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VAN AALTEN v. HURLEY

July 30, 1959

Gertrude VAN AALTEN, Plaintiff,
v.
Roy T. HURLEY, Joseph V. Miccio, S. B. Kurzina, Jr., Jack O. Charshafian, Frank W. Mercik, William T. Lake, James G. Byron and Curtiss-Wright Corporation, Defendants



The opinion of the court was delivered by: BICKS

Sub judice are cross-motions for summary judgment. Plaintiff, a stockholder of Curtiss-Wright Corporation, instituted this suit pursuant to Section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C.A. § 78p(b), *fn1" to recover 'short-swing' profits allegedly realized by the individual defendants. The important legal issue presented is whether, assuming arguendo the invalidity of Securities and Exchange Commission Rule X-16B-3, 17 C.F.R. 240.16b-3, *fn2" the exculpatory provision contained in § 23(a) of the Act, 15 U.S.C.A. § 78w, immunizes the defendants from the asserted liability. *fn3" In deciding the question presented by the instant applications we are called upon to determine the meaning and effect of the much-discussed *fn4" opinions in Greene v. Dietz, 2 Cir., 1957, 247 F.2d 689, affirming, D.C.S.D.N.Y.1956, 143 F.Supp. 464.

The pertinent facts are not in dispute. Plaintiff is the holder of record of 100 shares of the corporation's approximately 8 million shares of outstanding common stock. At all times here material the common stock of the corporation was listed on the New York Stock Exchange, a national securities exchange. The corporation was organized under the laws of Delaware, and has its principal place of business in Wood-Ridge, New Jersey. At the time of the transactions which are the subject of this suit the individual defendants were key members of the corporation's management team.

 The action is based upon acquisitions during 1957 by the individual defendants of shares of the corporation's common stock and sales of common stock within six months of such acquisitions. The defendants admit the sales but as to the alleged purchases, they aver and the undisputed facts indeed are, that such acquisitions were effectuated through exercise of options granted under and pursuant to the corporation's restricted stock option plan. None of the individual defendants sold stock which he had acquired pursuant to said option plan within six months from the date of acquisition. The sales were at a price in excess of the price fixed by the option plan.

 The stock option plan was evolved by a Stock Option Committee appointed by the Board of Directors. Three directors comprised the Committee, none of whom was an officer or employee of the corporation or a prospective optionee under the plan. The members of the Board who were eligible to participate in the Plan absented themselves from the Board meeting when the Plan was under consideration. The proposed plan was approved by the Board of Directors on December 31, 1954 and was adopted by an overwhelming majority of the stockholders at the annual meeting held on April 20, 1955. The proxy solicitation material for said meeting duly complied with the Commission's proxy rules.

 The plan authorizes the Board of Directors to grant to key employees options to purchase a maximum of 440,000 shares of the corporation's common stock at a price, payable in cash at the time the option is exercised, of not less than 95% of the price reached by the stock on the New York Stock Exchange on the date the option is granted, and to determine the employees to whom options would be granted and the number of shares to be offered to each of them respectively. The right to grant options terminates on December 31, 1964, or at such earlier time as the Board of Directors may determine.

 Directors as such are ineligible to participate in the plan; directors who also serve as officers are eligible but are barred from participating in Board action respecting the plan. Options are exercisable during the period beginning one year and ending ten years after the date of the granting thereof. They are non-transferable except by will or the laws of descent and distribution and are exercisable only by the employee-optionee during his lifetime. Upon accepting an option the employee obligates himself to remain in the corporation's employ for at least another two years; in the case of the defendant Hurley, however, his acceptance obligated him to continue on for an additional term of not less than three years.

 On December 31, 1954, all of the individual defendants, except the defendant Hurley, attended a meeting at which the defendant Byron, in the course of his duties as Vice-President in charge of personnel, explained the provisions of § 16(b) and Rule X-16B-3. He advised that the corporation's stock option plan complied with the conditions prescribed by the Rule and that acquisitions of stock pursuant to options granted under the plan were exempt from the operation of § 16(b). Later that same day, all of the individual defendants attended a meeting at which counsel for the corporation gave substantially the same advice. Promptly after the Plan became effective, all of the defendants who then were officers *fn5" duly reported receipt of their respective options to the Commission and to the New York Stock Exchange by filing Form 4. *fn6" Each defendant from time to time thereafter duly filed a report on Form 4 disclosing the changes in his holdings resulting from acquisitions of stock pursuant to the option plan. The sales and acquisitions alleged in the complaint are reflected in the disclosures made by the defendants consistent with the requirements of the Act and the Regulations promulgated thereunder.

 Prior to the earliest transaction here complained of, counsel for the corporation furnished it with an opinion letter and explanatory memorandum, to the effect that Rule X-16B-3 exempted from the operation of § 16(b) stock acquired pursuant to the corporation's option plan. None of the defendants entered into any of the transactions complained of prior to the time he had been apprised of the advice of counsel as to the exemption accorded by Rule X-16B-3. In the affidavits filed by the defendants each of them states that in exercising the option granted to him under the option plan and in making the sales alleged in the complaint, he relied in good faith on the provisions of Rule X-16B-3, and that when he effected said transactions he had no knowledge or information that in Greene v. Dietz, supra, two members of the Court of Appeals for this Circuit had expressed doubts as to the validity of the Rule.

 Plaintiff makes no attempt to controvert the pertinent facts set forth to establish the defense under § 23(a) of the Act. She contents herself with urging that 'after June 7, 1957, *fn7" defendants must conclusively be presumed to have had knowledge of the decision of the Court of Appeals in Greene v. Dietz and could not therefore profess to have exercised options, or sold shares, in reliance on Rule X-16B-3' so that 'as a matter of law, (they) could not have relied in good faith upon the * * * exculpatory provisions of Section 23(a) of the Act.' Implicit in this contention is the impermissible suggestion that the Court decided an issue which it expressly stated was 'not essential to (its) opinion' 247 F.2d 689, 692, or that its expression of doubt as to the power of the Commission to promulgate Rule X-16B-3 is or was intended to be a judicial determination of invalidity.

 As originally enacted in 1934, § 23(a) did not contain an exculpatory clause. This provision was added to the Act in 1936 in order 'to provide that persons who act in good faith in conformity with any rule or regulation of the Commission * * * shall not be subjected to liability if such rule or regulation is subsequently rescinded or invalidated for any reason.' S.Rep.No.1739, 74th Cong., Sess., p. 4 (1936). Section 23(a) of the Act, 15 U.S.C.A. § 78w, in relevant part, provides as follows:

 'No provision of this chapter imposing any liability shall apply to any act done or omitted in good faith in conformity with any rule or regulation of the Commission * * * notwithstanding that such rule or regulation may, after such act or omission, * * * be determined by judicial or other authority to be invalid for any reason.'

 Exculpatory provisions of like purport are common in administrative statutes; they appear in the rule-making provisions of all the S E C legislation. Loss, Securities Regulation pp. 1097-1098 (1951). Their purpose is to broadly protect those who understandably *fn8" rely upon a duly promulgated rule of an administrative agency, notwithstanding that such rule is thereafter invalidated. Such protection takes on increasing importance in this modern era when administrative bodies regulate so substantial a segment of our society, and is especially applicable to those cases where judges themselves entertain diverse views as to validity of a particular rule. *fn9"

 The language of § 23(a), particularly the portion reading 'notwithstanding that such rule or regulation may, after such act or omission * * * be determined * * * to be invalid', makes it clear that the defense afforded by the Section is unavailable where the 'act or omission' takes place after a determination of invalidity. Since the transactions which are the subject of the complaint occurred before the Rule was held invalid in Perlman v. Timberlake, supra, and since the only other case theretofore decided and here pertinent is Greene v. Dietz, supra, our initial inquiry is whether in the latter case Rule X-16B-3 was 'determined' to be invalid within the meaning of § 23(a).

 There the Court of Appeals for this Circuit held that insiders who in good faith relied upon Rule X-16B-3 and sold stock within six months of exercising options granted under a plan conforming to the requirements of the rule were protected from liability under Section 16(b). In its initial opinion of June 7, 1957, a majority of the panel declined to adopt that portion of the opinion below (D.C.S.D.N.Y.1956, 143 F.Supp. 464, 472, 473,) which sustained the rule, stating in part 'although not essential to our opinion, we express doubt as to the power of the Commission to promulgate Rule X-16B-3 * * *'. 247 F.2d at pages 692, 695. The dissenting Judge agreed with the court below on the question of validity. 247 F.2d at page 696. An application for rehearing was denied on ...


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