Court Opinion

ID: 8898738
Source: CourtListenerOpinion
Date Created: 2022-11-27 00:37:04.782553+00
Date Added: 2024-06-11T17:07:40.813115
License: Public Domain

STEPHENSON, Circuit Judge
(dissenting).
I respectfully dissent.
I would affirm the action of the Securities and Exchange Commission in exempting the proposed merger from the proscription of 15 U.S.C. § 80a-17 et seq.1 I am satisfied that “the Commission’s action is based upon substantial evidence and is consistent with the authority granted by Congress.” Securities & Exchange Commission v. Chenery Corp., 332 U.S. 194, 207, 67 S.Ct. 1575, 1582, 91 L.Ed. 1995 (1946). See 15 U.S.C. § 80a-42(a).
The Commission is granted the broad authority to issue an order of exemption if the evidence establishes that:
(1) the terms of the proposed transaction, including the consideration to be paid or received, are reasonable and fair and do not involve overreaching on the part of any person concerned;
15 U.S.C. § 80a — 17(b)(1).
The Commission recognized that in applying this test “we must find this transaction fair to the stockholders of both companies. See Bowser, Inc., 43 S.E.C. 277 (1967).” (Comm.Op. at 8 n. 22).2 It took note of the contention of the two companies, Du Pont and Christiana, that in economic reality Christiana stock already is Du Pont stock under another name — 98% of Christiana’s total assets is Du Pont common stock. Thus the merger involves for all practical purposes an exchange of equivalents. On the other hand the three objecting Du Pont stockholders contended that the transaction would confer great benefits on Christiana’s stockholders; give Du Pont stockholders nothing worth mentioning but actually injure them; and serve no real business purpose for Du Pont. The Commission then proceeded to analyze these contentions.
The benefits to Christiana stock-holders3 will be substantial. They stem from the federal tax structure and stock market phenomena. Under current tax law Christiana pays an effective 7.2% tax on the dividend income accrued on its Du Pont stock before such dividend is disbursed to Christiana stockholders. The merger eliminates this tax burden. An alternative method of accomplishing the same end could be achieved by liquidation of Christia-na but it is conceded that tax consequences would make it more expensive than the merger which is a tax-free plan.4
The Commission noted that the tax benefits accruing to the Christiana stockholders
will inflict no corresponding detriment on Du Pont or on its stockholders. The burden will fall wholly on the United States. * * * Nor do we see how Section 17(b)’s “reasonable and fair” standard can be deemed to require Christian’s stockholders to turn every nickel of their tax savings over to Du Pont. The tax savings are of some weight. But it does not follow that the Du Pont stockholders are to be subrogated to the rights that the United States now enjoys under the status quo.
(Comm.Op. at 17-18, n. 44).
Taxpayers, of course, are not prohibited from arranging their affairs so as to minimize taxes. In Commissioner v. First Security Bank, 405 U.S. 394, 398-99 n. 4, 92 S.Ct. 1085, 1089, 31 L.Ed.2d 318 (1972), the Supreme Court observed that
Taxpayers are, of course, generally free to structure their business affairs as they *607consider to be in their best interests, including lawful structuring (which may include holding companies) to minimize taxes. Perhaps the classic statement of this principle is Judge Learned Hand’s comment in his dissenting opinion in Commissioner v. Newman, 159 F.2d 848, 850-851 (CA2 1947):
“Over and over again courts have said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant.”
See Knetsch v. United States, 364 U.S. 361, 365, 81 S.Ct. 132, 5 L.Ed.2d 128 (1960); Chirelstein, Learned Hand’s Contribution to the Law of Tax Avoidance, 77 Yale L.J. 440 (1968).
The stock market phenomenon is that Christian’s shares were selling at a discount of 23% when the merger negotiations were first announced and during the preceding two years the discount had been between 20% and 25%.5 The objectors and my colleagues insist that the fact that the market value of Christiana stock is affected by the intercorporate dividend tax and unrealized capital gains liabilities is no reason to ignore that value in determining its worth.
The Commission recognized that the benefits to the parties were not equal — the benefits inuring to the Christiana stockholders were greater than to the Du Pont stockholders.6 Christiana’s stockholders could have caused Christiana to be liquidated and thereby achieved the results contemplated by the merger. Admittedly, the merger was designed to avoid serious tax problems that Christiana’s liquidation would engender for its stockholders. However, the Commission concluded that these tax-related benefits should not be weighed against Christiana in determining the overall fairness of the merger.
Aside from those tax problems, however, the economic impact of this merger on Du Pont and its stockholders is no more onerous than the impact that would be produced were the Christiana stockholders to exercise their prerogative to liquidate Christiana. More specifically, the possible market effects resulting from the Christiana stockholders acquiring direct ownership of the Du Pont shares would be the same. It may be that in the course of bargaining between wholly unrelated parties, Du Pont could have exacted a handsome price for permitting consummation of the transaction in a form that relieves the Christiana stockholders of their tax problems. But Du Pont’s failure to do that does not render the transaction unreasonable or unfair. The Du Pont stockholders, including the objectors, have no property interest in the Christiana stockholders’ tax problems. A principal reason why Section 17 of the Investment Company Act requires us to pass upon the fairness of transactions such as this, is to prevent persons in a strategic position from using that position to effect transactions for other than fair value. And fair value does not change simply because a strategic posi*608tion arises from something other than affiliation.
(Comm.Op. at 18).
Instead, the Commission viewed the objectors’ claim of detriment by reason of market impact to be the crux of the case. Objectors fear that the merger will produce considerable selling of Du Pont that otherwise would not take place and thus the market price would be depressed. Christia-na argues there is little reason to believe that the Christiana stockholder will sell the Du Pont shares he receives in the merger because of adverse tax consequences. The tax basis of the Du Pont common stock received by the Christiana common stockholders who own only Christiana common stock will be the same as the basis of the Christiana common stock surrendered in exchange therefor. My colleagues are of the opinion that “the Commission erred in failing to give any weight to the factor of occasional detriment to Du Pont shareholders.” (Majority Op. at 605). I am persuaded that the thrust of the Commission’s view is that “[speculations about the probable behavior patterns of speculators are much too slender a reed on which to predicate findings of fairness under the Investment Company Act.” (Comm.Op. at 22). This disagreement brings into focus the dispute with respect to the valuation standard applied by the Commission in assessing the fairness of the transaction. 7
It is the Commission’s view that:
Here justice requires no ventures into the unknown and unknowable. An investment company, whose assets consist entirely or almost entirely of securities the prices of which are determined in active and continuous markets, can normally be presumed to be worth its net asset value. What better guide to its value could there be? The simple, readily usable tool of net asset value does the job much better than an accurate gauge of market impact (were there one) could. The record indicates that most of Christiana’s stock is held by long-term investors. Hence there is no pressing need to depart from the net asset value test.57
*609(Comm.Op. at 23-24 & n. 57).
My colleagues insist that the plain language of the Act does not permit the Commission to establish as a rule of law that closed-end, nondiversified companies should be presumptively worth the value of their net assets. (Majority Op. at 589, et seq.). I disagree. The Commission in this 17(b) proceeding has been delegated the responsibility of applying the “reasonable and fair” test. Its judgment in applying this broad criterion is not subject to reversal “save where it has plainly abused its discretion.” Securities & Exchange Commission v. Chenery Corp., supra, 332 U.S. at 208, 67 S.Ct. at 1583; accord, Niagara Hudson Power Corp. v. Leventritt, 340 U.S. 336, 347, 71 S.Ct. 341, 95 L.Ed. 319 (1951); Securities and Exchange Commission v. Central-Illinois Securities Corp., 338 U.S. 96, 126, 69 S.Ct. 1377, 93 L.Ed. 1836 (1949).8 The above cases involve application by the Commission of the “fair and equitable” standard of section 11(e) of the Public Utility Holding Company Act of 1935, 15 U.S.C. § 79k(e). In Chenery, supra, 332 U.S. at 209, 67 S.Ct. at 1583, the Supreme Court spoke as follows:
The Commission’s conclusion here rests squarely in that area where administrative judgments are entitled to the greatest amount of weight by appellate courts. It is the product of administrative experience, appreciation of the complexities of the problem, realization of the statutory policies, and responsible treatment of the uncontested facts. It is the type of judgment which administrative agencies are best equipped to make and which justifies the use of the administrative process. See Republic Aviation Corporation v. National Labor Relations Board, 324 U.S. 793, 800, 65 S.Ct. 982, 986, 89 L.Ed. 1372, 157 A.L.R. 1081. Whether we agree or disagree with the result reached, it is an allowable judgment which we cannot disturb.
I am persuaded that this language controls our action in this case.
In summary, the proposed merger involves essentially an exchange of equivalents — Du Pont stock for Du Pont stock. The benefits to Christiana stockholders are substantially greater than to Du Pont stockholders. This is due largely to tax consequences. It will be a tax-free exchange. Christiana shareholders avoid the probable tax consequences a liquidation would involve. They also rid themselves of the intercorporate dividend tax of 7.2% which has contributed to the discount in the market value of Christiana shares as compared to Du Pont shares.9 However, Du Pont shareholders have no property interest in these resultant tax savings. Further, the detriment to present Du Pont common stockholders is dubious. At the most there may be some additional selling of Du Pont stock which will temporarily affect the market value of Du Pont. This is highly speculative. The tax basis of Du Pont stock received by Christiana shareholders in the merger will be the same as the Christia-na stock surrendered in exchange therefor. Tax consequences will deter the temptation to sell. Under all the circumstances the Commission concluded that the disparity in benefits justified the proposed 2.5% discount ($55 million) from the net asset value of Christiana. It was within the range of fairness. A discount appreciably higher “would divest Christiana stockholders of a significant portion of the intrinsic investment values to which they are legally and equitably entitled” and thus “run afoul of the Act.” (Comm.Op. at 26).
*610The Commission exercising its expertise under applicable statutory authority made a judgment which we cannot disturb.10 I would affirm.
*614Assumptions
A. Adjusted net asset value as shown in DuPont Exhibit No. 5, pp. 6 and 7. Christiana’s holding of DuPont common stock is valued at $163,875, the average of the closing prices on the New York Stock Exchange, July 10 through 14, 1972. This value is also used to compute the number of DuPont shares to be issued to preferred and common stockholders of Christiana.
B. Earnings per share are based on net income of DuPont after the merger, calculated at $347.6 million:
Actual 1971 net income earned on common stock $346,500,000
Earnings of 4.46 percent on Chris-tiana assets to be redeployed by DuPont:
Wilmington Trust Co. share $ 2,699,424
News-Journal Co. share 24,260,000
Cash, less current liabilities 5,981,367
Claim for tax refund 11.723.013
44,663,804
Less adjustment for handling tax refund claim 12,723,013
Less expenses and taxes on sale of assets 7,619,606
Less merger expenses 1.500.000
$22.821.185 1,017,825
Preferred dividends saved by retiring Christiana's holding of 16,256 DuPont preferred shares, 16,256 X $4.50 73.152
$347.590.977
Values of Christiana assets are from DuPont Exhibit No. 5, pp. 4 and 6. The full amount of merger expenses is shown because these reduce the total extra assets available to DuPont. (4.46 percent is shown in Division’s Exhibit 12, Exhibit 4 — Kidder, Peabody).
C.Percentage changes in earnings and dividends per share are based on Chris-tiana’s 1971 earnings per share of $5.28 and dividend per share of $5.25, and DuPont’s earnings per share of $7.33 and dividend of $5.00.
D.Payout ratios for DuPont of 68.6 percent and 74 percent are based on data for the previous five years. 68.6 percent is the average of the three lowest ratios; 74 percent approximates the highest ratio.
1967 1968 1969 1970 1971
Payout ratio (%) 74.3 68.8 68.9 72.9 68.2
These data are computed from DuPont Exhibit No. 5, pp. C-3.
E. In these tables, dividends are maintained at specified proportions of earnings. These dividends change as earnings vary with differing discounts.
F. The computation of the premium, or increase in market value of Christiana shares, is based on the closing market price for DuPont and the closing bid price for Christiana on April 28, 1972, the day that merger discussions were announced, and July 17, 1972, the day the proposed merger terms were announced.
G. Shown to three decimal places; calculations done with six or more decimal places. Formula for computation:
-f ANAV (l-d)4 - 120 CP
XR = _DCSP_
CCS
where ANAV = adjusted net asset value ($2,223,425,827)
CCS = number of shares outstanding of Christiana common stock (11,710,103)
CP = number of shares outstanding of Christiana preferred stock (106,500)
d = discount from adjusted net asset value (stated as a decimal)
DCSP = price of DuPont common stock ($163,875)
XR = exchange ratio (number of DuPont common for one Christiana).
H.87.9 percent is shown because this is the percentage at which the dividend to Christiana common stock is the same before and after the merger.
*615I. 76.9 percent is shown because it portrays the effect of a 23.1 percent discount. This was the discount on April 28, 1972, based on mean market price and net asset value of Christiana (see Applicants’ Joint Exhibit IB, Exhibit 9 — Morgan Stanley).
J. The market value of the net shares of DuPont to be issued or retired is computed using the closing market value for DuPont on April 28, 1972 and July 17, 1972.

. Section 17(a) of the Investment Company Act of 1940.

. The findings and opinion of the Commission reported as Christiana Securities Company, Investment Company Act of 1940, Release No. 8615 (December 13, 1974) will be referred to as (Comm.Op.). To avoid repeating matters set out in the majority opinion of this court citation thereto will be as follows: (Majority Op.).

. Members of the Du Pont family hold about 75% of Christiana, the other 25% belonging to public stockholders.

. The merger is designed to be tax-free to Christiana and its stockholders and was conditioned on a ruling to that effect by the Internal Revenue Service. A favorable ruling has now been made. IRS Opinion Letter to Kenneth W. Gemmill, counsel for Christiana Securities Co., December 30, 1975.

. The discount is probably attributable to the intercorporate dividend tax of 7.2% and the fact that Christiana stock is a thinly traded over-the-counter issue whereas Du Pont is an active, well-known listed stock. (Comm.Op. at 22 n. 51).

. The principal benefits accruing to Du Pont stockholders arise from the merger agreement which provides for the issuance of Du Pont common stock equivalent in value to 97.5% of Christiana’s net assets after certain adjustments. The 2.5% discount from Christiana’s net asset value amounts to approximately $55 million. It should be noted, however, that since Christiana has a 28.3% interest in Du Pont, 28.3% of the 2.5% discount will go back to Christiana stockholders. Another benefit is the dispersal of control. The Commission accorded this little weight because it viewed the same as being more formal than substantive (Majority Op. at 602, 603). I agree with the majority that important advantages to Du Pont and the public would flow from an effective dispersion of control (Majority Op. at 603).

. Two other items deserve brief comment. The majority is of the view that substantial weight cannot be given to the bargain reached because of the absence of arm’s length bargaining (Majority Op. at 598); further that only limited weight can be given the recommendations of the financial advisors (Majority Op. at 598). I do not disagree. Neither does the Commission. The Commission recognized that “[i]t is precisely because transactions of this character are replete with inherent conflicts of interest that the Act requires that they be submitted to us.” (Comm.Op. at 26 n. 62).
The Commission noted that in some situations the opinions of experts were crucial, e. g., a question about the value of a major league baseball franchise, but such is not the case here. It commented:
The instant case, on the other hand, involves marketable securities. The questions presented are in our view essentially legal. Hence they cannot be resolved by reference to the opinions of financial experts, however conscientious and however eminent. We do not go so far as to say that expert testimony is of no weight here. Some of it we have found interesting and even instructive. But in view of the nature of the issues raised, we think its weight limited.
(Comm.Op. at 13-14 n. 38).

 Investment companies are as a general rule media for long-term investment. That makes net asset value the touchstone. And the Act is based on that premise. Section 2(a)(41)(B) states that “ ‘Value’ with respect to assets of registered investment companies . means . . . with respect to securities for which market quotations are readily available, the market value of such securities.” And although the closed-end discount phenomenon was well-known in 1940, the Congress that passed the Act chose to protect closed-end stockholders against dilution of intrinsic values rather than to facilitate the sale of new closed-end shares. Section 23(b) of the Act shows that. It provides that “No registered closed-end company shall sell any common stock of which it is the issuer at a price below the current net asset value of such stock.” And we have viewed net asset value as the controlling factor in Section 17 proceedings. See, e. g., Harbor Plywood Corporation, 40 S.E.C. 1002, 1010 (1962); Delaware Realty and Investment Company, 40 S.E.C. 469, 473 (1961). Compare Central States Electric Corporation, 30 S.E.C. 680, 700 (1949) (advisory report on plans for the reorganization of a closed-end investment company under Chapter X of the Bankruptcy Act *609urging “net asset value as the primary measure of value of an investment company.”)

. The Congress in numerous statutes has established the Securities and Exchange Commission as the expert government agency in securities matters. Securities Act of 1933, 15 U.S.C. §§ 77a-77aa; Securities Exchange Act of 1934, 15 U.S.C. §§ 78a-78jj; Public Utility Holding Company Act of 1935, 15 U.S.C. §§ 79-79z-6; Trust Indenture Act of 1939, 15 U.S.C. §§ 77aaa-bbbb; Investment Company Act of 1940, 15 U.S.C. §§ 80a-l-80a-52; Investment Advisers Act of 1940, 15 U.S.C. §§ 80b 1-21.

. See n. 5, supra.

. For an additional discussion of the fairness standard under the Act, see Harriman et al. v. E. I. DuPont de Nemours and Co., 411 F.Supp. 133, Civil No. 4721 (D.Del., December 23, 1975).
*611APPENDIX I

*612

*613APPENDIX II — Continued ($501,968,820) ($490,780,810) ($250,878,920) ($245,287,260) Market value of net shares(j) April 28, 1972 $18,624,602 ($31,715,293) July 17, 1972 $18,209,492 ($31,008,414) (2,983,470) (1,491,108) (188,501) 110,696 Net number of DuPont common to be issued (retired) $5.79 +15.8% $5.59 +11.8% $5.44 + 8.8% $5.41 +8.2% Dividends per share, 74 percent payout(d,e) Percent change from 1971(c) $5.36 + 7.2% $5.19 + 3.8% $5.05 + 1.0% $5.01 + 0.2% Dividends per share, 68.6 percent payout(d,e) Percent change from 1971(c) 76.9%(i) $7.82 + 6.7% 87■9%(h) $7.56 + 3.1% 97,5% $7.36 + 0.4% 100% $7.31 -0.3% Earnings per share(b) Percent change from 1971(c) EFFECTS UPON DUPONT COMMON STOCK OF VARIOUS DISCOUNT VALUES AND DIVIDEND POLICIES * MERGER AT SPECIFIED PERCENTAGE OF ADJUSTED NET ASSET VALUE (a) See assumptions on following pages, referenced by letters (a) through (j) on this table.