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

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Petition for Writ of Certiorari
- **Published:** January 1, 1970
- **Citation:** 400 U.S. 854

## Text

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At COURT We Ss | ee a
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[IN THE. aI
Supreme Court uf the Hnited” Siates
Ocrober TERM, 170 * aa os
| “NO. a eae aN ra fa
re —~~
e RAO Genxninar. ‘Inc, . | 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 |

: ‘ . PAG}
OPINIONS BELOW 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
‘ ” ane
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
a

%

Ww

“ill
. ° > F °
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

‘ “1\ q -
: PAG
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’
»
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;
~> . . 2
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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,
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 —

-

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.

.

_

ae

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mm

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

-

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

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—*
- 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

a

APPENDICES.

nA

: Pz .

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
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 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 re exchanged for 421,857
: rontier shares, and debentures which bees ame convertible
into 85,714 Frontier shares, RKO was able to maintain its
percentage of ownership of Frontier common stock at 56%.

In Dr. Bellemore’s opinion, the maintenance of its 56%
control through the purchase of the Central securities and
their exchange for Frontier securities at the time of merger

was valuable to RIKO, for which RKO would be willing to -

_pay a premium above market price.

Dr. Bellemore testified that on previous occasions pur-

chasers of the so-called “control factor” in Frontier, includ-

ing RKO, had paid premiums ranging from 15% to. 28%
above market prices,’ and‘he concluded that RKO would be
willing to pay 15¢¢ above-the inarket price on September 18,

‘1967, for the Frontier securities whieh would enable it*to re-

is 40% of the total of 3.7 million outstanding and 1.6 million from

options and warrants). However, this percentage is not relevant

inasmuch as it is clear that RIKO's object Was..to buy enough
Central securities so that after the terger it would maintain. its
percentage of ownership of the outstamding comnion stock at 56%,
without taking into consideration the options and warrants, which

‘might in the future be exercised.

3 After the merger, RKO owned its original 1,632,404 shares,
plus 421,857 converted from Central common, and 85,714 converted
from. Central debentures, for a total of 2.139, 975 ), out of 3,774,940
shares outstanding, or 56.69%

*In March 1962, the Goldfield Consolidated a Company
(later changed to The Goldfield Company) purchased from the
Maytag family 625, 046 shares of Frontier common, or 66.3%, for
“investment purposes” at an average price of $4. 80 per share, .
while the market price was 3°4 bid, 3% ‘asked, Which. price indi-._
cates-a premium of approximately 26%.

In November 1964, RKO purchased from Goldfield 651,308 shares

‘of Frontier common, or 54.1%, for “investment purposes” at a
price of $10 per share, which: was $l. 375 above market price, or a

premium of 15%. :

In December 1964, RKO purché acid 16 341 shares of Frontier
common from Frontier at $10 per share. "These shares had previ-
ously been held by- Frontier as treasury shares and the premium

paid was approximately 20%.

45a 2

tain its’ 56% control. Using the high price of Frontier
(26%), Smolowe v. Delendo Corp., 136 F.2d 231 (2d Cir.), |
cert. denied 320 U.S. 751 (1945), and adding the premiun
factor.of 15%, the fair’ market value of the block of Fron-
tier securities on September 18,- 1967 was $15,470,764., and
the realized profit to RKO on that date was $7,920,681. (or
a cost of $7,550,082.). res
__ RKO’s expert, Edward F. Dugan, Vice-President and di-
rector of Smith, Barney & Company, investment bankers,
testified that he specialized in airlines and that among the
accounts he has worked on since joining Smith, Barney in
1961 was RKO’s successful bid to take control of Frontier
in 1964, Frontier’s successful finaneing of a $15 million pub-
lic offering of debentures with warrants in Marelr 1967, and
Frontier’s $20 million offering of convertible debentures int
October 1967, Dugan testified that the bulk of his work had
been with small airlines, like Frontier-and Central.

Dugan testified that in evaluating the value of a block of
securities, such as the block of ‘over DO00,000 «shares of.
Frontier involved here, he would consider the following
ten elements: 1) the quoted market price;,2) where the
stock is traded; 3) the size of the block relative to the
number of shares outstanding and the trading activity in
the stock: 4) whether the stock was free lv tradeable gr was
.estricted by “investment purpgse” represe ntations; 5)
the identity of the seller; 6) any gove ynmental restrictions
on sale, such as the need for approval by the CAB; 7)
recent price movements in the stock; 8) price-earnings
(P/E) ratio of the stock relative to other stocks in the
same industry; 9) the financial trend of the ‘company ; 10)
the general trend in the market. |

Dugan testified that in light of these factors the fair
market price of the Frontier securities received by RKO on

46a

September -18, 1967 was 40% to 50% less than the market
price, for the following reasons: . 5;

First, the value’ would be reduced by about 20% because
the stock was not registered with the SEC and “therefore
the buyers must ‘give investment representations in order
to buy it.” Furthermore, if the stock were to be registered,
the registration Would have to- occur at the “worst” time for
Mrontier, —' ON ‘rontier = pending €20 million deben?
ture offer. \

‘ Second, the i would be reduced by an additional 10%
to 20% because RKO, the parent company, was the seller,
and this might be construed in the market as the first step
in a sell-out by RKO.

Third, the value would be reduced another 109% yo because —
Frontier common stock was selling at a P/E ratio of 80.
times earnings’ and the company’s immediate financial
picture was not good, with earnings considerably lower
than the.vear. before. Pee Wa ae
Finally, even if the prospective purchaser knew that
RKO would not continue to sell, the purchaser would know
that he was in a permanent minority position with RKO
holding 48°¢ of the stock. Dugarm testified that if.it was
made clear that RKO was not “bailing out,” the discount
from market price w ould still be about 331/ o%.

Dugan caleulated that with a 50% discount froin the high
market price on September 18, 1967, the value of the block
of Frontier securities was $6,725,315.75, 6r $824,766.75 less
than the purchase price of $7.550,082.50.. T hus, RIKO had |
realized no profit. ;

RKO’s computations indicate a realized profit of: $52 10,-
296.40 using a 40% discount factor, and a realized profit of
$1,417,005.16 using a 3314,% discount factor. ;

On rebuttal, Dr. Bellemore disputed Mr. Dugan’s analysts
of Frontier’s P/E ratio and testified that the American

Stock Exchange's ability to hatrle exchange and secondary
distributions would enable it to handle a block of this size
» at or about the prey vailing market price. i”
On the basis of the testimony, the. court does not find that
a discount faétor should by applied. to the market price of
Frontier stock on September 18, 1 967. '
Dugan was not testifying from the point: of view of
“market value, which is the test under Section 16(b), Blau
v. Mission Corp., supras Stella v. Graham-Paige Motors
Corp., 259 F.2d 476 (2d Cir. 1958), but from “investment
Value,” Which is more subjective, and more susceptible to’
individual variations because of ai emphasis. on Gne factor
rather than another. Section 16(b) is concerned with as
objective a valuation as possible, which is generally deter-—
mined by ‘the market value. Blaw v. Mission Corporation,
supra, Moreover, Pugaa gave no weight to the previous
history of sales of large control blocks of-Frontier securities
mat prices above, not below, the market: see footnote 4,°
supra: ae
The sole remaining question is Whether a: premium for.
control should be acded to the market price, which depends
on whether the stock was worth more to RKO’ than the.
aharket price, to enable it to retain 366¢ control following
the merger. Whether a premitun should be added to market
price to clot termine v-uized profit under Section 16(b) was
considered in Fistel vy. Christman, 185 F. Supp. 830, 832
(S.D.N.Y. 1955) ; and Blau y. Lamb, 242 F. Supp. 151, 160-1
(S.D.N.Y.-1965), aff'd in part, reed in part, 363 F.2d 507
(2d -Cir. 1966), cert. de red, B85 Us. 1002 (1967).

> Plaintiff's expert, Dr. Bellemore, testified that he made an “in-
vestment value” analysis of Frontier and concluded that the inyest-
* ment value was.very ‘close to thé market value and that n6 d.s¢ount
‘ factor should be applied. a"

ie te

48a

o>
’
’

~ In Fistel, Judge Weinfeld valued 4,217 shares of Federal

‘Enamel stock at no less than $140 per share. “There, the

expert witness testified as to market prices

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385605_0178%3A1. Public record. Not legal advice.