Petition for Writ of Certiorari — Tristar Corp. v. Freitas
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96 577 OCT 1 119%
No Sent Oe Bus CLERK
In The
Supreme Court of the United States
October Term, 1996
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TRISTAR CORPORATION,
Petitioner,
Vv.
ROSS A. FREITAS and CAROLINE SAFER KENNER,
Respondents.
¢
On Petition For A Writ Of Certiorari
To The United States Court Of Appeals
For The Second Circuit
.
PETITION FOR A WRIT OF CERTIORARI
¢
E.uor E. Po_esaum
(Counsel of Record)
Douctas W. BarucH
Friep, FRANK, Harris,
Suriver & JACOBSON
1001 Pennsylvania Avenue, N.W.
Suite 900
Washington, D.C. 20004-2505
(202) 639-7000
Counsel for Petitioner
COCKLE LAW BRIEF PRINTING CO., (800) 225-6964
OR CALL COLLECT (402) 342-2831
QUESTION PRESENTED
Whether the court of appeals for the Second Circuit
erred in holding, in conflict with the long-standing deci-
sion of the court of appeals for the Ninth Circuit, that the
limitations period for commencing an action under Sec-
tion 16(b) of the Securities Exchange Act of 1934, 15
U.S.C. § 78p(b), to recover short-swing profits, begins to
run prior to the filing of the mandatory reports that
provide the best, and in many cases, the exclusive source
of notice of the transactions upon which such an action
may be based.
ii
LIST OF TRISTAR CORPORATION’S PARENT AND
NONWHOLLY OWNED SUBSIDIARY COMPANIES
1.
Tristar Corporation’s parent companies are:
a) Transvit Manufacturing Corp., and
b) Starion International Ltd.
Tristar Corporation’s nonwholly owned subsid-
iary companies are:
a) Tristar de Mexico S.A. de C.V.,
b) Tristar do Brasil Cosmeticos, Ltda., and
c) Cosmeticos Tristar de Venezuela C.A.
iii
TABLE OF CONTENTS
CIDE IAIEM PRROMIN Ge. ose ccaccccescccevcsacecs i
LIST OF TRISTAR CORPORATION’S PARENT AND
NONWHOLLY OWNED SUBSIDIARY COMPAN-
SPORES A re rere ee Seer Tee eee eT REP ET ee ii
REMMI PAUL E RINSE EES 5c cc ces asecesncectenecess v
SY ME POe sc hace ee ess bib vcecenncdeecedege 1
ss CHER Lew eh) bos vedas seadsedecessne 1
STATUTORY AND REGULATORY PROVISIONS
EE nace W640 Gs be sce ede adeesdestaeseeeceea 1
Re ere ee rs Tere es eee 2
REASONS FOR GRANTING THE PETITION ....... 7
CES A WS OAWL OSS ANR OANA Beh T esd cnbeees eee 16
og ARS Se tea Seem a er re
Order of the United States Court of Appeals for
the Second Circuit Reversing the District
Court’s Grant of Summary Judgment in favor of
Tristar, dated May 21, 1996................... App. 1
Memorandum Opinion and Order of the United
States District Court for the Eastern District of
New York Granting in Part and Denying in Part
Tristar’s Motion for Summary Judgment, dated
CEE By ROPE Cs sh endvsecswserscessencus’s App. 12
Order of the United States Court of Appeals for
the Second Circuit Denying Petition for Rehear-
ing, dated July 16, 1996 .............ccceeuee App. 27
Section 16 of the Securities Exchange Act of
Serre crt reer ere ree eee eee eee ee ee eee eee App. 29
iv
TABLE OF CONTENTS —- Continued
Page
Opinion of the United States Court of Appeals
for the Ninth Circuit in Whittaker v. Whittaker
Corp., published at 639 F.2d 516 (1981)....... App. 35
é
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Lica
Vv
TABLE OF AUTHORITIES
Page
CASES
American Standard, Inc. v. Crane Co., 510 F.2d 1043
(2d Cir. 1974), cert. denied, 421 U.S. 1000 (1975).... 13
Bailey v. Glover, 88 U.S. (21 Wall.) 342 (1874)......... 9
Blau v. Albert, 157 F. Supp. 816 (S.D.N.Y. 1957)....... 9
Blau v. Mission Corp, 212 F.2d 77 (2d. Cir.), cert.
Gented, 207 U.S. 2006: CORI) sons conan shee ncnseeeess 15
Blau v. Ogsbury, 210 F.2d 426 (2d Cir. 1954)......... 14
Carr-Consolidated Biscuit Co. v. Moore, 125 F. Supp.
G23 CADPR. BID i roan ok Se baa veekee Oe rch ee 10
Exploration Co. v. United States, 247 U.S. 435 (1918) ..... 9
Foremost-McKesson, Inc. v. Provident Securities Co.,
OOD: AES Beer CGT 55s 5 a i ces 1 A ok A ee oe 4
Grossman v. Young, 72 F. Supp. 375 (S.D.N.Y. 1947) ..9, 13
Gollust v. Mendell, 501 U.S. 115 (1991)................ 2
Holmberg v. Armbrecht, 327 U.S. 392 (1946)............ 9
Kern County Land Co. v. Occidental Petroleum Corp.,
+ EE. CE Se SRO yh ick ep ieins bees avessaaaes 3
Kornfeld v. Eaton, 327 F.2d 263 (2d Cir. 1964)........ 15
Lampf, Pleva, Lipkind, Prupis, & Petigrow v. Gilb-
evtson, 501-135. SGD (A991) ows crveciecessenvedecess 9
Morales v. Mylan Laboratories, Inc., 443 F. Supp. 778
CWE. Ba. BF Op oss vis cand hy aS NS eee aes baie es 15
vi
TABLE OF AUTHORITIES — Continued
Page
Reliance Electric Co. v. Emerson Electric Co., 404 U.S.
QED. CIITA) < o's Kivccvidenkentncaoeeeeers 2, 13, 14
S. & S. Realty Corp. v. Kleer-Vu Industries, Inc., 575
PAG 2000 Ce Ce. Boras cs ven ikcosvereuckbevesornre 14
Shattuck Denn Mining Corp. v. La Morte, Fed. Sec.
L. Rep. (CCH) ¥ 94,429 (S.D.N.Y. 1974) ............ 9
Smolowe v. Delendo Corp., 136 F.2d 231 (2d Cir.),
cert. denied, 320 US. 7351 (IRB) oi cs cn ie ck 2, 14
Sonics International, Inc. v. Johnson, 387 F. Supp.
743. COLD. Wan. TOFS. iccicccanesskeaceearekeieiaas 15
Stella v. Graham-Paige Motors Corp., 132 F. Supp.
100 (S.D.N.Y. 1955), aff'd, 232 F.2d 299 (2d Cir.),
cert. denies; 352 US... Sk (395s «initia 6x00 11
Tristar Corp. v. Freitas, 867 F. Supp. 149 (E.D.N-Y.
en | EEE EE TEER Tee OP oye te ee ee Te” 1
Tristar Corp. v. Freitas, 84 F.3d 550 (2d Cir.), reh’g
GORGE CIDOG). ... oo.sxancdaas sdeeebee es Leese eee 1
Whittaker v. Whittaker Corp., 639 F.2d 516 (9th Cir.),
cert. dented, 454 US... 1031: C29GBD . viiccascsievens passim
STATUTES AND RULES
Securities Exchange Act of 1934
1S USC. § Feta) CISPR) ois cs esa creases passim
5 U.S.C... § TOG) CEeee) . vei sate akweaess passim
28 USA. & TEGEE): CEP ioe chic insceeeaeeecnvenes 1
17 CLR. © 200. 2Gas CASPO) iss co veh cceeeeuaeae 1, 8, 11
WE tan. ag he
|
ee ee
vii
TABLE OF AUTHORITIES - Continued
Page
SCHOLARLY Works AND OTHER AUTHORITIES
Steinberg and Lansdale, Jr., The Judicial and Regu-
latory Construction of Section 16(b) of the Securi-
ties Exchange Act of 1934, 68 Notre Dame L. Rev.
RE so 24 ROP ne pec meer re et tee ck crane ie ae eer ape ae 19
Rubin and Feldman, Statutory Inhibitions Upon
Unfair Use of Corporate Information by Insiders, 95
TRS ORE a a Bt) y Re er ere ee 10
Cook and Feldman, Insider Trading Under the Secu-
rities Exchange Act, 66 Harvard L. Rev. 385
CRO Odea ash c:c th bGoss hha PSKMRERES SEN MA CRESS SES 10
Exchange Act Rel. No. 28869 (Feb. 8, 1991) ......... 13
Exchange Act Rel. No. 37260 (May 31, 1996)........ 11
Se BO. IOs Feb CIPO) co vcbc seeks sc asevavescvcss 13
PETITION FOR A WRIT OF CERTIORARI
Petitioner Tristar Corporation hereby petitions for a
writ of certiorari to review the judgment of the United
States Court of Appeals for the Second Circuit in this
case.
OPINIONS BELOW
The opinion of the court of appeals (App. infra, 1) is
reported. See Tristar Corp. v. Freitas, 84 F.3d 550 (2d Cir.),
reh’g denied (1996). The opinion of the district court (App.
infra, 12) is reported. See Tristar Corp. v. Freitas, 867 F.
Supp. 149 (E.D.N.Y. 1994).
JURISDICTION
The judgment of the court of appeals was entered on
May 21, 1996. On July 18, 1996, the court of appeals
denied Petitioner’s timely motion for rehearing and sug-
gestion for rehearing en banc. App. infra, 27. The jurisdic-
tion of this Court is invoked under 28 U.S.C. § 1254(1).
¢
STATUTORY AND REGULATORY
PROVISIONS INVOLVED
Sections 16(a) and 16(b) of the Securities Exchange
Act of 1934, 15 U.S.C. §§ 78p(a) and 78p(b), and Rule
16a-3, 17 C.F.R. § 240.16a-3. App. infra, 29.
S
STATEMENT
1. Congress enacted Section 16(b) of the Securities
Exchange Act of 1934 (“Act”), 15 U.S.C. § 78p(b), to
prevent “the unfair use of information which may have
been obtained by [the corporate insider] by reason of his
relationship to the issuer.” Section 16 applies to any
director or executive officer, and to any owner of more
than ten percent of any class of equity securities regis-
tered under Section 12 of the Act (“Section 16 insider” or
“insider”).
Section 16(b) provides a unique cause of action, in
favor of the issuer of such securities (or, if the issuer fails
to act, any security holder of the issuer) to recover “short-
swing” profits realized by any Section 16 insider. Gollust
v. Mendell, 501 U.S. 115 (1991). A “short-swing” transac-
tion consists of two separate events - a purchase and a
sale — by a Section 16 insider within a period of less than
six months. Liability under Section 16(b) is automatic,
and is imposed without regard to the intent of the Section
16 insider. Under Section 16(b), any purchase may be
matched against any sale within the six-month statutory
period, and in the case of multiple transactions, the high-
est sale price is matched against the lowest purchase
price, so as to maximize the profit to be returned to the
issuer. Smolowe v. Delendo Corp., 136 F.2d 231 (2d Cir.),
cert. denied, 320 U.S. 751 (1943).
This Court has observed that “the only method Con-
gress deemed effective to curb the evils of insider trading
was a flat rule taking the profits out of a class of transac-
tions in which the possibility of abuse was believed to be
intolerably great.” Reliance Electric Co. v. Emerson Electric
ee ee
epee
—
oe
ee a eee ee
‘wa
Co., 404 U.S. 418, 422 (1972); Kern County Land Co. v.
Occidental Petroleum Corp., 411 U.S. 582, 592 (1973).
The statute provides that “[s]uit to recover such
profit may be instituted at law or in equity in any court of
competent jurisdiction by the issuer, or by the owner of
any security of the issuer in the name and in behalf of the
issuer... ” 15 U.S.C. § 78p(b). Section 16(b) further
provides that “no suit shall be brought more than two
years after the date such profit was realized.” 15 U.S.C.
§ 78p(b).
Section 16(a) requires each Section 16(b) insider to
“file with the Commission . . . a statement indicating his
ownership at the close of the calendar month and such
changes in his ownership as have occurred during such
calendar month.” 15 U.S.C. § 78p(a). Among other things,
the Section 16(a) reporting requirement serves to reveal
the existence of an insider’s short-swing transactions, if
and when the report is filed. See Whittaker v. Whittaker
Corp., 639 F.2d 516, 528 (9th Cir.), cert. denied, 454 U.S.
1031 (1981). App. infra, 61-62. The SEC, in implementing
Section 16(a), requires a report, called a Form 4, to be
filed within ten days after the end of a month in which a
change occurs in an insider’s holdings. Since May 1, 1991,
SEC rules have provided that certain transactions are
reportable on a different form, Form 5, which is to be
filed within forty-five days of the end of the issuer’s
fiscal year. Section 16(a) reports must be filed with the
issuer, the SEC, and any national stock exchange on
which the issuer’s equity securities are traded. Such
reports become matters of public record.
As the court of appeals stated below, “[w]Jhere the
requirements of Section 16(a) are met, the corporation or
shareholder may determine easily and quickly whether
any statutory insider has profited from a short-swing
transaction by examining the Form 4s filed each month
with the Commission. The corporation or shareholder
may then use the Form 4s to establish liability in an
action under section 16(b).” App. infra, 6. Once an action
is initiated, recovery “is virtually automatic,” App. infra,
7, since the “statute imposes liability without fault.” App.
infra, 6 (quoting Foremost-McKesson, Inc. v. Provident Secu-
rities Co., 423 U.S. 232, 251 (1976)).
2. On December 16, 1993, Petitioner Tristar Corpo-
ration (“Tristar”) commenced this action in the United
States District Court for the Eastern District of New York
pursuant to 28 U.S.C. § 1331 against defendants Ross
Freitas and Carolyn Safer Kenner to recover short-swing
profits realized by defendants in transactions involving
the securities of Tristar’s predecessor corporation, Ross
Cosmetics (“Ross”). At the time of the transactions at
issue, the equity securities of Ross were registered pur-
suant to Section 12 of the Securities Exchange Act, and
both defendants were directors and officers of Ross, as
well as beneficial owners of more than ten percent of the
outstanding shares of Ross. App. infra, 3. Accordingly,
defendants were “insiders” subject to the short-swing
profit disgorgement provisions of Section 16(b) and the
reporting/disclosure requirements of Section 16(a).
Between February 2, 1989 and June 15, 1989, the
defendants made several purchases of Ross stock. App.
infra 14. On May 31, 1989, defendants entered into a
contract to sell approximately 28 percent of the then-
outstanding shares of Ross common stock. App. infra, 13.
The district court, matching the purchases with the May
31 sale, determined that defendants reaped a short-swing
profit of more than $180,000. App. infra, 22.
There is no dispute that the defendants filed the
Section 16(a) report for the May 31, 1989 sale on “Decem-
ber 18, 1991 - over two and one-half years after the filings
were due.” App. infra, 5.
3. In the district court, the defendants contended
that Tristar’s complaint was not timely filed. The district
court, relying on long-standing precedent of the Ninth
Circuit court of appeals, Whittaker v. Whittaker Corp., 639
F.2d 516 (9th Cir.), cert. denied, 454 U.S. 1031 (1981), held
that the two-year limitations period was tolled until the
insiders filed the Section 16(a) report of the event that
gave rise to a short-swing transaction. App. infra, 20-21.
The district court determined that since the defendants
had not filed the Section 16(a) report of the May 31, 1989
sale until December 18, 1991, the two-year limitations
period did not begin to run until the date of filing. Id.
Tristar, in reliance on the Whittaker rule, commenced its
action on December 16, 1993, within two years of the
filing of the Section 16(a) report; accordingly, the district
court determined that the action was timely, App. infra,
21, and entered summary judgment in Tristar’s favor.
App. infra, 24.
The court of appeals reversed, finding that Tristar’s
complaint was not filed within the limitations period.
App. infra, 9. In so doing, the court of appeals pointedly
rejected the Whittaker position: “We thus disagree with
the approach taken by the Ninth Circuit in Whittaker, 639
F.2d at 530 (and by the district court in this case, 867 F.
Supp. at 154), which restarts the two-year limitations
period on the date that the (untimely) Form 4s are filed.”
App. infra, 8 (emphasis in original).
In lieu of the Whittaker rule, the court of appeals
adopted a new test for reckoning the limitations period
whereby the period begins to run before the Section 16(a)
report is filed. Specifically, the court held that: (a) the two
year limitations period begins to run on the date when a
purchase (or sale) occurs; (b) the limitations period con-
tinues to run until the last date on which the insider may
timely file the Section 16(a) report disclosing the transac-
tion; (c) if the insider fails to file by the last day permitted
under Section 16(a), the limitations period is tolled until
the Section 16(a) report is actually filed; and (d) once the
Section 16(a) report is actually filed, the limitations
period begins to run again. App. infra, 8-9.
Applying the new rule in this case, the court of
appeals calculated the limitations period as follows: (a)
the two-year limitations period began to run on May 31,
1989; (b) it continued to run for ten days, until June 10,
1989, the last day when the defendants could have filed a
timely Section 16(a) report for the May 31, 1989 transac-
tion; (c) the limitations period was tolled from June 10,
1989 until December 18, 1991, when defendants belatedly
filed the report; and (d) the limitations period began
running again on December 18, 1991, at which time any-
one seeking to initiate an action to recover the short-
swing profits had two years minus ten days - or until
December 8, 1993 - to commence their action. App. infra,
8-9. The court held, therefore, that Tristar’s December 16,
1993 complaint was eight days late and must be dis-
missed with prejudice. App. infra, 9.
¢
REASONS FOR GRANTING THE PETITION
The decision of the Second Circuit court of appeals
directly conflicts with the rule of the Ninth Circuit in
Whittaker and contravenes Congress’ express goal of
curbing insider trading abuses. The conflict in the circuits
is of importance to the shareholders of each of the com-
panies that have registered a class of equity securities
under Section 12 of the Securities Exchange Act — i.e., all
companies whose stock is traded on the New York Stock
Exchange, the American Stock Exchange, the several
regional exchanges (Boston, Philadelphia, Pacific, Mid-
west), the National Association of Securities Dealers
Automated Quotation System, and in certain companies
traded on the over-the-counter market.
The Second Circuit's rule for calculating the period of
limitations is incompatible with the purpose of Section
16(b), and is based on an erroneous assumption regarding
the relationship of Sections 16(b) and 16(a). Moreover, the
rule results in a limitations period that is difficult to
calculate in each case, depending upon the “timeliness”
of the Section 16(a) report under the SEC’s rules.
The Second Circuit assumed that the greatest period
of time that could elapse between a purchase or sale and
the timely report of the purchase or sale was forty days,
and the least amount of time was ten days. In fact, under
the Commission’s reporting rules, a period of more than
one year — as much as 410 days — may elapse between the
occurrence and the timely reporting of the purchase or
sale. See Rule 16a-3, 17 C.F.R. § 240.16a-3 (1996), App.
infra, 31.
Under the rule adopted by the court of appeals, the
two-year period begins to run when only the insider
knows of the transaction, and without regard to whether
the insider files the Section 16(a) report timely. From the
standpoint of the beneficiaries of Section 16(b) -— the
security holders of the issuer - it makes no difference
whether the Section 16(a) report was filed timely or
untimely: security holders cannot know of the existence
of a matchable purchase or sale transaction until the
report is actually filed.
1. As the court of appeals recognized in this case, it
has adopted an interpretation of the limitations period of
Section 16(b) of the Act that is in direct conflict with the
interpretation adopted by the Ninth Circuit fifteen years
ago in Whittaker v. Whittaker Corp., 639 F.2d 516 (9th Cir.
1981) (App. infra, 35). App. infra, 8. This direct conflict
between two of the courts of appeals most likely to
address Section 16(b) issues requires resolution by this
Court and provides a compelling reason for granting
certiorari.
In Whittaker, the court of appeals for the Ninth Cir-
cuit, after consideration of the possible competing inter-
pretations of Section 16(b)’s statute of limitations and the
terms of Section 16(a), concluded that the two year limita-
tions period “is tolled until the insider discloses the transac-
tions at issue in his mandatory § 16(a) reports,” App.
a a oe ee
infra, 59-60 (emphasis added). The Whittaker rule is con-
sistent with the interpretation of most courts and com-
mentators.?
' This so-called “disclosure” interpretation, which affords
both the issuer and its shareholders an opportunity to discover
the transactions, accords with the well-established doctrine that
“where the party injured by the fraud remains in ignorance of it
without any fault or want of diligence or care on his part, the bar
of the statute does not begin to run until the fraud is
discovered. ... ” Bailey v. Glover, 88 U.S. (21 Wall.) 342, 347
(1874). This doctrine is “read into every federal statute of
limitations.” Holmberg v. Armbrecht, 327 U.S. 392, 397 (1946); see
also Exploration Co. v. United States, 247 U.S. 435, 449 (1918)
(Congress is presumed to have passed a statute of limitations
with the “established doctrine” of Bailey v. Glover in mind).
This Court recently reaffirmed that the “venerable
principle” of Bailey v. Glover applies “in the usual case,” but
declined to apply it to causes of action under Section 10(b) of the
Act because “tolling doctrine is fundamentally inconsistent
with the l-and-3-year structure” of the applicable statute of
repose. Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501
U.S. 350, 363. “The 1-year period, by its terms, begins after
discovery of the facts constituting the violation, making tolling
unnecessary. The 3-year limit is a period of repose inconsistent
with tolling.” Id. The 1-and-3-year statute of repose at issue in
Lampf does not apply to Section 16(b). See id. at 360, n.5.
2 See, e.g., Grossman v. Young, 72 F. Supp. 375, 376-78
(S.D.N.Y. 1947) (insider’s failure to file disclosure statements
required by Section 16(a) for more than two years after the
transactions at issue prevents the running of the limitations
period: “It is incongruous to permit an insider to escape
repayment of his profits by compounding his fault in failing to
file the required reports.” Id. at 378.); Blau v. Albert, 157 F. Supp.
816, 819 (S.D.N.Y. 1957) (Section 16(b) action timely as long as it
is brought within two years of the date the insider files his
disclosure report, even if the action is filed more than two years
after the date of the transaction); Shattuck Denn Mining Corp. v.
10
In addition to the confusion and lack of uniformity
inherent in the Second Circuit’s rejection of the Whittaker
approach, the new rule would lead to anomalous results
which the court of appeals apparently did not consider
due to its mistaken belief that the maximum impact of its
new rule would be slight. The court erroneously assumed
that all Section 16(a) reports are required to be filed no
later than the tenth calendar day of the month following
La Morte, Fed. Sec. L. Rep. (CCH) ¥ 94,429 (S.D.N.Y. 1974)
(same); but see Carr-Consolidated Biscuit Co. v. Moore, 125 F. Supp.
423 (M.D. Pa. 1954) (the two-year limitations period runs from
the date of transaction, but the court refused to dismiss the
complaint until after providing the plaintiff with an opportunity
to demonstrate the existence of collusion between insider and
issuer in failing to file a Section 16(b) complaint sooner).
See also Steinberg and Lansdale, The Judicial and Regulatory
Construction of Section 16(b) of the Securities Exchange Act of 1934,
68 Notre Dame L. Rev. 33, 59 (1992) (supporting Whittaker
rationale and observing: “Allowing [insiders] to successfully
raise the statute of limitations defense when they have failed to
comply with Section 16(a) would thwart Congress’ objectives in
enacting that provision”); Cook and Feldman, Insider Trading
Under the Securities Exchange Act, 66 Harvard L. Rev. 385, 413
(1953) (arguing that tolling of Section 16(b) limitations period is
appropriate and consistent with the policy of the provision and
that an insider’s failure to disclose the transaction “prevent[s]
the statute from running.”); Rubin and Feldman, Statutory
Inhibitions Upon Unfair Use of Corporate Information by Insiders, 95
U. Pa. L. Rev. 468, 473-4 (1947) (arguing that the limitations
period “must be read in light of the purpose of Section 16(b) and
the decisions construing comparable federal statutes . . . the
time would not begin to run until plaintiffs in a Section 16(b)
action have discovered or with reasonable diligence should
have discovered the transactions which form the basis for the
action.”).
PATEL LN thas NAOH te AAA PSL ti | eee a
11
the month in which the transaction occurred. Accord-
ingly, the court reasoned that the maximum period dur-
ing which the limitations period would begin to run -
before being tolled by the failure to file a timely dis-
closure — would be 40 days. App. infra, 8 at n.1 (“For
example, if an insider earned a short-swing profit on May
1, 1989, that transaction would not need to be disclosed
until June 10, 1989”). This assumption was plainly wrong.
The Securities and Exchange Commission’s Section
16 reporting rules (the “1991 Rules”), in some circum-
stances, provide that reports of certain transactions need
not be made until more than one year after the date of the
transaction;> among other things, a Section 16(a) insider
may delay the “timely” filing of a Section 16(a) report for
certain transactions for a period of up to 45 days after the
end of the issuer’s fiscal year, where the insider “claims”
the availability of an exemption from Section 16(b). See
Rule 16a-3, 17 C.F.R. § 240.16a-3 (1996), App. infra, 31.4
Applying the court of appeals’ new standard to the full
range of “timely” reporting under Section 16(b) would
yield the following anomalous result: If an insider effects
3 The 1991 Rules, App. infra, 31, were adopted in Exchange
Act Rel. No. 28869 (Feb. 8, 1991), and became effective on May 1,
1991. Although the 1991 Rules have recently been. amended,
Exchange Act Rel. No. 37260 (May 31, 1996) (effective August
15, 1996), they do not affect any of the insider filing reports at
issue in this matter.
* The mere claim of an exemption preserves the timeliness
of ihe filing, even though the claim itself does not establish that
the exemption is in fact available. See Stella v. Graham-Paige
Motors Corp., 132 F. Supp. 100, 110-11 (S.D.N.Y. 1955), aff’d, 232
F.2d 299 (2d Cir.), cert. denied, 352 U.S. 831 (1956).
12
a transaction on January 1, and the issuer has a December
31 fiscal year-end, the Section 16(a) report for that trans-
action would not be due until February 14 of the follow-
ing year — or 410 days after the date of the transaction,
rather than the maximum 40-day period assumed by the
court. Under the rule adopted by the court of appeals,
since the limitations period runs between the date of the
transaction and the last day when the report may be
timely filed, all 410 days would be counted against the
limitations period, whether or not the insider thereafter
delayed in filing the report. The security holder who first
learns of the transaction on the day it is disclosed would
have less than eleven months to investigate whether the
claim to exemption was well-grounded and to initiate his
lawsuit under Section 16(b), substantially less time than
the two-year period which Congress specifically pro-
vided in the statute.
In breaking with Whittaker and adopting a new rule
for determining the limitations period, the court of
appeals simply did not credit the potential for enormous
reductions in the limitations period.5 Now, with this new
standard in place, the potential for wildly disparate deci-
sions and results in the Ninth and Second Circuits is great
and, for that reason, the split in the courts of appeals
should be settled by this Court.
5 The full implications of the court of appeals’ new rule
may not have been appreciated by the court because neither
party addressed, let alone advanced, either-in the district court
or on appeal in the Second Circuit, the interpretation ultimately
adopted by the court of appeals. The court of appeals did not
have the benefit of briefing or oral argument on its
interpretation of Section 16(b).
13
' 2. The court of appeals’ new limitations period test —
: runs counter to Section 16(b)’s express goal of “prevent-
ing the unfair use of information which may have been
i obtained by [the insider] by reason of his relationship to
the issuer.” 15 U.S.C. § 78p(b). Congress enacted Section
16(b) to protect “outside” shareholders from the schemes
of insiders. See S. Rep. No. 73-1455, at 55, 68 (1934). This
i Court has recognized that this statute was the “only
| method Congress deemed effective to curb insider trad-
ing abuses.” Reliance Electric Co., 404 U.S. at 422. The
statute also serves to ensure that the shareholders are
recompensed for the insider’s short-swing trading
profits. See American Standard, Inc. v. Crane Co., 510 F.2d
1043, 1060 (2d Cir. 1974) (“profits were to be restored to
the presumptively aggrieved cestui que trust, the issuer of
the securities”), cert. denied, 421 U.S. 1000 (1975).
ead Lee acl 5 A ea gal
itn ae ed WC hte ta RS > ee
The new rule imposed by the Second Circuit ignores
the twin propositions recognized in Grossman v. Young, 72
F, Supp. 375 (S.D.N.Y. 1947), that (i) the consummation of
a short-swing transaction itself gives rise to a cause of
action, but (ii) that until the outside shareholders of the
i issuer have notice of the transaction, they cannot know of
or pursue the cause of action. To commence the running
of the limitations period before even the most diligent
shareholders can have any knowledge of the cause of
action is contrary to Congress’ stated purpose of the
statute.°
PSS tte) Sade ts NAG tee er ating ts
© The statute expressly provides for a two-year limitations
period. 15 U.S.C. § 78a(b). As explained in note 1, supra, tolling
is read into every federal statute of limitations in which
Congress did not clearly establish a policy of absolute repose. In
14
3. The court of appeals’ ill-conceived rule was not
even applied properly in this case, reflecting that the
effects of the Second Circuit’s decision were not fully
considered by that court. The essential prerequisite to
instituting an action under Section 16(b) is the existence
of a “matchable” purchase and sale by the insider in any
given six month period, and an allegation that profit was
realized. If no profit was realized, there is no proper
cause of action, and the complaint may be dismissed. See,
e.g., Blau v. Ogsbury, 210 F.2d 426, 427 (2d Cir. 1954); S. &
S. Realty Corp. v. Kleer-Vu Industries, Inc., 575 F.2d 1040 (2d
Cir. 1978).
Although the court of appeals recognized that Tri-
star’s complaint alleged that defendants made purchases
as late as June 1989, App. infra, 3, it erroneously assumed
that only purchases during the six months preceeding
May 31, 1989 were matchable with the May 31, 1989 sale.
The May 31, 1989 sale was, of course, equally available
for matching with the purchases occurring in the subse-
quent six-month period. See Smolowe v. Delendo Corp., 136
F.2d 231 (2d Cir.), cert. denied, 320 U.S. 751 (1943). Here,
the existence of purchases in June 1989 make clear that
the court erred in using May 31, 1989 as the date on
addition to ignoring this well-established principle, the
construction of the limitations period advanced by the court of
appeals does not comport with the Act’s structure and stated
remedial goal. Thus, even if the court of appeals’ construction of
the statute were a reasonable one, it cannot stand. “[W]here
alternative constructions of the terms of 16(b) are possible, those
terms are to be given the construction that best serves the
congressional purpose of curbing short-swing speculation by
corporate insiders.” Reliance Electric Co., 404 U.S. at 424.
eet inias> sean aoe
a eet eT
ish Li IER ASE ARIAL LOK LOTTI BF VK KD
Gish RLS DA sate
” ge
15
which all Section 16(b) causes of action had accrued. See
Kornfeld v. Eaton, 327 F.2d 263, 265 (2d Cir. 1964) (reflect-
ing Commission’s interpretation that Section 16(b) limita-
tions period “commences on the date of sale (or purchase,
if that is later)”); Morales v. Mylan Laboratories, Inc., 443 F.
Supp. 778, 780 (W.D. Pa. 1978) (limitations period begins
to run on date of last transaction which is used to calcu-
late insider’s profit); Sonics International, 387 F. Supp. at
743 (same). Even though a Section 16(a) report had been
filed for the June 1989 purchases by July 24, 1989, the
Section 16(b) significance of the reported June 1989 pur-
chase was unknown until the report of the May 1989 sale
was filed in December of 1991. That the court of appeals
erred in dismissing the entire complaint, without analyz-
ing the limitations period applicable to these post-May
31, 1989 matching transactions by the insiders, is reflec-
tive of the court of appeals’ ill-considered adoption of its
new statute of limitations test.” |
¢
7 See, e.g., Blau v. Mission Corp., 212 F.2d 77, 79-80 (2d. Cir.)
(finding dismissal of Rule 16(b) action on limitations grounds
inappropriate since at least some of the transactions took place
within the requisite period), cert. denied, 347 U.S. 1016 (1954).
16
CONCLUSION
The petition for a writ of certiorari should be
granted.
Respectfully submitted,
Evuot E. Potesaum
(Counsel of Record)
Douctas W. BarucH
Frrep, FRANK, HArris,
SHRIVER & JACOBSON
1001 Pennsylvania Avenue, N.W.
Suite 900
Washington, D.C. 20004-2505
(202) 639-7000
Counsel for Petitioner
October 11, 1996
APPENDICES
App. i
INDEX TO APPENDICES
Page
Order of the United States Court of Appeals for
the Second Circuit Reversing the District
Court’s Grant of Summary Judgment in favor of
Tristar, dated May 21, 1996................... App. 1
Memorandum Opinion and Order of the United
States District Court for the Eastern District of
New York Granting in Part and Denying in Part
Tristar’s Motion for Summary Judgment, dated
POE Fy SOs vi Nicyuchsvthwautedswa ees App. 12
Order of the United States Court of Appeals for
the Second Circuit Denying Petition for Rehear-
is See OO, AON bo oe laste App. 27
Section 16 of the Securities Exchange Act of
DOPE sRaV CR CRUAARE ROSA U CERN o 405k ds cbReY Keane, App. 29
i7 C.RR. Section 240.16a-3.........5.ccccccesss App. 31
Opinion of the United States Court of Appeals for
the Ninth Circuit in Whittaker v. Whittaker Corp.,
published at 639 F.2d 516 (1981)............. App. 35
App. 1
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
No. 1305 - August Term 1995
(Argued: April 5, 1996 _ Decided: May 21, 1996)
Docket No. 95-7952
TRISTAR CORPORATION,
Plaintiff-Appellee,
-V, =
ROSS A. FREITAS and CAROLYN
SAFER KENNER,
Defendants-Appellants.
x
Before: KEARSE, JACOBS and CABRANES, Circuit Judges.
Appeal from a judgment of the United States District
Court for the Eastern District of New York (Dearie, ].),
granting summary judgment in favor of plaintiff Tristar
on its action, brought pursuant to section 16(b) of the
Securities Exchange Act of 1934, 15 U.S.C. § 78p(b), to
recover short-swing profits allegedly realized by defen-
dants Ross A. Freitas and Carolyn Safer Kenner. On
appeal, the defendants contend that Tristar’s complaint
was not filed within the two-year period of limitations set
forth in section 16(b), and that the district court erred by
App. 2
equitably tolling that period of limitations to render
timely Tristar’s complaint.
Reversed.
ANTHONY C. CIANCIOTTI,
Fried, Frank, Harris, Shriver &
Jacobson, Washington, D.C. (Elliot
E. Polebaum, Washington, D.C.,
on the brief), for Plaintiff-Appellee.
CHASE A. CARO, Caro & Graif-
man, New York, NY, for Defen-
dants-Appellants.
JACOBS, Circuit Judge:
Tristar Corporation (“Tristar”) brought this action
pursuant to section 16(b) of the Securities Exchange Act
of 1934, 15 U.S.C. § 78p(b), to recover short-swing profits
allegedly realized by defendants Ross A. Freitas and Car-
olyn Safer Kenner through the purchase and sale of secu-
rities of Ross Cosmetics Distribution Centers, Inc. (“Ross
Cosmetics”), later renamed Tristar. On July 20, 1994, Tri-
star moved for summary judgment. As an affirmative
defense to that motion, the defendants, appearing pro se,
contended that Tristar’s complaint was filed after the
two-year period of limitations set forth in section 16(b)
had expired. The United States District Court for the
Eastern District of New York (Dearie, J.) found that the
defendants had failed to make the mandatory filings with
the Securities and Exchange Commission (the “Commis-
sion”) that would have provided Tristar with notice of the
short-swing transactions and, for that reason, equitably
tolled the two-year limitations period for a period suffi-
cient to render timely Tristar’s complaint. Tristar v.
App. 3
Freitas, 867 F. Supp. 149, 153-54 (E.D.N.Y. 1994). Accord-
ingly, the district court granted summary judgment in
favor of Tristar.
On appeal, the parties ask us to decide whether the
limitations period set forth in section 16(b) is subject to
equitable tolling. We need not decide that question
because, even assuming arguendo that the defendants’
non-compliance with the filing requirements of the Secu-
rities Exchange Act tolled the limitations period, Tristar’s
complaint was still untimeiy filed. We therefore reverse
the district court’s grant of summary judgment in favor of
Tristar.
BACKGROUND
From 1982 through at least May 31, 1989, defendants
Freitas and Kenner served as officers and directors of
Ross Cosmetics and were beneficial owners of more than
ten percent of the outstanding shares of the company’s
common stock. In separate transactions occurring in Feb-
ruary, March, May and June 1989, the defendants pur-
chased more than 39,000 shares of Ross Cosmetics at
prices ranging from $1.10 to $4.50 per share.
On May 31, 1989, the defendants entered into a bind-
ing contract (the “Agreement”) to sell to Starion Interna-
tional Limited (“Starion”) a total of 906,594 shares of Ross
Cosmetics common stock, approximately 28 percent of
the company’s outstanding shares. The Agreement, which
was styled a “Periodic Loan Agreement” by the contract-
ing parties, required the defendants to transfer the shares
to Starion in more than a dozen installments. In return,
the defendants were to receive “loan disbursements”
App. 4
fixed at between approximately $4.65 and $7.50 for each
share in each installment. Through this transaction (and
others), Starion acquired control of Ross Cosmetics
(which was later re-named Tristar).
On December 16, 1993, Tristar filed its complaint
pursuant to section 16(b) of the Securities Exchange Act
to recover the defendants’ short-swing profits. Section
16(b) permits a corporation or shareholder to bring an
action for recovery of profits that a director, officer or
principal shareholder realizes by purchasing and selling
stock within a six-month period. 15 U.S.C. § 78p(b). Tri-
star alleged that from February 1989 to June 15, 1989 the
defendants purchased shares of Ross Cosmetics at prices
from $1.10 to $4.50 per share, and that the defendants
then realized a profit exceeding $270,000 on those shares
by selling them to Starion, pursuant to the Agreement, at
prices between approximately $4.65 and $7.50 per share.
On July 20, 1994, Tristar moved for summary judg-
ment. In an opinion dated November 9, 1994, the district
court determined that the Agreement constituted a “sale”
of securities as defined by section 3 of the Securities
Exchange Act, 15 U.S.C. § 78c(a)(14). 867 F. Supp. at 153.
The court also found that the defendants had reaped
short-swing profits by entering into the Agreement with
Starion, giving rise to a cause of action that accrued on
May 31, 1989. Id. at 152-53. But because the two-year
period of limitations set forth in section 16(b) expired on
May 31, 1991, the district court found that Tristar’s com-
plaint (filed on December 16, 1993) was “clearly
untimely.” Id. at 153. No one appeals these determina-
tions.
ani i Sailnet aie es
App. 5
However, the district court found that circumstances
warranted granting Tristar equitable relief. Because the
Agreement was entered into on May 31, 1989, each defen-
dant was required by section 16(a) to disclose the transac-
tion on or before June 10, 1989 in a filing - designated a
“Form 4” - with the Commission. See 17 C.F.R.
§ 240.16a-3(a) (1995). The defendants, however, failed to
file Form 4s until December 18, 1991 — over two and one-
half years after the filings were due. Tristar contended
that it was thus deprived during that period of notice of
the defendants’ short-swing transactions. The district
court, relying on the Ninth Circuit’s decision in Whittaker
v. Whittaker Corp., 639 F.2d 516, 527-30 (9th Cir.), cert.
denied, 454 U.S. 1031 (1981), held that section 16(b)’s two-
year period of limitations was equitably tolled during the
defendants’ delinquency. 867 F. Supp. at 153-54. The dis-
trict court then determined (as did the Ninth Circuit in
Whittaker) that the two-year limitations period began to
run on the date that the defendants filed their (untimely)
Form 4s — on December 18, 1991. Id. at 154. The court
therefore held that Tristar’s complaint, which was filed
on December 16, 1993, was timely under section 16(b),
and entered judgment against Freitas for $101,004.00, and
against Kenner for $81,893.75, plus pre-judgment interest.
DISCUSSION
Section 16 of the Securities Exchange Act is intended
“to curb short-swing trading by insiders whose position
gives them access to information not available to the
investing public.” Kern County Land Co. v. Occidental
Petroleum Corp., 411 U.S. 582, 592 n.23 (1973). Section
16(b) permits a shareholder or corporation to maintain an
App. 6
action against any director, officer or beneficial owner of
more than 10% of any class of outstanding shares (a
“statutory insider”) who profits from short-swing trans-
actions in that corporation’s securities. 15 U.S.C. § 78p(b).
A short-swing transaction is “any purchase and sale, or
any sale and purchase, of any equity security of such
issuer ... within any period of less than six months.” Id.
A suit to recover such profits may be brought “by the
issuer, or by the owner of any security of the issuer... in
behalf of the issuer . . . ; but no such suit shall be brought
more than two years after the date such profit was realized.”
Id. (emphasis added).
Section 16(a) provides a mechanism for facilitating
the recovery of short-swing profits by requiring statutory
insiders to disclose any change in ownership “within ten
days after the close of each calendar month” in which
such change occurs. Id. § 78p(a). That disclos‘ire is made
via a Form 4 (filed with the Commission and made pub-
licly available, see 17 C.F.R. § 240.16a-3(a) (1995)) which
sets forth the insider’s name, the date of the transaction,
the number of shares sold or bought and the price per
share. See Ownership Reports and Tracing by Officers,
Directors and Principal Security Holders, 56 Fed. Reg.
7242, 7278-81 (Feb. 21, 1991) (instructions for Form 4).
Where the requirements of section 16(a) are met, the
corporation or shareholder may determine easily and
quickly whether any statutory insider has profited from a
short-swing transaction by examining the Form 4s filed
each month with the Commission. The corporation or
shareholder may then use the Form 4s to establish lia-
bility in an action under section 16(b). Because the “stat-
ute imposes liability without fault within its narrowly
b
App. 7
drawn limits,” Foremost-McKesson, Inc. v. Provident Secs.
Co., 423 U.S. 232, 251 (1976), recovery in such actions “is
virtually automatic.” Whittaker, 639 F.2d at 522.
We have held that a federal statute of limitations may
be equitably tolled when “fraudulent or other conduct
conceal[s] the existence of a claim.” Bowers v. Transporta-
cion Maritima Mexicana, S.A., 901 F.2d 258, 264 (2d Cir.
1990). Where a claim has already accrued at the time of
the defendant’s improper conduct, courts suspend the
further running of the limitations period until the claim is
(or should be) known to the plaintiff, or until the
improper concealment has ceased: “Equitable tolling of a
statute means only that the running of the statute is
suspended, not that the limitations period begins over
again.” Benge v. United States, 17 F.3d 1286, 1288 (10th Cir.
1994) (quotation marks omitted). See also Singletary v.
Continental Ill. Nat'l Bank & Trust Co., 9 F.3d 1236, 1241
(7th Cir. 1993) (discussing equitable estoppel); Bowers, 901
F.2d at 264.
The period of limitations begins running under sec-
tion 16(b) on the “date [the short-swing] profit was real-
ized.” 15 U.S.C. § 78p(b). No appeal is taken from the
district court’s finding that short-swing profits were
“realized” on the date that the Agreement was entered
into - May 31, 1989 - and therefore that Tristar’s claim
accrued on that date. But the defendants were under no
obligation under section 16(a) to disclose any transaction
occurring in May 1989 until June 10, 1989. See 15 U.S.C.
§ 78p(a). So Tristar’s putative ignorance of the claim prior
to June 10, 1989 did not result from the lateness of the
App. 8
defendants’ filings.’ Equitable tolling would therefore be
unwarranted during the period from May 31, 1989 to June
10, 1989. We thus disagree with the approach taken by the
Ninth Circuit in Whittaker, 639 F.2d at 530, (and by the
district court in this case, 867 F. Supp. at 154) which
restarts the two-year limitations period on the date that
the (untimely) Form 4s are filed.
The defendants failed to make the requisite filings
with the Commission until December 18, 1991. That
period of delay —- from June 10, 1989 to December 18, 1991
~ arguably deprived Tristar of notice required by law.? We
therefore hold that any limitations period ran from the
date on which Tristar’s claim accrued (May 31, 1989) until
the last date on which the defendants could have timely
filed their Form 4s (June 10, 1989), i.e., for ten days; that
any suspension of the limitations period began on that
' Because a Form 4 need not be filed until ten days after the
month in which an insider transaction occurs, see 15 U.S.C.
§ 78p(a), a shareholder or corporation could be deprived of
notice that a cause of action has accrued for a period of up to 40
days. For example, if an insider earned a short-swing profit on
May 1, 1989, that transaction would not need to be disclosed
until June 10, 1989.
2 On June 5, 1989, Ross Cosmetics filed a Form 8-K (which
is required to be filed when a change of control of the registrant
occurs, see 17 C.F.R. § 249.308 (1995)) with the Commission
disclosing the Agreement. There is therefore record evidence
that Tristar - which, as noted, is controlled by Starion, the same
entity that purchased the defendants’ shares — had actual and
contemporaneous notice of the defendants’ short-swing profits.
However, because we hold that Tristar’s complaint would not
be timely even if the limitations period were tolled, we need not
decide whether Tristar’s putative knowledge renders the
equitable tolling doctrine inapplicable.
App. 9
date and continued unti] the date on which the Form 4s
were actually filed (December 18, 1991); and that the
remaining limitations pericd of two years less ten days
began running on that date. Tolling the period of limita-
tions in this manner would extend the time in which
Tristar could have brought an action from May 31, 1991
(the date on which the limitations period would other-
wise have expired) to December 8, 1993.
Tristar’s complaint, of course, was not filed until
December 16, 1993. Thus, even if section 16(b) is subject
to equitable tolling, Tristar’s complaint would be
untimely anyway. We therefore reverse the district court’s
entry of judgment for Tristar and direct the court to
dismiss Tristar’s complaint.
CONCLUSION
The judgment of the district court is reversed, and
the district court is directed to dismiss the complaint.
App. 10
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
UNITED STATES COURT HOUSE
40 FOLEY SQUARE
NEW YORK 10007
MANDATE
GEORGE LANGE III
CLERK
At a Stated Term of the United States Court of
Appeals for the Second Circuit, held at the United States
Courthouse, Foley Square, in the City of New York, on
the 21st day of May, one thousand nine hundred and
ninety-six.
PRESENT: HON. Amalya L. Kearse
HON. Dennis G. Jacobs
HON. José A. Cabranes
Circuit Judges
Docket No: 95-7952
TRISTAR CORPORATION,
Plaintiff-Appellee,
-V-
ROSS A. FREITAS and CAROLYN
SAFER. KENNER,
Defendants-Appellants.
Appeal from United States District Court for the Eastern
District of New York.
This cause came on to be heard on the transcript of record
from the Eastern District of New York and was argued by
counsel.
ee ee a
App. 11
- ON CONSIDERATION WHEREOEF, it is now hereby
ORDERED, ADJUDGED, and DECREED that the judg-
ment of said district court be and it hereby is reversed in
accordance with the opinion of this court.
For the Court
GEORGE LANGE III, Clerk
By:
/s/ Arthur M. Heller
Arthur M. Heller
Administrative Attorney
App. 12
UNITED STATES DISTRICT
COURT EASTERN DISTRICT OF
NEW YORK
TRISTAR CORPORATION,
Plaintiff,
- against -
ROSS A. FREITAS and CAROLYN
SAFER KENNER,
CV-93-5722 (RJD)
MEMORANDUM
AND ORDER
Defendants.
xX
For Plaintiff
Eliot Polebaum, Esq.
Anthony C. Cianciotti, Esq.
Fried, Frank, Harris, Shriver & Jacobson
1001 Pennsylvania Avenue, N.W. Suite 800
Washington, D.C. 20004-2505
For Defendant
Ross A. Freitas (appearing pro se)
155 South Ocean Blvd. Unit 138
Boca Raton, Florida 33432
Carolyn Kenner (appearing pro se)
155 South Ocean Blvd.
Unit 124
Boca Raton, Florida 33432
DEARIE, District Judge.
Preliminary Statement
Plaintiff, Tristar Corporation (“Tristar”), formerly
known as Ross Cosmetics Distribution Centers Inc.
(“Ross Cosmetics”), brings this action pursuant to Section
16(b) of the Securities Exchange Act of 1934, 15 U.S.C.
App. 13
§ 78p(b) (“the Act”), to recover short swing profits from
defendants Ross A. Freitas and Carolyn Safer Kenner.
“For the purpose of preventing the unfair use of [inside]
information,” section 16(b) requires statutory insiders to
disgorge to the issuer any “profit” realized from any
purchase and sale (or sale and purchase) of securities
occurring within a six month period. 15 U.S.C. § 78p(b).
Tristar moves for summary judgment pursuant to Fed. R.
Civ. P. 56(c) against defendants, who are defending this
action pro se.
Background
Plaintiff Tristar was known as Ross Cosmetics from
1982 through 1993. (Rule 3(g) Statement at 1.) At the
relevant time periods, defendants, in addition to being
officers and directors of Ross Cosmetics, were each bene-
ficial owners of more than 10 percent of the outstanding
shares of the corporation. (Rule 3(g) Statement at {i 4-7,
9-11.) As insiders, defendants were indisputably subject
to the reporting requirements of section 16(a), (Rule 3(g)
Statement at { 12), which places them within the scope of
section 16(b), the statute which requires the disgorgement
of insider short swing profits.
On May 31, 1989, when over 3 million shares of Ross
Cosmetics were outstanding, defendants Freitas and Ken-
ner entered into a binding contract, captioned “Periodic
Loan Agreement” (“Loan Agreement”), to dispose of
906,594 shares of Ross Cosmetics common stock or
approximately 28 percent of the outstanding shares. (Rule
3(g) Statement at {J 7-9.) Under the Loan Agreement,
defendants agreed to transfer the Loan Agreement shares
App. 14
(“Agreement Shares”) to Starion International Limited, a
British Virgin Islands Corporation (“Starion”); for 577,120
of the Agreement Shares defendants were to receive a
fixed price amounting to $7.50 per share. Pursuant to the
Loan Agreement, payments for the Agreement Shares
were characterized as “loan disbursements.” The dis-
bursements were to be transferred to defendants in six-
teen installments at the $7.50 per share price according to
the timetable and in the amount set forth in Schedule A
and Schedule B. (Rule 3(g) Statement at { 15.) An initial
transfer of 60,868.00 shares for $283,310.62 at the share
price of approximately $4.45 a share took place on the
execution date of the agreement. (Loan Agreement at
Schedules A and B.) Despite the installment feature of the
Loan Agreement, it was “executed with the intention and
belief . . . that it was and is to be performed in its entirety
by the parties and was and is to be indivisible.” (Loan
Agreement at { 10.1(i)).
In a series of transactions occurring between Febru-
ary 2, 1989 and June 15, 1989, defendants Freitas and
Kenner purchased shares of Ross Cosmetics. (Rule 3(g)
Statement at {J 28-29.) If the May 31, 1989 agreement
was in fact a sale of the Agreement Shares, then defen-
dants clearly purchased and sold shares within a six-
month period. Defendants did not file Form 4 as required
by section 16(a) until December 18, 1991. (Rule 3(g) State-
ment at ¥ 32.) Plaintiff brought this action on December
16, 1993.
The Court heard oral argument on this motion on
November 4, 1994. As the Court noted, this motion pre-
sents two threshold legal issues: (1) whether the Loan
App. 15
Agreement executed on May 31, 1989, although denomi-
nated a “loan agreement,” actually constituted a binding
“contract to sell or otherwise dispose of” shares for the
purposes of section 16(b) and (2) whether plaintiff's
motion is barred by the applicable statute of limitations.
Discussion
Standard of Review
Summary judgment should be granted only where
there is “no genuine issue as to any material fact and the
moving party is entitled to judgment as a matter of law.”
Fed. R. Civ. P. 56(c); Anderson v. Liberty Lobby, Inc., 477
U.S. 242, 256 (1986). The moving party must demonstrate
the absence of any genuine issue of material fact. See
Adickes v. Kress & Co., 398 U.S. 144, 157 (1970). Summary
judgment is appropriate if, after drawing all reasonable
inferences in favor of the party against whom summary
judgment is sought, no reasonable trier of fact could find
in favor of the non-moving party. Matsushita Elec. Indus.
Co. v. Zenith Radio Corp., 475 U.S. 574, 587-88 (1986).
The Statute
Section 16(b) provides, among other things, that
when a statutory insider — that is, an officer or director
who is required to file reports under section 16(a) -
purchases and sells shares of covered equity securities
App. 16
within a six-month period, the profit on those transac-
tions is recoverable by the issuer.! The statute represents
a congressional effort “to curb short-swing trading by
insiders whose position gives them access to information
not available to the investing public and the ability to
influence corporate policy.” Kern County Land Co. v. Occi-
dental Petroleum Corp., 411 U.S. 582, 592 n.23 (1973) (cita-
tion omitted). Employing what is commonly referred to
as a “crude rule of thumb,” section 16(b) “is not aimed
solely at the actuality of evil, or the veritable employment
of inside information for purely speculative purposes, but
also at potentiality for evil inherent in all insider short-
swing trading.” Newmark v. RKO Gen., Inc., 425 F.2d 345,
350-351 (2d Cir. 1970) (citation omitted).
1 The statute provides in relevant part:
(a) Every person who is directly or indirectly the beneficial
owner of more than 10 per centum of any class of any equity
security (other than an exempted security) . . . or who is a
director or an officer of the issuer of such security, . . . shall file
with the Commission . . . a statement indicating his ownership
at the close of the calendar month and such changes in his
ownership as have occurred during such calendar month... .
(b) For the purpose of preventing the unfair use of information
which may have been obtained by such beneficial owner,
director, or officer by reason of his relationship to the issuer, any
profit realized by him from any purchase and sale, or any sale
and purchase, of any equity security of such issuer (other than
an exempted security) within any period of less than six
months . . . shall inure to and be recoverable by the issuer,
irrespective of any intention on the part of such beneficial
owner, director, or officer in entering into such transaction of
holding the security purchased or of not repurchasing the
security sold for a period exceeding six months. ...
15 U.S.C. § 78p(a)-(b).
App. 17
Does the Loan Agreement constitute a section 16(b) “sale”?
The term “sale” is defined in the Act to include “any
contract to sell or otherwise dispose of” shares. 15 U.S.C.
§ 78(c)(a)(14). In practice, this seemingly straightforward
definition can be difficult to apply, although the defini-
tion does indicate that “something less than final execu-
tion and delivery of securities may constitute a sale.”
Portnoy v. Revlon, Inc., 650 F.2d 895, 898 (7th Cir. 1981). See
also Kern County Land Co., 411 U.S. at 593 (“The statutory
definitions of ‘purchase’ and ‘sale’ are broad and, at least
arguably, reach many transactions not ordinarily deemed
a sale or a purchase.”) Given the complexities of modern
financial transactions, it is often difficult, looking solely
at the terms of the statute, to assess when, and whether, a
16(b) sale has occurred.
, Since traditional cash-for-stock transactions clearly
fall within the purview of the statute, with transactions of
this type courts employ an objective approach, not look-
ing beyond the statutory language. With “unorthodox” or
“borderline” transactions, courts have developed an
alternate approach, inquiring whether the particular type
of transaction involved is one that gives rise to specula-
tive abuse. See Kern County Land Co., 411 U.S. at 593-595
(citations omitted); see also Newmark, 425 F.2d at 351 (cit-
ing Blau v. Lamb, 363 F.2d 507 (2d Cir. 1966), cert. denied,
385 U.S. 1002 (1967)). This “pragmatic” approach, “con-
struing section 16(b) in a manner that seems most consis-
tent with Congress’ purpose,” has been specifically
affirmed and frequently utilized in the Second Circuit.
See, e.g., Mendell v. Gollust, 909 F.2d 724, 728 (2d Cir. 1990)
(citations omitted). As a general rule, a sale occurs when
App. 18
“the insider has incurred an ‘irrevocable liability’ to dis-
pose of the stock so that his ‘rights and obligations’ have
become fixed.” Lewis v. Bradley, 599 F. Supp. 327, 330
(S.D.N.Y. 1984) (citations omitted).
The Court has examined the Loan Agreement and
finds that on May 31, 1989 defendants did in fact “con-
tract to sell or otherwise dispose of” the Agreement
Shares within the meaning of section 16(b). The Court is
persuaded that the Loan Agreement has the ordinary
indicia of an installment sales contract. On May 31, 1989,
defendants deposited all the Agreement Shares into
escrow and deposited into escrow proxies appointmg
Starion as true and rightful attorney and proxy for defen-
dants. Whenever Starion provided a “loan disbursement”
to defendants, the appropriate amount of shares were
transferred out of escrow to Starion. Each time Starion
paid an installment, Starion would receive another block
of shares. Accordingly, the Court finds that the agreement
was a sale for the purposes of section 16(b), and that
defendants were contractually bound on May 31, 1989.2
See Blau v. Ogsbury, 210 F2d 426, 427 (2d Cir. 1954)
(purchase occurred when defendant “incurred an irrevo-
cable liability to take and pay for the stock. Thereafter for
all speculative purposes he owned the stock.”) See also
2 The Court also notes that even if the Court were to find
that this was an “unorthodox” or “borderline” transaction — that
is, one that was not obviously a sale — the appropriate analysis is
whether the transaction involved is one that gives rise to
speculative abuse. See Kern County Land Co., 411 U.S. at 593-595
(citations omitted). It is clear that the May 31st transaction gives
rise to the type of speculative abuse section 16(b) was designed
to prohibit.
App. 19
Stella v. Graham-Paige Motors Corp., 132 F. Supp. 100, 106
(S.D.N.Y. 1955) (“a contract for the sale of stock which the
seller expected to fill by delivering stock which was
subject to a pledge at the time of the making of the
contract would result in a ‘sale’ as of that time rather than
as of the date that the seller succeeded in redeeming it
from the pledge”); SEA Rel. No. 18114 (Sept. 23, 1981, 46
Fed. Reg. 48147, at Q. 16) (stating that an insider who
purchases securities under an installment agreement is
deemed to have acquired beneficial ownership of such
securities at the time he makes a firm commitment for its
purchase). Defendants’ argument that the sale was not
binding on May 31, 1989 because it was still possible that
Starion would breach the contract is rejected. A common-
sense assessment of the mechanics of the Loan Agree-
ment reveals that all of the Agreement Shares were com-
mitted on May 31, 1989.
Statute of Limitations Defense
Defendants’ second argument is that plaintiff’s action
is barred by section 16(b)’s statute of limitations. Section
16(b) provides that no suit to recover short swing profits
“shall be brought more than two years after the date such
profit was realized.” 15 U.S.C. § 78p(b). This suit was
filed on December 16, 1993, the sale of shares occurred on
May 31, 1989, and all of the relevant purchases occurred
between February 2, 1989 and June 15, 1989. Accordingly,
if there is no tolling with respect to section 16(b) claims,
plaintiff’s action is clearly untimely.
The Act is silent as to whether tolling of the two-
years limitations period is permitted. Courts who have
App. 20
confronted the issue have noted that the legislative his-
tory with respect to this provision is equally silent. Whit-
taker v. Whittaker Corp., 639 F.2d 516, 527-528 (9th Cir.),
cert. denied, 454 U.S. 1031 (1981) (citing Grossman v. Young,
72 F. Supp. 375, 378 (S.D.N.Y. 1947)). There are essentially
three possibilities with respect to section 16(b)’s limita-
tions period: (1) that no tolling is allowed under the
statute (“the strict interpretation”); (2) that the two-year
period is tolled until the corporation had sufficient infor-
mation to put it on notice of the alleged violation (“the
notice or discovery interpretation”); and (3) that the two-
year period is tolled until the insider files are requisite
16(a) reports (“the disclosure interpretation”). Whittaker,
639 F.2d at 527. See also Marc Steinberg and Daryl Lands-
dale, The Judicial and Regulatory Constriction of Section 16(b)
of the Securities Exchange Act of 1934, 68 NOTRE DAME L.
REV. 33, 55 (1992).
In Whittaker, the Ninth Circuit specifically adopted
the “disclosure” interpretation, following the lead of sev-
eral district courts in the Southern District of New York.
See Whittaker, 639 F.2d at 527-530; Grossman, 72 F. Supp. at
378; Shattuck Denn Mining Corp. v. La Moret, (1973-1974
Transfer Binder) CCH Fed.Sec.L.Rep. PP 94,429, at 95,472
(S.D.N.Y. 1974); Blau v. Albert, 157 F. Supp. 816, 819
(S.D.N.Y. 1947). This interpretation is eminently sensible:
“[I]t would be a simple matter for the unscrupulous to
3 The Court rejects defendants’ argument that the Ninth
Circuit retreated from the Whittaker rule in Kay v. Scientex
Corporation, 719 F.2d 1009 (9th Cir. 1983). The Kay case did not
involve tolling, nor did the Kay Court give any indication that it
was abandoning Whittaker. See Kay, 719 F.2d at 1014-15.
App. 21
avoid the salutary effect of Section 16(b) which provides a
remedy for the recovery of short term profits, simply by
failing to file monthly reports in violation of subdivision
(a) and thereby concealing from prospective plaintiffs the
information they would need to adequately protect their
interests. Such a construction would reward the violation
of the statute and would manifestly frustrate congres-
sional intent.” Whittaker, 639 F.2d at 528 (quoting Blau v.
Albert, 157 F. Supp. at 819) (other citation omitted).
Defendants urge the Court to adopt either the “strict
interpretation” that no tolling is available or the “notice
or discovery interpretation” which tolls the limitation
period only until the corporation had sufficient informa-
tion to put it on notice of the alleged violation. It is, after
all, defendants repeated position that, even though the
section 16(a) forms were not filed at the appropriate
times, Starion clearly had knowledge of defendants’ puta-
tive insider trades back in 1989.
Notwithstanding defendants arguments, the Court
adopts the disclosure interpretation, an approach that is
consistent with precedent, logic, and Congressional
intent. Under this approach, since the complaint was filed
within two years of defendants’ belated filing of the
forms required by section 16(a), the action is timely.
Accordingly, defendants’ statute of limitations defense is
rejected.*
4 In the alternative, defendants contend that the disclosure
interpretation cannot survive the Supreme Court’s
determination in Lampf, Pleva, Lipkind, Prupis, & Petigrow v.
Gilbertson, 111 S. Ct. 2773, 2780 (1991) that tolling is
inappropriate under section 10(b) of the Securities Act. In Lampf,
App. 22
Calculation of Damages
Lowest Purchase Price, Highest Sales Price
In calculating the profit realized as a result of short
swing stock profits, the appropriate method, laid down
by the Second Circuit in 1943, is the “lowest price in,
highest price out” method. Smolowe v. Delendo Corp., 136
F.2d 231 (2d Cir.), cert. denied, 320 U.S. 751 (1943). This
approach has been unanimously affirmed in this circuit.
Using this method, defendants’ short swing profits were
$101,004.00 for Freitas and $81,893.75 for Kenner.
Employment Contracts
Tristar argues that, since defendants’ employment
contracts ($44,436.00 for Freitas and $33,172.90 for Ken-
ner) should be regarded as additional consideration for
because section 10(b) is silent on the issue, the Supreme Court
selected a one year from disclosure or three year from the
conduct framework as the appropriate statute of limitations for
section 10(b) violations. The Court then found that the one-
year/three-year structure is incompatible with equitable tolling.
The rationale underlying the Lampf decision is inapplicable to
the section 16(b) context. Indeed, in Lampf the Supreme Court
explicitly distinguished section 16(b) from the other securities
statutes that had the one-year/three-year scheme. Lampf, 111 S.
Ct. at 2780 n.5 (“Because [section 16(b)] requires the
disgorgement of unlawful profits and differs in focus from
section 10(b) and from the other express causes of action, we do
not find Section 16(b) to be an appropriate source from which to
borrow a limitations period here.”) Certainly, Lampf does not
preclude the Court from concluding that tolling is still available
under section 16(b).
App. 23
the sale of their shares, these figures should be consid-
ered part of the Court’s computation of defendants’ short
swing profits. Defendants dispute that the employment
contracts constitute additional short swing profits, stating
that their duties and responsibilities remained unchanged
by the Loan Agreement. In accordance with the Court's
comments in open court, the Court finds that there is a
material issue of fact as to whether the employment
contracts constitute additional consideration for the sale
of the Agreement Shares. Accordingly, on this point,
plaintiff's motion for summary judgment is denied.
Pre-Judgment Interest
Plaintiff seeks prejudgment interest. Since section
16(b) is silent with respect to this issue, the award of
prejudgment interest, although generally part of short
swing profit recovery, is not mandatory. Whittaker, 639
F.2d at 533 (citation omitted). In a section 16(b) case,
interest “is given in response to considerations of fair-
ness. It is denied when its exaction would be inequita-
ble.” Blau v. Lehman, 368 U.S. 403, 414 (1962). In this case,
considering the equities involved, pre-judgment interest
is appropriate.
Conclusion
Defendants engaged in short swing transactions
while they were insiders of Ross Cosmetics. Accordingly,
plaintiff’s motion for summary judgment for the recovery
of the profits from those transactions is granted. With
respect to the amounts sought by plaintiff corresponding
to the payments due to the employment agreements,
App. 24
there is an question of fact as to whether the employment
contracts constitute additional consideration for the sale
of the Agreement Shares. Accordingly, on this issue,
plaintiff’s motion for summary judgment is denied. In all
other respects, plaintiff's motion is granted.
SO ORDERED.
Dated: Brooklyn, New York
November 9, 1994
/s/ Raymond J Dearie
RAYMOND J. DEARIE
United States
District Judge
App. 25
UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF NEW YORK
x
TRISTAR CORPORATION, CV-93-5722 (RJD)
Plaintiff, ORDER AND
- against - FINAL JUDGMENT
ROSS A. FREITAS and
CAROLYN SAFER KENNER,
Defendants.
\
WHEREAS, on November 9, 1994, the Court entered
partial summary judgment on behalf of Plaintiff TRISTAR
CORPORATION (“TRISTAR”) in the amount of $101,004
against Defendant ROSS A. FREITAS (“FREITAS”) and
$81,893.75 against Defendant CAROLYN SAFER KEN-
NER (“KENNER”), plus prejudgment interest from May
31, 1989;
WHEREAS, Plaintiff TRISTAR advised the Court that
it withdraws any claim to additional amounts received by
Defendants FREITAS and KENNER pursuant to two
employment agreements entered into between Defen-
dants and Ross Cosmetics Distribution Centers, Inc.,
dated May 31, 1989;
It is hereby ORDERED, ADJUDGED, AND
DECREED that, Plaintiff TRISTAR shall have final judg-
ment entered against Defendant FREITAS in the amount
of $101,004, plus prejudgment interest from May 31, 1989,
and against Defendant KENNER in the amount of
$81,893.75, plus prejudgment interest from May 31, 1989
App. 26
until the date hereof. Interest shall be calculated at a rate
of nine percent (9%) per annum. Defendants FREITAS
and KENNER shall be jointly and severally liable for
these amounts.
/s/ Raymond J Dearie
HONORABLE
RAYMOND J. DEARIE
UNITED STATES
DISTRICT JUDGE
August 8, 1995
App. 27
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
UNITED STATES COURT HOUSE
40 FOLEY SQUARE
NEW YORK 10007
GEORGE LANGE III
CLERK
At a stated term of the United States Court of
Appeals for the Second Circuit, held at the United States
Courthouse, Foley Square, in the City of New York, on
the 18th day of July one thousand nine hundred and
ninety-six.
Tristar Corporation
Plaintiff-Appellee,
Vv Dkt No: 95-7952
Freitas
Defendants-Appellants.
A petition for rehearing containing a suggestion that the
action be reheard in banc having been filed herein by the
appellee Tristar Corporation.
Upon consideration by the panel that decided
the appeal, it is Ordered that said petition for
rehearing is DENIED.
It is further noted that the suggestion for rehearing in
banc has been transmitted to the judges for the court in
regular active service and to any other judge that heard
App. 28
the appeal and that no such judge has requested that a
vote be taken thereon.
FOR THE COURT
GEORGE LANGE III, Clerk
By: /s/ Beth J. Meador
Beth J. Meador,
Administrative Attorney
App. 29
Section 16 of the Securities Exchange Act of 1934
§ 78p. Directors, officers, and principal stockholders
(a) Filing of statement of all ownership of securities of
issuer by owner of more than ten per centum of any
class of security
Every person who is directly or indirectly the benefi-
cial owner of more than 10 per centum of any class of any
equity security (other than an exempted security) which
is registered pursuant to section 78! of this title, or who is
a director or an officer of the issuer of such security, shall
file, at the time of the registration of such security on a
national securities exchange or by the effective date of a
registration statement filed pursuant to section 78I(g) of
this title, or within ten days after he becomes such benefi-
cial owner, director, or officer, a statement with the Com-
mission (and, if such security is registered on a national
securities exchange, also with the exchange) of the
amount of all equity securities of such issuer of which he
is the beneficial owner, and within ten days after the
close of each calendar month thereafter, if there has been
a change in such ownership during such month, shall file
with the Commission (and if such security is registered
on a national securities exchange, shall also file with the
exchange), a statement indicating his ownership at the
_ close of the calendar month and such changes in his
ownership as have occurred during such calendar month.
App. 30
(b) Profits from purchase and sale of security within
six months
For the purpose of preventing the unfair use of infor-
mation which may have been obtained by such beneficial
owner, director, or officer by reason of his relationship to
the issuer, any profit realized by him from any purchase
and sale, or any sale and purchase, of any equity security
of such issuer (other than an exempted security) within
any period of less than six months, unless such security
was acquired in good faith in connection with a debt
previously contracted, shall inure to and be recoverable
by the issuer, irrespective of any intention on the part of
such beneficial owner, director, or officer in entering into
such transaction of holding the security purchased 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 jurisdiction
by the issuer, or by the owner of any security of the issuer
in the name and in behalf of the issuer if the issuer shall
fail or refuse to bring such suit within sixty days after
request or shall fail diligently to prosecute the same
thereafter; but no such suit shall be brought more than
two years after the date such profit was realized. This
subsection shall not be construed to cover any transaction
where such beneficial owner was not such both at the
time of the purchase and sale, or the sale and purchase of
the security involved, or any transaction or transactions
which the Commission by rules and regulations may
exempt as not comprehended within the purpose of this
subsection.
App. 31
17 C.F.R. Section 240.16a-3
Rule 16a-3. Reporting Transactions and Holdings
(a) Initial statements of beneficial ownership of equity
securities required by Section 16(a) of the Act shall
be filed on Form 3. Statements of changes in benefi-
cial ownership required by that Section shall be filed
on Form 4. Annual statements shall be filed on Form
5. At the election of the reporting person, any trans-
action required to be reported on Form 5 may be
reported on an earlier filed Form 4. All such state-
ments shall be prepared and filed in accordance with
the requirements of the applicable form.
(b) A person filing statements pursuant to Section 16(a)
of the Act with respect to any class of equity securi-
ties registered pursuant to Section 12 of the Act need
not file an additional statement on Form 3:
(1) When an additional class of equity securities of
the same issuer becomes registered pursuant to sec-
tion 12 of the Act; or
(2) When such person assumes a different or an
additional relationship to the same issuer (for exam-
ple, when an officer becomes a director).
(c) Any issuer that has equity securities listed on more
than one national securities exchange may designate
one exchange as the only exchange with which
reports pursuant to Section 16(a) of the Act need be
filed. Such designation shall be made in writing and
shall be filed with the Commission and with each
national securities exchange on which any equity
security of the issuer is listed at the time of such
election. The reporting person’s obligation to file
reports with each national securities exchange on
which any equity security of the issuer is listed shall
be satisfied by filing with the exchange so desig-
nated.
App. 32
(d) Any person required to file a statement with respect
(e)
(f)
to securities of a single issuer under both Section
16(a) of the Act and either Section 17(a) of the Public
Utility Holding Company Act of 1935 or Section 30(f)
of the Investment Company Act of 1940 may file a
single statement containing the required informa-
tion, which will be deemed to be filed under both
Acts.
Any person required to file a statement under Sec-
tion 16(a) of the Act shall, not later than the time the
statement is transmitted for filing with the Commis-
sion, send or deliver a duplicate to the person desig-
nated by the issuer to receive such statements, or, in
the absence of such a designation, to the issuer’s
corporate secretary or person performing equivalent
functions.
(1) A Form 5 shall be filed by every person who at
any time during the issuer’s fiscal year was subject
to Section 16 of the Act with respect to such issuer,
except as provided in paragraph (2) below. The Form
shall be filed within 45 days after the issuer’s fiscal
year end, and shall disclose the following holdings
and transactions not reported previously on Forms 3,
4 or 5:
(i) all transactions during the most recent fiscal
year that were either exempt from Section 16(b) of
the Act or constituted small acquisitions pursuant to
§ 240.16a-6(a);
(ii) all holdings and transactions that should have
been reported during the most recent fiscal year, but
were not; and
(iii) with respect to the first Form 5 requirement for
a reporting person, all holdings and transactions that
should have been reported in each of the issuer’s last
two fiscal years but were not, based on the reporting
App. 33
person’s reasonable belief in good faith in the com-
pleteness and accuracy of the information.
(2) Notwithstanding the above, no Form 5 shall be
required where all transactions otherwise required to be
reported on the Form 5 have been reported before the due
date of the Form 5.
(g) All transactions shall be reported on Form 4, except
as follows:
(1) Small acquisitions as specified in § 240.16a-6(a)
shall be reported in the manner specified by that
section;
(2) Exercises and conversions of derivative securi-
ties exempted pursuant to § 240.16b-6(b) shall be
reported in the manner specified by § 240.16a-4; and
(3) Transactions that are exempted by operation of
any rule pursuant to section 16(b) of the Act, other
than exercises and conversions of derivative securi-
ties exempted pursuant to § 240.16b-6(b), shall be
reported on either Form 5, or, at the option of the
reporting person, Form 4, but in no event later than
the due date of the Form 5 with respect to the fiscal
year in which the transaction occurred.
(h) The date of filing with the Commission shall be the
date of receipt by the Commission; provided, however,
that a Form 3, 4, or 5 shall be deemed to have been
timely filed if the filing person establishes that the
Form had been transmitted timely to a third party
company or governmental entity providing delivery
services in the ordinary course of business, which
guaranteed delivery of the filing to the Commission
no later than the required filing date.
(i) Duplicated or facsimile versions of manual signa-
tures of persons required to sign any document pur-
suant to Section 16 of the Act that is filed or
App. 34
submitted to the Commission under the Act shall be
considered manual signatures for purposes of the
Act and rules and regulations thereunder; provided
that, the original signed document is retained by the
filer for a period of five years and, upon request, the
filer furnishes to the Commission or the staff the
original manually signed document.
ee AT ee eee
App. 35
William R. WHITTAKER, on behalf of
himself, and executor of the estate of
Beulah Whittaker, Plaintiff-Appellee,
Vv.
WHITTAKER CORPORATION, a
California Corporation,
Defendant-Appellant.
William R. WHITTAKER, on behalf of
himself, and executor of the estate of
Beulah Whittaker, Plaintiff-Appellant,
Vv.
WHITTAKER CORPORATION, a
California Corporation,
Defendant-Appellee.
Nos. 77-2297, 77-2550.
United States Court of Appeals,
Ninth Circuit.
Argued and Submitted Oct. 4, 1979.
Decided Feb. 12, 1981.
Corporate insider, who paid amount of alleged short-
swing profits to corporation on demand, brought action
seeking declaratory judgment of nonliability and return
of the monies previously paid. The United States District
Court for the Central District of California, Laughlin E.
Waters, J., found insider liable but also found that the
statute of limitations operated to cut off his liability
because of a specified date, and corporation appealed.
The Court of Appeals, Tang, Circuit Judge, held that: (1)
although securities in question were in insider’s mother’s
name and profits realized from their trading went into
her account, insider, who utilized his mother’s assets as
App. 36
his own pursuant to general power of attorney, was liable
for short-swing profits; (2) trial court, in computing
profits for purposes of determining liability under section
of Securities Exchange Act governing short-swing profits,
properly matched lowest purchase price with the highest
sales price in any given six-month period; and (3) case
would be remanded for consideration of the equities
prior to determination as to whether to award prejudg-
ment interest as part of recovery.
Affirmed in part; reversed and remanded.
Robert E. Cooper, Gibson, Dunn & Crutcher, Los
Angeles, Cal., for defendant-appellant; Martin C. Wash-
ton, Los Angeles, Cal., on brief.
William T. Bisset, Hughes, Hubbard & Reed, Los
Angeles, Cal., for plaintiff-appellee; William H. Levit, Jr.,
Los Angeles, Cal., on brief.
Appeal from the United States District Court for the
Central District of California.
Before CHAMBERS and TANG, Circuit Judges, and
ORRICK," District Judge.
TANG, Circuit Judge:
This case involves liability under the insider short-
swing trading provisions of the Securities Exchange Act
of 1934, § 16, 15 U.S.C. § 78p. The principal questions
* Honorable William H. Orrick, Jr., United States District
Judge for the District of Northern California, sitting by
designation.
App. 37
presented are whether shares nominally owned by
another may be attributed to an insider for liability under
§ 16(b) and whether the two-year limitations period of
§ 16(b) may be tolled. On demand by the Whittaker
Corporation (Corporation), the putative insider, William
Whittaker (William), paid the amount of alleged profits
from insider transactions between December 1, 1965 and
December 31, 1970 (the relevant trading period). He later
sought a declaratory judgment of nonliability under
§ 16(b) and return of the monies previously paid. The
district court found William liable but also found that the
statute of limitations of § 16(b) operated to cut off liability
for transactions prior to January 29, 1969. We affirm the
district court on the issue of William’s liability, but we
reverse and remand on the limitations issue.
PRELIMINARY BACKGROUND
The Whittaker Corporation is a corporation in which
William Whittaker and his mother, Beulah Whittaker,
owned substantial percentages of stock. William was a
director and Chairman of the Board of Directors during
the relevant trading period. In 1965, because of amend-
ments broadening § 16, the Corporation became subject to
§ 16 of the Securities Exchange Act of 1934, 15 U.S.C.
§ 78p (hereinafter § 16).
Briefly, § 16(a) requires “insiders” —- any person who
is a 10% beneficial owner of a company whose securities
are registered under the Act or a director or an officer of
the company - to file menthly reports with the Securities
and Exchange Commission (SEC) showing any changes in
the person’s ownership in the company. Section 16(b)
App. 38
declares that any profits which such person may realize
by any purchase and sale of the company’s securities
within six months shall inure to and be recoverable by
the company. Suits to recover such profits may be
brought by the company or by any shareholder in a
derivative suit if the company fails to do so. No such suit
shall be brought more than two years after the date such
profit was realized.
Since 1959 William had power of attorney from his
mother Beulah to conduct business matters for her. The
securities transactions involved in this case took place
between December 1, 1965 and December 31, 1970. Wil-
liam purchased Whittaker Corporation common stock
and convertible debentures for his mother’s account, and
within six months of such purchases, sold common stock
for his own account and convertible debentures and com-
mon stock for his mother’s account. None of the transac-
tions involving securities for his mother’s account were
reported to the SEC as required by § 16(a). The district
court determined that, because of the relationship
between William and his mother, the control William had
over her stock, and the benefits he realized from it, he
must be deemed the beneficial owner of his mother’s
stock, and so should have reported the transactions under
§ 16(a) and was liable to the corporation under § 16(b) for
profits derived from those transactions involving his
mother’s stock which he realized by a purchase and sale
of the Corporation’s securities within six months.
The Corporation asserts it did not learn of the full
extent of William's total control over his mother’s shares
until the fall of 1970. It then compiled a list of all Wil-
liam’s transactions in the securities of the Corporation,
App. 39
determined which were six-month short-swing insider
trades » 1d computed the profit realized by William. In
January 1971, the Corporation demanded payment of
these realized profits plus interest.
On January 29, 1971, William paid the amount
demanded, denied liability and reserved the right to
bring an action to determine his liability and to seek
return of the monies. William remained with the Corpora-
tion as President until November 1974 and as Chairman
of the Board until January 31, 1975. On July 29, 1975,
William and his mother commenced this action for a
declaration of nonliability under § 16 and recovery of the
money.
Trial was held before the court without a jury. The
district court found that William was liable as an insider
for the transactions in his mother’s shares, but that the
statute of limitations of § 16(b) barred recovery for all but
one year of the relevant trading period. That is, only
profits on transactions within two years prior to the
Corporation’s demand in January 1971 could be recov-
ered. On the transactions for which the Corporation
could recover, the district court computed profits realized
according to the rule of “lowest price in, highest price
out” within six months and awarded the Corporation pre-
judgment interest. The Corporation was then ordered to
pay back the balance of the money paid in 1971.
ISSUES ON APPEAL
1. Was the Corporation’s notice of appeal filed
timely? (Raised by William on motion to dismiss)
App. 40
2. Was William the beneficial owner of his mother’s
shares, so that profits realized in his transactions in those
shares were “profits realized by him” for § 16(b) liability?
(Raised by William on cross-appeal)
3. How should the two-year limitations period of
§ 16(b) be construed? (Raised by the Corporation on
appeal)
4. Is the “highest sales price, lowest purchase price”
method for computing profits in insider trading the cor-
rect method? (Raised by William on cross-appeal)
5. Was the award of prejudgment interest on the
amount of profits recovered by the Corporation incor-
rectly decided by the district court? (Raised by William
on cross-appeal)
A
NOTICE OF APPEAL
William has moved to dismiss the Corporation’s
appeal on the ground that the notice of appeal was not
timely filed. The judgment of the district court was
entered on April 7, 1977. The judgment included the
award of costs to the plaintiffs, William and Beulah Whit-
taker, as the prevailing party. On April 14, 1977 defendant
Corporation moved to retax costs, specifically that all
parties “bear their own taxable costs pending appeal of
this action.” The Corporation argued that it, not the
plaintiffs, should be considered the prevailing party. The
motion to retax costs was denied on April 26, 1977. Hav-
ing learned that William would oppose any filing of a
App. 41
notice of appeal as untimely on the ground that the 30-
day period for filing under Fed.R.App.P. 4(a) had begun
on April 7, 1977 and so had expired, the Corporation
moved the district court for either 1) a determination that
the motion to retax costs had extended the time for filing
a notice of appeal since it was a Fed.R.Civ.P. 59(e) motion
to alter or amend the judgment or 2) an extension of time
for filing the notice of appeal by reason of “excusable
neglect” in learning of the date of entry of judgment. The
district judge rejected the excusable neglect contention
but agreed the motion was a Rule 59(e) motion, even
though it was denied. He ordered the Corporation’s
notice of appeal accepted for filing. It was filed May 18,
1977.
Failure to file a timely notice of appeal is jurisdic-
tional; and the Court of Appeals would lack jurisdiction
to review the judgment. Browder v. Director, Department of
Corrections, 434 U.S. 257, 264, 98 S.Ct. 556, 561, 54 L.Ed.2d
521 (1978); Rodriguez v. Southern Pacific Transportation Co.,
587 F.2d 980, 981 (9th Cir. 1978); Alexander v. Sacha, 439
F.2d 742 (9th Cir. 1971). The notice of appeal must be filed
within 30 days of the entry of judgment. Fed.R.App.P.
4(a). But the running of this time is terminated by a
timely filed motion under, inter alia, Fed.R.Civ.P. 59(e)
(motion to alter or amend the judgment), and the 30-day
time commences anew from the date such motion is
decided. The Corporation’s motion was filed within the
10-day time limit for Rule 59(e) motions. Its notice of
appeal was filed more than 30 days from the entry of
judgment, but less than 30 days from the district court's
denial of its motion to retax costs. The issue then is
whether the Corporation’s motion is a 59(e) motion
:
;
7
App. 42
(which extends the time for appeal) or a Rule 54(d)
motion which reviews the Clerk’s actions regarding costs
(which does not extend the time for appeal).
The Corporation styled its motion a motion to retax
costs and did not recite that it was proceeding under Rule
59(e). “But nomenclature is not controlling.” What is
required is that the requested relief be “relief which
might have been granted under Fed.R.Civ.P. 59(e).” Sea
Ranch Ass’n v. California Coastal Zone Conservation
Comm'n, 537 F.2d 1058, 1061 (9th Cir. 1976). Accord Mir v.
Fosburg, Slip Op., at 1707, 646 F.2d 342, at 344 (9th Cir.
1980).
A motion to amend the judgment with respect to
costs has been heard as a 59(e) motion where the motion
was to tax costs against a different party, United States v.
Crawford, 36 F.R.D. 174 (W.D.La.1964); or to delete the
award of costs altogether, United States v. 2,186.63 Acres of
Land, 464 F.2d 676, 677 (10th Cir. 1972); or to add costs
where none were in the judgment before, see Alameda v.
Paraffine Companies, Inc., 169 F.2d 408, 409 (9th Cir. 1948)
(prior to Rule 59%e), treating such motion as amending
judgment so as to extend time for filing notice of
appeal).!
1 Similarly, motions to reconsider the award of attorney's
fees and motions to add attorney’s fees to the judgment have
been treated as Rule 59(e) motions. See Hammond v. Public
Finance Corp., 568 F.2d 1362 (5th Cir. 1978); Stacy v. Williams, 50
F.R.D. 52 (N.D.Miss.1970), aff'd, 446 F.2d 1366 (5th Cir. 1971);
Farmington Dowel Products Co. v. Forster Mfg. Co., 421 F.2d 61, 76
n. 39 (1st Cir. 1969). Contra Lichtenstein v. Lichtenstein, 55 F.R.D.
535, 537 (E.D.Pa.1972), rev'd on other grounds, 481 F.2d 682 (3d
Cir. 1973), cert. denied, 414 U.S. 1144, 84 S.Ct. 895, 39 L.Ed.2d 98
App. 43
On the other hand, Rule 54(d) motions are appropri-
ate for correcting clerical errors in the bill of costs, dis-
puting particular items or amounts, or otherwise
amending an accepted award of costs. For substantive
challenges as to the appropriateness of awarding costs at
all, especially where such challenge involves a redeter-
mination of who was the prevailing party, Rule 59(e) may
be appropriate. We do not mean to imply that these
categories are exclusive. It may be that some motions
could be characterized as under both Rules 54(d) and
59(e) motion.
William relies on Environmental Defense Fund, Inc. v.
Froehlke, 368 F.Supp. 231 (W.D.Mo.1973), aff'd, 497 F.2d
1340 (8th Cir. 1974). But in Froehlke the district judge
found that the plaintiffs actually were seeking only a
review of amount of costs and a determination of which
costs were taxable to plaintiffs. 368 FSupp. at 252-53.
Moreover, the court appears to have been led to treat the
motion as a 54(d) motion so as to reach the merits and
avoid the untimeliness problem created if it were treated
as a 59(e).2
(1974) (motion to amend judgment to add attorney’s fees treated
as 54(d) motion, not 59(e) motion, but done so in order to avoid
dismissal of motion as untimely).
? See 368 F.Supp. at 253. William also relies extensively on
Knowles v. United States, 260 F.2d 852 (5th Cir. 1958). But Knowles
does not aid William. In Knowles, the plaintiff was disputing
only two items of cost. Moreover, those costs had been levied on
plaintiff by the district court in regard to a prior appeal of the
case; they were not directly related to the judgment appealed
from. Those costs were treated as a separate matter by both the
district court and the Fifth Circuit. Finally, from the Fifth
Circuit’s opinion it is apparent neither that the motion to vacate
App. 44
The Corporation’s motion here was not a motion
challenging any item of cost or amount of any item as
assessed by the Clerk. Rather, it was a challenge as to
who should be entitled to costs, that is, a question of who
the prevailing party was. As the district judge recog-
nized, because of the unusual procedural circumstances
of this case, the roles of plaintiff and defendant were, in
effect, reversed. Normally, the corporation would be the
plaintiff, suing to recover the insider profit. Although
William was technically the prevailing party since he won
a money judgment, the Corporation had prevailed on the
gravamen of its claim. If the suit had been a normal
insider trading case, the Corporation would have “pre-
vailed.” Thus, the Corporation’s motion went to the heart
of how the judgment was to be characterized. The district
judge is surely in a position to understand the ramifica-
tions of the motion on the judgment. Cf. In re Estate of
Butler’s Tire & Battery Co., Inc., 592 F.2d 1028, 1032 (9th
Cir. 1979) (district court’s extension of time for appeal for
excusable neglect under Fed.R.App.P. 4(a) overturned
only for abuse of discretion). He thought the relief
requested, if granted, “would have necessarily resulted in
an amendment of that judgment.”?
these costs was made or treated as a Rule 59(e) motion nor that it
was even timely filed as a Rule 59(e) motion with respect to the
judgment Knowles sought to appeal. If it were not a timely Rule
59(e) motion, it could not have extended the time for appeal.
3 The problem was only partly that the judgment as signed
had expressly contained an award of costs to William. Even if
that were not in the judgment, and the Clerk had merely
awarded costs to William as a matter of course as the
“prevailing party,” a motion challenging the Clerk’s action on
the ground that the Corporation should be deemed the true
App. 45
We agree and consider the Corporation’s motion cor-
rectly construed as a Rule 59(e) motion. Since it was
timely filed, it extended the time for filing the notice of
appeal under Fed.R.App.P. 4(a). The Corporation’s appeal
is timely.
II.
BENEFICIAL OWNERSHIP AND PROFIT REALIZED
A. General Principles for § 16
Section 16(b) declares, in effect, that directors, offi-
cers, and 10% beneficial owners are presumed to have
inside information and then states the corporation can
recover any profits made by these insiders on transac-
tions within a six-month period. This recovery rule is
virtually automatic. Neither actual possession of inside
information nor use of such information need be shown.
Even initial good faith intent to hold the securities for
longer than six months is no defense. “In short, this
statute imposes liability without fault within its narrowly
drawn limits.” Foremost-McKesson, Inc. v. Provident Securi-
ties Co., 423 U.S. 232 at 251, 96 S.Ct. 508 at 519, 46 L.Ed.2d
464. However, “it is an objective rule and does not reach
every transaction in which an investor actually relies on
inside information, or in which the potential for such
reliance is great.” Lewis v. Varnes, 505 F.2d 785, 787 (2d
Cir. 1974). See Blau v. Max Factor & Co., 342 F.2d 304, 307
(9th Cir.), cert. denied, 382 U.S. 892, 86 S.Ct. 180, 15
L.Ed.2d 150 (1965); Rheem Mfg. Co. v. Rheem, 295 F.2d 473,
prevailing party would still be a Rule 59(e) motion insofar as it
sought an interpretive amending of the judgment.
App. 46
475 (9th Cir. 1961). See generally 2 L. Loss, Securities Regu-
lation (2d ed. 1961) at 1040-44.
In interpreting § 16 for situations which do not fall
obviously within its scope, a certain tension is immanent
[sic]. On the one hand, “where alternative constructions
of the terms of § 16(b) are possible, those terms are to be
given the construction that best serves the congressional
purpose of curbing short-swing speculation by corporate
insiders.” Reliance Electric Co. v. Emerson Electric Co., 404
U.S. 418 at 424, 92 S.Ct. 596 at 600, 30 L.Ed.2d 575. This
“objective approach” goes back to the earliest cases inter-
preting the statute. “The statute is broadly remedial... .
[I]t was intended to be thoroughgoing, to squeeze all
possible profits out of stock transactions, and thus to
establish a standard so high as to prevent any conflict
between the selfish interest of (an insider) and the faith-
ful performance of his duty.” Smolowe v. Delendo Corp.,
136 F.2d 231, 239 (2d Cir.), cert. denied, 320 U.S. 751, 64
S.Ct. 46, 88 L.Ed. 446 (1943). See also Adler v. Klawans, 267
F.2d 840, 846 (2d Cir. 1959) (§ 16 to be interpreted broadly
so as to give full effect to plain congressional intent).
On the other hand, because of the mechanical appli-
cation of § 16(b), imposing liability without fault on
transactions within its scope, courts more recently have
been hesitant to bring borderline transactions under that
scope by interpretation where congressional intent was
unclear and the transaction in question was not of a type
giving rise to speculative abuse. See, e.g., Foremost-
McKesson, Inc., 423 U.S. at 252, 96 S.Ct. at 520 (person
must be 10% owner prior to purchase at issue); Kern
County Land Co. v. Occidental Petroleum Corp., 411 U.S. 582
at 593-95, 93 S.Ct. 1736 at 1744-1745, 36 L.Ed.2d 503 (sales
App. 47
in context of blocked tender offer); Reliance Electric Co.,
404 U.S. at 424 n. 4, 92 S.Ct. at 600 n. 4 (person must be
10% owner at time of sale at issue); Blau v. Max Factor &
Co., 342 F.2d at 306-09; Lewis v. Varnes, 505 F.2d at 789;
Matas v. Siess, 467 F.Supp. 217, 220-21, 224 (S.D.N.Y.1979).
Under this “subjective” or “pragmatic” approach,
courts inquire whether the transaction involved carries a
potential for insider abuse. Only those types of transac-
tions which do are then found included within the statu-
tory scope. Kern County Land Co., 411 U.S. at 594-95, 93
S.Ct. at 1744-1745. However, the pragmatic approach has
not ousted the objective view. Rather, the pragmatic
approach is used to determine the boundaries of the
statute’s definitional scope in borderline situations, espe-
cially unorthodox transactions. Id. For a garden-variety
transaction which cannot be regarded as unorthodox, the
pragmatic approach is not applicable. Mouldings, Inc. v.
Potter, 465 F.2d 1101, 1104-05 (5th Cir. 1972), cert. denied,
410 U.S. 929, 93 S.Ct. 1368, 35 L.Ed.2d 591 (1973); Tyco
Laboratories, Inc. v. Cutler-Hammer, Inc., 490 F.Supp. 1, 7
(S.D.N.Y.1980); Matas v. Siess, 467 F.Supp. at 220. In such
cases, if the situation is within the requirements estab-
lished by Congress for § 16, then the mechanical, “objec-
tive,” operation of the statute imposes liability.
B. The Question Presented and Factual Background
Under § 16(b), the corporation may recover “any
profit realized by him [the insider]” in covered short-
swing transactions. In the present case, the securities in
question were in William’s mother’s name and the profits
realized in their trading went into her accounts. Thus, the
App. 48
question arises whether these profits* were profits “real-
ized by him” and so recoverable or were realized only by
his mother and so not covered by § 16(b). William, relying
on the narrow interpretive approach discussed above,
argues that the term “by him” should be read strictly and
narrowly and that, so read, it does not include the profits
here. The Corporation and the district court below, how-
ever, use the concept of “beneficial ownership” in § 16(a)
in order to give content to the term “realized by him” in
§ 16(b). Under that analysis William was found liable
under § 16(b).
William raises his issues on cross-appeal as pure
questions of law; he disputes none of the fact findings
below. Accordingly, we accept and rely on the facts as
found by the district court. In any event, the district
court’s findings of fact as to these issues are not clearly
erroneous under Fed.R.Civ.P. 52(a). Pertaining to the
ownersnip issue, the district court found the following.5
In 1959, because of her advancing age, his mother
granted William a broad general power of attorney, giv-
ing him the right to pay her bills, sign checks for her,
manage her financial and business affairs, and purchase
* More accurately, if the Corporation’s position is correct
and these securities are treated as William’s, then profits would
be computed by comparing purchases and sale of all the
securities (both in Beulah’s and William’s names) and not
merely comparing purchases and sales of those securities in the
mother’s name.
5 This account is taken principally from pages 4-6 and 12-13
of the district court’s unpublished opinion, reprinted in
[1977-1978 Transfer Binder] CCH Fed.Sec.L.Rep. J 96,008 at
91,528-29 & 91,531.
oF AERP wh aC ES
App. 49
and sell securities for her investments. In 1969, this
power was renewed. “At all times relevant to this litiga-
tion, Mr. Whittaker made and executed virtually all
investment and business decisions for his mother on his
own initiative and in his sole discretion pursuant to this
power of attorney.”
A joint bank checking account, bearing Beulah’s and
William’s names, was set up for her expenses. From 1960
and throughout the relevant trading period, William
maintained and personally signed all checks drawn on
this joint account. During the same period, Beulah’s
income was deposited to this account and her expenses
paid from it.
The district judge further found that “it is clear that
Mr. Whittaker exercised virtually complete control over
his mother’s affairs. .. . ” Throughout the relevant trad-
ing period, William received a series of substantial loans
from his mother. His control over her finances enabled
William “to freely borrow large sums of money from her
while never having to consider paying the money back,
posting adequate security or even paying any interest
that might accrue.” Moreover, William used his mother’s
assets to fund, through interest-free loans, advantageous
investment opportunities he otherwise might have had to
forego. William would borrow from a bank in his
mother’s name, and the interest would be paid from her
funds.
As the district judge summarized, “(i)n short, the
evidence indicates that Mr. Whittaker felt free to utilize
his mother’s assets exactly as if they were his own. It is
thus obvious that Mr. Whittaker stood to gain on any
App. 50
profits he might make for his mother through the pur-
chase and sale of Whittaker Corporation securities.”®
C. “Profit realized by him”
On this factual basis, the district court concluded that
William was the “beneficial owner” of the securities
under the definition of beneficial owner developed for
§ 16(a). Insiders must include in their reports required
under § 16(a) those securities of which they are the “ben-
eficial owner.” See SEC Securities Exchange Act Release
No. 7793 (Jan. 19, 1966) (discussed at page 526 infra).
Under the applicable principles William was the benefi-
cial owner and should have included them in his § 16(a)
reports. This determination is uncontested. The district
court then held that, if one is the beneficial owner, the
securities are “his,” and thus one must be chargeable
with the profits under § 16(b), relying on Whiting v. Dow
Chemical Co., 523 F.2d 680 (2d Cir. 1975), aff'g, 386 F.Supp.
1130 (S.D.N.Y.1974), and on Altamil Corp. v. Pryor, 405
F.Supp. 1222 (S.D.Ind.1975).
William contends the district court was in error
because Blau v. Lehman, 368 U.S. 403, 82 S.Ct. 451, 7
L.Ed.2d 403 (1962), requires a narrow reading of “profits
realized by him” in § 16(b) and particularly because the
equation of “beneficial ownership” for § 16(a) reports
with profit attribution for § 16(b) liability is erroneous as
® The district court also noted that this was supported
further by the fact that William was the sole beneficiary under
his mother’s will and would be her sole intestate heir, that she
was of an advanced age and in poor health, and that it was
unlikely that her will would be changed.
.
‘ 4
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:
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App. 51
a matter of law. We reject William’s contentions and
affirm the district court on this issue. Our affirmance
rests on two distinct grounds.
First, quite apart from any consideration of beneficial
ownership, we hold that on the facts as found by the
district court the profits are profits realized by William
under § 16(b). William controlled his mother’s invest-
ments. He thus controlled the trading in Corporation
securities. He determined the timing and amount of sales
and purchases. William had control over his mother’s
assets and so had control over money received for the
Corporation securities. He could use those assets as freely
as if they were his own. And in fact he did so use them, in
large amounts, on several occasions. On these facts -
control over the securities and unfettered ability to use
the money for his own benefit - any reasonable inter-
pretation of “profit realized by him” must encompass the
instant case. Cf. Mouldings, Inc. v. Potter, 465 F.2d at
1103-05 (insider designated others to whom profits would
go, profits held attributable to insider for § 16(b) lia-
bility).
Blau v. Lehman, 368 U.S. 403, 82 S.Ct. 451, 7 L.Ed.2d
403 (1962), on which William relies principally, does not
require a different result. In Lehman, Blau, a shareholder
in Tide Water, brought a § 16(b) claim against Lehman
Brothers, an investment banking house, and Thomas, a
partner in Lehman Brothers and a director of Tide Water.
While Thomas was a director of Tide Water, Lehman
Brothers had engaged in short-swing trading of Tide
Water stock for its own account and realized profits
thereon. The Supreme Court held that all the Lehman
App. 52
Brothers profits were not profits realized by Thomas per-
sonally and so Thomas was not liable for them under
§ 16(b). 368 U.S. at 413-14, 82 S.Ct. at 456-457.
William argues that, just as the Lehman profits were
not attributable to Thomas, so his mother’s profits are not
attributable to him. William’s reliance is misplaced. Leh-
man is clearly distinguishable. One partner in an invest-
ment firm has neither the same control over trading nor
the same benefit from profits in the firm‘’s portfolio that
William had over his mother’s securities. Indeed, several
of the facts in Lehman underscore this distinction. Lehman
Brothers purchased the Tide Water securities without
consulting Thomas, and, once the purchases were discov-
ered, Thomas was insulated from financial interest in
them. See 368 U.S. at 406, 82 S.Ct. at 453. While it may
have been “nothing but a fiction to say that Thomas
‘realized’ all the profits earned by the partnership of
which he was a member,” 368 U.S. at 414, 82 S.Ct. at 457,
it would be an equal fiction here to say these profits are
not William’s.”
7 William also cites several cases in which other provisions
of § 16(b) have been construed strictly and argues that “profits
realized by him” must be similarly construed. See Foremost-
McKesson, Inc., supra; Kern County Land Co., supra; Reliance
Electric Co., supra. See page 10 supra. See also Lewis v. Mellon Bank,
513 F.2d 921 (3d Cir. 1975); American Standard, Inc. v. Crane Co.,
510 F.2d 1043 (2d Cir. 1974), cert. denied, 421 U.S. 1000, 95 S.Ct.
2397, 44 L.Ed.2d 667 (1975).
App. 53
D. “Beneficial ownership” and “profit realized”
Our second rationale for affirmance involves consid-
eration of the interrelationship between beneficial owner-
ship in § 16(a) and profits realized by him in § 16(b).
While we agree with the district court’s result snd also
agree that there is a strong relationship between these
provisions of § 16(a) and § 16(b), we do not agree that
there is always an automatic equivalence between the
two.
The intent and purpose of § 16 must be gleaned from
the statute as a whole rather than from its isolated parts.
Adler v. Klawans, 267 F.2d 840, 844 (2d Cir. 1959). Sections
16(a) and 16(b) must also be read together because they
are grammatically related. See American Standard, Inc. v.
Crane Co., 510 F.2d 1043, 1058 (2d Cir. 1974), cert. denied,
421 U.S. 1000, 95 S.Ct. 2397, 44 L.Ed.2d 667 (1975). In
particular, the scope and definition of insider or benefi-
cial owner for § 16(b) has been determined by reference
to § 16(a). See Foremost-McKesson, Inc., 423 U.S. at 234 n.1,
96 S.Ct. at 511 n.1; Kern County Land Co., 411 U.S. at 591
n.21, 93 S.Ct. at 1743 n.21; Reliance Electric Co., 404 U.S. at
419 n.1, 92 S.Ct. at 597 n.1 (second paragraph). Under
§ 16(a), an insider is required to report changes in owner-
_ ship of covered securities “of which he is the beneficial
owner.” Thus, for reporting purposes, stock ownership is
attributed to directors and officers (as well as to principal
- 10% — shareholders) by the concept of beneficial owner-
ship. Moreover, the identity of some insiders (i. e., those
who are insiders by virtue of 10% beneficial ownership)
for § 16(b) liability is determined by reference to § 16(a).
App. 54
Thus, it is not far-fetched similarly to determine by refer-
ence to § 16(a) what stock those insiders own for § 16(b)
liability.
The Second Circuit adopted this approach in a simi-
lar situation. In Whiting v. Dow Chemical Co., 523 F.2d 680
(2d Cir. 1975), aff’'g 386 FSupp. 1130 (S.D.N.Y.1974), the
court determined that a spouse’s shares were beneficially
owned by the insider and that once the insider is the
“ “beneficial owner,’ he must be chargeable with all the
profits or none.” Whiting, 523 F.2d at 689. In Whiting the
shares were owned by the non-insider wife, and she had
predominant control over them. However, analyzing all
the facts, the court determined that the transactions were
part of a jointly managed common investment plan, that
the income was available to both spouses, and in particu-
lar that the proceeds of the sale of the wife’s shares had
been used to finance the husband’s purchases. The court
then concluded these facts made the husband the benefi-
cial owner of these stocks under the SEC’s definition of
beneficial ownership. See SEC Securities Exchange Act
Release No. 7793 (Jan. 19, 1966) (“Release 7793”).8
Essentially, under Release 7793, a person is a benefi-
cial owner of shares held in another’s name if the person
8 SEC Release 7793 is reprinted in CCH Fed.Sec.L.Rep.
WI 26,031 & 26,032. It appears in pertinent part in Whiting, 523
F.2d at 686 n.10. For general discussions of Release 7793, see 5 L.
Loss, Securities Regulation (2d ed. Supp. 1969) at 3063-66;
Feldman & Teberg, Beneficial Ownership Under Section 16 of the
Securities Exchange Act of 1934, 17 Case Western Res.L.Rev. 1054
(1966).
BATT E g ah Sy
App. 55
either obtains benefits substantially equivalent to owner-
ship or has the power to revest title in himself. However,
Release 7793 defined beneficial ownership only for pur-
poses of the § 16(a) reporting requirement. A subsequent
SEC Release made it clear that the requirement to report
beneficially owned shares was not coextensive with
§ 16(b) liability. SEC Securities Exchange Act Release No.
7824 (Feb. 14, 1966), reprinted in CCH Fed.Sec.L.Rep.
{I 26,030 (“Release 7824”). Rather, liability under § 16(b)
for transactions in beneficially owned shares is “to be
determined by the facts of each particular case in an
appropriate action brought by the issuer or its security
holders.” Release 7824. Under Release 7793, “a person
ordinarily should include in his [§ 16(a) reports] securi-
ties held in the name of a spouse or minor children as
being beneficially owned by him.” It is this routine, auto-
matic (“ordinarily”) quality of § 16(a) reporting that
makes the mere presence of a § 16(a) reporting require-
ment, without more, unsuitable as a conclusive determi-
nant of § 16(b) liability.
The Whiting court recognized this limitation on
§ 16(a) beneficial ownership, 523 F.2d at 687, and further
recognized the underlying reason for it - namely, that
“[a] definition of ‘beneficial ownership’ may be broad
enough to require reporting for purposes of public expo-
sure but too broad for the imposition of liability under
§ 16(b).” 523 F.2d at 685 n.8. But, the Whiting court still
ended with a general proposition that, if one is the “bene-
ficial owner,” one is chargeable with the profits. 523 F.2d
at 689. The Whiting court apparently created an unex-
pressed new term, “beneficial ownership for § 16(b) pur-
poses.” The court then took the defining characteristics of
App. 56
beneficial ownership in Release 7793 and applied them to
the facts of the particular case, as Release 7824 advised.
This application was done not simply to find if beneficial
ownership for § 16(a) reporting was met, but to deter-
mine if the actual rewards of ownership were sufficiently
present to warrant attributing the stock to the insider-
spouse for § 16(b) liability. See 523 F.2d at 688-89. See also
386 F.Supp. 1130, 1136-38 (district court in Whiting). It
was this “beneficial ownership for § 16(b)” which was
dispositive in determining what profits were “realized by
him.”
The district court below, relying on Whiting, engaged
in a similar reasoning. Analyzing the facts of William's
control and benefit over the shares, the court concluded
he “must be deemed the beneficial owner of [his
mother’s] securities for purposes of § 16(b).”
William argues the Whiting analysis equates § 16(a)
reporting and § 16(b) liability and that such an equation
unduly expands § 16(b). While the Whiting analysis is
somewhat ambiguous, we do not read that case as mak-
ing such an equation. Rather, the Whiting court engaged
in a factual determination of beneficial ownership speci-
fically for purposes of § 16(b). Nor, in following Whiting,
did the district court in the case at bar make such an
equation. The district court did not rely on the mere fact
that his mother’s shares were beneficially owned by Wil-
liam for § 16(a) reports. The court took evidence on the
relation between his mother and William, the extent of
William’s involvement in managing her affairs, and par-
ticularly the degree of control William had over the Cor-
poration securities, and the extent of his ability to enjoy
the benefit therefrom. Only after evaluating this evidence
App. 57
did the district court conclude that his mother’s securities
should be attributed to William in computing his profits
realized under § 16(b).
In affirming the district court finding, we hold that
an insider who trades in shares which he or she bene-
ficially owns within the meaning of § 16(a) may be sub-
ject to the sanctions of § 16(b). Such liability should be
imposed, however, only following a determination by the
trial court not simply that the requirements of beneficial
ownership were met for purposes of the § 16(a) reporting
requirement, but that actual rewards of ownership were
sufficiently present to warrant attributing the stock to the
insider for purposes of § 16(b). In making this determina-
tion, the court should especially consider as key factors
the degree to which the insider exercised control over the
securities and the insider’s ability to use the profits
made. See Note, “Beneficial Ownership” Under § 16(b) of the
Securities Exchange Act of 1934, 77 Colum.L.Rev. 446,
460-62 (1977).
William also contends that this analysis, like the
Whiting court’s, run contrary to the strict interpretive
approach of the Supreme Court in Foremost-McKesson,
Inc., Kern County Land Co., and Reliance Electric Co. Our
reading of § 16(b) is not expansive. Moreover, in this
instance, SEC Releases and an interrelationship between
§ 16(a) and § 16(b) are involved; the cited Supreme Court
cases do not deal with interpretations in a similar context.
Similarly, in the instant case, unorthodox transactions
calling for the application of the pragmatic approach are
not present. See discussion at pages 522-523 supra.
App. 58
Our analysis, though approaching the issue through
the theory of “beneficial ownership”, arrives at the same
conclusion as our analysis of whether “profits were real-
ized” by William. See discussion at page 524 supra. Thus,
the district court’s finding of liability under § 16(b) must
be affirmed.
Ill.
TWO YEAR LIMITATIONS PERIOD
A. Background
Section 16(b) provides that no suit under the section
“shall be brought more than two years after the date such
profit was realized.” On demand by the Corporation,
William paid the amount claimed on January 29, 1971.
This date became the applicable date from which the
statute of limitations is measured. If the two year period
is applicable, then the Corporation is limited to recovery
of profits realized only after January 29, 1969.
But how is the application of the two year time limit
of § 16(b) to be construed? The parties present three
theories of interpretation. First, William advances the
“strict” interpretation under which the two years run
strictly from the time the profits were realized, without
any tolling. Second, there is a “notice” or “discovery”
interpretation under which the time period is tolled until
the Corporation had sufficient information to put it on
notice of its potential § 16(b) claim. Finally, the Corpora-
tion advances the “disclosure” interpretation under
App. 59
which the time period is tolled until the insider discloses
the transactions at issue in his mandatory § 16(a) reports.?
The district judge hypothetically applied the notice
interpretation. He found that various corporate officers
had information which put the Corporation on notice
throughout the relevant trading period. It was admitted
that William did not disclose the transactions in his
mother’s shares on his § 16(a) reports as he was required
to do. But the district court did not consider the dis-
closure interpretation separately, perhaps reasoning that
actual notice would override any failure to report. Then,
since tolling was not available, the district court deter-
mined it need not decide between the notice or strict
interpretations.
On appeal, the Corporation renews its disclosure
interpretation argument, and William renews the strict
interpretation. Secondarily, accepting the notice inter-
pretation, each side advances arguments that the facts do
or do not support the district court’s conclusion that the
° There is also mention of a fraudulent concealment theory
under which the time limit is tolled as long as the insider
conceals the transactions from the Corporation. But as it has
been used in the few prior § 16(b) cases, this is only a step in the
analysis toward the disclosure interpretation. The failure to
disclose in § 16(a) reports, whether intentional or inadvertent, is
deemed concealment, thus triggering the traditional equitable
tolling doctrine of fraudulent concealment. See, e. g., Blau v.
Albert, 157 F.Supp. 816, 819 (S.D.N.Y.1957) (quoting Cook &
Feldman, Insider Trading under the Securities Exchange Act (Part
I), 66 Harv.L.Rev. 385, 413 (1953)).
App. 60
Corporation had notice. We hold the disclosure inter-
pretation is the correct construction of § 16 and accord-
ingly reverse the district court. Therefore, we need not
reach the district court’s conclusions based on the notice
interpretation.
B. Tolling and the Reporting Requirement
The ultimate question is one of congressional intent,
“whether tolling the limitation in a given context is con-
sonant with the legislative scheme.” American Pipe and
Construction Co. v. Utah, 414 U.S. 538, 558, 94 S.Ct. 756,
768, 38 L.Ed.2d 713 (1974). Neither the mere fact that a
statute creating a cause of action also contains a time
limitation nor whether a time limitation is viewed as
substantive or procedural forecloses the question of
allowing or disallowing tolling; the determinative factor
is whether tolling is not inconsistent with the legislative
purpose. See id. at 556-59, 94 S.Ct. at 767-769.
The bare words of the time provision of § 16(b) do
not say whether tolling is or is not allowed. Normally, we
would turn to the legislative history. But the legislative
history of § 16(b) is silent concerning this provision. See
Grossman v. Young, 72 F.Supp. 375, 378 (S.D.N.Y.1947)
(first case construing time provision of § 16(b)). However,
examining the legislative purpose of § 16 as a whole and
considering the place of the time provision in that overall
legislative scheme, we infer that tolling of the two year
time period is required when the pertinent § 16(a) reports
are not filed.
The legislative history and purpose of § 16, discussed
in Part IIl-A above, clearly reveal a strong congressional
Ten eT Gromer ~ sigtis=, Peyinpeze arabe err pry
App. 61
intent to curb insider trading abuses. This purpose would
be thwarted if insiders could escape liability by not
reporting as required under § 16(a). “[I]t would be a
simple matter for the unscrupulous to avoid the salutary
effect of Section 16(b) which provides a remedy for the
recovery of short term profits, simply by failing to file
monthly reports in violation of subdivision (a) and
thereby concealing from prospective plaintiffs the infor-
mation they would need to adequately protect their inter-
ests. Such a construction would reward the violation of
the statute and would manifestly frustrate congressional
intent.” Blau v. Albert, 157 F.Supp. 816, 819 (S.D.N.Y.1957).
Accord Grossman v. Young, 72 F.Supp. at 378-79.
This conclusion is further supported by consideration
of the complementary nature of § 16(a) and § 16(b). As
subdivisions of the same section, they should be read
together. See, e. g., Foremost-McKesson, Inc., 423 U.S. at 234
n.1, 96 S.Ct. at 511 n.1; American Standard Inc., 510 F.2d at
1058. See also discussion at pages 525-526 supra. The time
limit is made a part of the section itself rather than
incorporated by reference to another provision. The dis-
closures and reports of § 16(a) are an integral part of the
context of § 16 within which § 16(b) must be read. The
short limitations period is understandable only in the
context of the insider’s duty to make prompt disclosure.
See Grossman v. Young, 72 F.Supp. at 378. “Effective opera-
tion of Section 16(b) is made possible by Section 16(a)’s
requirement of full and prompt publicity. ... ” Note, The
Scope of “Purchase and Sale” Under Section 16(b) of the
Exchange Act, 59 Yale L.J. 510, 512 (1950).
Similarly, Congress’ express provision in § 16(b) that
individual security holders may bring suit on behalf of
App. 62
the corporation to recover insider profits bolsters our
interpretation. Even if other corporate officers or direc-
tors should know of an insider’s transactions, this would
not be the disclosure § 16 demands, because security
holders can bring suit on the corporation’s behalf. “Only
by full compliance with Section 16(a) can the security
holders be charged with adequate notice of the transac-
tion.” Cook & Feldman, Insider Trading Under the Securi-
ties Exchange Act (Part I), 66 Harv.L.Rev. 385, 414 (1953).
Such shareholders are likely to be outsiders, minority
holders. Their main source of information for the suits
Congress has empowered them to bring likely will be the
required § 16(a) reports.!° If insiders could insulate their
transactions from the scrutiny of outside shareholders by
failing to file § 16(a) reports and waiting for the two year
time limit to pass, then Congress’ creation of these share-
holders’ derivative suits would be nullified.
This congressional interest in affording individual
security holders the opportunity to sue under § 16 mili-
tates in favor of the disclosure interpretation over the
notice interpretation in another respect. Under the notice
interpretation, the question arises whether the knowledge
of corporate officers or directors should be attributed to
the corporation, thus giving it notice and allowing the
limitations period to run. Normally, knowledge of corpo-
rate officials is imputed to the corporation. But in the § 16
10 The reports are available to the public at the SEC and at
the exchanges. 17 C.F.R. § 240.24b-3(a). The information in all
the reports is compiled and published by the SEC in a pamphlet
available at SEC offices and exchanges and widely distributed
by subscription. See 2 L. Loss, Securities Regulation (2d ed. 1961)
at 1039 & n.9.
App. 63
context, if corporate officials’ knowledge of another
insider’s trading and indeed even the trading insider’s
own knowledge were imputed to the corporation, then
the corporation’s right to recover the profits and espe-
cially the ability of minority shareholders to bring such
suits would be seriously impaired. Cf. Schur v. Salzman,
365 F.Supp. 725, 733 (S.D.N.Y.1973); Jefferson Lake Sulphur
Co. v. Walet, 104 F.Supp. 20, 23 \E.D.La.1952), aff'd, 202
F.2d 433 (5th Cir.), cert. denied, 346 U.S. 820, 74 S.Ct. 35, 98
L.Ed. 346 (1953) (corporation’s § 16(b) suit not estopped
on ground that corporation approved of transactions,
since corporation’s action under control of very insiders
involved). See also Cook & Feldman, supra, 66 Harv.L.Rev.
at 413-14. Collusion among insiders and, a more likely
occurrence, the unarticulated acquiescence in or averting
of gaze from a powerful insider’s transactions thus
would be rewarded under the notice interpretation. This
problem does not arise under the disclosure interpreta-
tion. Thus, the disclosure interpretation adopted herein
better serves the purposes of the statute.
Finally, the purpose of § 16 to impose absolute
accountability within clearly demarcated boundaries,
supports the disclosure interpretation. This goal of clear
boundaries is served by a limitations period which can be
mechanically calculated from objective facts. The dates on
which purchases and sales are made are such facts, as are
the dates on which § 16(a) reports are filed with the SEC.
By contrast, under the notice interpretation, the running
of the limitations period would depend on uncertain
determinations of what knowledge should lead a corpo-
ration to discover its cause of action. Thus, the disclosure
App. 64
interpretation better serves the statute’s purpose than the
notice interpretation.
C. Statutory Analysis and Prior Cases
Only a few cases have considered the two year lim-
itation provision of § 16(b). Three cases from the Southern
District of New York agree with our analysis. See Shattuck
Denn Mining Corp. v. La Morte, [1973-74 Transfer Binder]
CCH Fed.Sec.L.Rep. I] 94,429, at 95,472 (S.D.N.Y.1974).
Blau v. Albert, 157 F.Supp. 816 (S.D.N.Y.1957); Grossman v.
Young, 72 F.Supp. 375 (S.D.N.Y.1947). One case from the
Middle District of Pennsylvania rejected this analysis and
adopted a strict interpretation of the two year limit. See
Carr-Consolidated Biscuit Co. v. Moore, 125 F.Supp. 423
(M.D.Pa.1954).'! Grossman v. Young and Blau v. Albert are
the better reasoned decisions, and reference is made to
them for more elaboration of the disclosure interpreta-
tion. See also 2 L. Loss, Securities Regulation (2d ed. 1961)
at 1055-58 (discussing the two year limitation, approving
Grossman, and critizing Carr-Consolidated Biscuit Co.).
The court in Carr-Consolidated Biscuit Co. relied on the
discarded theory that substantive statutes of limitation
11 In four other cases, the two year limit, strictly calculated,
was held to bar suit or was assumed to be the measure, but in
these cases the question of tolling due to failure to file § 16(a)
reports was not presented. See Morales v. Mylan Laboratories, Inc.,
443 FSupp. 778 (W.D.Pa.1978); Cowsar v. Regional Recreations,
Inc., 65 F.R.D. 394 (M.D.La.1974); Chambliss v. Coca-Cola Bottling
Corp., 274 F.Supp. 401 (E.D.Tenn.1967), aff'd, 414 F.2d 256 (6th
Cir. 1969), cert. denied, 397 U.S. 916, 90 S.Ct. 921, 25 L.Ed.2d 97
(1970); Blau v. Lamb, 191 F.Supp. 906 (S.D.N.Y.1961).
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App. 65
are entitled to literal application by the courts and may
not be tolled. See 125 F.Supp. at 429-30. But this theory
was effectively renounced by the Supreme Court in Amer-
ican Pipe and Construction Co. v. Utah, 414 U.S. 538, 556-59,
94 S.Ct. 756, 767-769, 38 L.Ed.2d 713 (1974). The Carr-
Consolidated Biscuit Co., court also relied on a comparison
of the limitation provision in § 16(b) with those in other
securities statutes — for example, §§ 9(e) and 18(c) of the
1934 Act, 15 U.S.C. §§ 78i(e) and 78r(c), and § 13 of the
1933 Act, 15 U.S.C. § 77m. See 125 F.Supp. at 430-31. In
those statutes, Congress expressly provided for the oper-
ation of limitations periods in other than a strict manner.
The court surmised that the absence of an express provi-
sion for tolling in § 16(b) necessarily shows congressional
intent of a strict interpretation. Urging the strict inter-
pretation, William renews this comparison of statutory
provisions argument, citing recent Supreme Court cases
in other securities areas using such an analysis. See Ernst
& Ernst v. Hochfelder, 425 U.S. 185, 206-09, 96 S.Ct. 1375,
1387-1388, 47 L.Ed.2d 668 (1976) (various standard-of-
liability provisions of the 1934 Act must be read
together); Blue Chip Stamps v. Manor Drugs Stores, 421 U.S.
723, 733-36, 95 S.Ct. 1917, 1924-1926, 44 L.Ed.2d 539
(1975) (various standing-to-sue provisions of the 1934 Act
must be read together).
As an approach to statutory construction, this com-
parative analysis is obviously sound. In this instance,
however, the comparison is not so helpful to William's
position. First, the light those other provisions may shed
on § 16(b) by comparison depends on the clarity of the
other provisions in their own right. But the meaning of
the other provisions of the 1934 Act, §§ 9(e) and 18(c), is
App. 66
not clear. See, e. g., Jacobson v. Peat, Marwick, Mitchell &
Co., 445 FSupp. 518, 526-27 (S.D.N.Y.1977) (construing
“accrued” in § 18(c)).
Furthermore, the provisions actually appear silent on
the question of tolling. They each create a three year
limitations period from the time the action accrues but
make an additional, shorter limit of one year from actual
discovery of the facts constituting the action. Indeed,
these provisions appear to have a meaning contrary to
that advanced by William and Carr-Consolidated Biscuit
Co. William argues these provisions expressly provide for
tolling and therefore the absence of similar congressional
expression in § 16(b) is revelatory. But, on their face,
these provisions appear provide an absolute three-year
maximum, beyond which suit may not be brought regard-
less of when the facts are discovered. See, e. g., Bader v.
Fleschner, 463 F.Supp. 976, 981 (S.D.N.Y.1978). Thus, the
absence of similar language creating a maximum time
limit in § 16(b) shows that Congress contemplated tolling
in appropriate circumstances in § 16(b) cases. We do not
decide whether this interpretation of §§ 9(e) and 18(c) is
correct. It merely shows that the comparative analysis
argument advanced by William is unpersuasive.
Moreover, even if the comparison of § 16(b) with the
other provisions were more favorable to William's posi-
tion, the comparison of statutory provisions analysis
would not be complete until the language of § 16(b)’s
limitation provision had been considered in light of the
context of all of § 16. As discussed earlier, § 16(b) is
interrelated with the congressionally created reporting
requirements of § 16(a). Sections 9(e) and 18(c) do not
have simila: disclosure provisions. Therefore, comparison
App. 67
with them is unhelpful in determining how a disclosure
provision interacts with a limitations period.
In summary, we hold that an insider’s failure to
disclose covered transactions in the required § 16(a)
reports tolls the two year limitations period for suits
under § 16(b) to recover profits connected with such a
non-disclosed transaction.’? The two-year period for
§ 16(b) begins to run when the transactions are disclosed
in the insider’s § 16(a) report. See Blau v. Albert, 157
F.Supp. at 819; Shattuck Denn Mining Corp. v. La Morte,
supra. This interpretation is consistent with the legislative
scheme of § 16. It is supported by prior cases construing
the section and by securities commentators. The district
court’s result on the limitations issue is therefore
reversed.
IV.
PROFIT COMPUTATION METHOD
In calculating the profit realized as a result of Wil-
liam’s securities transactions the district court used the
“lowest purchase price, highest sale price” method. This
method was set forth long ago by the Second Circuit in
Smolowe v. Delendo Corp., 136 F.2d 231 (2d Cir.), cert.
denied, 320 U.S. 751, 64 S.Ct. 56, 88 L.Ed. 446 (1943).
Courts appear nearly unanimous in approving the
2 We note that the American Law Institute’s proposed
Federal Securities Code expressly provides for tolling in insider
liability recovery while there is violation of the reporting
requirement. See Federal Securities Code (Proposed Official Draft,
March 15, 1978) §§ 605(a) (reporting requirements), 1717
(insider liability), & 1727(d) (statute of limitations and tolling).
App. 68
Smolowe rule; commentators are also generally in favor,
but there are some critics. See 2 L. Loss, Securities Regula-
tion (2d ed. 1961) at 1062-65; 5 L. Loss, Securities Regula-
tion (2d ed. Supp.1969) at 3024-25; Cook & Feldman,
Insider Trading Under the Securities Exchange Act (Part II),
66 Harv.L.Rev. 612, 612-14 (1953). The question of the
profit computation method for § 16(b) is one of first
impression in this circuit. The Corporation urges that we
adopt the long-standing Smolowe rule. William argues the
Smolowe rule is incorrect and proposes a rule matching
sales with purchases closest in time. Persuaded by its
merit and its long continued use in other courts, we
adopt the Smolowe rule.
Under the Smolowe rule, the highest sales price is
matched with the lowest purchase price in any given six
month period.'’ In analyzing the legislative history and
the remedial nature of the statute, the court in Smolowe
concluded:
The statute is broadly remedial. [citation omit-
ted] Recovery runs not to the shareholder, but to
the corporation. We must suppose that the stat-
ute was intended to be thoroughgoing, to
squeeze all possible profits out of stock transac-
tions, and thus to establish a standard so high as
to prevent any conflict between the selfish inter-
est of a fiduciary officer, director, or stockholder
‘3 The operation if the Smolowe rule is explained at, e. g., 2
L. Loss, Securities Regulation (2d ed. 1961) at 1063 (quoting
Rubin & Feldman, Statutory Inhibitions upon Unfair Use of
Corporate Information by Insiders, 95 U.Pa.L.Rev. 468, 482-83
(1947)).
App. 69
and the faithful performance of his duty. [cita-
tions omitted] The only rule whereby all possi-
ble profits can be surely recovered is that of
lowest price in, highest price out — within six
months.
Smolowe, 136 F.2d at 239. Eight years later the Second
Circuit again considered the profit computation issue
and, after an independent analysis, affirmatively reas-
serted the Smolowe doctrine. Gratz v. Claughton, 187 F.2d
46, 50-52 (2d Cir.), cert. denied, 341 U.S. 920, 71 S.Ct. 741,
95 L.Ed. 1353 (1951) (L. Hand, J.).
The Second Circuit continues to adhere to the
Smolowe rule. See Feder v. Martin Marietta Corp., 406 F.2d
260, 269 (2d Cir. 1969), cert. denied, 396 U.S. 1036, 90 S.Ct.
678, 24 L.Ed.2d 281 (1970); Adler v. Klawans, 267 F.2d 840,
847-48 (2d Cir. 1959). Cf. Cummings v. Commissioner, 506
F.2d 449, 452 (2d Cir. 1974), cert. denied, 421 U.S. 913, 95
S.Ct. 1571, 43 L.Ed.2d 779 (1975) (in analysis that insider’s
repayment of § 16(b) profits is a long term capital loss,
court uses Smolowe approvingly).
The large majority of profit computation cases expec-
tably are in the Second Circuit and, particularly, in the
Southern District of New York. A long series of district
court cases there have continued to apply the Smolowe
rule. See, e. g., Lewis v. Levinson, [1978 Transfer Binder]
CCH Fed.Sec.L.Rep. { 96,430 (S.D.N.Y.1978); Makofsky
v. Ultra Dynamics Corp., 383 F.Supp. 631, 638-39
(S.D.N.Y.1974); Schur v. Salzman, 365 F.Supp. 725, 730-31
(S.D.N.Y.1973); Volk v. Zlotoff, 318 F.Supp. 864, 865
(S.D.N.Y.1970).
App. 70
When the question of profit computation in § 16(b)
has arisen in other courts, they too have adopted the
Smolowe rule of lowest price in, highest price out. See
Western Auto Supply Co. v. Gamble-Skogmo, Inc., 348 F.2d
736, 742-43 (8th Cir. 1965), cert. denied, 382 U.S. 987, 86
S.Ct. 556, 15 L.Ed.2d 475 (1966); Morales v. Mylan Laborato-
ries, Inc., 443 FSupp. 778, 780 (W.D.Pa.1978); Heli-Coil
Corp. v. Webster, 222 F.Supp. 831, 837 (D.N.J.1963), aff'd as
modified on other grounds, 352 F.2d 156 (3d Cir. 1965);
Arkansas Louisiana Gas Co. v. W. R. Stephens Investment Co.,
141 F.Supp. 841, 847 (W.D.Ark.1956). See also Ohio Drill &
Tool Co. v. Johnson, 498 F.2d 186, 194-95 (6th Cir. 1974)
(directing Smolowe rule be used in profit computation
under state insider trading statute).
William cites one case as disapproving the Smolowe
rule, namely, Allis-Chalmers Manufacturing Co. v. Gulf &
Western Industries, Inc., 527 F.2d 335 (7th Cir. 1975), cert.
denied, 423 U.S. 1078, 96 S.Ct. 865, 47 L.Ed.2d 89 (1976). In
Allis-Chalmers, the Seventh Circuit declined to apply the
Smolowe rule in the case before it. But the court in Allis-
Chalmers did not reject the Smolowe rule; indeed it
“agree[d] with the underlying principle of
the . . . Smolowe case.” 527 F.2d at 355. The court distin-
guished its case from Smolowe on the ground that Smolowe
involved the problem of trade-matching. There were mul-
tiple sales and purchases, and some rule had to be
adopted to determine how they should be matched for
computing profit. But Allis-Chalmers involved a question
of valuation of the shares and was not a trade-matching
case, and so the court did not apply the Smolowe rule. See
527 F.2d at 354-56. Cf. Anderson v. Commissioner, 480 F.2d
1304, 1307 (7th Cir. 1973) (in holding insider's repayment
App. 71
of § 16(b) profits a long term capital loss, Seventh Circuit
approvingly cites Smolowe rule).
William also maintains the Smolowe rule is inconsis-
tent with the legislative history of § 16(b). That the
Smolowe rule serves the legislative purpose of § 16(b) is
amply demonstrated in the previously discussed Second
Circuit cases. William’s principal argument is a compari-
son of the original version of § 16(b) with the final result.
The original Senate and House versions of what became
§ 16(b) provided for a variation of the “lowest in, highest
out” method of profit calculation.'* This language did not
appear in the final version enacted into law. William
argues this shows congressional rejection of such a
method of profit calculation and it is thus improper for
the courts to resurrect it.
This argument is without substance. As William con-
cedes in his brief, there is no statement anywhere in the
legislative history as to why this language did not appear
in the final version. There is no intimation that Congress
‘4 The pertinent language of the earlier bills provided as
follows:
For the purposes of this subsection the profit
shall be calculated on the sale or sales by such person
of such security made at the highest price or prices
and on the purchase or purchases made by such
person of such security at the lowest price or prices
during the six months’ period, irrespective of the
certificates for such security received or delivered to
such person during such period.
S. 2693, H.R. 7852, 73d Cong., 2d Sess. § 15(b) (1934), reprinted in
Legislative History of the Securities Act of 1933 and Securities
Exchange Act of 1934 (Ellenberger & Mahar ed. 1973).
App. 72
disapproved of it. William’s characterization of what
occurred as “congressional rejection” is extreme. If Con-
gress had deleted this language and replaced it with
other language describing another method of profit calcu-
lation, one might infer that Congress disapproved of the
prior language. Cf. National Automatic Laundry and Clean-
ing Council v. Shultz, 443 F.2d 689, 706 (D.C.Cir. 1971)
(positive congressional action in rejecting amendments,
unlike mere inaction, carries some weight). But all that
occurred here is that certain language did not appear in
the final version. Statutory interpretation cannot rest
safely on mere inaction in Congress; nor can it rest on
unexplained changes made in congressional committees.
Federal Trade Commission v. Dean Foods Co., 384 U.S. 597,
609-10 & n. 11, 86 S.Ct. 1738, 1745 & n. 11, 16 L.Ed.2d 802
(1966); Trailmobile Co. v. Whirls, 331 U.S. 40, 61, 67 S.Ct.
982, 992, 91 L.Ed. 1328 (1947); United Sates [sic] v. Imperial
Irrigation District, 559 F.2d 509, 535-36 (9th Cir. 1977),
rev'd on other grounds sub nom. Bryant v. Yellen, 447 U.S.
352, 100 S.Ct. 2232, 65 L.Ed.2d 184 (1980). Legislative
silence cannot be viewed as an expression of congres-
sional intent. Without some indication in the legislative
history of the reasons why this change occurred, it is
unwise to infer much from the silence of Congress. Cf.
Scripps-Howard Radio, Inc. v. Federal Communications Com-
mission, 316 U.S. 4, 11, 62 S.Ct. 875, 86 L.Ed. 1229 (1942)
(search for significance in Congress’ silence is often the
pursuit of a mirage).
Also persuasive is the fact that in the over thirty-five
years since Smolowe was decided and has been applied,
Congress has failed to act to set aside the rule through
contrary legislation. We believe the Smolowe rule is in
App. 73
accord with the absolute and thoroughgoing nature of
liability under § 16(b). This statute is intended to be a
deterrent to a type of activity which Congress realized
was subject to much abuse. In some cases the Smolowe
rule can be criticized for harshness and artificiality. But
other methods would be equally artificial.15 The Smolowe
rule assures full recovery of profits for the corporation.
The Smolowe rule of matching the lowest purchase price
and highest sale price within six months serves the pur-
pose of § 16(b). Following the unbroken acceptance of
this method by other courts, we adopt it as the rule in
this circuit. The district court is affirmed on this issue.
V.
PREJUDGMENT INTEREST
Although § 16 says nothing about the recovery of
interest one way or the other, prejudgment interest is
generally considered a part of § 16(b) recovery. However,
its award is not mandatory. See generally 5 L. Loss, Securi-
ties Regulation (2d ed. Supp. 1969} at 3025-27. The
allowance of interest is within the discretion of the trial
court, but “the granting of such allowance should not
follow as a matter of course.” Gold v. Sloan, 486 F.2d 340,
353 (4th Cir. 1973), cert. denied, 419 U.S. 873, 95 S.Ct. 134,
42 L.Ed.2d 112 (1974). Rather, in a § 16(b) case interest “is
15 William urges a rule whereby purchases are matched
against the immediately preceding or immediately following
saies, whichever is higher. A similar proposal, that the matching
of shares be on a last in-first out basis, was rejected in Lewis v.
Levinson, [1978 Transfer Binder] CCH Fed.Sec.L.Rep. | 96,430
(S.D.N.Y.1978).
App. 74
given in response to considerations of fairness. It is
denied when its exaction would be inequitable.” Blau v.
Lehman, 368 U.S. 403, 414, 82 S.Ct. 451, 7 L.ed.2d 403
(1962). “Whether interest will be awarded is a question of
fairness, lying within the court’s sound discretion, to be
answered by balancing the equities.” Wessel v. Buhler, 437
F.2d 279, 284 (9th Cir. 1971) (10b-5 case). Accord Western
Auto Supply Co. v. Gamble-Skogmo, Inc., 348 F.2d at 744
(§ 16(b) case). A reviewing court will upset the district
court’s decision granting or denying prejudgment interest
only if it is so unfair or so inequitable as to require it. Blau
v. Lehman, supra ; Blau v. Lamb, 363 F.2d 507, 528 (2d Cir.
1966), cert. denied, 385 U.S. 1002, 87 S.Ct. 707, 17 L.Ed.2d
542 (1967).
Among the factors to be considered in weighing the
equities is whether the insider acted innocently or know-
ingly. In many cases, interest has been denied where it
was shown the insider acted in good faith. See, e. g., Gold
v. Sloan, supra; Oliff v. Exchange International Corp., 449
F.Supp. 1277, 1302 (N.D.II1.1978); Morales v. Gould Inves-
tors Trust, 445 FSupp. 1144, 1156 (S.D.N.Y.1977), aff'd
without opinion, 578 F.2d 1369 (2d Cir. 1978); Volk v. Zlotoff,
318 F.Supp. 864, 867 (S.D.N.Y.1970); Marquette Cement
Mfg. Co. v. Andreas, 239 F.Supp. 962, 968 (S.D.N.Y.1965).
These cases do not mandate a requirement of bad
faith or willful violation for the award of prejudgment
interest; rather, they justify its denial when such factors
are absent. In the balancing of equities in these cases, it is
not a one-dimensional question of subjective good or bad
faith. The type and degree of the insider’s inadvertence,
the position of the insider in the corporation, and other
circumstances of each case are considered. Even when
perme eee sce sc at emectrcrs commen ma
App. 75
bad faith may have been absent, interest is still some-
times awarded. See Champion Home Builders Co. v. Jeffress,
385 F.Supp. 245, 250 (E.D.Mich.1974); Perfect Photo, Inc. v.
Grabb, 205 F.Supp. 569, 573-74 (E.D.Pa.1962). See also
Magida v. Continental Can Co., 231 F.2d 843, 848 (2d Cir.),
cert. denied, 351 U.S. 972, 76 S.Ct. 1031, 100 L.Ed. 1490
(1956). Cf. B. T. Babbitt, Inc. v. Lachner, 332 F.2d 255, 259
(2d Cir. 1964) (interest awarded without discussion). The
insider must show there is an overriding inequity in
allowing interest in order to overcome the granting of
interest. Western Auto Supply Co., 348 F.2d at 744. The
insider’s good faith must be shown; bare allegations are
not sufficient. Gold v. Sloan, 486 F.2d at 353; Lewis v. Realty
Equities Corp., 396 F.Supp. 1026, 1034 (S.D.N.Y.1975).
When an insider repays the corporation promptly
upon demand, that has been taken as betokening good
faith and justifying denial of interest, especially when the
prompt repayment means the corporation has not lost use
of the money for a long time. See Abbe v. Goss, 411 F.Supp.
923, 926 (S.D.N.Y.1975); Lewis v. Wells, 325 F.Supp. 382,
387 (S.D.N.Y.1971).
Another factor in balancing the equities is the length
of time involved. When there has been substantial delay
between transactions and complaint or between com-
plaint and judgment, courts consider who was responsi-
ble for the delay an important factor in allowing interest
for such periods. See Gold v. Sloan, supra; Lewis v. Realty
Equities Corp., 396 F.Supp. at 1035; Schur v. Salzman, 365
F.Supp. 725, 734-35 (S.D.N.Y.1973); Blau v. Lamb, 242
F.Supp. 151, 161 (S.D.N.Y.1965), aff'd, 363 F.2d 507, 528 (2d
Cir. 1966), cert. denied, 385 U.S. 1002, 87 S.Ct. 707, 17
L.Ed.2d 542 (1967). Moreover, a delay can alsc be a factor
App. 76
in establishing the date from which interest accrues. Nor-
mally, interest accrues from the time of the transactions.
See, e. g., Western Auto Supply Co., 348 F.2d at 744. But
where delay has occurred for which the insider was not
responsible, in accommodating the equities some courts
have awarded interest to run from the commencement of
suit. See Champion Home Builders Co., 385 F.Supp. at 250;
Schur, supra. In Schur the court particularly distinguished
between the pre-complaint delay for which the plaintiff
was responsible and the delaying litigation tactics for
which the insider defendant was responsible.
In the case at bar, the district court awarded prejudg-
ment interest on the profits recoverable, i. e., those not
barred by the district court’s ruling on the limitations
issue. William argues the district court erroneously
applied an absolute rule granting interest instead of
weighing the equities. The use of an absolute rule with-
out regard to the equities would be incorrect. But it is not
apparent that the district court used an absolute rule. The
lower court’s opinion on this point may reflect a decision
that, after considering the circumstances of this case, the
equities did not tip in favor of departing from the usual
objective nature of § 16(b) liability.
But we need not decide this today. Our decisions on
liability and the limitations period may result in a larger
amount of profit recovery and a longer period of liability.
This may have an effect on the balance of equities. Thus
we remand the question of prejudgment interest to the
district court for reconsideration in light of the foregoing
principles. See Thomas v. Duralite Co., Inc., 524 F.2d 577,
589 (3d Cir. 1975) (similar remand of prejudgment interest
App. 77
in 10b-5 case). We express no opinion on whether pre-
judgment interest is appropriate here. The balancing of
equities on the award of interest must be done in light of
all the facts and circumstances of the case. In the first
instance, that determination is left to the discretion of the
district court.
CONCLUSION
We hold today that William is liable under § 16(b) for
profits realized in transactions connected with William’s
trading of shares held in his mother’s name. In this result
we agree with the district court. However, we also hold
that the two-year limitations period of § 16(b) is tolled as
long as the insider has not disclosed the transactions on
the required § 16(a) reports. Thus, since reports of the
transactions in question here were not filed, William’s
liability is not cut off by the limitation period. We reverse
the district court in this regard. Further, we agree with
the district court that the Smelowe rule for trade-matching
to calculate profits is correct. Finally, we remand the
award of prejudgment interest to the district court for
reconsideration.
AFFIRMED in part; REVERSED and REMANDED for
proceedings in accordance with this opinion.
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.