Warren E. Burger: We will hear arguments next in Gould against Ruefenacht. Mr. Epstein, you may proceed whenever you are ready.
Robert C. Epstein: Thank you, Mr. Chief Justice, and may it please the Court, it is our contention that Mr. Ruefenacht's right to veto every major company decision is joint management of the Continental business in which he repeatedly referred to himself as a partner and the fact that this was an entirely private transaction unique between two individuals which in no sense involved a public capital market, that these collective factors require the conclusion that in substance this was the purchase of a one-half interest in a business, and that the transfer of stock was merely incidental to the transaction. We submit that the federal securities laws were never meant to cover this kind of a transaction, and that Mr. Ruefenacht's claims of fraud belong in state court. As authority for our position, Your Honors, we rely fundamentally upon the legislative history of the federal securities laws. Now, it is true, as was pointed out this morning, that the legislative history does not specifically address the sale of business situation, and indeed both factions in the current judicial debate acknowledge that Congress never specifically considered the sale of business question. However, the legislative history is replete with an unmistakeable Congressional emphasis upon the goals that the securities laws do seek to achieve. Those goals, reaffirmed in the legislative history as recently as 1982, and as expressed by this Court in Forman fundamentally were to protect the integrity of public capital markets and to protect investors dealing in those markets. Now, the legislative history also indicates that these goals emerged from a Congressional recognition that the dispersion of corporate ownership had led to abuses in the capital markets where people who ran corporations were taking advantage of people who owned corporations. Most importantly, Your Honors, it was recognized by Congress that the effects of such abuses transcend the individual's loss, but rather chill investment and capital formation generally. It was also recognized by Congress that such abuses could be perpetrated because the owners of corporations did not have managerial control over the operations of those corporations. The owners held the symbols of ownership but had no ability effectively to influence the destiny of their investment or to influence the operations or the profitability of the corporation. There is nothing, not one word in the legislative history about protecting someone like Mr. Max Ruefenacht, who engaged in a purely private transaction, unique, as I said, between two individuals which indeed involved stock which could not have been publicly traded because it did not have a common or equivalent value to most people.
Byron R. White: Well, this argument would lead to just saying that there isn't any private sale of stock that was reached by the securities law.
Robert C. Epstein: No, Your Honor, that is not our position.
Byron R. White: Well, it sounds like it so far.
Robert C. Epstein: Well, it is not our position--
Byron R. White: A purely private transaction?
Robert C. Epstein: --We are a purely private transaction.
Byron R. White: Well, so are thousands of others that are covered, I suppose.
Robert C. Epstein: Well, that may be so, Your Honor. May I point out that where the context is a public context involving either an organized exchange or a public solicitation, such as was involved in Howey and other cases, in our view, that goes so much to the heart of what Congress was talking about when it passed the securities laws that there ought to be coverage. Where you are dealing, however, in an entirely private context, the inquiry has to be a little deeper. That is not to say that private transactions will necessarily not be covered, but the inquiry is into the economic realities of those transactions. And if I may at this point, in further answer to your question, Your Honor--
Byron R. White: Well, if I just buy some shares of General Motors from some other person and he misrepresents, is that exempt from the securities laws?
Robert C. Epstein: --I don't believe so, Your Honor, because--
Byron R. White: I can't imagine anything more private.
Robert C. Epstein: --Well, except for the fact, Your Honor, that there is an important public element there, and that public element is--
Byron R. White: Well, what if the stock isn't registered? It is just a small corporation. I just buy some shares of a private company from another person, no public... is that a public matter?
Robert C. Epstein: --No, Your Honor. The way you have framed that hypothetical, no, that seems to be an entirely private and unique transaction.
Byron R. White: Would that be covered by the securities laws under your view?
Robert C. Epstein: Under my view, Your Honor, an entirely private transaction like the one you just... I would have to ask Your Honor some more questions about the facts.
Byron R. White: You may. 0 [Generallaughter.]
Robert C. Epstein: The first question I would ask would be whether Your Honor as the purchaser of that stock in a privately held corporation--
Byron R. White: I would have to report it at a certain way.
Robert C. Epstein: --I understand that, Justice. Whether Your Honor participated in some fundamental sense in the activities of that corporation.
Byron R. White: I just bought the stock for investment, and that is all I wanted to do.
Robert C. Epstein: Assuming that to be true, Your Honor, I would also ask whether this stock that Your Honor bought was a smaller unit of a larger offering or whether it was--
Byron R. White: No, it was just... the stock has been in these same hands for a long time. The fellow was just tired of owning it, so he sold it to me.
Robert C. Epstein: --Not covered, Your Honor.
Byron R. White: Not covered.
Robert C. Epstein: Not covered.
Byron R. White: Is that the established rule or--
Robert C. Epstein: Well, Your Honor, there is no established rule. That is, I believe, one of the reasons that we are here today, because there is confusion, but on this point of public versus private, I would like to raise and bring to the Court's attention the Superintendent of Insurance case, which has been cited by my opponents all throughout this litigation as standing for the proposition that private transactions are covered by the securities laws. It is true, as Justice Douglas pointed out there, that that was a private transaction. However, there was an important public element to that transaction, which was that the securities that were sold in that case were Treasury bonds. These were securities that were, if not being publicly traded at that time, were certainly of a common or equivalent value to most people, and therefore could have been publicly traded, and therein, I submit to the Court, lies an important public interest in that private transaction. Now, we submit, Your Honor, that there is nothing in the legislative history indicating a desire to protect someone like Mr. Ruefenacht, who, as I said, engaged in a purely private transaction, idiosyncratic, as between two individuals, which involves no public capital market. There is nothing in the legislative history indicating a desire to protect Mr. Ruefenacht, who jointly managed this company, and who was no more dependent upon others in this business than one partner is dependent upon another partner to use his or her best efforts and inimitable talents to make a business a success. Indeed, may I point out to the Court that there was no one in this business who had more control over profitability than Mr. Ruefenacht, and I specifically point to Magistrate Peretti's findings on the fact that Mr. Ruefenacht's veto powers extended not just to questions of capital structure of this company, such as the issuance or transfer of shares, but also to operational decisions going right to the heart of what this company's business was, namely, questions of borrowing money and of the taking on of new product lines. We submit that this Court in evaluating this transaction under the securities laws cannot ignore Congress's goals simply because there was stock involved in the transaction, but in effect that is just what the Third Circuit did by looking only to the characteristics of the stock and ignoring all of the findings found by the magistrate. We don't believe that the literal or mechanical approach taken by the Third Circuit was ever intended by Congress in the application of the federal securities laws. The legislative history urges flexibility in application of the securities laws, but does not say that the Court shall be flexible only where the result will be to extend coverage. Also, the context clauses, whether they be viewed as relating to the economic context of the transaction, as we believe this Court clearly held in the Weaver case, or as relating to the linguistic context of the statute, as the Third Circuit said, in either of them, I submit to the Court that the context clauses amount to Congressional caveats against literalism and amount to a sufficient basis for the District Court looking into the economic realities of this transaction. Finally, as we read this Court's decisions from Joiner through Weaver, the Court has never taken a literal or mechanical approach to the securities laws, but rather has repeatedly cautioned against just such an approach. Now, I submit, Your Honors, that the flaws in the Third Circuit's approach to the securities laws are perhaps put best in focus when one considers application of the securities laws to transactions in notes. Under a literal approach, all note transactions would be covered including mortgage notes executed in connection with the purchase of a single family residence, and also including notes executed in connection with consumer financing transactions. But both sides of the current judicial debate, including such eloquent proponents of the literal approach as Judge Friendly and Judge Gibbons below, both sides acknowledge that Congress just could not have meant to cover those kinds of transactions, and as a result both sides, with some variations, employ a case by case analysis in the note context to determine which note transactions implicate federal securities laws concerns. I submit to the Court that the very same type of case by case analysis is just as essential in the stock area for the very same reasons, namely, to avoid sweeping within the coverage of the federal securities laws a multitude of cases which involve no significant federal concern but which happen to involve stock. One of the concerns which led the Third Circuit to rule as it did was what can be called the line drawing concern, a concern by Judge Gibbons about distinguishing covered transactions from non-covered transactions. I submit to the Court that that concern can be greatly ameliorated by the decision in this case. A narrow holding here that Mr. Ruefenacht's absolute veto powers, joint management, and the fact that this was a unique transaction, that those factors require a conclusion that this was not a federal securities transaction--
Byron R. White: --What is your... I know you say we ought to look at the economic realities and all that. I am not sure I know even what you mean. Is it your view that you should look to see if the purchase is for investment or for management or for what?
Robert C. Epstein: --The objective of the transaction, Your Honor, is one of the economic realities. That is precisely correct. And here the--
Byron R. White: Well, which is it? Which is covered and which isn't?
Robert C. Epstein: --There are gradations of cases, Your Honor, and it is difficult for me to answer that entirely in the abstract. I can say to Your Honor--
Byron R. White: Well, if you can't, I don't know what kind of a bright line you are drawing.
Robert C. Epstein: --Your Honor, the line we are drawing is between the kinds of transactions Congress intended to cover and did not intend to cover. Let me see if I can--
Byron R. White: That is fine. Now tell me what it is.
Robert C. Epstein: --Okay. When we are dealing with "public transactions", and I put that term in quotes, Your Honor, transactions which involve the public capital markets, whether organized or not, I submit that we are involved with a situation going so fundamentally to the concerns of Congress that the federal securities laws ought to apply as a general proposition. Where we are dealing in private transactions, Your Honor, the inquiry has to be into whether the purchaser in this case was dependent upon the efforts of others or not dependent upon the efforts of others. That inquiry involves two components as I see it.
Byron R. White: In general you are talking about whether he is making an investment or whether he is buying it to make money by himself.
Robert C. Epstein: That is exactly correct, Your Honor. In a general sense, that is true.
Byron R. White: Well, refine it if that is too general.
Robert C. Epstein: Well, there are two components to that inquiry. Component Number One, as we see it, is the control analysis that was performed by the magistrate and by the District Court below, where someone obtains the kind of control that Mr. Ruefenacht obtained over a company. He is not the kind of investor that Congress was seeking to protect. He is not in that peculiarly vulnerable position which generates a need for the special protections of the federal securities laws.
Warren E. Burger: He didn't have an affirmative control, did he?
Robert C. Epstein: He could not impose his will on the corporation, Mr. Chief Justice, that is correct, but what he could do--
Warren E. Burger: He could veto.
Robert C. Epstein: --That is exactly right, Your Honor, and not only that, through his joint management of the company as a result of his efforts in obtaining sales and operations and so on and so forth, he had, as the magistrate found, a fundamental influence over whether this corporation did well or did not do well. So he was anything but a passive investor in that sense.
Harry A. Blackmun: You speak to the veto power. The veto cuts both ways, doesn't it?
Robert C. Epstein: Yes, Your Honor, in the sense that Mr. Ruefenacht could not do anything without his partner going along.
Harry A. Blackmun: Exactly.
Robert C. Epstein: That is exactly right, Your Honor. There was here a deadlock situation, but we submit that Mr. Ruefenacht's veto powers amount to fundamental control going right to the heart of--
Byron R. White: But it is also a good way to protect his investment, isn't it?
Robert C. Epstein: --In a generic sense of the term "investment", Your Honor, that is true. In a generic sense, Your Honor, almost anything that you buy can be considered an investment to the extent that you expect to earn a living perhaps from it or to have that asset that you purchased--
Byron R. White: Yes, but a veto power doesn't always have the characteristics of control. It has just got... it is a limited partner. You may not want to control the business at all except to protect your investment.
Robert C. Epstein: --That is true. I suppose in the Weaver case Your Honor, the Weavers were in a sense Weaver case, seeking only to protect their investment, but nevertheless the Court found that their measure of control simply over the borrowing of money was uncharacteristic of the security. If I may, I would like to turn to some of the concerns that--
John Paul Stevens: May I ask a question?
Robert C. Epstein: --Yes, Your Honor.
John Paul Stevens: We are all trying to grasp exactly where the dividing line is. You don't take the position then, I gather, that every sale of control is exempt from the Securities Act?
Robert C. Epstein: No.
John Paul Stevens: It is only if there is a sale of control and the purchaser thereafter relies on the management efforts of other to produce--
Robert C. Epstein: Yes, Your Honor, and in a private setting that would be especially true.
John Paul Stevens: --So every sale of a business to, say, a bank or a trustee which would then be... you would have to get some outsider to manage for them, those would all be covered, 12 percent sale of the business in the other case or your business here.
Robert C. Epstein: Again, if we are talking--
John Paul Stevens: To a bank or a university who is going to hire some management expert to run the business for them. Covered or not covered?
Robert C. Epstein: --If we are dealing in a totally private setting, not a publicly traded security in any sense--
John Paul Stevens: Not a publicly traded security.
Robert C. Epstein: --Then it would not be covered, and the fact that management was delegated to somebody else makes no difference.
John Paul Stevens: So is every sale of control of an unlisted security exempt under your view?
Robert C. Epstein: No, Your Honor. I am not making a distinction between whether a security is listed on an organized exchange. There may be closely, and I am sure there are, closely held corporations which go into the "public capital markets" to obtain funds and as a result of going into those markets they implicate a federal securities interest, in my view. If there is some wide dispersion of ownership, even though the security is not listed on any exchange, the transfer of 100 percent of that security may very well still be covered because you are dealing in a marketplace.
John Paul Stevens: Well, let me go back. Every sale by a 100 percent owner to a 100 percent purchaser of an unlisted security, always exempt?
Robert C. Epstein: Yes, Your Honor, I believe so. I can't see a situation where it would not be.
John Paul Stevens: All right, then the next question is, all sales of control of an unlisted security by control block, 52 percent 30, or whatever it takes to constitute realistic control of an unlisted security, always exempt?
Robert C. Epstein: Yes, if... yes, if that security was not of a nature which could be publicly marketable. If you are dealing--
John Paul Stevens: Well, I mean, if it is a big company, you are always going to be publicly marketed.
Robert C. Epstein: --Well, if we are talking about a security, Your Honor, which has roughly equivalent value to most people, and I take that language from the Weaver case, if we are dealing in that kind of security, in my view, you start to implicate the kinds of Congressional concerns that I have been trying to address. So, I can't give you a categorical answer on that point, Your Honor. Your Honor is giving me a quizzical look, and I am trying to give you the best answer that I can, but I have to qualify it because there can be no categorical rule, I don't believe, in these kinds of situations. As the Weaver court stated, it is important to look to the entire factual matrix. One element of that factual matrix, I submit, is the nature of the instrument, whether it was idiosyncratic to that--
John Paul Stevens: I am assuming, you know, ordinary common stock, you know. I am not talking about idiosyncratic instruments. We have just ordinary stock. That part is easy. But I still... I just really don't understand your distinction.
Robert C. Epstein: --Your Honor, when I talk about idiosyncratic instruments, I am talking about the kind of stock that was involved in this case, which had value only as between Mr. Ruefenacht and Mr. Burkle, and had no widespread value to anyone else, had no equivalent value, as I said before, to other people.
John Paul Stevens: Why didn't it have value to somebody else? You say they resold 10 percent to each of ten people. Why wouldn't that have value?
Robert C. Epstein: It would have value in that sense, but it did not have the kind of value that existed between these two people. For example, one of the facts that the magistrate found was that the purchase price of the stock was in part related to Mr. Ruefenacht rendering his services to the corporation. That is an element of the uniqueness of this transaction between these two individuals which is different from a transaction we hypothesize where the stock would be sold to somebody else.
John Paul Stevens: But you would come out differently if it were a publicly traded security?
Robert C. Epstein: Yes, Your Honor--
John Paul Stevens: You would agree, sale of control of a publicly traded security with management prerogatives and all this is covered by the Act?
Robert C. Epstein: --Yes, Your Honor. Frankly, I can't distinguish that conceptually from a tender offer situation, because when you are dealing in public markets, you get so much to the heart of what Congress was talking about in the securities laws that I think the securities laws do apply in Your Honor's hypothetical. Now, to address some of the concerns of the Court below, one concern was that application of the so-called sale of business doctrine would lead to anomalous results. But may I point out to the Court that the Third Circuit did not find that it would be anomalous in this case or inconsistent with the legislative goals in this case to disqualify the transaction from coverage. Admittedly, there have been raised in the briefs and in the academic commentary a great number of very perplexing factual issues, and we don't purport to address all hypothetical cases today. What we do ask the Court for is a ruling on this case, which we believe will set forth clearly the applicable principles, and the so-called anomalous cases we believe will in large measure take care of themselves. Also, the Court below was concerned about devoting federal judicial resources to the economic substance inquiry. Now, it is true that in this case we have a two-day non-jury hearing before the magistrate devoted to the issue of control, but the projected trial time that was saved by that inquiry was far greater than two days. Now, I cannot prove this, Your Honors, but I submit to you that the vast majority of questions of coverage under the securities laws will be clear. Securities involved in organized exchanges, public capital markets, widespread solicitations or offerings or purchases, those cases, in my view, are clearly covered. Where there is a legitimate issue concerning federal securities laws coverage, which I submit will occur most frequently in the private sphere, I submit that the resources devoted to that inquiry are well worth the savings in federal trial time otherwise devoted to questions or matters which involve no significant federal concern, but which happen to involve stock. Finally, as I started to say earlier, the Third Circuit was mightily concerned about where to draw the line. Justice Stevens' hypotheticals put that concern greatly in issue. That is a concern which, as I said, I hope this case will help to ameliorate, but I don't believe that simply by adopting a mechanical test which makes line drawing very easy is the answer to that problem. In conclusion, Your Honors, we ask this Court to decide this case based upon the facts of this case, as the District Court did, and not based upon hypothesized concerns in other cases which in a fundamental sense led the Third Circuit to rule as it did.
Byron R. White: But I suppose you must hope that we decide the immediate preceding case in a particular way.
Robert C. Epstein: That's right, Your Honor. That is right. I agree that the Landreth case should be decided in the same way that this case should be decided.
Byron R. White: Either way. No. 0 [Generallaughter.] You don't mean either way.
Robert C. Epstein: Your Honor leads me to an interesting point, and that is the point of common venture which was raised earlier in the colloquy, and I would like to tackle that one head-on. It is a difficult point. As we pointed out, the federal courts seem to be very confused about what is a common venture. I submit to you that there was no common venture in this case, and as authority for that position I rely upon Howey and I rely upon Weaver. I point out to you that in the Howey case where the common venture requirement was framed, the matter involved 42 purchasers out of a solicitation of several hundred. I point out to you that in the Weaver case, in Chief Justice Burger's opinion, there was great emphasis at the end of the opinion on the fact that there was a privately negotiated, face-to-face transaction unique as between two individuals. I suggest to you that juxtaposing those two cases leads to the conclusion that where you have, as in this case, a completely unique transaction between two privately contracting parties, that that is not the kind of common venture that this Court has been addressing over the last 40 years, and we therefore ask the Court based upon the facts of this case and not upon hypothesized concern or the single fact relied upon by the Third Circuit, which essentially was that there was stock involved in this transaction, we ask the Court to reverse the Court below. Thank you.
Byron R. White: Very well. Mr. Pearlman.
Peter Steven Pearlman: Mr. Chief Justice, and may it please the Court, on behalf of Max Ruefenacht, the purchaser of one-half of the shares of traditional common stock of Continental Import and Export, Inc., I submit that to accept the sale of business doctrine will require this Court to disregard accepted principles of statutory construction by ignoring the specific and unambiguous language of the securities statutes, abandon its own prior precedent and policy, and to adopt a policy which is ambiguous, unworkable, not readily definable, and which creates results which are arbitrary and unfair in the extreme. For 50 years, and through numerous securities cases, the question of whether the federal securities laws apply to traditional common stock has not troubled this Court, nor should it now. Nonetheless, Mr. Ruefenacht has devoted the last four years of his life to litigating just that issue. The legislation which is in issue here is the definitional section of both the Securities Act of 1933 and the Securities Exchange Act of 1934. In both circumstances, the legislation says clearly that a security is defined as a list of items including specifically "stock". This Court does not sit as a superlegislature. It is not up to this Court or any court to determine whether Congress was wise in enacting such a definition. The term "stock" in the statute is clear and unambiguous. It is to be given its ordinary clear meaning. Under those prescriptions, the shares which Mr. Ruefenacht purchased, albeit a private, non-publicly traded corporation, were shares of stock, and he is entitled to remedies under the federal securities laws. Petitioner submits that we must depart from the letter of the statute, that we must ignore its plain meaning, and that we must examine the legislative history. The perceived intent of Congress, and when I say perceived, I mean petitioner's perceived intent of Congress, to determine what they really meant when they gave a very clear and unambiguous definition in the statute. The simple introductory answer to that is that it is not up to a Court to examine legislative history when the statute on its face is clear, but even an examination of the legislative history does not avail petitioner in the way in which he wishes. The legislative history itself does not evince any intent to exclude transactions such as that to which Mr. Ruefenacht and Mr. Bunkle entered. Quite the opposite. This Court in its prior precedent has uniformly stated that instruments which answer to the name of stock, which are stock, which bear the traditional attributes of stock, are securities. This Court has said it in Joiner. This Court has said it in Tcherepnin, in Forman, and most recently in Weaver, where this Court stated that the statutory definition of a security excludes only currency and notes with a maturity of less than nine months. It includes ordinary stocks and bonds. Nothing could be more ordinary than the stock and the bonds which Mr. Ruefenacht acquired. Petitioner submits that the respondent is attempting to engraft into the statute something which is not there. Just the opposite is true. We are dealing here today with a situation where the statute says plainly any stock. Mr. Ruefenacht acquired stock. In fact, the attempt to toss out all other portions of the definition other than that of investment contract not only violates almost every relevant concept of legislative interpretation, but makes no sense from a general common sense standpoint. When this Supreme Court enunciated its opinion in Howey, it specifically dealt with the case involving an investment contract, and it said that the definition of an investment contract is investment of money in a common enterprise, expectation of profits to come from the efforts of others. Since then, this Court has used that definition on many occasions. And on every single such occasion it has been used to define an investment contract, to see whether a particular transaction qualified as an investment contract. This Court has never applied that standard to determine whether traditional common stock was a security, nor should it.
Byron R. White: What did we use in the notes case?
Peter Steven Pearlman: I don't believe that this Court has made a determination on--
Byron R. White: On notes?
Peter Steven Pearlman: --a specific notes case. I don't believe that this Court has spoken on that, and I recognize that there is a split in the circuits on--
Byron R. White: On that?
Peter Steven Pearlman: --on that issue as well. That is not before the Court today, but perhaps at some future time it will be.
Byron R. White: Maybe you will be here on that.
Peter Steven Pearlman: It would be my great pleasure, Justice White. It would be my great pleasure and my great honor.
William H. Rehnquist: Well, that really is the most difficult part of your argument, isn't it? Isn't it pretty well conceded that some differentiations have to be made as to notes, and so why shouldn't differentiations be permitted as to shares of stock?
Peter Steven Pearlman: Justice Rehnquist, I don't believe that it is necessary to make these differentiations with respect to notes. I do not believe that we should sit down and try and determine what "notes" should be included within the statutory definition. I believe that the statutory definition specifically excludes certain types of notes, notes with a maturity of less than nine months, but I do not believe that the statutory definition of notes permits an examination into the underlying transaction. I would suggest, however, that to the extent that there is some confusion with respect to notes, it may be that notes are a less commonly defined term than stock. "Investment contract" is a vague term. It is a term to which this Court has applied a certain definition. Stock is something which is, I think Professor Lewis has said, so quintessentially a security as to foreclose further analysis. It may be that notes fall somewhere in between, and it may be, although I disagree, and of course, as I said, the case is not here today, but it may be that with respect to notes, it is somewhat less specific than stock. It is perhaps somewhat vaguer and more akin to an investment contract, although not necessarily with the same standard to be applied, and it may be that some definition is necessary with respect to note, just what a note is, what type of note we are talking about. But there is no definition which is necessary with respect to traditional stock. Stock has been defined. At least what this Court means by stock was defined. It was defined in Tcherepnin. It was defined further in Forman. So I do not believe that whatever problems may have arisen in the circuit with respect to notes need cause a problem with respect to whether or not this Court should adopt or reject the sale of business doctrine. Until I came here or until I read the briefs, I should say, in connection with this appeal and then was reinforced a little bit this morning and then this afternoon by Mr. Epstein, I really thought I understood what the sale of business doctrine was. I thought the sale of business doctrine was that you looked to the economic realities of the transaction and apply the Howey test to see whether you fall into that category. I always felt it was impossible to really come to any sort of a meaningful conclusion by use of the Howey test because it necessarily excluded certain things which no one had ever questioned were security, such as Williams Act cases, such as many publicly traded transactions, because obviously frequently when a tender offer is made, there is the intent to control. That is one of the major purposes for the tender offer. I now find out this morning that the Howey test is not the sale of business doctrine, or vice versa, because apparently under the version of the sale of business doctrine which I heard today, you applied the Howey test sometimes, but sometimes you don't apply the Howey test. Certainly you don't apply it when you are dealing with publicly traded corporations, I guess. At least in a tender offer with publicly traded corporations. I am not sure where the line is drawn. There you have to look to some other sort of legislative philosophy. I am not sure what that philosophy is or is supposed to be. But what you do is, you sit down and you look at the Congressional intent, I guess, every time a securities case comes to court. And having done that, you decide whether it is publicly traded or privately traded, and then you have to form your own concept of whether or not it is a security. The test is completely unworkable. Clearly the Howey test cannot apply to transactions involving mergers, Williams Act cases. When the Williams Act was passed, incidentally, it was used... it used exactly the same definitional section. If Congress had intended to make control an issue, or if Congress had thought there was a problem with control in the current definition, they could have modified that definition. They could have given some specific statement of intention with respect to tender offer cases, the acquisition of control. They didn't, because stock is stock. So we are here today being urged to accept a doctrine which really has not been defined.
Byron R. White: Well, you say that any sale of any kind of stock that any fool would recognize as stock is reached by the securities laws?
Peter Steven Pearlman: I don't know if any stock that any fool would recognize as stock is reached by the securities laws. Certainly something which Your Honors would recognize as stock would be reached by the securities laws. Perhaps something which I would recognize--
Byron R. White: Well, a fortiori if a fool would even recognize it. 0 [Generallaughter.]
Peter Steven Pearlman: --I am sure that was intended to reflect the recognition.
Byron R. White: Anyway, you think that stock is stock, any sales stock is covered.
Peter Steven Pearlman: Any sale of what is really stock is covered. I recognize the problem that arose in Forman, and without necessarily agreeing or disagreeing with whether or not that was traditional stock and whether it should have been considered stock, I recognize that there are circumstances when having called something stock doesn't mean that it really is stock. You can suggest that the world is flat. That doesn't mean that it is. There are a number of policy considerations which favor the rejection of the so-called sale of business doctrine. The primary, and the one that first comes to ind, is the fact that the Securities Acts are to be construed liberally to enhance their remedial intent. Certainly attempting to strike from the definition something which is clearly there, something which is unambiguously there does much damage to and doesn't benefit in any way the remedial intent of the securities laws. The problem with control is something which I have already discussed, and that is not only does any test which is premised on control exclude transactions which I don't think anyone would ever intend be excluded, but it is very difficult to define control, as to when the control was to be exercised, what is control under any given circumstance, and the Ruefenacht case illustrates that, I think, rather well. There has been some suggestion that when a person acquires control they don't really need the protection of the federal securities laws, because they have the ability to control the destiny of the business. I suppose the simple answer to that is that the federal securities laws apply to fraud which took place before you assumed your control, and about the best you can do once you have assumed this control whatever it is, is to be in a good position to grab the bucket and start bailing. It hardly is a good justification, however, for adopting the control standard. I suggest therefore that this Court reject the sale of business doctrine as it is carved out of whole cloth, having taken... having made an attempt to add to the statute something which was never there in the first place by arguments which have no basis in logic and no basis in law, and affirm what I think my counsel that took the same position as I take today in Landreth this morning described as the scholarly opinion of Judge Gibbons of the Third Circuit. I consider it well reasoned, and I wholeheartedly hope and expect that this Court will agree. I have nothing further to say affirmatively. I would be honored to answer any questions this Court may have of me.
Byron R. White: None, apparently.
Peter Steven Pearlman: Thank you.
Warren E. Burger: Mr. Goelzer.
Daniel L. Goelzer: Thank you. Mr. Chief Justice, and may it please the Court, in defining what is a security, Congress used the plain term "stock", and the stock in this case is the garden variety of that type of instrument. Nowhere in the Securities Act or in the Securities Exchange Act did Congress suggest that sales of this sort of ordinary stock were ever to be excluded from the securities laws. The petitioners' case rests in part on the notion that only passive public investors were intended to enjoy the protection of the securities laws, that those who engaged in private negotiated transactions where they have some ability presumably to extract information for themselves are not within the protection of the securities laws. But Congress, I think, considered that issue and reached a different conclusion. Section 4 of the Securities Act of 1933 contains exemptions from the registration provisions of the Act. Almost 30 years ago, in SEC versus Ralston Purina, this Court construed the private placement exemption as excluding from registration and its disclosure obligations transactions where the purchaser can fend for himself or have obtained his own access to the sort of information that registration would supply. Congress made clear in the introductory phrase to Section 4 that transactions excluded from registration were included in antifraud protection. I think the arguments that petitioner makes here in this regard were simply considered by Congress, and the place it drew the line was between registration and antifraud protection, not by excluding these private transactions from the scope of the securities laws. Petitioner argues that ordinary common stock is not stock at all when it changes hands in a transaction where the buyer acquires some measure of control over the issuing company, but if this Court were to adopt that theory, it would multiply the complexity and expense of both SEC and private securities litigation. I would like to consider Commission litigation first. Under the test the petitioner advocates, Commission enforcement actions would necessarily become more complex for reasons having little or nothing to do with Congress's objectives in enacting the laws. Petitioner argues in essence that every time a judge is confronted with a securities transaction, he needs to make his or her own decision concerning whether Congress intended federal protection to apply to that transaction. Thus even if the Commission were to prove that a violation had occurred under the ordinary meaning of the laws, would still be open to the defendant trying to convince the Court that there was something in Congress's spirit or intent not manifested in the words which provided a defense.
Sandra Day O'Connor: Mr. Goelzer, if your view is adopted by this Court, what is it likely to do to the numbers of cases dealt with by the Commission? Will it increase the numbers, do you think?
Daniel L. Goelzer: If my view is adopted, I think it won't have any effect on the number of cases that the Commission deals with, since it has always been the Commission's assumption since 1933 and 1934 that any transaction in ordinary stock is within the scope of the securities laws. The Commission would not typically bring an enforcement action in a case involving a transaction between two private parties simply because it wouldn't be a good use of our resources, although--
Sandra Day O'Connor: Is it likely to increase the numbers of cases filed in federal courts, do you think, to any significant degree?
Daniel L. Goelzer: --I think not, Your Honor. It certainly wouldn't increase them beyond what they were before 1980 or 1981, since no Court had suggested that this sale of business doctrine existed at all before that time. I think if the doctrine is adopted, if the petitioner's position is adopted, we will have at least the same number of cases, but they will all include a long threshold consideration of whether control, a very subjective and amorphous concept, existed in the case or not.
Sandra Day O'Connor: What is the Commission's position concerning notes, and what type of meaning should be adopted for that word in the statute?
Daniel L. Goelzer: Well, as was pointed out earlier, this Court, of course, has not considered the meaning of the term "note" in the--
Sandra Day O'Connor: No, I asked what the Commission's position is.
Daniel L. Goelzer: --Well, as I would with stock, I would begin with the literal term of the statute, and start with a presumption that any note is included within the scope of the Act. The lower courts have held, and the Commission doesn't disagree with it, that there are certain families, certain categories of notes that were not within Congress's intent that would relate primarily to notes issued in commercial transactions, mercantile transactions to finance inventory, for example, or for consumer purposes. Other than those rather specialized exemptions or exceptions, I would say that a note is within the scope of the definition. I think it is not... the definition of security contains many terms. Stock is one. Note is one. Investment contract is another. I think it is not surprising that each term has its own specialized meaning and its own body of case law interpreting it, but as I said earlier, in this case there is no question, no one has suggested that it is not conventional stock that is involved. I think that a second way in which Commission enforcement actions would be significantly burdened if the petitioner's position were adopted is that inherent in that position is that each security transaction must show that it meets the definition of investment contract, yet the Commission often brings actions that involve instruments that don't promise a share of profits. Rather, they promise a fixed return to the investor. The lower courts have disagreed concerning whether a fixed return meets the profit element of the Howey test, yet if it doesn't, such ordinary things as long-term corporate bonds issued by blue chip companies would be excluded along with irregular and unusual instruments issued by individual promoters. At best, the Commission would be forced to relitigate all of this ground, presumably already covered during the past 50 years under the doctrine. I think it is also worth pointing out that the position the petitioner urges would result in arbitrary and illogical distinctions in private litigation. For example, in this case, if Mr. Ruefenacht had purchased his 50 percent interest in Continental in a series of five transactions of 10 percent each, presumably the first four would form a basis for federal litigation, the last would not, or if in the same transaction in which Mr. Ruefenacht purchased, his brother had purchased 5 percent of the stock based on the same representations that were made to Mr. Ruefenacht, the brother would apparently have a cause of action, Mr. Ruefenacht would not. And if Mr. Ruefenacht had purchased his controlling interest from ten shareholders, each with 5 percent, apparently he would not have a cause of action against them. Would they have a cause of action against him? They would seem to be the sort of people that Congress intended to protect, even under the petitioner's theory: passive, non-controlling investors. Yet the petitioner says there was no securities transaction involved. One circuit, the Seventh Circuit, has suggested that there is a securities transaction for the sellers but not for the buyers. I think that leads to a good result, and I would support it, but I think the logic of the same transaction being or not being a securities transaction depending upon whether you are plaintiff or defendant, is illusive, and the issue would undoubtedly be litigated in the lower courts and perhaps ultimately brought back to this Court. Finally, I would point out that adoption of the sale of business doctrine will inject great uncertainty into business transactions. Any time that a significant amount of stock is purchased, the parties will have no definite way of knowing whether they have Possible liabilities and possible rights under the federal securities laws. All that, no matter how sophisticated the advice they might get from counsel, all that will have to await litigation in the federal courts over this illusive and difficult issue of control. Absent some clear directive from Congress that the securities laws were intended to create this sort of uncertainty, or that it is a necessary consequence of them, I think this Court should be reluctant to create it. For nearly 50 years, the business community, the Courts, and the Commission have taken Congress at its word and assumed that any purchase or sale of ordinary corporate securities, whether... corporate stock, whether between sophisticated or unsophisticated parties, was within the antifraud protections of the securities laws. If petitioners or others believe now that that determination should be changed, they should address their arguments to the Congress, not the Courts. Thank you.
Warren E. Burger: Do you have anything further, Mr. Epstein?
Robert C. Epstein: Yes, briefly, Your Honor. My remaining--
Warren E. Burger: You have four minutes remaining.
Robert C. Epstein: --Thank you, Mr. Chief Justice. I first would like to address Justice O'Connor's question about what will the result in this case do to the workload of the federal courts. This is, of course, theoretical, but I submit to the Court that especially with the increased awareness among practitioners of this issue, that if the sale of business concept is rejected, that plaintiff's lawyers will be constrained to bring all cases that in any tangential way involve stock and an allegation of fraud in federal court. Plaintiff's lawyers, I submit, would be remiss if not negligent in failing to bring those cases in federal court so as to take full advantage of the easier burden of proof under the federal securities laws and of the broader privity requirements. Secondly, a great deal has been made about the so-called structure of the securities laws and how that supposedly indicates a Congressional intent on the sale of business question. I submit that is an incorrect argument for the simple reason that both sides of the current debate recognize that Congress never considered this question, and if Congress never considered this question, I think that the better place to look for the Congressional intent is not to the structure of the Acts but to the legislative history of the Acts. Finally, the point has been made that control or the passing of control should have no relevance because fraud very often takes place before control passes. Well, there are several answers to that. Answer Number One is that as Congress saw it, the dependance of the investor defines whether he was the kind of person that should receive protection of the securities laws, and the passage of control defines whether the individual was dependent. Secondly, in the investment contract context, in the Howey case context, I think all sides recognize that the control analysis is very important to the third prong of the Howey test, and it is important because it gives courts a pathway to the legislative intent and a means to evaluate whether the investor involved in a particular case is in that peculiarly vulnerable position which Congress sought to address. Thank you, Your Honors.
Warren E. Burger: Thank you, gentlemen. The case is submitted.


Warren E. Burger: We'll hear arguments next in 74-22, Ivan Allen Company against the United States. Mr. McAlpin, you may proceed whenever you're ready.
Kirk M. McAlpin: Mr. Chief Justice and may it please the Court. The case before you today is in behalf for the taxpayer Ivan Allen Company. This is a penalty tax case is that referred to you also is an accumulated earnings tax case had arises under Section 531, 537 Internal Revenue Code. If the Court would permit, I might in one very brief moment spelled out the particular provision of 533 which is of issue in this case. The very Section 533 portion which is particularly pertinent to the consideration says this, "The fact that the earnings and profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid the income tax with respect to shareholders." I might state briefly that Ivan Allen Company is involved in this case by reason of the purchase of Xerox stock in 19 -- for the years 1965-1966. The issue here is whether or not Ivan Allen Company accumulated earnings beyond a reasonable needs of the business that we -- to their earnings and profits succeed are reasonable business needs for those years. The issue has been framed by stipulation to present a relatively simple issue insofar as the business figures of the corporation are concerned. The amount of Xerox stock, which we claim and did so claim successfully in the District Court, which was purchased from earnings, the accumulated earnings was $154,000.00. That is the amount of investment which we have in liquid assets. That amount was reflected in the year 1965 as $154,000.00 and the year 1966 a taxable year in June of 30th that was reflected as $135,000.00 because some of that Xerox stocks have been sold in the year 1965. The question here before this Court and it's whether or not the earnings and profits in determining this question whether the earnings and profits exceed the reasonable business needs of the business are reasonable needs to be compared with the earnings and profits reflected in the liquid asset as we contend at cost or as the Government says, as total resources available including unrealized appreciation as the government contends. The Xerox stock web from a basic cost of $154,000.00 in the year for the taxable year of 1965 to $1,640,000.00 rough years, and the year of 1966 as the records will show that same stock at that time $135,000.00 had a liquidation of market value less cost of your -- well, market value of that time of $2,500,000.00.
William H. Rehnquist: Mr. McAlpin, why does an office supply company buy a stock like Xerox?
Kirk M. McAlpin: Alright, sir. The reason was, they were, I don't know if it's in the record, they were in the 3M, they had the franchise for 3M Machine, this old machine which Minnesota mined. They lost that franchise, they saw that Xerox on the market. They are aware and they saw that Mr. Allen back in the 60's. He had some cash money, Your Honor, and this is accumulated earnings which a record will show was needed in operating capital stipulated that this cash, we agree as an operating capital. He invested this in a security rather leave in oddly in the cash or just in the savings account.
William H. Rehnquist: Do you say Mr. Allen had some money? You --
Kirk M. McAlpin: No, no, I'm saying he was part of the company as Mr. Ivan Allen I say --
William H. Rehnquist: In corporation?
Kirk M. McAlpin: It's a corporation. He was the President of the company at this time. But it was a corporation --
William H. Rehnquist: It was a substitute for putting the money in the bank?
Kirk M. McAlpin: Yes, sir. As a matter of fact, this case would not be here today if Ivan Allen Company had just wanted to be safe and just leave the $154,000.00 in cash because it is stipulated by the Government that -- we so state that the cost to our investment as it is invested -- cost of our earnings that which is the investment of Xerox and liquid assets is available to meet reasonable business needs. We say that the appreciation is not available that these are not earnings and that the amount earning so we paid tax of $154,000.00 which went into -- which are accumulated earnings had we left and I don't think the Government will contend otherwise, had we left that $154,000.00 just in cash have management which was hesitant to make decisions, hesitant to looked around and see what was a good investment for some temporary money while they are waiting to use as his operating capital, and this was and stipulated as to cost it was operating capital. Have they left that $154,000.00 in cash as operating capital, there would be no claim because it is stipulated in this case that the amount of all reasonable business needs as an operated in capital $1,000,002.00 in 1965 and $1,000,004 in 1966 would equaled exactly the accumulated earnings for the years -- the same years of 1965 and 1966 if the stock is treated as we respectfully submit in earnings that the investment that they had in liquid assets that would be $1,000,002.00 which will be the accumulated earnings, and $1,000,004.00. So you see, we are saying that $154,000.00 and respectfully $135,000.00 of those two years. In cash, that was all the earnings we had. We put it into the liquid assets, it was proper operate in capital and available to meet the business needs. Now, here's the case and here's what the Government says --
William O. Douglas: Mr. McAlpin, before you go on, you're talking about unrealized appreciation investment in stock market?
Kirk M. McAlpin: That's correct.
William O. Douglas: As of what dates are we talking about that the Government take year in market value?
Kirk M. McAlpin: Yes, sir. The government --
William O. Douglas: This year in as I recall.
Kirk M. McAlpin: Yes, sir. June of 30th of 65' and June of 30th of 66'. Now, the Government contends --
William O. Douglas: Does the record show --
Kirk M. McAlpin: Yes, sir. I think --
William O. Douglas: -- the high and low market --
Kirk M. McAlpin: State by attorney at page 70 and page 90 --
William O. Douglas: Mr. McAlpin, I'm asking you another question.
Kirk M. McAlpin: Excuse me.
William O. Douglas: Does the record show the high and low market price of Xerox in each of fiscal years in question?
Kirk M. McAlpin: I'm not certain it does, it only shows the -- what the Government refers to as the net liquidation value. They show the market and in the record shows the cost of conversion which will cost that showing does not show the variation.
William O. Douglas: Is that taking into account the capital gain stocks?
Kirk M. McAlpin: Yes, the cost of conversion --
William O. Douglas: The cost of conversion is different from the --
Kirk M. McAlpin: Oh, no that's the cost. They have stipulated that there would be approximately -- I believe 37.5% if we did sell the stock. That would be all our capital gain stock, the 6% other tax and then the -- some dispute about the Georgia tax but we claim that there is three taxes which would apply if we were forced to convert and therefore, we would not have the full value even under their theory available to meet business needs. I think that is in the record Your Honor and stipulated.
William O. Douglas: Mr. McAlpin, on page 55, I think there is a stipulation about the cost of converting and I suppose had the corporation on December 30th or two days before the end of the taxable year or maybe on fiscal year basis yes June 30th. In June 28th if it had liquidated the Xerox stock without the net figure after capital gain and capital gain tax and brokerage commission, you wouldn't be here arguing then there would be an improper accumulation of surplus?
Kirk M. McAlpin: Had we converted it?
William O. Douglas: Had you converted it?
Kirk M. McAlpin: Yes, sir. But what we have done we would naturally we would have paid the capital of the intersection, Your Honor at that time. We would then have as we did when we saw the thousand shares of Xerox in 1966, we would put it into our business for operation. We would earn money. We would pay for the income tax on that as we did in 1966. You'll notice our earnings went up from $341,000.00 to $629,000.00 and we would have then -- yes, we would have used it and put it in but the question Your Honor may be this, does that statute 531 to 37 and the legislative history require a conversion of what the Government is claiming and what's he did successfully in the Fifth Circuit and prevailing upon the First Circuit to reverse Judge Moye with -- Judge Moye the District Judge established a principles which we urging in this Court. What they would do then is force a conversion or if they certain the last day of our taxable year. It would be without reference at all as to whether or not business judgment the term, and the time, and the place, and the best conditions under which investment should be sold and whether or not it would be wise to sell it all over at that time.
Potter Stewart: What was the Government's theory, I thought it was -- first of all I don't think that the Government claims at all that this unrealized appreciation is itself earnings and profits. But that the Government's theory is that with the existence of this large unrealized profit in the investments you made in this company that your other earnings and profits were more than available to meet the needs of the business and therefore, where you stand were declared, you're in trouble under the statute.
Kirk M. McAlpin: But the Government says well, we --
Potter Stewart: It doesn't say you should've sold your stock or had to sell your stock --
Kirk M. McAlpin: So much I would asked would be necessary to pay the amount of the dividends or let's say claim we say we should pay all of our profit earnings and profits in the taxable years. Now, Your Honor what they --
Byron R. White: Often earnings and profits are not in cash. That's true, isn't it?
Kirk M. McAlpin: Oh, that's correct. That's correct. That would be reflected in property very frequently, yes sir.
Byron R. White: Right.
Kirk M. McAlpin: But the point is the statute makes a comparison. We would submit that the statute makes a comparison as to earnings with the reasonable business needs for the taxable year. Now, what they say is that they are not tax -- that's what they have taxing of that amount exceeds when you put market on it that that's what they're taxing. But what they do, Your Honor, they go to liquid assets and they claim that all amounts which we are holding as investment in liquid assets under the Smoot case which we hold at cost, that is our cost a $154,000.00. They take this and they put the appreciated value on it, and then they say, "You look at total sources of funds in making the comparison." Now, there is no statute, no regulation under 535 or 531 in anyway that ever adopts except in this case and in the Fifth Circuit. They did this and they call it in the tax court which we say is wrong. We ask this Court to disregard that decision but what they do is that they take that figure which is in total -- which is in the liquid assets and they have interpreted that they say that all of your liquid assets, all the current liquid assets, that when you compare that with your business needs at a converted figure which would be the hundred to million sects that if that exceeds your reasonable business needs then you have accumulated earnings which you must pay tax on a county tax. Now, --
Byron R. White: Now, wait as minute. Let's assume that the company buys some stock at for a $100,000.00 and it didn't enhances and that increases in value 10 times since it was a million.
Kirk M. McAlpin: That's right.
Byron R. White: And there it is and but the Government doesn't contend you have to pay any of that out any of that enhancement of?
Kirk M. McAlpin: No, sir. They say --
Byron R. White: But if you -- if the next year you have a dollars worth of earnings and profits you had to pay that up.
Kirk M. McAlpin: That's right. They say we should --
Byron R. White: But any year and which you have a loss you don't have to pay anything else.
Kirk M. McAlpin: That's correct. What they did --
Byron R. White: So, it doesn't say that certain that the enhancements of earnings and profits suppose must be converted and paid out.
Kirk M. McAlpin: They have met that that is not earnings but Your Honor the way they go about it is this. They have applied a different rule. They have -- they are forcing a conversion on your asset, your liquid -- the so much to your liquid assets are at cost.
Byron R. White: They don't force the conversion. They just say that your current year's liquid asset -- you current year's earnings and profits must be paid out.
Kirk M. McAlpin: Well, but Your Honor the measure there the comparison is under Section 533 of the Code and the comparison the words are "earnings and profits" as you measure, you compare your earnings and profits for that year the accumulate earnings and profits -- your accumulate earnings and profits as against your reasonable business needs. Now, if you look at cost, our reasonable business needs over $1,000,002.00 in 65' are accumulated earnings of $1,000,002.00. They agree then that's exactly the same. Now, what they're saying that you take total resources, you take your liquid assets and when you take liquid asset you appreciate the stock which has a cost value reflected in liquid assets. Now, we'll come to that word, that is a very critical word because if misstated the rule we submit in the Smoot case.
William O. Douglas: Which is a critical word?
Kirk M. McAlpin: The word "reflected" the Smoot case in 1960 --
William O. Douglas: Incidentally, it is agreed that the Xerox stock is completely marketable it is liquid, I take it here.
Kirk M. McAlpin: Yes, sir. But this case would be establish in the rule though, in this particular instances it is liquid. We would loss value in the courts we have come at par. We would loss value of approximately from 30% to 37% or maybe by reason of conversion. We will be forced to sell it is liquid but this would apply to closely held corporations in which one of the concerns would be evaluation, it would a closely held corporations stock be able to have an available ready sale. Now, you see the Ninth Circuit in Golconda, they held that eventhough there's tax Court, they held it was an applicable because it was a publicly held corporation. So, the imposition that would be establish in this case under Fifth Circuit has established says that," at the end of every taxable year that all your total, not your earnings and profits as the statute says, all your total resources must be look to, to see whether or not you can meet your reasonable business needs." Now, that means on December the 31st you have effect that they have been told that that market value whatever the stock is at that time stock market value at that time establishes that you have been told, you have that you will be in place of market value on it. Now, let's assume Your Honor and we say and you set it in this Court in Eisner in 1938, you have very -- you expressed concern about force conversion, the American Trading Company Fourth Circuit did the same thing in 1973. What you would do in December the 31st, you force -- you make him determine a market value on that stock. The question is and this is where the error is, there is no insurance that that will continued to be available into the next year even under January of 2nd, suppose in antitrust suits or some fraud suits were filed. You say that where stock is worth a billion and a half dollars or in antitrust suit was filed against Xerox Corporation on January 1st. You have established that not by business judgment but by the determination of the Government. The Government has come in and told you when your sale is and on January the 2nd, the question is continue the availability to meet prior operating in business needs. Now, on January the 2nd, something completely happens as to Judge Moye says secretary of State's petitions it goes to Europe.
William H. Rehnquist: Well, even if that doesn't happen, isn't one of your responses to Justice White's earlier question that even though you're not told by the government to liquidate your Xerox stock, if you have to distribute all of your earnings and profit to make up operating needs. You're going to have to liquidate some of your Xerox stock.
Kirk M. McAlpin: Yes, sir. But only, Your Honor, only to the extent of a hundred -- yes, operating needs $154,000.00. Now, we stipulate as part of our operating capital. We would have to sell $154,000.00 worth to take care of it but we would have to sell all of it. Now, what the Government -- we would have to sell the whole thing we just have to sell that $154,000.00 of our amount. What or maybe, it maybe more but what the Government is saying is when you measure it we had to -- they have said we have to pay out the whole $600,000.00 of profits for the taxable years that we had dividend then we should pay all of that out. Now, we did pay out a dividend and we have been paying our dividends but they said all of it should be because when you take your appreciated value, they say they're not tax, and they have met they say appreciation is not an income. But what they have done is they have converted earnings in some form or another to look equity, they used another equity test and which they say that you reach up in any total resources. Now the question I want to make, the Smoot test, they say Smoot. Smoot was a case in which was referred to is a pre-Smoot days and post-Smoot days, before, it was the size of the accumulated earnings; they look the accumulated earnings to determine whether or not you had accumulated in excess your reasonable the business needs. In 1960, in the Smoot case, what they have did they separated, they said there are certain things while they are earnings. There is no way you can use those for to me reasonable to business needs. They are in your plant in your equipment. So, they took that out. They said, "To the extent your earnings to that you can accumulate with impunity." Then they came and said, "Now, what we should do for a practicality of this?" And this as they establish a liquid assets and said that so much of surplus as it is reflected in the liquid assets so much of the earnings -- earnings separate -- you separate the same thing. So much as it is reflected in liquid assets are to be measured against the reasonable needs and if you exceed that then you have violated the statute.
Byron R. White: But wouldn't you be here making the same argument if for some reason or another the company had liquidated its Xerox stock and were sitting there at the end of the year with the money in the bank having paid its capital against tax. Wouldn't you say that --
Kirk M. McAlpin: No, we would pay to dividends Your Honor. That what -- if we have liquid --
Byron R. White: No, wouldn't you be still be making the argument that insofar as the cash that you now had, absolute cash, reflected in enhancement -- in stock value that you wouldn't -- that it could not be and should not be considered in --
Kirk M. McAlpin: No, sir. We have agreed that the stock of our earnings are invested --
Byron R. White: Well, it isn't my point. I know you've agreed that that to your stock costs --
Kirk M. McAlpin: Is $154,000.00.
Byron R. White: Yes, but --
Kirk M. McAlpin: It's probably reasonable business needs.
Byron R. White: Yes, but now let's assume that the stock had gone up to a million dollars and you sold it.
Kirk M. McAlpin: We did do that in 1966.
Byron R. White: Alright and let's assume you sold it you had the cash in the bank. Now, is that available to measure --
Kirk M. McAlpin: That would be part of our liquid assets and to meet reasonable business needs.
Byron R. White: And the Government then could take that into account?
Kirk M. McAlpin: That would go into our earnings. We did do just sell. We sold a thousand shares and then put it in --
Byron R. White: It was going to your earnings -- it would be part of your earnings because it was gain, I mean, it was earnings, it was income because you sold the stock?
Kirk M. McAlpin: That's correct. No question about it but we elected and did to the converting. It was a business judgment as to when it was desirable.
Byron R. White: Alright, but now let's assume that you paid the tax on it that year and you took it in the income that year.
Kirk M. McAlpin: Alright, sir.
Byron R. White: Next year, you still got the money in the bank and then you have some more earnings and profits, must you pay the amount?
Kirk M. McAlpin: Absolutely, that would then be income and we would be --
Byron R. White: So, you not still accumulated earnings and profits in it?
Kirk M. McAlpin: But then, we would make the pay the dividends is the question here Your Honor is, when is it wise to do that? I know we're not trying to mean anyway technical.
Byron R. White: So, you're -- and this is unrealized income?
Kirk M. McAlpin: Unrealized income as unrealized appreciation.
William O. Douglas: And this has to be your answer what you just gave to Mr. Justice White has to be your answer really and what your opinion your case on is that it is unrealized and liquidated --
Kirk M. McAlpin: That's correct.
William O. Douglas: -- and you want the privilege of a business judgment and as to one --
Kirk M. McAlpin: That's correct, Your Honor and while it maybe that we are following we say has good reason. They stat -- the legislative history of this particular Act since 1954 has been to favor of taxpayer, the language of words earnings were deliberate. They are to determine the source and which the funds to be pay the legislative history shows that every amendment has been favor in the small businessmen, just this year the exemption is going from $60,000.00 to 1975 or $175,000.00. The question of reasonable business needs, you used to have to have a specific plan. It was amended at Section 537 to say reasonably forcible needs and here, we come right that now to include these new ideas which the Government is injecting and there is no word of liquidity, there is no -- the statute then used liquidity test. The liquid assets test which they have misconstrued in this brief, we're saying to the Fifth Circuit. Likewise, puts your evaluation on a basis of measuring of earnings and while the legislature has -- the Congress has written in this way in Bronstein case in 1963. You recognized that while it was a matter of taxation and that that's the way the legislation was written and it was a matter -- if that's the way Congress did it and it didn't appear to be a type of situation for the judicial determination. We would submit, Your Honor that the question of a legislative interpretation is very deliberate here, it's very much designed because they even recognize that they were concern about the Government harassing, it's in our brief, harassing small businessmen and they have now took the penalty tax off, and another thing we must recognize that this is a penalty judge. We pay the income tax and the rule of Goal versus Golez, in the case of penalty taxes that you must construe any enlargement of misconstruction or interpretation question as against the Government and for the taxpayer. We say there is no ambiguity. The term in 1936 the word "gain" was change to "earnings", so, of the earnings and profit and every measure, every deliberate concern of the legis -- of Congress has been on earnings and yet, they bring --
Byron R. White: I don't understand the government to be contending of course we'll hear from them and due course, but I don't understand then to be contending that this unrealized appreciation is earnings and profits.
Kirk M. McAlpin: They contend that it is not, Your Honor. But what they --
Byron R. White: You concede that it is not.
Kirk M. McAlpin: They reach out for a new term called "total resources available."
Byron R. White: Yes.
Kirk M. McAlpin: That's not what the statute says, the statute says, "earnings and profits available."
Byron R. White: Well, did have earnings and profits --
Kirk M. McAlpin: Yes, sir.
Byron R. White: -- and the Government's position is where this unrealized appreciation of the Xerox stock, those earnings and profits were unreasonably accumulated if they weren't paid out.
Kirk M. McAlpin: But they --
Byron R. White: Now also, I should point out that the dividends doesn't have to be a cash dividend. The dividend could've been paid out in the form of Xerox of stock --
Kirk M. McAlpin: Well, Your Honor --
Byron R. White: -- to your shareholders.
Kirk M. McAlpin: That's very interest and I'm glad you mentioned it because one of the indications that cause a proper value is in regulations to 562 when you give your unrelated stock out they give you a credit only at cost. They don't give bucket. Yes, what they trying to do is trigger us at market example in when we give -- when we transfer 870 shares of Xerox to our shareholders in 1965, it had a market value approximately $87,000.00. If you notice on your balance sheet that in that year, we were going to credit for $6,500.00, Section 312 of the Internal Revenue Code talked about earnings says that there must be that when there's a recognition at the time that that is when the gain and that's when earnings become indicative. It is nothing in the statute --
Potter Stewart: And it's the shareholders' basis on receipt of dividend in kind as the basis for each share, the corporation's cost --
Kirk M. McAlpin: He has to pay, when the shareholder gets it, they give the corporation only cost deduction but when he gets it he must pay market value.He pays tax on a basis of market value.
Potter Stewart: That's dividend, the market value and what's the -- and then his basis if he later sells at this market --
Kirk M. McAlpin: It is a new market.
Potter Stewart: Yes.
Kirk M. McAlpin: And as American Trading you asked by the dividend American Trading -- the Government made the same contention there. They said what that would do is dissipate the entire thing that they would have -- first, you loss 37.5%. The Government determines when you sell your stock and on that very day, you loss up to 37.5% in your value which is not available to meet, then you get a cost deduction and if it's treating you at market and then your stockholder has to pay the full value when he gets it. Now, as the Court said in the Couch Nebraska 1964, I hate to say that to the Court but it's on point and I think it's very significant. They say, "They hope that they don't see day the courts said." When government invades business to such of extent, in this very issue, that they can determine when stocks are sold and therefore, they held in that case that force conversion was not desirable that whether was doing is put in Government in the back -- into the management seat and all decisions are manageable will be trigger thereafter. We submit as you have also said in Eisner that this was not the effect design and other issues I know I could treat but --
Warren E. Burger: Very well, Mr. McAlpin. Mr. Crampton.
Scott P. Crampton: Mr. Chief Justice and may it please the Court. I'd like to start at the outset and try to put in focus our understanding of these statutes that we have before you. The basic purpose of course is to avoid the so-called "incorporated pocket book." Congress determined that stockholder should not be permitted to accumulate idle funds in a corporation in order to avoid dividend taxes that they would otherwise have to pay themselves. As we look at the statute, there is a two fold test here. The first, Section 531 imposes the tax on the accumulated taxable income. This is an additional tax on income for a given taxable year. It applies only to that income which is permitted to accumulate in that particular year. The income involved is determined basically from the books of the corporation and it is determined in much the same way as your regular corporate income is determined but then modified for certain adjustments. And so far as we see it, this is simple book keeping, you come up with income that's determined the way everyone understands it. If you have no income, you have no problem under this statute. If income does exist though, when you've done this computing and it is not distributed as dividends to the stockholders, then you look to see if this income can be distributed without a hardship to the company. The statute speaks of the earnings and profits being permitted to accumulate beyond the reasonable needs of the business. And I think the word "needs" here is the keyword for our second test. It seems to us that this isn't economic test. Here, the statute departs from concepts of taxable income that we know under bookkeeping and it requires us to measure the resources of the corporation against its needs. The case is construing the statute refer to this as "net liquid assets." If you take your current assets and your current liabilities and you see what are the economic resources that the corporation.
William O. Douglas: Mr. Crampton.
Scott P. Crampton: Yes, sir.
William O. Douglas: What do you mean by liquid assets? How did you define them for this purpose?
Scott P. Crampton: I think those are read assets that can be readily converted to cash, probably inventory receivables things like that that would come into income within a year or less than a year.
William O. Douglas: Suppose you had a highly marketable piece of real estate that you can sell any day.
Scott P. Crampton: I think that would probably a liquid asset then assume in your premise.
William O. Douglas: Right, how would you determine the value?
Scott P. Crampton: I think you have to determine the value of these properties as the same way we determine values in many other areas like you would for estate tax purposes in the question of condemnation. You have a question here it's a fact question, that the Court would have to consider.
William O. Douglas: And that means that the Government would get an appraiser and the taxpayer would get an appraiser and they would be miles apart and they compromise somewhere in the middle which is what is usually happens.
Scott P. Crampton: Well, I think Your Honor in the situation you gave or you said it was readily saleable, I doubt if you'd have much of evaluation problem there, if there somebody wanting to buy this property you probably have pretty good idea what the sales price would be.
William O. Douglas: You have to sell it they would find it?
Scott P. Crampton: That's true. But that's true of your -- of any security like the Xerox stock here it have to be sold or some fluctuation in the market from the day to day. But we don't think you need to get into that much of a refinement. You look to see whether or not there is current assets here sufficient that the corporation could pay out these earnings and profits without disturbing its normal needs.
William O. Douglas: Do you recall what the fluctuation in Xerox stock was in the year 1974?
Scott P. Crampton: No sir,I don't know. I've got it here but I know it's a volatile stock in 74' --
William O. Douglas: It arranged according to mode year from 55 to and 134. Now, which day would the Government pick?
Scott P. Crampton: I don't think you pick a day on this as we view the case. Your Honor, you would look at the situation over the year and if there's a minimum value of 55 certainly that would be I think a realistic value to take. If that is the law because we are -- we're not trying to force a conversion here. We're just saying it you know in a day to day market place you've got some assets here and if you're sure that you can realize at least $55.00 of share on it, then that's something we could look at.
William O. Douglas: So, if there was a lower market value in the fiscal year in question the taxpayer could've taken that for purposes of this case.
Scott P. Crampton: I would think that would be reasonable.
William O. Douglas: I thought the -- I thought you took the market value on the last day of the taxpayer's of fiscal year.
Scott P. Crampton: I don't think it's ever been refined to that point.
Byron R. White: No, I thought that was your point in this case?
Scott P. Crampton: No, we have stipulated what the values were with counsel. We were trying to get out of the case some of these detail factual things and we have agreed with counsel for the taxpayer that these were the values and we have reduced those values by the capital gains tax and by the brokerage made of points, so as far as this case is concern, we have hard figures that these are the fair market values that both parties agreed they could use and then we have the cost figures which were equally refer.
William O. Douglas: Mr. Crampton, before you go on, how would sound the accounting principles require a corporation to carry the value of this Xerox stock at any particular day?
Scott P. Crampton: Oh, I think cost clearly.
William O. Douglas: There's no question about that, is there?
Scott P. Crampton: Not in my mind but I do know that most accountants will also and this taxpayer did. They showed the market value. I think at the end of the year as not quite a footnote but parenthetical addition to their balance sheet.
William O. Douglas: And if you file the registration statement with the SEC and undertook to show your assets at market you get deficiency immediately, wouldn't you?
Scott P. Crampton: You certainly -- they wanted to explain very carefully how you determine that this was the value you were putting on it.
William O. Douglas: And the reason for that is that there's nothing definite, really definite except cost.
Scott P. Crampton: That's true.
William O. Douglas: Market value varies -- it can't vary in with respect to stocks from day to day very widely.
Scott P. Crampton: I agree.
Warren E. Burger: Mr. Crampton, what if this taxpayer had purchased Xerox that the highest points, whatever that was, and that you were dealing with it in terms of today's market value, so that there would be an enormous unrealized loss. How would that figure in the process of taking in to consideration and language of the regulation taking into consideration of the total picture?
Scott P. Crampton: It's our view that the rule works both ways if you bought at the higher figures, Your Honor suggest and now it is not worth that then it's the existing market value that you look at in determining the needs of the business, and that was the holding of this Court in the National Grocery case which we referred in our briefs, in that case, they had earnings I think of some $800,000.00 and then admitted security losses of $2 million and the Court said, "You do look at the present value of those securities." And there's a quotation in our brief it's quite clear and I will come into it in a minute but the Court then went and had impose the tax because as you look over a 10-year average the had accumulated earnings and profits or something like $5 million that had never paid a dividend. But the Court there announced the rule and we think this is just the opposite of it and we certainly say the rule works both ways. Now, I think the pivotal question here, is how the resources of business should be measured? The counsel for taxpayer has set forth some of the facts but I'd like to summarize them briefly against the statute as we've indicated the facts that have been stipulated. This corporation had earnings after federal income taxes of about $180,000.00 in 1965 and almost $400,000.00 in 1966. It paid less than a third of these amounts out in dividends. In 1965, it paid $49,000.00 in cash dividend and distributed 870 shares of Xerox stock, in 1966, paid out $50,000.00 in cash dividends and a 10% stock dividend. Its reasonable needs as I say have been stipulated for 1965 they need at almost $2 million, I mean, a $1,200,000.00 and in 1966, they needed practically a million and a half, and these are liquid assets taken at book value and the parties has agreed that these amounts equal in needs of the business. If -- these are the liquid assets and they are the needs if you look at the book figures. Now --
Potter Stewart: What are liquid assets taken at book value? What are you talking about now, the earnings and profits of that year?
Scott P. Crampton: No. These are the assets on the books I have indicated, I think they would be realized within a year and the payables within a year. It's the readily receivable things that can be converted into cash if you need to, and that brings us right to the point of how you value the Xerox stock. We have --
Potter Stewart: As you can see that -- have there been no appreciation in value of the Xerox stock? There could've been no violation of the statute --
Scott P. Crampton: Under these facts, there been no liability at all. We agree with that and I think that the stipulations were designed to point that up and the real question is, we have also stipulated that after allowance for the capital gain's tax and the brokerage fees that the liquid assets of this corporation are practically double the figures that we stipulated as the corporate needs. The liquid assets, if you look at fair market value or $2 million and two some in 1965 over $3 million in 1966, and here, 76% of the voting stock was owned by Ivan Allen Sr. and Ivan Allen Jr. and because of that, the commissioner of Internal Revenue determine this assessment.
Warren E. Burger: I think we'll resume there Mr. Crampton.