Chenery Corporation v. Securities and Exchange Com'n

• Decision Date: 27 April 1942
• Docket Number: No. 8074.,8074.
• Citation: 128 F.2d 303
• Parties: CHENERY CORPORATION et al. v. SECURITIES AND EXCHANGE COMMISSION (FEDERAL WATER AND GAS CORPORATION, Intervenor).
• Court: U.S. Court of Appeals — District of Columbia Circuit

128 F.2d 303 (1942)

CHENERY CORPORATION et al. v. SECURITIES AND EXCHANGE COMMISSION (FEDERAL WATER AND GAS CORPORATION, Intervenor).

No. 8074.

United States Court of Appeals for the District of Columbia.

Argued February 10, 1942.

Decided April 27, 1942.

Mr. Spencer Gordon, with whom Messrs. William Merrick Parker and William DuBose Sheldon, all of Washington, D. C., were on the brief, for petitioners. Mr. Fontaine C. Bradley, of Washington, D. C., also entered an appearance for petitioners.

Mr. Homer Kripke, with whom Messrs. Chester T. Lane, General Counsel, Christopher M. Jenks, Assistant General Counsel, Lawrence S. Lesser, Special Counsel, and Frederick N. Jones, all of Washington, D. C., were on the brief, all of the Securities and Exchange Commission, for respondent.

Messrs. Charles E. Hughes, Jr., and Allen S. Hubbard, both of New York City, by special leave of court, filed a brief on behalf of Federal Water and Gas Corporation, as Intervenor.

Before GRONER, Chief Justice, and MILLER and VINSON, Associate Justices.

GRONER, C. J.

This is a petition to review an order of the Securities and Exchange Commission issued under the Public Utility Holding Company Act of 1935.¹ The order was made on an application filed with the Commission March 30, 1940, for approval of a plan of merger among Federal Water Service Corporation, Utility Operators Company, and Federal Water and Gas Corporation. Federal Water Service Corporation (hereinafter called Federal) is a Delaware corporation, and at the time of filing the application was the owner of securities of subsidiary water, gas, electric, and other properties. At the time in question, Federal had outstanding $5,222,000 of 5½ per cent Gold Debentures due 1954, four series of approximately 160,000 shares of preferred stocks, a little more than half a million shares of Class A stock, and a like amount of Class B stock. Federal's balance sheet showed a capital deficit of approximately four million dollars, in consequence of which, under the laws of Delaware, the payment of dividends on any Class of stock was prohibited. Utility Operators Company (hereinafter called Utility) was a holding company owning all the outstanding shares of Federal's Class B common stock and some 6,500 shares of its preferred stock. Federal Water and Gas Corporation's assets were unimportant, and its entire outstanding stock was owned by Federal. In November, 1937, Federal registered with the Commission, and on the same day filed an application pursuant to Section 7 of the Public Utility Holding Company Act of 1935 for a voluntary reorganization to be accomplished, pursuant to the Delaware law, through an amendment to its charter reducing its capital by a ratable reduction of the stated values of its several stock issues. The purpose was to eliminate its capital deficit and thus to enable it to resume payment of dividends on its preferred stocks. The Commission never formally acted on the application, nor on three other more or less similar plans proposed during the following three years, because, in the opinion of the Commission, Federal's capital was so reduced as to leave no equity for the Class B stock which, under the proposed plans, was to continue with large voting power. This the Commission thought was inequitable under Section 11(b) (2) of the Act.²

In January, 1940, the Supreme Court of Delaware decided Havender v. Federal United Corporation, 11 A.2d 331, the effect of which was to declare that under Delaware law preferred stock, together with dividends in arrears thereon, might be converted into new securities through a merger. Taking advantage of this opportunity for a rearrangement of its capital structure, Federal filed with the Commission, in March, 1940, a new application and declaration setting forth a plan of reorganization involving the merger of Utility and Federal Water and Gas into Federal. The former two filed declarations in accordance with the proposed merger.

During the period from November, 1937, when the first plan was filed, to June, 1940, some four months after the new plan was submitted, petitioners, who are officers and directors of Federal, and Chenery, a corporation owned by some of them, purchased approximately 12,000 shares of a total issue of approximately 160,000 shares of Federal's preferred stock. All of the purchases were currently reported to the Commission as required by Section 17 of the Act.³

The merger plan, which the Commission ultimately approved on conditions, contemplated the elimination of Class B stock and the conversion of the preferred stocks and Class A stock into new common stock with a new par value, the effect of which was to reduce materially the capital of the corporation. The condition to which we have just referred was that no shares of the new common stock should be issued in exchange for shares of preferred stock purchased in the three-year period, 1937-1940, by any officer or director of the corporation; but that the shares so purchased should be surrendered to the new corporation upon payment to the purchasers (petitioners) of the cost price and four per cent interest from the date of purchase. The Commission imposed this condition because it was of the opinion that officers and directors of Federal occupied, during the whole pendency of proceedings before the Commission, a fiduciary relation to the corporation and to its shareholders, as the result of which the purchase of stock, even though made honestly and after full disclosure and at a fair price at a public sale, was detrimental to the "public interest". The Commission's report points out that under the proposed plan these shares would participate on a parity with other shares of preferred stock, and this the Commission thought ought not in the circumstances to be allowed. The Commission said that, while admittedly the directors did not hold title to the company's stock, they nevertheless owed a duty in dealings with the shareholders as great as "that of a trustee who holds title to a res for the benefit of his beneficiaries". On this theory, it concluded that, since a "trustee" may not become the purchaser of property which he holds in trust, neither may the officers or directors of a corporation, under any circumstances or conditions, purchase shares of stock pending Commission proceedings.

This brings us, then, to the question in the case, which is whether these purchases of stock, in the circumstances narrated, were "detrimental to the public interest or the interest of investors" within Section 7 of the Act.⁴

Preliminary to the discussion of this question, it may be helpful to relate briefly the conditions under which the stock was purchased. When the first plan was proposed, members of the Commission's staff objected to the retention of voting power in Federal by its Class B common stock, substantially all of which belonged to Utility Operators Company, which in turn was controlled by officers and directors of Federal. This opposition held in suspense for two and a half years the proposed plan and various subsequently suggested amendments. Notice of the Commission's position in this regard was made public both by the Commission and Federal, and it is agreed was known and understood by stockholders or investors. Realizing that if the Commission persisted in this stand the officers and employees of Federal who had invested in this class of stock would find themselves without either a stake or influence in the company they had helped create and by which they were employed, Chenery, president of Federal, suggested to many of them that they use what money they could spare to buy preferred stock, stating that he would follow the same course. This resulted in purchases over a period of two and a half to three years on the part of various officers and directors of the corporation. The average purchase of each of the 16 officers and directors, other than Chenery and one Vandenberg was around 130 shares. Chenery, for the account of a family corporation controlled by him, purchased approximately 8,000 shares, of which a lot of 2,700 shares was not a purchase but an exchange for $100,000 of Federal's prior debenture gold bonds, and as to which the other party to the transaction testified that he preferred to have the bonds to the stock "and today I am very much delighted we made the trade". The remaining director, Vandenberg, who at the time of the merger — we gather from the record — had ceased to be an officer and director of the corporation, purchased in the open market approximately 1,700 shares.

The Commission's brief and argument in this court explicitly declare that the conclusion to outlaw this stock is not "predicated on any finding that petitioners defrauded or failed to make the fullest disclosure to the stockholders from whom they purchased the shares in question." On the contrary, the Commission, very properly, admits that the transactions complained of were consummated without "any ulterior purpose" and equally without any intention to profit personally "in the consummation of the plan through having traded while the proceedings were pending". We have, therefore, a case in which the facts are agreed, the good faith of petitioners admitted, and the decision based squarely on the assumption that the purchase of securities of a corporation by its officers or directors for their own account, pending action on an application for approval of a merger, is "detrimental to the public interest" as that phrase is used in Section 7(d) (6) of the Act. It is true that the Commission in its brief refers also to the standard "fair and equitable" applicable under Section 11(e) of the Act; but if there is a substantial distinction in meaning or purpose between the phrase "detrimental to * * * the interest of investors or consumers" and the phrase, not "fair and equitable to the persons affected by such plan", — which we think is not the case, — the fact is that the...