Park & Tilford v. Schulte, 57

• Decision Date: 26 March 1947
• Docket Number: Docket No. 20317.,No. 57,57
• Citation: 160 F.2d 984
• Parties: PARK & TILFORD, Inc. v. SCHULTE et al.
• Court: U.S. Court of Appeals — Second Circuit

160 F.2d 984 (1947)

PARK & TILFORD, Inc. v. SCHULTE et al.

No. 57, Docket No. 20317.

Circuit Court of Appeals, Second Circuit.

January 8, 1947.

Rehearing Denied March 26, 1947.

COPYRIGHT MATERIAL OMITTED

Edwin A. Falk, of New York City (Gale, Bernays, Falk & Eisner, Murray C. Bernays, Edgar A. Samuel, and Norton I. Katz, all of New York City, on the briefs), for Arthur D. Schulte et al., defendant-appellants.

Max L. Rothenberg, of New York City (Hirson, Bertini & Rothenberg, and Max M. Hirson, all of New York City, on the brief), for Park & Tilford, Inc., plaintiff-appellee.

John B. Creegan, Asst. U. S. Atty., of New York City (John F. X. McGohey, U. S. Atty., of New York City, on the brief), for the United States, intervenor-appellee.

Nathan B. Kogan, of New York City, for Marjorie D. Kogan, intervenor-appellee-appellant.

Roger S. Foster, Sol., Robert S. Rubin, Asst. Sol., and W. Victor Rodin, Atty., all of Philadelphia, Pa., for Securities and Exchange Commission as amicus curiae.

Before SWAN, CLARK, and FRANK, Circuit Judges.

CLARK, Circuit Judge.

In Smolowe v. Delendo Corporation, 2 Cir., 136 F.2d 231, 148 A.L.R. 300, certiorari denied Delendo Corp. v. Smolowe, 320 U.S. 751, 64 S.Ct. 56, 88 L.Ed. 446, we upheld and applied § 16(b) of the Securities Exchange Act of 1934, 15 U.S.C.A. § 78p(b), making any profit from a "shortswing" speculation in corporate stock by an "insider" inure to the benefit of the corporation. The statute reaches any profit realized by, among others, a beneficial owner of more than 10 per cent of any class of any equity security "from any purchase and sale, or any sale and purchase, of any equity security" of the corporation within any period of less than six months, unless acquired in good faith in connection with a previous debt. It authorizes suit therefor by the corporation or by a stockholder if the corporation fails to sue within 60 days after request or fails "diligently to prosecute the same thereafter." This case now presents the further issue whether an initial purchase is shown by exercise of an option, within the six months' period, to convert preferred into common stock, the Act defining "purchase" to "include any contract to buy, purchase, or otherwise acquire." § 3(a) (13), 15 U.S.C.A. § 78c (a) (13).

The plaintiff is a corporation whose common stock is registered on a national securities exchange. The defendants are three brothers, trustees for a trust created by their father, David A. Schulte, a former president of plaintiff, and in 1945, chairman of plaintiff's board of directors. One of the defendants is likewise a member of plaintiff's board of directors. Through ownership of a majority of the common, voting stock, defendants in 1943 controlled the plaintiff. Defendants also owned 6,604 shares of plaintiff's preferred stock, which was redeemable by the plaintiff at $55 per share on 90 days' notice. This stock was also convertible by the shareholder into common stock in the ratio of 1¼ shares of common for each share of preferred stock. If plaintiff gave notice of redemption, the shareholder could nevertheless exercise the conversion privilege until the redemption date. From late 1943 until May, 1944, there was a spectacular rise in the market price of plaintiff's common stock, probably because of the rumor of an impending dividend to be paid in liquor. On December 20, 1943, plaintiff served notice of redemption of its preferred stock, and on January 19, 1944, defendants exercised their privilege and converted their preferred into common stock. On that date the market price of the preferred was about 55¼ and the value of the block which defendants converted, as found by the court, was $364,871. On that date, also, the stipulated market price of the common was 58¼ and the market value of the entire block of common acquired by defendants was $480,853.78. Within six months defendants sold the common for $782,999.59.

Plaintiff thereupon brought this action under the statute to recover the profits realized by defendants. Marjorie D. Kogan, a minority stockholder who had previously brought a representative suit under this statute against David A. Schulte individually, moved to intervene herein and to consolidate her representative suit with this one.¹ The District Court denied her motions, but permitted the United States of America to intervene pursuant to 28 U.S. C.A. § 401, because the constitutionality of § 16(b) was being questioned by the defendants herein. On the merits the District Court entered judgment for the plaintiff for $302,145.81, together with interest and costs. This sum represented the difference between the receipts realized from the sale of the common and the stipulated market value of the common on the conversion date. Defendants appeal from the judgment, and the minority stockholder appeals from the denial of her motion to intervene in the District Court. This court has already granted her motion for leave to intervene in this appeal, and has consolidated the two appeals for hearing and decision. The Securities and Exchange Commission has filed a brief amicus curiae urging affirmance of the recovery under the statute, and allowance of Kogan's motion to intervene.

We think a conversion of preferred into common stock followed by a sale within six months is a "purchase and sale" within the statutory language of § 16(b). Whatever doubt might otherwise exist as to whether a conversion is a "purchase" is dispelled by definition of "purchase" to include "any contract to buy, purchase, or otherwise acquire." § 3(a) (13). Defendants did not own the common stock in question before they exercised their option to convert; they did afterward. Therefore they acquired the stock, within the meaning of the Act. The Act certainly applies as well to executed acquisitions as to executory contracts to acquire. Not otherwise could the Act accomplish the Congressional purpose to protect the outside stockholders against at least shortswing speculation by insiders with advance information. Smolowe v. Delendo Corporation, supra, 2 Cir., 136 F.2d 231, 235, 148 A.L.R. 300; Kogan v. Schulte, D.C.S. D.N.Y., 61 F.Supp. 604.²

The transaction is not within the exception provided in § 16(b) for stock "acquired in good faith in connection with a debt previously contracted," since the exception is clearly inapplicable to anything except transactions in connection with actual debts. It is a strained concept, indeed, to regard preferred stock convertible into common as a debt here. Ownership of preferred or common stock creates an equity interest, and not a creditor's interest, under these circumstances. In re Phoenix Hotel Co. of Lexington, Ky., 6 Cir., 83 F.2d 724, 727, 728, certiorari denied Security Trust Co. v. Baker, 299 U.S. 568, 57 S.Ct. 31, 81 L.Ed. 418. Indeed, § 3(a) (11) of the Act, 15 U.S.C.A. § 78c(a) (11), defines "equity security" as "any stock or similar security; or any security convertible, with or without consideration, into such a security." The transaction may not, as defendants assert, be withdrawn from operation of the Act on the theory that the conversion was a forced, and not a voluntary, act by defendants. Whatever might be the considerations involved in that situation, it is clear that here defendants were not forced to convert, but instead made an everyday business decision as to the most profitable of three courses of action — redemption, conversion, or outright sale of their preferred. Indeed, the contention that defendants were forced to convert is somewhat absurd, in view of the fact that since defendants controlled plaintiff they could have prevented the passage of the redemption resolution or rescinded it after it had been passed.

Defendants' contention that § 16(b), as applied to the situation at bar, is unconstitutional is entirely without merit; indeed it is foreclosed by Smolowe v. Delendo Corporation, supra.

The minority stockholder urges that the judgment recovered by plaintiff was too small. She attempted to argue this or other points at the trial, but because intervention had been previously denied her, her counsel was not allowed to speak. Under our grant of permission to intervene on this appeal she is entitled to raise the point now, and we think it is well taken. Under the statute the amount recoverable by plaintiff is the receipts from the sale of the stock, minus the actual purchase price. The common stock in question here was purchased by exchanging preferred for it. Its purchase price was therefore the market value of the preferred on the conversion date, which was found by the district judge, and, indeed, conceded by the parties, to be $364,871. The preferred stock here involved could have been, and was, converted into common stock having a considerably higher market price.³ This fact does not affect the selection of the figure representing the purchase price. Apparently not all preferred stock had actually been converted, and the record does not present facts explaining what might seem on the surface unusual discrepancies in market value. As between the two figures, the choice of the price of the preferred is more consistent with the purpose of the Act as expressed in Smolowe v. Delendo Corporation, supra, 2 Cir., 136 F.2d 231, 239, 148 A.L.R. 300. This is "to squeeze all possible profits out of stock transactions, and thus to establish a standard so high as to prevent any conflict between the selfish interest of a fiduciary officer, director, or stockholder and the faithful performance of his duty." The judgment entered by the District Court was based on the erroneous use of the market price of the common stock on the conversion date, as the purchase price. It should therefore be increased to $418,128.59, together with interest and costs.

With reference to Kogan's application to intervene below, we think, as we have indicated in allowing her to intervene here, that the interests of minority shareholders were not...