Court Opinion

ID: 6920596
Source: CourtListenerOpinion
Date Created: 2022-07-23 23:00:04.200444+00
Date Added: 2024-06-11T16:06:47.361941
License: Public Domain

CLARK, Circuit Judge
(dissenting).
Against the background of “a widely condemned evil,” § 16(b) of the Securities Exchange Act of 1934 put teeth into the concept of a corporate director’s fiduciary obligation by the simple but arbitrary course of requiring him to disgorge to his corporation “insider” profits from stock speculation obtained under stated circumstances and without regard to his own good faith or innocence. This device has worked successfully where more refined methods might have failed; and although the provision “is probably the most cordially disliked provision in all these statutes from the point of view of those whom it affects,” Loss, Securities Regulation 578 (1951), yet its policy is so important and so generally approved that repeal seems unlikely, id. 579; Cook & Feldman, Insider Trading under the Securities Exchange Act, 66 Harv.L.Rev. 385, 612, 641 (1953). In our first case construing it we said, “The statute is broadly remedial,” and went on to say: “We must suppose that the statute was intended to be thoroughgoing, to squeeze all possible profits out of stock transactions, and thus to establish a standard so high as to prevent any conflict between the selfish interest of a fiduciary officer, director, or stockholder and the faithful performance of his duty.” Smolowe v. Delendo Corp., 2 Cir., 136 F.2d 231, 239, 148 A.L.R. 300, certiorari denied Delendo Corp. v. Smolowe, 320 U.S. 751, 64 S.Ct. 56, 88 L.Ed. 446. That principle has since shaped our statutory interpretation as well as that of other courts and is restated in our latest and full opinion in Adler v. Klawans, 2 Cir., 267 F.2d 840.
To this uniform interpretation there appears to have been one notable exception, the decision relied on as authoritative here, Rattner v. Lehman, 2 Cir., 193 F.2d 564. That case held that where' a director was fortunate enough to be a partner in a brokerage firm which did the actual trading, he and his partners were relieved of liability for insiders’ profits perhaps in all cases, but in any event in nearly all. The decision below, affirmed by my brother Medina, goes far to complete the process of complete immunity toward which my brother Swan, with relentless logic, tends. I think the principle is anomalous in granting exemption in the very cases where the incentive to take insiders’ profits is strongest as a part of a trading firm’s normal business and where exception is the most *794difficult to understand. So I believe we should review the ruling in the light of experience and the present-day situation. And at the very least we should request assistance in the form of a brief amicus curiae from the S.E.C., which has often been most helpful on mooted issues in the past, but which has here not allayed, but has rather added to, the confusion, as I point out hereinafter.
I suggest that re-examination of the. Rattner precedent is indicated for several reasons: the circumscribed nature of the discussion there had; the teaching of later experience; the equivocal position of the S.E.C. — now apparently clarified contra to the decision; and the confusion as to its possible scope and real or apparent exceptions. My own conclusion is that the case should be overruled or at least limited and that the partners here, including Thomas, should be required to pay Thomas’ company the profits they made from short-swing trading in its stock.
The Rattner decision appears to be supported on three grounds, two of them stated in the opinion and a third adduced by later commentators. First reliance is placed upon a “literal reading” of the statute. But any reading, literal or otherwise, can hardly avoid the legal meaning of “owner” or eliminate the basic principles of partnership. Under these principles, clearly stated in New York law as embodied in the Uniform Partnership Act, property bought with partnership funds is partnership property, and a partner is co-owner with his partners of specific partnership property holding as a tenant in partnership with an equal right with his partners to possession of specific partnership property and with an equal share in the profits and surplus. N. Y. Partnership Law §§ 12, 40, 43, 50-52. Moreover, the partnership is charged with knowledge of or notice to a partner. Id. § 23. I submit that on a literal legal reading of the statute, Thomas, was co-owner with all the other partners of the Tide Water stock when bought and of the profits when sold, and that Thomas stood at'all times legally charged with full knowledge of what was going on in his firm, just as the other partners had like knowledge. Further,' I do not doubt that in any ordinary well run partnership, the practical facts of life actually coincide with these legal facts, and that one partner either actually knows what is going on in his group or is content to leave action to his colleagues. In any event, the legal situation seems clear — so much so that in my view co-owners cannot be excluded from the operation of the statute without a serious distortion of its terms. Furthermore to close the gap now opened up would require rather awkward and seemingly superfluous phraseology, such as that “owner” actually does include “co-owner.”
A second ground of support for the decision was deduced from the legislative history and from the fact that a provision in earlier drafts which had made liable any person who acted on confidential information disclosed by a director was eliminated from the statute as finally enacted. But as the S.E.C. pointed out in its brief amicus curiae in Rattner, this history, so far as pertinent, really points the other way and in favor of an automatic application of the statute without the necessity of proving the parties’ intent. That, too, is the view of the legislative history we emphasized in Smolowe v. Delendo Corp., supra, 2 Cir., 136 F.2d 231, 235, 236. But the Rattner decision forces for this important class of cases the very step which we felt Congress had avoided, namely, a “subjective standard of proof, requiring a showing of an actual unfair use of inside information.” 2 Cir., 136 F.2d 231, 236.
The third ground of support, adduced by some commentators, 25 So.Calif.L.Rev. 475, 478 (1952), 100 U. of Pa.L.Rev. 463, 465 (1951),1 is the harshness in result of the contrary conclusion. Passing the question whether Congressional in*795tent is to be thus limited, one may question whether this is not an attack on the •entire statutory policy which is somewhat misdirected when leveled only at a single consequence as here. Admittedly the statute operates stringently, with burdensome results to individuals, in ■many, possibly most, cases. But that ■seems not a sound reason for excepting its operation in this important and natural field of operation. True, the ■amounts involved may be large, as is to ■be expected from the high financial character of the protagonists naturally involved in the trading by Wall Street investment firms. But that may be easily taken as an argument for application of the statute here.2 I think the exemption ■of these firms would be hard to explain to the ordinary small-scale director not so exempt and indeed to the investing public generally.
But if the requirement of a subjective standard of proof is to stand, then the question at once arises as to how much. And here the Rattner case did at least suggest the possibility of some limitation. The majority expressly declined to consider whether the result might be different had the partner “caused” the firm to make the short-swing transactions. Judge L. Hand in an obviously worried concurrence went further and, assuming for his disposition of the case that the firm had bought and sold the shares without any advice or concurrence by the director-partner, intimated that the result might be different if a firm deputed a partner to represent its interests as a director on the board. Here the evidence of director-participation is rather sharper than Judge Medina intimates and goes so far that it is hard to see what more the director could have done to assist his partners short of doing the trading himself. For in his deposition Thomas stated that he had suggested to his partners “from time to time that I thought Tide Water under the new management was an attractive investment” and again, “When the new management came in, my opinion was asked of what I thought of it, and after I watched them in, I expressed my opinion freely that I thought the management was first-rate, that the company would do well under that management.” He also said that one of the partners with whom he discussed the Tide Water management after he became a director was Mr. Hammerslough, the trading partner who actually directed the firm’s purchases of Tide Water stock; and Hammerslough himself testified on deposition that after Thomas became a director he “spoke very highly of the management and prospects of the Tide Water Oil Company. I believe he thought very highly of it.” Unless judges are to be incredibly naive as to the facts of financial life, it is difficult to see what Thomas needed to say more to show that the lily was already gilded. The facts as to the proposed Tide Water exchange were published in the Wall Street Journal so that further details as to that would have been quite superfluous. In fact I regard all this discussion whether or not the firm “deputed” its members to sit on many corporate boards as naive. Obviously this was an arrangement of mutual benefit to both sides; what difference can it make in realities which extended the first invitation? And what further official “deputation” is needed more than the mere fact of this mutually beneficial management? So unless Rattner is to afford exemption in almost all situations of financial importance, we must reverse to hold that the suggested exceptions here apply to support firm liability.
In this situation the S.E.C. has not yet afforded us its accustomed assistance. *796In the Rattner case its general counsel filed a brief amicus curiae wherein it first urged that the statute in terms was to be construed as I have stated above and much of the reasoning I have employed was there adduced in support of its view. Then it undermined its own opinion by urging that it had freed the defendants of liability by adopting its Rule X-16A-3 (b) requiring a partner to file a report to it “only as to that amount of such equity security which represents his proportionate interest in the partnership,” and that the defendants were justified in assuming the Commission to hold the other partners not liable here. The court in the Rattner case rejected this argument, saying: “The Commission may exempt ‘transactions’ ; but it cannot reduce the liability imposed by section 16 (b).” Rattner v. Lehman, supra, 2 Cir., 193 F.2d 564, 566. That the Commission had its doubts at least as to the policy of its rule is shown by the following statement in its Rattner brief: “For reasons summarized below the Commission now has substantial doubt as to whether Rule X-16A-3 fully effectuates the statutory purpose of Section 16. It is therefore currently considering amending the rule to limit the broad exemption now implicit in it.”
At any rate the Commission soon (1953) amended its rule to require a partner to report the entire amount of the security owned by the partnership, Rule X-16A-8(g), adopted by Sec. Ex. Act Rel. 4801 (1953), now 17 CFR (1960 Supp.) § 240.16a-3(b). Loss, Securities Regulation 585-587 (1955 Supp.). And there the matter now stands, with the Commission at odds with our interpretation.
The matter of the validity of such a Commission regulation is obviously still an open one. We expressed doubt as to another rule in Greene v. Dietz, 2 Cir., 247 F.2d 689, which was thereafter held invalid in Perlman v. Timberlake, D.C.S.D.N.Y., 172 F.Supp. 246; but the contrary was held in Continental Oil Co. v. Perlitz, D.C.S.D.Tex., 176 F.Supp. 219. Seemingly the Commission still relies on its power under the statute. See Timbers, Management Compensation Plans: SEC Problems, Proceedings of the Second Annual Institute on Corporate Counsel, April 21, 22, 1960 (Fordham Univ. Press) 28, 37-38; Meeker & Cooney, The Problem of Definition in Determining Insider Liabilities Under Section 16(b), 45 Va.L.Rev. 949, 957 (1959); Cook & Feldman, Insider Trading under the Securities Exchange Act, 66 Harv.L.Rev. 385, 612, 632-635 (1953); Loss, Securities Regulation 578 (1951). This is an obvious state of confusion and uncertainty which is unfortunate to the public, the investors, and their traders. I do not believe any inference can be drawn from the failure of Congress to act to correct the Rattner decision; that body has lately been interested in other matters more immediately troublesome than that of the regulation of private investments and the S.E.C. obviously has not given it positive leadership. So it would seem to me that at least before we dispose of this vastly important issue we should ask the S.E.C. for its informed comments.
I should add that I agree with the method of computation, finding a “purchase” under § 16(b) and a total profit to the firm of $98,686.77, which Judge Dawson followed and Judge Medina approves in his opinion. But this computation, upon which we all agree, highlights the anomaly of the ultimate conclusions reached by my brothers. For they are forced to concede that insider profits were made and that there must be restitution to the corporation, but then they differ widely as to how much is to be restored. It seems to me that neither of their results can be justified logically or legally under any principles of the law of partnership with which I am familiar. I submit that if there were insider profits (as their concession shows) then the partnership and the individual partners must be held liable to return these profits in full to Tide Water. And that should be our decision. The final anomaly in our exceptional treatment of this ease is the denial of all interest for the use of the sums found due the corporation, contrary *797to our uniform practice in other cases. Magida v. Continental Can Co., 2 Cir., 231 F.2d 843, 848, certiorari denied Continental Can Co. v. Magida, 351 U.S. 972, 76 S.Ct. 1031, 100 L.Ed. 1490; Blau v. Mission Corp., 2 Cir., 212 F.2d 77, 82, certiorari denied Mission Corp. v. Blau, 347 U.S. 1016, 74 S.Ct. 872, 98 L.Ed. 1138; Park & Tilford v. Schulte, 2 Cir., 160 F.2d 984, 988, 989, certiorari denied Schulte v. Park & Tilford, 332 U.S. 761, 68 S.Ct. 64, 92 L.Ed. 347. If there are special equities here, they have not been stated.
I would reverse and remand for the entry of a judgment returning to the Tide Water corporation all the profits made from the transaction by the defendants, together with interest and costs.

. Other comments on the decision appear in Loss, Securities Regulation 585 (1955 Supp.), and Cook & Feldman, Insider Trading under the Securities Exchange Act, 66 Harv.L.Rev. 385, 391, 403, 633-634 (1953).

. Enforcement of strict accounting and refund against corporate fiduciaries is not exactly a novel legal idea. See Gratz v. Claughton, 2 Cir., 187 F.2d 48, 49, certiorari denied 341 U.S. 920, 71 S.Ct. 741, 95 L.Ed. 1353; Berner v. Equitable Office Bldg. Corp., 2 Cir., 175 F.2d 218; Nichols v. S.E.C., 2 Cir., 211 F.2d 412, 417-418; Surface Transit, Inc. v. Saxe, Bacon & O'Shea, 2 Cir., 266 F.2d 862, 868; In re Midland United Co., 3 Cir., 159 F.2d 340; Woods v. City Nat. Bank & Trust Co. of Chicago, 312 U.S. 262, 268, 61 S.Ct. 493, 85 L.Ed. 820; Loss, Securities Regulation 594 (1955 Supp.).