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August 3, 1970

Harold KRAMER, Plaintiff,
William AYER and Itek Corp., Defendants

Edelstein, District Judge.

The opinion of the court was delivered by: EDELSTEIN

EDELSTEIN, District Judge.

Plaintiff, a stockholder of Itek Corporation, [Itek] a nominal defendant, brought this action under Section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b) (1964) *fn1" to recover on behalf of Itek profits allegedly realized by defendant Ayer as a result of various sales by Ayer of shares of Itek common stock within six months after his acquisition of that stock. Ayer has moved for summary judgment, and plaintiff, while cross-moving for summary judgment in his favor, has also moved in the alternative for an order directing trial on the single issue of the amount of recoverable short swing profits allegedly realized by Ayer.

 Ayer was the founder, president and a director of Applied Technology, Inc., [ATI], as well as the holder of 169,700 shares of its issued and outstanding common stock, or approximately 15.5 percent of the total. Early in 1967 ATI and Itek entered into merger negotiations which culminated in a public announcement on May 1, 1967, of a proposed merger and an executed written merger agreement dated June 7, 1967. Ayer was one of the principal merger negotiators for ATI.

 The merger agreement contemplated a statutory merger of the two corporations with Itek being the surviving corporation. The effective date of the merger was defined by the agreement as the close of business on the date upon which the last of the acts required by the agreement to make the merger complete was performed. On that date each issued and outstanding share of ATI common stock was to become.43 of a share of the common stock of Itek and Ayer was to become an officer and director of Itek.

 Actual consummation of the merger was made dependent upon the performance of various stated conditions, such as the approval of the stockholders of each corporation, the exchange of various documents, and compliance with the statutory requirements of California and Delaware, the states of incorporation of ATI and ITEK respectively. While each corporation pledged to make every reasonable effort to comply with and perform the terms and conditions of the agreement, each corporation also had the option of terminating the agreement at any time for any reason. The agreement also provided that prior to the effective date of the merger no rights were conferred by it on anyone other than ATI and Itek.

 A specific condition of the merger agreement required the five major stockholders of ATI, including Ayer, to execute and deliver to Itek a "Shareholder Agreement." In this agreement these stockholders warranted, in substance, that they would not sell the Itek stock which they were to receive upon the merger except for such shares as they could sell without registration in conformity with Rule 133 of the Securities and Exchange Commission adopted under the Securities Act of 1933. Ayer alone was required to warrant that in any event he would not sell more than 25 percent of his Itek shares within one year of the effective date of the merger.

 Approval of the merger by the stockholders of both corporations was obtained on September 18, 1967. On the next day, September 19, 1967, representatives of ATI and Itek attended a closing where they exchanged the documents specified in the merger agreement. Then, on September 20, 1967, the documents prescribed by state law were filed with the Secretaries of State of California and Delaware. The merger then became complete.

 Thereafter, on four separate days within six months of the merger Ayer sold varying amounts of his newly acquired Itek stock. A schedule of these sales appears in the margin. *fn2" After the first sale was made by Ayer the question of a possible violation of Section 16(b) was raised. Itek and Ayer finally agreed that Ayer would pay to Itek the profits he realized by these sales. These profits were calculated as being $23,777.80. Ayer paid this amount to the corporation and now claims that he is entitled to summary judgment because whatever liability he may have to Itek has been satisfied. Plaintiff replies that, in fact, Ayer's profits far exceeded the sum paid by him to Itek, and that summary judgment awarding the actual amount of profits earned by Ayer should be entered in favor of plaintiff.

 Calculation of the amount of profits earned by Ayer would appear on the surface to be a simple matter, the equation being clear and well established, namely, the net receipts derived from the sales of Ayer's shares less their cost to him. E.g., Park & Tilford, Inc. v. Schulte, 160 F.2d 984, 988 (2d Cir. 1947). There is no dispute as to the net amounts received by Ayer on his sales. The parties sharply disagree, however, as to the proper method of determining the cost to Ayer of the shares sold by him. The $23,777.80 figure relied upon by Ayer was determined by using a cost figure arrived at by multiplying the number of Itek shares sold on each date by 147 7/8, the closing price of Itek on the New York Stock Exchange on September 20, 1967. *fn3" Except for the sales effected on September 22, 1967, of a total of 9000 shares, Ayer's sales of Itek were made at a price per share less than 147 7/8, and thus Ayer claims that he realized a profit only from the sales of September 22, 1967. Plaintiff contends that the cost of the shares sold cannot be determined by looking to the market price of Itek at any time. Instead, the cost of the shares sold must be determined by valuing the ATI shares which were exchanged by Ayer for the Itek shares which he subsequently sold. Several alternative arguments are offered by plaintiff as to the proper method of valuing those ATI shares. Whether Ayer's theory or one of plaintiff's theories is correct and whether summary judgment for either party is proper are the basic issues raised by the cross-motions before the court.

 Ayer's theory as to the proper method of determining the cost of the Itek shares sold by him is incorrect because his theory bases the cost of the Itek shares sold solely on the market price of Itek stock on the effective date of the merger. The Itek sold by Ayer, however, was acquired by the exchange of an agreed upon number of shares of ATI; it is the value of those shares of ATI that determines the cost to Ayer of the Itek shares sold by him. Simply stated, for Section 16(b) purposes, in calculating the cost of the stock that was sold, it is the market value of what was given up to obtain that stock that is determinative. E.g., Park & Tilford, Inc. v. Schulte, supra; Blau v. Lamb, 242 F. Supp. 151 (S.D.N.Y. 1965), aff'd. in part and rev'd. in part 363 F.2d 507 (2d Cir. 1966), cert. denied 385 U.S. 1002, 87 S. Ct. 707, 17 L. Ed. 2d 542 (1967); cf. Blau v. Mission Corp., 212 F.2d 77 (2d Cir.), cert. denied 347 U.S. 1016, 74 S. Ct. 872, 98 L. Ed. 1138 (1954). To be sure, the market value of what was received may be relevant when other indicia of the value of what was given up are lacking. See, B.T. Babbitt, Inc. v. Lachner, 332 F.2d 255, 258 (2d Cir. 1964); Marquette Cement Mfg. Co. v. Andreas, 239 F. Supp. 962 (S.D.N.Y. 1965); Stella v. Graham-Paige Motors Corp., 132 F. Supp. 100, 107 (S.D.N.Y. 1955), rev'd on other grounds 232 F.2d 299 (2d Cir.), cert. denied 352 U.S. 831, 77 S. Ct. 46, 1 L. Ed. 2d 52 (1956). But the question always must be the market value of the property relinquished. Ayer errs because in the first instance he turns to the market value of the property received.

 Plaintiff, on the other hand, attempts to determine the market value of the ATI shares used by Ayer to acquire his Itek shares. While focusing on the market value of ATI is both necessary and proper, the analysis which plaintiff offers to the court is deceptively misleading. ATI, according to the plaintiff, was actively traded over the counter. Curiously, though, plaintiff only has submitted to the court bid and asked quotations for the stock. Bid and asked quotations cannot, as plaintiff suggests, especially in an active market, be used blithely as substitutes for market price. Yet plaintiff offers several theories of valuing ATI and each theory relies upon what purports to have been the lowest *fn4" bid quotation of ATI on the day involved in the particular theory put forth. No justification for this reliance upon the bid and asked quotations instead of upon actual market prices is offered by plaintiff.

 Reliance upon the lowest bid quotation for September 20, 1967, the date of the merger, *fn5" is one alternative theory suggested by plaintiff. However, even though it is the market value of the ATI stock when it was used to acquire the Itek stock sold that is the ultimate issue, plaintiff offers this alternative theory only as a last resort. The amount of the recoverable short swing profits earned by Ayer varies directly, of course, with the cost basis of the Itek shares which he sold. According to plaintiff, the bid and asked quotations for ATI are highest on the dates closest to the date of the merger. For this reason, plaintiff strenuously urges that for the purpose of calculating the recoverable profits earned by Ayer, the market value of ATI should be derived from the bid and asked quotations of that stock on April 28, 1967, the last business day before the public announcement of the proposed merger.

 While plaintiff argues that once the news of the impending merger was made public the market price of ATI no longer was determined "by the normal economic factors such as profits, sales, assets, liabilities, etc., but rather by consideration of monetary benefit to be derived from the merger," he does not urge that the bid and asked quotations of September 20 be disregarded because there is any evidence of market fraud or manipulation. Nor does plaintiff intimate that the September 20 market for ATI was not sufficiently active so as to provide a proper reflection of value. On the contrary, plaintiff contends that the market in ATI was at all times an active one. The essential rationale of plaintiff's argument is that Section 16(b) is a remedial statute designed to deter corporate insiders from taking unfair advantage of information not available to ordinary investors. And to maximize the deterrent effect of this section, in the oft-quoted language of Smolowe v. Delendo Corp., 136 F.2d 231, 239 (2d Cir.), cert. denied 320 U.S. 751, 64 S. Ct. 56, 88 L. Ed. 446 (1943), it is necessary to "* * * squeeze all possible profits out of [proscribed] stock transactions. * * *" The only way in which this can be accomplished here, and the only way in which Ayer can be prevented from taking advantage of his violation, plaintiff argues, is by excluding from the market value of ATI any increment in price traceable to the merger. Plaintiff concludes that the bid and asked quotations for April 28, 1967, are the last ones which were "* * * unadulterated by public knowledge of the proposed merger;" hence these quotations should be relied upon here. *fn6"

 In Park & Tilford, Inc. v. Schulte, supra, reliable market prices were unavailable and the court therefore relied upon a stipulation as to the value of the preferred stock in issue there. Plaintiff attempts to extend the Park & Tilford case by arguing, as an alternative theory to the above, that Ayer, by his own actions has "agreed" at various times that the market value of his ATI stock should be derived from market quotations on dates other than September 20, 1967. First, by reaching an oral agreement of merger with Itek on behalf of ATI by the end of April 1967, wherein an exchange ratio was agreed upon, Ayer is said to have agreed that the value of his ATI stock should be derived from the bid and asked quotations of April 28, 1967. Second, by signing on June 7, 1967, the shareholder's agreement required by the merger agreement, Ayer is said to have obligated himself not to exchange his ATI shares except pursuant to the merger. This, plaintiff contends, means that Ayer agreed that the maximum cost basis of his ATI shares was no greater than the low bid quotation on June 7. Finally, on August 16, 1967, Ayer, as President of ATI, sent proxies to the stockholders of ATI soliciting their approval of ...

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