Steel Partners Ii, L.P., Plaintiff-Counter-Defendant-Appellant v. Bell Industries, Inc., Defendant-Counter-Claimant-Appellee

315 F.3d 120, 2002 U.S. App. LEXIS 27127, 2002 WL 31886655

• Court: Court of Appeals for the Second Circuit
• Decided: December 30, 2002
• Docket: Docket 00-9341
• Status: Published

Opinions

JOHN M. WALKER, JR., Chief Judge.

Plaintiff-counter-defendant-appellant Steel Partners II, L.P. (“Steel Partners”) appeals from the September 27, 2000, judgment of the United States District Court for the Southern District of New York (Naomi Reice Buchwald, District Judge) granting summary judgment in favor of defendant-counter-claimant-appellee Bell Industries, Inc. (“Bell”) and declaring that a $1.30 dividend paid on 200,000 Bell shares owned by Steel Partners for less than six months fell within the definition of “profit” as used in Section 16(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78p(b), and thus was required to be disgorged to Bell. We hold that under the circumstances of this case, the dividend was not subject to disgorgement. Accordingly we reverse the district court and remand for entry of summary judgment in favor of Steel Partners.

BACKGROUND

Bell stock is publicly traded on the New York Stock Exchange. Steel Partners, an investment fund, began acquiring Bell stock in October 1998. That same month, Bell entered into an agreement (subject to shareholder approval) for the cash sale of a large division, its Electronics Distribution Group (“the Division”).

On December 23, 1998, Bell issued a proxy statement to its shareholders seeking approval of the sale. On December 31, 1998, Steel Partners’ holdings in Bell reached ten percent, making it a statutory insider of Bell under Section 16(b). Steel Partners remained a statutory insider during the rest of the period relevant to this suit. Bell shareholders approved the sale of the Division in January 1999 and the sale closed with Bell receiving approximately $177 million in cash.

In February 1999, the company issued a press release announcing its intention to use the proceeds of the sale to make a cash distribution of approximately $7.00 per share to its shareholders within ninety days — its first cash dividend in six years. In May 1999; Bell declared “an initial cash distribution” of $5.70, payable in June 1999, representing “the first portion of the previously announced planned distribution,” and publicly announced its “plans to distribute additional cash of approximately $1.30 per share following the sale of remaining real estate properties associated with the [Division].”

Steel Partners made a final purchase of Bell stock — the 200,000 shares at issue in this suit — on October 7, 1999, and paid $5.30 per share. On October 8, 1999, Bell issued a press release stating that its Board of Directors had rejected an offer from Steel Partners to purchase Bell Industries for $5.30 per share, but that it would consider a higher offer.

On October 20, 1999, Bell publicly announced its intention to make the second cash distribution of the Division proceeds “during the fourth quarter” of 1999. On December 3, 1999, as previously forecast-ed, Bell declared the distribution of $1.30 per share, payable on December 17, 1999, to shareholders of record on December 10, 1999. The dividend was distributed as announced on December 17 (the “December Dividend”). The next business day, Steel Partners sold 547,200 shares at an average price of $6.37 per share. It is undisputed that for purposes of Section 16(b), this sale necessarily included the 200,000 shares Steel Partners had purchased on October 7.

On January 21, 2000, in order to effectuate compliance with Section 16(b), Steel Partners paid Bell $214,960, the difference between the $6.37 sale price of the 200,000 shares and the $5.30 price for which they were purchased two months earlier. After receiving the $214,960 payment, Bell claimed that Steel Partners’ “profit” under Section 16(b) also included the December Dividend, ie., an additional $1.30 per share or $260,000.

Steel Partners commenced this action on January 24, 2000, seeking a declaration that it had disgorged all profits owed under Section 16(b). Bell counterclaimed for a declaration that the December Dividend represented part of Steel Partners’ “profit” under Section 16(b). The parties thereafter cross-moved for summary judgment and submitted Joint Stipulated Facts.

For purposes of the summary judgment motion, Bell does not dispute that at all relevant times Steel Partners: (1) had no representative on Bell’s Board of Directors; (2) was not consulted before Bell’s decision to declare cash distributions; and (3) learned of Bell’s intention to distribute dividends, including the December Dividend, at the same time as the public and all other Bell shareholders.

In granting summary judgment in favor of Bell, the district court reviewed prior case law that held that dividends are not generally included in the calculation of Section 16(b) profits if they are paid out in the ordinary course of business, see, e.g., Blau v. Lamb, 363 F.2d 507, 528 (2d Cir.1966); Adler v. Klawans, 267 F.2d 840, 848-49 (2d Cir.1959), and concluded that because the December Dividend represented the balance of a cash distribution of the proceeds from the sale of 49% of Bell’s assets, it was not a dividend paid out in the ordinary course of business and therefore had to be disgorged. See Steel Partners II, L.P. v. Bell Indus., Inc., No. 00 Civ. 0499, 2000 WL 1372831, at *3 (S.D.N.Y. Sept. 21, 2000).

DISCUSSION

We review a grant of summary judgment de novo. See Beckford v. Portuondo, 234 F.3d 128, 130 (2d Cir.2000). Summary judgment is appropriate only where, “[e]xamining the evidence in the light most favorable to the nonmoving party,” Adjustrite Sys., Inc. v. Gab Bus. Servs., Inc., 145 F.3d 543, 547 (2d Cir.1998), the record shows “that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law,” Fed.R.Civ.P. 56(c).

Section 16(b) of the Securities and Exchange Act of 1934 provides in relevant part:

For the purpose of preventing the unfair use of information which may have been obtained by [an insider, including the beneficial owner of 10% or more of the issuer’s stock,] by reason of his relationship to the issuer, any profit realized by him from any purchase and sale ... of any equity security of such issuer ... within any period of less than six months ... shall inure to and be recoverable by the issuer, irrespective of any intention on the part of [the insider] in entering into such transaction or holding the security ... purchased....

15 U.S.C. § 78p(b) (emphasis added).

The purpose of Section 16(b) is to deter “insiders,” who are presumed to possess material non-public information about the issuer, from using such information to purchase or sell the issuer’s equity securities at an advantage over persons with whom they trade. See Gwozdzinsky v. Zell/Chilmark Fund, 156 F.3d 305, 308, 310 (2d Cir.1998). The statute imposes “strict liability for all transactions that meet its mechanical requirements,” id., and, by its plain language, requires that “any profit” derived from the matching of any purchase and any sale of a corporation’s securities occurring within six months of each other must be disgorged, irrespective of the insider’s actual knowledge or intent or whether overall trading during that six months (ie., all sales and purchases combined) resulted in a loss. The issuing corporation or, derivatively, a shareholder is entitled to maintain an action seeking to have the profit disgorged to the corporation. See 15 U.S.C. § 78p(b); see also Tristar Corp. v. Freitas, 84 F.3d 550, 552 (2d Cir.1996).

At issue in this case is whether the December Dividend paid on the 200,-000 shares purchased by Steel Partners on October 7, 1999 and sold on December 20, 1999 (three days after the December Dividend was paid), constituted a “profit realized by [Steel Partners] from [the] purchase and sale.” Unfortunately, that determination cannot be made by resort to the plain language of the statute: Dividends, which are neither contingent upon nor influenced by the occurrence or timing of a subsequent sale of the shares, do not inevitably constitute “profit” from a purchase and sale, and can just as readily be categorized as an incident of ownership. Cf. Champion Home Builders Co. v. Jeffress, 385 F.Supp. 245, 250 (E.D.Mich.1974) (holding that dividends constituted distribution of earnings, not profit from purchase and sale). Several of the terms used in Section 16(b) are defined in the statute and regulations. See, e.g., 15 U.S.C. § 78c(13) (defining “purchase”); 15 U.S.C. § 78c(14) (defining “sale”); 17 C.F.R. § 240.16a-l (defining most of the terms used in Section 16); 17 C.F.R. § 240.16a-2 (defining persons and transactions subject to Section 16); 17 C.F.R. § 240.16b-6 (defining types of derivative securities and transactions subject to Section 16). The term “profit” is not defined, however.

Where, as here, the transaction at issue does not plainly fall within the literal terms of the statute, “[t]he judicial tendency, especially in this circuit, has been to interpret Section 16(b) in ways that are most consistent with the legislative purpose.” Feder v. Martin Marietta Corp., 406 F.2d 260, 263 (2d Cir.1969); see Gwozdzinsky, 156 F.3d at 308, 310 (noting that courts look to policy “to avoid the harsh results of this inflexible rule”). The usual problems associated with discerning the purpose of a legislative enactment from uncertain legislative history are obviated here because “[t]he objectives sought to be accomplished in adopting Section 16(b) are clear from the language of the statute without reference to the legislative history.” Adler, 267 F.2d at 844. Congress stated its purpose in the statute itself: to “ ‘prevent[ ] the unfair use of information which may have been obtained by [a statutory insider] by reason of his relationship to the issuer.’ ” Id. (quoting Section 16(b)). Thus, whether or not a “borderline transaction” falls within the parameters of Section 16(b) ultimately turns on “whether the transaction may serve as a vehicle for the evil which Congress sought to prevent — the realization of short-swing profits based upon access to inside information.” Kern County Land Co. v. Occidental Petroleum Corp., 411 U.S. 582, 594, 93 S.Ct. 1736, 36 L.Ed.2d 503 (1973); see also Reliance Elec. Co. v. Emerson Elec. Co., 404 U.S. 418, 424, 92 S.Ct. 596, 30 L.Ed.2d 575 (1972) (“[W]here alternative constructions of the terms of § 16(b) are possible, those terms are to be given the construction that best serves the congressional purpose of curbing short-swing speculation by corporate insiders.”); Blau, 363 F.2d at 519 (noting statutory policy of “preventing the unfair use of inside information by corporate insiders”).

In Kern County, the Court, recognizing the overbreadth of Section 16(b), observed that “under the[ ] strict terms [of Section 16(b)], the prevailing view is to apply the statute only when its application would serve its goals.” 411 U.S. at 595, 93 S.Ct. 1736. Thus, courts are authorized to

look[ ] into the substance of borderline transactions alleged to have violated Section 16(b) to determine whether in fact [they] contravened the underlying rationale of [Section 16(b)] (i.e., presented the potential for speculative abuse of inside information), and, where the possibility of speculative abuse was not shown, to refuse to impose liability.

Gwozdzinsky, 156 F.3d at 310; see, e.g., Kern County, 411 U.S. at 596, 93 S.Ct. 1736 (profit made by ten percent beneficial owner on option did not fall within Section 16(b) because facts failed to support inference that owner had or was likely to have access to inside information); Blau, 363 -23 & n. 22, 528 (stock conversion and payment of dividends did not fall within Section 16(b) because they did not involve possibility of speculative abuse). The Second Circuit has applied this principle to the questions of whether a “purchase and sale” has in fact occurred, see Gwozdzinsky, 156 F.3d at 310, and whether someone qualifies as an insider, see C.R.A. Realty Corp. v. Crotty, 878 F.2d 562, 566 (2d Cir.1989) (“The general approach established by our Court ... is consistent with that of the Supreme Court in § 16(b) cases in which the [Supreme] Court has emphasized that potential access to inside information is the key to finding liability, rather than rigid application of statutory designations.”) (citing Kern County, 411 U.S. at 597-604, 93 S.Ct. 1736 and Foremost-McKesson, Inc. v. Provident Sec. Co., 423 U.S. 232, 251-54, 96 S.Ct. 508, 46 L.Ed.2d 464 (1976)).

With respect to dividends, we have observed that they should be subject to disgorgement in connection with a concomitant “purchase and sale” when they are the result of manipulation by the Section 16(b) insider (e.g., when the insider engineers the declaration of the dividend and then purchases shares before the dividend is publicly announced). See Blau, 363 F.2d at 522 n. 22. The absence of manipulation or access to insider information, however, has led us to exclude dividends from recapture in certain circumstances. See id. at 528; Adler, 267 F.2d at 849. In Blau we held that dividends paid out in the ordinary course of business should not be subject to disgorgement. See Blau, 363 F.2d at 528. In Adler, we discussed three other factual permutations that would preclude the imposition of liability: (1) where the trader first purchased shares long after the dividend had been declared and before the trader became an insider; (2) where the trader, although owning a substantial amount of stock, was not an insider at the time the dividend was declared; and (3) where the trader received the dividend only with respect to shares subsequently sold for a loss that was greater than the dividend. See id. at 848-49. We held that none of these circumstances justified disgorgement because the statutory presumption — that an insider is in a position that could be used to influence the sale price — was inapplicable. See id. at 848 (“Our primary holding simply gives effect to the statutory mandate that, at some moment before making a sale of stock, the insider was in an official position which he could have used to influence the sale price.”).

None of the specific circumstances identified in Blau and Adler as precluding Section 16(b) liability are present here. As noted by the district court, the December Dividend was not ordinary. See Steel Partners, 2000 WL 1372831, at *3. Bell had paid no cash dividends between 1993 and 1999. Cf. Blau, 363 F.2d at 528 (finding dividend to be “regular, quarterly” payout to shareholders based on company’s dividend payment history). Indeed, Bell’s decision to pay a dividend in 1999 was prompted chiefly by an extraordinary transaction: the sale of the Division.

In arguing against disgorgement, Steel Partners points out that it was not a statutory insider at the time Bell’s board approved the asset sale that led to the extraordinary dividend. This fact is not dispositive, however, because Steel Partners was a statutory insider by the time Bell’s shareholders approved the sale of the Division and the sale was consummated. Additionally, the December Dividend was not formally declared until after Steel Partners purchased the 200,000 shares at issue, and only then was the record date fixed. These events, under circumstances not present here, could have provided an opportunity for abuse and thus would ordinarily weigh in favor of finding that the December Dividend constituted Section 16(b) profit subject to disgorgement.

The facts of this case, however, lead us to the opposite conclusion, namely that because there was no possibility of speculative abuse of inside information, the December Dividend should not be subjected to Section 16(b) disgorgement.

The Stipulated Facts presented to the district court demonstrated that Steel Partners had neither access to inside information nor control or influence over Bell’s corporate affairs and, thus, was in no better position than other shareholders or the public to weigh the benefits of purchasing or selling the shares. To begin with, these events took place during a failed attempt by Steel Partners to take over Bell. This situation, therefore, is not unlike the one presented to the Supreme Court in Kern County, with respect to which the Supreme Court noted that given the hostile atmosphere, it is “unrealistic to assume or infer ... that [the takeover party] had or was likely to have access to inside information.” 411 U.S. at 596, 93 S.Ct. 1786; see also Am. Standard, Inc. v. Crane, Co., 510 F.2d 1043, 1053 (2d Cir.1974) (“[T]he status of a defeated tender offeror affords no presumption of abuse of confidential information by virtue of relationship to the issuer ... [and] rebuts the presumption of control.”).

Other stipulated facts confirm that Steel Partners did not have access to inside information or control over the December Dividend. As Bell conceded, Steel Partners had no representative on Bell’s Board of Directors; it was not consulted before Bell’s decision to declare cash distributions (including the December Dividend); and, finally, it learned of the decision to pay dividends (including the December Dividend) at the same time as the public and all other Bell shareholders. These conceded facts negate any inference that Steel Partners could have abused inside information or manipulated the December Dividend by virtue of its position as a stockholder of more than ten percent of Bell’s stock. See Kern County, 411 U.S. at 596, 93 S.Ct. 1736.

Moreover, the December Dividend could not possibly have provided an opportunity for speculative abuse because it was a matter of public knowledge months before Steel Partners purchased the 200,000 shares in October 1999. Bell’s intention to pay a $7.00 dividend was first announced in February 1999 and most of that dividend ($5.70) was declared in May and paid out in June of 1999. Steel Partners’ receipt of this initial dividend payment presented no Section 16(b) issues.

Bell publicly announced its intention to pay the December Dividend in May 1999, more than four months before Steel Partners made its final 200,000 share purchase of Bell Stock. As we explained in Adler, there is little possibility of abuse of nonpublic information when a dividend “ha[s] been publicly announced before the purchase of stock by the insider and before he became such” because the “market price ... represents a ‘bargain’ [that] includes and contemplates any dividends” such that the insider is “in no different position with respect to this dividend from that of any other member of the stock buying public.” ¹ 267 F.2d at 848; see also Gwozdzinsky v. Magten Asset Mgmt Corp., 106 F.3d 469, 471 (2d Cir.1997) (finding that when all stockholders are treated the same (Le., via pro rata rights and public information), “there is little fear of insiders using confidential information to benefit themselves at the expense of other shareholders”); Roberts v. Eaton, 212 F.2d 82, 85 (2d Cir.1954) (“[L]ike treatment of all stockholders will in most cases remove the possibility of abuse.”). Thus, even if it could be argued that Steel Partners somehow calculated that if its takeover efforts failed, it could nevertheless reap the benefit of the announced December Dividend, the dividend still would not fall within the confines of Section 16(b) because Steel Partners’ speculation would not have been based on inside information. See Kern, 411 U.S. at 597, 93 S.Ct. 1736 (noting that even if tender offeror speculated that it could profit from defensive merger, this would not have been speculative abuse based on inside information so as to fall within Section 16(b)). As we have noted, Section 16(b) cannot and does not seek to punish all possible abuses by an insider. See Blau, 363 F.2d at 522 n. 22 (noting limits on the harms that are redressable by Section 16(b)); Lewis v. Varnes, 505 F.2d 785, 787 (2d Cir.1974) (same). Rather, its aim is to deter the use of inside information to disadvantage those with whom the insider trades. No such disadvantage could occur here.

In sum, we hold that because Steel Partners had neither access to nor an opportunity to abuse material non-public information, it is not required to disgorge the December Dividend under either a literal reading of Section 16(b) or the policies that underlie the rule. This is not to say that dividends may never be included in the calculation of Section 16(b) profits. As we noted in Adler, “[situations may well arise relative to dividends where they are so inextricably connected with the ‘purchase and sale’ of stock and possible manipulation by insiders ... as to compel the formulation of a rule on the subject ... to prevent the frustration of the statutory purpose.” Adler, 267 F.2d at 849; see also Blau, 363 F.2d at 522 n. 22 (noting circumstances in which dividends might be included as Section 16(b) profit). But to require disgorgement under the circumstances of this case would simply result in a windfall to Bell at the expense of a spurned suitor.

CONCLUSION

We hold that the December Dividend paid on the 200,000 Bell shares owned by Steel Partners was not part of the “profit realized by” Steel Partners from its short-swing purchase and sale of those shares. Accordingly, we reverse the district court’s grant of summary judgment in favor of Bell and remand for entry of summary judgment in favor of Steel Partners.

1 . Although the statement in Adler exempting from disgorgement "dividends which have been publicly announced before the purchase of stock by the insider and before he became such," Adler, 267 F.2d at 848 (emphasis added), can be read as requiring that the dividend be publicly announced both before the shares were purchased and before the defendant became an insider, we believe that with respect to traders who become statutory insiders solely by virtue of owning ten percent or more of the issuer's stock, it is only necessary that the dividend be publicly announced before the shares at issue are purchased. This is because, regardless of when a dividend is publicly announced, there can be no Section 16(b) liability if a ten percent beneficial owner was not already an insider before purchasing the shares at issue. See 15 U.S.C. § 78p(b) (this section does not cover "any transaction where [a] beneficial owner was not such both at the time of the purchase and the sale”); Foremost-McKesson, 423 U.S. at 239, 249-50, 96 S.Ct. 508 (a beneficial owner is liable under Section 16(b) only if he already owned ten percent of the stock before the purchase at issue). The situation is different when insider status is based on the fact that the trader is a director or officer of the issuing corporation. As the court held in Adler, a director can be found liable under Section 16(b) even if he was not a director at the time he purchased the particular shares at issue. See Adler, 267 F.2d at 847. Thus Adler’s requirement that a public announcement of a dividend occur both before the shares were purchased and before the trader became a director has meaning. In the context of ten percent insiders, however, it would be superfluous to require that a dividend be publicly announced both before purchase and before becoming an insider. The critical question in Adler as applied to ten percent owners is whether the shares at issue were purchased before or after the dividend was publicly announced.