The opinion of the court was delivered by: MOTLEY
Memorandum Opinion on Defendants' Motion to Dismiss
This action under Section 16(b) of the Securities Exchange Act of 1934
raising difficult issues of application of that statute is before the court on the motion of defendants Siess, Nelle, and McDowell, joined in by defendant Apco Oil Corporation, pursuant to Rule 12(b)(6), Fed.R.Civ.P., to dismiss the complaint for failure to state a cause of action. The motion is denied for the reasons set forth below.
Plaintiff is a stockholder of Apco Oil Corporation (Apco), suing in its behalf. The facts as set forth below follow the allegations of the complaint, which must be taken as true for purposes of this motion to dismiss. Apco's common stock is traded on the New York Stock Exchange. The sequence of events leading up to this litigation began in 1972, when Apco adopted a stock option plan ("the plan") for compensation of certain key employees. In connection with the plan, the optionees were given stock appreciation rights (SAR's). These SAR's gave the optionees the right to receive, either in cash or in stock at their election, the increase in the value of the optioned shares from the date of grant of the option to the date of exercise of such rights. The defendants herein, Charles P. Siess, Glen A. Nelle, W. E. McDowell, D. H. Bailey and John Doe, Michael Moe and Richard Roe,
are officers and/or directors of Apco, who allegedly were given stock appreciation rights under the plan. At unspecified times between January 1, 1975 and the filing of the complaint in this action on July 23, 1976,
the seven defendants allegedly exercised stock appreciation rights under the plan, receiving aggregate profits of $ 408,602, most of which was paid to them in cash.
Plaintiff alleges that each exercise of stock appreciation rights for cash under Apco's plan constituted a simultaneous purchase and sale of a security by an insider within six months, and the consequent generation of short-swing profits which should have inured to the issuer (Apco) under § 16(b).
Plaintiff further contends that each of the defendants exercised stock appreciation rights as a device to conceal what would otherwise clearly have been illegal transactions under § 16(b).
Defendants' response is that even if all the allegations of the complaint are taken as true, plaintiff has failed to state a cause of action. Defendant bases this conclusion on two basic grounds: first, that an actual purchase and sale are required to create such liability, both of which cannot possibly arise out of a single transaction, such as the exercise of a stock appreciation right; and second, that no liability may be found under § 16(b) where only one investment decision is made within the statutory six-month period. Defendant draws these conclusions principally from a group of recent Supreme Court decisions construing § 16(b), Foremost-McKesson, Inc. v. Provident Securities Co., 423 U.S. 232, 96 S. Ct. 508, 46 L. Ed. 2d 464 (1976); Kern County Land Co. v. Occidental Petroleum, 411 U.S. 582, 93 S. Ct. 1736, 36 L. Ed. 2d 503 (1973); and Reliance Electric Co. v. Emerson Electric Co., 404 U.S. 418, 92 S. Ct. 596, 30 L. Ed. 2d 575 Reh. denied, 405 U.S. 969, 92 S. Ct. 1162, 31 L. Ed. 2d 244 (1972); and from two recent cases from this District wherein the exercise of stock appreciation rights was held to give rise to no liability under § 16(b), Freedman v. Barrow, 427 F. Supp. 1129 (S.D.N.Y.1976); and Rosen v. Drisler, 421 F. Supp. 1282 (S.D.N.Y.1976).
A. SECTION 16(b) THE OBJECTIVE APPROACH VS. THE SUBJECTIVE APPROACH
Section 16(b) of the Securities Exchange Act was originally intended to operate as a "relatively arbitrary rule capable of easy administration."
Irrespective of any motive or intent on the part of a covered officer, director, or ten percent shareholder of an issuer to indulge in short-swing trading on the basis of inside information, any profits gained from sales and purchases or purchases and sales within a period of six months or less were made recoverable by the statute. For many years the statute did operate almost mechanically, with courts applying it in what has come to be known as the "objective approach".
Then came a series of cases demanding the application of the statute to transactions which were not classic purchases and sales for cash, such as stock conversions, mergers, and stock options. The courts developed the so-called "subjective approach" in response to these situations, finding 16(b) liability whenever the transaction in question was of a type likely to involve the potential for the sort of speculative abuses which § 16(b) was designed to prevent.
In the words of the Supreme Court:
"In deciding whether borderline transactions are within the reach of the statute, the courts have come to inquire whether the transaction may serve as a vehicle for the evil which Congress sought to prevent the realization of short-swing profits based upon access to inside information thereby endeavoring to implement congressional objectives without extending the reach of the statute beyond its intended limits."
The "subjective" (or "pragmatic") approach was designed to moderate the harshness of the application of § 16(b)"s "liability without fault" standard to situations which, though arguably involving some equivalent of a § 16(b) purchase and sale, could not possibly allow for insider speculation and profiteering on non-public information.
The rule is still as it was stated by the Second Circuit in 1970, in Newmark v. RKO General :
"Whether certain "unorthodox' transactions, well illustrated here by the exchanges of securities incident to a merger . . ., are "purchases' or "sales' for the purpose of section 16(b) cannot be resolved by mere reference to the words of the statute. In such cases, the determination of the statute's relevance must rest, initially, on whether there exists the potential for evil against which the statute was intended to guard. . . . Only when an opportunity for speculative abuse is present is it necessary to determine whether the transactions alleged to give rise to 16(b) liability may fairly be characterized as insider purchases and sales."
The exercise of Apco stock appreciation rights for cash is clearly an unorthodox transaction within the meaning of the above quoted decisions, and this court so holds. See also Freedman v. Barrow, supra, and Rosen v. Drisler, supra. Thus, the court must turn its attention to the question of whether or not such exercise presented a possibility of speculative insider abuses, so that § 16(b) purchases and sales should be found.
B. THE POSSIBILITY OF SPECULATIVE ABUSE IN THE EXERCISE OF SAR'S
One common thread running through many of the cases where No liability was found is the tendency to involve involuntary participation on the part of those alleged to have engaged in short-swing trading.
Thus, no 16(b) liability was found in Kern County Land Co. v. Occidental Petroleum, supra, a case where a would-be acquiring company was left with a large block of shares in the target company following an unsuccessful merger attempt. The unsuccessful tender offeror subsequently exchanged stock of the target company for stock of a third company which had entered into a defensive merger with the target, and also ...