Ruefenacht

v. O'Halloran, 737 F.2d at 338.

The plaintiffs in Forman purchased shares of

stock“ in a cooperative housing corporation entitling

them to apartments in a state-subsidized and super-

vised non-profit housing cooperative. They acquired

this “stock” solely to obtain a place to live, the num-

ber of shares being proportionate to the number of

rooms in the apartment. The ‘stock” lacked the char-

acteristics of ordinary stock. It paid no dividends

and could not be pledged, encumbered, or transferred

“bonds,” should not be narrowed to include only instruments

that share characteristics “of an investment“ common to the

other named instruments. Securities Industry Ass’n, slip op.

11-16. Such a restrictive reading, this Court pointed out, is

not indicated by the phrasing of the statutory sections, is

inconsistent with the broad statutory scheme, and is not

supported by the legislative history. Ibid. Each of these con-

clusions is equally applicable and compelling here.

16

to a non-tenant. Each apartment owner was entitled

to one vote, regardless of the number of shares held.

Any tenant terminating his occupancy was required

to resell the “stock” to the issuer at the initial selling

price or, under certain circumstances, to sell to a

qualifying replacement tenant at virtually the same

price. 421 U.S. at 842-843, 851.

In ruling that the so-called “stock” interests were

not “securities,” the Court engaged in a two-step

analysis: it first considered whether they were secu-

rities by virtue of coming within the definitional term

“stock”; and, then, alternatively, the Court considered

whether they were securities by virtue of coming

within a more general definitional term, such as “in-

vestment contract.” With respect to the first question,

this Court recognized that an instrument should not

be deemed to be a security simply because someone

chose to call it “stock.” The Court explicitly acknowl-

edged, however, that the name given an instrument

may be highly pertinent (421 U.S. at 850-851):

In holding that the name given to an instru-

ment is not dispositive, we do not suggest that

the name is wholly irrelevant to the decision

whether it is a security. There may be occasions

when the use of a traditional name such as

“stocks” or “bonds” will lead a purchaser justi-

fiably to assume that the federal securities laws

apply. This would clearly be the case when the

underlying transaction embodies some of the sig-

nificant characteristics typically associated with

the named instrument.

The Forman Court concluded that the purchasers

in that case were not misled by the word “stock” be-

cause the shares they had bought bore none of the

indicia typically associated with stock. In so holding,

17

the Court identified five characteristics of stock: (1)

the right to receive dividends contingent upon an

apportionment of profits; (2) negotiability; (3) the

ability to be used as collateral; (4, voting rights in

proportion to the number of shares owned; and (5)

share appreciation. Id. at 851. Judged by such cri-

teria, the cooperative shares were not instruments

“that in our commercial world fali within the ordi-

nary concept of a security” (ibid.; quoting H.R. Rep.

85, 73d Cong., Ist Sess. 11 (1933)). Thus, the Court

held that, as a matter of economic reality, the plain-

tiffs in Forman had not purchased stock within the

meaning of the securities laws.

The Court then examired the instrument to deter-

mine whether it nonetheless constituted a security by

coming within one of the more general terms that

also appear in the statutory definition, including

“investment contract” and “an instrument commonly

known as a ‘security’.” 421 U.S. at 851-858.“ Apply-

ing the Howey test, the Court concluded that because

the purchasers of the cooperative housing corporation

shares wanted only to acquire living quarters for per-

sonal use, not to make an investment in the hope of

In Forman, the Court stated that the investment con-

tract test applies to both terms. 421 U.S. at 852. (“We per-

ceive no distinction for present purposes, between an ‘invest-

ment contract’ and an ‘instrument commonly known as a

Security.“ »The touchstone is the presence of an in-

vestment in a common venture premised on a reasonable ex-

pectation of profits to be derived from the entrepreneurial or

managerial efforts of others.”). The Court did not thereby

imply that the same test would govern the more specific terms,

such as “stock,” “bond,” or “debenture.” But see King v.

Winkler, 673 F.2d at 344-345 (construing the quoted lan-

guage in Forman as mandating that test for conventional

instruments such as stock).

18

receiving profits from the efforts of cthers, their

“stock” was not an investment contract.

In reaching that conclusion, the Court observed

(421 U.S. at 852-853) that the Howey test “embodies

the essential attributes that run through all of the

Court’s decisions defining a security.” Contrary to re-

spondents’ contention (Br. in Opp. 9), the Court, in

making that statement, was “merely describing its

pest decisions,” all of which happened to deal with

unusual or unconventional instruments. Daily v.

Morgan, 701 F.2d at 499-500." It was not referring

to any decision construing the term “stock.” The

Court has not suggested that the Howey test should

be “invoked ritualistically whenever the existence of

a security is at issue.” Meason v. Bank of Miami,

™ The court of appeals had relied on the investment con-

tract analysis as an alternative basis upon which to conclude

that the “stock” involved in that case was a security. 421

U.S. at 846.

18 See Tcherepnin v. Knight, supra (involving withdrawable

capital shares of a savings and loan association); SEC v.

United Benefit Life Ins. Co., 387 U.S. 202 (1967) (involving

combined variable and fixed annuity) ; SEC v. Variable Annu-

ity Life Ins. Co., 359 U.S. 65 (1959) (involving variable an-

nuity contract); SEC v. WJ. Howey Co., supra (involving

sales of citrus acreage coupled with optional service contracts

to cultivate the crops); SEC v. C.M. Joiner Leasing Corp.,

supra (involving sales of assignments of oil leases).

International Brotherhood of Teamsters v. Daniel, 439 U.S.

551 (1979), which reiterated the Forman description of past

decisions by the Court (439 U.S. at 558 n.11), likewise lends

no support to the sale of business doctrine. That case dealt

with a participation in a pension plan, an interest which, un-

like stock, is not enumerated in the statutory definition. Since

a pension interest could not be a security unless it came within

a general term, it is hardly surprising that this Court dis-

cussed the interest under the rubric of investment contract.

652 F.2d 542, 549 (5th Cir. 1981), cert. denied, 455

U.S. 939 (1982). Rather, “the Court has applied

the Howey test when considerations pertinent to an

investment contract applied to the instrument in

question” (ibid.). Thus, in Forman this Court uti-

lized that test only to determine whether the coop-

erative shares, which it had already concluded were

not conventional stock, were nonetheless securities in

the form of an investment contract. But, as stated

in Coffin v. Polishing Machines, Inc., £96 F.2d 1202,

1204 (4th Cir.), cert. denied, 444 U.S. 868 (1979),

“({a]bsent some showing that ordinary corporate

stocks are other than what they appear to be,” appli-

cation of the Howey test is inappropriate.

B. In urging an interpretation contrary to the

statutory language and legislative history, respond-

ents, citing Marine Bank v. Weaver, supra, point (Br.

in Opp. 7-18, 12) to the clause “unless the context

otherwise requires,” which precedes the definitional

sections.” In Weaver, the Court, relying on that

„Application of the investment contract test in all cases

lower courts have suggested instruments paying a fixed inter-

est do not meet the “profits” element of that test. Briggs v.

Sterner, 529 F. Supp. 1155, 1168 (S.D. Iowa 1981). See

generally, Hunssinger v. Rockford Business Credits, Inc., 745

F.2d 484 (7th Cir. 1984) (if Howey applied to all instru-

ments, many instruments assumed to be securities, including

twenty year corporate bonds, would not be securities because

they could not meet the definition of “profit’”’).

2 The Seventh Circuit in Sutter v. Groen, 687 F.2d at 200-

201, also relied on Weaver to support the sale of business

doctrine.

clause, held that, in the light of the comprehensive

scheme under which federally regulated and insured

banks conduct business, certificates of deposit of such

banks are not securities for purposes of the antifraud

provisions of the federal securities laws.“ The Court

concluded in Weaver that holders of such bank cer-

tificates of deposit are abundantly protected under

the federal banking laws, and thus imposition of an-

other federal statutory scheme would contravene Con-

gressional intent. 455 U.S. at 558-559. No such con-

textual considerations are relevant here, because there

is no alternative federal comprehensive regulatory

scheme.”

As Judge Friendly emphasized in Exchange Na-

tional Bank v. Touche Ross & Co., 544 F.2d at 1137-

21 The Securities and Exchange Commission, the Comp-

troller of the Currency, the Board of Governors of the Fed-

eral Reserve System, and the Federal Deposit Insurance Cor-

poration filed a brief amicus curiae urging that position.

22 Respondents suggest (Br. in Opp. 13) that the petitioner

has an adequate remedy under state law. However, as the

Third Circuit has observed :

The premise that common-law remedies are necessarily

adequate in the sale-of-business context is flawed. The

defendant, for example, may prove to be insolvent,

prompting the plaintiff to seek out solvent defendants

edy could be had. The Acts, for example, confer addi-

tional benefits on parties victimized by fraud, including

the absence of express defenses and certain procedural

advantages.

Ruefenacht v. O'Halloran, 737 F.2d at 336 ( footnotes

omitted).

21

1138 (emphasis in original), a party who relies on the

«unless the context otherwise requires“ language of the

statutory definitions when an instrument fits within

their plain terms to argue that the antifraud provi-

sions are not applicable has the burden of showing

that the context otherwise requires. Weaver in-

volved an exceptional situation where the context did

so require. Certainly, the context of the present case,

in which petitioner’s interest comes within the funda-

mental Congressional purpose of protecting pur-

chasers and sellers of stock, does not justify a depar-

ture from the statutory language.

III. IMPORTANT POLICY CONSIDERATIONS ALSO

COUNSEL REJECTION OF THE SALE OF BUSI-

NESS DOCTRINE

A. “The most prominent feature of the sale-of-

business doctrine is its attendant uncertainty of ap-

plication * “ Ruefenacht v. O'Halloran, 737 F.2d

at 332. The inability of parties to a transaction to

predict whether the securities laws are applicable

“raises the cost of economic transactions, inhibits the

The court added: “So long as the statutes remain as

have been for over forty years, courts had better not

depart from their words without strong support for the con-

vietion that, under the authority vested in them by the con-

text’ clause, they are doing what Congress wanted when they

what it said.” 544 F.2d at 1138.

If intent to manage [the acquired corporation] is

relevant, adoption of the [sale of business] doctrine will

lead to countless issues of mixed fact and law such as

whether part-time managers are passive or active, what

itially to remain passive but are soon forced into man-

agement roles.

Golden v. Garafalo, $78 F. 2d at 1145-1146.

Control may be exercised, for example, by alliances of

minority shareholder factions. One indicator of whether

a minority share effectively exercises control might be

whether the purchase price of the share exceeded the pre-

vailing market price. Another might be the voting pat-

terns of various factions. * * * [T)estimony might be

taken on the intent of the purchasers and the realities

of corporate management.

Ruefenacht v. O'Halloran, 737 F. 2d at 332.

The Seventh Circuit, which requires such an inquiry in

cases involving stock transfers, has fashioned a “main pur-

pose” test, whereby a purchaser who has acquired more than

50% but less than 100% of a corporation's stock will be

V.

637 F.2d 1147 (7th Cir.), cert. denied, 451 U.S. 1017

(1981) (holding that the purchaser of 100% of the

stock in a company did not acquire securities), with

McGrath v. Zenith Radio Corp., 651 F.2d 458 (7th

be difficult to apply and [would] create a capricious

basis for dispensing the protection” of the securities

laws. Occidental Life Insurance Co. v. Pat Ryan &

Associates, Inc., 496 F.2d 1255, 1263 (4th Cir.), cert.

denied, 419 U.S. 1023 (1974).“

B. There is no warrant for excluding purchasers

of conventional stock from the protections of the secu-

rities laws on the notion that an entrepreneur is essen-

tially different from an investor (see Pet. App. 7a).

Investors often participate in management in order

to protect their interest. Ruefenacht v. O'Halloran,

737 F.2d at 334. Congress intended so funda-

intent clearly in the statutory language or the legis-

lative history. Securities Industry Ass'n, slip op. 14-

15 (quoting American Tobacco Co. v. Patterson, 456

U.S. 63, 72 n.6 (1982) ). Nor does “telling a defrauded

purchaser that he has no federal remedy because he is

an ‘entrepreneur’ and not an investor appeal to

any “abstract sense of fairness.” Daily v. Morgan,

of stock under the sale-of-business doctrine is wholly

arbitrary with respect to the state-law definitions that are

the source of the terms in the 1933 and 1934 Acts.

Ruefenacht v. O Halloran, 787 F.2d at 336.

2* This Court’s decision in Marine Bank v. Weaver, supra,

701 F.2d at 503. Indeed, it has been suggested that

a large purchaser may have a “more pressing need

for protection to the extent that he has expended a

greater amount of his resources.” Occidental Life

Insurance Co. v. Pat Ryan & Associates, Inc., 496 F. 2d

at 1263.

The fact that the petitioner may not be a “passive”

(Pet. App. 8a) or unsophisticated investor is no

reason to foreclose it from bringing suit under the

antifraud provisions of the securities laws (see Resp.

Br. in Opp. 3, 4). Those protections are not limited to

the unsophisticated.” The possibility of fraud, as al-

leged here, is not eliminated because the purchaser ac-

quires a controlling stock interest. As demonstrated

by recent history, management of even closely regu-

lated companies can deceive their auditors and regu-

lators. See e.g., Dirks v. SEC, 463 U.S. 646 (1983)

(describing the fraud practiced by Equity Funding

Corporation of America).“

2° The Second Circuit pointed out in a case involving a Chi-

cago bank and a New York Stock Exchange member broker-

age firm, Exchange National Bank v. Touche Ross & Co., 544

F.2d at 1137: “While banks are in a favored position to ob-

tain disclosure, the target of §§ 10 (b) of the 1934 Act and

17(a) of the 1933 Act is fraud, which a bank’s ability to ob-

tain disclosure cannot always prevent.”

One of Congress’ purposes in singling out the named

instruments in the Act was to facilitate [non-market] trans-

actions [in those instruments] without the ensuing delays,

duplication of effort, and expenses associated with the ‘caveat-

stockholder’ era of deregulation.” Ruefenacht v. O'Halloran,

737 F.2d at 333 (citing H.R. Rep. 1383, 73d Cong., 2d Sess.

4-5 (1934)). The sale of business doctrine represents a re-

turn to that era. It may be true that in the absence of

statutory protection against material misrepresentations, cer-

tain purchasers would be able to hire a team of accountants

and attorneys to uncover adroitly hidden liabilities or other

Like any securities investor, the petitioner and its

investor group were concerned with the value of the

stock they were acquiring, and were seeking to make

a profit which would be reflected in the price of those

shares. The extent of petitioner’s present ownership

interest and of its present power to affect policies

of the corporation provides no basis for denying it

protection under the federal securities laws. The

alleged fraud occurred in connection with the pur-

chase, and related to the condition and circumstances

of the corporation and the value of the stock at the

time of purchase. Petitioner was then no less a pas-

sive investor than a person who buys shares in the

market.

C. Finally, contrary to the view of the court below

(see Pet. App. 8a), the difference between a sale of

a majority or 100% stock interest and a sale of assets

is not merely one of form: “Generally speaking, one

who purchases the assets of a business is not liable

for its debts and liabilities, while one who purchases

the stock in a corporation—a separate legal entity—

assumes ownership of a business with both assets and

liabilities.” Daily v. Morgan, 701 F.2d at 504 (cita-

tions omitted). Thus, buyers of business enterprises

may very well wish to consider, in the mix of tax,

personal liability, and other factors bearing on

whether the transaction should be structured as a

transfer of stock or assets, the need for antifraud

protection. Since “[lliabilities * are often the

subject of inaccurate or incomplete disclosures”

(ibid.), antifraud protection may be particularly im-

portant in the context of a stock sale. Here, the

parties chose to structure their deal, not as a sale of

concealed facts. However, such an inquiry would be both

costly and inefficient.

27

assets, but as a stock sale.“ Under these circum-

stances, respondents, who are accused of fraudu-

lently misrepresenting the timber company’s liabil-

ities, are in a poor position to challenge the expecta-

tion that the antifraud provisions would apply. See

Daily v. Morgan, 701 F.2d at 503.

CONCLUSION

The judgment of the court of appeals should be

reversed.

Respectfully submitted.

Rex E. LEE

Solicitor General

Louis F. CLAIBORNE

Deputy Solicitor General

CHRISTOPHER J. WRIGHT

Assistant to the Solicitor General

DANIEL L. GOELZER

General Counsel

PAUL GONSON

Solicitcr

JAcon H. STILLMAN

Associate General Counsel

ROSALIND C. COHEN

Assistant General Counsel

STEPHEN M. DETORE

Attorney

Securities and Exchange

Commission

DECEMBER 1984

„ An assumption by petitioner that the antifraud provi-

sions would apply to this sale would have been reasonable

where, as here, the stock purchased has all the traditional

attributes commonly associated with stock ownership. United

Housing Foundation, Inc. v. Forman, 421 U.S. at 850-851.

® ©. 8. eovennment eee orrice, 1904 40166 % 10127