Gwozdzinsky on Behalf of Revco D.S., Inc. v. Magten Asset Management Corp., 126

• Decision Date: 03 January 1997
• Docket Number: No. 126,D,126
• Parties: , Fed. Sec. L. Rep. P 99,371 Margaret GWOZDZINSKY, derivatively on Behalf of REVCO D.S., INC., Plaintiff-Appellant, v. MAGTEN ASSET MANAGEMENT CORP.; Talton R. Embry; Revco D.S., Inc.; General Motors Hourly-Rate Employees Pension Plan; General Motors Retirement Program for Salaried Employees; L.A. Fire & Police Pension Systems--Fund 2525; Western Union Pension Trust; The Bakal Company; The Core Investment Limited Partnership; Levi Family Trust; Allen H. Luray; Pearlstone 54 Trust; Ellen's U/W J.H. Pearlstone; Jennifer Russell, Defendants-Appellees. ocket 96-7233.
• Court: U.S. Court of Appeals — Second Circuit

Page 469

106 F.3d 469

65 USLW 2504, Fed. Sec. L. Rep. P 99,371

Margaret GWOZDZINSKY, derivatively on Behalf of REVCO D.S., INC., Plaintiff-Appellant, v. MAGTEN ASSET MANAGEMENT CORP.; Talton R. Embry; Revco

D.S., Inc.; General Motors Hourly-Rate Employees Pension

Plan; General Motors Retirement Program for Salaried

Employees; L.A. Fire & Police Pension Systems--Fund 2525;

Western Union Pension Trust; The Bakal Company; The Core

Investment Limited Partnership; Levi Family Trust; Allen

H. Luray; Pearlstone 54 Trust; Ellen's U/W J.H.

Pearlstone; Jennifer Russell, Defendants-Appellees.

No. 126, Docket 96-7233.

United States Court of Appeals, Second Circuit.

Argued Sept. 5, 1996.

Decided Jan. 3, 1997.

Paul D. Wexler, Bragger & Wexler, New York City, for Plaintiff-Appellant.

Lee S. Richards, Richards Spears Kibbe & Orbe, New York City, for Defendants-Appellees.

Before: FEINBERG, CARDAMONE, and McLAUGHLIN, Circuit Judges.

McLAUGHLIN, Circuit Judge:

Plaintiff appeals from an order of the United States District Court for the Southern District of New York (Sweet, J.), granting defendants' motion for summary judgment and dismissing plaintiff's complaint.

BACKGROUND

Margaret Gwozdzinsky is a shareholder of Revco D.S., Inc. ("Revco"). Magten Asset Management Corp. ("Magten") is a New York corporation and a registered investment advisor. Talton Embry ("Embry") is Magten's sole officer and director and co- In June 1994, Revco issued a prospectus to its shareholders offering the right to buy additional shares of Revco common stock. Revco intended to use the proceeds of the sale to acquire another company, Hook-SupeRX, Inc. The prospectus offered each holder of common stock the right to purchase additional shares at a reduced rate. Each holder could purchase .305 new Revco shares for each share of stock already owned ("subscription privilege"). To ensure that all new shares would be purchased, the offering contained an "oversubscription privilege" guaranteeing that each holder who exercised all his or her rights under the subscription privilege could buy additional new shares, up to twice the number of shares purchased under the subscription privilege.

Chairman of Revco's Board of Directors. In March 1994, Magten, Magten's clients, and Embry collectively owned approximately 14.8% of Revco's outstanding common stock.

The price per share was $14. The market price of the stock, of course, was considerably higher, ranging from $16.75 per share on the last full day of trading before the rights offering was announced to $18.25 per share the day before the prospectus was printed.

In July 1994, Embry, Magten, and Magten's clients exercised their rights under the subscription privilege and the oversubscription privilege. Collectively, they purchased 2,380,128 shares under the basic subscription privilege and the oversubscription privilege. After exercising all of their rights under the offering, Magten's, Magten's clients' and Embry's collective ownership of Revco stock increased from 14.8% to 15%. Within six months of the purchase several Magten clients sold their new shares at a substantial profit. Neither Embry nor Magten itself sold their new Revco stock within six months of the purchase.

After Revco itself declined to bring suit, Gwozdzinsky sued Embry, Magten and several Magten clients on behalf of Revco in the United States District Court for the Southern District of New York (Sweet, J.) to recover "short-swing" profits earned from the purchase and sale of the new Revco stock. Because Magten, Magten's clients and Embry collectively own more than 10% of Revco's stock, they are subject to the restrictions of § 16(b) of the Securities Exchange Act of 1934 ("the Act"). Gwozdzinsky alleges that Revco is entitled to the profits earned by Magten's clients from the sale of the new Revco stock bought and sold within six months, because the transactions violated § 16(b) of the Act. Defendants moved for summary judgment. The district court granted the motion and dismissed Gwozdzinsky's complaint, finding that the transactions were exempt from § 16(b) by Rule 16a-9 of the Securities and Exchange Commission ("SEC").

Gwozdzinsky now appeals, arguing that (1) summary judgment was improper because the transactions did not fall within the SEC Rule 16a-9 exemption from § 16(b); and (2) even if summary judgment was proper, we should find SEC Rule 16a-9 void as an invalid exercise of the SEC's authority.

DISCUSSION

Section 16(b) of the Securities Exchange Act of 1934 provides that:

For the purpose of preventing the unfair use of information which may have been obtained by ... [an] owner, director,or officer by reason of his relationship to the issuer, any profit realized by him from any purchase and sale ... of any equity security of such issuer ... within any period of less than six months ... shall inure to and be recoverable by the issuer.... This subsection shall not be construed to cover ... any transaction or transactions which the Commission by rules and regulations may exempt as not comprehended within the purpose of this subsection. 15 U.S.C. § 78p(b).

SEC Rule 16a-9 provides that:

The following shall be exempt from § 16 of the Act: ... (b) [t]he acquisition of rights, such as shareholder or pre-emptive rights, pursuant to a pro rata grant to all holders of the same class of equity securities registered under Section 12 of the Act.

The dispute centers around whether Revco's offering qualifies as a pro rata distribution under subsection (b) of Rule 16a-9.

Although Rule 16a-9 was promulgated in 1991, there appear to be no cases interpreting the scope of the rule. The district court relied upon the plain language of the rule and Congress's intent in enacting § 16 of the Act, to conclude that Revco's offering fell within the exemption provided by 16a-9(b). We agree.

Rule 16a-9(b) specifically exempts "the acquisition of rights ... pursuant to a pro rata grant to all holders of the same class of ... securities." SEC Rule 16a-9(b). This language applies to any rights held by all shareholders in proportion to their percentage of stock ownership. Rule 16a-9 expressly cites preemptive rights as an example of the type of transaction exempted under the rule. Preemptive rights are the "right[s] of shareholders to acquire newly issued shares from the corporation ... pro rata to their existing holdings." Andrew L. Nichols, Shareholder Preemptive Rights, Boston B.J., Nov.-Dec.1995, at 4.

Gwozdzinsky argues that Revco's offering is not pro rata, as intended by Rule 16a-9(b), because the purchase of additional shares was not mandatory. This argument is unconvincing. A "right," by nature, is not an obligation. The holder is entitled to exercise that right, but is not required to do so. Preemptive rights allow shareholders to purchase enough stock to maintain their percentage of ownership, but do not obligate shareholders to buy the offered stock. With preemptive rights, as with the Revco offering, some people will exercise their right and others will not. Gwozdzinsky would have it...