The opinion of the court was delivered by: CARTER
Plaintiff alleges a violation of § 16(b) of the 1934 Securities Exchange Act, 15 U.S.C. § 78p(b). This section, aimed at curbing certain forms of corporate insider abuse of non-public information, requires that insiders disgorge to the corporation any profits realized within a period of six months on any purchase and sale of the corporation's stock.
Before the court are cross motions for summary judgment. Since I conclude that defendant's sale of Gable stock occurred more than six months after his last purchase, no § 16(b) liability arises from these transactions. Consequently, summary judgment for defendant is granted.
In 1972, the defendant was the sole owner and chief executive officer of Tibbetts Water & Waste, Inc. ("Tibbetts"). In April of 1972, the defendant, Tibbetts, Gable Industries, Inc. ("Gable") and a Gable subsidiary all entered into an Agreement and Plan of Merger ("Agreement") whereby the Gable subsidiary would be merged into Tibbetts, which would then continue to operate as a subsidiary of Gable. In essence, the merger Agreement was a sale by defendant of Tibbetts to Gable, in exchange for stock in Gable.
On the effective date of the merger, defendant's stock in Tibbetts would be converted into 218,330 shares of Gable, plus the right to receive additional shares from time to time, depending on the earnings of Tibbetts in the next four fiscal years. Generally, the plan provided that if Tibbetts' earnings in each of those years exceeded specified sums, defendant would receive Gable stock equal in value to a multiple of those "excess" earnings, using the average price of the stock during the relevant fiscal year as the basis for calculating the number of shares to be issued. However, the total number of shares that could be received over the life of this "earn-out" provision could under no circumstances exceed 300,000.
Entitlement to these earn-out shares was dependent solely on the future earnings of Tibbetts and in no way conditioned upon any act by the defendant.
The merger was closed on June 22, 1972, and defendant received the initial 218,330 shares. During the next few years, Tibbetts did well, and defendant received large blocks of shares under the earn-out arrangement, so that by April, 1974, he owned more than 10% of the shares of Gable, and thus became a § 16(b) beneficial owner. At the end of 1974, the earn-out arrangement still had two more years to run. By that time, however, defendant had already received enough earn-out shares so that, given the ceiling in the Agreement, he could receive a total of no more than another 105,362 shares, whatever the earnings of Tibbetts might be.
On February 28, 1975, Gable's fiscal year ended, and the computations on that year's earn-out could begin. On July 10, defendant received stock certificates for 105,362 shares, the maximum allowable. Some 6 weeks later, on August 19, defendant sold his entire holdings in Gable, which then totalled 407,350 shares, to The Flintkote Company for $15 a share, about double the market price of Gable on that date. Flintkote apparently paid this premium to defendant because it was attempting to gain control of Gable.
It is undisputed that defendant made a "sale" on August 19, 1975. But when he "purchased" the last block of 105,362 shares is hotly contested. Plaintiff argues that the "purchase" occurred on July 10, when the shares were received, or alternatively, on February 28, when the fiscal year closed, and the entitlement to the shares became "fixed" and calculable. Defendant's contention is that there was no "purchase" in 1975 because the stocks were received as a result of a long-term investment made in 1972. Secondarily, it is urged that if there was a purchase in 1975, it occurred no later than January (more than six months before the sale), by which time Tibbetts had already earned enough profit to entitle the defendant to all the shares he received in July.
A threshold question is raised by plaintiff's undisputed failure to request of Gable Industries that it prosecute this claim against defendant before initating suit in a derivative capacity, as required by § 16(b). Absent such a demand, or a showing that a demand would have been futile, an individual shareholder lacks the capacity under § 16(b) to bring suit.
However, it appears undisputed that Gable Industries has known of this lawsuit since at least November or December of 1976 (deposition of Neal Schachtel, President of Gable Industries, pp. 6-8, 16-21), if not immediately after the suit was commenced (deposition of defendant, pp. 97-98). Under these circumstances, standing to challenge plaintiff's failure to make the demand to sue lies only with the corporation. The "demand provision is for the benefit of the corporation on whose behalf the claim exists . . .," Schur v. Salzman, 365 F. Supp. 725, 732 (S.D.N.Y. 1973) (Weinfeld, J.), and it has frequently been held that only the corporation has standing to object to plaintiff's failure to wait the required sixty days after the demand is made before instituting suit, Benisch v. Cameron, 81 F. Supp. 882 (S.D.N.Y. 1948) (Conger, J.); Grossman v. Young, 72 F. Supp. 375 (S.D.N.Y. 1947) (Rifkind, J.), or to other formal irregularities in the demand. Schur v. Salzman, supra. There is no reason for a different rule regarding the demand itself where, as here, the corporation is aware of the lawsuit and is thus able to protect its interests by intervening into the action, if it so chooses. Accordingly, the insider defendant here lacks standing to assert plaintiff's failure as a defense.
Section 16(b) was designed to discourage the speculative use of inside information by corporate insiders who trade in the stock of the corporation. See, e.g., Kern County Land Co. v. Occidental Petroleum Corp., 411 U.S. 582, 591-92, 36 L. Ed. 2d 503, 93 S. Ct. 1736 (1973). In order to maximize its effectiveness, the statute "imposes liability without fault."
That is, if a transaction of the kind described in § 16(b) occurs, the insider must disgorge his profits without regard to whether he actually used inside information or intended to engage in short-term speculation. Id. at 595. The issue in this case, however, is whether a § 16(b) transaction occurred. More precisely, since the section only applies to purchases and sales that occur within six months of each other, the question presented here is when does a purchase occur within the meaning of § 16(b). Answering that question requires an understanding of the purpose of the six month rule and the "evil" that § 16(b) is designed to remedy.
Although the statute is intended to curb the use of advance knowledge of privileged information by insiders in their market transactions, it is not concerned with all forms of such insider abuse, see Foremost-McKesson v. Provident Securities Co., 423 U.S. 232, 255, 46 L. Ed. 2d 464, 96 S. Ct. 508 (1976); Provident Securities Co. v. Foremost-McKesson, 506 F.2d 601, 615 (9th Cir. 1974), aff'd, 423 U.S. 232, 46 L. Ed. 2d 464, 96 S. Ct. 508 (1976), such as simply selling or buying on the basis of advance information.
Rather, the particular abuse at which § 16(b) takes aim is an investment decision by an insider, based on inside information, to engage in "in-and-out" or "out-and-in" trading, with the goal of reaping a profit because of advance knowledge of events. "Congress had in mind [only] a specific type of two-part transaction ":
a purchase and sale, or sale and purchase, which are but two parts of a single plan to gain advantage of knowledge of information of a limited circulation. It was recognized, however, that proof that trading was based on inside information and was purely for speculative, rather than investment purposes, would be hard to come by. But it was also realized that "since the speculative advantage to be gained from inside information is usually short lived,"
a short term turn-over in stock was far more likely to be a speculative adventure to capitalize on inside information than a pair of widely spaced trades. Congress thus overcame this serious obstacle to effective remediation by engaging in the conclusive presumption that two trades by an insider within six months of each other were speculative and based on inside information.
That this is the proper reading of the purpose of § 16(b) and the rationale of the six month rule is clear from the section's legislative history. The original version of what was to become § 16(b) of ...