Provident Securities Co. v. Foremost-McKesson, Inc.

• Decision Date: 19 September 1974
• Docket Number: No. 71-2965,FOREMOST-M,71-2965
• Citation: 506 F.2d 601
• Parties: Fed. Sec. L. Rep. P 94,811 PROVIDENT SECURITIES COMPANY, a California corporation, Plaintiff-Appellee, v.cKESSON, INC., a Maryland corporation, Defendant-Appellant.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 601

506 F.2d 601

Fed. Sec. L. Rep. P 94,811

PROVIDENT SECURITIES COMPANY, a California corporation Plaintiff-Appellee, v. FOREMOST-McKESSON, INC., a Maryland corporation, Defendant-Appellant.

No. 71-2965.

United States Court of Appeals, Ninth Circuit.

Sept. 19, 1974

Certiorari Granted Feb. 18, 1975

See 95 S.Ct. 1117.

Morton Moskin, New York City, N.Y., (argued) of Landels, Ripley & Diamond, San Francisco, Cal., for defendant-appellant.

Walter R. Allan (argued) of Pillsbury, Madison & Sutro, San Francisco, Cal., for plaintiff-appellee.

Before ELY, TRASK and WALLACE, Circuit Judges.

OPINION

WALLACE, Circuit Judge:

Provident Securities Company (Provident) filed this action, seeking a declaration of nonliability for short-swing profits under section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. 78p(b). Foremost-McKesson, Inc. (Foremost) counterclaimed, seeking a declaration of liability and recovery of the profits. Both parties moved for summary judgment and the district court found in favor of Provident, holding that the Provident-Foremost transaction did not fall within section 16(b) since it did not involve the potential for speculative abuse of inside information condemned by the Act. Provident Securities Co. v. Foremost-McKesson, Inc., 331 F.Supp. 787 (N.D.Cal.1971). We affirm, but on other grounds.

Provident (now dissolved) was a holding company owned by the descendants of W. H. Crocker. In the fall of 1968, it tentatively decided to liquidate its assets and hired Dillon, Read & Company to analyze its financial structure and to seek a purchaser which in turn led to Provident negotiating with Foremost. Initially Provident hoped to sell its assets for cash since cash would be easy to distribute to its shareholders. But eventually it compromised and accepted convertible debentures, one half of which would be registered as soon as possible after closing so that the stock could be offered to the public.

On September 25, 1969, pursuant to this compromise, Provident and Foremost executed a purchase agreement which provided that Foremost would purchase approximately two-thirds of Provident's assets for $54,000,000, consisting of $4,250,000 in cash and $49,750,000 in Foremost six percent convertible subordinated debentures. On October 15, 1969, the closing was held under the purchase agreement. At that time Foremost delivered to Provident a check for $4,250,000 and a debenture in the principal amount of $40,000,000. This debenture was subsequently split into two debentures in the principal amounts of $25,000,000 and $15,000,000. At the time of closing and in Provident's behalf, Foremost also delivered to an escrow agent a debenture in the principal amount of $2,500,000. The debentures were immediately convertible into common stock in an amount in excess of 10 percent of Foremost's outstanding shares. At the completion of the sale, Provident became a beneficial owner of more than 10 percent of a class of Foremost equity securities as provided in section 16(a) of the Act, 15 U.S.C. 78p(a). On October 20, 1969, Foremost delivered to Provident an additional debenture in the principal amount of $7,250,000.

The following day, October 21, 1969, Provident, Foremost and Dillon, Read & Company, as representative of the underwriting group (Underwriters), executed an underwriting agreement providing for the sale by Provident of the debenture in the principal amount of $25,000,000 to Underwriters at a price of $25,366,666.66. On October 24, 1969, Provident distributed debentures to its shareholders in the aggregate principal amount of $22,250,000. At this point Provident ceased to be a 10-percent shareholder of Foremost stock.

On October 28, 1969, the closing under the underwriting agreement was held and Provident transferred the $25,000,000 debenture to Underwriters in exchange for a check in the amount of $25,366,666.66. The following day, after waiting the necessary time for the check to clear, Provident distributed the cash to its shareholders. On August 31, 1970, following the completion of liquidation proceedings, Provident was dissolved and its remaining assets transferred to a liquidating trust.

A. The Threshold Test-- Potential for Speculative Abuse

Section 16(b) of the Securities Exchange Act was enacted to prevent corporate officers, directors and principal shareholders from profiteering in inside information through short-swing speculation. The section was designed to discourage corporate insiders from reaping profits from fluctuations in the price of their corporation's stock that were predictable on the basis of inside information. ¹

Consistent with this statutory purpose, the Supreme Court in Kern County Land Co. v. Occidental Petroleum Corp., 411 U.S. 582, 595, 93 S.Ct. 1736, 36 L.Ed.2d 503 (1973), recently adopted a pragmatic approach that subjects short-swing transactions by an insider to section 16(b) scrutiny only if they involve the potential for speculative abuse of inside information. As a prerequisite to the Kern County threshold test, however, the Court indicated that there must be an 'unorthodox' transaction such as 'stock conversions, exchanges pursuant to mergers and other corporate reorganizations, stock reclassification, and dealings in options, rights, and warrants.' 411 U.S. at 593 n.24, 93 S.Ct. at 1744. The Court's examples of 'unorthodox' transactions were probably not intended to be all inclusive but suggest that if the transaction is cash-for-stock or essentially cash-for-stock, then the Kern-County threshold rule should not be applied. In the orthodox case, the transaction must be tested against the literal terms of the section.

The Provident-Foremost transaction was essentially a cash-for-stock transaction. Provident purchased Foremost debentures, convertible immediately into a large block of common stock, in exchange for two-thirds of its assets. There was no substantial period of delay between the initial agreement and the exchange of consideration. The rights and obligations of the parties were fixed when the purchase agreement was executed. The purchase price did not depend on a formula that was tied to the price of the stock on the market, cf. Booth v. Varian Associates, 334 F.2d 1 (1st Cir. 1964), cert. denied, 379 U.S. 961, 85 S.Ct. 651, 13 L.Ed.2d 556 (1965), but was fixed at the time of agreement. The transaction was not merely a record-keeping maneuver, cf. Blau v. Max Factor & Co., 342 F.2d 304 (9th Cir.), cert. denied, 382 U.S. 892, 86 S.Ct. 180, 15 L.Ed.2d 150 (1965), but was an actual transfer of stock for assets. Given these facts there is no reason to treat the Provident-Foremost transaction as anything other than an orthodox sale of stock. As Professor Loss writes:

Conversion and merger-like transactions aside, the voluntary exchange of securities, either for assets or for other securities, at least of a different issuer, is ordinarily as much a 'purchase' or 'sale' as if the consideration had been cash.

2 L. Loss, Securities Regulation 1072 (2d ed. 1961).

Provident argues that the transaction was in reality not a purchase, but rather a sale of assets. It points out that it originally preferred cash, but, at Foremost's insistence, compromised to accept convertible stock. But even though this assertion may be correct, it does not alter the nature of the transaction for section 16(b) purposes. Provident exchanged its assets for Foremost stock. The only distinction between this transaction and the usual cash-for-stock sale is the nature of the consideration. In all other respects the transaction was orthodox. See Stella v. Graham-Paige Motors Corp., 132 F.Supp. 100, 102-103 (S.D.N.Y.1955), modified, 232 F.2d 299 (2d Cir.), cert. denied, 352 U.S. 831, 77 S.Ct. 46, 1 L.Ed.2d 52 (1956). We see no meaningful distinction between consideration in the form of cash and consideration in the form of a corporate asset. Consequently, as was implicit in Kern County, the actual-potential-for-abuse threshold test is not relevant to our determination since that potential is presumed if the elements of the section are satisfied.

But even if the Provident-Foremost transaction were unorthodox, it involved the potential for speculative abuse of inside information and, therefore, is subject to section 16(b) scrutiny. Under the Kern County rule it is not necessary that the plaintiff prove actual abuse; the transaction must be subjected to scrutiny if there is a potential. 411 U.S. at 595, 93 S.Ct. 1736; see Smolowe v. Delendo Corp., 136 F.2d 231 (2d Cir.), cert. denied, 320 U.S. 751, 64 S.Ct. 56, 88 L.Ed. 446 (1943); The Supreme Court, 1972 Term-- Liability for Insider Trading Under Section 16(b), 87 Harv.L.Rev. 291, 295-296 (1973). In determining whether a transaction has that potential, the Kern County Court looked primarily to two factors: (1) Could the defendant reasonably be expected to have had access to inside information? And (2) did he initiate the transaction voluntarily? 411 U.S. at 596-600, 93 S.Ct. 1736.

Section 16 requires that we presume that a shareholder who owns 10 percent of his corporation's stock has access to inside information. Apparently, Congress assumed that a 10-percent shareholder would generally have sufficient control of the corporation to have such access. ² Where, however, the hostility of the management of the corporation to the 10-percent shareholder precludes any real possibility of access to inside information, as in the Kern County tender offer situation, the presumption may be rebutted and the court may conclude that he in fact did not have access. 411 U.S. at 598, 93 S.Ct. 1736. Provident has not demonstrated that the Foremost management was hostile. To the contrary, the general cooperation involved in the transaction would indicate that Provident conferred intimately with the Foremost management and could well have had access to confidential corporate information.

The second factor the Supreme Court considered in ...