Gwozdzinsky v. Zell/Chilmark Fund, L.P.

• Decision Date: 02 September 1998
• Docket Number: Docket No. 97-9406
• Citation: 156 F.3d 305
• Parties: Fed. Sec. L. Rep. P 90,280 Margaret GWOZDZINSKY, Derivatively on behalf of Revco D.S., Inc., Plaintiff-Appellant, v. ZELL/CHILMARK FUND, L.P. and Revco D.S., Inc., Defendants-Appellees.
• Court: U.S. Court of Appeals — Second Circuit

Page 305

156 F.3d 305

Fed. Sec. L. Rep. P 90,280

Margaret GWOZDZINSKY, Derivatively on behalf of Revco D.S Inc., Plaintiff-Appellant, v. ZELL/CHILMARK FUND, L.P. and Revco D.S., Inc., Defendants-Appellees.

Docket No. 97-9406.

United States Court of Appeals Second Circuit.

Argued June 12, 1998.

Decided Sept. 2, 1998.

Glenn F. Ostrager, Ostrager, Chong & Flaherty, P.C., New York City (Bragar & Wexler, P.C., New York City, on the brief), for Plaintiff-Appellant.

Alan L. Unikel, Seyfarth, Shaw, Fairweather & Geraldson, Chicago, IL (James M. Wyman, Chicago, IL, & John C. Sabetta, New York City, on the brief), for Defendant-Appellee Zell/Chilmark Fund, L.P.

Before: WALKER, McLAUGHLIN, and PARKER, Circuit Judges.

JOHN M. WALKER, JR., Circuit Judge.

Plaintiff-appellant Margaret Gwozdzinsky appeals from a judgment of the United States District Court for the Southern District of New York (John E. Sprizzo, Judge) granting summary judgment in favor of defendant-appellee Zell/Chilmark Fund, L.P. ("Zell/Chilmark") and denying Gwozdzinsky's cross-motion for summary judgment in an action filed by Gwozdzinsky under Section 16(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78p(b). See Gwozdzinsky v. Zell/Chilmark Fund L.P., 979 F.Supp. 263 (S.D.N.Y.1997). Gwozdzinsky seeks disgorgement of profits allegedly realized by Zell/Chilmark under two standby purchase agreements it entered into with nominal defendant-appellee Revco D.S., Inc. ("Revco") in connection with two pro rata rights offerings Revco made to all of its shareholders. We affirm.

BACKGROUND

Revco, one of the largest drug retail chains in the United States, is a Delaware corporation with its principal place of business in Ohio. Revco's common stock trades on the New York Stock Exchange. Gwozdzinsky is a Pennsylvania resident who owns Revco common stock. Zell/Chilmark is an investment fund that owns roughly twenty percent of Revco's outstanding common stock and is controlled by Samuel Zell and David Schulte. At all relevant times, both Zell and Schulte were members of Revco's Board of Directors and Zell was Co-Chairman of Revco's Executive Committee.

On June 1, 1992, Revco emerged from bankruptcy under a plan of reorganization which required, inter alia, that Revco issue an aggregate of $433.2 million in debt securities with interest rates of eleven percent or higher. Subsequently, in order to reduce its interest expenses and improve its debt-to-equity ratio, Revco adopted a recapitalization plan that included raising $110 million in equity through the sale of 13,750,686 shares of common stock in a pro rata rights offering to shareholders of record on December 28, 1992 (the "1992 Rights Offering"). Under the 1992 Rights Offering, a shareholder would receive 0.384 rights for each share of Revco common stock owned. One full right entitled a shareholder to buy one share of Revco common stock for $8.00 per share. In addition, an oversubscription privilege was available to each shareholder who exercised all of her accumulated rights, enabling the shareholder to purchase, at $8.00 per share, additional unsubscribed shares on a pro rata basis up to the number of rights the shareholder exercised.

To ensure that the 1992 Rights Offering would raise $110 million in equity, on December 15, 1992, Revco entered into a Standby Purchase Agreement (the "1992 Standby Purchase Agreement") with Zell/Chilmark and Magten Asset Management, Inc. ("Magten") whereby the latter parties agreed that they would (a) exercise all of the rights and oversubscription privileges distributed to them under the 1992 Rights Offering and (b) purchase, at $8.00 per share, any shares that remained unsold (the "Remaining Shares"), up to an aggregate cost of $150 million. As compensation for assuming these obligations, Zell/Chilmark and Magten received a standby purchase fee of $1,452,448 from Revco, of which Zell/Chilmark's portion was $841,265. Revco specified the terms of both the 1992 Rights Offering and the 1992 Standby Purchase Agreement in a prospectus dated December 17, 1992.

In January 1993, Zell/Chilmark exercised its rights under the 1992 Rights Offering by purchasing 2,706,558 shares of Revco common stock pursuant to its accumulated rights and 134,982 shares pursuant to its oversubscription privilege. That same month, Zell/Chilmark purchased an additional 517 shares of Revco common stock pursuant to its obligations under the 1992 Standby Purchase Agreement. In September 1993, Zell/Chilmark purchased an additional 17,153 shares pursuant to the oversubscription privilege and an additional 12,912 shares pursuant to its obligations under the 1992 Standby Purchase Agreement. In compliance with Section 16(a) of the Exchange Act, see 15 U.S.C. § 78p(a), Zell/Chilmark disclosed all of these purchases to the Securities and Exchange Commission ("SEC") in its 1993 Form 4 filing.

In 1994, Revco effected a second pro rata rights offering (the "1994 Rights Offering") in order to finance its proposed acquisition of another retail drug chain. While the structure of the 1994 Rights Offering was similar to that of the 1992 Rights Offering, Revco's common stock had appreciated considerably since 1992. Each shareholder received 0.305 rights for each share of Revco common stock owned. A full right entitled a shareholder to buy one share of the 15,500,000 shares of Revco common stock offered at a price of $14.00 per share, for a total of $217 million in equity. As with the 1992 Rights Offering, an oversubscription privilege was available to each shareholder who had exercised all rights available under the 1994 Rights Offering.

On June 8, 1994, Revco entered into a second Standby Purchase Agreement with Zell/Chilmark (the "1994 Standby Purchase Agreement"), the terms of which were disclosed together with the terms of the 1994 Rights Offering in a prospectus issued the following day. Zell/Chilmark received a standby purchase fee of $2,839,058 in exchange for once again agreeing to (a) exercise all of the rights distributed to it under the 1994 Rights Offering, including those offered under the oversubscription privilege, and (b) purchase any Remaining Shares for $14 per share.

Zell/Chilmark exercised its rights under the 1994 Rights Offering on July 7, 1994, by purchasing 3,025,738 shares of Revco common stock under its accumulated rights and 153,511 shares pursuant to its oversubscription privilege. It purchased an additional 2,589 shares at a price of $14.00 per share in accordance with its obligations under the 1994 Standby Purchase Agreement. Zell/Chilmark disclosed these purchases to the SEC in a Form 4 filing on July 27, 1994, and in an amendment to that filing on January 9, 1995. It is undisputed that as of October 17, 1997, the date of the district court's opinion, Zell/Chilmark had not sold any Revco stock.

In December 1995, Gwozdzinsky filed a derivative action in the district court asserting, inter alia, that Zell/Chilmark, as an "insider" of Revco, realized short-swing profits in violation of Section 16(b) of the Exchange Act when it entered into the 1992 and 1994 Standby Purchase Agreements and received standby purchase fees. Gwozdzinsky's claim is premised on the theory that Zell/Chilmark's purchase obligations under the standby purchase agreements were derivative securities that fall within the scope of Section 16(b). Specifically, she argues that the agreements constitute the writing of put options by Zell/Chilmark, thus establishing a "call equivalent position." ¹ Gwozdzinsky further asserts that most of these short put options expired or were canceled because Zell/Chilmark was ultimately required to purchase only a relatively small number of shares pursuant to the Standby Purchase Agreements. Accordingly, Gwozdzinsky seeks the return of the 1992 and 1994 standby purchase fees to Revco, pursuant to Rule 16b-6(d). ²

Gwozdzinsky also argues that even if the standby purchase agreements do not constitute conventional options, we should read Section 16(b)'s definition of derivative securities broadly to include these transactions, which carried the potential for speculative abuse and thus are within the scope of those evils that Congress sought to prevent through Section 16(b). This argument is premised on the fact that both the 1992 and 1994 Rights Offerings were planned and administered while Zell and Schulte, Zell/Chilmark's controlling partners, were members of Revco's Board of Directors (the "Board"), while Zell was Co-Chairman of the Board's Executive Committee, and while Zell/Chilmark owned approximately 20% of Revco's common stock. Thus, according to plaintiff these insiders were able to manipulate the terms of the 1992 and 1994 Rights Offerings using inside information for their own benefit at the expense of the public.

Zell/Chilmark moved for summary judgment on the grounds that (1) the challenged transactions were proper business transactions that neither established "options" nor violated Section 16(b); (2) even if the transactions could be considered "options," there could be no "short-swing" profits because Zell/Chilmark engaged in purchases only, and not sales; (3) the options did not expire but were in fact exercised by Revco when Zell/Chilmark purchased shares pursuant to the standby purchase agreements; and (4) Gwozdzinsky's claim with respect to the 1992 Rights Offering was time-barred by the two-year statute of limitations governing actions under Section 16(b).

Gwozdzinsky cross-moved for summary judgment, claiming that Section 16(b) applied to Zell/Chilmark's transactions and that her claim with respect to the 1992 Rights Offering was not time-barred because Zell/Chilmark's improper Form 4 disclosure tolled the statute of limitations.

In entering summary judgment in favor of Zell/Chilmark, the district court rejected Gwozdzinsky's argument that the Zell/Chilmark transactions fell within the scope of Section 16(b), finding that (1) the...