Foremost-McKeeson, Inc. v. Provident Securities Co.

Supreme Court of the United States
1976 U.S. LEXIS 145, 423 U.S. 232, 46 L. Ed. 2d 464 (1976)

ELI5:

Rule of Law:

Under Section 16(b) of the Securities Exchange Act of 1934, liability for short-swing profits does not attach to a purchase-sale sequence if the investor was not a beneficial owner of more than 10% of the company's stock prior to the purchase transaction that made them an insider.

Facts:

Provident Securities Co., a personal holding company, decided to liquidate its business and find a purchaser for its assets.
Foremost-McKesson, Inc. and Provident executed a purchase agreement on September 25, 1969, for Foremost to acquire two-thirds of Provident's assets.
As consideration, Foremost delivered cash and a series of its convertible subordinated debentures to Provident, with the final debentures being delivered on October 20, 1969.
Upon receipt of the final debentures, Provident's holdings became convertible into more than 10% of Foremost’s outstanding common stock, making Provident a beneficial owner under the statute.
On October 21, 1969, just one day after becoming a beneficial owner, Provident executed an underwriting agreement to sell a $25 million debenture.
On October 24, Provident distributed some of the debentures to its own stockholders, which reduced its convertible holdings in Foremost to below the 10% threshold.
The sale to the underwriters, which was part of Provident's plan to dissolve, was completed on October 28, 1969, well within six months of the acquisition.

Procedural Posture:

Provident Securities Co. initiated a lawsuit against Foremost-McKesson, Inc. in the U.S. District Court for the Northern District of California, seeking a declaratory judgment that it was not liable under § 16(b).
The District Court, a trial court, granted summary judgment in favor of Provident.
Foremost-McKesson, as the appellant, appealed the judgment to the U.S. Court of Appeals for the Ninth Circuit.
The Ninth Circuit, an intermediate appellate court, affirmed the District Court's ruling, holding that Provident was not a beneficial owner 'at the time of the purchase.'
The U.S. Supreme Court granted certiorari upon petition by Foremost-McKesson.

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Issue:

Under § 16(b) of the Securities Exchange Act of 1934, is a beneficial owner liable for short-swing profits if the initial purchase is the very transaction that brings their ownership above the 10% threshold?

Opinions:

Majority - Mr. Justice Powell

No. A beneficial owner is not liable for short-swing profits under § 16(b) unless they held that status before the purchase that is part of the purchase-and-sale sequence. The statute's exemptive clause, which states it does not cover transactions where the owner was not such 'at the time of the purchase,' must be interpreted to mean prior to the purchase. The legislative history shows Congress intended to prevent insiders from abusing pre-existing access to information, not to penalize the very transaction that confers insider status. Imposing § 16(b)'s strict, no-fault liability based on ambiguous language would be improper, especially when the statutory scheme distinguishes between directors/officers and beneficial owners, who are presumed to gain access to information only after acquiring a substantial stake.

Analysis:

This decision resolves a significant and long-standing ambiguity in § 16(b) jurisprudence by establishing a clear, bright-line rule for when liability attaches to a new beneficial owner. It creates a crucial safe harbor for the 'entry' transaction, meaning the purchase that elevates an investor to over 10% ownership is exempt from short-swing profit disgorgement. This holding narrows the scope of § 16(b)'s strict liability for beneficial owners, solidifying the distinction between them and traditional insiders like directors and officers. The ruling provides certainty for investors engaging in large-scale stock acquisitions, allowing them to structure transactions without fear of inadvertently triggering § 16(b) on their initial purchase.

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