Biggs, Chief Judge, and McLaughlin, Kalodner, Staley, Hastie, Ganey, Smith and Freedman, Circuit Judges. McLaughlin, Circuit Judge (concurring and dissenting). Hastie, Circuit Judge, with whom Kalodner, Circuit Judge, joins (dissenting in part and concurring in part).
Heli-Coil Corporation brought this suit against one of its directors, Mr. Reginald Webster, to recover alleged short-swing profits under § 16(b) of the Securities Exchange Act of 1934, 15 U.S.C.A. § 78p(b). The pertinent portion of § 16(b) is set out below.*fn1 All of the events upon which the suit at bar is based took place prior to the effective dates of the Securities Acts Amendments of 1964, Pub.L.No. 467, 88th Cong.2d Sess., Act of August 20, 1964, 78 Stat. 565. We therefore take the statute as it existed prior to the amendments just referred to.
Webster, an industrialist, became a director of Heli-Coil soon after the company was organized on October 16, 1958, at the suggestion of W. C. Langley & Co., (Langley) investment bankers for the company. At the time of his election Webster had been for many years and still is the chairman of the board of Standard-Thompson Corporation, the common stock of which is traded on the American Stock Exchange. On November 20, 1958, Webster purchased at par value plus accrued interest, $60,000 principal amount of Heli-Coil 5% Convertible Debentures due November 1, 1973, and 500 shares of Heli-Coil common stock at $14.50 per share, the par value of the common stock being $1 per share. The debentures were limited to the aggregate principal amount of $1,300,000 and were callable by the company at any time at its election at prices as fixed in the debenture. None were called for redemption. The debentures were to mature in November, 1973. Any debenture holder at his option at any time on or before November 1, 1973, could convert a debenture into common stock of the company "at a conversion price equal to $16 2/3 principal amount of Debentures for each share of Common Stock, or at the adjusted conversion price in effect at the date of the conversion determined as provided in said Indenture." It should be noted that the debenture indenture contains typical anti-dilution provisions protecting the conversion rights of the debenture holders.*fn2
On December 11, 1958, the shares of Heli-Coil common stock were listed for trading on the American Stock Exchange. The debentures were never registered on any national securities exchange but were traded in the over-the-counter market.
In February, 1959, Langley informed Webster that some of their customers had converted Heli-Coil debentures into the common stock of the company and suggested to Webster that he convert his debentures. The basis of the suggestion for the conversion, according to the uncontradicted testimony of Webster, was that Langley considered Heli-Coil's prospects excellent and that the elimination of indebtedness from the balance sheet of the company would "make a better statement." On March 18, 1959, Webster converted all his debentures into 3600 shares of Heli-Coil common stock, receiving no money upon the conversion. At the time Webster converted his debentures, holders of debentures in principal amount totaling $185,000 had already converted their debentures into common stock, and by April 30, 1959, $283,000 in principal amounts of debentures had been so converted.
On July 16, 1959, approximately eight months after Webster had purchased his debentures, he sold 1000 shares of Heli-Coil common stock for cash in the amount of $69,470.60. Thereafter, on August 26, 1959, Webster sold 200 shares of Heli-Coil common for $14,293.55, and on September 1, 1959, he sold 100 shares of Heli-Coil common for $7,096.86. Prior to the sale of the 1000 shares of Heli-Coil common, Webster consulted with a partner in Langley, Mellor, and with his own accountant, as to whether or not he was "at liberty to sell the stock."
Information respecting Heli-Coil's financial condition was submitted to its board of directors from time to time and it appears that there was nothing in this information to indicate that retention of Heli-Coil common stock was unwise or that any investment in that stock was in jeopardy. Indeed, the company was in good condition and had already declared a dividend. The common stock was rising steadily in value. It is not charged and there is no evidence that at the time Webster sold his stock in the period July-September, 1959, his sales were inspired by any information that was not possessed by or available to any other stockholder, or that Webster acted in other than good faith in selling the stock. Indeed Webster testified that he sold the stock to raise cash to pay some of the expenses incurred in the operation of his racing stable.
The court below filed an opinion, 222 F. Supp. 831, and gave judgment in favor of Heli-Coil in the sum of $116,544.36 without interest.*fn3 Webster has appealed.
Contentions of the Parties
Heli-Coil contends (1) that the voluntary conversion by Webster of his debentures into common stock and the subsequent sale of that common stock was a "purchase and sale" within the meaning of the statute; (2) that the voluntary conversion by Webster of the debentures into common stock was a "sale" within the purview of the Act; (3) that the profits resulting from Webster's voluntary acquisition of common stock upon the conversion of the convertible debentures and his subsequent sales of 1300 shares of common stock less than six months after the conversion, were not exempted by § 16(b) as profits on securities acquired "in good faith in connection with a debt previously contracted"; and (4) that the conversion of convertible debentures into common stock is not arbitrage and does not fall within the exemption provision of § 16(d), 15 U.S.C.A. § 78p(d).
Webster in substance endeavours to negate each of these contentions.
Prior to the rehearing en banc we requested the Securities and Exchange Commission to file a brief and to give the court the benefit of oral argument as amicus curiae. The Commission has done this through its counsel. We conclude that the position taken by the Commission's counsel is correct for the reasons set out hereinafter.
Statement of Pertinent Statutes and Regulations
The facts are not in dispute. The court below held that the conversion of the debentures into common stock constituted a sale of the debentures and a purchase of the stock within the meaning of § 16(b), and determined further that neither the "securities acquired in good faith in connection with a debt previously contracted" clause, nor the arbitrage exemption of § 16(d) were applicable. The sum of the lower court's holding was that Webster was liable for profits derived by him from the disposition of the debentures upon conversion within six months after his acquisition of them, and from the sale of common stock within six months after the conversion of the debentures into common stock. See note 3 supra.
The Commission's counsel take the position that the court below was correct in concluding that Webster's voluntary conversion of debentures into common stock constituted a sale of the debentures and a purchase of the common stock within the purview of § 16(b), and also that the court below was correct in concluding that the marks 16(b) and 16(d) exemptions referred to above were not applicable, but the Commission's counsel concluded that no profit was realized by Webster from the disposition of the debentures upon their conversion, and that accordingly the judgment against him should be reduced to $45,144.36, the amount of the profit which he realized from the sale of the common stock within six months of the conversion.
The position of the Commission's counsel is, we believe, soundly based on both the language of the statute and its legislative history, as well as on Rule 16d-1, 17 CFR 240.16d-1, promulgated by the Commission pursuant to the authority of the Act. The Securities Exchange Act of 1934 was intended by Congress "to insure the maintenance of fair and honest markets in [securities] * * * transactions."*fn4 The provisions of § 16(b) were designed to implement this intention by making it unprofitable for insiders to engage in short-swing speculations. The preamble to § 16(b) expressly states that the section was framed "For the purpose of preventing the unfair use of information which may have been obtained by [a] * * * beneficial owner [to the extent defined by the statute], director, or officer by reason of his relationship to the issuer * * *." The abuses which led to the enactment of § 16(b) were manifold and have been documented so fully in the legislative history of the Act and in the decisions*fn5 that they need not be enumerated exhaustively or discussed fully here.
Prior to the Securities Acts the difficulty in maintaining a suit by a corporation, or a stockholders' derivative suit, against an officer or director who had profited from inside knowledge of the corporation's business or financial position, was in proving that it was the intent of the officer or director to speculate on the basis of his inside information. Section 16(b) was designed to obliterate this difficulty. Section 16(a), 15 U.S.C.A. § 78p(a), required officers and directors of any corporation the securities of which had been registered pursuant to § 12 of the Act, 15 U.S.C.A. § 78 l, as well as beneficial owners of more than 10% of every class of such securities, to file reports of their holdings and transactions in any of the corporation's equity securities.*fn6 Section 16(b) provides for the recovery by the corporation of any profits realized by an officer or director from "any purchase and sale, or any sale and purchase" of such securities within a six-months' period. Section 3(a) (13), 15 U.S.C.A. 78c(a) (13), defines a "purchase" as including "any contract to buy, purchase, or otherwise acquire," and § 3(a), (14), 15 U.S.C.A. 78c(a) (14), states that a "sale" includes "any contract to sell or otherwise dispose of." The term "profits" is not defined in the Act.
As we have indicated § 16(b) provides that the Commission by rules and regulations may exempt any transactions not comprehended within the purview of the section. Section 16(b) also exempts from the provisions of the section any "security * * * acquired in good faith in connection with a debt previously contracted * * *." Section 16(d) provides that the provisions of § 16 "shall not apply to foreign or domestic arbitrage transactions unless made in contravention of such rules and regulations as the Commission may adopt in order to carry out the purposes of this section." The Commission adopted Rule 16d-1 pursuant to this authority.*fn7
A. The Conversion of the Debentures Was a Sale of the Debentures and a Purchase of the Common Stock
Congress defined "purchase" and "sale" in broad terms. Sections 3(a) (13) and 3(a) (14) in our opinion cover not only contracts of purchase and sale but also agreements to "otherwise acquire" or to "otherwise dispose of" securities within the purview of the Act. True, the language of the sections last referred to seems to refer to executory contracts but it must be concluded that these provisions of the Act were intended to apply to executed transactions. If it were otherwise all relief under the Act would have to be by way of injunction or prohibition, surely an impermissible conclusion. The conclusion of the court below that Webster's conversion of his debentures into stock was a sale of the debentures and a purchase of the stock within the definitions of the Act seems to us to be indubitably correct.
There are, insofar as we are aware, but four decided cases which rule directly on the issue of the applicability of § 16(b) to a conversion transaction. The trial court in the case at bar based its ruling largely on Park & Tilford v. Schulte, 160 F.2d 984 (2 Cir. 1947), cert. denied, 332 U.S. 761, 68 S. Ct. 64, 92 L. Ed. 347 (1947). We shall discuss this case first.
In Park & Tilford, some, but by no means all, of the facts involved in the instant case were present. In that case three Schulte brothers, one of whom was a director of the plaintiff corporation, as trustees of a trust created by their father, were the owners of a majority of the common stock of the plaintiff and substantial owners of its preferred stock with a conversion privilege. The common stock was enjoying a substantial rise in market value. While this increase in market value was in progress, the company, which was subject to the control of the Schultes, served a 90-day notice of the redemption of the preferred. In about a month the Schultes exercised the conversion privilege, contending that they were forced to convert because the redemption price was less than the market value of the common. The Schultes then sold their common stock within six months of their conversion at a large profit. It seems apparent from reading the opinion of the court that the Schultes' profit was gained by the exercise of knowledge gleaned from their "insiders'" position, an operative fact not present in the case at bar. The circumstance that ...