Securities and Exchange Commission v. Sterling Precision Corporation, and the Equity Corporation

Chicago, 111., pro Homer, berg, Specks to made be rata. & Corpora- counsel), Series C Preferred Stock was redeem- Precision per plus able share dividends $10 tion. unpaid; accrued less SMITH, Cir Before FRIENDLY redemption, stock was called for “the GIGNOUX, Judges, District cuit so shares redeemed shall be se- Judge.* by lected lot or in such manner as may Board of Directors determine Judge: FRIENDLY, Circuit * * *.” The indenture under which appeal primary on issue The the Debentures issued a contained for from an order District Court of Sterling covenant not that would redeem of York District Southern New any stock without the consent of hold- granting summary judgment to defend- outstanding of of ers Deben- 60% Sterling Corporation in an ant Precision except out tures of the net amount of injunction whether action the SEC is earnings proceeds and the of sales of Sterling’s of bonds its 1956; January 1, stock since breach of “pur- preferred and stock were a give this covenant would of holders of Ster- chase” such securities option to declare Debentures them ling Equity Corporation, a immediately payable. due and registered owning company Sterling In 1966 found itself with a Sterling’s voting more than of se- 5% large $7,700,000, cash balance of about curities, 17(a) (2) within the ban of § constituting some of its total assets. 35% Company of the Investment Act. We management proposed program Its they hold were not. whereby these be funds would used in years As a result of ten transactions part to redeem the Debentures Pre- and earlier, of need not details by Equity, thereby ferred Stock held of stated be view take terminating affiliation, which Ster- August 9, 1966, case, Equity, on owned ling regarded handicap opera- as Sterling’s $1,637,000 of Converti- 4%% meeting August 4, 1966, tions. At a on January 1971, 1, ble Debentures due and the directors authorized the officers 355,052 374,826 outstanding of shares negotiate with the other two Debenture Sterling’s par of Cumula- $10 value 5% August holders for their On consent. Eq- tive Convertible Preferred Stock. 8, reported Chairman con such uity’s holdings preferred stock and forthcoming sent would be in considera 120,340 3,600,- common shares out tion of an increase the interest rate outstanding constituted 11.8% possibly and the issuance of war 6% voting Sterling, securities and purchase 300,000 rants to not more than Sterling person” made “an affiliated shares of common stock. The Board Equity 2(a) (3) (B). under § thereupon Equity’s called Debentures provided, quali- redemption Debentures and Preferred Stock on 1966;1 material, 1, fications not October waived notice 4% outstanding the total then should be and surrendered its securities re August called for March 15 of on on 9. Due to subse year principal plus quent quintupling each at their amount price of the market provided stock, accrued It interest. was also of its common the transaction has special proved Sterling; that on against notice the Debentures beneficial as might price redemption price redeemed the same $5,191,379, at the total any part Equity’s a whole time or from the stock into Deben time; time the latter re- event tures Preferred Stock would have * sitting Maine, 17(a) (2) Company Of the District Court of of the Investment by designation. require exemp- Act and thus did not an 17(b). tion opinion given Sterling 1. an Counsel had the transaction was within Delaware, statutes, notably price tion a market had convertible been organized, General January 4, where $14,000,000 on over 243; by judicial de Corporation Law § Com- Section cision, Utilities v. Public see Venner pany provides: Act 235, Commission, 134 N.E. 302 Ill. any affili- unlawful “It shall be Starring compare (1922), v. principal promoter person of or ated Co., 21 Del.Ch. Felt American Hair & registered invest- for a underwriter 21 Del. aff’d 191 A. 887 (other than a ment (Sup.Ct.1938) with 431, 2 A.2d 249 Ch. in section described of the character & Chemical Martin American Potash any (A) af- 12(d) (B)), or Corp., 301- A.2d Del.Ch. pro- person, person of such a filiated (Sup.Ct.1952); A.L.R.2d underwriter, principal act- moter, or law, corporation see writers — n ing principal (1961); Henn, Corporations 170 & n. 37 security “(1) any knowingly (1946). to sell Ballantine, Corporations 263 registered property year to such or other Indeed, a before the Invest any company controlled adopted, or to Company Act was the Su ment registered by company, unless such preme upholding in said, had a Court solely (A) securi- such sale involves contention the Government the issuer, buyer the is the ties of which of debentures not a was (B) of the seller is exchange” securities affording “sale or the benefit part a of gains the issuer which are capital of treatment general offering holders of a to the revenue laws: securities, (C) securi- class of its or “Payment discharge of a bond is deposited of a ties with trustee exchange neither nor sale within pay- periodic trust or unit investment commonly accepted meaning thereof; depositor plan by ment words.” “(2) purchase knowingly, from to Fairbanks, United States v. 306 U.S. registered company, any or from such 436, 437, 607, 608, 59 S.Ct. 83 registered company controlled such (1939). L.Ed. 855 company any security prop- or other recognize We these considera erty (except securities statute, par tions not A are conclusive. * * issuer) seller is the ticularly dealing an esoteric one with subject, may in use a word We start our consideration from sometimes supplied point speech a sense from that in common different a usage. maturity dictionary paying Cf. prior or common maker’s a note to Bottling Co., 350 NLRB in not v. Coca-Cola accordance with its terms would 264, 269, regarded “purchase.” 100 L.Ed. U.S. 76 S.Ct. as a While few (1956). right saying necessary in people is find it to resort SEC would meaning dictionary we should decide issue as one ato to ascertain the law, though term, federal a Delaware International even Webster’s construing (2d corporation Dictionary 1960) laws ed. tells us that court might “purchase” acquisition “the come to a different conclusion. means anything Annuity to, property Co., in, a SEC v. Variable Life Ins. title or money price; buying equiva or its U.S. 79 S.Ct. 3 L.Ed.2d lent,” (1959); Knight, purchase Tcherepnin to is to “obtain and that (anything) by money paying equiv or its U.S. 19 L.Ed.2d 564 S.Ct. (1967). Sterling may acquire It true alent.” did not title to also that “sale” Stock; meaning Preferred it have a broader in securities its Debentures or legislation discharged Perhaps impor in them. more than the Internal Revenue lawyers tant, Still, the normal discourse of Code. when due allowance has apart this, good redemptions purchases. been made for re sets a deal recognized eorpora- The distinction is mains from what we first said. “Pur- peculiarly purpose, technical term turn a When to we find the chase” is not we legislative legislation all, history specific when not silent on “[a]fter question Making expressed terms is addressed our in technical issue. own guesses can, to the run of men and is there- would common best we think according Congress plain it fore to be understood to could ordinary redemptions thing, meant man to include all sense of the as the in § ordinary right rely purchases. has words it did all a Holly compulsory redemp- to him.” Addison v. clearest is a addressed case tion, Inc., required Hill such as Fruit Products U.S. perform annually respect 1215, 1221, 88 618, 64 L.Ed. 1488 43% asserting (1944). party outstanding. of Congress that a word the Debentures A then meaning surely given did a statute should be not intend that an company’s speech acquisition it different from what has or, instance, more men common the stock a non- 5% speech lawyers, place common has the bur- should showing necessity applying latter den of or evident under the that context purpose requires to the Commission this. of a necessary transaction avoid default. context, turn we find When we equally We are confident that than di- rather SEC’s burden increased would not have meant to include total Investment Com- minished. While the pro ones, though rata even quite pany inclu- defines “sell” in Act at the of an “affiliate” not an volition 2(a) (33), it no terms, contains sive § Though company. Congress investment “purchase,” and in several definition of principally protect- was ing with concerned 7(a) (2), 7(b) provisions, 1(a) (1), §§ companies of the assets investment Congress (2), 18(e) re- (2), and unscrupulous management, it nev- “pur- redemptions well as ferred to permitted to ertheless affiliates “sell” instances, chases.” some of these While company back investment securities g., explicable in of e. terms are § 17(a) (1) (A), without SEC approval, § practice open-end com- the panies investment and the Commission concedes this that shares on redeem their own to redemptions by includes the ap- demand, would not that consideration company. investment If be- 18(e) (2) ply, example, to which § redemptions type lieved that this that section renders the restrictions of safely unsupervised, could it fol- left by regis- of senior securities the sale redemptions lows a that “af- fortiori inapplicable, companies tered closed-end filiates” in substantial accordance with material, qualification to with a not here the terms of their securities should also purpose of such securities sold for the refunding be. For in eases of this sort there is security another senior danger no that the investment through redemp- “payment, purchase, unfairly prejudiced. could be When it exchange.” tion, retirement, can It bought securities, the did so with it the does, argued, be gress that as the Con- SEC recognition they subject that to lapsed old-fashioned into the here call; only thus, potential arising the evil method would wherein a draftsman out of the transaction is that the invest- never word if would do as use one five company might ment influence its “af- 18(e) Still, well. if draftsman of § filiate” call, make a to to the detriment (2) “purchase” in- not sure was security of the other holders the non- legitimate redemption, is cluded ground there company. danger While the can assume for wonder how we recognized such influence was at the (2) 17(a) was con- draftsman § time the passed, Study Act was see SEC especially opposite, when fident of the of Investment Trusts such a counter to the construction runs ordinary meaning Companies, parts words. 4 and H.Doc. general urged upon expansion passim the Cong., pp. 27-8 et 1st Sess. principal us. (1942),2 was not one it remedy, sought see the Act evils Rejection po broad SEC’s Funds, Study of Mutual School Wharton “purchase” 17(a) in sition that Sess., Cong., pp. 400- H.Rep. 2d redemptions brings to the cludes us Indeed, decla- (1962).3 elaborate in narrower the statute issues whether 1(b) of the evils which ration in § arguably cludes some sought prevent con- does not statute quality purchase the essential of a Congres- express tain an declaration and, so, -pro the non whether rata char danger. Sec- with sional concern perhaps acter of those here at issue — empha- 1(b) tion which SEC accurately more of the sizes, on the kind of “affiliated reads 4—suffices to that test. Debentures meet injure person” in- who is able The issue is narrowed still further re- vestment rather than the Sterling’s counsel, the concession of that, We cannot verse. believe accept which accordance policy, priority Con- name of this low ordinary language, that ac use gress would have desired Commis- quisition of the re bonds less than police redemptions non-invest- sion to demption price “purchase,” would be a companies thoroughly ment more though acquirer even then cancelled redemptions by companies them; discharge through payment is ef dangers with it which involved security paid fected when a is off primarily none concerned. While in substantial accordance with its terms. justify these considerations would argue apply failure to transactions departure in fact there nowas from the terms, Corp., within its Blau v. Mission governing provisions of the Debentures (2 denied, Cir.), 212 F.2d 77 cert. Equity, they say, at all. could not have 1016, 74 U.S. 98 L.Ed. 1138 accept -pro refused to rata non re (1954), Commission — as since their re view 17(b) required, (2), to make that sure § quirement solely for the benefit of the “not over transaction does involve holders whose Debentures would other reaching part any person on the con join wise not be redeemed. While we they argue against powerfully believing the Commission in that cerned” — by testimony funds, brief The SEC’s also cites in increase the size of the did not Schenker, Esq., in-depth analysis David chief counsel of undertake a new at this Study, Hearings yet Investment Trust S. on time since is “there no as evidence any widespread departure before a subcommittee 3580 Senate from Currency, Banking policy company] Committee on and [investment traditional 257-59, Cong. (1940), evidencing disapproval portfolio 3d 76th Sess. of company possible by management liquidating he discussed the where evils hold- company causing ings.” an investment one con- Id. at 310. engage subsidiary transac- trolled to in complete 4. Since the directors had free- another. tions with preferred dom to determine which shares sponsored by redeemed, unnecessary 3. Later studies the Com- be were to it was Equity qua pre- suggest compa- get mission that to the consent of pow- seriously pre- not abused their nies have ferred or of stockholder the other er The Wharton in over “affiliates.” ferred stockholders order to effect Study, supra, redemption Equity’s preferred found mutual School’s managers participate Equity’s in fund the affairs Once stock. Debentures were only very portfolio companies redeemed, advantage in limited it not take could ways. redemp- Id. at The most recent 26-27. the clause which made a stock Policy Report, Im- Public tion an event of certain Commission default under Company plications circumstances the absence of consent Growth, Cong., by at H.R. 2d Sess. 89 of the Debenture holders —even if 60% (1966), indicating applicable, 308-09 while the clause was here which the findings Study’s in this School does Wharton record not reveal. may be obsolete in view of the area 300% object (1944). holder of Debenture could a S.Ct. L.Ed. 124 non-pro rata redemption Volkswagenwerk Aktiengesellschaft since this Cf. a FMC, high might 390 U.S. deprive interest him of a prematurely (1968). or a rate terminate conver- L.Ed.2d 1090 right privilege, sion such a would not light major In of our view on the very Equity been from have valuable to presented, issue of construction find we practical standpoint. a For we know of unnecessary grounds it to consider other prevented principle that would have no urged by Sterling for affirmance Sterling making complete re- from Equity. in accordance inden- with Affirmed. reborrowing ture from then holders wished whose bonds had not it Rehearing Petition On redeem, might on such terms agreed. find it think We hard to PER CURIAM. the 19.40 been would have principal point The made greatly concerned over an rehearing petition for concerns SEC’s receiving like full drew, the inference 393 F.2d redemption price simply because other (1) 17(a) exemption § ultimately might bondholders make out which, Company Act of the Investment especially when, still, indicated, better urged by reading on the broad even readily could so accom- Commission, redemption would cover a plished available means which se an investment its own clearly prevent. the statute did not Con- Com held an curities affiliate. sequently we find that the transaction’s argues ex mission deviation from the terms set out light general plicable provisions Debenture was not so substantial as to relating of such securi “purchase.” transform it into a 23.1 and related matters in 22 and ties §§ only the conten However, inspection provisions, remains There of these twenty years “pur notably 23(c), Com for over tion that shows that even considered read to mission has chase” were cover a redemptions, contends, Congress these when es cover even as the Commission total, safeguards of Atlas In the Matter see tablished certain basic require Corporation, approval. 23 S.E.C. 43 and did not Commission sinking requirement, pursuant explanation fund Commission’s of this provisions Securities In the Matter of Bankers the basis that these see cover (1947), un Corporation, simply S.E.C. transactions those within reinforces less affiliates view that Con exemption gress regard 17a-4 in Rule established did not call affiliation as applicants ing special redemptions. In these cases the 1947. both treatment of voluntarily sought exemption Congress Our inference that § did not 17(a) being 17(b), applicability require approval SEC of a transaction simply assumed, pri is the sort with which the Act was marily con sued. Uncontested administrative concerned —in an instance relatively causing struction of this nature carries affiliate’s an com investment weight. Fishgold Dry pany little v. Sullivan to redeem its own securities held 290, Repair Corp., affiliate, hardly dock & 328 U.S. it could (1945); require approval 1230 L.Ed. meant such Co., priority v. U.S. lower Skidmore Swift & area non- ly surplus) ap- 1. “redeemable securities” dealt out of to receive proximately proportionate terms of 22 are securities “under the his share of holder, upon presentation assets, which the issuer’s net current or the cash designated by person equivalent 2(31). issuer or to a thereof.” § (whether issuer, absolute- is entitled securities, re- thus unimpaired. mains study of the Com

After careful uncon petition, remain we

mission’s Congress over concerned

vinced that receiving the full an redemption security specified in price when the affiliation an affiliate even ownership by the affiliate stems from company and a the investment when, fortiori here, affiliation arises ownership company’s the investment evi In absence clear affiliate. contrary purpose,

dence of such as DeSmedt, 366 found in FMC v. to exist denied, (2 Cir.), cert. F.2d 469-470 L.Ed.2d 87 S.Ct. U.S. Congress should words of applied ordinary If in their sense. problem requires presented sug remedy, nothing in the record gests, proposals for modification of the Company pending Act now provide appro

before will an

priate vehicle for an amendment more closely danger tailored asserted reading the broad which the argues.

SEC petition rehearing denied. PRINTING PRESS-

WINSTON-SALEM UNION AND ASSISTANTS’ MEN 318, Appellee, NO. COMPANY

PIEDMONT PUBLISHING WINSTON-SALEM, Appellant. OF

No. Appeals

United States Court Circuit. Fourth

Argued Dec. 1, 1968. March

Decided

Case Details

Case Name: Securities and Exchange Commission v. Sterling Precision Corporation, and the Equity Corporation

Court Name: Court of Appeals for the Second Circuit

Date Published: Apr 29, 1968

Citation: 393 F.2d 214

Docket Number: 31729_1

Court Abbreviation: 2d Cir.