The opinion of the court was delivered by: WARD
Plaintiff Macauley Whiting brings this action pursuant to Section 16(b) of the Securities Exchange Act of 1934 ("§ 16(b)" of "the Exchange Act"), 15 U.S.C. § 78p(b), and 28 U.S.C. § 2201, seeking a declaratory judgment that he is not liable to defendant Dow Chemical Company ("Dow") for profits allegedly realized upon certain sales and purchases of Dow stock in September, November and December of 1973. Dow counterclaims for $208,203.80 plus interest, the amount which it contends is recoverable by the company according to the applicable rules of law, should this Court find plaintiff liable under § 16(b). The Court has jurisdiction and venue is proper in this district. 15 U.S.C. § 78aa.
Mr. Whiting has been a director of Dow since 1959. His wife, Helen Dow Whiting, a granddaughter of the founder of Dow, has owned Dow common stock since childhood and substantial quantities of that stock (although less than 10% of the outstanding shares of the company) since 1962. The common stock of Dow is an equity security registered and traded on the New York Stock Exchange, Inc., and is not an exempted security within the meaning of 15 U.S.C. § 78c (a)(12). The present controversy arises out of Mrs. Whiting's sale of 29,770 shares of common stock of Dow during September and November, 1973 at various prices totalling $1,645,063.58, and Mr. Whiting's exercise, on December 27, 1973, of an option granted to him by Dow to purchase 21,420 shares of its common stock at an aggregate option price of $520,774.
The question now before the Court is whether Mr. Whiting thereby "realized profit . . . from any purchase and sale, or sale and purchase, of any equity security of such issuer (other than an exempted security) within any period of less than six months . . ." within the meaning of § 16(b) of the Exchange Act. The parties base their arguments in large part upon the premise that that question in turn rests upon whether Mr. Whiting is the "beneficial owner" of the shares held by his wife.
Defendant vigorously contends that the purposes of § 16(b) can be effectuated only if it is held to apply to the situation now before the Court; plaintiff equally vigorously argues that the holdings and the transactions of husband and wife in this case are separate and cannot be matched against each other for purposes of § 16(b) liability. Both Mr. and Mrs. Whiting testified at the trial.
Plaintiff demonstrated that his wife has assets many times greater than his own, and from them pays by far the largest share of the family expenses. She maintains her own personal records, her own checking and brokerage accounts, and does not mingle her assets with his. While the largest part of her personal estate consists of her Dow common stock, Mr. Whiting does not communicate with his wife concerning the affairs of the company. Mrs. Whiting controls all specific transactions involving her assets, to the extent that she has placed them in a discretionary account with Smith, Barney & Co., Inc., to whom she has given general instructions and some of whose specific purchases she authorizes. She does not, as a matter of practice, discuss individual transactions with her husband, and there is no evidence that he controls her decisions concerning even the general aspects of her management of her estate. It is clear that Mrs. Whiting autonomously manages her own separate estate and is not the "alter ego" of her insider husband.
It is also clear, however, that the Whitings enjoy the mutual affection, respect and communication which one would expect of a happily married couple, and that together they and their children benefit, in terms of style of life, from Mrs. Whiting's substantial wealth. They share a common home, own a vacation home which they use together, and Mr. Whiting does contribute virtually his entire salary to defray the family expenses which are met primarily by Mrs. Whiting.
Mr. Whiting serves as trustee of several trusts in their childrens' names, which consist largely of gifts of Dow common stock from Mrs. Whiting. She commonly takes advantage of his annual gift tax exclusion to make gifts to their children's trusts, as well as to charitable organizations. They file a joint income tax return which maximizes the deductions available to both. They use the same financial advisers although their accounts are formally separate, and they are frequently, although not invariably, present together at meetings with those advisers to discuss the overall management of their respective estates and the estates of their children. Mrs. Whiting pays the fees of these advisers. Together the Whitings have discussed the general philosophy which should govern the management of Mrs. Whiting's estate, and in early 1972 agreed upon a major shift in that philosophy. Since that time she has disposed of certain percentages of her Dow stock annually, reinvesting the proceeds elsewhere in the interest of diversifying her holdings and obtaining maximum tax benefits. Upon occasion Mrs. Whiting consults her husband concerning the desirability of certain investments in areas of his expertise, and although she does not invariably follow his advice she appears to have considerable respect for his opinion. In short, the resources of both husband and wife are significantly directed toward their common prosperity, and they easily communicate concerning matters which relate to that prosperity.
Congress enacted both § 16(a) and § 16(b) of the Exchange Act (15 U.S.C. § 78p)
for the purpose of preventing speculation based upon inside information or other abuses of their position by directors, officers, and large shareholders of registered corporations. Section 16(a) subjects all holdings and transactions by such persons to the closest scrutiny, in order that detailed exposure itself will discourage abuses. 2 Loss, Securities Regulation 1038 (1961). Section 16(b) focuses more directly on the evil of abuse of inside information for short-swing speculation in the securities of the insiders' corporations, and somewhat arbitrarily requires insiders of a listed corporation to disgorge to the corporation any profit realized upon purchases and sales of its securities within six months.
The words, "beneficial owner," are used in § 16(a) and § 16(b) for two different purposes. First, "insider" status may derive from beneficial ownership of more than ten percent of the equity securities of an issuer of registered securities. Insider status carries with it both an obligation to report holdings and transactions to the Securities and Exchange Commission ("the Commission"), under § 16(a), and possible liability for profits under § 16(b). Second, § 16(a) imposes upon officers and directors of an issuer of registered securities, in addition to ten percent beneficial owners, the obligation to report to the Commission the amount of securities of that issuer of which they are the beneficial owner, as well as any changes in that ownership. Thus the words "beneficial owner" at once define one category of persons who are subject to both sections 16(a) and 16(b), and determine which holdings all insiders must report, under § 16(a).
The reporting requirements of § 16(a) are broader in scope than the liability provisions of § 16(b); changes in beneficial ownership within a six-month period, such as transfer of shares whether by gift or for consideration to a spouse or other family members, although duly reported may not always give rise to liability. 2 Loss, Securities Regulation, 1082-3, nn. 197-199 (1961); 5 Loss, Securities Regulation 3066 (1969); Feldman & Teberg, Beneficial Ownership Under § 16 of the Securities Exchange Act of 1934, 17 W.Res.L.Rev. 1054, 1063 (1966). The Commission has supported broad interpretations of the reporting requirements, reasoning that Congress intended the trading activities of insiders to be subject to the most careful scrutiny, for its deterrent effect not only upon abuse of inside information for short-swing profit, but also upon other abuses to which other sections of the statute are more specifically directed. See Feldman & Teberg, supra at 1063.
The question under § 16(b) is more narrowly whether the insider has "realized profit" by "any purchase and sale," terms not completely defined in the statute, but interpreted by the courts and the Commission in light of the purposes of that section. In interpreting the language of § 16(b), the courts have kept in mind that § 16(b) was designed to be largely automatic in application,
and to "squeeze all possible profits" from short-swing trades by insiders, Smolowe v. Delendo Corp., 136 F.2d 231 (2d Cir. 1943), cert. denied, 320 U.S. 751, 88 L. Ed. 446, 64 S. Ct. 56 (1943), and have strictly construed the language in favor of the corporation's recovery of maximum amounts. They have also, on occasion, mitigated the harsh effects of the rule by examining whether a transaction or individual class of transactions lends itself specifically to the abuses the section is designed to prevent, e.g., Kern County Land Co. v. Occidental Corp., 411 U.S. 582, 36 L. Ed. 2d 503, 93 S. Ct. 1736 (1973); Reliance Electric Co. v. Emerson Electric Co., 404 U.S. 418, 30 L. Ed. 2d 575, 92 S. Ct. 596 (1972); Blau v. Lehman, 368 U.S. 403, 7 L. Ed. 2d 403, 82 S. Ct. 451 (1962), and if it does not, have strictly construed the language in favor of the insider. There has thus emerged a tension between not always compatible guides, reflected in dissenting opinions to significant cases as they are decided.
In Blau v. Lehman, supra, for example, the Supreme Court held a partner liable for only his pro-rata share of profits realized upon his partnership's purchase and sale within six months of shares in a corporation of which he was a director. The partnership had acted independently of any specific advice from him, without his specific knowledge, and he disclaimed any interest in any proceeds of the transactions. The Court refused to hold that the partnership as a whole was an insider, or to accept the harsh effect of holding the director liable for the full amount of profit realized by the partnership, since the language of § 16(b) speaks specifically to "profit realized by him" referring solely to the insider. In a vigorous dissent Justice Douglas urged that the partnership as a whole be considered a person, an insider because of one of its members was an insider. He discussed the large potential for abuse of inside information in the partnership context, emphasizing the automatic and arbitrary character of the section and the Court's consistent prior policy of rigorously squeezing all profit from transactions by insiders in a six-month period. 368 U.S. at 414 et. seq.
Again, in Reliance Electric Co. v. Emerson Electric Co., supra, the court looked to the strict language of § 16(b), and in the context of a defeated tender offer permitted a ten percent beneficial owner deliberately to dispose of shares acquired within six months in two stages, only one of which would be subject to § 16(b) liability. The majority reasoned that Congress has created a strict and arbitrary rule of liability which should not be extended beyond the literal meaning of the section's language. Justice Douglas' dissent emphasized the prophylactic purpose of § 16(b), and again urged a flexible construction of the statute which would serve that purpose. 404 U.S. at 427 et. seq.
And most recently, in Kern County Land Co. v. Occidental Corp., supra, the Supreme Court held that in the context of a defeated tender offer, a binding option agreement to sell the shares acquired during the campaign, negotiated within six months of purchase, but effective only beyond that time, was not a "sale" for purposes of § 16(b) liability. The court considered the transaction not susceptible of the kind of abuse toward which § 16(b) is directed. Once more, Justice Douglas argued for a statute, a "bright-line test," even should ...