Source: https://law.justia.com/cases/federal/appellate-courts/F2/738/73/135954/
Timestamp: 2020-02-29 04:47:04
Document Index: 793306888

Matched Legal Cases: ['§ 78', '§ 78', '§ 78', '§ 78', '§ 78', '§ 78', '§ 78']

Fed. Sec. L. Rep. P 91,546c.r.a. Realty Corporation, Plaintiff-appellant, v. Tri-south Investments and Drexel Burnham Lambert, Inc.,defendants-appellees, 738 F.2d 73 (2d Cir. 1984) :: Justia
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Fed. Sec. L. Rep. P 91,546c.r.a. Realty Corporation, Plaintiff-appellant, v. Tri-south Investments and Drexel Burnham Lambert, Inc.,defendants-appellees, 738 F.2d 73 (2d Cir. 1984)
US Court of Appeals for the Second Circuit - 738 F.2d 73 (2d Cir. 1984) Argued Feb. 22, 1984. Decided June 22, 1984
Plaintiff C.R.A. Realty Corporation ("CRA"), a shareholder of the nominal defendant Tri-South Investments ("TSI"), appeals from a final judgment of the United States District Court for the Southern District of New York, Abraham D. Sofaer, Judge, dismissing its complaint against defendant Drexel Burnham Lambert, Inc. ("Drexel"), which sought to recover amounts allegedly due TSI pursuant to Sec. 16(b) of the Securities Exchange Act of 1934 ("1934 Act" or "Act"), 15 U.S.C. § 78p(b) (1982), on account of Drexel's short-swing trading in TSI securities while Drexel was the beneficial owner of more than ten percent of TSI's common stock. The district court granted Drexel's motion for summary judgment dismissing the complaint on the ground that Drexel was a market maker in TSI securities and hence was exempted by Sec. 16(d) of the 1934 Act, 15 U.S.C. § 78p(d) (1982), from liability for short-swing profits under Sec. 16(b). On appeal, CRA contends that the exemption provided by Sec. 16(d) is inapplicable as a matter of law because Drexel enjoyed short-swing profits in TSI's common stock but at most was a market maker only in its convertible debentures, and that even if the exemption were applicable in theory, the court should not have granted summary judgment since genuine issues of fact exist. We disagree with both contentions and affirm the judgment of the district court.
The district court, in an opinion dated August 17, 1983, and reported at 568 F. Supp. 1190, granted Drexel's motion for summary judgment and dismissed the complaint. The court ruled that the affidavits presented by Drexel were sufficient to establish that Drexel had been a market maker in TSI debentures throughout the pertinent period, and that CRA's evidence as to the gaps in the Yellow Sheets did not create an issue of material fact. Hence, Sec. 16(d) exempted Drexel's transactions in TSI debentures from Sec. 16(b)'s provisions.
Section 3(a) (11) of the 1934 Act, 15 U.S.C. § 78c(a) (11), defines an "equity security" to include not only stock, but also any security that is convertible into stock. Section 3(a) (38), 15 U.S.C. § 78c(a) (38), defines a "market maker" as
Section 16(b) was enacted in 1934 to " 'curb the evils of insider trading [by] ... taking the profits out of a class of transactions in which the possibility of abuse was believed to be intolerably great.' " Foremost-McKesson, Inc. v. Provident Securities Co., 423 U.S. 232, 243, 96 S. Ct. 508, 516, 46 L. Ed. 2d 464 (1976) (quoting Reliance Electric Co. v. Emerson Electric Co., 404 U.S. 418, 422, 92 S. Ct. 596, 599, 30 L. Ed. 2d 575 (1972)). Congress accomplished this purpose by creating the conclusive presumption that directors, officers, and beneficial owners of more than 10% of a class of the corporation's equity securities had access to inside information and by providing for recapture of all short-swing profits obtained by these statutory insiders, regardless of whether they actually had inside information and regardless of their motive or intent. Id. 423 U.S. at 243-44, 96 S. Ct. at 516. Since the liability imposed is strict and the remedy harsh, however, courts have been chary of holding transactions within Sec. 16(b) unless Congress's intent to make the section applicable was clear. See, e.g., id. at 252, 96 S. Ct. at 520 ("It is inappropriate to reach the harsh result of imposing Sec. 16(b)'s liability without fault on the basis of unclear language. If Congress wishes to impose such liability, we must assume it will do so expressly or by unmistakable inference."); Blau v. Lamb, 363 F.2d 507, 515-19 (2d Cir. 1966) (given the lack of clarity as to whether conversion of preferred stock into common constitutes a "sale" within Sec. 16(b), section should not be applied unless use of inside information is implicated), cert. denied, 385 U.S. 1002, 87 S. Ct. 707, 17 L. Ed. 2d 542 (1967).
In 1964 the Act was amended to bring the securities of companies traded over-the-counter within the short-swing profits provisions of Sec. 16(b). Pub. L. No. 88-467, Sec. 8(a), 78 Stat. 565, 579 (1964); see H.R.Rep. No. 1418, 88th Cong., 2d Sess. 29 (1964); S.Rep. No. 379, 88th Cong., 1st Sess. 69 (1963), U.S.Code Cong. & Admin.News 1964, 3013. Congress and the Commission were aware, however, that without an exemption, ordinary market-making activity in over-the-counter securities by firms that were insiders by reason of the size of their stock holdings would result in repeated liability under Sec. 16(b), see Hearings on H.R. 6789, H.R. 6793, and S. 1642 Before a Subcomm. of the House Comm. on Interstate and Foreign Commerce, 88th Cong., 1st and 2d Sess. 1227-28 (1963-64) (statement of SEC Chairman Cary), and there was concern that the threat of such liability would cause a reduction of the market-making activities of these firms, see Hearings on S. 1642 Before a Subcomm. of the Senate Comm. on Banking and Currency, 88th Cong., 1st Sess. 400-01 (1963) (statement of the SEC). In order to encourage market making by removing the Sec. 16(b) threat, therefore, Congress adopted a proposal by the Commission for a general exemption for market-making activity, and enacted Sec. 16(d) to exempt from Sec. 16(b) all transactions in "an equity security ... by a dealer in the ordinary course of his business and incident to the establishment or maintenance by him of a primary or secondary market ... for such security." 15 U.S.C. § 78p(d).
CRA focuses on the use of the phrase "such security" in Sec. 16(d) to argue that the exemption for market-making activity applies only to the security in which the market making occurs and that "such security" here can mean only the convertible debentures. While this is not an implausible reading of the statute, it is not the only plausible reading. The phrase "such security," in Sec. 16(d) refers back to "equity security," and in attempting to fathom the meaning of that term we look to the statutory definition. Section 3(a) (11) defines "equity security" to encompass not only "stock," but also "any security convertible ... into such a security." Reading Sec. 16(d) with this definition in mind, therefore, the phrase "such security" could refer to either the common stock or any security convertible into the common stock. Cf. Blau v. Lamb, supra, 363 F.2d at 521-25 (convertible security and security into which it is convertible are economic equivalents since they are merely "different forms of the same participation in [the] issuer," id. at 523). Thus, we conclude that Sec. 16(d) does not clearly have the meaning that CRA attributes to it. Lacking a clearer expression by Congress of an intention to impose strict Sec. 16(b) liability for trades in common stock incident to market making in a debenture convertible into the common, we decline to accept CRA's construction of Sec. 16(d). See Foremost-McKesson, Inc. v. Provident Securities Co., supra.
CRA predicts that the exemption of a debenture market maker from Sec. 16(b) liability for trading in the common stock into which the debenture is convertible will lead to rampant pernicious insider trading in common stock by these broker-dealers. We are not persuaded. The exemption provided by Sec. 16(d) extends only to trading that is "incident to" market-making activity. Thus, only common stock trades directly related to the market-making activity in the convertible securities would be found exempt from Sec. 16(b). Nor would application of the exemption immunize broker-dealers from liability for actual misuse of inside information, since such misuse would expose them to civil liability under antifraud provisions of the securities laws, see, e.g., 15 U.S.C. § 78j(b); 17 C.F.R. Sec. 240.10b-5, to disciplinary sanctions by the Commission, see, e.g., 15 U.S.C. § 78o(b) (4), and to criminal prosecution, see, e.g., id. Sec. 78ff. We agree with the Commission that " [r]eliance on the antifraud provisions, as opposed to the more specific prophylactic protections of Section 16(b), is appropriate in this situation in light of the valuable role of the market-making function and because trading in the ordinary course of market making is generally not intended to take advantage of inside information." (SEC brief on appeal at 10.)
Drexel's employees' affidavits stated that for the entire period in question Drexel had in fact held itself out as willing to buy and sell TSI convertible debentures for its own account on a regular and continuous basis. The affidavits by broker-dealers other than Drexel confirmed this statement and showed that these firms had dealt with and recognized Drexel on this basis. CRA did not attempt to rebut these affidavits by presenting "specific facts showing that there [was] a genuine issue for trial," as required by Fed. R. Civ. P. 56(e). Rather, it sought to side-step this obligation by simply characterizing the facts asserted as mixed questions of law and fact and stating that they were "disputed." The material aspects of these affidavits were, however, factual, and CRA was obliged to respond with a factual showing of its own in order to call Drexel's presentation into question. It did not, and the court's ruling that CRA had presented no genuine issue of material fact was proper.