Petition for Writ of Certiorari — Blau v. Petteys

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pas Bs ae Pe Of. « Supreme Court; US i ier

Pond oe eS ot \ we TTeD =] |

Nov 7: 986 im oe

Super nt ie ind ie

_ OCTOBER TERM, 1966,

ISADORE BLAU, .a stockholder of Northwest Airlinés, Inc, . +. |

suing on behalf of himself and all other stockholders similarly ~ |

bigs and ‘ on behalf and in the . — - Northwest Airlines,

Bes te

BSS ats i are Petitioner,

o | agamst”

zs ALONZO } PETTEYS and C. FRANK REAVIS, |

a] Respondents.

_ PETITION FOR WRIT OF CERTIORARI TO. RAS

‘THE UNITED STATES COURT.OF APPEALS =e

FOR THE EIGHTH CIRCUIT -.

. a. nx .

. . ; ; “ ‘ . .

Morris J..Levy

Counsel for. Petitioner,

261 . Broadway,

New York, N. Y.. 10007. «

ap ae LO SDT ae ee Stee

| SHANDELING, Pussimes Gross & AARON,

Of Counsel, eee e-

| _ Blau v. Lamb (C. A. 2), unreported; Ratner for writ:

Ae Blau v. Lehman’ (C. A 2), 286 F. 2a 786, afd 308

U.S. 408 E

- Booth v. Varian sutiatés Ine. Uc. A b, 334. F.

* Conclusion ee ee eh eeeee we : 14

* Quistions Presented. Sie Review aie g sith. SuGestt fh. vit 2 |

Statutes og BERET DOPE NR Gone fice ES

Stateeicat of Meote 0... es. eieesesseetepeen/ B.

Reasons Relied on for Granting the Writ'......:...+ S fale

7. 2 x : és gts Ke ees

“The: crt alerw en decided an eae. ques: Se ere

tion of Federal law contrary to the express statu- - auc

tory language and its, legislative tery. and con- ae

, Seay to. or ag eumsragrti decisions . oS ee Na

I—The decisis’ by bythe Court’ below in in direct com- one Dey

- flict withthe decision rendered by. the _ Court of 5

Appeals for the Third Circuit ae eet See ne Anke

% 7

— % A Ta, oe .

cet ‘ eee Tanu oF Cases |

B. T. Babbitt, Ine, v. Lachner (C. A. 2), 332 F. 2d 255 Bae

‘ of certiorari No. 720 pending before Supreme net

‘Court of the United States ... sete ceene cesses 12...

OM PHA WES ih TST ES

Pen

ey Ne eR Tee

, - a Sis _ > . ‘ a

o ‘ J a 4 ae

oo x i “ aaa Soe

ii INDEX ee a

: - Werbaiolo ¥. ‘Newman (C. A.-6y, 359 F. 12a U2 oo q

ee _ * Gratz v Claugh A. 2), 187 F. od 46: a 8,9

; -‘Heli-Coil ‘ TP. v. Wehster (C.. A. 3); 352 F. ‘2d ,

a ee at os ieekubetectsbbercosws iecvekeke we 10 og 6y 8, 12, 13

ths Raa NS ae Park & Tilférd, Ine. Schulte (C. A. 2), 160 F. 2d 984 ~ 8.

fost Res Gar Smolowe v: Delendo — seit A. 2), 136 F. 2d 231 8

e 4 naa : hk

| | Srarures. Sa6 Ts 7 ‘

" Securities ‘Exchange Act ‘of 1934: @ f E Bey < oo

Sects. 3(a) (13), 3(a) (14), 15, U.S.C.A., ‘Secta. Ss

—- 78e(a) (13), T8e(a) (14) SO reser eret See ie 2,3, 8

Setts., 16(a), 16(b), 15 US.C.A., Sects. 78p(a), :

a /T8p(b) aD pe ey Body pty ane ee gid vePe see 2,3, 6,37 .

Sect. 21, 15 USCA, Soot, TB0a..2..070.-5 ep eta 8 |

os pe wo ae iy 4 :

ve ee i. R.. Report No. 1388, 34 ‘Cong., od Sess, (1934), A ee

Ce | rian 3 Re p.* J EES es eer ee eae ¥en Ve when pies

_ S. Report No. 792, 73d Cong. Od Sess. (1934), pp.7-9 8

“3s 8. .Report No. 1455, 73d Cong., 2d Sess. eh), pp.

"Stock Exchange Practices, Hearings before thé Senate ES

f . Committee on Banking and Currency, 73d Cong, efit.

“p. Iat Bess. Pt. 15 (ier PP- C685, 6557, 6558 .. . 1,9

: eae INDEX TO APPENDIX | ’

III 5 oS iesicvcciecccdeccsaces pry ee speed 15

. i eh aS cle db euweeKe nae’ 37

jer

Se Se |

a "Northwest — cota

3 fee Ee eae

Supreme Gourt of the United States

foes OCTOBER TERM, 1966

oe as : ten :

- ,

- 2

ogee , rr

Tsaponz Baw, a stoikholder: of Northwest Airlines, Ine,

“*" “suing on behalf of himself and all other stockholders*

-similarly situated .and on behalf and in the right of .

mE ay ER “: Petitioner,

“Augmo Prem and, Peon Raa 6

Boca ~ Respondents.

‘ PETITION FOR WRIT OF ‘CERTIORARI TO

‘ .. THE UNITED STATES COURT en

og To THE Hoironsaz, T THe Curr Tih ‘AND assailati Jus-

” TIORS OF Tae Surname codvpr tae Unrrep Sratzs:

Your petitioner, Isadore Blau; a stockholder of North- :

-west Airlines, Inc. (Airlines), acting on behalf’ of himself an

-and the other. stockholders of said corporation, respect...

fully prays that a Writ of Certiorari issue to review the

judgment of the United States Court of Appeals for the -

Eighth Cireuit,; rendered October 19; 1966, which reversed

the judgment entered against the respondents 3 in the United

States District Court for the District of crapraites Fourth °:

Division ma. ee

_prvurecomnavinees

the’ Clerk of the United tates Court of —_— for the Eighth

Cireuit.

The opinibn of the District Court, (RB. 1ida-1218) is re-

Q ported i in 246 F. Supp. 526. The majority and dissenting

Opinions - of the Court of Appeals (R. 1-21, Appendix,

: swiray ¥ pp. rest have not Ag] ve Teported.’”

ae a

"Jurisdiction

“The iedaeler of the Court of Appeals (R. 20, Appendix,

infra, p. 36) was entered on “October 19, 1966. - ey

Jurisdiction .is conferred upon this pales by 28 v. 8.0;

, Boats, Let):

Questions Piesented for Review: |

+ Where directors of a listed issuer voluntarily | con-

_ vert their issuer’s convertible preferred stock into common,

‘and then sell such common shares less than six months

later, do such acquisitions of the common shares constitute ~

- purchases’? thereof under ‘the language and meaning of

» Seetions 3(a) (13) and 16(b) of the Securities Exchange

Act of 1934, 15 U.S.C.A., Sects. 78e(a) (13) and 78p(b)*

, peek delegated to the Commission alone, to exempt, from

2. Under Section 16(b) of the Securities Exchange Act :

, 1934, 15-U.S.C:A., Sect. 78p(b), does thie Court have’

authority, which the Congress specifically and exclu-

- the statutory- operation a transaction embraced within the

express language and intended meaning of that statute,.

. although the Commission itself has not vale anid any

Tale granting such: an exemption?

8. Under Section 16(b) of the Secarilins xchange Act ees

of 1934, 15 U.S.C.A., Sect. 78p(b); in order. for an ‘‘in-

sider’s”’ conversion of his issuer ’s acti ee equity secu-

ents’ ‘motion,

25 Ea kN 3

- } as obit throne ‘ ‘ : eel

Bek ‘

. Tities to he construed a “purchase” of the. shares sii

- -. thereby, must the issuer, or a ‘stockholder suing on its

behalf; bear the burden of proving that such conversion.

was the type of tratisaction which could possibly ‘lend

itself wt the he encompassed by | that ncae

‘Statutes Involved _

Pertinent provisions of tlie Sidarities Exchange Act a

ee 1934, Sections 3(a) (13), 3(a)(14), 16(@): and 16(b), 15 :

| -US.C.A., Sects. 78¢(a) (13), 78e(a) (14), 78p(a) and 78p(b), .

. . pages: 235, 322, 62 cum. supp., are wet —, in Sppendix,

infra, @ at —

peas ; p j ‘Statement of Facts m,

he action. was instituted by petitioner, Blan, a as a oo

: ‘niles of Airlines, pursuant to the provisions of Section

16(b) of the’ Securities Exchange Act pf 1934, 15 U.S. C.A;,

Séct. 78p(b); to. recover the profits realized by: the re-

. : spondents, Petteys and Reavis, as the result of their respec-

“tive purchases and sales of Airline’s common stock within —

aloft & period of less than six months (BR. 60a-63a). ane ee

- The basis fdr jurisdiction of the United States District :

Court for the ‘District of Minnesota, Fourth Division, to

. which®court such action had been transferred,* is Section: B

27 of the Securities iba Act of” 1934, 15 U. S.C. A.

Sect. 78aa.

During all material ‘ined here involved ‘the. a ir

Petteys and Reavis, were directors of Airlines (R. 24a- °

ashi Airlines’ shares of coms | ron have at all times ©

’ The action had been cath initially. in ‘the Utited States .

District Court for the Southern ew York ahd had

_ been transferred to the District: rt of Mi ota upon respond- '

' j . ; ’ Ay Ag | 4 . . . : + %

= ‘

: 4 : . " @

@ ® .

| heen listed on the ew: York ‘Stock Exchange; : ite: Con. ,

-. . -vertible Preferred shares were listed on’ such Exchange

- : until the latter. part of February, 1963 (R. 22a). |

The Preferred stock was convertible into common at any

- time: prior to January 1, 1964 at ‘the conversion tice, :

of $26 per, share. plus accrued dividends (R. 22a, 67a).

On: ‘January 14, 1963, the Board of Directors -of Airlines

passed a- feeciution calling ‘the Convertible Preferred |

stogk for redemption on February 14, 1963 at $26. 16 per .

oo share (B.. 25a, 67a), The market value of such Preferred

stock .on the date’ of the redemption Resolution ranged

between. $34-$3414 per share (R. 28a). The respondents,

_ Petteys and Reavis, as. direttors of Airlines, voluntarily

voted for the redemption Resolution (R. 102a).°

On Ji anuary. "17; 1963, when-its market price was between

$3544-$3514 per share, the-respondent,' Petteys, voluntarily

‘converted «5,000. shares of Airlines’ Preferred stock into

4,808. shares of common; less- than’ six.months later, i.e.,

between May 27, 1963.. and. June 18, 1963 he sold 9,808, °

‘’

‘shares of the common stock at prices ranging between

ae ,$51-$55Y5 per share (R. 26a-28a). - *.

‘On J anuary 31, 1963, when its market ptice was $38

"per share, the respondent, Reavis, ‘voluntardy converted .

1,167 shares of Airlines’ Preferred stock into 1,123 shares ~

of .common;-less than ‘six months later, ie., on June: 5,

1963, he sold 1,600: shares ofthe common stock sit prices.

ranging hetween $5314 -$5354 per share (R. 27a,°28a)..

On February 25, 1963, eleven days after the redemp- -

tion date, the Board of Directors of Airlines increased the

quarterly divifends on the common stock from 20¢ to las :

*? ‘per share-(R..107a).

Following the Board’s action with respect to the in- ©

crease of such dividends, the market price of the. common

— er pene aco - ate, 107a). .

¢ $ .-

———

ents’ acquisitions of

* 2

Based, upon. wich snidipiate facts, all » lb with the |

_ exception of - Airlines, moved for a summary judgment:

> (Ri 18a-19a, 70a-72a, 97a-98a).. The district court held

that the respondents’ respective acquisitions of the com-

= mon stock through their voluntary:.conversions of the -

Preferred constituted ‘‘purchases’’ of the common shares .°

** ander the. language and. meaning of ‘Sections 3(a) (13) :

-and 16(b) of the Secgrities ‘Exchange. Act of 1934. . It

_ further held that since the tesponderits had sold the com-

mon sifares of. Airlines less than six months after: their

‘purchases’? of such stock, any profits ‘realized from these |

_ transactions were recoverable from the respondents under

the applicable provisiens of Section, 16(b) of “the .Act.

. Accordingly, the court granted a sumrhary judgment; |

against the —— in the aggregate sum + — 56

(R. 114a-125a).

‘ In accordance with the order granting ite Sg

the Securities-“‘and Exchange Commission thereafter’ filed.

. its amtcus curiae memorandum with the Court of Appeals»

in support of the district. court's judgment: . The Court of

a dissenting opinion by Judge Blackmun.

Instead of applying the literal language of the statute

‘ and its “‘objective’’ approach. with respect to the stock —

ex conversio}s, the majority of the Court ‘applied a ‘“‘sub-

jective’’ test under which it concluded’ that the respond-

e common stock through their con-

versions of the Prefe

‘‘purchases’’ of .the common shares because such ‘trans-

actions allegedly. ‘‘could not possibly have lent itself to

the speculation encompassed within the purposes .of Sec-.

tion 16(b) of the Act’’ (R. 18, Appendix, infra, p. 42). »

‘The dissenting opinion held,.on the other hand, that the

_ express language of the statute and its ‘‘objectiwe’’ ap-—

plication required that the respondents’ acquisitions of

the common shares. be construed Section 16(b) ‘<pur-

: Appeals reversed the judgment of the district court, with

‘did‘not constitute Section 16(b) ~~

”~

‘chases’? because ‘‘the recognized purpose and aim of the

. ‘statute are-‘more consistently and protectively to be served

if the statute is construed literally and objectively rather

than non-literally and subjectively on a case-by-cane sal

esrtuas (R. 20, Appendix, infra, p. ep:

_ Reasons Relied. on for Granting the Writ :

1. The Court. of Kopeals for the Eighth Circuit has de;

-_ eided an important question of federal law which. has not -

been, but should be settled by this Court. The interpreta-_

. tion of the federal statute .by the Court of Appeals finds

no sanction in the language of the statute itself and is in

conflict with legislative history and _ _ purpose which

_ prompted its enactment.

a The majority opinion of the Court: of puenet S for

_. the Eighth Cireuit ‘conflicts directly, with the majority en

bane opinion of the Court of Appeals for the Third’ Cir-.

cuit ‘in Heli-Coil Corporation v. Webster, (C. A. 3, 1965),

352 F. 24.156. As the result’ of such conflicting decisions,

‘a-chaotic condition of uncertainty and confusion has arisen

with respect to the proper interpretation and application

of Section 16(b) of the Securities Exchange Act of 1934,

which can - be resolved by this Court. ©

ARGUMENT

The Gantt below valk decided an important question _—

. of Federal law contrary io the express‘statutory lan- .

guage and its legislative history and contrary to > price

: rer decisions.

The stated purpose. of ‘Section 16(b) of the Securities

Exchange Act of 1934 is ‘‘preventing the unfair use of in-

: ; ‘

. Ph 8 EIN eee SE -

‘. >

a) 8

; :

side information which may have heen’ ebieanea ‘i. such

beneficial owner, director, or officer by reason of his: rela-

tionship to.the issuer.’’ The statyte imposes liability upon

’ such ‘‘insider’’ for all profits realized by. him from his

- purchases and sales ‘of his issuer’s equity securities within

less than six months, ‘‘irrespective of. (his) intention in ..

entering into such transaction of holding the security pur- —

chased or of not repufchasing the pee e sold for a period

exceeding six months.”" :

- The statutory einen as ae as its legislative eae:

clearly demonstrate that the insider’s liability was.intended”

to be predicated solely upon an objective test which would

require: no proof that the insider actually obtained any

confidential information or that he misused it for his per-

sonal benefit in effecting his short-term transaction.? Such

- considerations were deemed ‘‘entirely irrelevant’ upon |

the theory that ‘‘if only those persons were liable who could’

. be proved to have a bargaining advantage, the execution of

the statute would be so ectaaptinted as to defeat its whole

1 The: aie statutory provisions are set forth in the Appa,

_ infra, p. 37.

-- *The operation of Section 16(b)‘v was explained by Thonias G.

Corcoran, the Administration’s spekesman at the bentings ~— led .

~ to its adoption, as follows:

. “That is to prevent directors receiving benefits of tau -tenn

. Speculative. swings on the securities of their own companies,

because of inside information, The profit on such transaction

under the bill would go to the corporation. You ‘hold the

director, irrespective of any intention or expectation to sell the

security Within 6 months after, because. it would be absolut

impossible to prove the existence of such intention.or expecta-

tion, and’ you have to have this crude rule of thumb, because

you cannot undertake the burden of having. to prove that the

director intended, at the time he t, to get out on a short

__. swing.” . Stock Exchange Practices, Hearings Before the Senate

Committee on Banking and Currency, 73d Cong., ‘1st Sess., pt..

15 (1934), pp. 6463, 6557.

Ne Ferraiolo v. Newman (C.. A. 6), 259 F. ‘2d 342.

a ate

purpose. ’”* Moreover, it was felt that ‘had Congress: in- °

~ tended that only profits from an actual misuse of inside .

information should be recoverable, it would’ have been —

simple. enough to say so.’ ‘s

7 TheCéngressional hearings saeaadiiae the enactment of

Sectién 16(b) of the Act had disclosed that options, con-

versions and similar devices lent themselves quite readily .

to abuses’ involving unserupulous short-term trading by,

corporate insiders. :

In order to close off this avenue against active insider

abuse, Congress expressly broadened the ordinary defini-

tions ‘of ‘‘purchase’’ and ‘‘sale’’ to include within their

scope Mh contract to buy, purchase, or otherwise ac-

quire’, and ‘‘any contract to sell or otherwise dispose

eee ;

In most sosiiaicess where an jaadee has aiaioati con-

verted his: issuer’s convertible securities the courts have

generally applied such statutory definitions to.the trans-

-- action involved by construing the conversion to-be-a Sec-—

_”_ tion 16(b) “purehase-or a “sale” *

By expressly eliminating all considerations with ieapionk..

to-the insider’s, subjective purpose in effecting his short-

Swing. minalas i eechau clearly evinced its intention

; Sa ae

<Ovels:3 Claughton (GA. 2); 187° F. 2d 46, 50.

" § Smolowe v. Denlendo Corp. (C. A. 2),' 136 F. 2d 23%, 239.

- § Booth v. Varian Associates, Inc. (C. A. 1), 334 F. 2d 1, 3-4;

ee, ep. No. :

2 2e Rep. No. 1455; 73d Con. 2d.“Sess. (1934), pages 55-68;

. No. 792, 73d Cong. 2d Sess. (838) pages 25; Fr H.R. ~~

No. 33, 73d Cong. 2d "Sess: *(1934),

* See Sections 3(a) (13) and 3(a) (14) of the Act, ‘infra, page 38.

: 8 Pork & Tilford,. Inc. v. Schulte (C. A, 2), 160 F. 2d 984;

> ” Blaw y. Lehman (C. A. 2), 286 F. 2d 786, aff'd 368 U. S. 403;

a T. Babbitt; Inc. v. Lachner (C, A. 2), 332 F. 2d°255; Booth v.

Varian Associates, Inc. (C: A. 1), sages; Hel saad Corp. v. Web-

ster. (C. A. 3), 2 F, 2d 156. |

-o

that the provisions of Section 16(b) should be applied

automatically to such transaction without prior inquiry as

to its fairness or its susceptibility to the statutory evil,

‘*even though it may cover instances where it Ate evil) hal

mot present.’

Such purposeful simplicity in the statutory Salitleia

was intended to operate as one of its greatest deterrents ©

in discouraging the insider from engaging in short-term

speculation in his issuer’s securities and his possible mis-

use of inside information in connection therewith. In order.

-not to envelop the execution of the statute in a morass of

factual and legal issues which would tend to vitiate ‘the

simplicity of its operation and destroy its. effectiveness,

the ‘statutory application demanded ‘‘the necessity of hav- -

- ing a general rule’”® to be applied alike in all cases, ex-—

-cept in those instances where the Commission by rules and

regulations may have exempted the transaction as “‘not -

comprehended within the urpere of f this subsection ( See-

— fon T6b)’.

Although in its set opinion nh Court of Appeals

seems to have conceded that the. respondents’ acquisitions 7

of their common shares through the.conversions of:the .

Preferred constituted Section 16(b) ‘‘purchases’? under .

the express statutory definition of that term and ‘‘within

- the literal boundaries.of the Act”’, it refused to follow such -

an objective and literal ebproach ‘to the. problem,

But as Judge Blackmun so aptly pointed out in his’ dis- .

senting opinion,” ‘‘* * * either the sainte means what it

. a . . Ps ts cs : ae

_ * Gratz v, Claughton (C. A. 2), supra, at page 50.

* 1©“Yoy thave to have a general rule. In particular transactions

it might work a hardship, but those transactions that are a hard-

ship represent the sacrifice to the necessity df having a general rule.”

Hearings on Stock pagal Practices, supra,, fate » at P. 6558

(testiniony of Corcoran).

*: Appendix, infra, p. 33, ° ie eee

10° .

literally says or that it does not; that ifthe Congress in-

_ tended to’ provide additional exceptions (to the statutory

ae application), it. would have done so in clear language; and

tHat the recognized . purpose and aim ‘of the statute are

more egnsistently and: protectively served if the statute is

construed literally and objectively rather than posebenelly:

and subjectively on a case-by-case application’, —--

dn discarding such an objective atid Literal Giploach

: clearly intended by the ‘Congressional mandate, the major-

ity of the-Court chose instead to substitute a subjective

test to the transactions involved by examining all the- sur-

rounding facts to determine whether the respondents’ con- -

versions were susceptible to the abuses against which

‘Section 16(b) was designed. It laid down the rule that

‘Seach éase must be examined on its:own facts and the Act

‘ only applied when these facts disclose the possibility of.

abuses that the Act were designed to prevent.’*? Applying

such a subjective test, the majority concluded that the re-

spondents’ acquisitions of the common shares did not con-

stitute Section 16(b) ‘‘purchases’’ because their conver- -

_ sions of the Preferred stock allegedly were not susceptible .

to the statutory abuses.

go We believe that’such a narrow, restricted view of the .

~ statute’s application is erroneous, illogieal and completely

‘reptignant to the. legislative intent because the history and

ra express language of Section 16(b) clearly indicate that -

\| . Congress intended ‘to eliminate such a subjective test on

a case-by-case basis.. For under such a test the applicability.

_ of ‘Section 16(b) toa particular short-swing transaction

\as ways remain uncertain and nebulous and dependent -

; proof of factual issues, which would completely .

| t} oy the intended effectiveness of the statute and «its

sufe and, speedy’? remedy. .

Moreover, if the Courts were permitted to ee a sub- :

si test upon a casé-by-case basis to determine whether

« é y

<i ° : z: ; ce :

12 haaall: joint at p. ms

‘the transaction involved were susceptible to the statutory

abuses, this would be tantamount to empowering them te—

exempt a transaction from the statutory operation as ‘not

comprehended within its purpose.”

But nowhere in the. statute or its legislative history does. -”

it appear that Congress intended to empower the courts to —

exempt transactions from the operation of Section 16(b).,

On the contrary, under the express language of that statute,

~ such exemptive ‘powers were granted exclusively to the

_ Commission to whom the administration of the statute was . .

‘ - expresslyjentrusted. The. Courts have not been authorized

to pre-empt Sach ‘powers. -

_ The rationale of the majority opinion, if if permitted gto

stand; would have far reaching implications beyond the

immediate issue here involved. For, not only would its

subjective test for the statutory application be requiredein

the case of conversion transactions alone, ‘it would neces- |

sarily be required to be followed i in eases where the insider —

exercises an option to acquire his issuer’s stock, in cases

_ where he exchanges his issuer’s shares for the securities of

- another corporation, in cases where he received his issuer’s _

shares in exchange for property, ahd in numerous similar -

- situations. In fact, it is entirely conceivable that an insider

might urge in the. future that his ordinary. cash purchases aaa

-and sales of his issuer’s securities within less than six

months are exempted from the statutory application: unless

“they can be. ches to: be a. to the proscribed

abuses. — ,

Such uncertainty with celal to the. natdiany paver

is contrary to its intended purpose as well as its language

and would result in a complete emasculation ¢ of its im prophy-— ae

lactic provisions.

“

1s The Cominlaiienn itsélf had not exempted the respondents x

conversions from the operation of Section 16(b). :

oe The decision ‘ the Court below i is in direct ili

-. with. the decision rendered dy the Court va Appeals

for the Third Circuit:

In holding that the respondents’ éiltuibaiey conversions a

of Airlines’ Preferred into common stock did not constitute

Section 16(b) ‘‘purehases”” of the.common,'* the Court of

we Appeals for-the Eighth Circuit laid down the rule that, in

every case inVolving an insider’s conversion of his issuer’s

convertible security, the test as to whether such conversion

constitutes a Section 16(b) ‘‘purchase’’ or a ‘‘sale’’ must

be determined upon a “subjective’’, rather than an ‘‘ob-

jective’’,; evaluation of the transaction itself, its attendant -

circumstances and its ultimate effect. Under such a ‘‘sub- ©

jective’? test the issuer; or a stockholder suing on its be- _

- half; would be required to prove gs a sine qua non for the

statutory © application, that thé insider’s voluntary con-

. vérsion of his issuer’s convertible security afforded him —

with .some opportunity to misuse his inside information. a

Unless‘such proof was forthcoming to show. that such’ con-

version was susceptible to the statutory abuse, it would not —

_be construed a Section. 16(b) ‘*purchase’? or a ‘‘sale’’.* -

The recent decision by the Court of Appeals for the Third -

Circuit in Heli-Coil Corp. v. Webster (C. A. 3, 1965),°352

F. 2d 156, conflicts directly with the decision of the me

' Circuit in the case.below.

In Heli ‘Coil the insider had purchased his issuer’s con- |

‘vertible securities and ‘had then voluntarily converted them -

into common stock less ‘than | six months ‘later. In holding

.. 184 Both respondents, as directors of‘ Airlines, had voted: in favor

- of the Resolution authorizing the redemption of its Preferred: stock, | ; .

and they had also voted in favor of. increasing the dividend on the By

common ‘shares thereafter.

_ The Eighth Circuit followed -the recent. Second Circuit’s de-

cision to the same‘effect in ‘Blau v. Lamb (C- A. 2, 1966), which

is still unreported. A petition for a writ of certiorari (No. 720) |

was filed with this Court. in the Lamb case but has not yet been

: acted 7

13,

‘ that the insider’s conversions constituted Section. 16(b)

‘*sales’’ of the convertible securities, the Court of Appeals .

for the Tiird Circuit laid down the rule that the proper

test for détermining whether an insider’s voluntary con-

version of his issuer’s securities constitutes a Section 16(b).

‘purchase’? or a ‘sale’? must be predicated upon an ‘‘ob-

jective’’ test, rather than upon a ‘‘subjective’’ one. It

further held ‘that under guch an “‘objective’’ test, it was

was. susceptible to the statutory abuse. The incidence. of

entirely immaterial] and unnecessary for a determination of —

’ the-issue whether or not the insider’s voluntary conversion

his nee to the issuer was all that the ntatute re- |

i quired.*® :

. Although the majority. ‘in the Bighth Cireuit, specifically oe

recognized that'its decision completely conflicted with both

_the rationale: and result in the Heli-Coil.case,.it sought to

ae justify its ruling upon the ground that the Heli-Coil deci-.

sion is ‘‘at present a minority ruling and is founded almost

~ solely upon the rationale of Park & Tilford. Since Park € |

Tilford has now been. severely limited by.the later Second

"” Cireuit decisions on this i issue, we cannot refrain from, the ©

’ belief that Hel-Cott i is likewise weakened.’"* -

Regardless as to whether Heli-Coil is fined gy ae

minority ruling’’, however, it is inescapable that such deci-

sion has created a clearly. delineated division and conflict:

_ between the various Cireuit Courts as to the proper inter-

_ pretation and application of Section 16(b) of the Act. This Cae

conflict of ideology has already led to considerable con-

* fusion. which undoubtedly will continue to be compounded ©

in future cases unless this Court finally resolves the mat-

ter. Such confusion and uncertainty now ‘‘leaves this i im-

portant area of the law almost ludicrously uncertain’’.

Unless, this Court ee the proper course for its rey

28 The Heli-Coil case was decided. by the Court. en banb with -

6 of the judges voting in favor of such “objective” approach to.

- the statutory application, _while. 2 iyders dissented therefrom. i

a Senet, infra, PP. 26-27. Sees oH

. 4 y

| initieepretdion, dounts: in different Circuits will continue to. .

decide Section 16(b) cases by applying different standards

in each case. This can only lead to complete deterioration

and ultimate destruction of the statute’s intended | purpose.

As J udge Blackmum sO aptly observed i in his dissenting

opinion :” : : ‘Perhaps the Supreme Court one day.soon will .

‘tell & how, these somewhat conflictiag approaches. to/Sec-

‘tion’ Het?) by the: Courts of Sues are to be resolved. ee

= CONCLUSION, - . *”

For the fertgoing reasons, this petition for | a writ a

ee _- of certiorari should be granted.

et Respectfully submitted,

‘Monnaw J. Seve,

Counsel for Petitioner, —

Isadore Blau, _

261 Broadway, . .

New York, N. Y. 10007. on

ee aes Pani, Gross & Annox,

Of Counsel.

Be: Appendix, infra, p. 35.00 rains :

* ‘Bunice 8. Butler and ro

- €

Reavis, Appellants,

a ee %,"*

. Airlines, Ine, Appéilees. -

ain:

ae,

Wes: 3

Dery £

| Monae’ Pettey and. C. F Yank ,

Alonzo Petteys ‘ ‘at C. Fiank

| ye Blau and Northwest

: _ Appellees. J

ae. Inc., |

Judges.

5 This appial presents another difficult question on the: -

igen suslioatiity of ie qnnetiqns: of § a of the Securities |

aes iS ad

| hs ee APPENDIX

| | Opinion.

| Batted Stites Court. at Appeals

: / ets FOR THE BIGHTH CIRCUIT |

2a.

“Nos. 18,277:18, 26 |

Appeals from the United ;

“States District Court .

for the orenascu: Min-

nesota.

ot iS apse {October 19, 1966.]

: Before a Oosrennov7, BuackMon ‘and Gmsox, Circuit

;

ee ae Act of 1934, 15 Uv. S.C. 4 78p(b)? to a conversion

of preferred stock into:common stock, which was then sold -

within six-months of the conversion. * Appellants, Petteys -

and Reavis, appeal from a judgment of the United States

- District Court for the District of Minnesota holding them

liable for profits realized from the sale of Northwest Air-

~ dines, Ine.. common stock ina transaction -held to: be a ie

. ‘short-swing* speculation proscribed: by §16(b). The cases

were joined for trial and one opinibn written by the Dis-

trict Court. Jurisdiction of.the cases filed is. founded upon

§ 27 of the ‘Act, 15 USC. » $T8(sa), and upon 28 U.S.C.

§ 1331.

The facts .of thies cases are not-in dispute.” Patteys

and-Reavis are minority stogkholders and were during the

peniod i im question, two of the thirteen directors of North-. ee |

west . Airlines, Ine. (Company). On: January 14, 1963, .

Petteys: owned 5000 shares of the Company’s 51, % con- "

.. vertible cumulative preferred stock and 15,000 shares of

‘common stock. Reavis owned 1167 shares of the preferred _

and 4000 shares of the common | stock. Each had

ved his stock for more than six x months. On January

3 1§ 16(b) Securities Exchange Act of 1934, 15 U. S. C: § 78p(b) :

“For the purpose of. preventing the. unfair use of information

_ which may have been obtained by such beneficial owner, director, or

officer by reason of his relationship to the issuer, any profit realized

_by him from any ‘purchase and sale, or-any sale and purchase, of

any equity security “of such issuer (other than an exempted secur-

ity) within any period of less than six months, unless such security

was acquired in @good faith in connection witha: debt: previously |

contracted, shall inure to-and be recoverable bythe issuer, irre- .

spective of. any intention on the part of such beneficial owner,

director, or officer * * *. Suit to;recover such profit may be insti- -

ted at Jaw or in equity in any court of ¢ompetent jurisdiction by

the issuer, or by’ the owner of any security of the issuer in the

= and in behalf of the issuer, * *-*. This subsection shall not

to caver any transaction * ++ which the Commission

es and regulations may exémpt as ame comprehended within

Ls purpose of this subsection.”

5 a

> .

. ™

ee 8 ok % eo” * . ry

; P a A ‘

Fs) | = /

‘ : ’ % o /

. ’ ° ° e . ° y

’ .

14, 1963, the a had calahailg "449 615 shares of.

preferred stock. and 1,388,459 shares of common stock.

_ The common and preferred stock were listed and traded

on the New York Stock Exchange; and the preferred. stock

was protected against dilution: resulting from the issuance’

of additional common stock. The preferred and common

stock © each had one vote ‘per-share. Petteys had been a

. director since 1945 and Reavis since 1952. The preferred

stock was convertible at. any time on-the hasis of $25 for

éach: preferred share into common stock at a conversion

price of $26. for each common share pine accrued dividends

prior to Jan ‘1, 1964.

.At.a meeting of the Company’s board of “aikectore on

January 14, 1963, it was unanimously decided: that the - . .

elimination of the preferred stock was desirable since -

‘.. this would place’ the Company in a‘ more advantageous

. position to seek new capital. It was, therefore, unani-

mously decided to call for redemption of the preferred

' shares at $26.161815 per share on the entire outstanding

issue ($26 redemption price plus accrued dividénd).: Both : =.

Petteys and Reavis were present at the directors’ ineeting. -

The matket value of the preferred stock on this date was

. $34 per share, or about $8 more per share than the re-

| demption price. The common: stock of the Company at

that time was selling for about $36 per share, which was

; approximately equal -to the conversion rate of 9615 of:

common per share of preferred. Due to this ‘wide differ- ©

ence between the market value of the stock and the re-.

demption. price, it was believed that the preferred share-

holders. would exercise their rights to convert their pre- —

ferred shares into common prior. to the redemption date

of February 14, 1963. ‘This jidgment proved to be correct

__ in that 99:98% of all the preferred shares were. converted. ae

_> Only 70‘shares were not coriverted. _

On January 17, 1963, when its ecik: price was .ap- -

ey: $35 per ‘share, sera eonverted his 5, 000

a°

Opinion, —

‘shares of preferred stock for. 4, 808 Dias of common

stock. Less than six months .after the conversion (be-

tween May 20 and June 18, 1963) | Petteys sold 9,808 shares

of .common stock at prices ee from 51 to 55% per

share.

- Reavis sieiaiee his 1 467° shares of preferted. stock |

omJanuary 31, 1963, when the market value was approxi-

, mately. $38 per share and received therefor 1,123 shares

of ‘common stock. Less than ‘six months later (June Dy

1963) Reavis 8dld 1,600 shares of common stock at prices

ranging from 531, to 535@ pershare.. - *

On February 25, 1963,’ eleven days after the terminal

date of the redemption call, the board of directors in- ~

- ereased the quarterly djvidend on its common stock from

.20 cents to 25 cents per share; After the increased divi-

* -~-dend,, the market price- “of the common stock increased

ae -—-gubstantially..

The Minnesota’ suit, Number 18277, was filed July &

1964, in the District. Court by Petteys and Reavis, seeking

a. judgment against the Company. to the effect that these

transactions were not proscribed short-term profits making )

them accountable therefor to the Company under :§ 16(a)

and (b) of the Securities Exchange Act. On July 8, 1964,

Eunice S. Butler, a stockholder, was granted leave to in-

tervene to seek judgment on behalf of the Company. On

July-14, 1964, the Company filed. an answer, stating, ‘‘It::

is and has been unwilling to institute or prosecute an

action against the plaintiffs.”? Qn July 17, 1964, Isadore

Blau, another stockholder, instituted an action’ in the

United States District Court: for the Southern: District

of New. York against Petteys, Reavis and the Company,

alleging a §16(b) liability of Petteys and Reavis to the

Company. The New York case: was -then transferred to

the District of Minnesota. Both cases were combined for

‘s hearing on cross-motions for summary judgment. Sum-

WSs

o .

19. |

Opinion,

‘mary judgment was is apprSpriate as the facts were not in

_ dispute.

'’- The District Court denied Petteys’ and Reavis? shclhcne’

granted the motions of intervener, Butler and plaintiff

Blau, and held, in an opinion reported at 246 F. Supp. 526

‘ (B. Minn. 1965), that the conversion of the preferred stock

into common stock constituted a ‘‘purchase’’ within the

meaning of 4 16(b), and therefore Petteys and Reavis were

liable to the Company for profits derived from the sale -

of the common stock within six months after the date of

**purchase’’ or conversion.

Petteys and Reavis contend that the conversion of pre-

_ ferred stock into common stock under’ the particular facts

of this case was not a ‘purchase’? within the meaning of

§$16(b).

: Petteys and Reavis, as ‘directors, are ‘‘insiders’” under .

§16(a) and subject to the requirements of §16(a) and

the civil liabilities of § 16(b). The only question remain-

ing i ther their- conversion of #preferred stock. into

conimon stock constituted a purchase of the common so

that the subsequent sale of common within six months .

thereafter would make them liable to the Company for

‘any profit realized on the sale transactions. The fact that

Petteys and Reavis had other common stock, purchased

prior to the periods in question, from which their sales.

were, or'could have been, made i is ‘immaterial. .

" 'b“Tusiders” ag denoted in’ cases end atticlts ‘dealing with § 16(b)

are those who are ogi to report under § 16(a) any sale or pur;

-_— of stock, and are subject to the sanctions of § 16(b). They

are: “16(a) Every person who is directly or indirectly the beneficial.

: seule of more than 10 per centum of any class of equity secur-

ity * * * or who is a director or officer: of . the issuer of such

security, ogee

® Although it is not clear whether the shares sold were the same

' certificates acquired in the conversion, this point is immaterial.

- (Footnote continued on following page)

et: Q ae .

The reasons for the enactment of the Securities Ex- .

"change Act of 1934 and the specific purpose.to be served

by $16(b) are fully documented and examined in prior

§16(b) cases discussed in this. opinion, and will not be

. repeated in. detail here. In summary, congressional in-——

vestigations in the early. 1930s disclosed sed a.number of in- |

; stances in which ‘‘insiders’’ of corporations had abused —

their fiduciary positions by using confidential corporate

information to aid their pérsonal market, activities. Armed

with information not available to ordinary stockholders,

these ‘‘insiders’’ brought about artificial, but predictable, —

fluctuations in the market and, in so doing, were able to.

reap substantial profit with little or no investment risks

to themselves—all at the expense of outside stockholders |

and the public. This manipulation and ‘‘sure thing’? specu- -—

lation discouraged valid investment and contributed “tot

the causé and depth of the economic collapse of 1929.

>’ Congress, therefore, set out to remedy this particlar evil

-. with*$16 of the Securities Exchange Act of 1934.*

Section 16(b). of the Act was enacted expressly ‘‘for

the purpose of preventing the unfair use of information ©

which may have been obtained by such beneficial owner, .

director, or officer * * *.’”? To implement this statement

( Footnote continued from preceding page)

Equity securities ‘are treated as fungible. items. “(S)ince all shares |

of a corporation’ s stock are alike and interchangeable, it is of no ©

* consequence whether . those bought and sold are represented <4 the

same certificates.” Walet v, Jefferson Lake Sulphur Co., 202

433, 434 (5 Cir. 1953), cert. denied 346 U.S. 820; Smolowe Vv. en

; Delendo Corporation, 136 F. 2d 231 (2 Cir. 1943), cert. denied 320

U. S. 751; Western -Auto Supply Co. v. Gamble-Skogmo, Inc., 348

F. 2d 736 (8 Cir, 1965); cert. denied 382_U. S. te

' 4For a more complete discussion of the tichpipnind and pur-

poses of the Act, see Smolowe v. Delendo Corporation, 136 F. 2d

231 (2 Cir. 1943) ; Blau vy. Lamb. ..... F.2d. {2 Cir. June.

27, 1966) ; Comment, 59 Yale cs 510 (1950) ; Comment, 45 Va.

L.Rev. 949 (1959) ; Comment, Harv. L.Rev. 385 (1953).

nil

* OL

3 _ Opinion.

. 4

of purpose, “the statute provides that profits realized St

‘‘insiders’? from the purchase and sale, or sale ‘and pur-

: . chase, of equity securities of a company within a period

"of less than six months inure to the benefit. of the company.

‘This liability is enforceable by the company, or if the

company fails to act, by a stockholder- acting in a deriva-

tive capacity. The Act broadly defines ‘“purchase’’ as

““any contract to buy, purchase, or otherwise acquire,’’

and ‘‘sale’”’ as “any contract to sell or otherwise dispose

of.”’ 15 U.S.C. §78(c) (13) (14). :

The section. establishes liability ‘irrespective of any

intention on the part of (the insider).’? Though perhaps

reaching harsh results in individual cases, this arbitrary:

rule is thought necessary for the attainment of the goal:

set forth in the statute. If it were otherwise, ‘‘insiders’””

could continue all but the most blatant of practices and

_ take refuge behind an artificial wall of good faith. Experi-

ence with the common law remedy had convinced Congress

. that actual proof of -bad faith was a most difficult burden. -

. and thus discarded any~ subjective - approach _ based on

intent and established an objectivé sanction against '$0-

. ealled short-swing profits irrespective of intent. This sanc-.

tion does not prohibit short-swing sales; it only takes

aWay their profit from such transactions and places.it-in |

the corporation. Thus, the motivation for ‘inarket manipu- —

'. Jation is considerably depressed.

‘The courts have recognized the broad remedial p purposes

behind this section and; when a transaction is capable of

insider. abuse they have liberally construed the rule and’ —

applied it without hesitation and without regard to good

-. faith. See, Smolowe v. Delendo Corporation, 136 F. 2d 231 ©

(2 Cir, 1943), cert. denied 320 U. S.- 751; Blau v. Lehman,

286 F. 2d 786 (2 Cir. 1960), aff'd 368 U. S. 403; Booth v. -

_ Carian Associates, 334 F. 2d 4 a Cir. mien. cert. denied :

379 U. S. aye

arent tps P-va~erets

Opinion -

There i is, eile a ‘very different and difficult problem

_-when a transaction falls ‘within the literal boundaries of

‘the Act, by giving a broad interpretation of the definitions

of: purchase as ‘‘any contract to buy, purchase or other- .

wise. acquire,’’ and sale as ‘‘any contract to sell or other-

wise dispose of,’’ yet due to the particular factual situa-

tion which makes unfair speculation impossible it is clearly

beyond the Act’s preventive purposes. “In that situation

the question arises, should the Act be literally applied

without further inquiry and without regard to the pur- |

poses, or should the broad and arbitrary rules be applied _

only to situations which are capable of the abuse that the

statute was designed to prevent? We believe that each

— /

ease must be examined on its-own facts and the Act only

’ applied when thesé facts disclose the possibility of abuses

that the Act were designed to prevent.

The first case dealing with the conversion. of stock and

| the applicability of the ‘‘purchase’’ and ‘‘sale’’ provi-

sions to a conversion, was Park & Tilford, Inc. v. Schulte, -

160 F. 2d'984 (2 Cir. 1947), cert. denied 332 U. S. 761. In

this case the ‘‘insiders’’ were in complete control of the

corporation. At a time when the value of the corpora-

tion’s preferred shares was above the call price, the-‘‘in-

siders’’ exercised their corporate control by having the

corporation call’ the outstanding preferred on a given

mits. future date. They, of course, converted. their preferred

into common and within six months of the conversion sold

the common at a substantial profit. The court held that

the conversion was a ‘‘purchase’’ within the definition set

- out in the statute and a sale within six months made them

liable to the corporation for the profit. On the facts of

this. case, the holding was undoubtedly correct. . The> pre- .

ferred stock was not readily marketable and was not pro-

tected from dilution. Thus, it’ maintained a value ‘inde-

’ pendent of the common. As the.‘‘insiders’’ were able to

- get a call date at their will, they were in a position to use

+ 1965).

_ Opinion. | |

inside information to determine this call date and to ma-

nipulate the independent values of the two securities to

their profit. The court, however, in reaching its correct _

decision on the facts, uséd language unnecessarily broad. —

- Loss, SECURITIES REGULATION, Vol. II, Ch ~ 6E(8),

~ at page 1067 (2d ed. 1961). This language has gine been:

interpreted as meaning that §16(b) must be applied to

all stock conversions and the strict terms of the statute

are to be applied without regard to the purposes of the _

Act. See, Helt-Coil Corp, v. Webster, 352 F. 2d 156 (3 Cir.

Though understandable, this was eachihie: an ‘tenvest

interpretation to place on Park & Tilford, in that the

Second Circuit, which has more §16(b) cases than any

other circuit, has since refused to follow the broad implica-

tions of that case. Since Park & Tuford, the Second Cit-

cuit has examined each case on an ad hoc basis to, deter-

mine whether the transaction came within the ‘purpose of

.the Act.’ It specifically refused to be bound by a “‘black-

letter rubric’? or a ‘‘rule of thumb’’ as spits & .Tuford

supposedly demanded. :

In Shaw v. Dreyfus, 172 F. 2d 140 (2 Cir. ‘{949), eert.

denied 337 U. S. 907, the Court refused to hold that the —

receiving of a stock purchase warrant which was awarded |

equally to all shareholders was. a ‘‘purchase’’ within the

definition of the Act: The Court based its decision on the

fact that; ‘¢ ‘inside’ information which. the directors ‘may

have, cannot possibly be used to the detriment of other |

stockholders * * *. Nor will the purposes of the statute

be defeated * * *.” :

Roberts v. Eaton, 212 F. 2d 89 (2 Cir. 1954), a denied

- 348 U. S. 827, held that a reclassification of stock was not

a ‘‘purchase’’ of the new stock. Judge. Clark, the auther

of the Park ¢ Tilford- decision, stated at page 86, ‘‘The

_ reclassification at bar could not possibly lend itself to the

- Onini

speculation sieibieinanel by § 16(b). This being SO, it was

not a ‘purchase’ * * *,’?

_ Even though ‘the Court; in Blau v. Lana. supra, held

that a transfer came. und¢r. the provisions of § 16(b), the _

. Court stated at page 792 that 4, “‘Transaction is a ‘pur-

chase’ if in any way it lends itself to the accomplishment

_ of whatthe statute was designed to prevent.’’ |

Though. establishing a general ‘approach contrary to the —

implications in Park ¢ Tilford, these three cited cases did.

not involve the sprecise question of the treatment of con-

versions. Park ¢ Tilford was still cited for.the proposi- ©

tion. that conversions must flatly be considered ‘‘pur-.

chases’’, without further inquiry. This was true, however,

only until the\ recent Second Circuit case of Blau v.-Lamb,

. F.2d. (2-Cir. 1966). The Court there was pre-

sented with a » problem of whether the conversion of pre-

ferred stock into common stock constituted .a ‘‘sale’’ of :

- the preferred.’ In. determining the correct approach for : |

pened this issue, J page: Waterman, for the Court,

stated : te.

‘“ Aside from the settindtons to the site in Park ~

4 Tilford, our court appears always to have. recog-

nized that in deciding whether’a certain transaction

_ ‘is a Section 16 (b) ‘purchase’ or ‘sale’ it is relevant

-©° to first consider whether the transaction in any way

makes possible the ie insider trading that Section

16 (b) was designed to prevent: * * * The applica- . -

- tion of Section 16 (b) depends upon whether the trans- .

action in question could tend to eo what the .

_ fe st was denigued to prevent.”

-In ioiskinig at the particular circumstances of the conver: .

sion, the Court concluded :

‘ (The) vonversion afforded the insiders no oppo ss

nity to ‘realize a gain by speculative trading in Air-

an en ERAN ns nee cee

ae oR eee

way Preferred. For this reason, we hold ‘that the

‘conversion was not. a Section 16 (b) sale’ of the Pre

ferred.’’ rs |

With. this casé the viieeill Cirouit limited Park & Tilford

_ to its facts and completely destroyed any force found in

the particular. language of that decision intimating that a

>: completely objective ‘‘role of thumb”’ had, to be applied ,.

in all-conversion caseg.. The Lamb opinion relied heavily —

upon Ferraiolo v. Newman, 259 F. 2d :342 (6 Cir. 1958), —

cert. denied 359 U. S. 927, and Blau v. Max Factor é Com-

pany, 342 F. ‘ma 1965), cert? denied 382 U.-S.

892. Judge Wate after reviewing the decisions, con-

cluded that: yak gana a

‘The | decided cases in this and other circuits es not. .

require us to-hold that, without further analysis, the

conversion * * * must be regarded as a Sec, 16 (b)

‘sale’. * * * Instead, most-of the appellate decisions,

_.. inefading the more receiit decisions of our court, state _,

’ & that the application of Section 16(b) depends upon.

_ whether the transaction in question could tend to ac- —

complish what the section. was designed to prevent. th

: ilies see J udge Van Oosterhout ’s dissent in part in

Western Auto Supply meet v. Gamble-Skogmo, ps

348 F. 2d 736, at 745. é

The facts in the Ferrailo case are almost exactly in point

° with the facts.of the case at bar. A non-controlling director

held’ convertible preferred stock. While the market was

a" high the corporation éalled for a redemption at a price

below the market. The director, of course, converted his

. preferred into common and, as here, sold the’ common

within six months of the conversion. The Court stated,

, at page 345, “Every: transaction which can reasonably be .

defined as a ’ purchase will be so defined, if the trarisaction —

\ mas a , 2

oN oe : $ 1 J 4 jf , ~

¢} \ . a : ,» :

— Opinion.

‘is of a kind which can possibly lend itself. to the speculation’

encompassed by Section 16 (b).’?: In examining the con- -

version on its particular facts, the Court concluded, at ~

p. 346 of 259. F..2d, that it was not a purchase because;

‘‘Newman’s conversion of Ashland preferred to Ashland... a

_ common had none of the economic indicia of a purchase;

it created no opportunity for profit which had not existed

since 1948. The transaction is not ene that could have lent |

- itself to the practices which Section 16 (b), was enacted to

_ / prevent.’’ : 4

Blau v. Maa: Factor, supra, coneorned a situation where

' thé insider held common stock which was in every” way

‘identi@l to Class A stock éxcept the board of directors

had the authority to declare less dividend on the common.

Each-had the same market value, same voting power and

were fully convertible. The.insider, converted his common -

for Class A and. sold the Class A, within six: ‘months. The

Court held, at pages 307-308 of 342 F. 2d:

“¢(A) Transaction is held to be a ‘purchase’ within s

- section 16(b) ‘if.in any way it, lends itself to the ac- ~

complishment of what: “the. statute is designed to pre-

“ vent.?* * * E

. The qachange of Class “A for Common did not,

interrupt the continuity of appellees’ investment: it

did not increase or decrease the amount’ invested, or

alter in. any way the risk assumed * * *, (T)he ex-

_ change conferred no opportunity for speculative profit

' which ee did not already enjoy.’’

These bik cases eitined to apply a “rule of ‘hina id

; examined the facts of the case in the light of the purposes

‘of the statute, and in each case. concluded that the par-

ticular conversion did not constitute a ‘‘purchase’’ because

there'was no opportunity for speculative profit.

There 4s no doubt-that the majority in:Heli-Coil Corp.

v. Webster, supra, takes = epproa and reaches a result

S o é | hi °

a Ppa iter Shon pe

A ae eae

et ‘Opinion, | ‘ z ft ; :

OO o hess

inconsistent with the aforementioned ikek H eli-Coil y

pressly holds: ‘“We conclude that Section 16(b). does aut

.. up a ‘rule of thumb’ and was intended by Congress to do. |

ie precisely that.’’ p. 166 of 352.F. 2d; but that is, however,

at present a minority ruling and is founded almost solély

‘ upon the rationale of Park & Tilford. ‘Since Park & Til-

ford has now been severely limited by the later Speond Fe

“Circuit decisions on this issue, we cannot refrain {xb

‘belief the Heli-Coil-is likewise weakened. ye. ;

‘Our decision in Western Auto. Supply? ompany Vas

. .Gamble-Skogmo, Inc., 348 F. 2d 736 (8 ‘Cir: - 1965), cert.

denied 382 U. ‘987, was interpreted by the S.E.C.. as in- -

dicating that w adopted the so-called Park & Tilford

- objective approach to § 16(b)“problems. Obviously, the

facts of the two cases are not analogous, . Even so, we ;

‘find no dictum inconsistent with our holding herein. We

held that the statute must. be ‘liberally construed’ tocarry °.-.

out the express legislative policy”’ and that the good faith

of the insider is no defense. This is a correct statement

-of the law that we will continue to. follow. We certainly

did not hold in Gamble-Skogmo that the statute must be

_ literally applied even when the ‘‘express legislative policy’’

was not applicable to the faétual ateehign under vanarmnnind *

tion,

bya majority of the circuits, that each case must be ex-

amined on its own particular facts. If, from an examina-

tion of the particular facts, a transaction ts of a kind that. ;

can possibly lend itself to- the speculation encompassed

by § 16(b) “and falls within the broad definitions ‘of ‘‘pur-

chase’’ and ‘‘sale’’, it will be so defined. However; if an

.° - examination of the facts indicates that there is no’ possi-

bility-of abuse, there is no need to apply a §16(b) label:

to the See: ~~ Comment, 59 Yale L. J. 510 (1950) ; ;

‘Therefore, notwithstanding the broad entenee: in the :

’ Park & Tilford case and the ruling in Heli-Coil Corp. v.

Webster, we believe the rule has been clearly established |.

9 é . _ wr .

' _, Opinion.

" “Loss, pare & REGULATION, Vol. TI, Ch. 6C(g),

at pages 1069-1070 (2d ed. 1961); Cominent, 45 Va. L. Rev.

124, 126 (1959). ee |

A facet to ooneider as ‘milftating against paititing every

7 conceivable conversion. witlt the same broad brush, ‘Te-

- gard&ess of the lack of opportunity for short-swing market.

‘manipulation, is the manifestly absurd and unfair result

that can flow from such a per se black-letter rubric. As

noted by Loss, supra, at 1068: ee

a ‘*As a matter of fact, if every conversion involved

; both-a “ purchase’ of common and a ‘sale’ of preferred,

- no director or officer. or 10. per cent beneficial owner

éould ever buy preferred or sell common. in the market -

next six months would subject: nate to liability.” 16

€ >

The conversion ‘trefenotions nate ‘besa : ‘variously a

ferred to as ‘‘statutory purchases,’’ Blau v. Maz Factor,

supra, and ‘“uhorthodox ‘purchase and sale’ cases.’? See

Loss, supra., They.are not true’ sales but represent a type «|

ae of exchange of equivalents that can be read’ ‘into a literal

interpretation of the § » 16(b) ‘language of “otherwise ace

quire”? and ‘otherwise ¢ dispose of”’.

Undoubtedly, Congress realized that with shh all-inclu-

sive definitions there would be situations in which the

definitions would be applicable’ yet the transactions would

be of a nature that was not comprehended as being within

Be “the purposes of the Act. : -Congress specifically gave au-

* thority to make this determination to the Securities and

Exchange - Commission so that an administrative inter-

pretation could facilitate enfotcement of the Act and yet.

prevent undue hardship on fhose ‘caught in ‘the web of a .

vinced that this authofity is the exclusive prerogativ

"*.. Gategorically broad proscription. _ We have not been a

| the S:E.C. and is not also subject to. adjudication by the

oe courts. Courts have Ate been, and should be, reluctant’ sete

ae J $e

ce sd, =” be

Ay.

Si a Opinion: |

_ tovimpose broad stautory rules that-result in ‘gunposslees Ryne

and , unnecessary harshness. When the reason-of the law

ceases, ‘the law itself ceases (to operate), is a well-known

and time-proved rule of construction that is appropriate

’ in this case. Cessante ratione’ legis, cessat et ipsa lex.

See Blau v.,Lamb; supra. Since the purposes of the Act

~ are stated clearly ‘and appear side-by-side with the literal

demands, we do not believe we haye been: precluded by

Congress from pursuing an equitable and historic role by

examining the facts of each case <in the light of the stated

goals to determine on an ad hoc*basis whether the pur- _

poses of the Act are in any way being served by an ap- —

plication of the literal provisions. If no purpose is served |

_ . by attaching the artificial label of. ‘purchase’? to a trans-

action when it has none of the common indicia. of a pur-

- _ é@hase, no such label is ‘demanded, nor will one be attached.

‘This, we believe‘to be the correct law and it is the law

ae to be applied by us to the facts of this case. :

As a general proposition, conversions of equity securi-*

ties are not transactions which normally lend themselves

to short-swing speculation. 59 Yale L.J. 510 (1950). This

is not to say that the vehicle of conversion may not, under.

ahy” circumstances,. be used for the ‘purposes of unfair °

speculation. We can. envision in the abstract: a combina-

tion of facts and events in which insiders might gain an

_ unfair advantage by the exercise of their conversion

rights, and no doubt clever individuals conversant with :

. the subject can envision many.. However, so unlikely is

abuse of the contractual conversion privilege that the

S.E.C. with its considerable expertise and years of experi-

ence in’ dealing with these matters, has concluded that

the conversion of equity securities is not even compre-

. hended within the. ‘purposes of § 16(b). of the Act. Pur--

suant to its statutdry authority, on February 1%, 1966

“the S.E.C. amended Rule 16b-9, 17 O.F-R. § 240.16b-9 to

read, in its pertinent part, as follows:

. ‘Exemption from Section. 16(b) of Transactions in-

ore the Conversion of Equity scons onie!

Opi ee

@) Any acquisition or disposition of an ecquity

., Security involved in the conversion of an equity

' security ‘which, by its terms or pursuant to the

* terms of ‘the corporate charter‘or-other governing |

instruments, is -convertible | immediately or after

a stated period of time into another equity se-

curity of -the same issuer, shall be exempt from -

the oferation of Section 16(b) of the Act; st?

In its seinsionin brie to’ thi Court, the S.E.C. has argued”

that this rule must be applied prospectively only and that,

since the conversion, as well as the trial, preceded

‘enactment of the rule it should not be applied as a matter~

of law to the case now before us. Given the law set forth °

' herein, whether this exemption should be applied retro- -

actively to conversions capable of abuse, we need not.

decides, From an examination of the facts before us, the . \

unique facts of this particdlar case, we are convinced.

that no unfair speculation was ‘possible. The meaty

Tare combination of many factual elements which would

. Iahke short-swing speculation possible are not present

> herein. The conversion of the securities thus did no{con-

. stitute a ‘‘purchase’’ within the meaning. of the statute,

and appellants, Petteys and Reavis, consequently are not

liable for any profit received by a subsequent sale. The

retroactivity of this new rule is thereby rendered a moot

question. ~.

The preferred stock held by the two directors was-fully

marketable and listed on the New York Exchange. It was

_ protected against dilution, had equal voting power, was

fully convertible and’ at all times maintained a market _

value. equivalent to the common. The conversion did not

increase or decrease the amount invested, -change the pro-

portion of. ownership, affect voting rights, or substantially

_ alter the risk assumed. Blau v. Max Factor, supra. - Thus, ..

‘it appears to us that the common-and preferred are truly _

- “économie equivalents’’ in which speculation from: their |

| gs

“31

* Opinion.

conversion would be virtually impossible. Ferratolo v.

‘Newman, supra; Roberts v. Eaton, supra.

In facing.a call of the preferred, if the directors ound

. to maintain their investment, which they had: every right ~

: to do, the only course open to them-was a conversion.

Unlike Park & Tilford, where the controlling directors

unilaterally decided to_call the preferred and themselves ‘'

established the call “date, the directors herein were

< not-in control of the corporation. The call date was set

- and, to maintain their long-term investment i in ‘the corpo-

~Yation, they had no choice but to convert. This conversion -

being ‘‘forced’’ upon them, it is not a type of situation

' that one can normally expect to use for a — ‘specu-

lation. Ferraiolo v. Newman, supra. “

In the case before us, the stockholders were adequately

informed of the proposed call. ° Substantially all of the

shareholders réspénded to the economic demands of the

call, and, like Petteys and Reavis, converted thejr pre,

ferred for common rather than. suffer a needness and: sub-

stantial economic loss. With nearly all of the outstanding

preferred shares being converted (99.98%), we cannot

envision how directors Petteys and Reavis, by their con-

: Version, could gain an unfair advantage over the other

‘shareholders. In: reality, all were treated alike and thus

none was vulnerable to unfair advantage due to actess to®

_ Inside information... Even the assumed inside knowledge

° of the future dividend increase, in this case,’did not open .-

up possibilities of abuse, as all preferred shareholders —

“converted for common and thus received the increased

dividends. and ‘the benefit of consequent market rise (the

70 shares not converted are. treated as de minimis). Since

all shareholders remained in an equal position, none was,

or could have been, taken advantage of by- the conversion

- an insider. Shaw vy. Drea, supra. ~

, a

ie eet

___, Opinion. a

_. Itis, therefore, our conclusion that this particular trans-

action under the facts and cifcumstances of this case: could

‘ not possibly have lent itself to the speculation encompassed ~

‘within the purposes of §16(b) of the Act. This being so,

‘, .the conversion ‘should-not be considered ‘as a ‘‘purchase’’ —

' within the purview of the Act’s provisions. Our position .

on this conclusion is supported, we believe, by the like —

conclusion in Ferraiolo v..Newman, the. analogous cases

of Blau v. Lamb; and Blau v. Max Factor, and by the

rationale of. the recent ruling of the S.E.C. amended Rule

16b-9, acknowledging that conversions are not the type

of ‘‘transactions’’ that are ‘‘comprehended within the

purposes of Section 16(b).”” é

While our decision is not based on the S.E.C. amended

Rule 16b-9 dealing with conversions, the rule is: noted as.

a recognition of the rationale that ordinarily conversions

" are not purchases or sales. The eontract, rights of con-

~ versions are secured at time of purchase of the convertible ~

oR rotate as a reasoned in nen v. Lomb, er

ae ge

**We think that in cases like the present: involving the

| purchase of a convertible security and its subsequent

conversion, the issue should be whether the under-

lying security has been sold within six months from

the acquisition of the convertible security.”’ (Noting .,

‘the dissent in’ part of J — Hastie ond Kalodner -

in H leli-Coil).

By,

A like . sipplication would place thé transactions at bar —

beyond not only the purposes of the Act but also the-broad

terms thereof.

- Accordingly, judgment is veversed with inistructions to”

— ert in me of appellants. .

33 . * S. ao

Dissenting Opinjon |

Biscxmuy, Circuit Judge, dissenting

‘Having been a member of the majority in ‘Westera Auto

Supply Co. v. Gamble-Skogmo, Inc., 348 F.2d 736 (8 Cir.

1965), cert. denied 382 U.S. 987, I feel obliged respectfully

to dissent. While that case and this one are factually

different, I suspect that the results are philosophically

inconsistent.. I also wonder whether: our decision in

. Gamble-Skogmo might not, in part at. least, have prompted :

Judge Nordbyé to decide oppositely in the two cases at

the trial level. me

The majority seem to concede that the conversion hare

‘‘falls within the literal boundaries of the Act’’ and ‘“‘can

be read into a literal interpretation of the $16(b) [§3 —

_(a)(13) and (14)] language of ‘otherwise acquire’ and

‘otherwise dispose of’ ’’. “Further, I bear in-mind the in- .

' escapable facts here (a) that these plaintiff-directors voted -

for the call of the preferred; (b) that they voted for the

increase in common dividend effective shortly thereafter ;

‘after the conversion were exactly the same as they would

have been had they sold their preferred on the open mar-

ket and forthwith used the proceeds of that sale to pur- —

' chase common on the market; and (d) that in the latter "

situation, with the ensuing sale of common, no one would |

or cduld dispute the applicability of §16(b) and the con-

. ‘sequent liability of the’ plaintiffs. These facts, it seems

* : to me, add up to the possibility of misuse of inside infor-

' mation. And this mere possibility suffices. ci ae

My own reaction is that either the statute means what: .

it literally says or that it does not; that if the Congress

intended to provide additional] exceptions, it would have

done so ih clear language; and that the recognized purpose

and aim of ‘the-statute are more consistently and protec-

_ Dissenting Opinion.

. tively to be ee if the ‘statute i is construed literally and: |

objectively rather than non-literally and subjectively on &

: case-by-case application. The latter pneroapny: | is a weak-

ening process. _

However, with the Second’ Circuit now clearly withdraw-

ing from Judge Clark’s broad measure of §16(b) as ex-'

pressed-in Park ¢ Tilford,; Inc. v. Schulte, 160 F.2d 984

(2 Cir. 1947), cert. denied 332 U.S. -761, the Courts of

= Appeals, other than thé Third Circuit’s 6-2 en banc ma-

jority in Heli-Coil Corp. v. Webster, 352 F.2d 156 (3 Cir.

' 1965),“appear now to prefer to follow the ad hoc path.

The Supreme Court ultimately may say that that view is -

to be preferred. At least, Mr. Justice Stewart ’s attitude is

apparent from his authorship of the opinion in Ferraiolo

v. Newman, 259 F.2d 342 (6 Cir. 1958), cert. denied 359

U.S. 927. Until the Supreme Court does go state, however,

I must, in good conscience, adhere to my literal and ob-

jective construction. preference. .

I confess that my persuasion has been deeply shaken by

_ the Security and Exchange Commission’s recent about-face

with its amendment. of its-Rule 16b-9, 17 C.F.R. 240.166-9,

and its announced position that from and after February

17, 1966, a conversion of this kind is outside the statute

and not: touched by it, but that these plaintiffs’ particular

conversions, effected prior to that date, are within the

statute and subject to its consequences. I am not entirely —

‘sure that Congress, by the subsection’s final sentence,

meant to give the Commission the power so to ‘legislate A

-at will by-abruptly changing the reach of the statute: which

it had regarded otherwise for over a generation, or that,

if it did, such delegated authority is not vulnerable to

attack, or that the announced new rule is consistent’ with

the statute anyway... But these are issues which. we: nped.

not 1 now decide.

A a ey ee ee =

. the Courts of Appeals are to be ee In he mean-

Dissenting Opinion,

Perhape the Sannin Court one day soon will tell ns

how these somewhat conflicting approaches to § 16(b) by

time, I would affirm.

te... true copy.

Ame ek ou os a

Je.) 3 igi U, 8. Court “5 Appeals, Eighth Circuit:

4 %.

: Judgment of Reversal. |

UNITED STATES. COURT OF APPEALS —

For THE EieutH Circuit.

: September Term, 1966

Alonzo Petteys and c. Frank

Reavis, . hens ae

No. 18277. Appellants, Appeal from the United:

“ 3 . | States District Court!

. VS. : _ for the on of Min-

: - |. negota.. . .

Eunice §. Butler and Northwest |.

Airlines, Toe: » “ys ;

a eh |

Alonzo Pitiovs and ¢. Frank

Reavis; 7 ca

- No. 18278, Se Aupeliests, aia from the United

; ees pies eg tates District Court

, « V6. 2, Lee for the District of Min-.

nesota.

Isadore Blau and Northwest B if

Airlinés, Tas. :- > ae are

These causes came on to be heard’ on the sane from’

the United States’ District Court for the District of Min-

-- nesota, and were argued by counsel.

. Qn Consideration -Whereof, It, is now fete. Ordered

- and Adjudged by ‘this Court that the judgment of the said

District Court in these causes be“and the same is hereby, _

reversed with costs, and that Alonzo Petteys and C. Frank

Reavis have and recover against Eunice S. Butler; North-

west Airlines Inc., and Isadore Blau the sum of . ~

' Dollars for their costs in this behalf expended, and have.

execution therefor. -

And it is further Ordered by this Court that these

District - Court with instructions to grant: judgment in ~

favor of appellants, Alonzo Petteys and C. Frank Reavis,

in accordance with the weeny opinion of this Court this |

aay filed herein.

"October 1, 1966.

A ot ea AN he are

a at ne Rt COMMIT Nt ec i bt aes

> Sections 16(a) and Section \(b) of the Securities Ex- —

change Act of 1934, 15 US.CA., Sects. ‘Tp(a). and

— T8p(b), provide as follows ; te ~

: (a) Every person who is' diredtly or indirectly the

beneficial owner of more than 10 per centum of any

class of any equity security (other than an exempted

security) which is registered pursuant to section 78 of

_ this title, or who is a director or an officer.of the issuer

of such security, shall file, at the time of the registra-

tion of such security on a national securities exchange

or by. the effective date of a registration statement .

filed pursuant to section 78 (g) of this title, or within

ten days after he becomes such beneficial owner) di-

rector, or officer, a statement with the Commission —

(and, if such security is registered on.a national se-,

curities exchange, also with the exchange) of the

-amount of all equity securities of such issuer of which

he is the beneficial owner, and within. ten days after

the close of each calendar month thereafter, if there

has been a change in such ownership during such

months shall file with the Commission (and if such | ‘

security is registered on a national securities ex-

change, shall also file with the exchange), a statement

indicating his ownership at the close of the calendar

- month and such changes in his ownership as have

occurred during such calendar month.””

.“*(b) For the purpose of preventing the unfair use

of information which may have been obtained by such ~

_beneficial owner, director, or officer by reason of his

relationship to the issuer, any profit realized by him |

from any purchase and sale, or any sale and-purchase, .

exempted security) within any period of less than six

- months, unless such security was acquired in good |

f Y eee ya tatutes.

| faith i in connéction with a debt previottsly contracted,

, Shall inure to and be recoverable by the\issuer, irrespec-

. tive of any intention ‘on the part of such beneficial

- ° , owner, director or offer in entering into such transac- .

tion of holding the security purchased or of not repur-

chasing the security sold for a. period exceeding six -,

months. Suit to recover such profit may be instituted

_ at law or in equity in any court of competent juryisdic- —

tion by the issuer, or by the owner of any security of

the issuer in the name and in behalf of the issuer if the

issuer shall fail or refuse to bring such suit within sixty

days after request or shall fail diligently to prosecute _

the same thereafter; but no such suit shall be brought

more than two years after the date such profit was real-

ized. This subsection shall not be construed to cover

any transaction where such beneficial.owner was not

such both at the time of the purchase and sale, or the

~ sale and purchase of the security involved, or any trans-

action or transactions which the Commission by rules —

and regulations may exempt as not. _—e

within the purpose of this subsection. ”

“Section 3(a) (13) of the Securities Excienge Act of.

_ 1934, 15 U.S.C.A., Sect. 78e(a) (13), provides as follows:

«The terms ‘buy’-and ‘purchase’ each include any

contract py y; panshase, or otherwise acquire. -

1934, 15 U.S.C.A., Sect. 78e(a) (14), provides as follows:

-‘*The terms ‘sale’ and ‘sell’ each include any’ contract

to sell or otherwise agents 'e « he

~ pez

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