Tcherepnin v. Knight, 104

• Decision Date: 18 December 1967
• Docket Number: No. 104,104
• Citation: 19 L.Ed.2d 564,389 U.S. 332,88 S.Ct. 548
• Parties: Alexander TCHEREPNIN et al., Petitioners, v. Joseph E. KNIGHT et al
• Court: U.S. Supreme Court

389 U.S. 332

88 S.Ct. 548

19 L.Ed.2d 564

Alexander TCHEREPNIN et al., Petitioners,

v Joseph E. KNIGHT et al.

No. 104.

Argued Nov. 13, 1967.

Decided Dec. 18, 1967.

Arnold I. Shure, Chicago, Ill., for petitioners.

Philip A. Loomis, Jr., Washington, D.C., for the United States, as amicus curiae.

Charles J. O'Laughlin, Chicago, Ill., and Stuart D. Perlman, New York City, for respondents.

Opinion of the Court by Mr. Chief Justice WARREN announced by Mr. Justice BRENNAN.

The narrow question for decision in this case is whether a withdrawable capital share in an Illinois savings and loan association is a 'security' within the meaning of the Securities Exchange Act of 1934, 48 Stat. 881, 15 U.S.C. § 78a et seq.

The petitioners are a number of individuals holding withdrawable capital shares in City Savings Association of Chicago, a corporation doing business under the Illinois Savings and Loan Act.¹ On July 24, 1964, they filed a class action² in the United States District Court for the Northern District of Illinois, alleging that the sales of the shares to them by City Savings were void under § 29(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78cc(b), and asking that the sales be rescinded. Named as defendants in the complaint were City Savings, its officers and directors, two state officials who had taken custody of the Association,³ and three individuals named as liquidators by the Association's shareholders in voting a voluntary plan of liquidation.⁴ The complaint alleged that the withdrawable capital shares purchased by the petitioners were securities within the meaning of § 3(a)(10) of the Securities Exchange Act,⁵ that the petitioners had purchased such securities in reliance upon printed solicitations received from City Savings through the mails, and that such solicitations contained false and misleading statements in violation of § 10(b) of the Securities Exchange Act⁶ and of Rule 10b—5 adopted thereunder by the Securities and Exchange Commission.⁷ More specifically, the complaint alleged that the mailed solicitations portrayed City Savings as a financially strong institution and its shares as desirable investments. But the solicitations failed to disclose, inter alia, that the Association was controlled by an individual who had been convicted of mail fraud involving savings and loan associations, that the Association had been denied federal insurance of its accounts because of its unsafe financial policies, and that the Association had been forced to restrict withdrawals by holders of previously purchased shares.

The respondents filed motions to dismiss on the ground that the complaint failed to state a cause of action under § 10(b) because the petitioners' withdrawable capital shares were not securities within the meaning of the Securities Exchange Act. The District Court denied the motions to dismiss, ruling that the petitioners' shares fell within the Act's definition of securities. However, recognizing that the ruling 'involves a controlling question of law as to which there is substantial ground for difference of opinion,' the District Court certified its order for an interlocutory appeal to the Court of Appeals for the Seventh Circuit under 28 U.S.C. § 1292(b). The Court of Appeals, with one judge dissenting, agreed with respondents that the withdrawable capital shares issued by City Savings did not fit the definition of securities in § 3(a)(10) of the Securities Exchange Act. Consequently, it ruled that the District Court was without jurisdiction in the case, and it remanded with instructions to dismiss the com- plaint. 371 F.2d 374. Because this case presents an important question concerning the scope of the Securities Exchange Act, we granted certiorari. 387 U.S. 941, 87 S.Ct. 2076, 18 l.Ed.2d 1326. We disagree with the construction placed on § 3(a)(10) by the Court of Appeals, and we reverse its judgment.

Section 3(a)(10) of the Securities Exchange Act of 1934 provides:

'3. (a) When used in this title, unless the context otherwise requires—

'(10) The term 'security' means any note, stock, treasury stock, bond, debenture, certificate of interest or participation in any profit-sharing agreement or in any oil, gas, or other mineral royalty or lease, any collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit, for a security, or in general, any instrument commonly known as a 'security'; or any certificate of interest or participation in, temporary or interim certificate for, receipt for, or warrant or right to subscribe to or purchase, any of the foregoing; but shall not include currency or any note, draft, bill of exchange, or banker's acceptance which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited.'

This case presents the Court with its first opportunity to construe this statutory provision. But we do not start with a blank slate. The Securities Act of 1933 (48 Stat. 74, as amended) contains a definition of security⁸ virtually identical to that contained in the 1934 Act. Consequently, we are aided in our task by our prior decisions which have considered the meaning of security under the 1933 Act.⁹ In addition, we are guided by the familiar canon of statutory construction that remedial legislation should be construed broadly to effectuate its purposes. The Securities Exchange Act quite clearly falls into the category of remedial legislation.¹⁰ One of its central purposes is to protect investors through the requirement of full disclosure by issuers of securities, and the definition of security in § 3(a)(10) necessarily determines the classes of investments and investors which will receive the Act's protections. Finally, we are reminded that, in searching for the meaning and scope of the word 'security' in the Act, form should be disregarded for substance and the emphasis should be on economic reality. S.E.C. v. W. J. Howey Co., 328 U.S. 293, 298, 66 S.Ct. 1100, 1102, 90 L.Ed. 1244 (1946).

Because City Savings' authority to issue withdrawable capital shares is conferred by the Illinois Savings and Loan Act, we look first to the legal character imparted to those shares by that statute. The issuance of with- drawable capital shares is one of two methods by which Illinois savings and loan associations are authorized to raise capital.¹¹ City Savings' capital is represented exclusively by withdrawable capital shares. Each holder of a withdrawable capital share becomes a member of the association¹² and is entitled to 'the vote of one share for each one hundred dollars of the aggregate withdrawal value of such accounts, and shall have the vote of one share for any fraction of one hundred dollars.'¹³ The holders of withdrawable capital shares are not entitled to a fixed rate of return. Rather, they receive dividends declared by an association's board of directors and based on the association's profits.¹⁴ The power of a holder of a withdrawable capital share to make voluntary withdrawals is restricted by statute.¹⁵ While withdrawable capital shares are declared nonnegotiable and not subject to Article 8 of the Uniform Commercial Code,¹⁶ such shares can be transferred 'by written assignment accompanied by delivery of the appropriate certificate or account book.'¹⁷

While Illinois law gives legal form to the withdrawable capital shares held by the petitioners, federal law must govern whether shares having such legal form constitute securities under the Securities Exchange Act.¹⁸ Even a casual reading of § 3(a)(10) of the 1934 Act reveals that Congress did not intend to adopt a narrow or restrictive concept of security in defining that term.¹⁹ As this Court observed with respect to the definition of security in § 2(1) of the Securities Act of 1933, 'the reach of the Act does not stop with the obvious and commonplace.' S.E.C. v. C. M. Joiner Leasing Corp., 320 U.S. 344, 351, 64 S.Ct. 120, 123, 88 L.Ed. 88 (1943). As used in both the 1933 and 1934 Acts, security 'embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.' S.E.C. v. W. J. Howey Co., supra, 328 U.S. at 299, 66 S.Ct. at 1103. We have little difficulty fitting the withdrawable capital shares held by the petitioners into that expansive concept of security. Of the several types of instruments designated as securities by § 3(a)(10) of the 1934 Act, the petitioners' shares most closely resemble investment contracts. 'The test (for an investment contract) is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.' Id., at 301, 66 S.Ct. at 1104. Petitioners are participants in a common enterprise—a money-lending operation dependent for its success upon the skill and efforts of the management of City Savings in making sound loans. Because Illinois law ties the payment of dividends on withdrawable capital shares to an apportionment of profits,²⁰ the petitioners can expect a return on their investment only if City Savings shows a profit. If City Savings fails to show a profit due to the lack of skill or honesty of its managers, the petitioners will receive no dividends. Similarly, the amount of dividends the petitioners can expect is tied directly to the amount of profits City Savings makes from year to year. Clearly, then, the petitioners' withdrawable capital shares have the essential attributes of investment contracts as that term is used in § 3(a)(10) and as it was defined in Howey. ²¹ But we need not rest our decision on that conclusion alone. 'Instruments may be included within any of (the Act's) definitions, as matter of law, if on their face they answer to the name or description.'...