UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT
decided: September 22, 1975.
MACAULEY WHITING, PLAINTIFF-APPELLANT,
THE DOW CHEMICAL COMPANY, DEFENDANT-APPELLEE
Appeal from a declaratory judgment of the District Court for the Southern District of New York, Robert J. Ward, J., holding a director of a corporation liable to the corporation for short-swing profit pursuant to Section 16(b) of the Securities Exchange Act. The Court of Appeals, Gurfein, Circuit Judge, held that, in the circumstances disclosed, sales by the wife of the director of corporate shares owned by her within six months of the exercise of a stock option by the director-husband should be matched for Section 16(b) purposes and the profit paid to the corporation. Affirmed.
Gibbons,*fn* Gurfein and Meskill, Circuit Judges.
GURFEIN, Circuit Judge:
This appeal presents a difficult and important question of first impression in this court concerning the interpretation of § 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b), as it applies to the matching transactions of a corporate insider and his spouse. The issue is whether a corporate director may be held to have "realized profit" within the meaning of § 16(b) as a result of a matching of his wife's sales and his own purchase of his company's securities within the statutory six-month period.*fn1
In a thorough opinion after a non-jury trial, Judge Ward dismissed the complaint of Macauley Whiting, a director of Dow Chemical Company ("Dow"), which sought a declaratory judgment that he was not liable to Dow under § 16(b) and awarded judgment to Dow on its counterclaim for the profits realized. 386 F. Supp. 1130 (S.D.N.Y. 1974). We affirm.
Helen Dow Whiting sold an aggregate of 29,770 shares of Dow stock for $1.6 million during September and November of 1973 at an average price of $55- $56. In December 1973 her husband, appellant Macauley Whiting, exercised an option to purchase 21,420 Dow shares for $520,000 at a price of $24.3125. He exercised the option with funds he borrowed from his wife, which were part of the proceeds of her sales of the Dow stock in the preceding two months.
Macauley Whiting has been a director of Dow since 1959. His wife of thirty years is a granddaughter of the founder of Dow, and acquired substantial amounts of Dow stock over the years by gift and inheritance, and these assets are segregated from appellant's. On the other hand, Judge Ward found that "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." Moreover, the Whitings' separate accounts are managed by the same financial advisors. The Whitings file joint tax returns, and their common financial planning has included Mrs. Whiting's use of her husband's annual gift tax exclusion to make charitable gifts and gifts to trusts established for their six children.
Mrs. Whiting's personal wealth and income - primarily consisting of dividends and capital gains derived from her Dow holdings - is considerably larger than that of her husband. Although Judge Ward found that Mr. Whiting contributes virtually his entire salary toward family expenses, he also found that Mrs. Whiting is primarily responsible for the considerable costs incurred in the style of living the Whitings have chosen to pursue. It is her dividend income, for example, which has provided for education of the Whitings' children, which defrays medical expenses, which maintains a family vacation home, and which pays real estate taxes on the Whitings' property.
Mrs. Whiting's sales of the Dow stock in September and November of 1973 were made pursuant to a long-term investment plan, arranged by the Whitings and their financial advisor, which was designed to diversify the holdings of the family and to obtain tax benefits. The Court found that the Whitings discussed the general philosophy to govern the management of Mrs. Whiting's estate, and, in early 1972, agreed on a major shift in their philosophy. They then discharged their long-time investment advisor. Desiring to pursue a more aggressive investment program, the Whitings in late 1972 retained new investment counselors, Smith, Barney & Company, Inc. ("Smith Barney"), and new tax, accounting and estate planning advisors, Goldstein, Golub, Kessler & Company ("Goldstein"). As had been the case with their previous financial advisor, the Whitings continued to maintain formal segregation of their investment accounts, but these accounts were managed jointly as discretionary accounts under the supervision of one person at Smith Barney.
Since January 1966, in the Form 3 and 4 reports he was required to make as a Dow director pursuant to § 16(a),*fn2 Mr. Whiting regularly reported his wife's Dow stock as "directly owned" by him, and never disclaimed ownership as he might have pursuant to SEC regulations,*fn3 a procedure of which he was made aware by Dow's counsel. Under SEC Rule 144(a)(2)(i), 17 C.F.R. § 230.144(a)(2)(i), effective April 15, 1972, Mrs. Whiting as a "relative or spouse" was herself required to report her sales of Dow stock. From the outset Smith Barney advised the Whitings that it considered Mrs. Whiting to be a "control" person of Dow by reason of Mr. Whiting's position as a Dow director. The Whitings acquiesced in such treatment, and Mrs. Whiting, thereafter, regularly filed Form 144 reports with the SEC covering her sales of Dow stock.*fn4
Judge Ward found that not only did Mr. and Mrs. Whiting use the same financial advisors, but both were present at many meetings with these advisors; they had a "general philosophy" concerning the management of the family estates. He also found that Mrs. Whiting upon occasion "consults her husband concerning the desirability of certain investments in areas of his expertise," but that "Mr. Whiting does not communicate with his wife concerning the affairs of [Dow]." 386 F. Supp. at 1132.
In December 1972 discussions were begun at the Goldstein office, Mr. and Mrs. Whiting being present, at which certain of the subjects were recorded as "Mr. Whiting's 1972 executive compensation award," joint contributions to their charitable foundation and "investment philosophy." They met with the advisors again on May 31, 1973 when, among other things, there was a discussion of estate planning, investments in municipal bonds and "whether Mr. Whiting should exercise his options in Dow Chemical in 1973 or 1974." A Goldstein executive was "to prepare a projection comparing the tax consequences of the sale of Dow stock versus the exercise of stock options." The reference to sales of Dow stock was in the context of the planning of sales of Mrs. Whiting's Dow stock.
The conference was resumed on October 29, 1973, when "it was suggested that Mr. Whiting exercise his options in Dow Chemical, in total, this year, due to the adverse consequences which could result upon the exercise in 1974 if the proposed concept of minimum taxable income becomes law." The possible tax difference between exercise in 1973 and in 1974 was described as about $245,000. The question of the best method of funding the exercise of the option was discussed, together with "the tax and economic consequences of intra-family borrowing as opposed to borrowing from a third party" (emphasis added).
During the time these discussions were taking place, the pace of Mrs. Whiting's disposition of Dow stock was increased from 2% a year to 5% in the spring of 1973, and to 10% in the fall of 1973.*fn5
Thus, while Mrs. Whiting was selling 29,770 shares of Dow stock in September and November, Mr. Whiting was buying, through exercise of the option, 21,420 shares in December. Mrs. Whiting was selling at an average price of $55- $56, while Mr. Whiting was buying at the fixed price of $24.3125.
As we have seen, Goldstein advised the Whitings on October 29 that Mr. Whiting should finance the exercise of his option by means of an intrafamily loan from his wife. Mr. Whiting explored the possibility of obtaining a personal loan through Harris Bank of Chicago, and he was quoted an interest rate of 1/4% to 1/2% over the then prevailing prime lending rate of about 10%. Ultimately, for reasons not revealed by the record but apparent from the circumstances, Mr. Whiting informed the Harris Bank that "we have been able to get the cash required from sale of stock and will not need the loan at this time" (App. p. A88) (emphasis added). The "sale of stock" to which Mr. Whiting referred was the very sale of Dow stock by Mrs. Whiting now at issue. Appellant borrowed the $520,000 he needed to exercise his option from his spouse and used it for that purpose. The loan was at 7% interest, and no repayment terms were specified.
It is strange that more than forty years of experience with Section 16(b) has yielded practically no judicial guidance on Section 16(b) liability concerning attribution of transactions by the spouse of a director.*fn6 But see Blau v. Potter, CCH Fed.Sec.L.Rptr. para. 94,115 (S.D.N.Y. 1973); Schur v. Salzman, 365 F. Supp. 725, 732 (S.D.N.Y. 1973). And see SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 841 n.4 (2 Cir. 1968), cert. denied, 394 U.S. 976, 89 S. Ct. 1454, 22 L. Ed. 2d 756 (1969). The decision below proceeded on the assumption that, under the circumstances related, appellant was the "beneficial owner" of the securities sold by the wife.
Cases where the husband simply buys stock and puts the shares in his wife's name are relatively simple; so, too, perhaps where he has sole control of her account. The difficulty arises when, as here, the securities are incontestably the wife's, but where the husband obtains benefits, nevertheless, from the dividends and proceeds of sale through the wife's supplying the larger share of family expenses. The problem is compounded by the action of both spouses in managing both the sales and the exercise of the option jointly, and further by the use of the proceeds of sale for the exercise of the option.
Judge Ward concluded that "there is no evidence that he controls her decisions concerning even the general aspects of her management of her estate." 386 F. Supp. at 1132. Appellant contends that the court's conclusion that there was no evidence of control mandates a declaratory judgment for the plaintiff. We cannot agree, for the legal conclusion depends upon the totality of the facts.
Recognizing that the wife has her separate estate, and that the husband does not "control" its disposition in the exclusive sense of the term, the question is whether the other indicia of their relationship are sufficient to bring the transactions under the rule of Section 16(b), as the District Court held.
The method to be used in interpreting the reach of § 16(b) has been the subject of judicial differences of opinion. See the respective arguments of Judge Medina and Judge Clark in Blau v. Lehman, 286 F.2d 786 (2 Cir. 1960).
Though the present Chief Justice believed that § 16(b) is "subject to that interpretation most consistent with the legislative purpose ", Adler v. Klawans, 267 F.2d 840, 844 (2 Cir. 1959), he also concurred in Reliance Electric Co. v. Emerson Electric Co., 404 U.S. 418, 422, 30 L. Ed. 2d 575, 92 S. Ct. 596 (1972), where the Court said that "[a] person avoids liability if he does not meet the statutory definition of an 'insider.'" And the Court in Blau v. Lehman, 368 U.S. 403, 411, 7 L. Ed. 2d 403, 82 S. Ct. 451 (1962), rejected the argument "that the Act should be broadened . . . to prevent 'the unfair use of information' more effectively than can be accomplished by leaving the Act so as to require forfeiture of profits only by those specifically designated by Congress to suffer those losses."
Congress has made no specific provision for treating as an insider the spouse of an insider who has a separate estate, but the statute does require reporting by a director of securities of the issuer of which he is "the beneficial owner." § 16(a).*fn7 To find a director liable for a violation of § 16(b) with respect to purchases and sales of stock of which he is the "beneficial owner ", we may consider whether the reporting provisions give meaning to the liability provisions. See Lewis v. Varnes, 505 F.2d 785, 788 (2 Cir. 1974).*fn8
The Securities and Exchange Commission has variously required the reporting of securities owned by the spouse of an insider when the insider had received "benefits substantially equivalent to ownership" by reason of his spouse's holdings or when the insider has the right to revest title to such shares in himself.*fn9 There appears to be no judicial decision squarely in support of the Commission's interpretation though there can be little doubt that the second part of the definition, not applicable here, is correct.
The question is whether the term "beneficial owner[ship]" includes securities from which the spouse has shared "benefits substantially equivalent to ownership." See SEC Securities Exchange Act Release No. 7793 (Jan. 19, 1966), quoted in the margin.*fn10
In a traditional sense, in the absence of a statutory definition, a beneficial owner would be a person who does not have the legal title to the securities but who is, nevertheless, the beneficiary of a trust or a joint venture, or is a shareholder in a corporation which owns the shares. See, e.g., Marquette Cement Mfg. Co. v. Andreas, 239 F. Supp. 962, 966-67 (S.D.N.Y. 1965). In the normal equity sense, Mr. Whiting would not be the beneficial owner of his wife's separate estate.
The Commission's definition seeks to go further to include situations where the insider indirectly benefits from the dividends though he does not own the shares. The theory is that such an insider would be tempted to pass on inside information to the holder of the stock from which he, himself, "benefits" and thus falls within the class intended by Congress.*fn11
The January 1966 release of the Commission said that "a person ordinarily should include in his reports filed pursuant to Section 16(a) securities held in the name of a spouse or minor children as being beneficially owned by him." But it amended the release within a month to make it clear that a requirement to report is not necessarily coextensive with § 16(b) liability. The Commission in the subsequent Release No. 7824 of February 14, 1966 stated that the opinion expressed with respect to beneficial ownership of securities held by family members does not necessarily mean that liability will result under Section 16(b) from transactions by such family members. This was a matter to be determined by the facts of each particular case in an appropriate action brought by the issuer or its security holders. See Shreve, Beneficial Ownership of Securities Held by Family Members, 22 Bus. Law. 431 (1967).
Thus, in a statute (§ 16(b)) intended to be simple and arbitrary in its application, we confront a situation that cannot be resolved by legal interpretation but which requires a determination of questions of fact. Statements that the purpose of the statute is remedial, Smolowe v. Delendo Corp., 136 F.2d 231, 239 (2 Cir.), cert. denied, 320 U.S. 751, 88 L. Ed. 446, 64 S. Ct. 56 (1943), and that the "garden variety" of transaction in violation of § 16(b) makes for absolute liability, Abrams v. Occidental Petroleum Corp., 450 F.2d 157, 162 (2 Cir. 1971), aff'd sub nom. Kern County Land Co. v. Occidental Petroleum Corp., 411 U.S. 582, 36 L. Ed. 2d 503, 93 S. Ct. 1736 (1973), are of some help. On the one hand, we construe the words of the statute with a liberality of interpretation, see Adler v. Klawans, supra, 267 F.2d at 844-47; Petteys v. Butler, 367 F.2d 528, 532 (8 Cir. 1966), cert. denied, 385 U.S. 1006, 87 S. Ct. 712, 17 L. Ed. 2d. 545 (1967); and on the other hand, we recognize that the efficacy and purpose of § 16(b) is its certainty and predictability. See 2 L. Loss, Securities Regulation 1043 (2d ed. 1961). When its application is certain, the unwary who fall within its terms have no one but themselves to blame.*fn12 When status as "beneficial owner" becomes a question of fact rather than of law, the warning may sometimes be inadequate for the automatic liability imposed.
In this case, the record indicates that appellant was informed by the assistant general counsel for Dow that SEC Securities Exchange Act Release No. 7793 issued January 19, 1966 "now requires a director or officer to report the holdings of securities of his wife and minor children. The rationale of this new interpretation is that the income derived from shares so held might be used to maintain a common home or meet expenses which could otherwise be met by the husband from other sources, or the husband might have the ability to exercise a controlling influence over the purchase, sale, or voting of the securities." Appellant was also informed that "it may be desirable for any director or officer who wishes to expressly disclaim such beneficial ownership to do so whenever he files future reports with the SEC."
Thus, appellant had a general awareness that he might be deemed "the beneficial owner" of his wife's shares.*fn13 He apparently did not know, however, that if shares are sold within six months before the exercise of an option, that is as much in violation of § 16(b) as if the option had been exercised before the sale. See B. T. Babbitt, Inc. v. Lachner, 332 F.2d 255 (2 Cir. 1964).
"Beneficial owner" is the language of § 16(a) and we have been told to read the words of § 16(b) not literally. In the broader sense, we think the term should be read more expansively than it would be in the law of trusts. For purposes of the family unit, shares to which legal title is held by one spouse may be said to be "beneficially owned" by the other, the insider, if the ordinary rewards of ownership are used for their joint benefit. These rewards are generally the dividend income as well as the capital gains on sale and the power to dispose of the shares to their children by gift or upon death.
While we cannot earmark the proceeds of Mrs. Whiting's particular sales as going to household and family support, we know from the findings that the larger part of their joint maintenance came from her estate, the bulk of it in Dow stock. We also know that they engaged in joint estate planning. So that while it is true that if they ever separated, Mrs. Whiting would take her Dow shares, it is also true that while they continue to live as a married couple, there is hardly anything Mrs. Whiting gets out of the ownership that appellant does not share.
While the case is harder than if it had been Mr. Whiting who had put the shares in his wife's name originally, the mischief that "inside information" will be used is just as great.
In the words of the present Chief Justice, "in addition to the intent and purpose of the legislation which we must glean from the statute as a whole rather than from isolated parts, we must consider the results which would flow from each of the two interpretations contended for. If we find one interpretation tends to carry out and the other to defeat the purposes of the statute, the resolution of the issue becomes simple." Adler v. Klawans, supra, 267 F.2d at 844.
Turning to the specific facts, while there was no exclusive "control" by appellant over his wife's separate investments generally, there was sufficient evidence to establish that the questioned transactions were part of a common plan, jointly managed by husband and wife.
In analyzing the family income available yearly, their joint advisors treated their separate accounts as one in order to reach an aggregate sum. This was sensible, for the Whitings were living on the incomes of both. The plans to divest Mrs. Whiting of some of her Dow holdings were discussed by appellant who took an interest in a more aggressive investment policy. The very exercise of his option was the subject of discussion in the joint planning sessions participated in by both the Whitings. The decision to sell her Dow shares in the fall of 1973 was participated in by appellant, and his exercise of option was discussed within the framework of her sales. Impressive as evidence of joint control is also Mrs. Whiting's loan of the wherewithal for Mr. Whiting's exercise of his option. The sales and purchase (through exercise of the option) were part of the same plan and executed within six months of each other.
In these circumstances we hold that, while actual control may make a director or a ten percent owner a "beneficial owner" of another's shares, see Blau v. Mission Corp., 212 F.2d 77, 80 (2 Cir.), cert. denied, 347 U.S. 1016, 98 L. Ed. 1138, 74 S. Ct. 872 (1954); Feder v. Martin Marietta Corp., 406 F.2d 260, 263-66 (2 Cir. 1969), cert. denied, 396 U.S. 1036, 24 L. Ed. 2d 681, 90 S. Ct. 678 (1970), it is not necessary that the control be exclusive.
In so interpreting "beneficial owner" we are not "adding" to the prophylactic effect Congress itself clearly prescribed in § 16(b). See Blau v. Lehman, supra, 368 U.S. at 414. Prophylaxis is meant to prevent rather than to cure what has already happened.
If, then, appellant is "the beneficial owner" of his wife's securities of the issuer for § 16(b) purposes, how does one interpret the statutory language of § 16(b) "any profit realized by him " (emphasis added)?
If we hold that he is the "beneficial owner" he must be chargeable with all the profits or none, in the absence of a way to measure benefit. Cf. Blau v. Lehman, supra, 286 F.2d at 791. It is fiction, of course, to say that he will get all the profit for himself, but here the prophylaxis comes in. The whole profit is "his" profit, "realized by him" because the shares are "his" by the statutory "beneficial owner" concept as applied, and because he is a person in a position to obtain inside information.
This may be a case where innocents were trapped by the statute and its gloss. See Keller Industries, Inc. v. Walden, 462 F.2d 388 (5 Cir. 1972). If Mr. Whiting had not exercised his option until June 1974, just before it expired, he would have incurred no § 16(b) liability, for the six months from the time of Mrs. Whiting's last sale in November 1973 would have expired. But the threat of a new tax bill in 1974 apparently made him exercise the option in 1973. The path of this harsh statute is strewn with such possibly innocent victims. But to allow immunity here would open the door to patent abuse which Congress sought to prevent by a catch-all type of statute, at least where the purchase and sale aspects of the transaction are not subject to dispute.*fn14
The judgment is affirmed.
The judgment is affirmed.