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Portnoy v. Kawecki Berylco Industries Inc.

decided: October 1, 1979.


Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. No. 78-C-2103 -- Nicholas J. Bua, Judge .

Before Fairchild, Chief Judge, and Swygert and Pell, Circuit Judges.

Author: Pell

The sole issue in this appeal is whether the plaintiff, a shareholder of both Cabot Corporation (Cabot) and Kawecki Berylco Industries, Inc. (KBI), has standing to bring an action under Section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b), for recovery of profits allegedly obtained by International Mining Corporation (IMC) from short-swing trading of shares of KBI.*fn1 The structure and relationship of the corporations involved and the changes in that structure and relationship are critical to the outcome.

At the time the plaintiff filed his complaint on May 26, 1978, he was a shareholder of KBI and of Cabot.*fn2 Cabot was the parent of Cabot Special Metals Corporation (CSMC), which in turn owned Tuckerton Corporation (Tuckerton). Five days later, on May 31, 1978, Tuckerton merged into KBI. The plaintiff and other premerger shareholders of KBI received cash in exchange for their shares of KBI common stock, and CSMC became KBI's sole shareholder. Thus, KBI became a wholly owned subsidiary of CSMC which was a wholly owned subsidiary of Cabot. After the merger, the plaintiff amended his complaint to state that it was brought on behalf of Cabot in addition to KBI. As a result, the standing issue is really a bifurcated one. First, we must determine whether the plaintiff lost his standing when, because of the merger, he lost his status as a shareholder of KBI, and second, we must determine whether his status as a shareholder of Cabot confers standing.


Section 16(b) provides in part: "Suit to recover (short-swing) profit may be instituted at law or in equity . . . by the owner of any security of the issuer in the name and in behalf of the issuer . . . ." When the plaintiff filed his § 16(b) action, he was an owner of a security of the issuer (KBI). However, he lost that status five days later, and consequently, we are of the opinion that he lost the standing that he had as an owner of KBI stock. Only one case appears to be directly on point. In Rothenberg v. United Brands Company, (1977-78 Transfer Binder) Fed.Sec.L.Rep. (CCH) P 96,045 at 91,690, Aff'd, 573 F.2d 1295 (2d Cir. 1977), the court held that the plaintiff lacked standing in his § 16(b) action because he lost his shareholder interest in the issuer as a result of a merger of the issuer and another corporation which occurred after he filed his complaint but during the pendency of the action.

This result is consistent with cases decided under Rule 23.1, Fed.R.Civ.P.,*fn3 which governs "derivative action(s) brought by one or more shareholders or members to enforce a right of a corporation." It requires that the plaintiff fairly and adequately represent the interests of other shareholders similarly situated. Accordingly, a plaintiff in a derivative action must maintain his shareholder status throughout the pendency of the lawsuit, and an action will abate if the plaintiff loses his shareholder status before the litigation ends. Schilling v. Belcher, 582 F.2d 995 (5th Cir. 1978); Tryforos v. Icarian Development Company, 518 F.2d 1258 (7th Cir. 1975), Cert. denied, 423 U.S. 1091, 96 S. Ct. 887, 47 L. Ed. 2d 103 (1976). The underlying rationale of these cases is that because a shareholder will receive at least an indirect benefit (in terms of increased shareholder equity) from any corporate recovery, he has an adequate interest in vigorously litigating the claim. A non-shareholder or one who loses his shareholder interest during the course of the litigation may lose any incentive to pursue the litigation adequately. The same is true in the present case. Therefore, when the plaintiff lost his shareholder interest in KBI, he lost his standing to sue on behalf of KBI under § 16(b).*fn4


We now consider whether the plaintiff's status as a shareholder of Cabot gives him standing in this action. Section 16(b) provides that suit may be brought by "the owner of any security of the Issuer in the name and in behalf of the Issuer." (Emphasis added.) To determine the scope of the term "issuer" we need not look beyond the Securities Exchange Act of 1934 which defines "issuer" as follows:

The term "issuer" means any person who issues or proposes to issue any security; except that with respect to certificates of deposit for securities, voting-trust certificates, or collateral-trust certificates, or with respect to certificates of interest or shares in an unincorporated investment trust not having a board of directors or of the fixed, restricted management, or unit type, the term "issuer" means the person or persons performing the acts and assuming the duties of depositor or manager pursuant to the provisions of the trust or other agreement or instrument under which such securities are issued; and except that with respect to equipment-trust certificates or like securities, the term "issuer" means the person by whom the equipment or property is, or is to be, used.

15 U.S.C. § 78c(a)(8).*fn5 The statutory language is thus specific that the issuer is the person who issues the security which is involved in the short-swing trading, in this case, KBI.

The plaintiff asks us to broaden the definition to encompass Cabot which would make the issuer include the parent of the parent of the issuer. Although the plaintiff's contention is not absurd on policy grounds,*fn6 we cannot rewrite the statute to accommodate this situation. Congress has spoken clearly. When it wanted a broader definition of issuer, it drafted one. In § 2(a)(11) of the Securities Act of 1933, for example, "issuer" is defined as including "any person directly or indirectly controlling or controlled by the issuer, or any person under direct or indirect common control with the issuer." 15 U.S.C. § 77b(11). In § 16(b), on the other hand, Congress apparently intended only those with a less tenuous financial interest to have standing and confined standing other than to the "issuer" itself to "the owner of any security of the issuer."

In a similar vein, courts have refused to construe the phrase "officer of the issuer" in § 16(b) to include an officer of the subsidiary of the issuer or an officer of the division of the issuer. In Lee National Corporation v. Segur, 281 F. Supp. 851, 852 (E.D.Pa.1968), the court stated:

While the purpose of the Act is to recover "short swing profits" realized by so-called "insiders", the fact is that if it be the congressional intent to include officers of subsidiary corporations as well as officers of the "issuer" corporation, this can be quickly accomplished by a simple amendment to the ...

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