The opinion of the court was delivered by: Marovitz, District Judge.
Cross-Motions for Summary Judgment
Pursuant to Section 16(b) of the Securities Exchange Act of
1934 ("Act"), 15 U.S.C. § 78 p(b), this action is brought by John
Bershad, owner of certain of the common stock of defendant Cudahy
Company (Cudahy) to recover for the benefit of Cudahy the
purported "short swing" profits accruing to the defendant Bernard
P. McDonough from the alleged purchase by him and sale to United
States Smelting, Refining and Mining Company (Smelting) of
272,000 shares of the common stock of Cudahy within a period of
less than six months. In part, Section 16(b) reads as follows:
"(b) For the purpose of preventing the unfair use of
information which may have been obtained by such
beneficial owner, director, or officer by reason of
his relationship to the issuer, any profit realized
by him from any purchase and sale, or any sale and
purchase, of any equity security of such issuer
(other than an exempted security) within any period
less than six months, unless such security was
acquired in good faith in connection with a debt
shall inure to and be recoverable by the issuer,
irrespective of any intention on the part of such
beneficial owner, director, or officer in entering
into such transaction of holding the security
purchased or of not repurchasing the security sold
for a period exceeding six months."
Both sides have moved for summary judgment.
The essential facts in this case are undisputed. Cudahy is a
Maine corporation whose common stock at all pertinent times was
registered and traded on the New York Stock Exchange and not an
exempted security under Section 3(12) of the Act,
15 U.S.C. § 78c(12). On March 15 and 16, 1967, Bernard P. McDonough
purchased 141,363 shares of common stock of Cudahy from Continental
Illinois National Bank and Trust Company of Chicago, which was
acting as Executor of the Estate of Edward A. Cudahy. On the same
date McDonough, as attorney in fact for Alma McDonough, purchased
at a like sale for Alma McDonough 141,363 shares of Cudahy common
stock. These purchases were made at a price of $6.75 per share.
About two weeks later, on April 4, 1967, Bernard P. McDonough,
Donald E. Martin, Carl L. Broughton and Otto Gressens were
elected directors of Cudahy.
Thereafter, on July 20, 1967, Bernard P. and Alma McDonough
each owners of 141,363 shares of the common stock of Cudahy,
executed an agreement entitled "Option Agreement" with Smelting,
a copy of which agreement is attached to the respective
affidavits of the McDonoughs as "Affiant's Exhibit No. 1." At the
same time that the option agreement was executed, the McDonoughs
executed an escrow agreement, a copy of which is attached to both
the respective McDonough affidavits as "Affiant's Exhibit No. 2."
Also on July 20, 1967, the McDonoughs executed and delivered to
Jack Wilder, President of Smelting, a proxy, a copy of which is
attached as "Affiant's Exhibit No. 3" to the respective McDonough
affidavits. All of the negotiations which resulted in the
execution of the option agreement, escrow agreement and proxy
took place in Wood County, West Virginia, on July 20, 1967.
Bernard P. McDonough resigned as an officer of Cudahy on July
18, 1967, and as a director of Cudahy on July 25, 1967. Those
persons who were elected with McDonough as Cudahy directors on
April 4, 1967, resigned as well. On July 28, 1967, these
positions on Cudahy's Board of Directors were filled by persons
with strong ties to Smelting, including Martin Horwitz, then
Chairman of the Board of Directors of Smelting, and Jack Wilder,
then President and a director of Smelting.
Under the Option Agreement, Smelting paid $350,000.00 to the
McDonoughs for an option to purchase 272,000 shares of Cudahy
common at a price of $9.00 a share on or before October 1, 1967.
While the $350,000 belonged to the McDonoughs absolutely if the
option were not exercised, the money was to be applied against
the $2,448,000.00 purchase price if the option to buy the stock
were exercised. Under the proxy agreement, the McDonoughs granted
Smelting a proxy, irrevocable until October 1, 1967, to vote the
272,000 common shares of Cudahy. Following the execution of the
option agreement, escrow agreement and proxy, certificates
representing 272,000 shares of the common stock of Cudahy were
delivered to Ralph Bohannon, which certificates remained in his
possession in Clarksburg, West Virginia, until September 27,
On September 22, 1967, Martin Horwitz, then Chairman of the
Board of Smelting, directed a letter to the McDonoughs notifying
them of the exercise by Smelting of its option to purchase the
272,000 shares of Cudahy common stock. Five days later, in
Parkersburg, West Virginia, delivery of certificates representing
the 272,000 shares was made to Robert Pirie, who represented
himself to be an attorney for Smelting. At the time of the
delivery to Pirie, Bohannon, on behalf of the McDonoughs,
received a check in the amount of $2,098,000.00 from Pirie.
From this relatively simple set of facts, the respective
parties ask us to draw opposing conclusions. Defendants contend
that what took place was the granting of an option which was not
exercised and therefore did not mature into a sale of stock until
more than six months after the stock was originally purchased by
the McDonoughs. Plaintiff, on the other hand, suggests that the
transactions between the McDonoughs and Smelting constituted a
sale or contract to sell within the meaning of the statute.
Initially, it is clear that the law has drawn a distinction
between an option and a sale. The pure option contract is one by
which the owner of property agrees with another person that the
latter shall have the right to buy the former's property at a
fixed price within a fixed time. Graney v. United States,
258 F. Supp. 383, 386 (S.D.W. Va. 1966), aff'd 377 F.2d 992 (4th Cir.
1967); Whitelaw v. Brady, 3 Ill.2d 583, 588-589, 121 N.E.2d 785
(1954). For a price, the optionee purchases the right to choose
to conclude or not to conclude a particular transaction. For
example, in Silverman v. Landa, 306 F.2d 422 (2d Cir. 1962),
which was an action to recover "short swing" profits allegedly
accruing the result of violation of Section 16(b) of the Act, the
optionee paid a premium of $4,000 for the right to buy 1,000
shares of stock at the market price ($24 3/8 per share) on the
date that the option was granted.
In the pure option agreement, "(w)hile the option extends the
right to purchase, it imposes no binding obligation to do so upon
the person holding the option." Graney v. United States,
258 F. Supp. 383, 386 (S.D.W.Va. 1966), aff'd, 377 F.2d 992 (4th Cir.
1967). Discussing such an agreement in relation to Section 16(b),
the Second Circuit has said:
"By its nature, the option is one-sided; it fixes the
obligations, but not the rights, of the issuer. Landa
cannot be said to have `sold' or `purchased' Fruehauf
stock; should the options lapse unexercised (and in
fact the call options did so lapse), no change in his
beneficial ownership of the underlying security would
occur. And, most importantly, any change would occur
at the pleasure of the optionee. Only if both the
options had been exercised within their ...