Perlman v. Timberlake

• Decision Date: 26 March 1959
• Citation: 172 F. Supp. 246
• Parties: Michael PERLMAN, a stockholder of Jones & Laughlin Steel Corporation, suing on behalf of himself and all other stockholders similarly situated and on behalf and in the right of Jones & Laughlin Steel Corporation, Plaintiff, v. John E. TIMBERLAKE and Jones & Laughlin Steel Corporation, Defendants.
• Court: U.S. District Court — Southern District of New York

172 F. Supp. 246

Michael PERLMAN, a stockholder of Jones & Laughlin Steel Corporation, suing on behalf of himself and all other stockholders similarly situated and on behalf and in the right of Jones & Laughlin Steel Corporation, Plaintiff, v. John E. TIMBERLAKE and Jones & Laughlin Steel Corporation, Defendants.

United States District Court S. D. New York.

March 26, 1959.

Morris J. Levy, New York City, for plaintiff.

Rosenman, Goldmark, Colin & Kaye, New York City, for defendant John E. Timberlake, Ambrose Doskow, New York City, of counsel.

Sullivan & Cromwell, New York City, for defendant Jones & Laughlin Steel Corp., John F. Dooling, Jr., New York City, of counsel.

Thomas G. Meeker, and J. Gordon Cooney, Washington, D. C., for Securities and Exchange Commission amicus curiae.

RYAN, District Judge.

In this suit filed under Section 16(b) of the Securities Exchange Act of 1934, (15 U.S.C.A. § 78p(b)) to recover shortswing profits all parties have moved for summary judgment.

The claim pleaded is that defendant Timberlake, while a director of corporate defendant Jones & Laughlin (J & L), between April 1, 1957 and July 16, 1957 sold 1,800 shares and bought under a restricted stock option plan 2,500 shares of J & L common stock at a statutory profit of $56,132.74, measured against the shares sold.

The answers of both defendants admit the transactions alleged—the sale and a purchase pursuant to a non-transferable option held by Timberlake under a Stock Option Plan, which they allege met all the conditions set forth in Rule X-16b-3 of the General Rules and Regulations under the SEA of 1934. The answers also allege as a defense the good faith reliance of Timberlake on this Rule. The answer of Timberlake further pleads that any recovery of profits should be limited by Rule X-16b-6 and the answer of J & L in addition seeks a declaratory judgment of validity of Rule X-16b-3.

The Statutes and Rules under consideration are: The Securities Exchange Act of 1934, (Title 15, Sec. 78a et seq.),

Secs. 16(a) (b) (c)-78p; 23(a)-78w; 3(a) (12), 3(b)-78c; General Rules and Regulations under the SEA of 1934—:

Rules X-16B-3, (17 C.F.R. 240.16b-3) three versions as it read from 3/19/51 to 11/1/52; from 11/1/52 to 5/29/56; from 5/29/56 to date; X-16B-6 (17 C.F.R. 240.16b-6).

It is plaintiff's contention that Rule X-16B-3 has been held invalid by the Court of Appeals of this Circuit in the two opinions rendered in Greene v. Dietz, on June 7, 1957, and on the Petition for Rehearing August 12, 1957 (2 Cir., 247 F.2d 689 and 697); that this as a matter of law precludes reliance on the Rule by defendant Timberlake under Sec. 23(a); and that Rule X-16B-6 reducing the recoverable profits is invalid.

Defendants contend that the Court of Appeals did not determine invalidity; that the Rule is valid; and that in any event plaintiff may not recover because of Timberlake's good faith reliance on the validity of the Rule, but that if he be held liable, the profits are limited by Rule X-16B-6.

The Commission's motion to appear herein as amicus curiae in support of the validity of Rule X-16B-3 (it has filed a brief limited to that question) was granted on consent of all parties; it takes no position with respect to defendant's good faith or the validity of Rule X-16B-6.

The questions of law presented by the pleadings and the stipulated facts on these motions are: the validity of Rule X-16B-3; and if the Rule is found to be invalid by (a) a prior holding or (b) this court, defendant's immunity from liability under Sec. 23(a).

The following facts are not in dispute.

Plaintiff is a resident of State of New York and with his wife is co-owner of 11 shares of common stock of the corporate defendant.

Jones & Laughlin is a Pennsylvania corporation with its principal place of business at Pittsburgh whose common stock at all times material was registered on the New York Stock Exchange and was not an exempted security either under Secs. 3(a) (12) or 16(b) of the SEA of 1934; prior to June 5, 1953, and continuously since then defendant Timberlake has been a vice-president and since January 27, 1955 has also been a director of J & L, with his office at Pittsburgh and his residence a Mt. Lebanon, Pa. On January 17, 1951, a stock option plan applicable to officers and certain key employees was approved by amendment to the by-laws by a majority of the security holders entitled to vote at a special meeting for which proxies were solicited in accordance with the Rules and Regulations under Sec. 14(a) of the SEA (15 U.S.C.A. § 78n(a); the purpose of the plan was stated to be to provide added incentive to those charged with promoting the welfare of the corporation; the by-laws so amended authorized the Board of Directors to appropriate 15,000 shares of common stock for the Plan and to appoint a Stock Option Committee to administer the Plan subject to the approval of the Board of Directors. By amendment on December 9, 1954 this authority and power granted to the Stock Option Committee was given to the Compensation Committee and it was then also provided that no options were to be granted to any member of this Committee, although the Committee remained still subject to the Board of Directors, who themselves were eligible to participate in the plan. The option price, payable in cash, was set at the closing price on the day of the granting of the option or by amendment of February 8, 1952 at such higher price as the Committee might fix. No option was to be granted to any member of the Stock Option Committee with the exception of 15,000 shares (the maximum number) which were granted to Ben Moreell the Chief Executive Officer of the corporation, and also the Chairman of the Committee; the number of optionees (who might also be members of the Board of Directors) was to be determined by the Board but was not to exceed 100; the option was exercisable for a period of 8 years but only by the optionee while alive, and transferable only on death by will or descent and distribution, with no restriction on the resale of the stock so acquired; and it was only exercisable after one year's employment and on consideration of the optionee's remaining in the employ of the Corporation for at least two years from the granting of the option.

It has also been stipulated that on June 4, 1953 the Board of Directors approved the grant of an option to Timberlake and on June 5, 1953, a formal stock option covering an additional 5,200 shares (apparently there had been a prior option covering 4,800 shares) was given him under an agreement containing the conditions set forth in the plan described; the option price was fixed at $27.94 per share ($10. par value) which was above the closing market price of $22.125 a share and provision was made for dilution. The agreement also provided that Timberlake was to receive for his services a regular salary and such additional compensation as might be fixed from time to time by the corporation which reserved the right to terminate the option upon the commission by him of any act inimical to it.

The SEC on May 29, 1956 amended Rule X-16B-3 so as to exempt from Section 16(b) stock acquired pursuant to non-transferable options; the amendment remains effective to date; on June 1, 1956, Sharp, vice-president in charge of legal and corporate affairs of J & L, sent a letter to eleven officers of J & L including this defendant advising them of the amendment of the Rule and informing them that by virtue of it they were now free to purchase stock under their options at any time and need no longer delay a purchase for more than 6 months following their last sale of stock, but cautioned them that the amended Rule did not apply to any purchase made prior to May 29, 1956 and that it did not exempt any purchase not made pursuant to the option—which would continue to be matched with any sale within 6 months. Timberlake received the letter and relied on the amended Rule described in the letter when through the Pittsburgh office of a Pennsylvania brokerage firm he entered into the following transactions: on April 9, 1957, he sold 300 shares of common stock of J & L on the New York Stock Exchange at 50 1/8 realizing the net amount from such sale of $14,903.36; on July 12, 1957 he sold 1,500 shares of common stock on the New York Stock Exchange at 60½ realizing the net amount of $90,063.38; on July 16, 1957, he acquired directly from J & L at its Pittsburgh office 2,500 shares of common stock under his option agreement at $27.13 a share or at a cost to him for 1,800 shares of $48,834 ($27.13 represented a reduction in the option price of $27.94 to reflect a 3% dividend on December 28, 1956 in accordance with the anti-dilution provision). At the time of this purchase defendant Timberlake inquired of Wunderlich, vice-president and treasurer in charge of administering the plan, whether in view of his recent stock sales he would incur any Section 16(b) liability in making the intended purchase and was told that because of Rule X-16B-3 he would not. At that time neither Timberlake nor Wunderlich knew of the opinions in Greene v. Dietz of June 7, 1957 and neither learned of them or of the subsequent opinions until August 16, 1957 when they received a memorandum from J. T. Ross, Assistant General Counsel, to the effect that whereas Rule X-16b-3 had provided an exemption for stock acquired under a plan such as that of J & L and that it had been the opinion of their Legal Department that the stock was exempt, the Court of Appeals' recent opinion had cast doubt on the validity of the Rule and warned that it would be ill-advised to rely on it; and he concluded "although we think that the decision is wrong, you are hereby advised of the danger of reliance on Rule X-16B-3 at this stage." J. T. Ross had read the first Greene opinions in the last week of June 1957 but had not communicated with any of the officers or directors of J & L until after the second opinions.

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