of more than 10% of Bache's outstanding common stock at all times
within six months of June 12, 1981, Colan concludes that the
profits earned by First City from the conversion of such shares
constitute short-swing profits by an insider and therefore are
recoverable by Prudential-Bache under section 16(b).
In support of its motion for summary judgment, First City
contends that the conversion of its Bache stock into cash,
pursuant to the merger which it opposed, was not a "sale" within
the meaning of section 16(b).
III. Kern County, Its Progeny and the Pragmatic Approach.
Two identifiable analytical approaches for dealing with section
16(b) issues have been developed by the courts. As noted in Oliff
v. Exchange International Corp., 669 F.2d 1162, 1165 (7th Cir.
1980), under the objective approach, a court must determine
whether the transactions and the involved party fall within the
literal and broadly remedial requirements of section 16(b). If
so, the inquiry ends, liability attaches and profits must be
returned. Id. In an orthodox transaction, beneficial owners of
more than 10% of a corporation's stock are presumed to have
access to inside information and to have acted on the basis of
such information by engaging in a short-swing transaction.
Allis-Chalmers Manufacturing Co. v. Gulf & Western Industries,
Inc., 527 F.2d 335, 347 (7th Cir. 1975), cert. denied,
423 U.S. 1078, 96 S.Ct. 865, 47 L.Ed.2d 89 (1976).
In Kern County Land Co. v. Occidental Petroleum Corp.,
411 U.S. 582, 93 S.Ct. 1736, 36 L.Ed.2d 503 (1973), the Supreme Court
developed a "pragmatic," or subjective, approach to questions of
section 16(b) liability in cases involving certain "unorthodox"
transactions. Under this approach, a court must determine whether
an "unorthodox" or "borderline" transaction — that is, one not
ordinarily thought of as a sale or purchase but arguably within
the broad statutory definition*fn4 — comes within the reach of
section 16(b) by inquiring "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, 411 U.S. at 594, 93 S.Ct. at
1744 (footnote omitted).
In Kern County itself, purchases within the scope of section
16(b) occurred when defendant Occidental acquired more than 10%
of the stock of Old Kern, the target company, as a result of a
tender offer. While the offer was in effect, Old Kern engineered
a defensive merger with Tenneco, involving an exchange of all
shares of Old Kern stock for shares of Tenneco stock. Occidental
attempted to block the proposed merger, but eventually dropped
its efforts after negotiating certain option arrangements with
Tenneco.*fn5 At a meeting of Old Kern shareholders to vote on
the merger, Occidental did not vote its shares but indicated
that, had it done so, it would have voted in favor of the merger.
Once the merger was closed, all Old Kern shareholders, including
Occidental, became irrevocably entitled and committed to exchange
their Old Kern holdings for Tenneco preferred stock. Id. at
584-89, 93 S.Ct. at 1739-41.
The Supreme Court held that this exchange did not constitute a
"sale" within section 16(b). In so ruling, the Court placed great
emphasis on two factors: (1) the involuntary nature of the
exchange; and (2) the absence of the possibility of
speculative abuse of insider information.*fn6 With regard to the
first factor, the Court observed that the merger was not arranged
by Occidental, but was sought by Old Kern to frustrate
Occidental's attempts to gain control of Old Kern. Furthermore,
once the merger was approved, Occidental had no real alternative
concerning the disposition of its Old Kern shares. While it could
have sold the shares before the merger was closed, such an act
would have subjected Occidental to prima facie section 16(b)
liability. Kern County, 411 U.S. at 599-600, 93 S.Ct. at 1747.
With regard to the second factor, the Court noted that while
Occidental was a statutory insider at the time it extended the
tender offer, its clear adversarial posture vis-a-vis Old Kern's
management afforded little possibility of access to inside
information by virtue of its stock ownership. Id. at 598-99, 93
S.Ct. at 1746-47.
Kern County has been interpreted and applied in two decisions
highly relevant to the case at bar. In American Standard, Inc. v.
Crane Co., 510 F.2d 1043 (2d Cir. 1974), cert. denied
421 U.S. 1000, 95 S.Ct. 2397, 44 L.Ed.2d 667 (1975), defendant began
purchasing large quantities of the common stock of Westinghouse
Air Brake Company ("Air Brake"). Air Brake declined Crane's
proposals for a merger and, instead, engineered a defensive
merger with Standard. Crane, which at this point owned in excess
of 10% of Air Brake's outstanding stock, then made a tender offer
for the shares of Air Brake. This tender offer failed, and the
Air Brake-Standard merger was approved. Pursuant to the terms of
this merger, Crane exchanged its Air Brake common shares for the
preferred shares of Standard. Crane eventually sold these shares,
obtaining a profit of approximately $10,000,000.00. American
Standard, 510 F.2d at 1047-49.
The Second Circuit found that the two factors highlighted by
the Supreme Court in Kern County were also present in American
Standard. Crane's exchange was involuntary, since it was
essentially powerless to control the course of events in light of
the opposition by Standard's management. There existed an
atmosphere of hostility, rendering it unlikely that Crane would
have access to insider information by virtue of its greater than
10% ownership. Id. at 1054. As summarized by the court:
"We believe that Kern County holds the defensive
merger situation to be sui generis in terms of §
16(b) liability. The implication is that the status
of a defeated tender offeror affords no presumption
of abuse of confidential information by virtue of
relationship to the issuer. By status it is
accordingly not `presumed to be an insider who will
receive information regarding the company before it
is made public.' . . . The adversary stance also
rebuts the presumption of control."
Id. at 1053 (citation omitted).