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Securities and Exchange Commission v. Sterling Precision Corp.

decided: March 26, 1968.


Friendly and Smith, Circuit Judges, and Gignoux, District Judge.*fn*

Author: Friendly

FRIENDLY, Circuit Judge:

The primary issue on this appeal from an order of the District Court for the Southern District of New York granting summary judgment to defendant Sterling Precision Corporation in an injunction action by the SEC is whether Sterling's redemptions of its bonds and preferred stock were a "purchase" of such securities by Sterling from The Equity Corporation, a registered investment company owning more than 5% of Sterling's voting securities, within the ban of § 17(a) (2) of the Investment Company Act. We hold they were not.

As a result of transactions ten years earlier, the details of which need not be stated in the view we take of the case, Equity, on August 9, 1966, owned $1,637,000 of Sterling's 4 1/2% Convertible Debentures due January 1, 1971, and 355,052 of 374,826 outstanding shares of Sterling's $10 par value 5% Cumulative Convertible Preferred Stock. Equity's holdings of preferred stock and of 120,340 common shares out of 3,600,000 outstanding constituted 11.8% of the voting securities of Sterling, and made Sterling "an affiliated person" of Equity under § 2(a) (3) (B).

The Debentures provided, with qualifications not here material, that 4% of the total then outstanding should be called for redemption on March 15 of each year at their principal amount plus accrued interest. It was provided also that on special notice the Debentures might be redeemed at the same price as a whole at any time or in part from time to time; in the latter event redemption was to be made pro rata. The Series C Preferred Stock was redeemable at $10 per share plus dividends accrued and unpaid; if less than all the stock was called for redemption, "the shares to be so redeemed shall be selected by lot or in such manner as the Board of Directors may determine * * *." The indenture under which the Debentures were issued contained a covenant that Sterling would not redeem any stock without the consent of holders of 60% of the outstanding Debentures except out of the net amount of earnings and the proceeds of sales of stock since January 1, 1956; breach of this covenant would give the holders of Debentures the option to declare them immediately due and payable.

In 1966 Sterling found itself with a large cash balance of about $7,700,000, constituting some 35% of its total assets. Its management proposed a program whereby these funds would be used in part to redeem the Debentures and Preferred Stock held by Equity, thereby terminating the affiliation, which Sterling regarded as a handicap to its operations. At a meeting on August 4, 1966, the directors authorized the officers to negotiate with the other two Debenture holders for their consent. On August 8, the Chairman reported that such consent would be forthcoming in consideration of an increase in the interest rate to 6% and possibly the issuance of warrants to purchase not more than 300,000 shares of common stock. The Board thereupon called Equity's Debentures and Preferred Stock for redemption on October 1, 1966;*fn1 Equity waived notice and surrendered its securities for redemption on August 9. Due to subsequent quintupling of the market price of its common stock, the transaction has proved beneficial to Sterling; as against the total redemption price of $5,191,379, the stock into which Equity's Debentures and Preferred Stock would have been convertible had a market price of over $14,000,000 on January 4, 1968.

Section 17(a) of the Investment Company Act provides:

"It shall be unlawful for any affiliated person or promoter of or principal underwriter for a registered investment company (other than a company of the character described in section 12(d) (3) (A) and (B)), or any affiliated person of such a person, promoter, or principal underwriter, acting as principal --

"(1) knowingly to sell any security or other property to such registered company or to any company controlled by such registered company, unless such sale involves solely (A) securities of which the buyer is the issuer, (B) securities of which the seller is the issuer and which are part of a general offering to the holders of a class of its securities, or (C) securities deposited with the trustee of a unit investment trust or periodic payment plan by the depositor thereof;

"(2) knowingly, to purchase from such registered company, or from any company controlled by such registered company any security or other property (except securities of which the seller is the issuer) * * *."

We start our consideration from the point that in common speech a maker's paying a note prior to maturity in accordance with its terms would not be regarded as a "purchase." While few people would find it necessary to resort to a dictionary to ascertain the meaning of that term, Webster's International Dictionary (2d ed. 1960) tells us that "purchase" means "the acquisition of title to, or property in, anything for a price; buying for money or its equivalent," and that to purchase is to "obtain (anything) by paying money or its equivalent." Sterling did not acquire title to its Debentures or Preferred Stock; it discharged them. Perhaps more important, the normal discourse of lawyers sets redemptions apart from purchases. The distinction is recognized in corporation statutes, notably that of Delaware, where Sterling was organized, General Corporation Law § 243; by judicial decision, see Venner v. Public Utilities Commission, 302 Ill. 232, 235, 134 N.E. 17, 18 (1922), compare Starring v. American Hair & Felt Co., 21 Del.Ch. 380, 191 A. 887 (1934), aff'd 21 Del.Ch. 431, 2 A.2d 249 (Sup.Ct.1938) with Martin v. American Potash & Chemical Corp., 33 Del.Ch. 234, 92 A.2d 295, 301-302, 35 A.L.R.2d 1140 (Sup.Ct.1952); and by writers on corporation law, see Henn, Corporations 170 & n. 37 (1961); Ballantine, Corporations § 263 (1946). Indeed, only a year before the Investment Company Act was adopted, the Supreme Court had said, in upholding a contention by the Government that the redemption of debentures was not a "sale or exchange" affording the benefit of capital gains treatment under the revenue laws:

"Payment and discharge of a bond is neither sale nor exchange within the commonly accepted meaning of the words."

United States v. Fairbanks, 306 U.S. 436, 437, 59 S. Ct. 607, 608, 83 L. Ed. 855 (1939).

We recognize these considerations are not conclusive. A statute, particularly one dealing with an esoteric subject, may sometimes use a word in a sense different from that supplied by the dictionary or common usage. Cf. NLRB v. Coca-Cola Bottling Co., 350 U.S. 264, 269, 76 S. Ct. 383, 100 L. Ed. 285 (1956). The SEC is right in saying we should decide the issue as one of federal law, even though a Delaware court construing its corporation laws might come to a different conclusion. SEC v. Variable Annuity Life Ins. Co., 359 U.S. 65, 79 S. Ct. 618, 3 L. Ed. 2d 640 (1959); Tcherepnin v. Knight, 389 U.S. 332, 88 S. Ct. 548, 19 L. Ed. 2d 564 (1967). It is true also that "sale" may have a broader meaning in securities legislation than in the Internal Revenue Code. Still, when due allowance has been made for all this, a good deal remains from what we first said. "Purchase" is not a peculiarly technical term and "after all, legislation when not expressed in technical terms is addressed to the common run of men and is therefore to be understood according to the sense of the thing, as the ordinary man has a right to rely on ordinary words addressed to him." Addison v. Holly Hill Fruit Products Inc., 322 ...

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