Warren E. Burger: We will continue the arguments in Securities and Exchange Commission against Sloan. Mr. Sloan you may continue whenever you are ready.
Samuel H. Sloan: Mr. Chief Justice and may it please the Court. I wish to bring the attention of the Court to a small factual matter which came to my attention yesterday. You mentioned 36 trading suspension orders and the source of this is because on Page 122 of the Appendix, there is a list of orders and there was a typographical error and that the SEC when they copied my original petition left out, the December 25, 1975 order.
Warren E. Burger: The question I think Mr. Sloan was a purely hypothetical right, asking whether if 36 consecutive 10-day orders were entered.
Samuel H. Sloan: Yes, but I did discover that there are 36 listed here and in fact they were 37, because there is a typographical error in their Appendix.
Warren E. Burger: But my hypothetical was deliberate in one last order to make it hypothetical.
Samuel H. Sloan: Okay, for whatever reason I did notice that -- in the original record, I do have the December 25 date in my petition I were to file to the Court of Appeals which has been transmitted to this Court. However, on the subject of the record I also wish to bring to the attention of this Court the fact that the SEC has refused to permit the record as it was, in the State it was, before the Court of Appeals to be transmitted to this Court. I mentioned this in my brief, and it is now a matter which is pending before the Court of Appeals because I filed a motion in the Court of Appeals to require that the SEC to certify the full record to the Court of Appeals and that matter is now pending. I have also explained what happened in some detail in a letter which I wrote to this Court, but he has advised me that he will not distribute it at this late date. What essentially happened was that after the Court of Appeals made its decision, the Court of Appeals sent the record back to the SEC which is its normal practice. When this Court granted certiorari, the SEC was directed or requested to send the record back to the Court of Appeals, so it could be transmitted to this Court, but what it did, was it switched the record, so that the record that was sent back to the Court of Appeals was not the record, which the Court of Appeals had returned to the SEC and the Court of Appeals does not appraise to this fact. So that the record which this Court has consist of memorandums dealing with trading suspension orders. I have no objection to this Court reading these memorandums, but the fact remains that they were not filed in the Court of Appeals. All that was filed in the Court of Appeals was a certified list. The record which has not been transmitted to this Court, concerns the record of the administrative proceedings against me which was a part of the record in the consolidated case when these two cases were before the Court of Appeals. The SEC says that that record is not pertinent to the issues involved in this appeal and therefore they will not transmit that record to the Court of Appeals for certification to this Court, even though they have been requested by the Court to the Court of Appeals to do so. So right now we have a situation because I happen to feel that that record is pertinent to the question of mootness which the SEC has raised particularly with regard to certain points which were discussed yesterday.
Potter Stewart: I thought the Court raised the question of mootness.
Samuel H. Sloan: Well, the SEC has always said that this case was moot right from the very beginning.
Potter Stewart: But did not the Court ask the parties to brief the question of mootness?
Samuel H. Sloan: Oh! Yes, they did, but the SEC was briefing the question of mootness already. Now this Court to the case of Weinstein versus Bradford, for example, which was discussed yesterday. It is true that the trading suspension orders have expired. However, at the present time there is an order currently outstanding which is a lifetime bar against me from being associated with the securities dealer. I believe that I can show through the record which the SEC has refused to transmit that this lifetime bar was based in part on successive trading suspension orders which the Court of Appeals declared to be illegal.
Thurgood Marshall: Was that order before the Court of Appeals?
Samuel H. Sloan: Yes, it was because there were two cases before Court of Appeals. The Court of Appeals consolidated both cases, the record is combined.
Thurgood Marshall: But, Why is that the Court of Appeals did not mention?
Samuel H. Sloan: Did not mention what?
Thurgood Marshall: That what you are talking about.
Samuel H. Sloan: Oh! It was prior the same decision. The decision in the Court of Appeals discussed two different cases, but they were consolidated. This Court when it granted certiorari only agreed to review the issues pertaining to one of the cases, but nevertheless I claimed that the record of both cases, since it was a consolidated case, it should be here, and I should be allowed to cite documents in the record of the other case which I think demonstrate that this case is not moot in my presentation.
William H. Rehnquist: Is it your contention then Mr. Sloan that the SEC relied on a number of factors in issuing its lifetime bar order against you and one of them was this 10-day order and therefore it is at least conceivable that if this 10-day order were found to be invalid they might not have entered the same lifetime bar order against you?
Samuel H. Sloan: Yes, what my contention is precisely is that the SEC when they issued successive 10-day suspension orders, deducted from my net capital certain securities which were it failed to deliver. Then they found me retroactively in violation to the Net Capital Rule, and on the basis of these findings that was in violation in Net Capital Rule, they then barred me from the securities business. If these 10-day suspension orders were illegal on the first place, I would say that they cannot rely on them to make net capital deductions and therefore the order which barred me for life in the securities business, is invalid. There is --
William H. Rehnquist: What is the tie in between the 10-day suspension and the net capital deduction?
Samuel H. Sloan: Yes, because the SEC has released Securities Exchange Act release 10209, which states that if a broker is short a security which is suspended from trading by the SEC, he is required to deduct from his net capital the fails to deliver in suspended securities, and I in fact was short at the time in the successive suspension order at a number of occasions, and they deducted the fails to deliver in suspended securities. Therefore it seems to me reasonable that if those orders were illegal they cannot rely on them to bar me from the securities business. I have not reached that point in this case, I do not know if this Court affirms the decision it may be that there would be further proceedings and I lose on that particular point, but it seems to me that I have the right to make this showing that they did in fact rely on successive trading suspension orders to bar me from the securities business.
William H. Rehnquist: As an argument against mootness?
Samuel H. Sloan: As in argument against mootness, this is precisely the point because I am here arguing the question of mootness.
Speaker: But Mr. Sloan what was the present status of the bar against your-- is that involved in some litigation?
Samuel H. Sloan: I know, there is no proceedings at all. The SEC claims that the Commission has --
Speaker: But, have you attacked anywhere this bar against your engaging in the securities business?
Samuel H. Sloan: Well, it was the prior decision against the Court of Appeals. I have not instituted any further proceedings for the reason that the SEC staff claims that as long as the case is pending in the courts, the SEC itself has no jurisdiction to review the matter because the Court of Appeals required exclusive jurisdiction with the filing of the record. I disagree with their contention, but as long as they are going to make it --
Speaker: Well, does a challenge to the validity of that order is whether or not there shall be one which will or will not turn on the result of this case?
Samuel H. Sloan: It may turn on the result of this case, I feel that.
Speaker: And that is why you suggest there is no mootness.
Samuel H. Sloan: That is right.
Speaker: Well, why is not the issue of that order close matter, you did not bring, you have not brought that case here.
Samuel H. Sloan: Well, I did bring the case here but you denied certiorari on that case.
Speaker: Well, so it is over.
Samuel H. Sloan: It is over, but nevertheless if this Court finds that the SEC acted illegally in issuing successive trading suspension orders -- I think I can go back to the Securities and Exchange Commission in the first instance and reopen it, that would be the place I would go to with that particular claim. And that is why I feel it is critical to have the record here so that the Judges to this Court can look at the record and see that in fact they did deduct from my net capital certain sums in money based on successive trading suspension orders. Now, I will point it out that because of the continuing policy of the SEC, this case has been going on for a long time. The specific orders which the Court of Appeals vacated were not themselves used by the SEC as a basis because by the time, this case got in the Court -- this is a third suit I brought -- by the time this case got before the Court of Appeals, it was too late to challenge those suspension orders because there is a 60-day limitation in Section 25 (a) of the Securities Exchange Act. Nevertheless the decision of the Court of Appeals makes it clear, I now believe, that if you will affirm that decision it will be cleared that all these were illegal that they have been issuing over the past 33 years, and this would give me a basis for going back to the Securities and Exchange Commission and asking them to reopen the procedure.
Thurgood Marshall: It would also a destroy or denials assret in the other one.
Samuel H. Sloan: No, this is a new proceeding, and if I go back to the Commission and start a whole new proceeding --
Thurgood Marshall: But you do understand that that other case is not before us.
Samuel H. Sloan: I understand that you did not grant certiorari in those issues.
Thurgood Marshall: Do you understand that the other case is not before us.
Samuel H. Sloan: No, I do not Your Honor, because --
Thurgood Marshall: Well, let me tell you, it is not. Will that up you?
Samuel H. Sloan: Well, but --
Thurgood Marshall: Could you argue on that assumption that I might possibly be right?
Samuel H. Sloan: Well, I am going to agree that you might possibly be right, but I am not going to concede that.
Thurgood Marshall: Do that for a minute now, in argument what we have got.
Samuel H. Sloan: Yes.
Thurgood Marshall: We have got the opinion of the Court of Appeals.
Samuel H. Sloan: Yes, but you do have --
Thurgood Marshall: Jedge Gendison's (ph) opinion. That is all we have.
Samuel H. Sloan: You do have the case before you, even though my petition was denied, and their petition in the same case was granted. I do not think a Court's jurisdiction is limited. I do not expect the Court to decide anything about that case, but I do not think the Court's jurisdiction is limited to specific points the SEC has raised.
Thurgood Marshall: Well, you would not assume that I might be right?
Samuel H. Sloan: Oh! No, I will assume that you might be right. I said I do not expect this Court to do anything with regard to that matter. I just said that only issue of mootness, which I am briefing and arguing is that I can demonstrate that the case is not moot through the record. I do not know what is going to happen if the Court of Appeals grants my motion the SEC transmits record to the Court of Appeals and that arrives here a month from now or so. It seems to me this is a very undesirable situation to be in.
William H. Rehnquist: Well, may I suggest that if the time was granted, you might get on to the merits.
Samuel H. Sloan: Now, in the -- yesterday the SEC gave three reasons for the trading suspension and they said that this suspension was of this length because there were three different things going on and this is the reason why they had let it for so long, and one was - market manipulation, two was - a change in management, three was - a late 10 (k) filing. I want to address the facts which are in the record with regard to these three merits. The change in management took place at a meeting of the Board of Directors of Canadian Javelin Ltd on March 06, 1976. At that time a group headed by William Wismer throughout the Doyle Group, throughout the management of Canadian Javelin Ltd., fired Mr. Doyle personally. This is reflected in the March 26 memo which is on Page 104-105 of the Appendix. The 10 (k) delinquency which is another reason cited by the SEC occurred on March 31, 1976 and this can be seen from Page 110 of the Appendix. So prior to March 6, there were 32 suspension orders, prior to March 31, there were 34 suspension orders, this means that the SEC suspended trading for 31 times because of the market manipulation, for two more times because of the change in management, and for another three times because of the lateness in the 10 (k) filing. The SEC also referred to a fugitive from Justice yesterday in the argument that they presented. However, on March 6, 1976 Mr. Doyle who is a notorious fugitive from Justice, who they are referring to, was thrown out of the company, he was fired personally, and the SEC claims that they suspended trading for that reason. On July 30, 1976, after the suspension was listed, there was a court order to special meeting of directors, special meeting of stockholder, which I intended, in Montreal which is also discussed in the record because a copy of the Judge's order is here. Holding a special action and at that point Doyle got back into management and through the Wismer Group out. So, now we have a situation where an individual, a Toronto attorney became the President of Canadian Javelin Ltd. At that point the SEC says, it suspends trading; three months later when the fugitive from Justice gets back and control over the company, they do not suspend trading and I point this out because I think this demonstrate really that reason that it is a fiction. In addition to that Mr. Justice Powell yesterday raised the question of whether a cooperation has the right to protest, to come in and ask for hearing to protest a trading suspension? Ironically it is reported in the Wall Street Journal that at the time of May 02, 1976 lifting the trading suspension management of Canadian Javelin Ltd petitioned the SEC to continue the trading suspension, and incidentally also, the earlier trading suspension which was terminated in January 1975, the management of Canadian Javelin again requested, a different management requested that the SEC continued a trading suspension and filed a motion and obtained the stay in the District Court. This illustrates a point that very often the cooperation itself does not want a trading suspension, even though it is to the detriment of its own stockholders, because the corporate management for their own personal reasons may desire that trading not take place. Now in the matter of the 10 (k), this 10 (k) report became delinquent on March 31, 1976, as the records state. I have not known of any case the SEC often suspends its trading because 10 (k) delinquency, but they do not suspend on the day that the 10 (k) became delinquent, and they do not suspend even two months later because the trading suspension here was lifted on May 02.
Byron R. White: Do you challenge, I think that you challenge solely the right of SEC to issue more than one suspension.
Samuel H. Sloan: Yes, that is correct. That is --
Byron R. White: And why do you do?
Samuel H. Sloan: Well, because they did say, yesterday that these were the reasons that they suspended trading, and I want to show that there was no rational basis for this. What they have done is make a --
Byron R. White: What if there had been, what if there had been. I thought your view was that without a hearing or without some further proceeding they just could not grant more than one 10-day suspension.
Samuel H. Sloan: Yes, I do feel that. That is a point which I thought might be raised when I went into discussion of this, but --
Byron R. White: Well, that is what the Court of Appeals held, doesn't it?
Samuel H. Sloan: Yes, that is what the Court of Appeals held. I just wanted to show that the there is not any rational basis for the --
William H. Rehnquist: Do you concede there or don't you that there are circumstances under which they would issue more than one 10-day inconsecutive suspension?
Samuel H. Sloan: No, I do not make that concession. As the amicus does make that concession, I do not because I do not believe that the SEC can be allowed particularly when they do not issue reasons for the trading suspensions. Therefore when they say that we are issuing a new suspension because we have a new reason for the suspension, and they have not said that in this case, but if they said that something simply new and differnt here as a reason. What happened is --
Byron R. White: What if it was the same old thing?
Samuel H. Sloan: Well, I think if it was the same old thing, it clearly would be prohibited by the statute, and I am saying even if it was for a different reason, it would also be prohibited. When Congress originally passed the permission in 1934, there Section 19 (a) had had four provisions – 1, 2, 3 and 4, Sections 19 (a) (1), (2) and (3) all required the SEC to give notice and the opportunity for hearing. Only Section 19 (a) (4) allowed the SEC to act similarly without notice and the opportunity for hearing, and both the House and Senate report stated in 1934 that they did not require the SEC to give notice and opportunity for hearing because this was a summary power to be exercised in emergency situation.
Speaker: Was this an argument that the statute authorizes only one single 10-day suspension?
Samuel H. Sloan: That is correct.
William H. Rehnquist: And if they want another one, they have to give notice and hearing.
Samuel H. Sloan: Well, that would be under (Inaudible) Section 12 (j) they could after --
William H. Rehnquist: All of their authority under (4) is exhausted at one suspension.
Samuel H. Sloan: That is right. There had been some instances this year in which the SEC on three separate occasions, but not successive, has suspended trading in Penn Central Transportation Company and a number of subsidiaries.
Speaker: Now, Mr. Sloan do you concede that the SEC would have power under 12 (k) to issue a 10-day suspension of trading, let us say, in January?
Samuel H. Sloan: Right.
Speaker: And then again to issue a 10-day suspension of trading under 10 (k) in March?
Samuel H. Sloan: Yes, I would agree as a statute has written it does.
Speaker: For the same reason?
Samuel H. Sloan: Yes it does permit that.
Speaker: Well, could it not issue a 10-day suspension on trading on January 2, and then takes it to January 12, and then on the morning of January 13, to issue a 10-day suspension on trading?
Samuel H. Sloan: No, I do not believe that this is permitted.
Speaker: Why not? What is the difference between January and March, and January 10, and January 12 , and January 13.
Samuel H. Sloan: Well, I think that this goes really to a matter of the intent of Congress. Congress did not intend that the SEC particularly if it -- since it never issues reasons for strains, we do not know if it has new reason or a different reason --
Speaker: Well, your point is though - with good reasons or bad, with or without reasons, no matter how great the reason or how great the public interest that 12 (k) as a matter of the power of the Commission simply does not empower the Commission to issue a suspension of trading for longer than a 10-day period.
Samuel H. Sloan: That is correct.
Speaker: That is your basic position as I understand, am I right?
Samuel H. Sloan: Yes, you do sir.
Thurgood Marshall: Well, what about the 1975 amendment, one year amendment?
Samuel H. Sloan: Well, Section 12 (j) which you are referring to is actually a renumbering, because it was formerly called Section 19 (a) (2), they moved it over the Section 12 (j). The Commission has had the power since 1934 to suspend the registration of a security. Now when they enacted 12 (j), they included a sentence which, in addition to renumbering, they include a sense which said that would be illegal for a broker, or dealer to buy or sell or to use the means of instrumentalities of interstate commerce to affect a transaction in the security whose registration has been suspended or revoked. So that this makes it clear, although it was clear already that the SEC could after notice and a hearing suspend the registration which would also suspend the trading in the security under Section 12 (j), but they have always had this power since 1934.
Thurgood Marshall: For one year.
Samuel H. Sloan: For up to one year. Incidentally, I would like to mention that in this case there is --
Thurgood Marshall: That is not involved in it.
Samuel H. Sloan: Well, they have an exercise that power under Section 12 (j) -- they have not provided notice and the hearing. I would like to point out that in this particular case, the SEC suspended trading for 370 days, which is more than one year therefore they actually suspended trading for more time under Section 12 (k) without noticing the opportunity for hearing then they were permitted to suspend with notice and the opportunity for hearing under Section 12 (j). So what they are saying is that they can suspend trading for a longer period of time without notice, indicating with notice, and I am sure that this could not possibly be what Congress intended. Now, also yesterday Mr. Justice Powell asked whether the rollover proceedings are ex parte? And of course of Commission says that this is not a rubber stamp procedure and the Commission very seriously considers the needs of investors and this of thing, but again although I do not want to go into the same track that I may have fallen and just a second ago, I think that the record demonstrates that the Commission not only is in the rubber stamp proceeding, but the Commission itself plays no part in the decision to suspend in this record of this case. The first trading suspension is dated April 29, 1975. The memorandum which they have submitted as to record of this trading suspension is a memorandum by the staff, dated May 02, 1975, three days later. So that it is clear this is not a memorandum from the Commission, this is a memorandum from the staff and it explains the reasons for the trading suspension. From this it is clear that the Commissioners themselves could not have received this memorandum at the time trading was suspended, and in fact since the suspension orders are not signed by the Commissioners, they do not bear the Commissioners' names, and we do not even know if the Commissioner is new. The Commissioners may have been on vacation at some place, we do not even know that they were in Washington at the time, they therefore did not participate and perhaps they were read in newspaper said trading have been suspended in Canadian Javelin Ltd., but this is really about all. It is quite clear that the Secretary of Commission is performing the ministerial task apparently at the direction of members of the staff and the Commissioners themselves are not involved.
John Paul Stevens: Mr. Sloan let me ask you, what is your view of what the Commission's duty was ten days after the first order was entered, if they were persuaded there was market manipulation going on, but they did not have real solid proof of it? What do you say they should have done?
Samuel H. Sloan: The market manipulation in this instance ended on February 12, 1975. I have the indictment -- this is the information that was filed in Canada by the Canadian authorities and the last watched trade that took place which is alleged here the 406 counts watched trade, the last one took place on February 12, 1975. And all of the trades alleged here are could on the Montreal or Vancouver stock exchanges. Now, in a hypothetical situation of what if there is a market manipulation, I would say that a trading suspension order which holds trading for ten days is sufficient to bring to an end any market manipulation, because usually our market manipulators, they rely on certain things to keep the price up. They have the park securities. I was a broker dealer for five years and somehow I have some idea of what they do when they manipulate a stock, and when a trading suspension comes along -- [Laughter] When a trading suspension comes along they suspend trading for ten days and that brings to an end any market manipulation. When the stock opens for trading again any stock in margin accounts almost always very often is sold the people who they have got the stock clocked in with almost always have to get out those investigations involved. The stock comes down and the manipulation is over and in practice. And I think, it could be assumed that this would happen even in theory. And I think that this is what Congress had in mind. They said that this was an emergency power, they did not say that this was something that Commission could do for more than a year as in this case or for 13 years as in Continental Vending Machine case.
John Paul Stevens: You do not suggest then that there should be some other legal proceeding or some other legal remedy that was available at the end of the ten days to perpetuate the suspension.
Samuel H. Sloan: The SEC already has a number of remedies - they have administrative remedies, they have injunctive remedies. If there is some remedy, in addition to that the appropriate relief is for them to apply to Congress for this remedy. Congress has given them Section 12 (j) and it stated in the Senate Report 1975 that this was intended to be exercised when they wanted to suspend trading for a period of extended duration. Now they say this is insufficient because many companies are not registered because they do not have as much as a million dollars in assets, and 500 stockholders which is required by Section 12 (g) of the Securities and Exchange Act. So they say, many securities are not registered therefore what is going to happen in a case of a security which is not registered, however we are going to stop trading in that. And I think the answer is that Congress simply did not intend that they should be allowed to do this, because you must remember that there are many corporations which are technically, which are traded, which are small and which's public interest is simply not sufficient for the SEC to get involved.
Byron R. White: Your answer to Justice Stevens is that, that under the statute there just is not any remedy provided to suspend the trading in the security for more than ten days even with the hearing.
Samuel H. Sloan: Summarily suspend trading.
Byron R. White: Even with the hearing.
Samuel H. Sloan: No, we are talking about securities which are not registered. Canadian Javelin is registered, so it does not apply in this case.
Byron R. White: But I am -- that is true about non registered way.
Samuel H. Sloan: Right. There are companies which are small corporations, they have less --
Byron R. White: Well, now by answering my Brother Stevens' question then what should the SEC have done here with respect to a registered security, started a new proceeding?
Samuel H. Sloan: Well, with respect a registered security, they can start proceeding under 12 (j) with respect to a non registered security --
Byron R. White: After notice and hearing.
Samuel H. Sloan: Yes, after notice and hearing.
Byron R. White: So again the ten days issue had gone under 12.
Samuel H. Sloan: Right. That is what they should have been in this case, but by the way in this case there was no issue or misconduct at least according to the indictment and according to the SEC's complaint against the Canadian, because the SEC filed a complaint in the Southern District of New York, but the defendants were Doyle and its cohorts, the Canadian Javelin Ltd. was not named as a defendant. Similarly, in the information filed in Canada, Canadian Javelin Ltd. was not a defendant so there was no issuer misconduct, therefore Section 12 (j) could not have been invoked. They make a big point of this, but I think the remedy is to go to Congress and ask for extended powers if that is what, what they need. Thank you very much.
Warren E. Burger: Your time is expired Mr. Sloan. Mr. Pitt -- your time has expired here. Mr. Pitt you have three minutes left.
Harvey L. Pitt: Thank you. The only brief points I wish to make or that as Mr. Sloan conceived at the end of his submission, 12 (j) was inapplicable in this circumstance because the market manipulation which went on was not engaged in by the company and therefore issuer misconduct was not involved in 12 (j) was inapplicable that would have meant that there was no remedy whatsoever. In addition to manipulation that we charged, was charged to have begun in the beginning of 1975 and continued right up to the date of the complaint. It did not stop in February 1975 according to the charges in our allegation. The last point --
John Paul Stevens: Mr. Pitt is Mr. Sloan correct in telling us that the change of management and the late 10 (k) filings occurred in March 1976 so they really could not have justified the first 25 or 30 suspension orders.
Harvey L. Pitt: We learned about it late, about that time.
John Paul Stevens: So that is your principal period of suspension.
Harvey L. Pitt: It was the manipulation.
John Paul Stevens: It was the manipulation.
Harvey L. Pitt: That is correct. We --
John Paul Stevens: Is it also correct that there was an order entered on Christmas that just did not get into the record?
Harvey L. Pitt: Apparently so.
John Paul Stevens: That I think was given great deliberation on that day.
Harvey L. Pitt: There was deliberation with respect to each of these suspension orders as I indicated yesterday.
Speaker: By which part?
Harvey L. Pitt: By the Commission itself.
Speaker: All the Commissioner went to office and on (Inaudible).
Speaker: All the members.
Harvey L. Pitt: I do not recall the precise date, I would have to look that, but I do not recall the precise date of the order, but what happens is that each of the Commissioners must approve the trading suspension order. It cannot be done by any other official.
Thurgood Marshall: Done in writing?
Harvey L. Pitt: Pardon.
Thurgood Marshall: Is that done in writing?
Harvey L. Pitt: There is a minute of the Commission entered; that is correct.
Thurgood Marshall: Where is that?
Harvey L. Pitt: That is -- there is an official Commission minute record book that is kept in the agency.
Speaker: Would that have been for December 25?
Harvey L. Pitt: I do not know if that was. I must confess I do not know if that was the precise date that that trading suspension order was entered. What would have happened is that the order might have been ordered on the 25 formally, but the decision to enter that order would have been taken three or four days prior to that.
Speaker: I just want to be sure of this. You are telling us that the full Commission, every member acts on a suspension order and personally signed something, is that it?
Harvey L. Pitt: A quorum of the Commission minimum of three of the five members, if some members are sick or out of town, they might not participate, but a minimum of three Commissioners must participate and their votes are recorded in an official minute. If the matter is taken around seriatim --
Speaker: Yeah, but what do they have before them in the Act?
Harvey L. Pitt: They have a staff memorandum and the advice of their legal assistants, each Commissioner has a separate legal assistant.
Lewis F. Powell, Jr.: Do the minutes show the reasons for the roll over the suspension?
Harvey L. Pitt: Sometimes they might and many cases they would reflect --
Lewis F. Powell, Jr.: Does that o contain a typical minute?
Harvey L. Pitt: This record does not contain a typical minute.
Lewis F. Powell, Jr.: Nor any does it.
Harvey L. Pitt: No.
Lewis F. Powell, Jr.: It does not contain any minute.
Speaker: Or are there supporting papers in the file somewhere?
Harvey L. Pitt: Yes.
Speaker: So what was presented to the Commission?
Harvey L. Pitt: Yes, those are in the record, the staff recommendations and the information that was given to the Commission are in the reocrd.
Speaker: Why not the Commission's minute presented all the rest of it, say.
Harvey L. Pitt: I simply do not know why that was not put in the record below.
Thurgood Marshall: But you say you did see the minutes that set on Christmas day, the Commission met.
Harvey L. Pitt: No, Your Honor. The Commission did not meet on Christmas Day. The period of the trading suspension commenced on Christmas Day. The staff recommendation would have come up three or four days earlier at which point the Commission would have met. The Commission probably took that action on December 21, or 22, to commence on December 25. The Commission itself would not meet on Christmas Day.
Lewis F. Powell, Jr.: Do the minutes record any findings?
Harvey L. Pitt: The minutes indicate that the staff has made certain matters known to in general, and that the Commission has taken action because the public interest and the protection of investor was required.
Speaker: Were those minutes available to Mr. Sloan when he complains about what the SEC have done?
Harvey L. Pitt: I am simply unaware whether he requested them in this case or whether they were made available.
Speaker: Well, what is the policy of the Commission?
Harvey L. Pitt: The policy of the Commission is often to make its minutes available in Court litigation where they are requested, and under the Freedom of Information Act where they are requested.
John Paul Stevens: Quite required from the Court litigation; normally you can see a court order without having litigation, is that the policy of the Commission?
Harvey L. Pitt: The Commission's minutes are made available under the Freedom of Information Act, unless they contain certain matters that might be exempt and they are --
John Paul Stevens: That implies that they are not made available to Mr. Sloan --
Harvey L. Pitt: I think Mr. --
John Paul Stevens: -- unless he proceeds under Freedom of Information Act.
Harvey L. Pitt: If Mr. Sloan makes a request to the Commission to seek Commission minutes and there is no exempt material in there and he would see the Commission's minutes.
Warren E. Burger: Did he get some of these memos that are in the record, did he gets some by supernal process or simple request?
Harvey L. Pitt: He did get, I think he requested them and we made them available as part of the record and he had them.
Warren E. Burger: Are you representing to us that had he requested the minutes, he would have got the minutes.
Harvey L. Pitt: I would have to know what was in the minutes? The precise minutes of these particular actions to say whether there might have been excisions, but I think he would have gotten the minutes, yes.
Speaker: Suppose, you think there is manipulation in an unregistered security and you want to suspend trading and you look at the statute, says ten days, you suspend and you continue to suspend, what is that pending? What other remedy, you cannot go on forever as longer you think there is manipulation?
Harvey L. Pitt: That is correct.
Speaker: What is that pending? What are you trying to find, you are investigating, you have probable cause you think to believe what?
Harvey L. Pitt: To believe if we can go into court either get a preliminary injunction or --
Speaker: Under what section of the statute?
Harvey L. Pitt: Under Section 21 of the Securities Exchange Act.
Speaker: So there is a remedy that you can have.
Harvey L. Pitt: To stop the manipulation.
Speaker: Yes. So, there is a remedy. You are not without remedy.
Harvey L. Pitt: We are not. The remedy we lack if Mr. Sloan's interpretation of the 10-day suspension power is correct, is from the time we learn that there might be a manipulation to the time that we conclude there is one and can go to Court to stop it, under Mr. Sloan's theory, we would be compelled to allow the manipulation to take place.
Speaker: So that you can do it on your own until you can convince a Judge to give you a preliminary injunction.
Harvey L. Pitt: Until we can find out who did it? And convince the Judge to enjoin.
Speaker: So without evidence you can do ex parte, but you have to have -- you really cannot --
Harvey L. Pitt: No, as I indicated yesterday I think that we could have used  --
Speaker: Well, if it is ex parte you did not give Mr. Sloan notice of it.
Harvey L. Pitt: Mr. Sloan avail themselves of a procedure that is published in the Code of Federal Regulations to price the Commission of information.
Speaker: That does not (Inaudible) being ex parte, does it?
Harvey L. Pitt: No, it does not.
Thurgood Marshall: Mr. Pitt, they did the general rule that one lawyer gets a temporary injunction or restraining order he thought he has undefined once he gets it. [Laughter] And I am only afraid, if admit that is true, why would not that be true once you get a 10-day one that you can renew forever, why would not you be absent?
Harvey L. Pitt: First, we do not suggest that we can renew the suspension forever and I wish to stress that point.
Speaker: Only 370 days. [Laughter]
Harvey L. Pitt: In this particular case and although the Court did not find an abuse --
Speaker: What about the one that went 13 years that Mr. Sloan mentioned.
Harvey L. Pitt: The one that went on for 13 years was a bankruptcy proceeding and in which --
Speaker: Well, was this a series of 10-day suspension?
Harvey L. Pitt: There was a series of --
Speaker: For 13 years?
Harvey L. Pitt: There was a series of 10-day suspensions. In that case we had specific request from Court appointed officers to suspend the trading and the Commission obliged the trustee and bankruptcy while a reorganization proceeding was effected. Our present policy would not be to repeat that kind of activity.
John Paul Stevens: Mr. Pitt, am I correct that the suspension order suspends trading in the stock by anyone whether involved a manipulation or not, now if you have got to go into Court you would proceed against the manipulators, you might get injunction against manipulation, but could you in court get injunction against trading by everyone?
Harvey L. Pitt: No, we could not.
John Paul Stevens: So, really this is a broader remedy in its coverage than the remedy you can get in court with notice and hearing all the rest, isn't it?
Harvey L. Pitt: This is a broader remedy and it is solely a stopgap remedy, until we can stop the market forces that are disrupting an orderly market place.
Potter Stewart: Stopgap.
Harvey L. Pitt: Stopgap. That is correct.
John Paul Stevens: May I ask one another question, is Mr. Sloan correct in saying the first suspension as I believe was on April 29, and the first memorandum then the Commission files explaining the reasons for the suspension or recommending it is May 02, is that correct?
Harvey L. Pitt: That is the first memorandum that is in the record, and I cannot be sure whether there was an earlier memorandum, but what often happens in response to that question is that the staff will come up on an emergency basis orally and advise the Commission that it has learned of certain facts and tell the Commission they, as in this case, had talked to Royal Canadian Mounted Police Authorities that they suspected a manipulation, and that there was a possible criminal indictment in Canada, and the Commission would, on the basis of that oral presentation, enter a suspension order. Under the Sunshine Act, this is now in effect, those discussions would be recorded and there would be a tape recording to verify it. That act was not in effect at the time that this occurred.
Warren E. Burger: Thank you gentleman. The case is submitted.


Earl Warren: Number 373, Commissioner of Internal Revenue, versus Philip J. LoBue. Mr. Elman.
Philip Elman: May it please the Court. This case is here on certiorari of the United States Court of Appeals for the Third Circuit. It's a federal income tax case and presents the question, whether an employee of a corporation who receives the right which he exercises to buy stock in the corporation at a price, which is considerably lower than the fair market price of the stock when he buys it. It's taxable on the gain thus realized. In other words, on the spread between what the corporation sells the stock to him for and what the corporation would receive for that stock, had it been sold on the open market, the Tax Court and the Court of Appeals --
Stanley Reed: What -- on his sale of that stock?
Philip Elman: On his purchase of the stock. The question is whether the employee is taxable on the difference between what he pays for the stock to the corporation, what the corporation sells it to him.
Stanley Reed: Before he sells it?
Philip Elman: That's right, sir, on the -- on his exercise of the option right given to him by the corporation on the purchase of the stock. Now, the Tax Court and the Court of Appeals have held that the employee, the taxpayer in this case is not taxable on that gain, and there is no dispute as to the facts which are in the main stipulated. This agreement here as in the lower courts centers solely, entirely on the legal validity of the criteria or standards used by the Tax Court and the Court of Appeals in reaching the conclusion that no tax was due even though there was an undoubted economic gain or benefit received by the employee when he purchased this stock at the favorable price. The -- before going into the detailed facts of the case, I should like if I may, in order to put the legal issue in the proper frame of reference, to refer briefly to the statutory provision which all agree is controlling here, that Section 22(a) of the 1939 Revenue Code which is set out in our brief at page 2. Section 22 (a) is the basic definition of income. It provides that gross income includes gains, profits and income derived from salaries, wages or compensation for personal service and the material that's omitted there indicated by the italics is just a parenthetical clause providing that -- including personal service for -- personal services rendered by officers of states, or compensation for personal service of whatever kind and in whatever form paid. And it goes on to specify various categories of income, and there is a concluding catchall clause which the Court is familiar with. That was before the Court in last term in the so-called windfall cases, the Glenshaw and General American Investors cases involving punitive damages under the antitrust laws and the Security Exchange Act. The catchall clause, or gains or profits and -- and income derived from any source whatever. And as the Court has noted on several occasions in recent terms that the statutory definition of income is so broad as to include all gains and only those gains are excluded from tax which Congress specifically excludes. And we have set out here the provisions of Section 22 (b) (3), which provides that the value of property acquired by gift, bequest, devise or inheritance shall not be included in the gross income and shall be exempt from taxation under this chapter. The comprehensiveness of the -- of the statute has been noted not only in the cases last term, but also in -- in cases such as the Rankin case involving illegally extorted payments and the Robertson case involving a prize received for a musical composition. But perhaps, the most important case in this context is the case of Commissioner against Smith in 324 U.S. 177 in which -- which is the leading case dealing with taxability of gains received under employee stock options and Mr. Chief Justice Stone's statement in that opinion has been frequently quoted that Section 22 (a) is broad enough to include any gains or benefits concertedly conferred on employees as compensation, whatever the form or mode that that compensation is given. Now, under the broad statutory provision as construed by the Court, it's therefore immaterial that the compensation does not take the form of cash. It takes the form of property and merchandize and stocks, or bonds or whatnot. It's also immaterial that the compensation is not given pursuant to a legal obligation or contract obligation. It's given voluntarily such as tips or Christmas bonus or something of that sort. It's taxable as compensation nonetheless, and it's also immaterial that the compensation takes the form of a byproduct of what might be called a noncompensatory, non-compensation motive on part of the employer. For example, in the Robertson case where the taxpayer was held to realize taxable income, what he received was a prize in the context for a symphonic composition. The donor of the prize, Mr. Henry Reichhold was a philanthropist. And his interest was not in compensating Mr. Robertson. His interest was in -- in furthering the cause of symphonic music generally and the particular cause of the Detroit symphony. And the Court held that nevertheless, since the payment was made in return for services rendered, it was taxable as income regardless of Mr. Reichhold's motives. As another example, if an automobile manufacturer were to decide for purposes of publicity or advertising, that it would compensate each of its employees, in part at least by giving them a new car each year, the value of that car would still be taxable to the employee even though an incidental purpose was served by the employee made them essential requirements of this new employee's --
Harold Burton: Aren't the findings here -- aren't the findings here by both Courts that this stock wasn't given for services?
Philip Elman: The finding in this case, sir, are based on what we conceive to be an erroneous standard that the --
Harold Burton: Well, they do make that finding, don't they?
Philip Elman: Yes, sir. The -- the fining is that in this case, there was no compensation because the employer intended the employee to acquire a proprietary interest. Now, we say that the Tax Court reached the wrong conclusion, made the wrong finding of fact because it asked the wrong question. We don't think that that -- under the statute that is the test and I shall elaborate my argument on that. I think it would be better to do so after going into the details of the facts. Now, in this case, the tax years involved are 1946 and 1947. The taxpayer was the New York sales manager of a -- of a Michigan chemical company, a rather small company which enjoyed a substantial expansion and prosperity in the immediate post war period, largely as a result of its sales of DDT in which it had done pioneering work for the army beginning early in 1944. In March 1944, the stockholders and directors of the company apparently realizing that it was on the brink of a period of expansion, decided upon a plan for allocation of 10,000 shares of common stock authorized but not issued to the -- to such key employees that should be determined by the Board of Directors over the ensuing three years and the option price, price specified was $5, which at that time was slightly more than the market price of the stock. There's been a stipulation that March 1944 when the plan, the general plan was agreed upon, the price was $4.50. Excuse me. Now, on June 29th 1944 and I shall be reading from the record beginning at page 17. In June 1944, the Executive Vice President of the corporation, a man named T.C. Davis wrote to the taxpayer that -- informing him of the stockholder's action and setting aside this 10,000 share allocation. He stated in the letter that the purpose of this is to provide an incentive to key employees, especially to permit such men to participate in the success of the company. In the next paragraph, he says, “Allotment of the stock will be made by the committee for the key men of the company on results accomplished. In other words, you will stand on your own record and participate in the stock purchase plan to the extent of your efforts, cooperation, and results. And in this letter, he tells him that he has been tentatively alloted 10 shares, and he repeats that the -- that in January 1945, when they actually make the -- the final allocation to particular employees, that assignment will be made on the basis of results accomplished. I am now reading from the middle of page 18, “You may be assigned a greater or less amount of stock based entirely upon your individual results and that of the entire organization.” Then, it goes on to enumerate the basic factors which will be taken into account, the labor costs, general efficiency in operation, increase in production and so on. And Mr. Davis said, “May I suggest that that you select those things wherein you can make the greatest contribution and strive to make the kind of record of which you and I maybe proud.” Then, on January 18th 1945, Mr. Davis informs the taxpayer that he has been definitely alloted 150 shares. And he says, this is in the middle of page 19, “That this allotment of stock is made by the committee and is in recognition of your contribution and efforts in making the operation of the company successful,” and he concludes that letter. On top of page 20, you'll of course understand that further allotments of stock under our plan will be recommended by the committee during 1945 and 1946. It is up to you to justify your participation in the plan during the next two years. In January 1946, once again, Mr. Davis writes to inform Mr. LoBue that he has received a further allotment of 150 shares. And in the paragraph beginning at the bottom of page 20, he says, “The committee's selection of the names of employees to receive the right to purchase this stock, the number of shares assigned to each selectee is determined by the committee after a careful appraisal of the individual's contribution to the company in the way of job performance during the past year. In other words, the extent of your participation to the plan is based on how well you handle your job during the year.” Then, in January 1947, Mr. LoBue is alloted 40 shares which represented his portion of the balance of the shares which have been available, and this letter too contains statements that the allocations were made after a careful appraisal of his contribution and it concludes, “I congratulate you on having earned this recognition given to you by the committee and trust that your future services, suggestions and interest in the corporation's welfare will warrant even greater recognition.” Now, Mr. LoBue exercised his rights under these three options by purchasing 300 shares of stock in 1946 at a time when the market price of the stock was $30.50 a share. His -- he paid $5 a share, which meant that for $1500, he acquired stock worth $9600, and the value of that gain, perhaps, can be measured by the fact that his regular salary was $6600 a year.
Stanley Reed: He gets -- he gets all at one time?
Philip Elman: No, he didn't get it all in one time. He got it -- he got -- he exercised his option under the third option, the 40 shares in February 1947. At that time, the stock was worth somewhere around $19. Now --
Stanley Reed: Well, all the rest he exercised at one time?
Philip Elman: He exercised his -- the first two options at one time. There were three options. He exercised the first two options by -- by paying for the -- by paying for the purchase price of the stock in February 1946. Now, I might -- may say that there is a question in this case as to whether the exercise of the option may not have occurred in an earlier period in 1945 when the taxpayer gave some promissory notes. That question was not reached by the Tax Court or the Court of Appeals because on the view the Tax Court took, there was no compensation at any time in connection with the acquisition of shares of stock. So that we -- we would suppose that that question will -- will be open to the taxpayer on remand if the Government's contention should prevail and the judgment should be reversed, but we don't think it's necessary for Your Honors to reach that question here. Now, I might -- I might also mention although it's --
Stanley Reed: He gave no indication that whether he would or wouldn't take it until --
Philip Elman: Until he gave the promissory notes.
Stanley Reed: Well, until just before January 1947?
Philip Elman: Yes, sir. When the -- when the --
Stanley Reed: Clear option up to that time.
Philip Elman: It was a clear option I assume was binding on a corporation. There is no suggestion it wasn't.
Stanley Reed: (Voice Overlap) --
Philip Elman: Yes, sir, there is no question about that I assume but the --
Stanley Reed: But not binding on him?
Philip Elman: Oh, certainly not. If the stock had gone down, he certainly would not have exercised it. It was -- it was contingent in that sense.
Stanley Reed: Just like he bought an option to buy the cause, something like that?
Philip Elman: Well, I -- I would suppose that there would be no difference from our point of view whether it was going to -- whether it was put in Colony or not. It was -- there was certainly no obligation on him to exercise the option basically. Now, I might --
Harold Burton: Do you charge him with any income if he had received the option and did not exercise it?
Philip Elman: The options were not transferrable, Mr. Justice. There -- there has never been any suggestion in this case prior to the filing of the brief on the merits of this Court by the respondent that the receipt of the option itself might be compensation. In fact, contention had been reached -- had been made. It certainly should have been considered by the Tax Court because it's -- it's clear that if -- if an option has value and if it's assignable, there is a determinable market value that it has. It's a piece of property in which it -- if it's -- if that were intended to be compensation under the Smith case, the tax could be imposed, but I had -- I don't think that question is in this case. It -- it was never in the case until it was brought into it by the respondent, his brief on the merits. And since the option was not transferable, it's hard to see how any market value could have been given to it.
Stanley Reed: Is the stock putting transfer transferrable?
Philip Elman: No, the -- it was not transferable because the -- the option -- the option specifically provided that the --
Stanley Reed: When he got the stock it was?
Philip Elman: Mr. Davis told Mr. LoBue that one of the conditions was that the option, the right to purchase the stock, is not transferrable. He couldn't give it to anyone else.
Stanley Reed: So, all you have to do is to exercise and then sell the stock?
Philip Elman: He could exercise. He was under no obligation to sell a stock. He could have held on to it. For all I know, he has held onto it. There's nothing on the record on that.
Felix Frankfurter: (Inaudible) I do not quite see him assuming the option was in and of itself after they did come through him under the status of an employee and that would have them. Now, that would ignore if they see a greater gain coming from the option which came in later.
Philip Elman: Well, the -- the question as to whether the compensation was the option or was the exercise of the option resulting in his acquisition of shares of stock. It was the question that was before this Court in the Smith case and there, it was -- there, the option when it was received had no value because the market price was not in excess of the option price and the -- this Court said, “Well, in no circumstances, certainly, the -- the mere receipt of the option couldn't have been intended to be the compensation. It was the exercise of the option that was the compensation. Well, the Tax Court in the Court of Appeals has been pointed out. It held that in this case, there was no compensation. It's a finding of fact, no compensation and we are not challenging the evidence, the evidentiary basis for lack of it from such a finding. What we are saying is that the Tax Court and the Court of Appeals applied the wrong test. Now, the test that was applied is known as the proprietary interest versus compensation test, and it -- it's fairly stated in the opinion of the Court of Appeals on page 160, Judge Maris points out that a virtually unbroken line of cases supports the Tax Court in holding that if the -- now, we disagree with Judge Maris as the authority, but that's not material at this point, the cases support the Tax Court in holding that if the grant of a stock option by a corporation to its employee is intended as additional compensation to him, the excess of the fair market value over, the option price is income taxable to him when the option is exercised. Now, that -- that certainly can't be disputed. But he goes on to say, “But on the other hand, if the grant of the option is intended to provide him with a proprietary interest in the business, no taxable gain is recognized when the option is exercised, and whether the grant of the option is the one or the other being in every case a question of fact. So, the question is under the view ,taken by the -- of the law taken by the Court of Appeals and Tax Court, you asked was this intended to his compensation? If so, taxed. Was it intended as to give the employee a proprietary interest? It's not taxed. And curiously, in -- in almost every opinion that I have examined on this subject, the -- the latter question is asked first, if the -- if the employer is found to have intended the employee to acquire proprietary interest in the company. That is conclusive of the question of whether there was compensation. Now, that -- that is the approach that was taken by the Tax Court in this case, and that was the -- apparently approved by the Court of Appeals. Now, we -- our difficulty with the proprietary interest test begins with our -- our inability to find any statutory authority for it. Under the -- under the rule of the Court of Appeals, there's a -- there is a middle ground between taxable compensation on the one hand and a nontaxable gift on the other hand. Right in the middle is an area of a benefit or gain received by an employee which isn't taxable to him not because it's a gift. There's no -- there's no finding here of a gift, no argument of a gift, not because it's a gift, but because of the existence of this intention on the part of the employer that by acquiring the stock in the corporation, the employee should have a proprietary interest.
Hugo L. Black: For what purpose? What purpose --
Philip Elman: Now --
Hugo L. Black: Did it appeared that he work harder if he had a proprietary interest?
Philip Elman: Well, it seems -- it seems to us that the -- that the analysis of the conception of a proprietary interest that is accepted by lower courts is -- is really incomplete, because almost every time, every time I should say, a corporation sells stock. It's implicit in the transaction that the purchaser acquires proprietary interest. That's -- that's just -- that's particularly true in a case where the -- where the corporation sets a price which is, for its stock, which is lower than that on the market. Now, when a -- when a corporation offers stock to its employees or to some of them at a substantial discount to say that it intends the employees to acquire proprietary interest, it doesn't answer the question why it so intends and what the corporation receives in return. Why the corporation should wish to sell its stock at less than what it can get in the marketplace? And -- and it seems -- it seems to us that the regulations adopted by the treasury are reasonable and -- and valid in providing that unless it's found to be a gift, unless you find that the employer was motivated by considerations of affection, their friendship and so on, the -- the reason why he wishes the -- the employee to acquire the stock is to improve the employee's interest in his work, his devotion, his morale, whatever it be called. There is a relationship between -- between giving him a discount and his services, which should be taxable as compensation even though it takes the form of stock rather than cash.
Felix Frankfurter: What's the relation, its relevance, Mr. Elman?
Philip Elman: That's set forth in our brief beginning at page 3. I should say our principle --
Felix Frankfurter: What's the thought of that?
Philip Elman: The -- the number that is, unless -- unless it's a gift --
Felix Frankfurter: (Voice Overlap) --
Philip Elman: -- unless it's a gift -- unless it's a gift, if -- if property is transferred by a corporation to its employee, it's taxable to the extent of the difference between the --
Felix Frankfurter: What does the Tax -- Tax Court do with the regulation?
Philip Elman: Tax Court thought that that regulation had a kind of automatic conclusive presumption effect that it precluded any inquiry into the fact. I think it was a -- that was a misconstruction regulation. It is not our position that there is anything automatic about this. There is -- there are questions of fact where the issue is raised as that the gain was intended as a gift, but we think that where that -- where the question is answered in the negative, this -- the normal presumption of compensation has nothing over to come and it should be taxable as such. Before I sit down, I should like to call the Court's attention, the provisions of the 1950 Amendment of the tax law. In 1950, Congress in response to the suggestion that the treasuries regulations resulted in -- in employees who have received such option being compelled to sell, to sell stock in order to pay taxes, Congress responded to that argument to a very limited extend. It -- it set up a category of restricted stock options.
Stanley Reed: Where is that?
Philip Elman: Pardon.
Stanley Reed: Where did you Act for this?
Philip Elman: We have not set forth the 1950 Act in the statutes involved section, sir, because this Act -- this -- the -- the Act is not involved strictly speaking. That's a 1950 Act, and the reason I mentioned it is that if the court below in this case is right, it creates a real incongruity in the tax law because under the 1950 Act, the restrictive stock option is defined as one in which the option price was at least 85% of the market price at the time it was given. It-s -- it's an option which can be exercised only during employment. The -- the stock has to be held for at least two years after the option is given or six months after the option is exercised. The employee can't hold more than 10% of the stock of the corporation. It's not transferable and so on. There are quite a number of restrictions that have to be met. And if all those conditions are met, then under the 1950 statute, the employee does not pay a tax when he buys the stock, but when he sells it. But then, he is taxed at the ordinary income tax rates to the extent of the difference between the option price and the market price, and the statute further provides that unlike this case, no deduction can be taken by the corporation and there is a further provision which I think is especially important. If the employee dies without selling the stock, his estate has to pay an income tax just if he had sold it during his lifetime. Now, under the decision of the Third Circuit in this case, the practical result is that the employee, when he buys the -- when he buys the stock, pays no stock at all. If he dies without selling the stock, his estate pays no tax because they take it on the basis of its market value at the time of his death. If he does sell it during his lifetime, he is taxed at the ordinary -- at the long-term capital gain rate, and the difference between the result in this case which turns on the existence of a proprietary interest motive and the 1950 Amendment in which there is no reference at all for proprietary interest, the only conditions are those that I have enumerated, seems to us to be highly significant.
Earl Warren: Mr. Barrett.
Richard F. Barrett: There are two basic questions presented in this case. The first is, is there a presumption under Section 22 (a) of the Internal Revenue Code of 1939, a conclusive presumption that stock options are granted to employees for one reason only, to compensate? The commissioner says, and as regulation say, that there is such a conclusive presumption that the courts are precluded from looking into the true intent of the transaction. The taxpayer says, “There is no such conclusive presumption and that if it is established as a fact that there is no purpose to compensate through the transaction, then the exercise of the option represents a mere purchase of property.” The Tax Court found that there was no intention to compensate. It did not find, as my Brother has said, that there was no intention to compensate because there was an intention to give a proprietary interest. It laid out very expressly and clearly of the criteria that if there is any intention to compensate, then there is compensation. But if there is a complete absence of intent to compensate and there happens to be another motive, which is the wish to sell stock to the employee, then the sale is a pure sale. The second question is whether this finding of the Tax Court, which is concurred in by the Circuit Court of Appeals, will be reviewed by this Court. Of course, it's a conclusive presumption of the Commissioner's regulations as upheld, then, this Court has no place for such a review. The Commissioner, however, argues in the alternative that the -- this Court will review this finding of fact and that it should reverse it as erroneous. The taxpayer contends that it is not subject to review here under well established principles of this Court, that such a two-court finding of fact will not, under Section -- Rule 52 (a) of the Federal Rules of Civil Procedure be reviewed except in the presence of very exceptional circumstances which are not present here. Now, it has been stated that the taxpayer contends there is conclusive presumption. I might say parenthetically that Mr. Justice Frankfurter asked for the gist of the regulations. They were not stated exactly as I understand them to be. They lay down a flat mandate without any exception to the gift. All words relating to love and affection, they state, and this appears at page 5 of the Commissioner's brief, the top of page 5, “If property is transferred by an employer to an employee for an amount,” this is any property, stock, or any other property, “for an amount less than its fair market value, regardless of whether the transfer is in the form of a sale or exchange. The difference between the amount paid for the property and the amount of its fair market value is in the nature of compensation and shall be included in the gross income of the employee.” And those are the only words in the statute, in the regulation, which is significant to this case that bear upon today. If the fact establishes that there is no purpose to compensate, the taxpayer says, “It's a transaction purchase, a purchase transaction.” Once this absence of intent to compensate is established, the employee relationship becomes insignificant and the employee stands in the same position as any other purchaser of property. This view has been consistently supported by the courts including this Court. In Smith against the United States, to which my Brother referred, this Court held that the exercise of an option by an employee resulted in compensation on the expressed grounds that the option was given in consideration to services. In Palmer against the United States, 302 U.S. 63, an advantageous exercise by stockholders of an option granted to them was held by this Court not to create a dividend since the purpose and intention of the grinding of the option was not to distribute earnings. The Palmer case is of special significance here because of the high degree of analogy in fact in the issues of the cases to the present case. In both cases, at the time of the adoption of the option plan, market value was either equal to or greater than as is true in this case, the option price in both cases when the option was exercised, market price was in excess of the price paid pursuant to the option. This Court said in the Palmer case, “That one does not subject himself to income tax by the mere purchase of property even at less than its true value and the taxable gain does not accrue to him before he sells or otherwise discloses of it.” The Commissioner contended that this discount in the Palmer case represented a dividend to the stockholders. This was rejected by the Court on the grounds, the expressed grounds that there was no purpose or intention to distribute a dividend. This is precisely the principle that the lower courts have applied in this case and in all other stock option cases involving employees. But the Commissioner argues that purpose and intention are immaterial where there is the employee relationship that the courts, if there such a relationship precluded from looking in to the question of intent. The influence of the employee relationship is so overriding in the view of the Commissioner as to require a complicit presumption of law that compensation is involved. Now, this Court has, on many occasions, expressed that this favor was statutory conclusive presumptions. As in violation of the due process provisions of the Fifth and Fourth Amendments, I do not cite these cases in my brief, so I like to take the liberty of citing three of the leading cases at this time, Helvering against Rankin, 295 U.S. 123, Heiner against Donnan, 285 U.S. 312, Hoeper against Tax Commission, 284 U.S. 206. Certainly, regulations, which attempt to provide a conclusive presumption, must themselves be arbitrary and invalid. Now, the Commissioner's conception of the law has not always been as it is now. From 1939 to 1946, his regulations regarding employee stock options provided that compensation was a question of fact. He also applied the same factual test in his regulations regarding stockholder's stock options. He also expressed this view in his brief in the Smith case to which we have referred before. At Page 14 of his brief, the Commissioner stated, “In determining whether a particular transaction involved,” this is his -- this is his brief in the Smith case, previously before this Court where he expressed this view of the transaction compared to what he is expressing now. “In determining whether a particular transaction involves the payment of compensation for personal services, the decisive factor is that of intention.” This is of course a question of fact. This is exactly the position of the courts below in this case and in all other stock option cases of employees and it's the taxpayer's position here.
Speaker: When did the Commissioner change his view?
Richard F. Barrett: He changed his view in 1946 for what represents one of the great mysteries of the tax field. He dated the options on the same date. I mean the change in the regulations on the same date. The effective date of them was the decision of this Court in the Smith case. And the Smith case offers no discernible basis for a chain from a determination of fact as to whether compensation exist to a determination to a conclusive presumption that it does, because in the Smith case, this Court said the options resulted in compensation because they were as a fact given in consideration for services. As a matter of fact, that fact was admitted and conceded in the Tax Court and in the Circuit Court of appeals and the case came to this Court on the fact that the options were given as compensation for service. Now, he also --
Felix Frankfurter: Mr. Barrett, may I ask you to indicate what is it be the meaning of proprietary interest? Does that mean that he enjoyed the satisfaction of the services of the stockholder? Is that what it means?
Richard F. Barrett: Yes, Mr Justice Frankfurter. He becomes a partner in the business. He is one of the owners as a (Voice Overlap) to an employee.
Felix Frankfurter: That is true to the extent to -- of every stockholder?
Richard F. Barrett: Very true, sir.
Felix Frankfurter: That is true (Inaudible)
Richard F. Barrett: Very true, sir.
Sherman Minton: Suppose he had made this offer to a person who was not a stockholder on exactly the same terms, will it be taxable to them?
Richard F. Barrett: Then traditionally and historically, based on this Court's view in the Palmer case and other cases, the question is, what was the intention involved?
Sherman Minton: If they were not employees just outside persons, they –-
Richard F. Barrett: And there was knowledge. Under the Jacobson case before this Court, it's cited in my brief. I can't remember the volume and page at the moment. If there was no attempt by the seller to get all that he could for the property, it was a gift for income tax purposes and exempt. Now, I would like to address my remarks to the point that Mr. Justice Harlan raised and go on to the change in 1946 and the regulations where this change was made to a conclusive presumption that because of the employer relationship, there must be compensation in every stock option case. The interesting point about that is, at the same time, there was no change made in the stockholder option regulations that related to dividends. Those remained the same that it would still open the question of facts just as to whether the purpose and intention was to declare a dividend. There seems to be a rather hypnotic influence exercised on the Commissioner by the employee relationship, one and one makes two for a stockholder, but the same in the case of an employee makes three. The regulations admit of no exception. Now, the Commissioner does do lip service in this case in his argument, not in these regulations to one exception, gift, but it's through lip service because the whole rationale of his argument is that if you're an employee, the employer will not make a gift to you. However, he says there's no middle ground that may not be a purchase transaction such as this case held there could be if that is the intent and purpose in the Palmer case. Now, the logical invalidity of the Commissioner's position can be illustrated by a rather homely and down to earth illustration. Corporation X, which is a closely held corporation and whose stock has no established market value, announces to all its employees that the stockholders are making an offer to them that they may buy a stock for a period of three months at the market price for the stock. The announcement states that this is in response to request from employees that they would be allowed to become stockholders. And the stockholders think that it would be sound for the corporation to have its employees participate in the stock ownership. The announcement also states that because of the unestablished market value of the stock, three independent competent appraisers will be selected to determine the market value. Many of the stockholders accept the offer, and in each case, the fair market value which is to be the purchase price, is determined on a bonafide careful basis by this committee of independent, expert and competent appraisers. Some stockholders turned down this opportunity because they object to the price determined as being too high. The Commissioner, using capitalization of earnings and book value and other evaluation formula methods, determines that the market price is an excess of that for which the stock was sold, and the Tax Court uphold this determination. Now, under the regulations, that discount for market is conclusively presumed to be compensation. It's perfectly clear that no gift is involved. It is also -- it's equally clear that the stock option was granted because of the employee relationship, but it certainly is equally clear that there was no intention to compensate. It was merely an intention to make the sale of stock, but because the sale was at a market price, in excess of the option price, the Commissioner says there is a conclusive presumption of compensation.
Hugo L. Black: Did you say there was no gift?
Richard F. Barrett: No gift because there was an effort made on the part of the seller, the corporation, to get all that it could in the transaction. That's the rule laid down by this Court in the Jacobson case.
Hugo L. Black: What was the stock worth at the time they gave the offer?
Richard F. Barrett: The independent investment experts appraise the stock at -- we will say $100 a share. There is no established market value, Your Honor, so they had to do it by appraisal. The Commissioner came in and said, “I say it's worth a $125 a share,” and the Tax Court upheld it to make a simpler illustration. The tax --
Hugo L. Black: Well, what was the option value?
Richard F. Barrett: The option --
Hugo L. Black: What was the --
Richard F. Barrett: -- the option price was $100 a share, the fair market value.
Hugo L. Black: Do I understand that the option price is in $100, and the actual value is in $5000? Do you say that would be no gift, no --
Richard F. Barrett: No, I would say there that I would conceive that there was obviously a purpose of compensating the employee.
Hugo L. Black: Another words, your argument --
Richard F. Barrett: If there is, if -- if it is shown as a fact that the purpose is to compensate then your illustration would certainly demonstrate it conclusively then there is compensation.
Hugo L. Black: Your argument is based on the fact then that by reason of the closeness of the option price to the extra value.
Richard F. Barrett: My argument in the -- in the hypothetical case is based on the fact that the seller made every effort to determine by independent appraisers how much the stock was worth. He had no listing on the New York Stock Exchange to look at. It was an untraded stock. He made every effort of other formula devices used by the Commissioner and upheld by the Tax Court say, “No our guess is that it's worth more.”
Hugo L. Black: What does the book say?
Richard F. Barrett: I was giving a hypothetical –-
Hugo L. Black: I mean, here.
Richard F. Barrett: Oh, here, I do not know. There's -- there's no issue on facts as to evaluation here.
Hugo L. Black: Well, then, what I want to get at, how much is it conceded, in fact the worth, and how much was the option price?
Richard F. Barrett: At the time that the option plan was adopted, the price was -- the -- the stock was worth $4.50 a share and the option price was $5. The plan was to sell it above the option -- above market. Now --
Hugo L. Black: Do you mean at the time they gave him the stock, it was worth --
Richard F. Barrett: At the time they gave him the -- at the time --
Hugo L. Black: At the time they gave him the option.
Richard F. Barrett: At the time they gave him the option, the market price had become higher than the option price, but the time that the plan was adopted, the market was --
Hugo L. Black: (Voice Overlap) was put in effect. When he got the options, did he --
Richard F. Barrett: Market --
Hugo L. Black: -- get more than his money is worth on the value of the option?
Richard F. Barrett: The market was higher than the option price, yes sir.
Hugo L. Black: How much high?
Richard F. Barrett: I think in one case, in one option, a $1.5 from $5 to 6.50 in another. I think from $5 to $19.50.
Hugo L. Black: And why do you say that was either a gift or a payment for something in so far as the difference between the values is concerned?
Richard F. Barrett: I say because there was no intention to compensate.
Hugo L. Black: No intention to compensate but what it did to compensate what it did a year?
Richard F. Barrett: They adopted the plan. They didn't know what the price was going to be when the options were granted. They adopted a plan. The stockholders said to the directors, “You take these 10,000 shares and you select employees that are key employees in the company and you give them this option to buy.” The whole plan was fixed. The only thing that was left open was who is going to be selected, not whether anyone would be selected. And at that time, the price of the stock was -- the stock was worth less than the price of the option. Now, at a later time, when the selections have been made and the plan had been carried through at that point, the stock had gone up. But a host of cases below without any exception have said that if under these circumstances, if the purpose of the whole transaction was not to pass out compensation it's merely an arrangement to sell property. And that the time to impose the tax is after you bought the property and you sold it and you find out how much you eventually net out of the transaction.
Hugo L. Black: I don't want to waste -- waste your time but I do want to state up to this time, my trouble with your case is this that reading these statements, it looks to me like they said in effect, “You're a good employee. We want you to be more loyal and do harder work and better work, and we're going to let you have this stock at an option whereby you make $5000, $6000 or $2000 whatever it was,” and I can't get to see how they could find that they didn't go for that purpose.
Richard F. Barrett: Well, I mean the -- the record of course is open in result of the Tax Court to look at all of the facts as to whether the inferences, perhaps on both sides, led to the finding of facts that the company was not intending to compensate or whether it was intending to compensate.
Hugo L. Black: Well, I was -- I've read the record entirely there. I'm not sure what up-to-date is, I can't see any inference on the other side unless you're going to say they won't give it to them. I can see that.
Richard F. Barrett: Well, in the Palmer case, we have no gift. We have a corporation issuing options to stockholders to buy a property at a certain price. It wasn't an excessive market. By the time they got the options and exercised them, the price of the -- the market price had gone up. This Court said, “There wasn't any purpose here to compensate, to declare a dividend. The purpose was merely to sell a property.
Hugo L. Black: But I can understand fully --
Richard F. Barrett: They said nothing. But what my point is, Your Honor, that there was nothing said about gift. There was a middle ground that the Commissioner says can exist to purchase transaction. That's what the Palmer case held that you can have a purchase transaction like in the middle --
Hugo L. Black: I can understand your case where at the time the gift from the stock option, they don't make it, but I -- it's a little different for me to see why you sell a man a gold dollar for 50 cents, you would need to give him something or give him -- or hire in the business.
Richard F. Barrett: Well, if -- if the seller is trying to get all he can, he is obviously not making a gift. If he happens not to get all that he can, he is obviously in the illustration I gave, not trying to compensate the employee because he's not trying to sell at less in under the regulation because it was sold at less. And because it was sold to an employee its compensation, we quarrel with the conclusive presumption.
Hugo L. Black: But I -- that -- that's -- I can understand that quarrel and if it's conclusive presumption where -- where they were not getting something, or nothing, or at least get involved in the money's worth, I can understand that as far as the presumption, I mean the regulation.
Richard F. Barrett: Well --
Hugo L. Black: The thing that hits me is how you could find if there's another gift or the other. I'm sorry for the (Inaudible)
Richard F. Barrett: If I can be -- If I can be helpful, I'm certainly glad to discuss it I don't think I have any more help to offer on that point.
Speaker: As I understand it --
Stanley Reed: (Voice Overlap) somewhat uncertain about just exactly this contract, as I understand it when the option is given to the employee, he is not expected to exercise it at all. But later on, after he had performed the services and had worked hard and contributed, then the directors might allot to him some of his 10,000 shares, but he was not given an option the day that the first letter was sent for so many shares.
Richard F. Barrett: No, he wasn't given the option because they had to get the thing cleared by the Michigan Securities Commission which --
Stanley Reed: No, no, but he -- even leaving aside all that, he only got an option to buy after his work to the preceding year had been completed and then the directors divided some of the shares, I don't suppose all the 10,000 at one time against a number of shares among X number of people at the end of the work.
Richard F. Barrett: Well, of course, there was no end of the work in the sense that his work continued, we'll say at the end of the calendar, end of the year.
Stanley Reed: (Voice Overlap) --
Richard F. Barrett: End of the year.
Stanley Reed: End of the year. So, for the preceding year in January, they allotted so many shares to this person if he wanted --
Richard F. Barrett: Well, the -- the --
Stanley Reed: -- to lessen the value.
Richard F. Barrett: The facts as to the terms of the option and the information given to the employee by the -- by Mr. Davis, the Chairman of the Board and the President of the company is given by -- my colleague here is highly selective. I mean, we bring forward in purpose to your attention in our brief all of the other things that was said about. We want you to be a stockholder. You should take pride of being an owner. Its -- his statement over here was heavily weighed, it was -- which I don't object at all towards an intention, simply to pick out someone who worked hard, but they were trying to pick out the people who were the key employees. They couldn't do it blindfolded and just walk around a game of blind man's buff picking out this follow and that in the dark its key employees and give them the option. They had to pick out people on merits so they had to refer to the good job they've done and all that type of thing.
Speaker: May -- I can't understand is why the intention to compensate, the intention to give ownership interest in mutually exclusive concepts.
Richard F. Barrett: They are not mutually exclusive and they're not so treated in the courts below. I think we can dispose of that by simply rating the rationale of criteria, as the courts below call it of the Geeseman case, a 38 B.T.A. case which they've expressly adopted in which they said, “This is the criteria we applied.” At page 7 of our brief, in the quotation near the center of the page, each court applied the criteria set out in Delbert B. Geeseman, “As a prerequisite to the conclusion sought by the respondent,” that's the Commissioner, which as his -- what he seeks is to be a compensation. “It should definitely and clearly appear that the transaction,” and then in italics, “is in fact to some extent the payment of compensation for services rendered or to be rendered.” Now, if --
Felix Frankfurter: Mr. Barrett, did both courts act exclusively on documents?
Richard F. Barrett: No, they acted on oral testimony?
Felix Frankfurter: What type of testimony?
Richard F. Barrett: By the President of the company and the President who conceived the plan. In my remaining moment or two, may I turn to the procedural aspect of this, if it please the Court, and that is the background of this finding of fact against which -- which we submit the Court should review this case. This Court has taken the position repeatedly that a two court finding of fact is not reviewable under Section 52 (a) of the Federal Rules of Civil Procedure, except, and these are the words of this Court, “In the presence of very exceptional and obvious error.” Now, on all the evidence here of the Tax Court including the un-rebutted testimony of Mr. Davis, the President of the employer corporation found that there was no purpose to compensate. And the Court of Appeals concurred without any qualification. So, we have here a question of whether a regulatory fiat that the acquisition, the advantageous purchase of stock by every employee from an employer is compensation, simply because of the employee relationship, whether because of such a -- such a conclusive presumption, the courts are barred from enquiring into the true facts as to the intention and motives. And really, whether it's compared to stockholders, employees are somewhat second class taxpayers in the sense that they cannot buy property from their employer corporation if that is the -- that there is no purpose to compensate.
Philip Elman: If the Court please, I don't know if my time is up. I believe I have an --
Earl Warren: Oh, I think you have a minute or two, yes.
Philip Elman: In very brief points, I should like to make first --
Earl Warren: Yes, yes.
Philip Elman: -- in response to Mr. Justice Black's questions to Mr. Barrett. We have set forth in our brief at page 29 the option prices, the fair market value in issue, fair market and the fair market value inquired. The 300 shares of stock were acquired in February 1946. The option price was $5 a share at that time. It remained $5 of course, and the fair market value was $30.50 –-
Hugo L. Black: At that time?
Philip Elman: At that time. And in January 1947 as to the 40 shares, option price still is $5, fair market value $19.50. I should like to make the further point, sir, that we do not say that there is a conclusive presumption that when -- when stock is purchased at a favorable price by an employee that it's taxable. The regulation has expressly recognize that where the transaction is exempt from taxation by law as in the case of a gift, then certainly intention is very material. If that issue is tendered as it was not in this case, but if it were tendered, the issue should certainly be a canvass, intention to make a gift if found by the triers of fact and if that finding is supported by the evidence, of course, established as a gift. If those questions of fact, as what -- that this Court is indicating a whole line of cases from the Jacobson case and the Robertson case going on back to (Inaudible) and Old Colony Trust Company, was -- was this given as an act of generosity, was it motivated by affection, friendship, charity?
Felix Frankfurter: Was propriety interest to be equated with gift?
Philip Elman: Not at all, sir.
Felix Frankfurter: Pardon me.
Philip Elman: It may be, it may be that where there is a gift, there's an --
Felix Frankfurter: That's why -- that's why your remarks about gift do not (Voice Overlap) --
Philip Elman: Our difficulty --
Felix Frankfurter: (Inaudible)
Philip Elman: Our difficulty is that which was expressed by Mr. Justice Harlan. We don't see how the intention to convey property to give the employee a proprietary stake in the business is inconsistent with -- with compensation any more than it's inconsistent with gift.
Felix Frankfurter: Well, that's what I understand as the category, compensation, gift as proprietary interest.
Philip Elman: We find compensation and gift in the statute, but we don't find proprietary interest.
Felix Frankfurter: All right.
Philip Elman: And if the right questions have been asked here, was there an intention to compensate, was there an intention to make a gift, this case would not be here. Thank you very much.