the outstanding common shares. (Stip. P5(d))
The purchaser defendant with the largest holding in Viacom International, 8.51%, was WJB, a Bahamian partnership. WJB purchased 2,538,500 shares in August and September 1986 and options on an additional 394,500 shares in September 1986. (Stip. P 5(e); Stip. Ann. 1) Tracing the division of WJB's profits and determining the GTO defendants' interest in those profits requires navigation of a tortuous financial landscape. GTO was the general partner of WJB and there were six limited partners, Coniston I, Coniston II, Helston, Sabre Associates, Sabre Operations Inc. and Princeton/Newport Partners Special Situation Fund. Each of the limited partners was entitled to a percentage of WJB's profits in proportion to its respective capital contribution: Coniston I (54.47%); Coniston II (7.71%); Helston (31.41%); Sabre Associates (1.71%); Sabre Operations, Inc. (3.7%); and Princeton/Newport Partners Special Situation Fund (1%).
In addition to their interests in Coniston I, Coniston II and Helston which have already been discussed, the GTO defendants shared in the profits of WJB through Sabre Associates, Sabre Operations and Princeton/Newport Partners Special Situation Fund. Regarding Sabre Associates, GTO had a 58.82% limited partnership interest, a 5.18% indirect interest through its partial ownership of the managing general partner, and a 15% interest in the profits of other entities which held an aggregate interest of 34.26%. Thus, GTO was entitled to 69.15% of Sabre Associates' profits.
Sabre Operations is a wholly-owned subsidiary of Sabre International Corp., 2% of which is owned by Sabre Newent Associates, a partnership in which GTO has a 50% interest. In addition to its 2% ownership interest, Sabre Newent was also entitled to 20% of the profits on shares owned by unaffiliated investors. Accordingly, GTO was entitled to 10.8% of the consolidated profits of Sabre Operations and Sabre International.
The GTO defendants did not have an ownership interest in the Princeton/Newport Partners Special Situation Fund. However, the Fund's investment manager was Sabre Management Co., through which GTO was entitled to a fee of 10% of Fund profits.
Thus, after the profits flowed through all the WJB limited partners, the GTO defendants' total share in the profits of WJB Associates was 27.71%.
At the time the purchaser defendants were buying Viacom International stock and options, Viacom International's management and National Amusements, Inc. ("NAI") were competing for control of Viacom International. (Malchman Aff. P9) On October 27, 1986, pursuant to an agreement reached on October 6, 1986, WJB sold NAI 2,687,000 shares of Viacom International at $ 43 per share. (Stip. P6) In addition, between October 7 and October 9, the other purchaser defendants sold a total of 830,000 shares on the open market at prices ranging from $ 43.4375 to $ 44.75 per share. (Stip. App. Ann. 2A at 27) All sales were made within six months of the purchaser defendants' initial acquisitions of Viacom International common stock.
Congress concluded that corporate insiders have access to valuable non-public information and that the probability that such information will be abused is intolerably high. In response to that perceived risk, Congress enacted a "flat rule" prohibiting insiders from realizing profits on short term transactions. See Reliance Elec. Co. v. Emerson Elec. Co., 404 U.S. 418, 422, 92 S. Ct. 596, 30 L. Ed. 2d 575 (1972); see also Kern County Land Co. v. Occidental Petroleum Corp., 411 U.S. 582, 591-95, 36 L. Ed. 2d 503, 93 S. Ct. 1736 (1973). To "prevent the unfair use of information which may have been obtained by [a] beneficial owner, director, or officer by reason of his relationship to the issuer,"§ 16(b) of the Securities Exchange Act of 1934 permits "the issuer, or . . . the owner of any security of the issuer", to bring suit in the issuer's name against any "beneficial owner, director, or officer" of the issuer to recover "any profit realized . . . from any purchase and sale, or any sale and purchase, of any equity security of [the] issuer . . . within any period of less than six months." 15 U.S.C. § 78p(b). The term "beneficial owner" is defined in § 16(a) as any person who directly or indirectly owns "more than 10 per centum of any class of" the issuer's securities. 15 U.S.C. § 78p(a).
Here, it is agreed that defendants were neither officers nor directors of Viacom International. (Stip. P4) It is uncontested also that no one of the defendants owned more than 10% of any class of Viacom International securities. (Stip. P7) Plaintiff contends, however, that because the GTO defendants controlled the purchaser defendants and shared in the profits, the GTO defendants should be considered the beneficial owners of the purchaser defendants' aggregate holdings. During the summer and fall of 1986, such holdings amounted to 12.04% of Viacom International's common stock;
thus, accepting plaintiff's argument would render the GTO defendants liable to Viacom Inc. for profits on the transactions.
The purchaser defendants, however, were not wholly owned by the GTO defendants and, as discussed above, because of varying capital contributions and fee arrangements, the GTO defendants were entitled to only a percentage of the profits earned by each of the purchaser defendants. If beneficial ownership is limited by pro rata financial interest in the entity holding the shares, then the GTO defendants were the beneficial owners of 1,149,744 shares out of the 4,132,400 shares held by the purchaser defendants. Thus, the question arises whether the GTO defendants should be considered the beneficial owners of all shares held by the purchaser defendants, 12.04% of Viacom International, or only the number of shares represented by their financial stake in the holdings of the purchaser defendants, 3.35% of Viacom International.
In Mayer v. Chesapeake Insurance Co., 877 F.2d 1154 (2d Cir. 1989), cert. denied, 493 U.S. 1021, 107 L. Ed. 2d 741, 110 S. Ct. 722 (1990), the Second Circuit considered an analogous situation. The Court held that although one of the defendants was chairman, president and chief executive officer of two public companies in which he owned a substantial amount of stock, that defendant was not a beneficial owner of the securities held by those companies or their subsidiaries. Id. at 1161-62; see also Margolies v. Rea Bros. Plc., [1982-1983 Transfer Binder]Fed. Sec. L. Rep. (CCH) P99,261 at 96,178-79 (S.D.N.Y. June 30, 1983) (cited in Mayer). Mayer reserved the question of whether the outcome would have differed had the owner of the securities been a closely held corporation. 877 F.2d at 1161.
Although Mayer did not address directly the question presented here, its analysis helps decide this case. Mayer distinguished between two aspects of beneficial ownership -- control over disposition of the securities and pecuniary interest in the securities. Judge Kearse, writing for herself and Judge Winter, over District Judge Sweet's dissent, concluded that despite defendant's control over disposition of the shares, his financial interest as a shareholder in the public companies which owned the shares was too insubstantial to amount to beneficial ownership. Judge Kearse reasoned that "even where an insider has complete control over a block of the stock of the registered company, if in fact he is not a beneficial owner in the traditional sense of the term and receives no direct pecuniary benefit from a profit in it, the profit is not received 'by him' and hence need not be disgorged pursuant to 16(b)." Mayer, 877 F.2d at 1160. Only in situations "where the insider has . . . control over the transactions and directly benefits from the profits, [is he] liable under § 16(b)." Id. at 1157. Plaintiff, pointing out that the GTO defendants had both control over and a pecuniary interest in the purchaser defendants' shares, argues that Mayer requires judgment in his favor. However, in so arguing, plaintiff incorrectly applies the "direct benefit" concept which the Second Circuit in Mayer held to be the crucial component of beneficial ownership. Id.
The Mayer court concluded that some degree of control over the issuer's shares is necessary but not sufficient for a finding of beneficial ownership; rather, direct economic benefit is the critical factor in § 16(b) beneficial ownership analysis. The Mayer court contrasted § 16(b) with § 13(d), 15 U.S.C. § 78m(d), the Williams Act filing requirement for holders of more than 5% of a class of equity securities, noting that "'[§ 16(b)] stresses the economic benefit to be derived from the securities and [§ 13(d)] emphasizes the ability to control or influence the voting or disposition of the securities. As a result different determinations under [§§ 16(b) and 13(d) ] are possible.'" Mayer, 877 F.2d at 1162 (quoting SEC Exchange Act Release No. 18114, 4Fed. Sec. L. Rep. (CCH) P26,062 at 19,063-7 n.17 (Sept. 23, 1981)). Judge Kearse also contrasted cases decided under § 13(d) such as GAF Corp. v. Milstein, 453 F.2d 709 (2d Cir. 1971), cert. denied, 406 U.S. 910, 31 L. Ed. 2d 821, 92 S. Ct. 1610 (1972), which focused on control, with those decided under § 16(b) such as Whittaker v. Whittaker Corp., 639 F.2d 516 (9th Cir.), cert. denied 454 U.S. 1031, 70 L. Ed. 2d 473, 102 S. Ct. 566 (1981) and Whiting v. Dow Chemical Co., 523 F.2d 680 (2d Cir. 1975), which focused on financial interest. See Mayer 877 F.2d at 1162.
In Whittaker, the defendant was granted an absolute power of attorney by his mother, a § 16(b) insider and, as a result, "'exercised virtually complete control over his mother's affairs.'" 639 F.2d at 523 (quoting district court). Because the defendant freely used his mother's funds for his own purposes and benefitted from all her assets "'exactly as if they were his own,'" (quoting district court), the Whittaker court concluded that profits on any trades made for the mother's account were realized by the defendant and that the defendant, therefore, was the beneficial owner of his mother's shares.
Similarly, in Whiting, supra, a director of Dow Chemical purchased Dow stock within six months of a sale of Dow stock by his wife. The Second Circuit held that the husband's lack of "exclusive " control over the wife's stock was not dispositive in determining whether he was the beneficial owner of that stock. Whiting, 523 F.2d at 685 (emphasis in original). Instead, the issue turned on the finding that "'beneficial owner[ship]' includes securities from which the spouse has shared 'benefits substantially equivalent to ownership.'" Id. at 686 (quoting SEC Exchange Act Release No. 7793, 4Fed. Sec. L. Rep. (CCH) P26,031 at 19,057-4 (Jan. 19, 1966)). Because the profit realized on the wife's sale was enjoyed by the husband just as if he had executed the transaction, the husband was considered a beneficial owner of the wife's stock.
It is clear from Mayer, Whittaker, and Whiting, that control without direct financial interest does not constitute beneficial ownership, and that even without complete or exclusive control direct financial interest in the issuer's shares may itself constitute beneficial ownership. However, the question remains whether the GTO defendants, who controlled all the Viacom International shares held by the purchaser defendants and admittedly had a financial stake in a percentage of the profits earned on the Viacom International transactions, should be deemed beneficial owners of all the purchaser defendants' shares, or only of that fraction of the shares corresponding to their pro rata financial interest in the purchaser defendants' holdings.
In both Whittaker and Whiting, defendants benefited directly from all profits received in the short-swing transactions. By contrast, those cases which have considered whether indirect financial interest constitutes beneficial ownership, have held that a direct financial benefit is necessary to beneficial ownership. See, e.g., Mayer, 877 F.2d at 1161-62 (controlling shareholder's financial interest too remote). In C.R.A. Realty Corp. v. Goodyear Tire & Rubber Co., 705 F. Supp. 972, 977 (S.D.N.Y.), aff'd mem., 888 F.2d 125 (2d Cir. 1989), Judge Lasker wrote that "existing case law supports the proposition that shares owned by different persons may not be aggregated to create a 10 per cent person absent an allegation that one person received direct pecuniary benefit from another's shares." See also Rothenberg v. Jacobs, [1988-1989 Transfer Binder]Fed. Sec. L. Rep. (CCH) P94,199 (S.D.N.Y. Jan. 11, 1989) ("Pecuniary benefit, rather than control over the securities is the determining factor of beneficial ownership . . . the language of 16(b) imposes liability for profits personally realized.") In C.B.I. Industries Inc. v. Horton, 682 F.2d 643 (7th Cir. 1982), Judge Posner wrote for a panel of the Seventh Circuit held that a trustee with unrestricted control of the trust res did not realize the profits earned by the trust through short-swing transactions. He reasoned that "profit realized by a corporate insider means direct pecuniary benefit to the insider as in the factual settings of Whiting and Whittaker." Id. at 646.
Admittedly, no one of the above cited cases addressed the situation presented here -- where defendants controlled over 10% of the issuer's shares but had a direct ownership stake in less than 10% of the issuer's shares -- but, in each of those cases beneficial ownership and liability were limited to those defendants who received a direct pecuniary benefit from the shares bought and sold. If beneficial ownership, and resulting liability, is determined based on direct financial benefit, it follows that if a person owns a percentage interest in a pool of the issuer's shares that person should be considered the beneficial owner of only that fraction of the issuer's shares that corresponds to his pro rata financial interest in the pool's profits.
Limiting beneficial ownership in this manner is consistent with how the SEC treated beneficial ownership at the time the Viacom International trades were made. In a release interpreting § 16(a) which has broader coverage than § 16(b), Mayer, 877 F.2d at 1159; SEC Exchange Act Release No. 7824, 4Fed. Sec. L. Rep. (CCH) P26,030 (Feb. 14, 1966), the SEC explained the rule regarding holdings of a general partnership as follows:
Question : Must a member of a partnership take into account the entire holdings of the partnership in determining whether he is a 10 percent beneficial owner of a class of equity security of a registered company?
Answer : No. A partner is required to include only his own economic interest in the partnership holdings. Thus only his pro rata interest in the securities held by the partnership must be added to his own personal beneficial interest.