The opinion of the court was delivered by: TYLER
Isadore Blau, a stockholder of Air-Way Industries, Inc. ('Air-Way'), brings this action under Section 16(b) of the Securities Exchange Act of 1934, (15 U.S.C. § 78p(b)), to recover for the corporation 'short-swing' profits realized in 1955 and 1956 by insiders of Air-Way.
Trial was had before this court, sitting without a jury, on February 4, 10 and 11, 1965, and proposed findings of fact and conclusions of law have been submitted by the parties. In compliance with Rule 52(a), F.R.Civ.P., this opinion shall constitute the court's findings and conclusions.
The two principal defendants in this action are Edward Lamb, an Air-Way insider by virtue of his position as a director and member of the corporation's executive committee, and Edward Lamb Enterprises, Inc. ('Enterprises'), an Ohio corporation wholly owned by Lamb and the members of his family. Enterprises has served as a holding company for the Lamb family interests and qualifies as an Air-Way insider by virtue of its beneficial ownership of more than ten per cent of the outstanding common stock of Air-Way. The latter is a Delaware corporation with its common stock listed on the American Stock Exchange. Air-Way was named as a defendant after refusing plaintiff's demand that it commence this action.
Plaintiff claims that Lamb and Enterprises realized profits from purchase and sale transactions in both the common and the preferred stock of Air-Way. Because of the novelty of the questions raised by the preferred stock transactions, they constitute the major area of dispute in this action. The claim on the common stock transactions, although involving a not insubstantial amount of damages, is comparatively less complex and will be dealt with separately hereinafter.
I. PREFERRED STOCK TRANSACTIONS
The following essential facts illuminate and bear upon the issues of short-swing profits allegedly realized on the Air-Way preferred stock.
On June 9, 1955, Air-Way offered the stockholders of Lamb Industries, Inc. ('Industries'), an exchange of one share of its newly-created convertible preferred stock for every five shares of Industries' common stock. Industries then was an Ohio manufacturing corporation.2a At the time this offer of exchange was made, Edward Lamb was the president and treasurer of Industries and controlled 97% Of its stock -- which was never listed on any exchange and had no fixed market value. Various employees of the corporation and residents of Middleville, Michigan, where Industries' plant was located, owned the remaining 3%.
Shortly thereafter, Lamb and Enterprises began a series of transactions in which, almost simultaneously, they exchanged their holdings of Industries common for Air-Way preferred stock and then exercised their options to convert the Air-Way preferred thus acquired into Air-Way common stock at the rate of 3 1/2 shares of Air-Way common for each share of Air-Way preferred. All exchanges and conversions took place within three months and were completed by September 15, 1955.
Plaintiff contends -- and I am persuaded -- that the exchange of Industries common for Air-Way preferred was a 'purchase' and that the subsequent conversion of Air-Way preferred into Air-Way common was a 'sale', giving rise to a 'profit' computed by substracting the value of the Industries stock surrendered on the date of exchange from the value of the Air-Way common received on the date of conversion, all within the meaning and intent of Section 16(b).
The mere fact that no cash changed hands does not preclude a finding that the exchange of Industries stock for Air-Way preferred constituted a 'purchase'. Stella v. Graham-Paige Motors Corp., 132 F.Supp. 100 (S.D.N.Y.1955), aff'd, 232 F.2d 299 (2d Cir. 1956) (exchange of assets for stock). Indeed, at least two other cases in this district, Fistel v. Christman, 135 F.Supp. 830 (S.D.N.Y.1955) and Blau v. Hodgkinson, 100 F.Supp. 361 (S.D.N.Y.1951), clearly support plaintiff's contention that the exchange was a 'purchase'.
In Fistel, Judge Weinfeld found a 'purchase' where the insider of company A acquired additional shares of company A by giving in exchange the shares of company B. Company B resembled Lamb Industries in that it was a closely held corporation whose shares were never actively traded. The insider held 90% Of its stock.
In Hodgkinson, pursuant to a plan of corporate simplification, the insider of the subsidiary corporation gave up his shares in the subsidiary and received shares of the parent corporation in exchange. Finding this transaction to be a 16(b) purchase, Judge Leibell explained:
'Under the plan for the corporate simplification, a stockholder of one of the subsidiaries was not obliged to accept stock of Federated for his stock in the subsidiary. He could have demanded the cash value of his stock in the subsidiary * * *. When the defendants turned over their stock in a subsidiary and received stock in Federated, they received something totally different from that which they surrendered -- stock in a different corporation * * *.' Blau v. Hodgkinson, supra, 100 F.Supp. at p. 373.
Turning to the conversion half of the transaction, the case most heavily relied upon by plaintiff to support his claim that the conversion of Air-Way preferred into Air-Way common constituted a 16(b) 'sale' in Park & Tilford, Inc. v. Schulte, 160 F.2d 984 (2d Cir. 1947). In that case, defendants owned a majority of the outstanding common stock and, in addition, a large block of preferred shares, convertible at the rate of 1 1/4 shares of common for each share of preferred, and redeemable by the corporation at $ 55 per share on 30 days notice. During a period in which the market price of the common rose steadily due to a rumor about a possible dividend to be paid in cases of liquor, the corporation gave notice that it would redeem the preferred. Thereupon defendants converted their preferred into common before the redemption date at a time when the market price of common stood at $ 58 per share. Defendants then sold the common within six months. The court, relying upon a literal interpretation of the statute which broadly defines 'purchase' as 'any contract to buy, purchase, or otherwise acquire', ruled (at p. 987): 'We think a conversion of preferred into common stock followed by a sale within six months is a 'purchase and sale' within the statutory language of 16(b).'
Although Park & Tilford is clear authority for treating a conversion as a 'purchase' of the security received, the interesting problem confronted here is the determination whether the conversion may also be considered a 'sale' of the convertible security. Logically within the purview of the statute, it would seem that every transaction which can be labeled a 'purchase' so far as the purchaser is concerned necessarily should be viewed as a 'sale' from the standpoint of the other party to the same transaction. Moreover, the danger of insider speculation is no less inherent in a situation where a conversion serves as the second half of the short-swing than where a conversion constitutes the first half or purchase' end of the short-swing. This view was recently taken in Heli-Coil Corp. v. Webster, 222 F.Supp. 831 (D.C.N.J.1963). In that case, defendant purchased convertible debentures, converted them into common stock within six months, and then sold some of the common within six months thereafter. Judge Augelli determined that the conversion constituted both a 'sale' of the debentures and a 'purchase' of the common stock, thus sustaining the plaintiff's contention that the purchase-conversion-sale transaction constituted two separate 16(b) violations.
Notwithstanding Park & Tilford and Heli-Coil Corp., Chief Judge Jones held in Ashland Oil and Refining Company v. Newman, 163 F.Supp. 506 (N.D. Ohio 1957), aff'd,3a 259 F.2d 342 (6th Cir.), cert. denied, 359 U.S. 927, 79 S. Ct. 606, 3 L. Ed. 2d 629 (1958), that not all conversions are transactions within the meaning of the Act. Defendant, a director of Ashland held convertible preferred shares. When the corporation announced that it would redeem the stock at $ 27 per share, he and all other preferred shareholders decided to exercise the right to convert to common which, at the time, was selling at $ 36 per share. Judge Jones held that this particular conversion was not a Section 16(b) purchase. He distinguished the case from Park & Tilford on substantially the following grounds: (1) the conversion was largely involuntary in view of the difference between the redemption price of the preferred and the market price of the common; (2) the shares received were almost the economic equivalents of the shares exchanged, both in price and in marketability, because of a provision protecting the convertible preferred against dilution and because both the preferred and the common were listed securities actively traded on national exchanges; (3) Newman was a director who had no controlling interest in the corporation and did not actively participate in corporate affairs.
Despite these distinctions, commentators have suggested that the Ashland Oil case may limit the scope of Park & Tilford as a precedent for applying 16(b) to securities conversions. See 72 Harv.L.Rev. 1392 (1959). As is apparent from Judge Augelli's opinion in Heli-Coil, however, it might be more accurate to observe that the Ashland Oil case brings to conversion transactions the same flexible approach consistent with Section 16(b)'s purpose as has been long employed by the courts in varying factual patterns to construe the essential statutory concepts of 'purchase' and 'sale'. This approach has been characterized as 'pragmatic rather than technical', Ferraiolo v. Newman, 259 F.2d 342, 344 (6th Cir. 1958), and the test, succinctly stated, is whether or not the transaction is question in ...