# Amicus Curiae Brief — Landreth Timber Co. v. Landreth

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Amicus Curiae Brief
- **Published:** January 1, 1985
- **Citation:** 471 U.S. 681

## Text

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

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385012_0783%3A04. Public record. Not legal advice.