Opinion ID: 545494
Heading Depth: 2
Heading Rank: 3

Heading: Broad Interpretation of Sec. 16(b)

Text: 16 When the statute permits interpretation the section traditionally has been read broadly in view of its remedial purposes. The disgorgement provision is aimed at deterring insider trading by removing the profits from a class of transactions in which the possibility of abuse [is] believed to be intolerably great. Id. at 422, 92 S.Ct. at 599. The statute presumes that insiders in a company have access to nonpublic information regarding its operation and will use that information when trading in the issuer's stock, and thus proof of the actual use of such inside information is not required. See Foremost-McKesson, Inc. v. Provident Sec. Co., 423 U.S. 232, 243, 251, 96 S.Ct. 508, 519, 46 L.Ed.2d 464 (1976); Reliance Elec., 404 U.S. at 422, 92 S.Ct. at 599; Smolowe v. Delendo Corp., 136 F.2d 231, 235-36 (2d Cir.), cert. denied, 320 U.S. 751, 64 S.Ct. 56, 88 L.Ed. 446 (1943). 17 We and most other courts have adopted a pragmatic approach, construing Sec. 16(b) in a manner that seems most consistent with Congress' purpose. See Kern County Land Co., 411 U.S. at 594, 93 S.Ct. at 1744 (the courts have come to inquire whether the transaction may serve as a vehicle for the evil which Congress sought to prevent); Reliance Elec., 404 U.S. at 424, 92 S.Ct. at 600 (where alternative constructions of the terms of Sec. 16(b) are possible, those terms are to be given the construction that best serves the congressional purpose of curbing short-swing speculation by corporate insiders.); Feder v. Martin Marietta Corp., 406 F.2d 260, 262 (2d Cir.1969) (courts interpret Sec. 16(b) in ways most consistent with legislative purpose even departing where necessary from the literal statutory language.), cert. denied, 396 U.S. 1036, 90 S.Ct. 678, 24 L.Ed.2d 681 (1970). II Standing Under Sec. 16(b) A. Broadly Construed 18 To effectuate its purposes the statute permits the owner of any security of the issuer to bring suit in behalf of the corporation. 15 U.S.C. Sec. 78p(b). Such person may institute a Sec. 16(b) claim in behalf of the issuer if the latter fails to bring suit after the stockholder so requests. See id. Because such a suit is not brought in his own, but rather the corporation's behalf, Sec. 16(b)'s standing requirements have been given wide latitude. See Pellegrino v. Nesbit, 203 F.2d 463, 466 (9th Cir.1953); see also Prager v. Sylvestri, 449 F.Supp. 425, 429 (S.D.N.Y.1978) (demand requirement of Sec. 16(b) exists for benefit of the issuer; defendant insider may not assert lack of demand as a defense.). A Sec. 16(b) plaintiff performs a public rather than a private function and is seen as an instrument for advancing legislative policy. See Magida v. Continental Can Co., 231 F.2d 843, 846-47 (2d Cir.), cert. denied, 351 U.S. 972, 76 S.Ct. 1031, 100 L.Ed. 1490 (1956). 19 The standing requirements for shareholder derivative suits are not applicable to a Sec. 16(b) plaintiff. See Blau v. Mission Corp., 212 F.2d 77, 79 (2d Cir.), cert. denied, 347 U.S. 1016, 74 S.Ct. 872, 98 L.Ed. 1138 (1954); Rothenberg v. United Brands Co., [1977-78] Fed.Sec.L.Rep. (CCH) p 96,045 at 91,691-92, 1977 WL 1014 (S.D.N.Y.); aff'd mem., 573 F.2d 1295 (2d Cir.1977); 2 L. Loss, Securities Regulation at 1045-47. Generally a derivative plaintiff must be a shareholder at the time of the transaction of which he complains, the action must not be a collusive one to confer federal jurisdiction, and the complaint must allege with particularity the efforts made to obtain the desired action. See Fed.R.Civ.P. 23.1. In contrast, in a Sec. 16(b) suit the complaining stockholder need not have held his securities at the time of the objectionable transaction. See Blau v. Mission Corp., 212 F.2d at 79. Suit may be brought by the holder of any of the issuer's securities--equity or debt--regardless of whether the security held is of the same class as those subject to disgorgement as short-swing profits. See 15 U.S.C. Sec. 78p(b); Smolowe, 136 F.2d at 241; 2 L. Loss, Securities Regulation at 1046. Further, the amount or value of a plaintiff's holdings or his motives for bringing suit are not relevant. See Magida, 231 F.2d at 847-48. 20 In keeping with the general rules of Sec. 16(b) analysis, the question of whether a plaintiff has standing to bring suit is, in part, determined by whether the policy behind the statute is best served by allowing the claim. Thus, in Blau v. Oppenheim, 250 F.Supp. 881 (S.D.N.Y.1966) (Weinfeld, J.), the district court permitted a shareholder of a parent corporation to bring a Sec. 16(b) suit on behalf of its issuer-subsidiary. There the company that issued the stock that was traded in contravention of the statute was dissolved in a merger. The court reasoned that where the issuer is merged out of existence, none of the original shareholders are left to bring suit. Id. at 886. A holding that would allow only the shareholders of the now defunct issuer to remedy the statutory violation would therefore make the statute unenforceable. See id. at 886-87; see also Portnoy v. Kawecki Berylco Indus. Inc., 607 F.2d 765, 768 (7th Cir.1979). In order to avoid a result that was contrary to the purpose of the statute the court interpreted the word issuer to include the parent corporation. Oppenheim, 250 F.Supp. at 884. 21 Defendants urge that we limit Oppenheim to permit a shareholder of a parent corporation to maintain a Sec. 16(b) suit with respect to the subsidiary's stock only when the original issuer did not survive a merger into the subsidiary. They contend that when the issuer survives the merger as a viable corporate entity enforcement of the statute by the issuer or by its shareholder, the parent corporation, is still available. We disagree with defendants' rationale; it would have been equally applicable to Oppenheim because there the Sec. 16(b) claim could have been brought by the issuer's survivor or by its shareholder, the parent corporation, yet the court did not restrict standing to those entities. The plaintiff in Oppenheim actually had less claim to standing than the plaintiff in the instant case, because in Oppenheim the plaintiff never held shares in the original issuer, but purchased shares in the parent only after the merger. Further, we do not rely on the interpretation of issuer set forth in Oppenheim, but focus instead on whether a security holder loses his standing as an owner of securities when his stock is involuntarily converted in a merger. 22 The probability that the statute will not be enforced is present to the same degree when the original issuer survives the merger as a wholly-owned subsidiary of the parent corporation as it was in Oppenheim. In such circumstance no public shareholders remain to bring an action. As a practical matter it is unrealistic to believe that the issuing corporation will bring an action against itself or its insiders. See Rothenberg, [1977-78] Fed.Sec.L.Rep. p 96,045 at 91,691; cf. Lewis v. McAdam, 762 F.2d 800, 802 (9th Cir.1985) (per curiam); Magida, 231 F.2d at 846. Leaving insiders to police themselves is not only contrary to Sec. 16(b)'s private shareholder enforcement purpose, but also can be expected to secure the same results as those obtained when a fox guards a chicken coop. Concededly, some protection against insider abuse may still be available through a stockholder's derivative suit for breach of fiduciary duty. Yet such a suit is not as effective as a Sec. 16(b) claim because shareholders are subject to the already noted more stringent standing requirements of Rule 23.1, and, in addition, the complaint may be countered with subjective considerations of intent or good faith, such as a business judgment defense. Cf. Oppenheim, 250 F.Supp. at 887. 23 Moreover, the SEC endorses the view that the policy of Sec. 16(b) is best effectuated by allowing plaintiff to maintain this suit. See Ownership Reports and Trading By Officers, Directors and Principal Stockholders, Securities Exchange Act Rel.No. 26333 (Dec. 2, 1988), 42 SEC Docket 570, 53 Fed.Reg. 49997 (Dec. 13, 1988) [SEC Rel. No. 26333]. Although not binding on us, the SEC's insights in construing securities laws are entitled to consideration. See Basic Inc. v. Levinson, 485 U.S. 224, 239 n. 16, 108 S.Ct. 978, 987 n. 16, 99 L.Ed.2d 194 (1988); TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 n. 10, 96 S.Ct. 2126, 2132-33 n. 10, 48 L.Ed.2d 757 (1976). 24 Proposed SEC Rule 16a-1(h) would specifically define owner of a security as either a current beneficial owner of securities of the issuer at the time suit was filed or a former beneficial owner who was compelled to relinquish his holdings as a result of a business combination. See SEC Rel. No. 26333. While the proposed rule is inapplicable in the case at hand, cf. Mayer v. Chesapeake Ins. Co., 877 F.2d 1154, 1162 (2d Cir.1989), cert. denied, --- U.S. ----, 110 S.Ct. 722, 107 L.Ed.2d 741 (1990), it reflects the strength of the SEC's convictions. B. Standing Not Barred by Existing Law 25 Defendants and the dissenting opinion assert it is settled law that a security holder who commences a Sec. 16(b) suit must remain a security holder throughout the litigation and if he ceases to own the securities he loses his standing to continue the action. See Untermeyer v. Valhi, Inc., 665 F.Supp. 297 (S.D.N.Y.1987), aff'd mem., 841 F.2d 1117 (2d Cir.), aff'd on rehearing, 841 F.2d 25 (2d Cir.) (per curiam), cert. denied, 488 U.S. 868, 109 S.Ct. 175, 102 L.Ed.2d 145 (1988); Rothenberg, [1977-78] Fed.Sec.L.Rep. (CCH) p 96,045; see also Lewis, 762 F.2d 800; Portnoy, 607 F.2d 765; Staffin v. Greenberg, 509 F.Supp. 825, 840 (E.D.Pa.1981), aff'd on other grounds, 672 F.2d 1196 (3d Cir.1982). That conclusion is not mandated either by the statutory language or by the cited cases. 26 First, the language of the statute speaks of the owner of securities; but such language is not modified by the word current or any like limiting expression. The statute does not specifically bar the maintenance of Sec. 16(b) suits by former shareholders and Congress, had it so desired, could readily have eliminated such individuals as plaintiffs. The broad meaning of the word owner better accords with the remedial purpose of the statute. Second, although some decisions have denied standing to a Sec. 16(b) plaintiff on the grounds that he is not a current security holder, those cases are distinguishable. The district court, for example, relied upon Untermeyer v. Valhi, Inc., which dealt with a plaintiff who owned stock of the parent corporation, but who never owned stock of the company that issued the shares traded in contravention of Sec. 16(b). 665 F.Supp at 298. Thus, even without a merger the Untermeyer plaintiff would not have had standing. In contrast, plaintiff here brought a valid Sec. 16(b) suit while he was a current shareholder of the issuer, and but for the merger standing would not be in issue here. 27 In Rothenberg v. United Brands Co., also cited by the district court, the shareholders received cash in the merger instead of securities. The crucial factor considered by the trial court was that in a cashout merger the former shareholders maintain no continuing financial interest in the litigation. See Rothenberg, [1977-78] Fed.Sec.L.Rep. (CCH) p 96,045 at 91,692. In the present case all former International shareholders obtained, as a result of the merger, shares of International's parent corporation, and plaintiff, as one of them, continues to have at least an indirect financial interest in the outcome of this lawsuit. Two additional reasons caution against an overbroad application of Rothenberg: That decision noted that even if plaintiff had standing the Sec. 16(b) claim failed on the merits, see id. at 91,693-94; and the court's standing analysis was premised on an analogous application of Rule 23.1 which, as noted above, does not govern shareholders bringing Sec. 16(b) claims. Id. at 91,691-92. 28 Contrary decisions of our sister circuits are similarly distinguishable. See Lewis, 762 F.2d at 801 (plaintiff shareholder of parent but never held stock in the issuer or its surviving subsidiary); Portnoy, 607 F.2d at 767-68 (cashout merger left plaintiff with no continuing financial interest in the litigation; plaintiff's alternative status as a shareholder in the grandparent corporation gave no standing for Sec. 16(b) suit on behalf of the issuer). In the case at bar, the conversion of International stock into Viacom stock presents a novel situation where former shareholders have a continuing interest in maintaining suit in behalf of the issuer. We conclude, therefore, that under those unique circumstances the cases cited by defendants are neither controlling nor persuasive. 29 Here plaintiff's suit was timely, and while his Sec. 16(b) suit was pending he was involuntarily divested of his share ownership in the issuer through a merger. But for that merger plaintiff's suit could not have been challenged on standing grounds. Although we decline--in keeping with Sec. 16(b)'s objective analysis regarding defendants' intent--to inquire whether the merger was orchestrated for the express purpose of divesting plaintiff of standing, we cannot help but note that the incorporation of Viacom and the merger proposal occurred after plaintiff's Sec. 16(b) claim was instituted. Hence, the danger of such intentional restructuring to defeat the enforcement mechanism incorporated in the statute is clearly present. 30 Quite plainly, a rule that allows insiders to avoid Sec. 16(b) liability by divesting public shareholders of their cause of action through a business reorganization would undercut the function Congress planned to have shareholders play in policing such actions. See Oppenheim, 250 F.Supp. at 887; SEC Rel. No. 26333. 31 Permitting plaintiff to maintain this Sec. 16(b) suit is not barred by the language of the statute or by existing case law, and it is fully consistent with the statutory objectives. The grant of summary judgment must therefore be reversed. If it is established that profits were realized in contravention of the statute they should be disgorged to International. The section is designed to protect fairness interests, not provide compensatory relief. The result we reach will adequately protect the former International shareholders who now own International indirectly as shareholders of Viacom. Cf. American Standard, Inc. v. Crane Co., 510 F.2d 1043, 1060-61 (2d Cir.1974), cert. denied, 421 U.S. 1000, 95 S.Ct. 2397, 44 L.Ed.2d 667 (1975). 32 Because the plaintiff has standing under Sec. 16(b), we do not reach the district court's rejection of plaintiff's standing argument based upon an alleged double derivative action. See Mendell, [1988-89] Fed.Sec.L.Rep. (CCH) p 94,086 at 91,087. 33 III Plaintiff's Standing as a Noteholder Under Fed.R.Civ.P. 60(b) 34 In light of our reversal of the November 9, 1988 order and subsequent judgment of dismissal gives plaintiff his requested relief, plaintiff's appeal of the motion brought pursuant to Rule 60(b) is to some extent mooted. Nevertheless, we write to affirm the district court's denial of the Rule 60(b) motion in order to emphasize that plaintiff's purchase of a senior subordinated note of International did not provide grounds to vacate the district court's initial order. 35 The relevant portions of Rule 60(b) provide that upon such terms as are just, the court may relieve a party ... from a final judgment [or] order ... for the following reasons: (1) mistake, inadvertence, surprise, or excusable neglect; ... or (6) any other reason justifying relief from the operation of the judgment. Fed.R.Civ.P. 60(b). Motions under Rule 60(b) are addressed to the sound discretion of the district court and are generally granted only upon a showing of exceptional circumstances. Nemaizer v. Baker, 793 F.2d 58, 61 (2d Cir.1986). 36 Plaintiff argues that he purchased the International note as soon as it occurred to plaintiff's counsel (1) that any security holder of International could maintain a 16(b) action and (2) that notes of International were available to be purchased. We agree with the district court that counsel's ignorance of the law on this point cannot form the basis for relief under subdivision (1) of Rule 60(b). See id. at 62-63. Nor can we say that the district court abused its discretion when it denied relief under subdivision (6) of Rule 60(b). Plaintiff's acquisition of a note following an adverse ruling on his claim to standing as a shareholder did not present the kind of extraordinary circumstance that mandates relief to avoid an extreme and undue hardship. See Ackermann v. United States, 340 U.S. 193, 199, 71 S.Ct. 209, 212, 95 L.Ed. 207 (1950); Matarese v. LeFevre, 801 F.2d 98, 106 (2d Cir.1986), cert. denied, 480 U.S. 908, 107 S.Ct. 1353, 94 L.Ed.2d 523 (1987). 37 As a noteholder of International, plaintiff clearly has standing to bring a Sec. 16(b) claim in International's behalf. See 15 U.S.C. Sec. 78p(b). Yet his newly acquired noteholder status does not afford grounds to vacate an order premised on his status as a former shareholder.