Appeal from a judgment of the United States District Court for the Southern District of New York, William C. Conner, Judge, awarding plaintiffs $1,290 on claim that defendants violated § 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b). Vacated and remanded.
Before: KEARSE and ALTIMARI, Circuit Judges, and STEWART, District Judge.*fn*
The cross-appeals before us concern a new variable in the calculation of short swing profit subject to section 16(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78(b) (1985). "For the purpose of preventing the unfair use of [inside] information," section 16(b) dictates that profit realized by a corporate insider on any purchase and sale (or sale and purchase) of securities completed within a six month period is recoverable by the issuer. 15 U.S.C. 78p(b) (1985). The class of statutory insiders governed by section 16(b) is composed of directors, officers, and beneficial owners, the latter defined as any owner of 10% of the issuer's stock both before the purchase and at the time of sale. Foremost-McKesson, Inc. v. Provident Securities Co., 423 U.S. 232, 249-50, 46 L. Ed. 2d 464, 96 S. Ct. 508 (1976); Reliance Electric Co. v. Emerson Electric Co., 404 U.S. 418, 419-20, 30 L. Ed. 2d 575, 92 S. Ct. 596 (1972). In this case the defendants' liability derives from beneficial ownership.
Plaintiffs Jeffrey W. Herrmann and Linda J. Herrmann ("the Herrmanns") are stockholders who brought this action on behalf of Walt Disney Productions Corporation ("Disney") to recover profit realized on the sale of 100 Disney shares bought and sold within a six month period by defendants Saul P. Steinberg, Reliance Group Holdings, Inc., and Reliance Insurance Company (referred to collectively herein as "Reliance").*fn1 Reliance conceded below that it is liable under section 16(b) to Disney for short swing profits realized on the 100 shares. Both parties appeal the District Court's calculation of these profits.
Reliance began to acquire large amounts of Disney stock beginning in March 1984. By early May 1984, Reliance had become a beneficial owner of more than 10% of Disney's outstanding common stock, bringing Reliance within the ambit of section 16(b).*fn2 Reliance purchased an additional 100 shares of Disney stock on June 1, 1984, paying $6,460 ($64.50 per share, plus $10 in brokerage commissions). In its June 8, 1984 13D statement filed with the Securities and Exchange Commission--and in letters delivered that day to Disney's directors--Reliance announced its intention to take over Disney through a tender offer for additional Disney shares sufficient to increase its holdings to at least 49%. Reliance also reiterated its previously stated intention to seek the removal of Disney's directors through a proxy contest.
At some point, presumably before its June 8 announcement, Reliance formed a new corporation to carry out its tender offer. The new corporation required total financing of $1,525,000,000 Loan commitments were obtained by Reliance's investment bankers, Drexel Burnham Lambert Incorporated ("Drexel"), from various sources, and Reliance paid these sources fees in proportion to their various commitments. In addition, Reliance compensated Drexel for its financial services. Other costs incurred in anticipation of the tender offer included public relations, legal, and proxy solicitation expenses.
On the evening of June 8--the same day that Reliance announced its tender offer-Disney offered to buy back all of its stock held by Reliance. After some negotiating, the parties entered into an agreement on June 11, 1984, in which Reliance agreed to cancel its inchoate tender offer and sell its 4,198,333 shares of Disney stock for $297,367,926.40 ("purchase price"). In addition to the purchase price, Disney paid Reliance $28 million as reimbursement for expenses incurred in preparing for the aborted tender offer. Apparently, this $28 million was also rendered in part to reimburse Reliance for actual purchases of shares, as discussed below.
How to factor this $28 million into the calculation of Reliance's short swing profit is the central issue on appeal.
The district court found that the expenses reimbursed had been incurred for its own benefit and thus were not "incidental" to the sale.*fn3 The court stated that the transaction fell within a blanket rule that tender offer expenses are not deductible from short swing profit. Accordingly, the district court added the $28 million to the purchase price, arriving at a per share sale price of $77.50 per share. Multiplying this $77.50 by one hundred and subtracting from that amount the $6,460 paid by Reliance for the 100 shares, the court calculated that Reliance had realized $1,290 in short swing profit. A judgment in this amount was entered for the plaintiffs.
The Herrmanns assert that the $28 million (which they call a "greenmail kicker") should be considered profit solely on the 100 share transaction, and that the court below erred in assigning only a pro rata share of the $28 million to the purchase price of the 100 shares. The Herrmanns admit that it is difficult to ascertain exactly what Disney received in consideration for its $28 million. In the face of this uncertainty, they assert that the district court should have awarded all of the $28 million to Disney as short swing profit, erring on the side of maximum penalty for Reliance's excursion into "greenmail."
Reliance contends that the district court erred in ignoring the legal consequences of its conclusion that the $28 million was reimbursement for the abandoned tender offer. Reliance argues that short swing profit does not include payments made to reimburse a party for takeover expenses unless those expenses were incurred in the purchase and sale of stock violative of section 16(b). Since the proposed tender offer had nothing to do with the 100 shares subject to section 16(b), Reliance reasons, the tender offer did not help it realize illicit short swing profits.
We hold that the district court erred in its treatment of the $28 million. The district court did not find a sufficient connection between the $28 million and the purchase and sales of the shares subject to 16(b) to justify its inclusion of the $28 million in the calculation of short swing profits. However, when the district court examines on remand the role of the $28 million in the Disney-Reliance transaction, such a ...