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Newmark v. RKO General Inc.

decided: April 30, 1970.


Kaufman and Feinberg, Circuit Judges, and Palmieri, District Judge.*fn*

Author: Kaufman

IRVING R. KAUFMAN, Circuit Judge:

Section 16(b) of the Securities Exchange Act of 1934 is one of several provisions of the federal securities laws designed to deter insiders from trading on the basis of information unavailable to the general public.*fn1 Commonly termed "a crude rule of thumb," the statute seeks to prevent insiders from realizing profits on securities held for short periods of time.*fn2 It is not aimed solely at the actuality of evil, or the veritable employment of inside information for purely speculative purposes, but also at potentiality for evil inherent in all insider short-swing trading.

To maximize its deterrent effect, the section is drafted in clear, straightforward terms. It provides that whenever a director, officer or owner of ten percent or more of any class of an issuer's securities purchases and sells equity securities of that issuer within a six-month period, he must return any profits he realizes to the issuer. There are no other prerequisites or postulates to liability. The purpose and reach of the statute, it was thought, would be clear, and litigation seldom necessary.

The complexities of the commercial and financial world, however, have defied the draftsmen's efforts at neat classification. Whether certain "unorthodox" transactions, well illustrated here by the exchanges of securities incident to a merger which form the basis of this appeal, are "purchases" or "sales" for the purposes of section 16(b) cannot be resolved by mere reference to the words of the statute. In such cases, the determination of the statute's relevance must rest, initially, on whether there exists the potential for evil against which the statute was intended to guard. Blau v. Lamb, 363 F.2d 507 (2d Cir. 1966), cert. denied, 385 U.S. 1002, 87 S. Ct. 707, 17 L. Ed. 2d 542 (1967). Only when an opportunity for speculative abuse is present is it necessary to determine whether the transactions alleged to give rise to 16(b) liability may fairly be characterized as insider purchases and sales.


The facts are undisputed. In April 1967, the managements of Frontier Airlines, Inc. and Central Airlines, Inc. reached a provisional agreement to merge their companies by an exchange of stock. Defendant RKO controlled Frontier at that time through its ownership of 56% of the company's outstanding common stock. On May 3 or 4, 1967, RKO contracted with several major Central shareholders to purchase, at $8.50 per share, 738,251 shares of Central common (representing 49% of Central's outstanding shares), and $500,000 of Central debentures convertible into an additional 149,994 shares. The parties do not dispute that these debentures were "equity" securities. The formal merger agreement, providing for the exchange of 3 1/2 shares of Central common for each share of Frontier common, was executed on May 4. The first disclosure of the agreements to the public and minority shareholders of both corporations occurred the following day.

Shareholder approval of the proposed merger was foreordained, for the terms of the purchase contract obliged the majority shareholders of both corporations to vote their shares in favor of the proposal.*fn3 The Central shareholders were also required to manage their corporation in a manner which would not prejudice RKO. Since two airlines were involved, consummation of the merger was conditioned on approval by the CAB. The task of processing the merger through the CAB apparently fell upon RKO; accordingly, its subsidiary Frontier was afforded full access to the books and records of Central. If, in RKO's "good faith judgment," the subsidy awarded the surviving corporation by the CAB was inadequate, or any of the other conditions imposed by the CAB adversely affected the interests of any of the parties, the contract granted RKO the right to abandon the agreements. An additional provision conditioned the merger on the consent of certain Central creditors and their waiver of Central's loan defaults.

As anticipated, the majority shareholders of the two companies voted their endorsement on July 27. On the same day, the Frontier shareholders authorized a two-for-one stock split. The exchange rate in the merger agreement was accordingly adjusted to 3 1/2 Central shares for each two shares of Frontier. Less than a week later, on August 2, the CAB added its imprimatur by approving RKO's purchase of the Central stock and the merger agreement. After Frontier, the surviving corporation, signified its satisfaction with the amount of the subsidy to the new airline and the other conditions imposed upon the merger by the CAB, the CAB's order of approval became final on September 1. During the ensuing weeks, Central's creditors, seemingly as a matter of course, agreed to waive Central's loan defaults.

On September 18, the purchase agreement was executed; RKO paid the contract price of $8,550,082.50 and received in return the Central shares and debentures. That same day the parties filed the merger agreement with the Secretary of State of Nevada, the state of incorporation of both Frontier and Central. The physical exchange of Central certificates for Frontier certificates, at the rate embodied in the merger agreement, occurred on October 1.

Plaintiff Newmark, an owner of Frontier debentures and warrants since April 1967, instituted this action in the Southern District of New York in December 1967.*fn4 After both parties moved for summary judgment on the undisputed facts we have recited, Judge Tyler granted Newmark's cross-motion for summary judgment on the issue of liability. A trial on the issue of damages followed; at its conclusion Judge Bonsal awarded damages in the amount of $7,920,681. The award was based upon the difference between the purchase price of the Central shares and debentures and the market price of their equivalent in Frontier shares on the date of the merger, to which sum Judge Bonsal added a control premium of 15%.


The threshold issue raised on this appeal is whether the purchase and subsequent exchange of Central shares lent itself to the type of speculative abuse which section 16(b) was designed to prevent. Blau v. Lehman, 286 F.2d 786 (2d Cir. 1960), aff'd, 368 U.S. 403, 82 S. Ct. 451, 7 L. Ed. 2d 403 (1962); Park & Tilford, Inc. v. Schulte, 160 F.2d 984 (2d Cir.), cert. denied, 332 U.S. 761, 68 S. Ct. 64, 92 L. Ed. 347 (1947). That RKO's heart may have been pure and its motivation noble matters not. The significant factor is whether RKO could have reaped a speculative profit from the "unfair use of information * * * obtained * * * by reason of [its] relationship to [Central]." Securities Exchange Act of 1934, § 16(b) 15 U.S.C. § 78p(b).

RKO's contract to purchase Central shares is a classic example of trading while in the possession of information unavailable to the general public. On May 3 or 4, 1967, RKO secured a contractual right, conditioned on CAB approval of a related merger, to purchase Central common shares for $8.50 per share. Because of its control of Frontier and consequent involvement in the merger negotiations between Frontier and Central, RKO had full knowledge of the proposed merger at the time it signed this contract. Release thereafter of the proposed merger agreement to the public caused a predictable rise in the price of the securities of both airlines. RKO was in an ideal position to take speculative advantage of this rise by purchasing Central ...

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