Morales v. Mapco, Inc.

• Decision Date: 27 August 1976
• Docket Number: No. 75-1414,75-1414
• Citation: 541 F.2d 233
• Parties: Fed. Sec. L. Rep. P 95,704 Richard MORALES, Plaintiff-Appellant, v. MAPCO, INC., and Donald B. Ross, Defendants-Appellees.
• Court: U.S. Court of Appeals — Tenth Circuit

Page 233

541 F.2d 233

Fed. Sec. L. Rep. P 95,704

Richard MORALES, Plaintiff-Appellant, v. MAPCO, INC., and Donald B. Ross, Defendants-Appellees.

No. 75-1414.

United States Court of Appeals Tenth Circuit.

Argued and Submitted March 22, 1976.

Decided Aug. 27, 1976.

David Lopez, pro se.

R. Thomas Seymour, Tulsa, Okl. (Lawrence T. Chambers, Jr., Doerner, Stuart, Saunders, Daniel & Langenkamp, Tulsa, Okl., on the brief), for defendant-appellee Ross.

Before McWILLIAMS, BREITENSTEIN and DOYLE, Circuit Judges.

BREITENSTEIN, Circuit Judge.

This is a stockholder's derivative action to recover for defendant Mapco short-swing profits said to have been made by defendant Ross, the financial vice president of Mapco. Suit was brought under § 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b). The district court granted summary judgment for Mapco and Ross. The stockholder appeals. We reverse.

So far as material, § 16(b) provides:

"For the purpose of preventing the unfair use of information which may have been obtained by * * * (an) officer by reason of his relationship to the issuer, any profit realized by him from any purchase and sale, or any sale and purchase * * * within any period of less than six months, * * * shall inure to and be recoverable by the issuer, irrespective of any intention on the part of such * * * officer in entering into such transaction * * *."

The section specifically authorizes a stockholder's derivative action.

The facts are uncontested. In 1964 Mapco issued warrants which were automatically converted into one-half share of Mapco common stock each on April 1, 1972. Alternatively, one warrant plus.$9.00 could be exchanged for one full share of Mapco stock prior to the expiration date. The warrants had an anti-dilution clause whereby the warrant holders were protected against the issuance of Mapco common stock at a consideration of less than $18.00 per share.

Ross acquired 3,616 Mapco warrants, and held them for more than six months. Through his broker Ross disposed of the following warrants on the dates shown:

                Quantity        Date
                --------  -----------------
                  200     February 28, 1972
                  100     February 29, 1972
                  200     March 6, 1972
                  400     March 9, 1972
                

Additionally, in March Ross sold 200 warrants to a third person and by the payment of.$9.00 per warrant, secured 2,516 shares of Mapco common himself.

Mapco common was a listed stock on the New York Stock Exchange. Warrants were sold and bought in the over-the-counter market. On February 28, the date of the first transaction in question, Mapco common closed at $41.00, and on March 24 at $43.25. The stock reached a high of $52.25 on June 20, 1972.

The stock obtained by the 900 warrants in issue went to the broker in its street name and was sold through the New York Stock Exchange. On the first two transactions, representing a total of 300 warrants, Ross paid to the broker the.$9.00 needed to convert each warrant into a full share of common. On the last two transactions, Ross' balance with the broker sufficed to furnish the needed cash. The broker furnished Ross with statements showing the transactions. Ross filed with the Securities and Exchange Commission its Form 4, "Statement of Changes in Beneficial Ownership of Securities," for the months of February and March, 1972. These listed the security as "Warrants: Exercised and Sold as Common," gave the transaction date, and stated the "Amount Sold or otherwise disposed of", as a total of 1100.

Section 16(b) declares its purpose to be the prevention of "the unfair use of information" by a statutory insider obtained "by reason of his relationship to the issuer." Reliance Electric Co. v. Emerson Electric Co.,404 U.S. 418, 422, 92 S.Ct. 596, 599, 30 L.Ed.2d 575 says that "the only method Congress deemed effective to curb the evils of insider trading was a flat rule taking the profits out of a class of transactions in which the possibility of abuse was believed to be intolerably great." " '(C)onsiderations of intent, lack of motive, or improper conduct' * * * are irrelevant in § 16(b) suits." Ibid. at 424 n. 4, 92 S.Ct. at 600 n. 4. See also Ernst & Ernst v. Hochfelder, --- U.S. ----, 96 S.Ct. 1375, 1388-1389 n. 28, 47 L.Ed.2d 668, 686 n. 28; and Kern County Land Co. v. Occidental Petroleum Corp., 411 U.S. 582, 595, 93 S.Ct. 1736, 36 L.Ed.2d 503.

Kern County notes, 411 U.S. at 593, 93 S.Ct. at 1744, that traditional cash-for-stock transactions within the six-month period are within the purview of § 16(b) and comments that "the courts have wrestled with the question of inclusion or exclusion of certain 'unorthodox' transactions." The court lists, Ibid. at n. 24, as unorthodox transactions those "dealings in options, rights, and warrants." We have here an unorthodox transaction.

In applying § 16(b) the courts have fluctuated from an objective test to a pragmatic test. Under the objective test a mechanical determination is made of whether the type of transaction or class of investor is wholly within or wholly without the purview of § 16(b). The pragmatic test requires examination of each transaction to determine whether an insider has used an opportunity to profit by undisclosed information. A discussion of the two tests is found in Kern County, 411 U.S. at 594 n. 26, 93 S.Ct. 1736. Kern County applied the pragmatic test to a merger situation and said that the involuntary nature of the transaction coupled with the absence of speculative abuse resulted in a situation beyond the purview of § 16(b). 411 U.S. at 600, 93 S.Ct. 1736. Reliance Electric applied the statute mechanically. It was concerned with a two-step sale, one step of which was without the six months period. 404 U.S. at 424-425, 92 S.Ct. 596.

Ferraiolo v. Newman, 6 Cir., 259 F.2d 342, cert. denied 359 U.S. 927, 79 S.Ct. 606, 3 L.Ed.2d 629, involved the conversion of preferred into common stock and, adopting the pragmatic approach, the court held that the transaction was not within § 16(b). The court pointed out equality of treatment, full disclosure, and no material change in proportional equity ownership. Ibid. at 346. It said that the transaction was involuntary because of the possibility of monetary loss, that the transaction had none of the "economic indicia of a purchase", and that the transaction could not have lent itself "to the practices which Section 16(b) was enacted to prevent." Ibid. In Ferraiolo the transaction did not require the payment of any money by the holder. Here.$9.00 had to be paid with each warrant to get a share of common. The preferred stockholder in Ferraiolo had an equity ownership. A Mapco warrant holder had a right to purchase. If the right was not exercised, he received one-half share of common on the expiration of the warrant. A right to purchase is not the equivalent of ownership of the property subject to the right. The warrant did not give ownership until exercised or terminated.

Petteys v. Butler, 8 Cir., 367 F.2d 528, cert. denied 385 U.S. 1006, 87 S.Ct. 712, 17 L.Ed.2d 545 was also concerned with conversion of preferred into common and like Ferraiolo is factually distinguishable from the case at bar. Neither Blau v. Max Factor & Company, 9 Cir., 342 F.2d 304, cert. denied 382 U.S. 892, 86 S.Ct. 180, 15 L.Ed.2d 150, nor Blau v. Lamb, 2 Cir., 363 F.2d 507, cert....