Petition for Writ of Certiorari — Rko General, Inc. v. Newmark

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[IN THE. aI

Supreme Court uf the Hnited” Siates

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e RAO Genxninar. ‘Inc, <3,

. : Petitioner, .

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Mancor NEWARK, ‘ :

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PETITION. FORJA W Rif OF CERTIORARE TO. THE

UNITED STATES COURT OF APPEALS

, FOR THE sar silat CIRCUIT ae

a 2 —__—

Mitton V. FRyeman .

Rictiarp J: ¥. fap ea?

1229 Nineteenth Fagor N. W.

Washington, D. C. 20036 ;

. manic Ys lor SrsOn

Of Coihsel: |

-Marviw: Scitwatrz pe ay ak eee

haa i Matas. e |

SULLIVAN & CROMWELL | Fd tise 13," ee ; o

48 Wall Street. ees

New York, ys York. ees, Pecks ah mR

ie 3 Wiaueas or ee “By pera

Prren. Comers: >. | bee

_ Recan’ Gotprars Powri. & Quixx . Ss ie

445 Park Avenue

New York, New York 10022

Arxoutp & PoRrTER >

7229 Nineteenth Street, No W.

Washington, D. C. 20036 Re :

July 34,1970... ; |

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INDEX |

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OPINIONS BELOW <1... SeRRe mee nat E

a) RISDICT ION 2 ae eee AS one 2

QUESTIONS PRESEN 23 gi noe RON a

STATUTE INVOLVED . Suu Bie de ee tae 3

‘\.. STATEMENT OF THE CASE ye 4

Emtrodinction .2.......0..s..:...4.... $eaeentbentionen Abcnnatincnusa cas resteee iene ee

4 My ¢ ‘ ; . 2 ‘ ‘ . i or

soe Ne BU aes resss farses cd aciecyncs PE oe ecsaansandiyacnevsenesens “se 6

The Proceedings Below Pes. Ss Daeecaty aos suas bers ea, 7 ee

REASONS#FCR GRANTING-THE WRIT 002 16°

2 TS TRAS OF GREAT. PUBLIC IMPORTANCE va

~ * POR THE COURT TO DECIDE WHETHER /

A STATUTORY MERGER CONSTITUTES”

‘A. “SALE” OF [SECURITIES OF THE

MERGED COMPANY, AND A “REALAZA-

TION” OF “PROFIT? -BY THE SHARE-

HOLDERS OF THAT COMPANY WITHIN’

THE ME ee QF SECTION 16(b), OF ‘THE +

. EXCHANG ae | sy Aeeene CRG” Shih Renee ee 16

a iF THE Qu ESTIONS, PRESENTED ARE SU B-

a WAN a me:

A. Section 16(b) applies when profit is realized

upon an in-and-out “purchase and sale” _....... 26

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ihe ‘ e > oe - . e

B. The spe wilative abuse theory of the Court of

n Appeals mistook a corporate merger for a}

Cash sale :........, Dtinseaas AOL Repsd Renner a Cen . oe

iy RKO mnitde a Spare ‘hase? "hut tee: 3S 30

D. i ko. paw not have | Use “ inside information

. for spee ‘ulative vo, Rees re Me Bete eke oats = Be:

4,

-1. There was no etal unfair, use of. inside

information. 2... ON ART AS IM dees ees rupee “32

2° There Was no potential for unfair use of ©

eat as TRWRE TUTOR So ose encseh ass. - 33

a. The selling Central insiders could not

‘ ‘35 SMO beet a Sea ence ge eee

: r) ;

ier ay : hb. The minority shaicholders of-C ‘cutee!

a . could not have hewn n abused re i eee a

KE. RKO te ver realized any profit ...... Phere Piacknat Pots

F. The courts’ are precluded from filing Sod

tion 16(b) hh nypility because the purchase | and

supposed “sale were approved by the €¢ eis 38

f ; i 2

ORCL Cc SES ll Binan oe 40

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Appendix A: Opinion of the Court of Appeals 2.0000..0- la

-* a : 7% *- ° e

Appendix. B: Opinion of the District. Court (Tyler,

‘Appendix C: Opinion of the District Court ilekeat

Appendix by Order ‘rs of the Court of Appeals Denying

‘Rehearing’ and ‘Rehearing itn Bane-...... o2%

. Appendix E: * iat of the Court 6f Appes als . meek o4a

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TABLE OF AUTHORITIES

Peay as er ome

CASES: | on = ee ree

; : ee.

-— Blawy: Lamb, 363 F.2d 507 (2d Cir. bop oa | denied,

“385 U.S. 1002 (1967) -.........-—3 Lea iRaneer ane 17,0,

Blau v. Lehman, 368 U.S. 408 (1962) oor 1S, 23, 25

Blauy. Max Factor & Co., 342 F.2d 3004 (9th Ch 1965), >

-cert. denied, 382 US. $92 (1963). ...... Sia, 5, 3]

Blawv. Mission Corp. a 212 7? mt a ae a C ir: Wee), cert. |

de med, 7 13) S. 1046 (1954)" Ea, Se greene Eeeceencceecceten a9

_ Ferraiédlo v. News man, 259 F. Yd 342: ‘eae Cir 4958),

cert. denied, 359 US. 927 (1959) 2 eae Mire 17/19, 20,

. 24, 34, 36

ee:

Gilbertville Trucking Coon. Cited States, am U ».

1135 (1962). ........... PRES ohe Pee hE at Eyre ewes SITES OTe a

Heli-Coil Corp. x. Webster, 352 Pid 156 (3rd. rie

. sega ae sao apa toasts ep tsndems ar da sneuden tase ocncgi A, In), 2 1, a7

iF Pette YS V. elites. 367 F2d..528. (Sth Cir. 968), ert .

2 * denied, 385 . say ERO: ee Oe FRernE WAT, 19, 22, 34

Robgrts \. Suieu, 2 F.2d 82° (2d Cir, 1954), cert.

de nied, 348 U 5. S27 OID hier elaresldetaieecschersh t..k%y 19, 25

SEC v. eee Securities, Ine. mn 393-0 %, 453 (1969). ee *

SEC v. Texas Gulf Sulphur’ Co., 258 -F. Supp. 262

_[5: D.N.Y 1966), aft’ din part ani rev'd. im part, 401

P2d 833. (2d Cir. 1968), cert. de nied sub nom. Kline

SE saad 394 U.S. 976, (1969). RAP Penn —, 25

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STATUTES axp Rv ES: :

Federal Aviation ‘Act of 1958, a y,

Sedtion 40s (40) yy BAC? 1378) « bepinseeCeanecenanne ae ae

Section 414. (49 U.S.C. 13884). eae

. Nev. Rev. Stat.’ pipes ! 12

f % “1 a é . f

TEGO TRANG ce ee ae

Securities Act of 1933 a Caney foot Sr : ’

ewtied. 6145 URE 67 fe) os . 23:

Securities Xchange: Act of 1934 ,

Rection 27 (15: USC: Gitea) ot tame iy

Section 16(b) (15 U.S.C: § TS8p(b)) Pavel res SIAL 3 passim

Section 10b (15 USC. $ iT, SS Me Mapaetbeoent alien sens go Seis

Seeurities and Exchange Commission .

" Rude 133 (17 CABSR. § 230188) ciel ence ane

Rule 10b-5 (17 CAELR. § 240.18b-5) te ee AT

SEC Exchange Act Release No. 4509 (OQetober 30, 1960) :

(CCH Fed: See. L. Rep, §76,080, p. T8757) ee” B

United States Code =: | |

Title 28, Section 1254. SERRANO RUDRA a Dsaiicsbodercedeecincts — .

Ornen AUTHORITIES: 71 *

Federal Trade Commission, Currént. Trends. in Merger

Activity, 1969, Statistical Re ‘port No. 6, p. 1, (Mareh

| dececauncena) rie -cssatasssacasetenscnndeuieln iewnel Riuasesheumepes ee |p

e *

d : saa . -¥

ee 7 : Sere ae = ree aes ; PAGE’

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Gobdman, Riintidins Short eins Liattt 3 Rey. of a

See. Reg. scien, Macc, nek SOD PE NLM ices ae 21, 23 os

2 Loss Securities Regulation, 1043 (2d ed. SEE asso. a |

Lowentels, Section 16(D); A New T re nd i in Re gulatiog \

Inside Trading, 54 Cornelt L. Revi 45 (1968) 2... 17,2 o5,\ °

‘Rappaport, SEC Accounting Practice antl Pracediie, ae ,

2d edy 1963) critthmeececteeenecesnesebeceseeigeceeanualie! eS Ole ea ow 3S.

56 and S. ea. YG,

~ Hearings ow S. Res. 4. and S. Res,

on “Banking. and

before the ‘Senate Committee

se Currency, 73d Cone., Yd Sess, (19! | SENS, eg aaa “eg -

"oS: Rep. Nov 12, 73d Cong. 2d Sess. (154) Shion rswehighceatngs 20;

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IN THE

Supreme Gourt of the Hunited. States

meg «OCTOBER FRRM, 1S70-

De cack cucens

RKO Genxtran: Ixc.,

Metitioner,

—yJ\ a

S . 9

oo Mancor, New anky |

Respond wi,

<i

_. PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT.OF APPEALS

FOR THE SECOND CIRCUIT

Petitioner RKO General, Ing., respectfully prays that a

Writ of Certiorari issue to review the judgment and: opinion

of the United States: Court of Appeals for the Second

— Cireuit in the above-captioned case. |

. eS 7

_ OPINIONS BELOW

"The opinion of the Court of Appeals ds reported at 425

_-F.2d 348 and also in CCH Fed. See. L. Rep. © 92,650. That

opinion is reprinted as “Appendix .¥ hereto, pp. la to 18a,

‘infra. The opinions of ‘the District Court for the eae rn

— Distriet of New York with respect to liabili tv (Tyler,

Md\damages approximating $8 million (Bonsal.:..) i

reported at 204 F. Supp. 308 and at 305 FL Supp: 316,

respectively, and are reprinted as Appendices B and C

hereto, pp. 19a to dla, mi fpra. |

ae

JURISDICTION ©. .-

— The judgment of the Court of Appeals was entered | on

April 30, 1970. (Appendix Ik, p. ota, infra.) A timely

petition for rehearing or, alternatively, for rehearing en

‘bane was denied June 2, 1970. (Appendix D,.p. d2a, ivefra.)

The jurisdiction of this Court: is invoked pursuant to ‘28

U.S.C..§ 1254(1). The basis of jurisdiction in’ the Distric

Court was Section »7 of the Securities Exchange Act

INB4, Ta USC. § Waa. ?

QUESTIONS PRESENTED

1. Within the meaning of Section 16(b) of the Securities

xchange: Act of L934, which provides for forfeiture of

profits realized on the shert-swing “purchase and sale” of

securities, does the filing-of a plan of statutory merger of

two publicly awned companies constitute a “sale” of seeuri-

fies of the merged company by the shareholders of that’

company where (i) all shareholders of each merging:

company are treated alikeyand (ii) the merger is approved

by the shareholders of cach merging company by a vote of

‘over 99 pe reent after rudl disc ‘losure of all reley ‘ant facts?

“2. Hf such a statutory merger constitutes a“sale” of the

securities of the Ine rged‘company in exchange for securities

of the surviving company, is any “profit realized,” within

-the mes anitig ‘of Section 16(b), by va shareholder company

which (i) purchased se curities of the merged company

on the day of the filing of the merger agreement pursatant

to and-as a necessary element of the merger plan and (ii)

continued to hold such’ securities beyond the six-month

: Statutory period?

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3. Where both the. “purchase” and the supposed, “sale

‘held to create liability under Section 16(b) were approved

by the CAB as not. “unfair” to andl having “no adve IT Se

effect on” shareholders or others, are the courts précluded

from finding a “possibility of unfair use of inside informa-

tion” in the very same transactions so approved by the.

CAB?

. Statute Involved

The. arene. provision involved ix Section 16(b) of "

Necurities Exehange Act of 1934 (“the Exchange Act”),

U.S.C. § 78p(b), which relates to insider short-swing ae

chases and sales” oaccurities. ‘The text of Sect?on 16(b) °

is ae fellows: 0".

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

‘information ‘which may have been obtained by such

beneficial. owner, director, or: oflicer by réason of his

relationship ‘to the issuer, any profit. re alized by hin |

from any purchase and'‘sale, or any saie and. purchase,

of any equity security of such issuer - (othe r than an

exempted. security) ‘within any period of less than .

‘six months, unless such security was acquired in good

faith in connection with a debt previously contracted,

shalk inure to and be recoverable -hy the issuer,

‘irrespective of any intention on the part. of suelr

beneficial owner, director, or officer in entering into .

such transaction of holding the security. purchased or

of not repurchasing the seeurity sold for a period

exceeding six months. Suit to recover such profit. may

be instituted at.law or in equity in any eourt of com-

petent jurisdiction by the issuer, or- by the owner .of

any security of the. issuer in the name and in behalf

of the issuer if the issuer shall fail or refuse to bring

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° 4s Ry oe e

such suit’ within sixty days atti’ raynest, or shall fail

diligently to: prosecute the same thereatter; but no

such suit shall he brought more than two vears after

the date such profit was realized. This subsection shall

not-he construed to cover any transaction. where such

beneficial owner was not such heth at the time of the

purchase and sale. or the ‘sale and «purchase; of the

security involved, or any transaction or transactions

wh, ich the Commission by rules - and regulations may

e exe mpt as not comprehe nded. within the purpose of

this subsection.”

_ STATEMENT OF THE CASE

Seen ee

_CRKO") invested 475 D site in securities of “Centyal

Airlines, Ine. (“GC entral’’) upon condition of a merger of

Central into ¥ rontier Airlines, Ine. (“Frontier”), an RKO

; subsidiary: company. On the same day, pursuant to share-

holier and Civil Aerona ities B oard (“CAB”) approval,

Central was me rged into. Frontie re RKO holds the seeuri-

ties resulting from the merger to this day. i

. Section 16(b) applies to in-and- out inside Y trading. He Te

Petitioner RI<O. got “in’-but never “out.”

Se ction ‘T6(h ) applies to “profit realized.” Heré nothing -

was’ realized. The Court helow said that by the merger

RKO received securities worth j in its opinion approximately

£8 million more than RKO paid for the se curities of Cen-

tral on that day. It entered a massive judgment of approxi-

mately $8 million, by far the largest single cash judgment

ever entered under Section 16(b) Pia perhaps the largest

ever under the federal se curities laws. Further, by the’

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‘time judgment, ‘was ordered Dy the District Court. the

securities received on the ‘merger (still -held by, RINO) were

1 worth at market $3.5 million less than the purchase price,

and today are worth at market $5.3 million Jess than the

‘ f

The ‘lower courts held that @ single investment decision

. . ; . 7 a haa 7%,.

to invest in a merged Central-Frontier airline’ on a

permanent basis involved both a “purchase and sale.” and

purchase price. -

that-an investment which was not. intended-to be liquidated, .

which could not have been tawfully liquidated anc. Which -

has not in fact been liquidated to this day braught RKO a

“realized profit” of $8 yuulion. , py Oe ee

— ae ‘ , "Ys

The Judgment below would require RKO: to pay $15.5

million ¢nstead of the-agreed purchase price of $7.5 mnillion

-—foF securities which today have a market value of $2.

million. , } ay

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Section 16(b), a simple, sensible absolute liability statute,

has been misapplied: here. Section 1b) was intended only

to. reach speculative in-and-out trading. Llere that statite’

was applied’to a long-term, indeed permanent} investment,

‘Section 16(b) was intended only to deprive a speculative

trader of the cash or eash equivalent profit realized on his

short-8wing trade.” Here the merger produced no cash or

cash equivalent profit: RKO, the parent company, received

only securities of the . surviving subsidiary, Central-

- Frontier. A sale by RKO of the Central-Frontier securities

received pursuant to ‘the merger would have violated the

_basie objective of the transaction as well as RIKO's

covenants to the sellers, to the shareholders, to the CAB

an\l to the Internal Revenue ‘Serviee. And these securities

. +The District Court (Tyler, J.) referred to the merged succes. |

Sor corporation as “Central-Frontier,” (See Appendix (“App.”) ’

B, p.'19a, infra.)

Some)

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a

“¢ ee ay 2

have notheen sold by RKO. Neverthe par RINO was ordered,

to pay an $8 million judgment for “profit realized” on a

Be _Saetion. Lacby “purchase and sale.”

The decision, for reasons stated Be low, is of ‘such. major

importgnee, so at variance with the decisions of this Court

and other Cirénit Courts, anc: SO so bound to cause confusion

+ in the law that review 2 and “dlarific ‘ation. by this Court are

o imperative." ee,

—_—

_ The Facts

Fhe Parties. RKO General, Ine. is a wholly-owned sub-

sidiary. of General Tire & Rubber Company, a publiely-_

owned company avhose shares ate traded on the New York

Stock Mxchange. In early 1967, R KO ow ned approximately

r D6 percent of the shares of Frontier Airlines, an’ airline

‘certifieated by the CAB and engaged ino scheduled local

service air transportation in 11 Roeky Mountain Stafes.°

The remaining 44 percent of the stock of Frontier Airlines

was broadly held by the public (in 1967, Frontier had 5,700.

shareholders-of record (J24..348a)). Frontier’s shares are

traded on the | American Stock Exchange (J.A. 264a, p. +

e °

In about March 196 RKO commnenced discussions. con- |

cerning a merger of Frontier Airlities with Central Air-

‘lines, another. scheduled local-serviee. airline operating in

cee the contiguous States ‘of Texas, Colorado, Oklahoma,

Kansas, Missouri and: Arkansas (J.A.402a; J.A. 264a, p.

29).- Central also had a large munber of public shareholders

(hr 1967 there were over 1,600 Central shareholders of

record (J.A. 344a)). Central shareS were traded in the

over-the-counter market > Yoda, p. 7 y and Central filed

2sArizona: C olorado, Missouri, Montana, Nebraska, New Mexico,

North Dakota, South Dakota; Texas, Utah and Wyoming. Joint

Appendix (““J.A.”) 264a, p. o4. a

i ¢

annual reports and financial statementsavith the Securities

-and Exchange Commission (*SHC"). |

Approximately 66 pe reent of the shargs of Central we re,

held by- SIX Central inside rs—the . Chairman of the Central

Board of ‘Directors and five other Central direc ‘tors (Jc.

264a, lixhtbit "A. pO JA. 2Zioa; Appj A. p. Day n. 3,

infra). nae Ariat

Frontier. was the fifth largest of the: thirteen scheduled —

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local-sgrvice airlines and Central was the smallest of these

(J.A. 264ay pp. 24, 30). F rontier had a stronger financ ‘jal

structure’ (JA. 3ilases. 38lda). It was hoped thata merged

Central- Frontier system would ‘resulg 1 in more/ profitable

‘operations (J.A. 319a). It was beheved that because the «

routes of the two airlines were contig: ‘ous’ and in. some -

cases aised the: s same airports, the recrged “ollpany might’

obtain through toutes, substantial cost savings and in-

¢

creased Ci ining (JA. 31la-12a).

° Merger Negotiations. Discussions concernitg: the _possi-

bility of a Central-Frontier nie rger took place during the

spring’ of 1966 (J.A. 402a- 03a) and then broke oft, In

‘September 1966, Central entered into a merger: agreement

‘with’ Ozark Airlines, which was, however, terminated. in|.

November 1966. In late February 1967; negotiations for a

Frontiey-Central merger were resumed but it was not until

May 2-4 that an agreement was reached (J.A, 408a-07a).

RKO degired ,to acquire a controlling interest in ‘Central

in. arder to maintain. its majority intercst in. the merged |

airline. and the Central insiders wanted ¢ “ash «for * their

shares. Therefore, it was agreed in May 1967 as. follotee :

that, there would be a Centrai-Frontier merger; Frontier

would be the surviving company; the exchange ratio would

he 3.5 shares of Central for one share of Frontier; and,

2

. .

upon condition -of the conclusion of the merger, RKO °.

would purchase: at $8.50 a share a majority of Central

securities from the Central insiders (J.A. 23Sa, 40-4a- Ula).

The ineveer and sioek. ‘purchase agreements were signed

Atective as of May 4 and on that same day public anhounce-

ment was made of the proposed Central-Frontier Merger

and RNO'’s securities purchise CJA. 250aeDla). The story

was carried in the Wall Street Journal the next day (J.-A?

398a ).” : So.

The merger agreement between Central and Frontier

provided fora statutory merger of these two Nevada —

corporations’ if, inter alia, the CAB approved the merger

without material adverse conditions and’ awarded Central-_

_ Frontier an acceptable subsidy rate and if certain creditors

of Central and Irontier approved (J.A: 264da, IK. A”).

*,

The purchase agreement betwee nm RKO and the Central,

insiders provided ‘that .RKO would’ buy, and the Central

insiders would sell controlling shares in Central for $8.50

per share or an aggregate price of $7,550,082.502 "This *

é

purchase was expressly’ conditioned upon a Central-

Frontier. merger (J.A) 275a ) |

ed , S by a.

In the purchase agreeme nt. RKO spedi fie: ily sepieaenied

| to the selling Central directors that-its purchase of Central

se curities was for. investme nt purposes only, a representa--

“The Central oad of ‘Directors: and. the’ Frontier Board of

Direstors formally approved the me reer avreement ‘on May 8 and

/ May N), respectively (S.A, 408a). .

af \ FQ . -\’ s 4 io by 3 F 0 . Y

* Section 78.495 of the: Nevada Revised’ Statutesfprovides that a

merger becomes effective upon the filing of a merger agreement. .

6 The sale included 49 percent of the common stock of ( ventral

and an entire issue of debentures convertible into another 7 per-

cent of Central’ stock. (See App. C, p. 44a, infra.) The. price —

per share was applied to the debentures so that RKO paid $8.50:

for each share into which the debentures were convertible.

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tion specifically ‘made. applic ‘able as well'to the ( ‘entval-

Frontier securities to be received upon the merger (JA.

>» 83a): A similar representation was: made to the CAB. In —

addition, RIXKO represented to the Internal Revenue Ser-

vice that it had no present intention to mepene of its in-

vestme nt (J.-A. 238a-39a J. ae .

a

Shareholder Approvals. On Jaily 3, after the filing of

bes .

"proxy materials with the SE 1C and: me receipt of the SEC's

comments (J.A. 268), proxy statements requesting ap-

‘ proval of the merger were mailed to all 5,700 Frontier‘

shareholders and 1 G72 Central shareholders: for ieetings

‘to be he lin Denver. aml. Fort Worth, respe etrvel¥, on. the

27th of: July (JA. 264a, p. 38)." The proxy “statements,

identical ex xegpt for separ ate notices of meeting, consisted,

of 59 printed pages, plus exhibits.

No suggestion has ever been made that the proxy state-

ment was not full, complete. and accurate in every respect.

‘The! statement described, in detail the principal share-

‘holders of both companies, ms merger agreeme nt, the stock .

purchase. agreement, the pr ice range of the stack of thre

companies, financial information relating to. both comn-

panies, the 1 ‘eoulation of airlines, the business and ‘propertw

“of the constituent corporations, and the proposed manage-

ment of the SUV iving: egtporation, . Attached also were the

text of the merger agreement, the provisions of the Nevada

corporation law respecting dissenters, as well as certain

amendments to the certificate of incorporation of the

4°

Tiss: broctipe eae (J.A. 264a). Ree ARR

® Respondent. Néeaisanit did not receive a proxy statement since

she'was not a shareholder of either Central or Frontier. She held

infra).

only Frontier debentures and Warrants APP B, Pp: 20a,-n. 1,

o

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On July 24 aut the respective, meetings of thy two: corpora-

tions, the merger agreeme ‘nt was approved bysover 99 per-

‘cent of the shareholders of hoth corporations. No cent

requested to be paid in Ci ish (. yA. 30a).

CAB Approvd. RINO was ‘the controlling person in one

airline (ke rontic ar) sand Was forbidden’ by Section 408 of the

Fedyral Aviation Act. 40 U.S2CL & ]378, to-aequire con-

i shares in wny other airline. (Central) without CAB

approval. Therefore . the RKO -stock purchase and_ the:

Central-Frontier merger could take place only with CAB

approval, —. eee Wee og | ry

Promptly after the signing: of the agreements of May 4,

1967, application was made to the CAB for ‘approval of?

“the. stock purchase and merger contemplated therein”

(JA. 26a, 299), “Phe CAB gave notice and held a publie

hearing before a [earing In xaminer. Nine. other airlmes

and four empfoyee Aehiggs Ree for and were eranted

permission’ to ‘intervene (J.AT 305a). No shareholder of

.. Central or Frontier appeared to oppose the merger (J.-A.

31a). Hearings were daly held*and on Migust. 2. 1967,

the Hearing: Examiner-rendered a detailed Initial Decision

| approv int thie ones purenase and merger ( JiA. 3012).

The Hearing ¥ xaminer’s Decision considered the pur-

chase agreement. and the merger agreement. since, as he

stated’ (J. A. 306a Ain), bothr required approval by _ the

(" AD. He considebied the financial condition of both’ com.

panivs, their subsidy sitnation with the C AB, the possible

savings from the mergerand the expected net income. He

found that “the financial strength-of the combined . com.”

panies will be sulistantially improved éver tliat of Central

at present” (J:A. 31la). Ile ‘disciissed. the possibility of

through-flights and resulting intreased net inceme (JA.

3ila-12a). “He consideréd the publie interest, including the

*“-*. -

“| agacae eat bas le by

+ ne ae

question “whether the price is rewsonablt with reference

not only to the two carriers but also toflie minority stock-

holders, the public, agd® the Peder al A ee mt” (J.A.

313a). He decided that “after th disruptions from con-

-summating the nierger have been overcome, the fimancial

benefit to F ‘rontier will Be substantial” ( J. Ax 313a- ita).

— The Flearing K xamminer noted thit =f mies ‘ant Frontier

‘havé been completely independent oreanizations and all

negotiations have heen carried on at arm's Jength” (J.4.

‘3i4a). He conside ‘red the market: pric es-and hook value at

various .times of the @entral and - Frontier stoek (J.-A!

3i4a-l- Ha). and deterniined that the $8.50 price for’C acsion

stoek was “withip the realm of sound business judeme nt.”

“it cannot rhe found that the te rms of sale of thet Con-

H e concludes

tral stock or the terms of. merger are unfair to either

‘ : : hee . : ees me a7

‘arrier, the stockholders of each, the Federal. Govern-

“aah or the general pore. Gs oi6a-l7a). ° V4

>

Ie also) considered the scdmomic. impact on personnel of +

s

the. airlines, the question of njonopoly and the possible: di-

version of traflic from other airlines and the question of

fo “s

subsidy, and through service. . He Jield that the merger

would “in the long-run decrease ‘the subsidy burden or lower:

comme reial -fares,- or hoth” (J.A. S21a). Inime diately. he

held, some subsidy’ savings should result from the mers cing rf

of operations and directed an.investigation to determine -a

rae

reasonable subsidy (JA. 820). He éonchided :

“The merger will have no ae Tse. © fect. on etther Cen-

‘tral or Frontier, their minority <toe holders, the. &en-

eral public, competing air carr iers, or the Federal Gov...

e ga

ernment” (ibid.). .

ad .

’ : 7 «~

| ed

= 12 |

The Hearing xaminer's: Decision was not appealed, and

on September 1, 1967 the CAB ordered that Deci ision to be-

-come’effective as of that date (J.A..300a).

¢

The ( ‘onsummation of the Purchase and Merger. On Sep-

‘tember 18, 1967, the C AB. determined the subsidy to be paid.

Central-Frontier (J.A. dooa). And’ by September 18,"

waivers of Central's defaults to its banks and consents to

the’ merger from all Central's and Frontier’s hanks had been

received as required under the merger agreement (J:A.

366a-73a). aS a ee .

Accgrdingly, on September 1S, 1967, all conditions having

been met, RIKO paid the $7.5 nition. purchase price to the

six selling Central directors and physically took possession

of the Central certificates. On the s same day, the Central.

Frontier merger agreement was filed with the Secretary. of

State of the State of Nevada, thereby effecting the merger,

‘as the Distriet Court (Bonsal,.J.) and the Court of Appeals

found below (App. Cy p. 42a, infras App. A, p. 6a, npriay?

~The Internal Rove me Service subseque antly ruled that the

nerger would be tax exempt and that Central. sharcholders ,

would sustain no taxable gain or deductible loss as a re-

sult of the merger .(J.A. 368a).

RKO.-continued to hold the securities. it received pur-

suant to the merger” and made no sales during the six-

*The merger agreement stated that it was to become effective

on the 1st of the month after the filing (J.A. 264a, Ex. “A”,

See. 9, p. 4). However, the October Ist date “was set purely for

sedkkcapiew hunmenac’ to allow the accountants-to adjust the’

. books as of the end of the month’ (J.A. 247a). Accordingly, be-

tween September 18 and October 1; various procedural matters ”

oceurred, including the issuance by the CAB of the Certificate to

Central-Frontier for Central routes, and on October 1, 1967, RKO

physically exchanged Central stock certificates for ai ais Cen-

trol-Frontier certificates (See App. C, p. 42a, infya)

“RKO received 738,251 ‘shares’ of Central dese which were

exchanged for 421,857 shares of (entral-Frontier stock. RKO

10

month period after ‘the nein (J.A; 425a, Int. 4; J.A.

428a, Int. 15). In fact, RKO holds these securities to this: |

dav. ©

3x. the time of the trial, these securities, for which RINO

paid approximately $7.5 million, had dropped in inarket

“value to $4:1 million.) Today they are worth approxi-

mately, $2.3 million."

as

The Proceedings Below——~ apne?

= <

“On December 14, 1967, anes nt Newmark, an‘ owner

of Frontier debentures and warrai ts, filed a complaint in

“the United States District Court for the Southern “ira

of New York alleging that. RIKO’s pur ‘hase of Central se-

curities was a “purchase” and that the Merger with F ron-

also received $500,000 principal face amount of Central -conver-.

tible debentures, convertible into 149,994 shares of, Central com-

mony stock prior to the merger,-and, convertible into $5,714 shares

» ‘of Central-Frontier common stogk from September 18, 1967. the

<4,

, time of the merger. .(The original merger agreement prov ided

Central-Frontier stock; however, on Jy 27 1967, ‘Frontier share-

holders ratified: a-2 for 1 split in Fréntier-common stock. The

merger exchange ratio was accordingly adjusted to provide ‘for the

exchange of 2 shares. of Cenrral-Frontier ‘common stock for each

3% shares of Central common stock.) App. ©, pp. 39a-41a, ania,

for the exchange of 31% shares of ihe 27 stock for. 1 share of

9 More. than one vedr after the merger, RKO. converted some

convertible debentures to. common stock, which common stock RKO

still holds. .

= The District Court (Bonsal, J°) noted that Frontier steck was

selling at the time of trial “at around 8 compared to 26-on Sep-

tember 18, 1967.” App. C, p. 50a, infra. RKO. owns the equiva-

lent of 507,571 shares of Frontier stock: (42 1.857 shares of Fron-

tier stock plus debentures convertible into 85,714 additional shares

of Frontier stock. See n.-8, supra.)* 507,571 shares at $8 per

share is $4,060,568. a ;

°10On July 15, 1970, Central-Frontier common stock closed on

the American Stock Exchange. at $4.50 per share. 507,571 shares

of Central-Frontier common stock at $4.50 a share is $2.284.069.50,

©

ou

tier constituted a “sale” by RKO resulting.in a “realized”

profit within the meaning of Section 16(b) of the exchange.

Act (B.A. 7a). Cross-motions for summary judgment were .

made: with respect to liability. And the Distriet Court

(Tyler, J.)-granted Respondent summary judgment.

Asa sore snatter, Judge Tyler found that Re-

spondent, & holder ‘of: Frontier debentures and warrants, -

could bring a Neetion 16 (b) action on behalf of Central

sinve Central's Section*{6()) claim “now belongs to Cen-

tral-Frontier as a_result of the merger” and, ‘that RKO

beneficially owned over 10. pereent of Central securities

at the time of RINO’s “purchase” and “sale” thereof (App.

« a [D. 20a, Blat rtray ee

Judge Tyler held that RIO made a Section L6(b) ur-

chase” of Contr securities on September 18, 1997, and a

Section 16(h) “sale” of these securities either on 4 lat same —

day or on’ October 1, 1967) 7

After trial onthe issue of damages, the District Court

(Bonsal, J.) concluded that -by the September 18, 1967 -

merger RKO has “sold” its Central securities for Central-

Frontier shares worth $15,470,764—a sum 15 percent above

the quoted market price for such securities on that day.

Since RKO paid $7,550,082 for its Central securities on

thet day, Judge Bonsa!l held that RKO “re alized” a one-

day Section 16(b) “profit” of $7.020,G81L.58. He nated that

J

'* We believe these rulings to be erroneous and one or both of

these issues may require decision on the ‘merits if certiorari is

granted.

12 App. B, ‘pp. 24a and 22a, n. 4, infra. Judge Ty ler's statement

that the purchase price was $8.550,082.50, App. B, p. 22a, infra,

was apparently a typographical error. See J.A. 55a. The purchase

price was $7,550,082.50. See Judge Bonsal’s opinion’, App. C, ‘p.

4la, n. 1, infra, and J.A. 251a-52a.

lo

RISO had owned 56 peckan of the stock of Frontier prior

to the merger and purchaged an equivalent amount -of

Central securities so as to ‘maintain its majority interest

in Central- Frontier, . Accordingly, he added to the Sep-

tember 18, 1967 aaa. market price . Central-Frontier °

securities a “premium factor of 1560" for obtaining and

maintaining a control position and ordered the entryof :

$7,020,681.58 Judgment against RKO (App. Cy p. a

infra). + Prac : pe

Judge Bonsal refused Respondent's rec dest for interest

= ( {

‘from September 18, 1967, because “in view of the fact

that [Central-Frontier] stock is currently quoted at around

Ԥ compared to 26 on September 18, 1967... the exaction

of interest would be inequitable” (ibid. oa

a

RKO appealed and on April 30, 1970, thie Court of oo

peals for the Second Circuit (per Kaufman, J., speaking

also for Feinberg, J.-and Palmieri, D.J.) affirmed the Dis-

trict Court in all respects. The Cirenit Court found that

RKO “purchased” '' and — Central securities. on a

single day—September 18, and that this “purchase

and sale” “lent -itself to* ihe: type of speculative abuse

which Section’ 16(b) was designed to prevent” (App. A,

pp. 6a, 7a, 16a, yinfra).

The Cireuit Court held that the merger would not be :

‘sale” unless there was “an opportunity for cee

abuse” (App. iz p. 4a, iefra). Sueh an opportunity was

found by the C ircuit Court on the basis of one essential

assumption, unexplained in the opinion: that RKO would

in some way ° “realize” real “profit” if RKO ‘merged Cen-

. tral with Frontier on a day when Central stock was sélling

‘ S

™ The Cireuit Court imeorrestiy States at one point that RIXO’s

purchase price was $8,550,082.50—again $1 million over the actual

purchase price (App. A, p. 6a, infra). See n. 13, supra.

*

-

16

on the market for more*than RIKO’s $8.50 a share purchase

price, The Court treated the temporary difference be-

tween purchase price and quoted market price on the day

of merger as a “speculative gain,” App. A, p. 9a, infra,

Presumably this was on the theory that receipt-of Fron-

tier shares as a result of the merger was equivalent to. the |

receipt of cash or-eash equivale nt which could be lmmedi-

ately fiquidated and was exactly like an amount paid to

a trader upon completion of an in-and-out purchase and.

sale. From this assumed’ éash or cash equivalent: realiza-

tion, it deducted thie cost of the purchase and denominated

the balance “realized” profit, to be surrendered to Central

or rather its, successor, Frontier, RKO’s petition: for re-

hearing or, alternatively, rehearing en bane, was denied

June 2, 10 (App. D, p. d2a, infra). |

REASONS FOR GRANTING THE WRIT

I. °

IT IS OF GREAT PUBLIC IMPORTANCE FOR THE

COURT TO DECIDE WHETHER A STATUTORY

MERGER CONSTITUTES A “SALE” OF SECURITIES

OF THE MERGED COMPANY AND. A “REALIZA. |

TION” OF “PROFIT” BY THE SHAREHOLDERS OF

THAT COMPANY WITHIN THE MEANING OF SEC-

TION 16(b) OF THE EXCHANGE ACT.

This case’ involves. by far the largest monetary judgment

ever entered ina Section 16(b) ease, and probably the

. largest ‘monetary Cudgine nt ever "entered in-any federal

securities action.

The court below disposed of a frequently reeurring and

fundamental federal securities law question which has not

been but should Je decided ‘bv. this Gourt. The applica-

bility of Section 16(b), a liability’ Without fault statute-—-

to corporate-mergers and securities conversions ix a ques-

tion of such consequence and has resulted m so much, liti-

gation with results so confusing as to require clarification

by this Court.

The ruling below is also in conflict with the rule laid down

in this Court’s only Section 16¢b) holding, and also in con-

‘flict with the rulings of at least four other Cireuits..

.

A. Corporate mergers are frequent commercial events,

which affect large numbers of officers, directors and other

insiders. In 1969, for example, there’ were 4,550 mergers

and acquisitions in this “country.” "Conversions and re-

classifications of securities, which present related Section

16(b) questions, are even more Gommon commercial trans-

actions-and have figured i in a significant number of Se tion

-16(b) cases." Section 16(b) has produced more litigation

than any other prov ision of er federal securities laws with

‘the possible exce ption of Rule 10b-5 under Section 10(b) of

the Exchange Act, 15 U.S.C. § $78} (b). Et has also produe od’

a large number of professional commentaries and anal-

yses." “The applicability of this fundamental securities’

statute to corporate mergers and conversions of securities,

15 Federal .Trade Commission, Current -Trends in Merger Ac:

_ tivity, 1969, Statistical Report No. 6, p. 1 (March, 1970).

. 1% See, e.g., Heli-Coil Corp. v. Webster, 852 F.2d 156 (3rd Cir.

1965); Ferraiolo v. Newman, 259 F.2d 342 (6th Cir. 1958). ecrt-

denied, 359 U.S. 927 (1959); Pette ys v. Butler, 367 F.2d 52s

(8th Cir. 1966), cert. di nicd, 385 U.S. 1006 (1967); Blau v. Mar

Factor & Co., 342 F.2d 804 (9th. Cir. 1965), cert. denicd, 3

. U.S. 892. (1965) ; Roberts v.. Eaton, 212 F.2d 82 (2d Cir. 1954),

cert. denied, 348, U.S. 827 (1954): and Blau v. Lamb, 363 F.2d

507 (2d Cir. 1966), cert. denied, 385 U.S: 1002 (1967).

17 See Lwewtile Section 16(b): A New Trend in Ricubilces

Inside Trading, 54 Cornell’ L. Rey. 45, 49-90, n. 20 (1968).

a

-

18. ie a

; i.

‘and tg insiders involved in such transactions, is clearly a

matter of sie -economnic impor tance.

If the de ‘cision below is correct, en avdinney, perfeetly

- proper commercial. transactions Will be. seriously upset.

Mergers and related stock purchases planned for simultane-

ots performance—as here—will. have to -be spaced arti--

ficially at least six months apart at-great commercial and -

economic inconvenience merely to avoid any question of

Section 16(b) liability. In many cases this will not be possi-

- ble and the transactions will have to be abandoned. Such

distortions in jimportant commercial transactions affecting

thousands of shareholders should not be allowed unless this

Court determines them to be the necessé ry conseque nee ofa

Congressional mandate. hen

B. In Blau ¥. Lehman, 368-U.S. 403 (1962), the only Sec-

_tion 16(b) case ever decided by: this Court, it was astpereetaik

edged that this statute imposes “extraordinary liability,’

id. at 409, and that such. liability’ ‘should not be stretched

judicially: The Court i in Lehman care fully limited the reach

of Section 16(b) and stated that any expansion of the stat-

ute should come, if at-all, from ‘the ( ongress, i. at 412 2-13.

This approach has been adopted by all the Circuits: exc ‘pt

the one below. However, the analyses of the Circuits are

conflicting and the present state of Section 16(b) law is

quite confused. . .

The Sixth, Eighth and Ninth Cireuits have held that a

conversion of securities is not a “sale” (or purchase”) un-

less the transaction allows the possibility. of speculative

abuse of insider information. Kach of these Cireuits held

that the securities conversion in issue was not a “purchase”

within the meaning of Section-16(b); therefore the subse-

quent sale within six months for cash did not raise Section

° ’

19

16(b) liability. Ferraiolo v. Newman, 959 F.2d 342 (6th

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

Butler, 367 F.2d 528 (Sth Cir. 1966), cert. dewted, 385 U.S.

19006 (1967); and Blau vy.-Max Factor & Co. 542 F.2d 304.

(9th Cir. 1965), cert. denied, 382 U.S. 892 (1965).

Th@ Third Circuit in Heli-Coil Corp, v..Webster, 352 F.2d

_ 156 (1965), held that a conversion of convertible debentures

into underlying common stock involved a “sale” of the

debentures and a “purchase” of the common stock but that

no profit was “realized” on such -a transaction since the

increment in va:ve was merely on paper.

The results in the Second Circuit have been particularly

inconsistent on conversion and reorganization cases, Cf.

the result below with Roberts v. Eaton, 212 F.2d 82 (24

Cir. 1954), cert. denied, 348: U.S. 827 (1954); Blau v: Mis-

sion Corp., 212 F.2d 77 (2d Cir. 1954). ceri. denied, 347

U.S. 1016 (1954); and Blau v. Lamb, 363 F.2d 507 «(2d Cir. .

1966), cert. denied 385 US. 1002 (1967). The Second

Cireuit employs the “pragmatic” test, and decides whether

or not the transactions in issue allow an opportunity for

. speculative abuse. However, the standards by which the

Second Circuit determines opportunity for abuse have not

been articulated.

. , ¥ ‘ 4

Such conflicting and confusing analyses have obscured

the,clear purpose and secrete reach of: Section 16(b). A

“simple” statute, 2 Loss, Securities Regulation. 1043 (2d. ed.

1961), has become unreasonably complicated. It is time for

this Court. to provide guidance.to the lower courts.

‘ a . .

Section 16(b).is a statute which assumes that if, e.g., a

director buys stock for x dollars and sells it within six

months for x ,+ y dollars, he has: cash in the amount of ©

x + y dollars in hand and it is a simple matter.to compel

20

lum-to pay the y dollars constituting ithe penn into: the

corporate treasury. He has the cash, the amount: due is’

easily caleulated,, the rule is clear and the possibility of

hardship to-him is diflieult to envision. The same would

—oby lously be true if the director. sold not for cash but fora

cash equivale nt—e.9., ret adil marketable securities such as

100: share, lots ‘of General Motors or Standard Oil of New

Je TSey.

o

But all the Cireuit Coumas (exéept the one below). have.

recognized ‘that corporate action such as a, merger; stock

reclassification or conversion-oF one security for. another,

<prese nts a wholly ‘diffe ‘rent situation. E.g., in. the present -

case, a parent corporation with one subsidiary aitline ae-

quired” control of another ‘subsidiary airline and merged

the two subsidiaries pursuant to government and share-

~~ holder ‘approval. There is a purehase and an outlay of

funds but there is no sale and no: realization of funds,

There is an x but no y.-There is no cash or cash equivalent

received. The shares reeeived on the merger are control

shares intended: to be’ held and required to be held for

‘inyestment:and are not readily .disposayle. There are no

funds on hand to pay any “realized profit” unless and tintil

the investmerit and the securities received on the merger

are liquidated. If liability is imposed, it will require pay-

ment ‘from sourcés unrelated to the transaction, c.g., a

borrowing ora sale of other productive assets of the parent

company, RKO. Add, of course,m many cases there may be

no. SOUTCES from which such a Judgment cam he met.

Sk Accordingly, in [ ‘erraiolo, ‘supra, the Sixth Cireuit, doit:

ing with a conversion of preferred for common,.refused to

find Section. 16(h) liabWity with respect. to a transaction

which “was not one falling within the ordinary coricept of

a ‘purchase, {but which] the statutory definition would

rae n>

not necessarily exclude’... . 259 F.2d 342 at 344. In

Heli-Coil, supra, on similar faets, the Third Cirewit found

a “purchase” or “sale” bit no “profit realized.” Thus

courts have recognized that stich transactions do not;truly -

involve a first time acquisition of-a.security, or a final dis-

‘position, as Section 16(b) - contemplated. They have’

weighed whether the transaction was merely a change’ in

form of the same investment: They have , considered

whether an exchange of one’ sécurity for another pro-

vided opportinity for abuse of inside, information, How- |

ever, not only ‘has the reasoning in such cases varied:

some results are difficult to reconcile’ with each other. As

evidence ‘ad by the facts in ‘the present case, determining a

“possibility of abuse of inside information” not on the.

\°

basis of facts of record but on the basis of spe ‘culation and

abstract theorizing peérmits arbitrary and unpredictable

results.’ |

Clarification of Section 16(b) ly this Court is neces-

sary. This Court should say whether transactions of ‘con-:

version, reclassification, and merger are over sales and

purchases within Section 16(b) and,-if they: are to ‘be re-

garded as purchases ‘and sales, whether profit is realized -

on such transactions. The Court should say whethe r in

construing’ Section 16(b), courts gare forbidden or per-

mitted to speculate without: evidenee, as the. court below

did, on ‘thé “possibility” of unfair use of information and,

If so, what standard is to be applied to prevent arbitrary

speculation. This Court should say whether the possibility:

of unfair use of inside information, . that is an appro-

186 | |. the case 4 case analysis as to ‘possibility for speculative

abuse’ offers . scant guidance to possible 16(b) defendants. ‘The

complexities of the commercial and financial world’ that have made

automatic liability workable, seem also to make the ‘flexible’ ap-

proach_ ‘troublesome in: its unpredictability.”. Goodman, E.rpand-

ing Short: — Liability, 3 Rev. of See: Reg. 891,.89% oon

@ ciate

“ee

- SA - er oe wet

. ‘. . e ys ° : aé “4° > >

priate standard, requires that there be a “possibility” of

injury to other shareholders, or whether; as “here, there —

cin bea possibility: of “abuse when no person or greup

could have been. hurt. .

Mr. Justice Harlan, for himself anil Mr. Justice Stewart,

expressed the view in SEC . National-Securities, Ine., 393

U.S. 453, 471. 472 (1969) (concurring: in part and dissenting.

in part) that the ‘definitions of “purchase’ “and “sale” for

parpeses of the Tederal securities laws are “fundamental

matters.” This-is especially so where the statute in question

imposes absolute liability without fault. In this “area where:

elib generalizations and unthinking abstractions are major

ore upational hazards,” (Marshall, J.), 7. at 465, and where

the commercial Consequences are so steep, at is of consider-_

able public importance for this Court to, decide here

whether or not a statutory merger involves a Section 16

“(h) “sale”. producing “realized” “profit” for the stoek-

holders of the merged company.

_ Aristic ‘ (then Judge) Blac kinun, idacentae) in Petleys

mits , Oe - F.2d 528.5389 (Sth Cir. 1966), cert. denied,

185 ELS. 1006 (1967), had ‘occasion to note the conflicts:

among the Cireuit Courts with, respect. to the reath of

ection: I6(h). Le said: m4

“Pe rhaps the Supreme Court one day soon will tell us

how these somew hat conflicting approaches to > 16(b) -

by the Court of Appeals are toobe resolved.”

We respectfully suggest that such resolution and’ clari-

fication are called for now. The case at bar squarely pre-

sents seh an opportunity; it involves a substantial jude-

ment of dubious validity, and questions common ‘to

frequent, commerei ia lly linportant transactions.

>

- _ 2 | ;

. The “ad cision a ‘low ix Se ee Rr with the Lehman

atti to Section 16(b). Hee a’ single transaction,

involving an Investment Inwequirne an extension of an

existing airlines bisifess, Was altifidjally split into both a

Kei 1G(b) “sale.” A

theoretica] opportunity for spec ‘lative 3 abuse Was premised

“Section 16(b) “purchase” and a Sec

upon an unsupported assumption that RKO could “realiz®

“profit” if the quoted market priée for Central stock on the

day of the purchase and merger exceeded RIKO's ‘purchase

pricé, And a transaction acknowledged | by the District

Court (Bonsal, J.) to. represent ih reality a loss for RKO

sufficient to make it “inequitable” to charge interest (App.

C, p. 50a, infraj—a $7.5 niillion purchase worth $4. 1 by the .

time of trial—was somehow: converted into a $7. 9 million

ealized™ profit. which must be forfeited! mare

Our ‘position is that a statutody merger of corporate |

subsidiaries is not a “sale” for purposes of Sebtion 16(b).

This Coirt recently noted that the word “sale"—one of

the ke ‘vy words in luis case—* fay take on differe ‘nt colora- :

tion in different sections of the SEC urities laws.” SEC |

National Securities, Ine. B93 U S. 453, 466° (1969), ; ,;

statutory merger, like the one involved here, is not a “sale”

for purposes of registration under: Section 5 of the

Securities Act of 1933, 15 ULS.C. § Te: see SEC Rule 133.

17 €. BR. § 230.133: cf. 393.U.S. 453 at 465-66. ‘Neverthe.

less, it National Sceurities, -this Court-held that’ sue hoa

merger is a “sale” within the. me: ining of Section 10(b) of

the Exchange Act, 15 U SC. § »78)(b), a statute outlawing

actual fraud and deecit in, euertion with the * ‘sale of

3 securities. 393 U.S. at 467. °

There is good’ reason. to interpret; Section 10(1) broadly ;

and Seetion FO(b) more narrowly.: Section 10(b) liability

is shased upon actual fraud and actual, insider misuse of

*o

°

24

insidér information. See, e.g., SEC vy. Texas Gulf Sulphur

Co., 258 F. Supp. 262 (S.D.N.Y. 1966), afd in part and

rev'd in. part 401 F.2d.833- (2d Cit. 1968), cert. denied sub

nom. Kline x. SEC, 394 US. 976 (1969). Section 16(b)

‘lability is imposed without fault) and without any evi-

dence of acttial abuse of inside information.

However, even if this Court were of the view that such

a merger might involve a “sale” for purposes of Section

16(b) if it allowed,an opportunity for speculative abuse,

it is incumbent upon this Court. to provide clear and

realistic guidelines’ for determining “opportunity. for

abuse.” The lower courts require such guidelines if they

are to enforge Section 46¢b) consistently and fairly. And

businessmen.need sugh guidelines if they are to plan their

affairs prudently. | |

Potential abuse should be found only where some specific

injury to some specrfic affected eroup=—the selling share-

holders, or the gther shareholders of the merging corpora.

tions; for example—anight be possible. If courts are to.

impose absolute liability without fault, because. of a pog- |

sibijity for abuse, at minimum that possibility should. be

one of specific harm to a specific affected group. Here

there was no such possibility. Tndeed, there was no use:

of inside mformation. The purchase and therger agree-

ments were announced immeiiately after they were made -

~ and the merger was approved after full disclosure’ to all

~the shareholders in ‘a complete and accurate proxy state-

atts

a

ment, (See infra, pp. 33-35.) Poli

Here, in the words of Mr. Histiee (then Judge) Stewart

in Ferraiolo vy. Newman,.259-¥.2d.342, 846 (6th Cir, 1958),

cert. denied, 359 U.S. 927 (1959) : “All of. the:.:. . share«

holders. were: treated alike; full disclosure was madé to

them; the conversion worked no material change in [their]

S

4

¥°

proportional equity ownership . ...” In Roberts v. Eaton,

212 F.2d 82, at 85 (2d Cir. 1954), cert. denied, 348 U.S, 827

(1954), Judge Clark, joined by Mr. Justice’ (then ‘Judge )

Harlan, noted that “like treatinent of all: stockholders will.

_in most cases remove the possibility of abuse.”

The Court -below ignored such factors in determinines

“opportunity for speculative abuse.” for purposes of Sees

tion 16(b). ?

The soundness of the Lelanaw interpretation of Section

16(b), as a provision not to be extended be ‘auise of its

liability Without fault aspect, is further confirmed by the

courts’ effective and flexible use of Section 10(b) and Rule 3

10b-5 in cases of actual unfair use of inside information.

See, Cs SEC y. Texas Gulf Sulphur Cé., 258-F: Supp.

262 ($.D.N.Y. 1966), afd? in part and rev'd in part, 401

F.2d 833, (2d Cir. 1968), cert. denied sub nom. Kline ‘.

SEC, 394 U.S. 976 (1969).

This situation urgently requires clarification bv. this:

Court. 7 es

—

'? We cite the words of a recent commentator ¢

“There is no longer any reason for the federal courts to be

harsh and objective in interpreting and applying section

16(b).: Everything that this section was designed to accom-

plish, and much more, is presently being accomplished under

* section 10(b) and rule 10b-5."" ac:

Lowenfels, Section 16(b): “A New Trend in Regulating In-

sider Trading, 54 Cornell L. Rev. 45, 63> (1968), ( Footnotes

omitted.) Another commentator has observed: “Newmark appears

to be evidence tliat the ‘statutory purpose’ approach, originally a

protection for defendants, can lead to the application, of Section

16(b) to situations unrelated to the statutory purpose—and better °

handled under the antifraud provisions of the Exeltange Act.”

Goodman, E.wpanding Short-Swing Liability, 3 Rev. of Sec, Reg.

~ 891, 896 (1970). . .

bd .

26

Il. THE QUESTIONS PRESENTED

ARE SUBSTANTIAL.

Liability was fowul below by disintegrating a_ single

investment transaction which allowed for no unfair use of

inside information. This transaction surely constituted a

“purchase,” but it did not constitute a “purchase and sale,

or produce, a “realized profit,” within the meaning of

Section 16(b). — . :

A. Section 16(b) applies when profit j is realized upon an

‘ in-and-out “purchase and sale”.

e wr

Section 16(b) was intended to take the profit out of in-

and-out short-swing trading by corporate insiders. As

Thomas G. Corcoran, one of the drattsmen of the Exchange

Act, testified, this section was intended to apply to an

insider who “bought fo get out on the short swing.”

Section 16(b) is with.us because “Improper use of inside

information by corporate insiders is most likely to occur in

. short-term, in-and-out trading. The temptation to trade

upon inside information is enhanced when the period for:

which capital must be committed is short.” Blau v. Max

Factor & Co., 342 42d 304, 308 (Oth Cir. 1965), cert. denied,

382 U.S. 892 (1965). (Emphasis upper.) Spectacular

examples of such in-and-out trading were befot®the Con-

gress which enacted Section: 16(b). The Senate. Report on

_ the Exe hange. Act* noted that Section 16(b) . .

” Tlearings on S. Res. 84 and S. Res. 56 and S. Res. 97, before

the Setiate Committee on Banking and Currency, 73d Cong., 2d

Sess. 6537 (1934). (Emphasis supplied.)

.*S. Rep. No. 792, 73d Cong., 2d Sess., p. 9 (19: 34); see also

Biau vy. Lamb, 363 F.2d 507, 514-15 (2d Cir. 1966), cert’ denicd,

385 U.S. 1002 (1967).

¢

OT

“... Wil render difficult or impossible the kind of

transactions which were frequently described to the

committee, where directors and large stockholders

participated in pools trading in the stock of thei Ir own

companies, with. the’ benefit of advance information

regarding an increase or resumption of. dividends in’

~ some cases, and the passing of" dividends in others.”

In the words of the SECysthe essential type of transaction

. intended té be discouraged was the. making of purchases

with the intention to make a quick sale and si Inaking of

sales with the intention of quick re purch: ime =

Thus Section hi(b) was intended to deprive an insider of. -

the cash or cash equivalent profit reaped—perhaps un-.

fairly—on a short-swing “purchase and sale.” Here there”

was no short-swing “purehase’ and sale:" there was no

opportunity for unfair treatment ‘of anyone; and there was

no “realized profit” in cash or cash equivalent.

>

Any Section 16(b) Judgment against RKO would Wave e to.

be satisfied from sources unrelated to the trans: action since

RKO obtained no money or money equivalent in connection

. —— the transaction in issue, (Bee supra, pp. 12- 13.)

B. The speculative abuse theory of the Court of Appeals

mistook a corporate merger for a cash sale. Notwithstand-

ing a purchase at arm’s length from knowledgeable Central

insiders, notwithstanding full disclosure to and “approval

by all concerned shareholders ‘rs and the CAB, and notwith-

standing equal tre atinent of ¢ all such shareholders, the Court

of Appeals concluded that the transaction raised possi- —

bilities for “the type of speculative abuse which ‘ ‘Section

*2 SEC Exchange ‘Act Release. No. 4509, October 30,-1960, CCH

Fed. See. Iu, Rep. 9.76, 080, Pp. 78,757 (48°52 Decisions).

«

ae

46(b) was designed to prevent.” (App. A, p. Ta, aafra.) This

conclusion depends .upon a single assumption: that: the

transformation of RINO's ‘Central securities into Central-

Frontier securities upon the filing of the Central-Frontier

merger agreement was equivalent to the receipt. by RKO

of cash or cash equivalent. -This assiumption begs the basie

question much mooted in the eases cited above of when and

to what-extent stock converted pursuant to a corporate

merger should be regarded as cash or eash equivalent.

Irom this assumption of cash equivalence, the Cireuit

Court inferred two opportunities for speculative abuse.

First, the Court stated that RIKO might be tempted to

schedule the filing of the merger agreement at a time when

the quoted market price for Central stock was high and

well above RKO's $8.50 purchase price, since ‘the, higher

the price at the time of the filing of the inbrger, the higher -

“the profit thereby “realized” by RIXO. Seeond, and con- -

versely,’ the Court stated that RKO might. be tempted to

‘back out of the merger (by taking the position that con-

ditions. precedent had not been fulfilled to its s satisfaction).

if the market price for Central stock dropped below the

$8.50, purchase price, thereby avoiding any loss.* (App.

A pp. | 8a-Ha, mpfra.) ° ee |

“These. conclusions might follow if the receipt of Central-

Mrontier securities upon the merger was in fact comparable

to the receipt of cash or cash equivalent. But so to -hold —

is to ignore the essence of the transaction. The merger

marked the commencement of RIKO’s interest in Central

Airlines, not the realization of any speculative profit on |

“3 Of course, if RKO had backed out of the transaction, there

could haye ‘been neither a Section 16(b) “purchase” nor a Section

16(b) “sale” nor any “profit: realized.”

a

any one-day purchase and sale of that interest. By no

reasonable theory can it be suggested that the possibility,

probability or certainty of an increase in market val le over

the $8.50 purchase price, which night oceur between May 4

and the filing of the merger agreement, could have induced

RKO to enter into this. transaction. RKO, Central and

‘Frontier were obliged ° to enter into major agreements,

complete elaborate SIC proxy procedures, convene special

shareholder . meetings, undertake extensive CAB approval

and subsidy proceedings and obtain an Internal Revenue

Service ruling. RKO. represe ‘nted to the selling -share--

holders, to the CAB, to thé IRS and to the SEC that the

purchase was for aia investment_and not for resale.

(J.A. 288a; J.A. 299a: JA. 346a.) It was clear that, if

RKO desired in fact re dispose. of Céntral or Central-

Frontier securities for cash, it could .not have done so

without violation of its covenants to the sellers, the share-

holders and the governmental agencies,

RIXKO was essentially purchasing Central-Frontier securi-

ties, which RKO ‘intended to hold and- which RKO has ine

faet-held for long-term investment. RKO‘s unquestioned

purpose was to purchase the securities ne cessary to main-

tain its majority position in Central- Frontier (supra, p.

7). Every obje etive ‘of the merger would have been’

defeated bya disposition of the purchased shares,

id

It thus could not make: the slightest difference to RKO.

whether, at the particular moment of the merger, Central

‘shares were selling on the market for RKO's purchase

price, or a lower price or a higher price. RKO could not

derive any advantage from a higher market price unless

and until RKO actually sold the ( entral-Frontier securities

obtained pursuant to the merger. And RKO did not sell,

either during the six- month statutory’ period or thereafter.

30 .

Indeed, even the Court below did not question RIKO’s inten-

tron to hold and not to sell. It afiirmed an- additional amount

in the judgment for a “control premium,” for the additional

henefit it believed RKO derived. f rom keeping the shares.

It compared the merger fox this purpose with “previous

purchases of large quantities Of Frontier shares” (App. A,

p. L7a, infra. ISmphasis supplied). |

We submit it is not permissible for a court to theorize a

possibility of speeulative abuse when, as here, the facts

belie any such possibility. ee

Section 16(b) is limited to a particular category of” in-

sider security transactions. Section 16(b) liability arises

Only when (1) there is a short-swing “purchase and -sale”

by a corporate insider,’ (2) who could unfairly use insider

information for speculative purposes,-and (3) “profit” is

“realized” on such transactions. Not one of these three

essential elements of Section 16(b) liability is present: in’

this case. ' ;

C. RKO made a “purchase” but no “sale.”

When the Central acquisition and merger took place on

September 18; 1967, RKO unquestionably made a “pur-

chase”—essentially a purchase of Central-Frontier securi-

ties. Only by separating the inseparable could the courts

helow conclude that RKO made a‘“sale” on the same date

through the same integrated transaction. |

- -

2* RKO was neither a Central officer nor director nor owner of

Central securities at the time of its*purchase of Central securities.

It was an outsider dealing at arm’s length with the Central in-

siders. Section 16(b)- applies only to beneficial owners who were

“such both at the time of the purchase and sale... .”” We belicve

. that RKO was not an insider at the time of purchase and that the

ruling below was erroneous in this respect. It will nevertheless be

assumed arguendo that RKO was such a Central insider.

e

an 3, oe | a5

The Central acquisition, through stock purchase and

merger, w as.a single business Weal. T he mere. ~ and stock

purchase agreements were dependent upon one another for

performance; they were sinultaneously negotiated, simul-

_ taneously approved by the CAB, and simultaneously’ per-

formed. The Secoud Cirenit acknowledged that,

s

, “RKO would have violated the re AB’s order had it

_ purchased the Central securities, backed out of the

merger, and disposed of the securities in return for.

cash. Under the terms of the [CAB] order, RKO wa

* required to exchange the Central securities it pur-

chased for [Central-F rontier |” ‘securities | _pursuant to

the mareer- agreement.” (App. A. p. Tea, n. 5, infra.)

- #K oomttally ieee was but one trans: action. it w as lmma-

terial as aspractie al matter whither the merger took place ,

before the stock purch: ase or vice verse. In either “ase,

‘

the ultimate result: was the same: RKO Was purchasing -

Central-Frontier securities. From the moment of purchase,

RKO was obliged to perforni the merger'and reeive en-

tral-I’rontier securities. Yet the C our't below said, in effect,

that it made an ¢8 million difference whether the merger

agreement was filed before or after: the stock purchase, 5

“In Blau Vv. Max Facies & Co. 342 F.2d 304 (9th Ci, 1965),

cert. denied, 382 } A, 392 (M65); one class of stock was

converted into another ‘class of stock and then si for eash

within six months of the conversion. ‘The X Ninth Cireuit

found no Se tion 16¢)) liability, heeause “only one invest-

ment decision [hac hea made] in the six months’ period—*<

the decision to [sell I. The exchange was in reality only a

5 In fact, the record. does not reveal the sequence of events an

Septeniber ‘18, 196.. It has been assumed, correctly we are ink

‘formed, that the sto’ purchase took place a few hours before

,the merger agreement was filed,

°

step in the process of sale... .” /d. at’308. Similarly, only

“one investment decision” was made here wifhin six months

of September 18, 1967: the decision by RIO to purchase

some ° Central-Frontier securities in connection with a

-Central-Frontier merger. The -two interrelated actions

tiken on September 18, 1967 were “in ‘re: ality: only

sit in the a. of purchase.

D. RKO could not ious used inside information for:

speculative profit.

The transaction in issue here, even if improperly split

into a “purchase and sale,” allowed no actual or potential

opportunity. for the unfair speculative use of insider in-

f ormation.

- There was no-actual unfair use of inside inforneation.

is Initial Decision of the CAB Hearing Examiner, which

Was subsequently made effective by the CAB: (J.A. 300

: specifically addressed itself to the effeet-of the-transaction.

in issue upon. Central shareholders and others. The CAB

‘found the merger and’ stock purchase to be .eminently

proper and to presage: no potential adverse effect upon

anyone. After full hearing, that Decision « oncluded :

- “Tt,eannot be found: that the terms of sale-of the

Centre ul stock or the terms of merger are unfair to

either carrier, to the stockholders of each, the Fede ial

Government, or the general publie. (S.A, 317a.) -

\ S F

“3 * * . * *

“The merger will have no adverse effect.upon efther

Central or Frontier, their minority stockholders, the -

general public, competing ajr carri ers, or the Federal

“Government.” (Jd. at eh eae ek

v

; Se Ae

The CAB found RKO’ Ss $7.5 million- purchase price to be

“within the realm of sound business: “Judgment” (J.A. 316a-

Iva). (It is questionable whether the CAB would have

found it equally sound for RKO to be charged an additional

$7.9 miHion—the.amount of the judgment helow—for the

same securities. ) CAB approval of the Central-Frontier

; merger and the RKO stock purchase establishes that these

acts allowed no actual unfair advantag xe to any of the par-.

ties involved. | &

2. There was no potential: for unfair use of inside tn-

jenna The Second Circuit stated “That RKO’s heart

may have been pure and its motivation noble matters not.

The significant: factor is whether RKO could have reaped

a speculative profit from the ‘unfair use ‘of. information

‘... obtained ... . by reason of [its] relationship to [Cen-

tral].°” (App. - p. Ta, infra; emphasis in the original.)

It is essential, however, in: determining potential unfair

use of insider information to determine:

To whom wv ould the use of such information be unfair?

/

/

Where no person or group could possibly be. ifurt by the.

_hypothetiec al use of inside information posited, there can

be no potential abuse within the meaning of Section 16(b).

Hence, even assuming that ‘the. purchase transaction in

issue here were a “purchase and sale,” Section 16(b) lia’.

bility could pr operly he imposed only: if some person or

group could. have been injured or disadvantaged thereby,

ITere there was no such person or group. ,

a

fa, The selling Central insiders could not have? ‘Deen

abused., Phe abuses which caused Congr ess to Enact’ See-

tion 16(b) were those perpetrated by insiders upon others.

Insiders would typically buy stock upon inside knowledge

of favorable developments to come and then sell when that

. | ‘ -

34

knowledge became publicly -knowng and the price of the

stock had consequently: increased.’ The unfairness in such

a transaction was unfairness to the. innocent seller,

Ilere there was no veesibility for RKO to take unfair

advantage of those selling to it. The sellers were Central

insider rs—principal shareholders and directors of Central

—who were, of course, yo less. informed. than RIXO con-*

cerning the proposed C éntral-Frontier merger.’ Oby iously,

these sellers with full knowledge found RKO’s purchase

price of $8.50 td be fair to them.”

b. The winevite vharehalde rs of Cential could not have

been abused. In de ‘termining whether’ there Was any pos-

sibility of abuse of ‘the ‘rr Central shareholders s, it is im-

portant to’ consider whether there was full ‘diselosure to

thein of the transaction-in issue. It is also important to

determine, Whether all Central shareholders ‘were tréated

- equally in the transaction in issue. Pelteys v. Butler, 367,

F.2d 528, 537 (Sth Cir. 1966), cert. denied, 385 U.S. 1006

(1967); and Ferraiolo v. Newman, 259 F.2d 342, 346 (6th:

Cir. 1958), cert. denied, 359 US. 927 (1959).

‘Here the ‘Inerger and stock’ purchase agreements were

promptly disclosed to the public and thoroughly described,

“again in a lengthy proxy statement delive red to all Cen-

tral and Frontier shareholders (J.A. 264a). The proxy

_ statement explicitly stated that the stock purchase agree-:

“ment was “subject... te the approval ‘of. the preyosed.

26 Cf. JA. 288a-with JA’ 264a, Ex. “A”, p. 9.

27 RKO paid $8.50 a share for Central stock which, on May 4,

1967,/was selling. at around $11.25 a share. J.A. 393a. However,

during the first quarter of 1967, Central stock fluctuated between

a low. bid price of $7.25 and a high asked price of $M. Jd. at

390a-92a. j

.

.

\ .

mi

~

merger between Frontier and Central by their respective

stockholders” (J.A. 264a, p. 3). a

On the basis of sueh complete disclosure, over 99% of

the shareholders of Central and Frontier approved the

merger, There is no-suggestién that such shareholder

approval was not based upon. coiplete and accurate dis-

closure. The affected-stockholders thus expressly and over- ;

whelmingly approved the proposed merger with full know]-

edge that. RIKO'’s $7.5 million securities purchase was an’

integral part of the transaction.

eo Moreover, all affected shareholders were treated alike in

the Central-Frontier merger. Al Central shareholders ex-

changed Central for Central-Frontier stock pursuant to the

same exchange-ratio. The District Court (Tyler, J.) found.

that all Central shareholders “may, have benefitted” from

— an increase in the market Value of their shares beeaduseof

the merger. (App. B. p. 32a, imfra.)- It would be more

accurate to say that all Central ‘shareholders but RKO

could Have been “benefited.” The Central-Frontiér erger-

was a bdon to all Central shareholders who desired to sel]

their Central or Centyal-Frontier shares at the temporar-

ilv higher market prices which the Court: below attributed

to the merger, RKO alone was not free to sell and take -

advantage of these tethporarily higher prices ( see supra, -

pp. 8-9). ear ;

s

* The Second Circuit did not indicate {f!or how the stock pur-

chase and inérger could have been unfair to minority Central

Shareholders. But the District Court (Tyler, J.) did note that

minority Central’ shareholders were not afforded RKO’s oppor-

tunity to purchase Central stock at $8.50 a share (App. B, p. 32a-.

Jnfra). It is, we believe. unprecedented to. suggest that_one could

take unfair advantage of minority shareholders “by buying stock

from controlling shareholders at asprice below market. Whether

a purchase from controlling ‘shareholders: at a premium price

above market, constitutes abuse of minority shareholders isa

oe

automatically conver ted to equivalent Central-Frontier-se-,

AE,

E. RKO never realized any profit.

On September 18, 1967, immediately prior to the filing

of the merger agreement, RIXO owned 56 percent of the

- common stock of Irontier and approximately 53 ‘percent

of the common stock (indluding shares to be issued upon»

conversion of convertible debentures) of Central. Upon

the filing of the erger agreemem, these sec urities were

‘eurities. RKO received nothing else in connection with the

merger.

oye bee eerie. Toh oe . : ris a

RKO'’s.Central-Frontier, securities were “the econémic

equivalent,” Ferraiolo v. Neweman, 259 F.2d 342, 345 (6th

Cir. 1958), cert. denicd, 359. U.S. 927 (1959), of RKO’s

Central securities and RKO's Frontier securities. The

whole was ‘precisely the stn of: the Bisting parts.

“The Second Circuit ae knowledged that the merger was

inseparable from the purchase: if the purchase took place |

the merger had to follow (App. A, pp. Ila-12a, n. 5, 2 ifra). iy

Thus from the moment Of the purchase, RKO was essen-

tially the ow ner of Central- Frontier securities,

“Why Ce ates al shares which, by law cna CAB order, were

‘required immediately to be converted ‘into’ Céntral- Frontier

shares bv merger were not economically on to.

the Central- F rontjer shares immediate ly reeeived on the

merger was not explained by the Court of Appeals. The

Court.did not question’ thé -real equiv alence—indeed,

identity—of the Central shares purchased and the Central-

‘ j J ‘

sedation much mooted in the courts, But whére, as here, the pur>

- chase price was ‘$8.50 and the «market price was around $11.25

‘on May 4, 1967 (J.A. 393a), any minority shareholders who wished

. to sell at that time would have done better:on the market.

Frontier shares into which they were converted by oper "a-

_ tion of law on the same day; rather, the Court stated that

such equivale nee must be disreg arded j in the case where two

corporations are involved rather than different securities

of the same. corporation.. (App. A,-p. 11a, ard. ) . This

cannot be a satisfactory answer under a statute which’

concerns economic realities, i.c ” profit realized and possible

use of inside information. For Section 16(h) | purposes, a-

theoretical distinction between. corporate entities cannot

-prevail over the facts of real economic equivalence, ;

RKO received and has held its Central-Frontier see urities

since September ‘18, sie In the words. of? the Third

Cireuit in Heli-Coil Corp. v. Webster » d02 F.2d 156, 167

(3d Cir. 1965), whatever ois existed on September 18,

1967, by virtue of the increased market. pene for Central-

Frontier securities on that day “were ‘paper’ profits held .

at the risk of the market and which could disappear if the .

market declined to a sufficient extent.” In fact, the ay

profits’ ’ of September 18, 1967 have more than ey ‘aporated.

.RKO'’s Central-F rontier securities which were purchased

for approximate ly $7.5 million, which lad a quoted market

price of approximately $13.3 million on September 18.‘ had

a quoted market price. of approximately $4.1 million by"

the time of trial below pe have a present quoted market

“price of approximately $2.3 million (supra, p. 13). This

“loss” was recognized by the District 2 ‘t (Bonsal, J.),

who concluded that the imposition of ifterest on “profit

realized” here would. be “inequitable.” (App. €, p.. 50a,

infra.) 3 “ae ks

RKO surely did not “realize” any profit i in any realistic

financial sense. The differential between RKO’s purchase

price and market price which obtained on September: 18,

3s

1967 could not have been treated by RIKO as incothe or

earning or profits.*" ww

The IRS contirmed that the conversion of Central

sec ‘urities into Central-Frontier securities, pursuant to the

nierger, did not result in taxable gain or duductible loss to

RKO or other Central shareholders (J.A. 368a):

We submit that no profit was “realized” for Section

l(b) purposes when Central securities ‘were converted

to Central-Ffontier securities by reason of the ‘Central

Mrontier merger.

F. The courts are precluded from finding Section 16(b)

liability because the purchase and supposed “sale” were

approved by the CAB. |

As previously noted (supra, pp. 10-12), the Central-

Frontier merger and RKO stock purchase were approved

by the CAB upon a full record and formal hearing. The

fe AB determined that the terms of the merger ‘and stock

purchase were not “unfair” to the shareholders or to any

other affected person and that the merger “will have no

adverse effect” upon the shareholders ot others (J.A. 317;

320a). No judicial review was’ sought Arom the C AB De-

~ cision and Order.

In these circumstances,-it is ‘our position that Section

414 of the Federal Aviation Act, 49 U.S.C. 9 13842" fore-

*° “While it may be entirely appropriate to use the increase or

decrease in net asset value between two perieds as a standard for

the company’s progress on a market value basis, it is misleading to

label the increase in net asset value as ‘earnings’ or ‘profits.’ Th

-conccpt of ‘profits’ docs not include an appreciation mm market

value that is not realized. Preé Traders, lne.. 7 SEC 926 (4940)."

Rappaport, SEC: Accounting Practice and Proecdure 16.20 (2d

ed. 1963). (Emphasis supplied. )

“ This section provides that “Any person affected -by any order

made.under [the merger and related provisions] of this title shall

ao:

closes any court from imposing Section 16()) liability he- ’

‘ause of any theoretical possibility ‘of unfair use of inside

information. Such a theory of liability Was expressly re-

butted by the CAB's findin: gs.

At minimum, tines findings by the C' AB are not sus-

ceptible to: collateral attac ‘k, such as in the present pro-

ceedings. Llowever, even assuming that the CAD’s findings |

could be clrallenged In such collateral fashion, there is no

hasis for overruling them here, :

a

Kven on direct judic lal re vie Ww of an- administrative

agency decision, the review of a factual finding “is ‘limited

to consideration of whether it has a rational basis and is

Moana. by a tleupste evidence, Gilbertville Trucking

Co. v. United States, 371-U.S. 115, 126 (1962). In the

C entral-Frontier mes reer procee ‘dings before the CAB, there

Was substantial evidence to support the CAB finding: the

Jower courts made no finding to the contrary.

.

But even assinning that Respondent Were free to. clial-

lenge the CAB findings de nore in the District Court

‘proceedings. Respondent absolutely failed to do so: She

introduced no evidence on the question, of fairness or

_ opportunity for abuse. Indeed. the CAB findings ate the - |

only evidence in the record before this Coat.

In the face of the CAB Decision and Orde ‘r, Section 16(b)

liability cannot pineriie! be-imposed here,”

ia a en ee ae on ee eit esi senktincoespemie- aun —

‘be, and is hereby, relieved es the operations of the ‘antitrust

laws’, ... and of ‘all, other restraints or prohibitions m: ide by, or

imposed under, authority of law, insofar as may be ne cessary to

enable such person to’ do anything authorized, approved, or

required by such order,” . '

40

CONCLUSION

‘For these reasons, a Writ of Certiorari should issue to

- review the judgment and opinion of the Second Circuit.

*

Respectfully submitted,

Mitton VY. Freeman

Ricuard J. Werruemer

1229 Nineteenth Street, N.W.

W ashington, D.C. 20036

Attorneys for Petitioner

Of Counsel:

Marvin SCHWARTZ

Davin L.’ McLean

SULLIVAN &° CROMWELL

48 Wall Street.

“New York; New York 10005

Joun J. Gaugay -

-Prerer G. Corperr

Recax Gor bFARB PowrLt, & Quinn

445 Park. Avenue

~ New York, New York 10022

eee & a R

1229 Nineteenth Stre et, NW. :

Washington, D.C. 20036 aha

July 31, 1970: - ae ek ee

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APPENDICES.

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APPENDIX A

Opinion of the Court of Appeals, Second Circuit

UNITED STATES COURT OF APPEALS

Kor ruk Seconp Circeiy

No. 6f'—September Term, 1969.

(Argued April 2, 1970 ©. Decided April 30,° 1970.)

Bocket No. 34845

, °s r

Marcor NEWMARK, *

oct 7 Appellee,

——f7 5 ;

— RKO Generar, INc.,

a Appellant,

and

lRONTIER AIRLINES, INC., .

. Defendant.

‘ oe

‘Before:

Kaupman and -J’rixpere, Cirgut Judges, and

PatMiERi, District Judge.*

. \2

e oe.

x2

' Appeal from an order of the United States District Court

for the Southern. District of New York, Harold R. Tyler,

Judge, granting plainhiff-appellee’s cross-motion for sum-

mary judgment on the issiie of liability and from a jude-

° e 3

* Of the Southern District of New York, sitting by designation.

eae Pa

ment entered in ‘the United States District Court for the

; Southern District of NewYork, Dudley D.-Bonsal, Judge,

‘sitting without a jury, awarding damages in the amount of

$7,920,681 under section 16(b) of the Securities Exchange

Act. of 1934, 15 U.S.C. y7Sp(b). . Affirmed.

»,

. %

“Marvin. Scuwarrz, New York, N N.Y. (David I.

Goldfarb Powell & Quinn, New York, N. Y.,

on the. brief), for appe lant.

co]

: ?

Sranury Ll. Kavemax,. New York, N.Y.

(Shepha wd"S. Miller, Allan: K. Peekel, and

Kaufman, T aylor, Kimmel & Miller, New

York, N. Y., on the: brief), for appellee.

Kavruay, Circuit Judge: :

-

Section 16(b) of the Securities Iss xchange Act of 1934 is”

one of several provisions of. the federal securities: laws

designed to deter imsiders from trading on the basis of

information unavailable to the general public.t| Commonly

nis ° ,

' The atute reads: a

or the purpose of preventing the unfair use of information

which may have been obtained by such beneficial owner, direc-

tor, or officer by reason of his relationship to. the issuer, any

profit realized by him from any purehase and sale, or any

sale and purchase, of any equity ‘security of such issuer (other

than an exempted security ) within any period of -less than

six months, unless such security was acquired in good faith

in connection with a debt prev iously contracted, shall mure to

and be recoverable by the issuer, irrespective. of any inten-

tion'on the part of such beneficial owner, direetor, or officer ing

entering into stich transactiong,of holding the security pur-

* chased or of not repurchasing 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 juris-

divtion :by the issuer, or by the owner of ‘any security of: the

MeLean, Sullivan &: Homans and Regan

3a

« e. iia ? be °

. termed “a erude rule of thumb,” the statute seeks to prevent

insiders ro realizing profits on securities held for -short..

‘periods of tine.’ It is not aimed Solely at the actuality of

- evil, or the veritable employment of inside information for

purely. speculative purposes, but also at potentiality” fore

evil. inherent’ in all insider short-s swing trading. |

To maximize its deterrent effect, the section Is - drafted

in clear, straightforward te rms. It provides that whenever

‘a director, officer or owner of ten percent or more of any

class of an issuer” ’s securities purchases and sclts equity

securities of that i issuer within a six-anonth period, he must

return any profits he realizes to the issuer. There are no

other prerequisites ar postulates to liability. The purpose

and reach of.the statute, it was thought, would be clear, and

litigation Seldom necessary. .

issuer in the-namie and in behalf of the inwabe if the issuer shall

fail or refuse to bring such suit within sixty days after re-°

_ quest or shall fail diligently to prosecute the same thereafter;

but no such suit-shall be brought more than two vears after

_the date such profit was realized. This section shall ‘not be

construed to cover any transaction where such beneficiak owner

was not such both at the time of the purchase and sate, or the |

sale and purchase, of the security inyolved, or any transaction

or transactions which the Commission by rules‘and regulations °

may exempt as not’ comprehended within the purpose of this

subsection. : ea

* The description, ‘ ‘a erude rule of thumb,” was first employ ed by

Mr. Thomas -Corceran, spokesman for the drafters of the statute,

during congressional hearings on the bill which ultimately became

section ‘16(b). Hearings Before Senate Committee on Banking &

Currency, 73d Cong., 2d Sess. 6557 (1934): The phrase now serves

to deseribe not only. the statute but. also-one approae ‘h to its appli-

eation. Under the “objective” or. “rule. of, thumb” approach, the

statute is applied to all transactions which seem to fall within its

terms, without regard: to whether imposition of liability would.

‘further the purposes of the statute. See, e.g. Weli-Coil Corp. v.

Webstpr, 352° F.2d 156 (3d Cir. 1965). We have rejected this™

interpretation, see Blau v. Lamb, 363 F.2d 507 (2d Cir. 1966), -

cert. denied, 385 U.S. 1002° (1967), in favor of the more “prag-

matic” approach of applying -the statute only to those situations

subject to speculative manipulation, For .a comparative analysis

‘de

ce) ° \. _o.

The sills of the commergial and financial world,

however, have defied the draftsmen’s efforts at neat classifi-

an)

cation. Whether certain “unorthodox” “transactions, well ~

illustrated here by the exchanges of securities ineident to

au merger w — form the basis of this appeak,are “pur-

chases” or “sales” for the purposes of section 16(b) cannot |

he ence by mere reference to the words of the statute.

In such eases, the determination of the statute’s relevance

must rest, initially, on whethgr there exists the potential

for evil against which the statute was intended to guard.

‘ Blawy. Lamb, 363 F.2d 507 (2d Cir. 1966), cert. denied, 885

U.S. 1002 (1967). Only when an opportunity for speculative

abuse is present is it necessary to determine whether the

transactions allgged to give rise to 16(b) ability may fairly

he characterized as insider purchases and sales. ‘

7 . : 7

T. Facts

The facts are undisputed. In April 1967, the manage-.-

ments of Frontier Airlines, Inc. and Central Airlines, Ine.

reached a provisional agreement to megge their companies

by an exchange of Sock. Defendant RKO controlled

_ Frontier at that time through its ownership of 56% of the

company’s outstanding common stock. On May 3 or 4, 1967,

RKO contracted with several - major Central shareholders to

purchase, at $8.50 per .share, 738,251 shares of Central

common (representing 49% of ‘Central’s outstanding

shares), and $500,000 of Central. debentures convertible

into an additional 199.994 shares. The parties do not dis-

pute that thése debentures were “equity” securities, The

formal mérger agreement, providing fér the exchange ‘of

«

of the two approaches to. application’ of ‘he statute, whic h con-

cludes that this Cireuit’s’ rule is preferable. see Note, Stock -E.r-

changes Pursuant to Corporate Consolidation: A Section 16/b) .

“Purchase -or Sale’ "2, 17 U. Pa. L. Rev. 1035 (1969).

& - a

. . 4 ° ; . F f ns e .

- . FS a. + ja : Pe

‘ - — ‘

314 shares of Central coniluon for e ach share of Frontier

common, was executed on May- 4, The first disclosure. of

thé agreements to the public and minority shareholders _ of

hoth corporations occurred the following. day.

Shareholder approval-of the proposed ‘merger was fore-

ordained, for the terms of the purchase’ contract obliged the

majority: shareholders of both corporations to vote their

shares in favor of the proposal.’ The Cehtral sharcholders ’

were also required to manage their cor poration i ina manner

w hich would not .ptejudice RKO! Since two airlines were

involved, consummation .of the merger was conditioned on

approval by the CAB. The task of processing the merger

through'the CAB apparently fell upon RKO: accordingly,

its subsidiary Frontier sias afforded full access to the books

and records of Central. Hf, in RKO's “good faith judg-

ment,” the subsidy awarded the surviving corporation by

the CAB was inadequate, or any of the other conditions -

imposed by the CAB adversely affect ed the interests of any

of the parties, the contract “ranted RKO the right to:

abandon the agreements, An additional provision con-

ditioned the Inerger on the consent of certain Central -

creditors and’their waiver of Central's loan defaults,

As anticipated, the majority” popes of the. two

companies voted their endorsement on July 2 : On the same

day, the Frontier shareholders penny a two-for-one

stock split. The exchange rate in the merger agreement was

accordingly adjusted to. 3M Central shares for each two

.

-

_

.

* Paragraph 2(b) of the purchase contract required the sellers.

“owners of 66% of Central's voting, shares, to cause “Central to

take all necessary corporate action to approve and- authorize the

“merger with Frontier (inchiding the approval thereof by Ceutral’s

stockholders)” ; Similarly, paragraph D(e). required RKO, owner

of 56% of -Frontier’s voting shares, to cause “Frontier -to take

all necessary corporate detion -to approve and authorize the merger.

‘with Central . . . including voting the stock of Frentier owned

by RKO i in favor ot such merger: coe

en

.

a

~

Nias one

a

ar tet oe ae

-shares‘tof Frontier. Less than a weekdater, on August 2,

thee CAB added its imprimatur by approving KO's pur-

_ chase of the Central stock and'the merger agreement, After

Frontier, thes surviving corporation, signified* its satis-

fietion with the amount of the subsidy to the new airline -

andthe other conditions imposed yoon the merger by the,

ness the CAB's order ofapproval became final on Septem-

her’ During the ensuing weeks, Central's _ereditorg,

Fee ee as a mi itter of COULSE, agreed to waive € ‘entral’s

loan defaults. Sit ae ne

On September 18,-the purchase agreement was executed ;

RIO, paid the gontract price of $8,550,082 50 and ree cived |

in return’ the -€ entral shares and debentures. That same —

-day the parties filed the merger. agreement © with the

Seeretary of State of Nevada, the state of incorporation of

both. Frontier and Central. The physic al. exchange - of

. Kentral certificates for Frontier cortific: ites, at the’ rate

embodied mn the merge r agreement, 0€ sclirred on October :

Plaintiff Newmark, an ‘ow ner of F rontier debentures and oy

warrants since April 1967, instituted this action in the

Southern Distriet of New York: ‘in December, TO67.. After

.

'

—

Sake od . aN , ed

*On this appeal, RKO raises for the first time x belated 5

‘to the ‘plaintiff's standing to muintain this action. The statute

authorizes “the owner of any security of the issuer. in this case

Central, to institute an ac tian on behalf of the issuer. Relying on.a

literal reading Of the Statute, RKO argues that plainti! T's owner:

ship of Frontier fecurities is irrelevant and that.since she never’

owned Central shares she does not have standing to bring this

action. This:argunment, is without merit. Céntral no longer exists,

Any cause of action it may have had now belongs to Frontier, the’

company into which it merged. Any recovery will redound to

Frontier's benefit, Those most interested. in securing this recovery

are the holders of .Frontier’s securities, and they are the prope r

parties to, bring an action for its benefit. Blaw % Oppenheim, 250

F.Supp. 881 (S.D.N.Y. 1966). Moreover, RKO did not raise

Newmark’s alleged lack of capicity to’sue in the district court; its

present attempt to raise this defense for the first time would appear

untimely. Fed. Rs Civ. P. Ufa), 12(b); C. Wright, Federal Court’

2s (2d ed. 1970).

\

q-. - 7a <.e

both parties moved for simmary “judgment on the undis-

. prted facts we h: we recited, Judge Tyler granted New-

* nat? S ¢FOsS-Inotion for subnnary judgment on the | Issue of

liability. A trial on the issue of damages followed: at its,

conclusion Judge Bonsal awarded damages in the amount.

vf $7,920,681, The. ‘award was bh: ased upon the difference

» between’ the purchase price" of the Central shares and

debe ‘ntures and the marker price of ‘their equivalent:

Frontier sharesjon the date of tlie merger, to which sum

Judge Bonsal added ft control preminn of THQ

TI. Povewriar: FOR Sprcunative’ Abr SE ’

“\- Be a6 - 4

; - Tlie threshold issue raised on ‘this appeal-is whe ‘ther the ,

purchase and subsequent exchange of Zentral’ shares lent ¢

ee

itself to the’ typeof speculative abus which section 16(})

Was’ designed to prevent. Blau y. Lelamay, 286 F.2d 786+(2d-

ne ir. 1960), aff'd, 368 U.S. 408 (1962) ; Park & Tiltord, Fue.

Schulte, 160 F.2d 984 (2d Cir. ). eert. de. Wie d, 382-U.S,

a (1947). That RKO's heart. nla have heen pure and its

motivation noble matters not- The significant factoy Is

whether: RKO could have veaped 2 speculative profit from

. the ‘sunfair use of information pang obtained . . by reason

of [its] Seas to [C entral |.” Sectivitinn Exe ‘hange

Act of 1934.916(b), I T,S.C _ S78p(h). |

RIO’s oe i, purchase Central sh@res is a vlassic

of information

inavaildhle. to. the general public. On M: VY 3° or 4. 1967,

on CAB ay

proval of -a related merger, to purchase Central common

example of trading while in the possessio

RKO seeured a contractual right, condition

shares Tor $8.50. per share,’ Bee ‘ause of its control of Fr6n-

tier and consequent involvement inthe mer eer negotiations

between Frontier and Central, RKO had fal] knowledeg >

of the proposed merger at the time it signed this contract.

Release thereafter: of. the proposed Merger agreement to.

“ | a

nr. Es -

; Sa’ ie : ie

: i \ |

the pablic caused a predictable ‘rise: i in the prige sof the

securities of both, airlines. RKO shin an ideal position»

‘to take specuintive advantage of this rise. by purchasing a

Central securities. at a price established in the purchase

agreement before public dise losure of the proposed merger

and disposing of: these securities after. disclosure shad

caused. them to, increase in. \ vah®. @- = * - e

In an effort to establish the ee nee of an opportunity

fy: -speciative manipulation, R KO” emphasizes the CON.

nection between the prices of Frontier amd Central shares

during the period substéquent to the release of the ime reer

Neree ment to the.public. It argues, that whate ‘ver the abso-

late prices of Frontier common, may htve Qeen at various” :

times during this period, it tended to remain pproximately *

314 times gredter than the price of Central Yommon, the:

ratio set forth in the merger agreement. Thus, RKO SQVs, .~°

it.was impossible to profit froman exchange of Central .

shares tor Hrengie® hares —Phis testnient would have—— 7 '

some ierit if RKO had possessed ‘no-more than an option

to pure ‘hase a — of .¢ ‘entral shares at an unspecified

“price, but on the facts before us, it is no more: than a red

herring: ENO possessttian option to purchase, not at the ’

market price oh the day ef purchase, britlat-the fixed price

-of $8.50 per share, Accordingty, the constant ratio hetween,

the priceXyot Central shares and F rontier shares did’ not

preclude the realization of Speculative profits ;.rather, the

fluctuating ratio between the prices of the shares of both

— and the previously established purchase price .

of $5.50 per sleure wade these- gains possible.

Si over, the pote phial for specule itive abuse did not end

with the fixing of the purchase price for Central. shares :

prior to the release of the ne ws of the proposed merger to

the public. Under the term? of the merger and purchase

agreements, RKO se eured seve} ral alvantages, Tt nat only

ae ee 7

acquired knowle dgze of what would transpire but also could JP

exercise substantial influence over the course of events,

Once the CAB had éranted its initial approvat on August 2.

RIO had the power to determine when or, for that patie

if the purchase’ and merger would take place. RKO had

no-obligation to purchase the Central shares unless, in its. ¢ -

“ood faith: judgment,” the subsidy granted the merged

airline by the CAB. was. satisfac ‘tory. It Was thus in-a

position toemayiimize its: spect: itive gain in Central shares .

by withholding its expression of satisfaction with the sub-

‘sidv until the rise in the price of hoth Central and Frontier

“shares fully reflected the j Impe nding merger, At the same

time, it should be clear that RKO's power to rejéetsthe

subsidy woud habye enabled it to es¢ape any pessible loxs

in Central sequries, Tf, for ‘some unexpec ted reason, the

contemplated rise in thie price of Central and, Frontier

shares had not: followed ‘the’ pubhie announcement Sy the ee

pr opoxed mereer- REO could © ‘asily have avoided the entire

transaction without i Incurring: any legal liability. The pur-

‘chase and merger agreements placed(RKO in a position

which must be: the dream of ‘évery speeulator—"Hends I

win, tails T do not lose.” «. : Mee BE n

In sup, the purchase and “subsequent © xeltange of re entral . «+

shares .were fraught with’ opportunities for thé kind: of

_ Speculative abuse section. 16(D) was: intended. -to-abort.

“RIKO’s success in fixing the purchase price ‘before the pros *

posed merger became public knowle dee opened the ae to -

possiblé speculative gains. Its abilite to determine whether’

‘and when the ‘ merger woitld be consummnated enabled t-te

maxifnize these gaink or. at the very least, toy avoid any

. c : . ;

TP. Srarcrory ReguireMents’ | - 8

Having disposed of the threshold question and deter-

mined that the Ree and exchange Of Central sh: ares

ew ee

7 om

* ‘ .

a

presented opportunities for. the type of speeulative evil

* against which, section 16(b) was intended to auard, we must

now decide w he ther R KO" x transactions in Central common

stock Fall withinis the scope of the statutory: provisions:

oe ‘Before liability can attach under 16(b) there must be (1) a>

oe purchase and. (2) a sale of securities (3) ‘by one who-owns

more than 10 percent of any one class of the issuer's securi-

ties (4) within a six-nenth period.

‘ , s ; -

. AS Purchase aud Holding Period

As t to two of the: four elements, theré can be little lix-

pute, Since all of ‘the events relevant to this appeal-trin-

? “ — spired within a ‘six-month span. during the year 1967, any

purchas ‘© and sale which formed a part of these events

occurred withiy the statutory péried> Similarly, by any

stationabdcfinition, RX Ye exchange of $7.55008250 in cash

» - * for Centtal’s common stock and conve rtible debentures Was

| “pure ‘Hase™of those securities.

“_ “ ‘ ¢ ‘ r'

‘B. Sale

Whether the subsequenteexchange of Central shares for

I" rontier shares pursuant to the merger azreeme nt consti-

ena thted 2 i “gale” of *the. Central securities for purposes of

Section 16(b) poses a somewhat more difficult: problem. -.

RKO contends that the &chanege did not fundame ntally

alter the nature of its holdings and the efore that it cannot.

fairly be characterized ax a sale. Before the exchange, RKO

| urges, it owned a bleck of shares in‘each of the two separate

companies; later, it.was the owner of an equivalent block:

in the company remaining alter thie inerger. This argent?

“in essence, urges us to invoke the “econamie equivalence”

_ test of Blau vy. Lamb, supray Where we held that the con-

version of preferred stock to common stock was not a sale |

under 16(b)° since “that Which the insider [surrendezed |

ta

a

and that which he [veccivetl were] simply different forms’

of the same participation in his issuer.” 368 F.2d at 523.

RKO's reliance on Blai Ve Lamb, howeer, is misplaced, .

The doctrine of eeconotuie ejiivalence ‘is: applicable only zo

exchanges involving the securities of a Single issuer; we

stated waned that “sales or purchases by an insider Of

his issuer’s securities for cash. the. securities of a different

company, or other property are within the reach of See.

tion 16(b) .:. 2" 3 3 Fld at 528, (emphasis ade od). When ——

RKO esehaiee its Central shares for F Prontier seeuritic oe

It received “the securities of ar different issuer.” which

represented ownership rights in the WW. merged: airline,

The “economic equivalence” exemption established by Blav

Lamb is, thus, inapplicable to this_case. Seo DBlaw-y.

Mission Corp., 212 F.2d-77 (2d Cirey, ce neodenied, BAT USe

16 (1954). as MTGE 5

The connection between the purchase of Central shares

and’ the inerger. of Central. and Frontier provides’ addi--

tional support-for the view that the exchange of se ‘eurities

was, a-stifficion ly ineaningful event, in view -of the Cretim-

stances present here, to be considered agale. We, note that

RKO concedes, indeéd argues strenuot sly, that” the pur-

chase and merger we re“inte rdependent. that the completion A

_of each transaction » Conditioned: upon, the consummatiow

of -the other. Gisen is interdey. endenee of the purchase.

and the merger, it cannot be urged that R KO could s simply

have purchased Central sec urities at thie: contract price: and -

sold them at a price inflated by the : amnotincenpfit of the

impe nding i merger. Iti Is clear in this_cGase, that only through

the exéhange prov ided for in the merger agreeme nt could

RN O have realized a speculative profit in Central shares, :

e

« ; @ 7

“As a, reoult ‘of RKO's holdin in Frontics, it was a “person

controlling an air carrier,” and itseaccuisition of a controlling

-* block of ‘the shares of another air earrier (cra) required CAB

ica . .

Alternatively, RIKO urges uted ecide that even if the

“exchange was a.sale, it failed to. re alize any profit on the

transaction, and. accordingly, plat atiff Was entitled to no

“recovery, |F iris argument rests alinost entirely on the de-

property should be fmamaterials i I the statute is to-ae hieve,

cision In [fe li- Coil ( ‘orp. v. Webster, 352 F. Yd 156. (3d Cir.

1965), which held there were no. profits. rei ulized.in a con-

version of seenrities, the rationale being that realizatign.

a

owould oceur only when the securities reeeived in the conver-

sion were sold for eash. The purpose of the statute, it”

seems to us, is quite clearly inconsistent with this*narrow

inter rpretation of “profits realized — The salutary oh jee-

tive of se ‘tion 16(b) ix to prevent an insider from ‘investing

the securities of lis issuer, holding. them briefly, yand -

then divesting himself” of hiseinvestment ata tidy profit.

Whether, upon divestinent, the insider receives cash or:

-

approval. Federal Aviation Act, S$408(a‘ (5), 49 U.S.C. $1378

(a)(5). As stated above, the CAB granted its\ approval of the

paces acquisition, but did sa on the: assum ptian® that the pur-

chase would be followed by a merger whiclf it found to be “con-

sistent with the ‘publie interest.” © Shier C AB did not rule that the :

purchase would be permissible if it were not accompartiod by the- '

merger, Therefore, RKO would hive violated the CAB's order had

it purchased the Central securities, backed out of the merger, and

disposed of the securities in- return for cash. Under the terms of the

dgency’s-order, RKO was required. to exchange the “Central secur-

ities it purchased for Frontier sec ‘yrities pursuant to the merger .

agreenient. os

S

‘Inf Blau v. Lamb, we expressly dectinbd th follow Heli-Coil’s -

treatment-of the “purchase and sale” issu® under section 16(b);

we also refuse to follow the restrictive interpretation of ‘ ‘realiza- ‘

tion of profits” advanced in that case. In Meli-Coil, the Third Cir- .

cuit was employing the “objective” approach to the applicability |

of section-16(b). Seevnote 2 supra. It may well be that the nar- *

row: definition of “profits realized” was: an attempt to avoid the’

harsh results which often follow from the “objegtive™ approach,

. as opposed to this Court’s “pragmatic” approach. -Sce Hemmer,

Insider Liability for Short-Swing Profits Pursuant to Mergers and

. Related Transactions, 22 Vand. IL. Rev. 1101 (1969).

*

~*

mh PN ee es eee Ce ee

its end what is significant: is that he has: attempted. to’ turn

a short swing in the pricéof his issuers securities to his

own personal advantage. RKO purchased Central secur:

ities for-some 7.5 mnillion atk. In return for these secur-

ities, it reveiyed Frontier shares worth more than 15 million

dollars. The receipt of these shares w as a sufficient realiza-

tion of profit to place the transaction “within the: scope of

section 1G(b): See. sae . Wission Corp., 212 F.2d 77 (2d.-

Cir.), cert. denied, 347 U.S. 1016 (1954): Blau v. bambi,

63 F.2d 507, 523 (241 ‘ ir. pater cert, de ‘nied B85 US. 1002

(1967). Satan Se

- Beneficial Owner asd

The fin: ul statutory provision required to be fulfilled be-

fore section 1G(b) Jiability may be imposed on RKO i Is thrat

‘it must have heen a Central insider, in’ this case’ a ten

percent’ beneficial ow ner, at the time it pure hased and sold :

Central securities. Since RKO* engaged in only a single

purchase of Central securitics, we are presented with the

question. whether the prohibition of section 16(b). émbraces

the very transaction wliich makes one a ten percent bene-

ficial owner, Ourdecision in Stella v. Graham- Paige ee

Corp., 232 Fi2d 299 (2d° Cib.): cert, denied, 352 U S.

(1956), makes it clear that the statute is applicable to nn

“* transaction, See 2 L. Loss, Securities Regulation 1060

(1961). a2 his rte is grounded on the freque ntly cited over-

riding’ purpose of the statute, deterrence of insider trading

on the basis of information imavailable fo the investing

public. The statutory, reference to a ten percent be ne es al :

owner rests on. the -presumption ‘that an owner of this -. ..

quantity oF Lassen aa yes acress ‘to inside ' Wick

Lo i ~

———__. :

* Since. the stated purpose of the statute is to’ prevent’ the unfair

usé of information w hich «insiders may have obtained by reason of¢

their: relationship to thei issuer, othe: reason for ine mane ten percent

¥ : e ? . ne . = : ; “ F ‘

‘T4a. 4 ; ee

Although this presumption. would not ‘justity the cone relusion

thant one who purchases 2 qui mntity of shares whié th makes

lini A te n percent beneficial owner lists done se-on the basis

of inside information, the pre arndd aces to such informa- 8

tion resulting. from ‘this purchase provides him with an’

opportunity, not avatlable: to the investing public. to sell

hix shares-atethe moment most advantageous to. him. Thus...

2t pure mise'or shares which makes the biiyer an insider. cre.

alos an op portunity for the typé of spee wi itive abuse the -

sti itute was enacted to pre vent. “yo

Moreover, on the facts before us{ we have” no difficulty

in “dee idling that k KO: hee wine a beneficial owner oF more

‘than ten percent of © entral’s commdn stoc ‘k before its’ pur-

chase of Central shares on ‘Septem er IS. On May 3.or 4:

MWT, RIO entered into. an agreeme nt ‘whieh granted. it a

conditional right. ‘to purchase more'than 506 of Central's

common stock ata fixed: pricecensured that Central would:

che ay anager in accordance with its inte rests, and Saag

a majority of Central ‘shares to be voted in support of:

merger it favored. This cottract..we cone Liade, scdaited

erights of ownership, particularly those rights most ims |

portant to the speculative purchaser, so substantial as te. *

make RK O.a ten percent benefic ial owner of Central at that

time, € ontrary to the Asse rtions oF. RKO, “this conclusion,

js in no way: inconsistent With ‘our decision in Stella ¥. |

Grahaw- Paige Motoks Corp., supra, that the holder of an

“option is not an insider until he has anade as ‘contnitine nt

to-exercise the options - 7. cee oe .

.

beneficial owners within the definition of insiders must have been’

the determination that ‘the owner of a quantity of stock that large

is likely t6 be privy to such information. “See 2 L. Loss, Securities ~

Regulation 1060-61 (1961) (ten percent beneficial ‘ owner presumed

“to have e access to inside information ).

* Blan Vv. _Ogsh ry, 210 F.2d 126 (2d Cir. 1954), a 1 second | Causes

cited by RKO in support of ‘the proposition that it tannot be

a

*

.

ec ae ee ane

TE ..

Stella rest&d on the assumption that ‘tone who: holds an |

“Unexéreised option is. not usual in a position, to obtain

: Jadvienee |- ‘information from the company, ue 252 Fi2d at Bol.

ue assumption. of no validity in the case be ‘fore us, At the

“tinte it secured ; | conditional right to. ptirehise Central ,

see urities, R Ka, Was In posession of adv: ance information

Of the ty pe mnoxt like ly to affect the price of Central shiatres,

~—confidential knowledge of an. impending nierger with °

- --\

> Frontier, - Prado apd agg eh, é é , ieriy

Accordingly, we’ conelule thi: at -RKO* hee: une al Central «

“insider, purchased Central securities and, less. than. six

months‘ later, sold’ these securities, The distr ict court prop-

erly required RKO to return the Irofits it realized on this

Salesto F ‘rontier » Central’ S SUCCESSOr. in te Test,

| : AY, ; Danaors

°

‘ xa “ t

A Cent al’ Debeniige s ‘

"Trude ‘Bons: al’ s ‘ae ‘termination. ot ‘the ; amount of profits

realized by RKO and, Conseque antly, his’ award of damages ’

to the plaintiff ayere based on tlie cone lusion that the merger

had ¢ constituted a sale notvonly of thet entral common stock

~ purchased . by, RKO. but also of. the Central debentures,

These debe Athhes, as we have indice ated, ‘Were convertible

“Into | ENO, shares: of ‘Central’ comnion: ‘stocks. The court’ s

wat] ol damages. included: ‘a sun deriver frovh the. diffe re

Pence be twee en the price RKO paid for the debe nttires-and

the value of the Ff rontier shares for whic ‘h 140,994 shares

of Central could: have -been exe lranged, pursuant. to tlfe_.

a.

With acs cameo >. ~ ee ee ee ————

-deented to bad e bei a Central-insider befor ‘e its purchase of C en-

tral shares, is in; tpposite, In that ease we Were called upon to sle-

‘cide when.a buyer aetiially purchased Shares, not when he became

a a beneficial | owner. ace p

eo +

:

:

et Aa «

. , ‘

merger agreement. RISO, ‘urging that the court erred. in

“aw arding this sum as damages, points out that it neither

converted the debentures into Central commor stock before

‘the meer nor converted these securities into . Frontier

‘stock after the merger. Without sucha conversion, it

argues, there could, not have been any sale of the deben: |

‘tures and, henee, any proiit realize d. ’

’ %

Ss con- _

ich it

Although this argument has surface appear ul, RK

tention distorts the nature of the: transactions in ww

engaged. RICO did not pure hase the:debentures ‘hbecatise of

‘their value as debt securities but beeause of their easy

convertibility into Central common. stock. The purchase

“pric eof SP 274049 bore no relation to the debe ntures’ face

_ ase of $500,000; rather, it was de ‘pendent upon the number

of Contral shares into which the. debe Atures could he @on-

verted and the purchase price of $8.50 for « ‘ach of ‘such

Shares, Pursuant to section 7(b) of the merger agreement,

the debentures hee “une convertible’ into Frontier shares

upon the constunmation of the merger. T hus, although there

vd Was no_ phivsical exchange of certificates, -the merger.

resulted in the exchange of the right to purchase Ce ntral

sshares “Fepresented by the debenfures for the right to —

“-pure ‘hase the shares of F rontier. It |s : this right to purchase,

rather than the debt characteristics of the debentures, which .

was important to. R KO." The district judge was therefore

entirely correct in char acte rizing this transaction as a sale

. “and awarding as damages the profits realized thereon.

ee : : ys 1

: a7 + gated

B. Control 1 remove, /

RKO lax no quarrel ‘with the method the diateist court

employed for the calculation of damages. The basie award

*Tt is interesting.to note that, throughout the purchase “agree-

. ménht, the Central stock and debentures were characterized collec-

* tively as “the Stock.”

S?. 3 .

’

.

: ‘ .

: . , .

y : ~ =. we"

%

% ‘ e e .

' * 4

= .

Ky ae :

of damages was the difference “hetween the price RKO patd

.

vs

for its C' entral securities and the market value, “on the date

i the me reer vor the F rontier securities. RKO rece ‘ved |

return forvits Totdines.in Central: To this basie stan, loge

ever, the distriet judge addled a control preminnvot. 15 pe

cent. ‘The addition of this control pre min, RINKO conte mis

o oy

Was erroneous,

We are of the view: : fluie the inclusion of a control

premiun in the damage award was justifieg. Ch Blau y.

Lamb, J40 F. Supp. iF YI (Ss DIN: y. 1965). rec'd oy part On

other grounds, 308 on 2a i 1: “| Cir. 1966). cer’, denied, B85

US. 1002 (1967). vofed j Wd I, Ms: See tiritios Regulation

a“

BOLI (1969); Fistel> y, Christman, I oF, Supp. S307

(A.D... 1955), uated in 2 "1. Loss. Securities’ Regulation

1083-74 (1961). It is elementary. that RKO could not‘have

“retained legal control of Frontier Without the block ol.

_oFronticr shares it: received in exchange for its Central

securities, At the trial on the j issue of damages, Dr. Belle-

More, a securities expert, provided: extensive testimony

concerming the value of attainine legal control. The district

court thus hi ul hefore it evidence that this Isloek of Frontier:

shares had a special value to RIKO whiely it would not hi ave

had to any other investor, Moreover, there was evide mee

Mat. previous purchases of large quantities of Frontier

been at a Substantis af premiinn, ranging from 15° to YOO

3 ;

ae support the contention that it would not have be ‘en Willing

to pay a premium in or der to retain its-legal control over Frontier

in this instance, RKO points to the contractual purchase price for

Central shares, which was belows rather than above, the market

a. This evidence is not convine ing. -[t does not show. or even

1

rongly suggest, that RKO would not have been willing to pay a.

\premium had it been forced to do so: Indeed. the prior purchases

of large blocks*ef Frontier shares suggest — it would have been

willing to do so:

. ”

Py ‘i

—_

shares which had. conferred control on the purchaser had:

: e

~ In view of all the evidence which the district judge con-

sidered, we cannot characterize: as tlearly erroneous his

finding that ‘the block of shares RKO receryed in exchange

for its Central securities was 15 peréent, more valuable to

it than to the average investor in the marketplace.

~Aflirmed.

/ ,

.

. : e

: ; ad 4

e Ira

¥ (

P

6

. : ; "

| APPENDIX B (

Opinion of ‘the District Court

UNITE D isi ATES DISTR wes T COUR®

Som HE RN Distric? ie Ww York *

——<>-_—

[SAME TITLE]

IKtavrMan, Texytor, Kian & Minter, sas.

New York City, by : ,"

STANLEY L. Kavruan, Esq.,

SHEPHARD MILLER, Iesa., and

. ALLAN PEeKEE,-Esq.,

i ; Nxittorneys ‘yr Plaintiff.

Rrcan, Gorprarp, Powensn & QUIYN, ses.

; eee 5,

_ New York City.) by

\ Joun Ff. Gareay, Ese. and

. Peter G. Corperr, os ae a

Attorneys for’ Defendant

RKO General, Ine.

Tyxer, D.J. .

This action under Section say of the Se curities Iy-

change Act of 1934 (15 U.S.C, ¢ > @8p(b)) raises some of the

questions left unresolved by the ito of Appeals for the,

Seeond Cireuit in Blau y. L amb. 3 008 F.2d 5OT (2d C ir, 1966),

cert. denied 385 U WS. 1002. ey. fk court’s most reeént:

in-depth excursion ‘into the complicated world of short-

swing insider profits.

Plaintiff's claint arises out of the ¢ events surrounding the

1967 merger of Central Airlines, Incorporated ("C entral”)

into Frontier Airlines, Ine. (cde ronticr™), the surviving

corporation.being Frontier. (For convenie nee, | will refer

i to the merged corporation as “Central-F rontier “*) Plain-

! \ : ‘ ‘

; iff, a frontier security holder ‘? claims that RKO General,

Ine. (RKO) realized short-swing insider profits in trans-

actions: in Central common stge k andl. convertible deben-

titres, and that the claim now belénes to( ‘entrat- iD rontier as

‘a result of the merger. At all rele “anit times, Central com-

mon was traded over-the-counter.

With the material facts undisputed, defendant RKO has

moved for summary judgment, and: plaintiff has CYOSs-

“moved for summary judement on the issue of lability, re-

“serv ing for future de ‘termination the calculation of the e xact

a amount of profits claimed to have heen res alized by RKO

se

YACTS

During the period immediately preceding April 5, 1967,

RKO held 566 of the outstanding common stock of Frontier

and was in the process : of negotiating-aamergcr between

——_——-F rontier and Central. On that-date, the management of the

two airlines agreed in principle to a merger of Central into

os Frentier with an‘exe ‘hange ratio of one share of Frontier

- common Stock for each 3Y/, 4 shares of Central common stock.

On May oor 4; 1967, RKO contracte ‘d. with a small num-

hor of major Ce nfral stock holder s to purchase 738,251 shares

. ‘ ‘In an ‘iffidavit verified on April 4, 1968, plaintiff avers that

f sinee April, 1967, she has been the owner of Frontier 14% deben- |

tures in the face’amount of $2,000 and warrants entitling her to

-purchase Frontier common.

‘= Rule 56(e), F.R.Civ.P.. Although the failure to show the exis-

tence of: profits will preclude the grant of summary relief on the

issue of liability, see c.g., Blan v. Lamb, 163 F. Supp. 528, 532

(S.D.N.Y. 1958), once the existence of profit has been established,

a court may enter partial summary judgment reserving for trial

the issue of the amount of damages. See Roth v. Fund of Funds,

Ltd., CCH Fed. See. L. Rep. 92,147 (S.D.N.Y. 1968); 2 Loss,

Securities Regulation " he ed. 1961).

- ; : wm bad

. “t.

ofc eaten common, re prese nting 950 of C entral’s oultatand=

ng shares, plus $500,000 principal face amount of Central

convertible debentures, which w ere convertible into an addi-

‘tional! 1 149,994 shares ‘of’ ,Central common.’. The purchase

was to be at thee fective rate of $8.50 per share of common

stock> As a part of this s agreement, RKO acquire ‘d the prom-

ises-of Central shareholders ow ning approximately 66% of

the. Central common that they would vote the shares in favor

of the

_agreemdnt, ne ‘ther the public nor the stockholders of the two

nerger. At the time of thee xecution” ‘of this purchase

corporations hard. been informed of the proposed merger

On, May\ 4, 1967, the tw oirlines exe cuted a formal agree-

inen® of m arger ‘at thy previously agreed upon exchange

rate. A press release on:the me reer ‘agreeme nt Was issued

the same ae Thesnext dav; May 5, 1967, reports in the’

financial press deseribed_the merger based on-the press re-

leg ase, and diséloxed ‘to the public RKO’s contract with the

s |

Central security holders. p

The ne cessary approval of the merger iy shareholder ma--’

jorities of the two airlines was obtained on July 27, 1967,

On the same date, the Frontier sMareholders ratified a two-

for- one split, of F rontier: common stock, which had been de-

clared by Frontier’ s board of directors on Mav 10, 1967, To.

compensate for the stock split, the terins of the merger were

adjusted to provide for an exchange rate of two shares of

- Frontier for each 31% shares of Central. — |

The requisite Civil Ae ronautics Board (“CAB" ) sinpravat

of the merger became effective on Septe mber 1, 1967, subject

. to the written acee "ptance’ by Frontier of certain conditions,

* It should be apparent from the fact that these. debentures ¥ were

convertible into over $1.2 #rillion worth of common stock that the

market value of the debentures was virtually dependént upon the

\ market value of Central common stock. The parties do not dispute

‘ that these debentures were “equity ” securities, ;

eo

’

v° .

vr] “A <

, an a Vine

Thereafter, on September Is 1967, RKO received the Cen-

tral stogk and eae iithe-debentines for which it had pre-

viously contracted and paid. a total purchase price of |

$8,590,082.5 D0 (mn the same day, the merger agreement was,

filed with the Secret ary of State for the State of Nev ada,

where both Frontier and Ceptral had bee ‘n incorporated.'

The CAB received notice of F rontier’s acceptance of the

regulatory board's conditions ‘to the me rger on September

1967, Atte same time, Frontier requested that the

CAB transiter Central's certificate of: public convenience

. °

effective October 1, 1967.

‘Apparently it was on October 1, 1967, that the.exchange

of securities between ’ Central and Frontier was consum-

mated. In exchange for its Central comnion stock and con-

‘vertible debentures, RKQ received 420,850 shares of Cen-

traf-Frontier common and Central-Frontier debentures eon-

- vertible into S5.S3L shares of Central-Frontier ‘common.

On.the basis of these faets, plaintiff eontends that RKO’s

acquisition of ¢ ‘entral securities and subseque nt dlisposition

-within\six months in the course of the merger with Frontier

falls squarely within the ‘proseription of Section 16(b).

‘RKO’ raises some’ eight separate rebuttals to this basic

contention of plaintiff. The first three, which will be dealt

with in Part IT of this opinion, are arguinents that plaintiff

has failed to establish three tlements-of its Section 16(b)

.

* RKO contends that the merger became effective under. Nevada

law upon this filing. Plaintiff disagrees, relying upon the term's of

the merger agreement and ‘the CAB order. She claims that the

merger did* not become effective ‘until October, 1, 1967. Since,

neither date is beyond six inonths from May 3. 1967, the disagree-

memt and argument hére ‘apparently. 20 only to the questions of

which date should be used to determine the specific amount realized

by RKO and its disposition of Central stock. Irrespective of which

date is chosen, the amount is certainly greater than the $8,550,-°

082.50 which RKO paid to acquire the securities. Déf.’s Brief,

Pp. 15. .,

aaa * Ps

claim—*purch: ase’, “sale”,-and “prot realized”. The final ,

five arguments 9-6 « variety of defenses ba: ed on ad-

ministrative rules, fcderal statutes, and common ‘aw princi--

ples. Vhis group of arguments -willbe discussed in Part

HI of the opinion. c

,

te . . ° Il _* : hes ae :

“PURCHASE”, “SALE”; AND “PROFNL

aut REALIZED” ne

o

-

. Defendant aims at the jugular of this: élaim under Section

-16(b), 15 U.S.C. §78}

pritfary elements of such a Claim has, heen established- by

the facts in this case: Althougli there is a variety of factual

wr

<

P(b),° by, arguing that none’ of the

and legal arguments ninde by RKO on these three points, a:

common thread ean )e discerned. Defendant consistently

maintains that the transactions already deseribed do not

present 2 sitiation whiclr lends itself to the type of insider

Abus se that Section 16(b) was ‘deSigned to prevent.

The most hotly. Contested issue in this case is “whether :

there was a PBale’ of the C entral securities, but it will be

—

—

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

.Wwhich may have been obtained by such’ beneficial owner, director,

or officer by reason of: his relationship to the i issuer, any profit. real-

ized by him from any purchase and sale. or any sale and purchas¢.

of, any equity security of such issuer. (other than an exempted

security ) Within any period of less than SIX mouths, . unless such

security was acquired in good faith in connection with a debt pre-

viously contracted, shall inure to and be ~ ‘overable by the ‘issuer

irrespective of any ‘intention on the pat’ .f such beneficial owner,

director, or officer iin - utering into such cransaction of. holding the

security purchased or of not repurchasing the se¢ urity sold for a

period, exceeding six months. . +. This subsection shall not be

construed to cover any transaction where such beneficial owner wus

‘not such both at the finie of the purchase and sale, or the sale and.

purchase, of the security involved, or any transaction or transac-

tions. which the Commission by rules and regulations may Ssempt

as not comprehended within the purpose of this subsection.

“- . ° °

‘helpful to considersthe “purchase” issue first since ‘its

‘outeome has some effect upon points. raised in the main.

question. Defendant admits, ax it must, that umder any

normal ‘meaning of the word, it made a “purchase” of the

_ Central securities for cash on September 18, 1967. (Def.’s

Brief, p. 29.) But, it argues, “the substance of the trans-

action: and the intent of the parties, was that RIO was not

purchasing shares of Central but. shares: of — | Central-

Frontier |." Even"if | were to concede-that gach was the

sole purpose of the ‘parties to. the transactions, Section

16(b) was designed to protect ‘the investing pubhie ‘and

shareholders other. than the ones iavolyed in the particular

acquisitions and. dispositions of shares: While RKO was

probably primarily conéerned with. the merger and with

‘maintaining its doininant position” in Frontier, the method

-it. used to effectuate its purpose was the acquisition of: the

common stock an¢ convertible debentures ‘of Central: In’

View of the purposes of Section 16(b) to protect against

short-sw ing Insider des alings | In.equity see urities regardless

of the subjective purpose of the insider, | must reject this

novel arguments | find that plaintiff has established that

there was a “purchase” « ft Central securities by RKO.

As I have noted, the ‘contri al issue is whether the e xvhange

of RKO's, Central securities for securities of Central-

Frontier was a “5 Sale” within tlie meannre of Section 16(b).

Under the. “automatic” or “rule ol thumb” test of Park

& Tilford, Inc. v. Schulte, 160 F, 2d 984 = Cir.), cert.

_ denied 332 vc S. 761 (1947) Vand its DESDONSs * this exchange

- ©The: -approach. taken in : Park & Tilford has been diskcaees rela-

tively recently. See, eg. Western Auto "Supply Co. v. Gamble

\ Skogmo, Inc., 348 F.2d 736 (8th Cir. 1965), cert. denied 382 U.S.

987 (1966); Heli-Coil v. Webster, 352 Fp2d 156 (2d Cir. 1965) ;

but see Pettys v. Butler, 367 F.2d 528 (8 1 Cir. 1966), cert. denied

385 U.S. 1006, (1967). 5 3

*

oe : » =

D

clearly would have Calle ‘N- within ‘he ambit of the statute

since RKO owned Central securities bef gre the merger but |

_ didnot ofterward: But the “rule of thumb” test has been

discarded. in this Circuit in favor of the so-c: alled*“prag-

-matie” test, Blau'v. Lamb, 365 2d v07: (2d Cir. 1966);

cert. denied 885 U.S. 1002 (1967), and this test appears to

-. be the criterion that Willsgovern in other Cireuits, Pettys

v. Butler, 367 F.2d 52 28 (Sth Cir. 166), cert, denied 385 U.S

- 1006 (1967). After a survey of ‘the legislative history of

Section: 16 a distillation ef the important didisioas in

‘ this” particular area, the ‘Court of Appeaks for the Second.

Cireuit articulated the rule “whether the transaction in

any way makes possible the unfair trading that’ Section -

16(b)- was designed to prevent.” Blau Vv. Lamkh, supra, at

518. > Oates in its

application, still has the advantage. of being objective, be-

cause once the possibility of insider abuse | is found to exist.

is rule, although it is less than auto

Section 15(b) ‘must be applied irrespective ‘of any actual

abuse. Jd., at 516. . | |

As [understand it, defendant makes two_basic arguinents

grounded upon Blauy.Lamb. The first is that the exe hanges .

in question’ was tantamount to*the type of conversion of

convertible securities into unde lying « connyon that existed

in Blau y. Lamb and other similar cases, ‘Petlys Vv: Butler,

367 F.2d 5es8: (Sth Cir. 1966), cert. denied. 385 U.S: 1006

"(1967) ; Blan V. Max Factor & Co., 342 F.2d 304 (9th i AS

cert. denied 882 U.S, 89v (1965) ; Ferraiolo y. Vewman, 259

I" 2d 342 (6th Cire), gb. de ‘nied 309 US. 927 (1958) - Blau

’ Mission Corp. 212.7% 2d 77 (2d Cir, D4) ; Roberts y.

mene F.2d SP (2d. Cir, ), cert. dinied 348 U.S. 897

(1954). The s second argument is based on. the the ‘ory that

- the praginatic test should: be extended bevohd the: “eco.

nomie equivalent” situations to cover the facts of thissease. .

°

- ©

_ into another of the same. issue)

sion in these cases,tlearly set out in Blau vy. Lamb, 363

-

e ‘«

ach of the cases on’ which defendant relies for: its first

argument involve either the ‘conversion, Ferraiolo v. New-

man, supra; Blau v. Max Factor, supra; Pettys v.. Butler,

supra, or reclassification, Roberts ve Katon, supra; Blau v.

~ Mission Corp.,, supra, of one class of an insurer’s securities

. The basis for the conelu-

}

F.2d at 521-522, is that the two types of stock were virtual

‘economic equivalents and the conversion or- reclassific¢a-

ve . . : . > s . ng Si " °

tion did not: present an additional opportunity for et

abuse. RINO- contends. that the securities which it gave up

‘and those whieh it received were virtually, economie equiva-

lents.

.

“Initially, | question’ whether an exchange of two differ-

ent issuers’ securities could ever present. the “economic |

equivalence” issue that appears to be the heart of the cases”

on which RKO relies. My reading of Blau v. Lamb indi-

eates to me “that the economie equivalenge on which the

court based. its redisoning was the objective, clearly demon-

’ e F . “3° * , - oy . . 38

strable, inarket igter-changeability of the two types of se-._

curities. It would seer th be nearly impossible to demon-

strate such economic equivalence where, the issuers -are

substantially. different companies: eCf.° Blau v. Mission

, Corp., supra., As the Blawy. Lamb court stated:

“sales or purchases by an insider-of his issuer's

securities for cash, the sceurities.of a different com-

_ pany, or other property are within the reach of See-.

tion 16(b), even’ though, if these are arms-length

transactions, each side will receive what if eonsiders

to be at least economically equivalent to what it sur-

_ renders: *Focens-om the factér of economic equiva.

lence is only relevant when—as in a conversion or a

>

-; 4 =

‘ a1 -.

Teasifcaton that ich the josie surrenders

and that which he Aeceives ‘are . sunply ne

. forms of the saine participation in his j issuer.” (Enh.

phasis added. ): 363 F.2dhat 523: | .

; J | { ¢

“OU yon this rez asoning ‘and definition : of -eeonomiec equiva-

lenlee, 1 conelude ’ Phat RKO iNej incorrect in its argument

_ a in this case. there was’ an “exchange” of different

‘orms of the s same participation in the j Issuer,

But an even more fundamental] difficiel t= confronts RKO

on this point. It ig abundantly clear that the "49% holding

of Central common stock be fore the mefger is in no way

equivalent to the 20- 259% holding of Central-F rontier ¢om-

. mon stock which it rece ived in e xchange.’ RIKO vigorously

O° :

contends that the. court shoulil take into account its prior

ownership of 566% of the common stock of F rontier ini eon-

sidering the economic. equivalence of the securities ,ex-

changed. Brie ‘fly stated,. its argument: is that ‘after the

merger, 9: . rl = ne Mastin

. [RKO] still held an equity. position-in a loe: al ser-

vice airline, which was no more than the sum of its

; equity position i in both lines prior to the merger, and

‘that equaty —— Was at all times stipe! to the

vieissitudes of therdtlarke t ious ” Def.’s Brie f; “pe 26 ig

1 reject this argument for t two reasons. Iirst, RKO’ s hold-

‘ings of F rontier furnished Ng assurance to the stockholders

of Central that: the ¢alie of their securities would Be ade-:

quately protected in the ate rger. Second, as is trne_in so

* Although the analysis pertains only to the transa¢tions in eom-

mon stock, it is equally applicable to transat ‘tion's m the cony ertible

debentures. ; . e

¢

?2Sa

many mergers, the record indicates that the resulting cor-

8

poration was more than the sum of its constituent parts.

Defendant makes an independent argument from Blau v.

Lamb based on the general’ principle that no “sale” will be

found wher the transaction dloes not admit of the possi-

bility of insider abuse. Basie: lly, RKO urges that, by the

time it hecame.an insider under’the statute, and hence was

presumed to have inside information, it was “locked into”

the merger at the 1 for 31, ratio, and could not possibly use

‘any insider information it might have aequired.

Defendant rests -this argument upon two eases decided

%.some time ago by the Court of Appeals for this Cireuit,

blawv. Ogsbury; 240 F.2d 426 (2d, Cir. 1954) and Stellay.

Graham-Parye Motors Corp,, 232 F.2d 299 (3d Cir.), cert.

deni?d 552. U.S. S31 (1956). A brief discussion of these two

‘ases will’ be helpful. : :

‘In Oashur y, the de fendant director- officer had been

awarded a.non- assignable option to purelfase 10,000 shares

of the contpany's ; common stock as a part of his compensa-

tion. The option was exercised in De eember, 1945, but the

actual exchange did not take place until December, 1948,

‘In refusing to. accept plaintiff’s argument that-tlie ‘ ‘pur-

chase” occurred in December, 1948, the court held that the

date of exercise was. the date o ehas yecause de-

_date of s the date of ‘“purchase” becaus |

fendant then “ineurred an irrevocable liability to take and

pay for the stock.” 210 F.2d at 427. Tn elaborating dts

_re asoning , the court stated :

+"

. It mattprs — to the speculator who had title or

* _ possession or who ean vote the stock or receive divi-

dends,/ What he needs is firm assurance that a fixed

* As the CAB examiner stated, ‘ T1It is clear that the com-

bined operations of Frontier and peti: will be more profitable

than the operation of two carriers as, separate entities . .°.”

29a ae

quantity can ia acquired or disposed of at a fixed ”

price; and speculation, actual or potential, is the only |

Vice within the purview “of 16(b)., . -” 210 F.2d at

427,

Although the gnsuage would appear to indicate that the

date of purchase was the date on which the option Was:

granted, the court was not required to reach that question

_ Since the December, 1945. date was outside the statutory

period of six months and w as sufficient to allow Summary

judgment for defendant. ” | pee

The court was pres sented with a | eomewhad diffe sail tes:

tual pattern in Stella. There th« defendant had contracted

to purchase thé statutory 10°C of the company's common.

stock subject: to the- condition that it receive a loan from

a named bank to pay for the securit The court rejected

the defendant's contention, that the date ofthe contract

_ was the date of purchase. Tt held that the “purchase” could

not occur until the condition precedent had been fulfilled,

The court also rejected Graham- Paige’ s argument that it

could not be considered an insider ‘at the time of the -pur-

chase. which made it a “beneficial owner’ ’ of over 10° of

- the common stock of the pees to

‘The court went on to consider a question: wholly: unneces-

sary for its decisions whether or not Graham -Paige had be-

LS,

come a “henefici al owner” of the securities: at the date of .

the contract. Its Teasoning on this point was as follows:

“In Blau v. Oasbury; supra, the duceHon was when

the holder as an option to buy stock bee ‘ame the ‘bene-

‘ficial owner.’ We held that it was not (a) the date

when be eeatsieas the option, nor (b) the day when

‘having exercised it, he paid for the. stock and ob-

: ~ tained legal title to it, but (¢) the day when he

30a

exercised. the option with the result that he -had

then » fixed right and obligation under an exécutory

contract. See also Park & ‘Tilford v. Schulte, 2 Cir.,

160° F.2d 984, YT where we said that, ‘upon. the

exercise of an.option, the optionee becomes an ‘ine

sider’ and thus within the Congressional purpose

to ‘protect the outside stockholders against at-least .

shoft-swing speculation by insiders with advance in-

formation.’. Our reasoning was that one who holds

an unexereised option ix not usually in a position = -

to obtain such information from the company. Here

Graham-Paige, as long as it had an election to back

out of the agreement to purchase, was not an ‘in-

sider™ under Section 16(b)."° 232 F.2d at 301. - °

With due respeet, L believe that the two cited bases for the

. courts \lictun give no support for the jcone.usion reached.

As | have pointed out, the defendant jn Blaw ve Ogshury

.Was a director-officer; hence, the court wud no legal reason

to consider ‘the date on which he became a “beneficial

owner” under the statute. The citation of Park & Tilford

in the above quotation is no more helpful heeause the hald-

ing in that case was that the conversion of convertible

within the mean-

preferred into common was a “purchase?

ing of the statute. — 2 | |

The obvious unstated -assumption in the quoted dietum

from Stella is that one cannot become a “beneficial owner”

until the “purchase”

the class of security. Although the court in Ogshury and

’

* which gives hin niore than 10% of

Stella was not directly faced with this question, I believe

that it is presented squarely by the facts of this case.

On May 3 or 4, 1967, after executing the contract to pur-

chase the Central securities, RKO was in the following, -

position. It held an option to buy a very-substantial num-

r

3la

ber of Central securities at the equivalent price of $8.50

per share on the condition that the merger was consum-

mated. It could rely upow the exchange ratio of one share

of Irontier for each 31% shares of Central. Thus, the

condition precedent to its obligation to purchase ‘the: shares

was the same occurrence which concluded the disposition

of he Central securities. Moreover, under the contract

RIO had thé obligation to process the merger through the

federal regulatory procedures of the CAB.

With this brief background in mind, the date on whieh,

the inside information became available te RKO as a

“beneficial owner” of Central securities must be decided.

In my view, the pragmatic approach outlined in Blaiw \

Lamb compels the conclusion that R KO was a “beneficial

owner” and presumably had ‘inside information on May

8 or 4, 1967, when it contracted to acquire the Central

securities on the sole condition that the Inerger be. com-

pleted. See, Feldman & Teberg, Beneficial Ow nership. un-

der Section 16 of the Securities Exchange | Act of 1934,

17 West. Res. L. Rev. 1054, 1083:1095 (1966). T might-add,

without necessarily Raacrecing: with the dictum of the

Stella court,” that it would tax the credulity of this court

to beleve that RKO did not in fact have inside informa-

.tion at the contract date by reason 6f its relationship with

Central. See, Feldman & Tehberg, supra, at 1090,

1 turn now to the ultimate question under the rubric of

Blau vy. Lamb—did the ditposition of these. securities in

- any way allow the abuse of inside information Ww hich See-

‘tion iG(b) was designed to prevent? IT believe that jt did

in at least two ways. First, at the time the contract Was

The court stated flatly, * ‘that one who holds an wnexercised

option is nut usually in a position to obtain {inside | information

from the company.” 232 F.2d at 301.

°

.

32a & ok

made to acquire the Central securities, RKO was or could.

-have been “gi unbling”’ > that the established exchange ratio -

would turn out to be more advantageous than its effective

purchase price of $8.50 per. share, The second possibility

of the misuse“of inside information is a result of the fact

that RICO could influence the speed and timing of the

merger, and possibly its outcome, In this connection, two

uncontroverted facts are pertinent: first, RIXKO had a very

significant ‘interest in both airlines before, the merger, and

‘thus as a practical matter may have, been able. to” force

‘abandonment of the merger; and, second, RISQ had _ to

specifically consent to certain conditions. placed on the

merger. by the CAB because it controlled Frontier. Under

the circumstances, I must ‘conclude. that there was a pos-

sibility of RIKO's use of inside information.

There is no need to deal extensively with RKO’s argu-

a

ment, derived from language in Roberts vy. EFaton, 212 F.2d

82, 85-86 (2d-Cir.), cert. denied 348 U.S. 827 (1954) and |

Shaw v. Dreyfus, 172 F.2d 140 (2d Cir), cert. denied 337

U.S. 907 (1949), that since shareholders _of- Central were

treated the same in the merger, there was no possibility

of insider abuse. All shareholders were not treated the

. ” : . . 4

same, since none but RKO was afforded: the opportunity

to acquire stock or contract for its acquisition on May 3

or-4, 1967, at what turned out to be the bargain price of

$8.50 per Share. Marquette Cement Mfg. Co. v. Andreas,

239 F. Supp. 962 (S.D.N.Y. 1965). Nor does the fact that -

all Central shareholders may have benefitted from an. in-

erease.in the value of their shares because of the merger

aid defendant. ~ 7 ric

Fk “inal *, RKO argues that even if there was a “purchase”

and até fale” within the statutory period, there was no

“profit reahzed”. . The primary basis for this argument

33a

is another of the é¢onversion cases, Heli-Coil Corp. vy.

Webster, BSINP.2d 156 (3d, Cir. 1965). In that case, the

court took thy “automatic” approach in finding that a con

Version fi a convertible. preferred ‘to comunom was a

Ssale’™ ol the convertible preferred, but ‘found that there,

Was he “profit realized” on the transaction. 1 note’ that in

Bia, Li Wh the Court of Appeals criticized the approach

taken on the “sale question in) Meli-¢ ‘ou; 303) F.2d. at

919-520. More ‘OVET, the reasoning of the Third’ Circuit: on

the question of “profit “veakized” can be understood as an’

attempt to mitigate the infle ‘ibility of the “automatie™ test

by coming to grips with the economic facts with which’ the

Second ( irewit was dealing in Blau v. Lamb. Since these

economic factors have been analyzed hereinabove; recon.

sideration of the s same, points under. this point is unneces-

sary. : :

_In summary, it is ruled that plaintiff has established the

thre ‘e contested elements of its Section 16(b) claim. -

ITT.

SPATUTORY AND COMMON LAW DEFENSES

Defendant raises.five “defenses”,-any one of which would

immimize it from Seetion 16(b)} ltability if accepted by this

court, despite the result already -reached in Part I] of this

opinion. “The most seriously asserted of these defenses ’ is

that this transaction is exempted’ from operation of the

statute by Section 414 of the Federal Aviation Act, 49.

U.S.C2'8 1384, which ‘states:

“Any person affected by any order made under see-

tions 1378, 1379, or 1382 of this. title shall be, and-is

hereby, relieved from the oper rations of oe

trust laws’, as designated in section 12 of Title 15.

’

and of all other restraints or prohibitions made by,

or imposed under, authority of law. insofar as may’

“be necessary to enable such person to do anything

authorized, approved, or required by such order.”

Defendant is correct in asserting that the immunity it

urges flows from the statute, if at all, and that there is .

no. requirement that the CAB have. specific: ally exempted

it from’ Section 16(b). See, Brotherhood of Locomotive .

Engineers v. Chicago &- Northwestern Ry. Co.; 314 F.2d -

424, 482 (Sth Cir. 1963). -T must therefore consider. the

question whether Section 414 was intended to protect per-

sons affected by a CAB order ftom Q Securities, exchange

Act ldaim under Section 16(b).

Delicate wrghle ms are often presented to a L court hearing

2 federal claim against a party which is subject to a com-

-prehensive regulatory scheme enacted hy ar. See,

g.. Pan Ajnericaw World Agrways, Tne. v. UL S., 371 US,

296 (1963). But I think that this issue can be resolved by a

relatively straight-forward interpretation of Section 414,

thus avoiding the broader “question of possible conflict he-

-tween the federal aviation Jaws and the federal securities -

laws. See 2 Loss, Securities Regulation 427, m. 215 (2d ed.

1961). aay ahi ay -.

Section 16(b) is a unique regulatory measure in that it

‘purposely includes within its reach some ‘innocent dealings

in order to “discourage transactions in an area in which

abuse was rampant. Blan ve Lamb, 363 F.2d 507, 515 (2d.

Cir. 1966). cert. denied 385 US. 1002 (1966). Thus, the Con-

gress Hd not prohibit short-swing transactions entirely, but

provided only that the corpor ation. could recover profits.

See cLdler y. Nlawans, 267 F.2d 840, 844 (2d Cir. 1959).

Therefore, an ‘insider Jike RIKXO is in né way precluded

. ° dpa

from executing’short-swing purchases and sales by Section

16(b).. | . _

T assume without. deciding that Section 16(b) is a

straint of law” within the meaning of Section 414,.set out.

above. But the stettite inmunizes KKO only ‘insofar as

bey.

re-

may be necessary to enable [RIXO] to do anything... ap-

proved... by such orden” 49 U.S.C. ¢ 1384. supra. Because

ef the peculiar method wsed by. Congress’ in Section 16())

ofthe Exchange Act, RKO Was capable of legally complet- :

ing the merger. Although it is presumably true, as defen. ”

dant argues, that it “would undoubtedly not have proceeded

with the merger if sulject to a suil of the present type,”

there was nothing in Section 16(b) which prevented it from

doing so. Tn other words, I see no direct. confliet between

Section 16(b) of the Exchange Act and the power of the -

CAB to approve mergers. See, Trans World Airlines, Ine.

v. Hughes, 332 F.2d 602, 608 (2d Cir. 1964). feet.

Defendant also claims .that the Securities Exchange |

Commission (“SHC"), pursuant to its statutory authority, ~—

15 U.S.C. § T8p(b), has exempted this transaction from the

Bini ‘ation of Section 16(b) as not within the statutory in-

tent. The first rule under which it claims is Rule [6b-

7(a) (3). 17 CPLR. § 240.16b-7, which is set out in the mar-

gin."” The short answer to ‘defendant's argument is that it

© “(a) The following transactions shall be exempt from, he pro-

visions of section 16(b) as not comprehended within t).e purpose

‘of said subséction : it |

_ (3) The acquisition YG a security of a company, pursuant to a

merger or consolidation, in exchange for as urity of-a company

which, prior to said merger or consolidation, held over 85 percent

of the combined assets of a!) the companies undergoing merger or

consolidation, computed eccording to their book values prior to

the merger or consolidation, as-determined by reference to their

most recent available financial statements for a 12-month period

prior to the merger or consolidation.” * \

.

36a

did not aequire “a security of a company . . . In exchange

for a security of a company which, prior ‘to said Wpetgen

held over 85 percent of the combined assets 2... RKO |

ee Central-Frontier shares in-exe ‘hange | for Ceuteat

shi ares. Central certainly did not own over 85‘ “ of the ¢ com:

“bined book \ faltie assets. )

RKO also claims ‘an exemption under Rule. 16b-9(a), 17

“ELR. § 240.16b-9, which is set out below." This rule cov-

vrs hy gbeiias inte nt ‘and plain Innguage the conversion of

* one class of eqnity, see urities of an issuer, into. another of.

the “same issuer”. 1 rejects RKO'S argument that. Central-

Frontier is the “same issuer” ‘as Central, for re: isons that

should be obvious: from amy discussion of defendant's ar-

eiment on this point at the outset of Part IT of this opinion.

Defendant raises two final defenses. which have no merit.

It argues that the very occurrence. which we have found to

he a “sale” was the cessation of the existence. of Central

and, therefore, the Section 16()) claim never: accrued to

“Central. Suflice it to saw that the claim aecrued to Cen-

tral at the moment’of the operation of the merger. Accep-

tance of defendant's argument would cre ate. an unwar-

ranted loophole, in the law, of, Section 16(b) ag applied to

mergers. Finally, defendant claims that‘the overwhelming

approval of the merger by the share holders of both air-

lines operates to estop Central, and hence plaintiff, from

asserting this claim. “T reject this argument ‘since it is the

law of this Cireuit that estoppel principles, are inapplicable

*"“(a) Any acquisition or disposition of an equity security in-

¢ volved in the conversion‘of an. equity security which, by its terms

or —— the ternis-af_the corporate charter ‘or-other govern-

-ing instriiments, is convertible immediately or after a stated. period

“of time into another eapity security of the same issuer, shall be

exemhpt from the operation of section 16(b) of the Act...” ”

1 RKO eoncedes that claims which ace ‘rued to Central now ie.

long to Central-Frontier.’ Def.’s Brief, pp. 41-52,

“ ft ‘ N

: :

. as

\

&

oa aha 87a

‘ ?

to Section 16(b) claims.: Marquette Cement Mfg. Co. x.

_ Andreas, 239 F. Supp. J62, 966 (S.D.N.Y. 1965) and cases ©

\ ited therein. | | Sears

ee

| CONCLUSION

>»

| Plaintiff hae ( stablished its Section 16(b) claim as a mat-

ter of law.on the undisputed facts of this. case. Therefore, ~

I direct entry of summary judgment on the i issue of liability ,

in favor of. plaintiff and deny: ‘defendant’ s motion for sum/

/

mary judgment. | ;

It is so ordered. .. ee eas tae

Dated: New York, i &

_~ ~ December 4, 1968.

7 HL. R. Ty, In

j | Ree: ‘US.D.J.

Mee

382

/ APPENDIX C. os

Opinion of the District Court

-

.

‘ “

UNITED STATES DISTRICT COURT

Souruern Districr or New York

. —_—>—-

[SAME TITLE]

—

“WKavemayn, Tayior, Komen & Miner,’ Hsqs.

~ New York, N.Y. *° ”

Attorneys for Plaintiff oo. ‘

Sranniey b. Navrmay, Esa.

SHepuarp S. Minurr, Ese.’ . ;

Aupan K. Preéxen, Mse.

Of Counsel

.

Recax Gororans Powrns & Quins, Esqss

New York,N.Y. °° i

Attorneys for defendant RIKO General, Ine.

Joux J. Garcay; Hse. cele

Perer G. Corserr, sa.

Of Counse!}

Snea Gattor Cum EN KO. & Goutn, -Esgs.

a New York, N.Y. Ga ab

Attorneys tor defendant Frontier Airlines,-Ine.

Francis J. Purcers, Msq. .

, ‘Of Counse!

Oprnion

jonsaL, D.J.

Plaintiff, a shareholder of Frontier Airlines, Inc. (Fron-

tiér), a Nevada corporation, brought this action imder Sec-

2 ‘ 5

° om |

.

ft

court, without a jury,

39a

pre 16(b) of tlie Sccurities [Exe ‘ange Act of 1934, » 15. USE.

) T8p(b), to recover on be ‘half of F rontier , “short- -swing”’

. " profits allegedly re alized\hy RKO Genéral, Ine. (RKO), an

“insider” of Frontier. “\ . .

In an opinion. reported at od Ir Surip. 358 (S. DN.Y.

AS), Judge Tyler held that, on the undisputed facts, plain--

Stitt stated aclaim upder Setion Nib), that RIKO was liable .

"Mo plaintiff for the short: -sWing a that

thevonly issue for trial Was the amount of the profit realized

iy RKO,

The issue of. the quot Of profit. Was tried before 1 the

‘ Fd

The undisputed facts, upon which Daze. ayiet found

liability, are as follows: ‘tags

f

On Apeil 5, 1967, RKO Gwned M65 of the vulstendiae |

common stock of Fi rontier PO: thet dates Frontier and Ce n-

tral Airlines, Ine. (C entral), a’ Nevada corporation, agreed:

in principle to a merger of Central into Frontier with an

xen ‘atio of one share of Frontier common stock for

each 514 shares of Central common stock.

Ine arly May 1967, RKO contracted w ‘ith a’small number

: “major Central sharchoiders to purchase 498,25) . shares

Central RS "ee stock, representing 49% of Central's

wlecubas shares and $500,000 principal face amount of,

Central convertible debe ‘ntures, which were convertible: into

an additional” 149,994 shares of Central common (herein-

after, the Central securities), The purchase of the Common

stock was made at the rate of $8.50 per share of common,

stock: the purcliase of the debentures was made ; at the rafe.

OF $8.50 per-share of the common stock into which the

debentures Were convertible, As. a part of the purchase

agreement, Central shi areholders owning Approximately

6% of the Central commen stock promised that they would

vote their shares in favor of the Inerger, At ~ time of the

. =

_*° a

’

«J

”.

oe?

f

40a . °

execution of the purchase agreement, neither the public nor

the other shareholders of the two corporations had been. in-

formed of the proposed merger.

Thereafter, on May 4.1967, Central and Frontier exe-

cuted. a formal agreement of merger at the. previously

agreed. upon exchange 1 ‘atio, VIZ, 314 shares of Central for

one share of Frontier, A press release on the merger agrée-

inent was issued that day, and the next, day reports based

on the release described the mer oor agreement and dis-

closed the existence of RIXO's- contract with the Central

shareholders to: purchase the Central SOC urities.

On May 10,1967, Frontier’s Board of Directors declared

a two-for-one split of I" rontier common stock.

On July 27, 1967, the shareholders of. Central and Frontier

approved the merger-and the F ronticr.shareholders ratified

the 2-1 split of Frontier common stock, the terms of the

exchange ratio being adjusted to compensate for the stock

split by providing an exchange. ratio of two shares of

Frontier common. stock for each 34% shares -of. Central

. common stock.

On September 1, 1967, subject to certain conditions to

he accepted by Frontier, the Civil’-Aeronanties Board's

(CAB) approval of the merger became effective. There-

after, on September TS, 1967, TUSO received the Central

securities for which it had contracted with the Central

shareholders and paid a total purchase price of: $7,550,-

QS2.50. On the same day, the merger agreement was filed.

with the Seeretary of State of the State of Nevada. On

September’ 20, 1967, the CAB reecived notice of Frontier’s

acceptance of the conditietis referred-te ahove and Fron-

~tier’s request that the CAB transfer Central’s certificate

of publie convenience to Frontier, effective October 1, 1967.

On October 1, 1967, the exchange’ of. securities between

‘Central and rR rontier took place. In exchange — its Central

ow

=

4la

.

securities, RKO received’ 421,857 shares of the new Frontier

‘common stock and iew Frontier debentures ‘convertible

into 85,714 shares of the new, Frontier common stock (here-

inafter, the Frontier securities), iy ea ae |

Judge Tytler found that RKO purchased the Central

securities in carly May 1967; that RKO sold its Central

securities when it exchanged them for the new Frontier, se-

curities on September 18, 1967, or October 1, N67: and ©

that RIKO realized.a profit by its sale of the Central secur?-

ties. PVR Fe . :

Since RKO purchased the. Central securities for $7,550,-

* 082.50 ($8.50 per share’ times 738,251 shares of common

stock, and $8250 per Share times debentures convertible.

into 149,994 shares of common stock), the measure of its

"RKO contends that an inerement of $5.29 must besadded to the

‘purchase price of $8.50 per share, whieh increment represents the

difference between the sale price of Central on the date the contract

to buy was exercised, September 18, 1967, and the sale price on the °

date the contract was executed, around May 4, 1967. However. in

his opinion, Judge Tyler found uncontested the fact that the price

RKO actually paid “was $8.50 per share, not $13.75) per share.

Furthermore, the so-called employee stock option cases,, cited: by

MIKO, are inapplicable here, since RKO. did not render any services

to Central during the period in question, nor was the option to buy

granted so as to stimulate RKO’s efforts on belialf of Central. Fur-

' thermore, RKO did not contract to buy from Central, but from

individual Central shareholders. Compidre Truncale y, Blumberg,

88 F. Supp. 677 (S.D.N-Y. 1950). See generally, Green and Kelly,

Application. of Section 16(b) to Insiders’ Transactions under Em-,

ployce Stock Option Plans, 17.Bus. Law. 402 (1962), reprinted in

American Bar Association, Selected Articlis on Fe daral Sceurities

Law 667 (1968). Therefore, the court adheres to Judge Tyler's

statement that ‘on September 18, 1967, RKO received the Centra]

stock and convertible debentures for which it had previousl¥ con-

tracted: and paid a total’ purchase price of #8,590,082.50 (sic),”

294 F. Supp. 358, 360. —

RKO also contends that the contract to purchase Central deben-

tures should be excluded entirely from the computations. However,

Judge Tyler held that the convertibility aspects of the transaction

| did not provide ar exemption from liability under ,Blau v. Lamb,

363 F.2d 507 (2d Cir, 1966). cert. de nic d, 385 U.S. 1002 (1967),

t

42a |

profit depends on the sales price, viz. the value of the ,

Frontier securities received in exchange for the Central

securities. Park & Tilford, Inc. v. Schulte, 160 F.2d 984 (2d

Cir.), cert. dented, 382 U.S. TOL (1947); Blau v. Mission

| Corporation, Y12 F.2d 77 (2d Cir), cert. denied, 347 US.

1016 (1954). |

Plaintiff contends that the appropriate date for deter-

mining the fair market value of the Frontier securities is

September 18, 1967, when the merger agreement was filed

With the Secretary of State of Nevada. Defendant argues

that the appropriate date is October 2, 1967, the first market

day after the securities were physically exchanged.

The date of October 1 (or October 2), 1967, has no-rele-

vance to the,issue of fair market value, since the onl thing

which occurred at that thne was the exchange of certifi-

cates, a “mechanical detail.” 2 Loss, Securities Regulation

1071-2 {2d ed. 19GL). Furthermore, Nevada law provides

that the filing date of a merger is the effective date of the

merger, (78495, Ne vada Revised Statutes, Therefore, the

court finds that the appropriate date for determining fair

market value is September 1S, 1967, when the mer ger agree.

ment was filed. ; |

. Both plaintiff and defendant offered expert testimony

as to fair market value on September 18, 1967.

Plaintiff's expert,. Dr. Douglas Bellemore, investment

analyst and a professor of finane “eat New York University

Graduate School of Business Administration, testified that

or sictian i Rule 16b-9, 17 CLLR. 240.16b-9, upon while h RKO relies,

see 294 F. Supp. at 362, 367. See generally, Lang and Katz, Lia-

bility for “Short Swing” Trading in Corporate Reorganization,

20 Sw.L.J. 472 (1966), reprinted in A.B.A., Selected Artieles on

. Federal Securities Law 679 (1968). It follows from Judge Tyler's

holding that the convertible debentures must be included in the

“computation of profit realized.

“ , "4

e «

t~ ¥ . . 48a. 7

the market value of a stock is the value per share at which

_the-stock is traded between informed buyers and sellers

under no compulsion to buy or sell. Such trades, occur on

national stock exchanges, such-as the New York or Amer- .

ican Stock Exchanges, when there is a “good continuous

market, an orderly market ... with frequent transactions,

reasonable volume .. . and not too significant spreads be-

tween the prices of the transactions.” es

Dr. Bellemore testified that in 1967 the market in’ Frontier

common stock, listed on the Américan Stock Exchange,

satisfied these conditions, and that the market price of

20 rontier on a given day corresponded quite closely to its’ -

market value. On September 18, 1967, the aver age market

price for Frontier was 26V% (high: 26%; low: 2534). How-

ever, Dr. Bellemore testified that, in his opinion, the average

market price did not represent the fair market value ‘of

the !*rontier stock to ‘RKO ‘beeause of the control factor.

’ Prior to the merger, RKO owned 56% of Frontier common

stock. Had RKO. not acquired the Central securities, its

percentage of ownership upon the merger neconeag effec-

tive would have dropped from 569 7e to 430 c. By aequiring

On September 18, 1967, before the merger became effective.

RKO owned 1,632,404 shares of Frontier common stock, or 56.02%

of the 2,914,006 shares outstanding (aftér-adjustment for 2-1

split). After the merger, there were to be 3.774:940 shares of.

Frontier common outstanding,’ of which RKO would own the same

1,632,404, or 43.42%.

Dr. Bellemore testified that if RKO had not acquired the Gaia

securities and if all outstanding warrants and options on Frontier

common stock were exercised (equivalent to 1.6 million shares),

RKO’s percentage of ownership would drop to 30% (RKO’s owner-.

ship of about.1.6 million is 30% of the total of 3.7 million outstand-

‘ing plus the additional 1.6 million from warrants and options).

There was no testimony as to what RKO’s percentage of ownership _

would be after the merger and after its acquisition of the Central

securities if all warrants and options were exercised, but using

the same figures, it appears that: RKO’s percentage of ownership

would be 40% (RKO’s ownership of 2.1 million after the merger

°

d4a

738,251 shares of ¢ ‘entral which we

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