Before SWAN, CHASE, and CLARK, Circuit Judges.
The issue on appeal is solely one of the construction and constitutionality of § 16 (b) of the Securities Exchange Act of 1934, 15 U.S.C.A.§ 78p (b), rendering directors, officers, and principal stockholders liable to their corporation for profits realized from security tradings within any 6 months' period. Plaintiffs, Smolowe and Levy, stockholders of the Delendo Corporation, brought separate actions under this statute on behalf of themselves and other stockholders for recovery by the Corporation - joined as defendant - against defendants Seskis and Kaplan, both directors and president and vice-president respectively of the Corporation. The United States, upon notification that the constitutionality of a federal statute had been called in question, sought intervention, which was granted, 36 F. Supp. 790; and thereafter the two actions were consolidated. After trial at which the facts were stipulated, the district court in a careful opinion, 46 F. Supp. 758, held the named defendants liable for the maximum profit shown by matching their purchases and sales of corporate stock, some transacted privately and some upon a national securities exchange, between December 1, 1939, and May 30, 1940, in conceded good faith and without any "unfair" use of inside information.
The named defendants had been connected with the Corporation (whose name was Oldetyme Distillers Corporation until after the transactions here involved) since 1933, and each owned around 12 percent (approximately 100,000 shares) of the 800,000 shares of $1 par value stock issued by the Corporation and listed on the New York Curb Exchange. The Corporation had negotiated for a sale of all its assets to Schenley Distillers Corporation in 1935-1936; but the negotiations were then terminated because of Delendo's contingent liability for a tax claim of the United States against a corporation acquired by it, then in litigation. This claim, originally in the amount of $3,600,000, had been reduced by agreement to $487,265, with the condition that trial was to be postponed (to await the trial of other cases) until, but not later than, December 31, 1939. The Corporation was, therefore, pressing for trial when on February 29, 1940, the present attorney for the defendants submitted to the Attorney General a formal offer of settlement of $65,000, which was accepted April 2 and publicly announced April 5, 1940. Negotiations with Schenley's were reopened on April 11 and were consummated by sale on April 30, 1940, for $4,000,000, plus the assumption of certain of the Corporation's liabilities. Proceedings for dissolution of the Corporation were thereupon initiated and on July 16, 1940, an initial liquidating dividend of $4.35 was paid.
During the 6 months here in question from December 1, 1939, to May 30, 1940, Seskis purchased 15,504 shares for $25,150.20 and sold 15,800 shares for $35,550, while Kaplan purchased 22,900 shares for $48,172 and sold 21,700 shares for $53,405.16. Seskis purchased 584 shares on the Curb Exchange and the rest from a corporation; he made the sale at one time thereafter to Kaplan at $2.25 per share - 15,583 shares in purported satisfaction of a loan made him by Kaplan in 1936 and 217 shares for cash. Kaplan's purchases, in addition to the stock received from Seskis, were made on the Curb Exchange at various times prior to April 11, 1940; he sold 200 shares on February 15, and the remaining shares between April 16 and May 14, 1940 (both to private individuals and through brokers on the Curb). Except as to 1,700 shares, the certificates delivered by each of them upon selling were not the same certificates received by them on purchases during the period. The district court held the transactions within the statute and by matching purchases and sales to show the highest profits held Seskis for $9,733.80 and Kaplan for $9,161.05 to be paid to the Corporation. Both the named defendants and the Corporation have appealed.
Section 16 (b) of the Securities Exchange Act of 1934 provides: "For the purpose of preventing the unfair use of information which may have been obtained by such beneficial owner, director, or officer by reason of his relationship to the issuer, any profit realized by him from any purchase and sale, or any sale and purchase, of any equity security of such issuer (other than an exempted security) within any period of less than 6 months, unless such security was acquired in good faith in connection with a debt previously contracted, shall inure to and be recoverable by the issuer, irrespective of any intention on the part of such beneficial owner, director, or officer in entering into such transaction of holding the security purchased or of not repurchasing the security sold for a period exceeding 6 months. Suit to recover such profit may be instituted at law or in equity in any court of competent jurisdiction by the issuer, or by the owner of any security of the issuer in the name and in behalf of the issuer if the issuer shall fail or refuse to bring such suit within 60 days after request or shall fail diligently to prosecute the same thereafter; but no such suit shall be brought more than 2 years after the date such profit was realized. This subsection shall not be construed to cover any transaction where such beneficial owner was not such both at the time of the purchase and sale, or the sale and purchase, of the security involved, or any transaction or transactions which the Commission by rules and regulations may exempt as not comprehended within the purpose of this subsection."
The controversy as to the construction of the statute involves both the matter of substantive liability and the method of computing "such profit." The first turns primarily upon the preamble, viz., "For the purpose of preventing the unfair use of information which may have been obtained by such beneficial owner, director, or officer by reason of his relationship to the issuer." Defendants would make it the controlling grant and limitation of authority of the entire section, and liability would result only for profits from a proved unfair use of inside information. We cannot agree with this interpretation.
We look first to the background of the statute. Prior to the passage of the Securities Exchange Act, speculation by insiders - directors, officers, and principal stockholders - in the securities of their corporation was a widely condemned evil*fn1 While some economic justification was claimed for this type of speculation in that it increased the ability of the market to discount future events or trends, the insiders' failure to disclose all pertinent information gave them an unfair advantage of the general body of stockholders which was not to be condoned. Twentieth Century Fund, Inc., The Security Market, 1935, 297, 298. By the majority rule, aggrieved stockholders had no right to recover from the insider in such a situation. And although some few courts enforced a fiduciary relationship and the United States Supreme Court in Strong v. Repide, 213 U.S. 419, 29 S. Ct. 521, 53 L. Ed. 853, announced a special-circumstances doctrine whereby recovery would be permitted if all the circumstances indicated that the insider had taken an inequitable advantage of a stockholder, even these remedies were inadequate because of the heavy burden of proof imposed upon the stockholders*fn2
The primary purpose of the Securities Exchange Act - as the declaration of policy in § 2, 15 U.S.C.A. § 78b, makes plain - was to insure a fair and honest market, that is, one which would reflect an evaluation of securities in the light of all available and pertinent data. Furthermore, the Congressional hearings indicate that § 16 (b), specifically, was designed to protect the "outside" stockholders against at least short-swing speculation by insiders with advance information*fn3 It is apparent too, from the language of § 16 (b) itself, as well as from the Congressional hearings, that the only remedy which its framers deemed effective for this reform was the imposition of a liability based upon an objective measure of proof. This is graphically stated in the testimony of Mr. Corcoran, chief spokesman for the draftsmen and proponents of the Act, in Hearings before the Committee on Banking and Currency on S. 84, 72d Cong., 2d Sess., and S. 56 and S. 97, 73d Cong., 1st and 2d Sess., 1934, 6557: "You hold the director, irrespective of any intention or expectation to sell the security within 6 months after, because it will be absolutely impossible to prove the existence of such intention or expectation, and you have to have this crude rule of thumb, because you cannot undertake the burden of having to prove that the director intended, at the time he bought, to get out on a short swing."*fn4
A subjective standard of proof, requiring a showing of an actual unfair use of inside information, would render senseless the provisions of the legislation limiting the liability period to 6 months, making an intention to profit during that period immaterial, and exempting transactions wherein there is a bona fide acquisition of stock in connection with a previously contracted debt. It would also torture the conditional "may" in the preamble into a conclusive "shall have" or "has." And its total effect would be to render the statute little more of an incentive to insiders to refrain from profiteering at the expense of the outside stockholder than are the common-law rules of liability; it would impose a more stringent statute of limitation upon the party aggrieved at the same time that it allowed the wrongdoer to share in the spoils of recovery*fn5
Had Congress intended that only profits from an actual misuse of inside information should be recoverable, it would have been simple enough to say so. Significantly, however, it makes recoverable the profit from any purchase and sale, or sale and purchase, within the period. The failure to limit the recovery to profits gained from misuse of information justifies the conclusion that the preamble was inserted for other purposes than as a restriction on the scope of the Act*fn6 The legislative custom to insert declarations of purpose as an aid to constitutionality is well known. Moreover, the preamble here serves the desirable purpose of guide to the Commission in the latter's exercise of its rule-making authority.
True, early drafts of the statute were without this preamble*fn7 But there is no indication, either in the Congressional hearings or in the debates, of dissent from the proposed objective standard of proof. Had the statute as enacted imposed more stringent penalties than appeared in these early drafts, there might be more reason for supposing that the introduction of a subjective standard was intended. But the statute as enacted actually omitted draft provisions rendering long and short sales by corporate fiduciaries within any 6 months' period unlawful and subject to criminal penalties*fn8 Furthermore, provisions in these early drafts declaring unlawful the improper disclosure of confidential information regarding securities by directors, officers, or principal stockholders, and holding that any profit made by any person to whom such unlawful disclosure was made should inure to the corporate issuer, were deleted, presumably because the burden of proof made enforcement unfeasible*fn9 Anomalously the construction of the statute which defendants would have us adopt would impose an equally severe burden as to profits made by the insiders themselves.
The present case would seem to be of the type which the statute was designed to include. Here it is conceded that the defendants did not make unfair use of information they possessed as officers at the time of the transactions. When these began they had no offer from Schenley's. But they knew they were pressing the tax suit; and they, of course, knew of the corporate offer to settle it, which re-established the offer to purchase and led to the favorable sale. It is naive to suppose that their knowledge of their own plans as officers did not give them most valuable inside knowledge as to what would probably happen to the stock in which they were dealing. It is difficult to find this use "unfair" in the sense of illegal; it is certainly an advantage and a temptation within the general scope of the legislature's intended prohibition.
The legislative history of the statute is perhaps more significant upon a determination of the method of computing profits - defendants' second line of attack upon the district court's construction of the statute. They urge that even if the statute be not construed to impose liability only for unfair use of inside information, in any event profits should be computed according to the established income tax rule which first looks to the identification of the stock certificate, and if that is not established, then applies the presumption which is hardly more than a rule of administrative convenience of "first in, first out."*fn10 Defendants rely on the deletion from early drafts of the statute, H.R. 7852, H.R. 8720, and S. 2693, of a provision that profit should be calculated irrespective of certificates received or delivered*fn11 H.R. 9323, which was finally passed by the House, failed even to penalize short-swing speculations, other than to prohibit short sales. But H.R. 8720 was never discussed by a House Committee of the ...