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BERSHAD v. MCDONOUGH

June 19, 1969

JOHN BERSHAD, PLAINTIFF,
v.
BERNARD P. MCDONOUGH AND CUDAHY COMPANY, DEFENDANTS.



The opinion of the court was delivered by: Marovitz, District Judge.

MEMORANDUM OPINION

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
  previously contracted,

  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, 1967.

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 ...

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