Source: https://casetext.com/case/blau-v-lehman-3
Timestamp: 2019-05-20 04:51:45
Document Index: 503567171

Matched Legal Cases: ['§ 78', '§ 16', '§ 12', '§ 23', '§ 240', '§ 16']

Blau v. Lehman, 286 F.2d 786 | Casetext
286 F.2d 786 (2d Cir. 1960)
United States Court of Appeals, Second CircuitDec 20, 1960
Decided December 20, 1960. Rehearing Denied in Banc February 21, 1961.
Cyrus R. Vance, New York City (Robert S. Carlson and Simpson Thacher Bartlett, New York City, on the brief), for defendants-appellees (other than Tide Water Associated Oil Company) and Joseph A. Thomas, defendant-appellee-appellant.
Walter P. North, Gen. Counsel, Securities Exchange Commission, Washington, D.C., for Securities and Exchange Commission.
In this action by a stockholder of Tide Water Associated Oil Company brought under Section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C.A. § 78p (b), to recover on Tide Water's behalf short swing profits alleged to have been realized by Joseph A. Thomas, a director of Tide Water, and by Lehman Brothers, a partnership of investment bankers and stockbrokers, of which Thomas was a member, the complaint was dismissed as against all the partners other than Thomas, after a trial by the court without a jury, and judgment was entered against him for only $3,893.41 and costs. The trial judge computed the profits of Lehman Brothers at $98,686.77 but refused to direct judgment against Thomas for more than the amount which was, despite his claim that he had received no part of the profits, found to have been "realized by him." The method of computing the profits was also matter of dispute between the parties. Plaintiff and Thomas have filed cross-appeals. The opinion below is reported in 173 F. Supp. 590.
To begin with, Judge Swan and I do not agree with this dictum, as we must take Section 16(b) as we find it, and we do not see how any sort of deputizing can make the partners or the partnership a "director" within the meaning of Section 16(b). But we do not have to decide the question, because the evidence in this case will not support an inference that Lehman Brothers deputized Thomas to represent its interests as director on the board of Tide Water. Doubtless the firm was pleased to have Thomas succeed Hertz as a director, and so was John Schiff, of Kuhn, Loeb Company, who introduced his friend Thomas to David T. Staples, president of Tide Water who thereafter invited Thomas to become a director. However, there is no evidence of any deputizing or other affirmative action by the firm to cause Thomas to be made a director to protect the interests of the firm or to become its representative.
Reference is made in plaintiff's brief to certain general statements in the findings contained in the opinion in United States v. Morgan et al., D.C.S.D.N.Y. 1953, 118 F. Supp. 621. These must be understood against the background of the entire history of the investment banking business in the United States that was in one way or another involved in the comprehensive and exceedingly complicated charges of conspiracy to violate the Anti-trust laws. Thus, in reference to a time prior to World War I, when there was a sort of informal working arrangement between Goldman, Sachs Co. and Lehman Brothers, the opinion states (at page 639):
There is only one way to prevent stock manipulation by insiders to whom confidential information is available, and that is to squeeze every possible penny of profit out of such transactions. This has been held to be the clear purpose of Section 16(b), a "broadly remedial statute." Smolowe v. Delendo Corp., 2 Cir., 136 F.2d 231, 239, 148 A.L.R. 300, certiorari denied, 1943, 320 U.S. 751, 64 S.Ct. 56, 88 L.Ed. 446. One way to do this was to construe Section 16(b) to include the partnership because of the unity of the partnership relationship and the fact that one of the partners is a director. But Rattner decided otherwise, and that is water over the dam as far as I am concerned. If we now hold that the director himself can escape by the mere device of a waiver and disclaimer, we shall have opened a breach in the law through which stockbrokers and investment banking houses, those most likely to be in a position to profit by the use of confidential information in stock speculation, can pass with impunity.
While no confidential information was improperly used in this case, we must bear in mind that the statute is designed to affect cases where confidential information might be used. Moreover, to permit a waiver and disclaimer to immunize the director would almost certainly lead to wholesale waivers and disclaimers by the various partners who are directors of corporations, with the result that the profits waived by one partner would increase the profits of the others and in the end each would have about the same amount of profits he would have received from such transactions had there been no waiver and disclaimer. When the Congress passed Section 16(b) it was never intended to permit any such merry-go-round as this.
The Method of Computing the "Profits Realized by" Thomas
We are not, however, computing profits in accordance with what might be the custom of traders and speculators in the stock market. We are construing a federal statute designed to prevent certain persons, including directors and officers, from making short swing profits by "the unfair use of information" available to them because of their confidential relationship to the corporation. The cases present the problem of what is a "purchase" in a great variety of factual combinations. But the underlying principle, as I understand it, is that the transaction is a "purchase" if in any way it lends itself to the accomplishment of what the statute is designed to prevent. The leading case is Park Tilford, Inc. v. Schulte, 2 Cir., 160 F.2d 984, certiorari denied, 1947, 332 U.S. 761, 68 S.Ct. 64, 92 L.Ed. 347. While we held the transaction not to be a "purchase" in Roberts v. Eaton, 2 Cir., 1954, 212 F.2d 82, the same line of reasoning was used. What was done in that case did not lend itself to the furtherance of the prohibited purpose. There is no rule of thumb; nor would it be wise to attempt to formulate such a rule.
See also Ferraiolo v. Newman, 6 Cir., 1958, 259 F.2d 342, 345, certiorari denied, 1959, 359 U.S. 927, 79 S.Ct. 606, 3 L.Ed.2d 629; Blau v. Mission Corp., 2 Cir., 1954, 212 F.2d 77; Shaw v. Dreyfus, 2 Cir., 172 F.2d 140, certiorari denied, 1949, 337 U.S. 907, 69 S.Ct. 1048, 93 L.Ed. 1719; Blau v. Lamb, D.C.S.D.N.Y. 1958, 163 F. Supp. 528, 534; Blau v. Hodgkinson, D.C.S.D.N.Y. 1951, 100 F. Supp. 361; Truncale v. Blumberg, D.C.S.D.N.Y. 1948, 80 F. Supp. 387.
Against the background of "a widely condemned evil," § 16(b) of the Securities Exchange Act of 1934 put teeth into the concept of a corporate director's fiduciary obligation by the simple but arbitrary course of requiring him to disgorge to his corporation "insider" profits from stock speculation obtained under stated circumstances and without regard to his own good faith or innocence. This device has worked successfully where more refined methods might have failed; and although the provision "is probably the most cordially disliked provision in all these statutes from the point of view of those whom it affects," Loss, Securities Regulation 578 (1951), yet its policy is so important and so generally approved that repeal seems unlikely, id. 579; Cook Feldman, Insider Trading under the Securities Exchange Act, 66 Harv.L.Rev. 385, 612, 641 (1953). In our first case construing it we said, "The statute is broadly remedial," and went on to say: "We must suppose that the statute 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 a fiduciary officer, director, or stockholder and the faithful performance of his duty." Smolowe v. Delendo Corp., 2 Cir., 136 F.2d 231, 239, 148 A.L.R. 300, certiorari denied Delendo Corp. v. Smolowe, 320 U.S. 751, 64 S.Ct. 56, 88 L.Ed. 446. That principle has since shaped our statutory interpretation as well as that of other courts and is restated in our latest and full opinion in Adler v. Klawans, 2 Cir., 267 F.2d 840.
The Rattner decision appears to be supported on three grounds, two of them stated in the opinion and a third adduced by later commentators. First reliance is placed upon a "literal reading" of the statute. But any reading, literal or otherwise, can hardly avoid the legal meaning of "owner" or eliminate the basic principles of partnership. Under these principles, clearly stated in New York law as embodied in the Uniform Partnership Act, property bought with partnership funds is partnership property, and a partner is co-owner with his partners of specific partnership property holding as a tenant in partnership with an equal right with his partners to possession of specific partnership property and with an equal share in the profits and surplus. N.Y. Partnership Law §§ 12, 40, 43, 50-52. Moreover, the partnership is charged with knowledge of or notice to a partner. Id. § 23. I submit that on a literal legal reading of the statute, Thomas was co-owner with all the other partners of the Tide Water stock when bought and of the profits when sold, and that Thomas stood at all times legally charged with full knowledge of what was going on in his firm, just as the other partners had like knowledge. Further, I do not doubt that in any ordinary well run partnership, the practical facts of life actually coincide with these legal facts, and that one partner either actually knows what is going on in his group or is content to leave action to his colleagues. In any event, the legal situation seems clear — so much so that in my view co-owners cannot be excluded from the operation of the statute without a serious distortion of its terms. Furthermore to close the gap now opened up would require rather awkward and seemingly superfluous phraseology, such as that "owner" actually does include "co-owner."
The third ground of support, adduced by some commentators, 25 So.Calif.L. Rev. 475, 478 (1952), 100 U. of Pa.L.Rev. 463, 465 (1951), is the harshness in result of the contrary conclusion. Passing the question whether Congressional intent is to be thus limited, one may question whether this is not an attack on the entire statutory policy which is some-what misdirected when leveled only at a single consequence as here. Admittedly the statute operates stringently, with burdensome results to individuals, in many, possibly most, cases. But that seems not a sound reason for excepting its operation in this important and natural field of operation. True, the amounts involved may be large, as is to be expected from the high financial character of the protagonists naturally involved in the trading by Wall Street investment firms. But that may be easily taken as an argument for application of the statute here. I think the exemption of these firms would be hard to explain to the ordinary small-scale director not so exempt and indeed to the investing public generally.
Other comments on the decision appear in Loss, Securities Regulation 585 (1955 Supp.), and Cook Feldman, Insider Trading under the Securities Exchange Act, 66 Harv.L.Rev. 385, 391, 403, 633-634 (1953).
Enforcement of strict accounting and refund against corporate fiduciaries is not exactly a novel legal idea. See Gratz v. Claughton, 2 Cir., 187 F.2d 48, 49, certiorari denied 341 U.S. 920, 71 S.Ct. 741, 95 L.Ed. 1353; Berner v. Equitable Office Bldg. Corp., 2 Cir., 175 F.2d 218; Nichols v. S.E.C., 2 Cir., 211 F.2d 412, 417-418; Surface Transit, Inc. v. Saxe, Bacon O'Shea, 2 Cir., 266 F.2d 862, 868; In re Midland United Co., 3 Cir., 159 F.2d 340; Woods v. City Nat. Bank Trust Co. of Chicago, 312 U.S. 262, 268, 61 S.Ct. 493, 85 L.Ed. 820; Loss, Securities Regulation 594 (1955 Supp.).
In this situation the S.E.C. has not yet afforded us its accustomed assistance. In the Rattner case its general counsel filed a brief amicus curiae wherein it first urged that the statute in terms was to be construed as I have stated above and much of the reasoning I have employed was there adduced in support of its view. Then it undermined its own opinion by urging that it had freed the defendants of liability by adopting its Rule X-16A-3(b) requiring a partner to file a report to it "only as to that amount of such equity security which represents his proportionate interest in the partnership," and that the defendants were justified in assuming the Commission to hold the other partners not liable here. The court in the Rattner case rejected this argument, saying: "The Commission may exempt `transactions'; but it cannot reduce the liability imposed by section 16(b)." Rattner v. Lehman, supra, 2 Cir., 193 F.2d 564, 566. That the Commission had its doubts at least as to the policy of its rule is shown by the following statement in its Rattner brief: "For reasons summarized below the Commission now has substantial doubt as to whether Rule X-16A-3 fully effectuates the statutory purpose of Section 16. It is therefore currently considering amending the rule to limit the broad exemption now implicit in it."
At any rate the Commission soon (1953) amended its rule to require a partner to report the entire amount of the security owned by the partnership, Rule X-16A-8(g), adopted by Sec. Ex. Act Rel. 4801 (1953), now 17 C.F.R. (1960 Supp.) § 240.16a-3(b). Loss, Securities Regulation 585-587 (1955 Supp.). And there the matter now stands, with the Commission at odds with our interpretation.
The matter of the validity of such a Commission regulation is obviously still an open one. We expressed doubt as to another rule in Greene v. Dietz, 2 Cir., 247 F.2d 689, which was thereafter held invalid in Perlman v. Timberlake, D.C.S.D.N.Y., 172 F. Supp. 246; but the contrary was held in Continental Oil Co. v. Perlitz, D.C.S.D.Tex., 176 F. Supp. 219. Seemingly the Commission still relies on its power under the statute. See Timbers, Management Compensation Plans: SEC Problems, Proceedings of the Second Annual Institute on Corporate Counsel, April 21, 22, 1960 (Fordham Univ. Press) 28, 37-38; Meeker Cooney, The Problem of Definition in Determining Insider Liabilities Under Section 16(b), 45 Va.L.Rev. 949, 957 (1959); Cook Feldman, Insider Trading under the Securities Exchange Act, 66 Harv.L.Rev. 385, 612, 632-635 (1953); Loss, Securities Regulation 578 (1951). This is an obvious state of confusion and uncertainty which is unfortunate to the public, the investors, and their traders. I do not believe any inference can be drawn from the failure of Congress to act to correct the Rattner decision; that body has lately been interested in other matters more immediately troublesome than that of the regulation of private investments and the S.E.C. obviously has not given it positive leadership. So it would seem to me that at least before we dispose of this vastly important issue we should ask the S.E.C. for its informed comments.
I should add that I agree with the method of computation, finding a "purchase" under § 16(b) and a total profit to the firm of $98,686.77, which Judge Dawson followed and Judge Medina approves in his opinion. But this computation, upon which we all agree, highlights the anomaly of the ultimate conclusions reached by my brothers. For they are forced to concede that insider profits were made and that there must be restitution to the corporation, but then they differ widely as to how much is to be restored. It seems to me that neither of their results can be justified logically or legally under any principles of the law of partnership with which I am familiar. I submit that if there were insider profits (as their concession shows) then the partnership and the individual partners must be held liable to return these profits in full to Tide Water. And that should be our decision. The final anomaly in our exceptional treatment of this case is the denial of all interest for the use of the sums found due the corporation, contrary to our uniform practice in other cases. Magida v. Continental Can Co., 2 Cir., 231 F.2d 843, 848, certiorari denied Continental Can Co. v. Magida, 351 U.S. 972, 76 S.Ct. 1031, 100 L.Ed. 1490; Blau v. Mission Corp., 2 Cir., 212 F.2d 77, 82, certiorari denied Mission Corp. v. Blau, 347 U.S. 1016, 74 S.Ct. 872, 98 L.Ed. 1138; Park Tilford v. Schulte, 2 Cir., 160 F.2d 984, 988, 989, certiorari denied Schulte v. Park Tilford, 332 U.S. 761, 68 S.Ct. 64, 92 L.Ed. 347. If there are special equities here, they have not been stated.
But, whatever the reasons to be assigned for the result, it leaves this important area of the law almost ludicrously uncertain. What now is the present force to be assigned to Rattner? Although it is assumed to compel the present decision, yet quite significantly not a single word in its defense has been uttered by any of the eight judges here engaged. My own criticisms uttered in my dissent have remained unanswered and have now, as is apparent, the support of the S.E.C. But even further, Judge Medina, in writing the main opinion and though he held himself bound by the decision, uttered as strong a criticism of its results as has appeared, in supporting the fundamentally inconsistent ruling that the partner-director must give up something representing his share of insider profits to the corporation. And in this Judge Swan concurred, although agreeing neither on the principle nor on the actual amount of the recovery. It is indeed ironical that so disfavored a precedent nevertheless has apparent power to control even to the extent of ruling out proper restrictions or exceptions there at least implied with respect to a director who gives actual investment advice.
It has remained uncited elsewhere except for one purely incidental reference in Lehman v. Civil Aeronautics Board, 93 U.S.App.D.C. 81, 209 F.2d 289, 294, note 9, certiorari denied 347 U.S. 916, 74 S.Ct. 513, 98 L.Ed. 1072.