VISTA RESOURCES, INC., ET AL., PETITIONERS V. THE SEAGRAVE CORPORATION No. 83-1084 In the Supreme Court of the United States October Term, 1983 On Petition for a Writ of Certiorari to the United States Court of Appeals for the Second Circuit Brief for the United States as Amicus Curiae TABLE OF CONTENTS Statement Discussion Conclusion QUESTION PRESENTED Whether the sale of a 100% stock interest in a company is a securities transaction within the meaning of the federal securities laws. This brief is filed in response to the Court's invitation to the Solicitor General to express the views of the United States. STATEMENT This action arises out of the sale by petitioner Vista Resources, Inc. ("Vista") of all of the outstanding stock of 29 of its first and second-tier subsidiaries, along with certain other assets (Pet. App. 13a). At the time of the transaction Vista, then known as the Seagrave Corporation ("Old Seagrave"), was a publicly held company whose shares were traded on the New York Stock Exchange (Pet. App. 13a). As part of the transaction respondent, a corporation organized as a vehicle for the acquisition, received the right to use the name Seagrave (hereinafter called "New Seagrave") (C.A. App. 37). New Seagrave brought this action against Vista, certain of its officers and directors, and others, seeking rescission and damages under antifraud provisions of the federal securities laws. /1/ Respondent alleged that petitioners had made untrue statements of material fact and had omitted to state material facts concerning the financial condition of Old Seagrave and its subsidiaries, and that such false and misleading information was contained in the company's 1979 10-K report which was furnished to respondent in connection with the transaction (C.A. App. 15-25). /2/ The district court, on petitioners' motion, dismissed the complaint, ruling that the stock of the subsidiaries did not constitute "securities" within the meaning of the federal securities laws (Pet. App. 12a). The ruling was based on the district court's view that, although the term "stock" is included in the statutory definition of security, the stock of the subsidiaries failed to meet the test set forth in SEC v. W.J. Howey Co., 328 U.S. 293 (1946) (Pet. App. 16a-21a). /3/ The court of appeals reversed, ruling that the federal securities laws apply to transfers of a 100% stock interest in a corporation. In rejecting the "sale of business" doctrine applied by the district court, the court of appeals reaffirmed its decision in Golden v. Garafalo, 678 F.2d 1139 (1982), which had been decided after the district court's decision in this case (Pet. App. 3a-5a). /4/ The court of appeals here reiterated its view that, if the instruments being transferred possess the characteristics of conventional "stock," they need not also meet the Howey test applicable to uncommon forms of securities (Pet. App. 5a-7a). /5/ DISCUSSION The decision by the court of appeals is correct. Nevertheless, in view of the conflict among the circuits and the significance of the issue presented to the interpretation of the federal securities laws, we believe the case warrants review by this Court. 1. The court of appeals correctly determined that a sale of a 100% stock interest in a company is not exempt from the antifraud provisions of the federal securities laws. The statutory language could hardly be more clear. The term "stock" is expressly included in the definition of security. /6/ It is true that this Court, in United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 848-851 (1975), declined to characterize as "stock" shares entitling a purchaser to lease an apartment. But the stock here, unlike the shares in Forman, "embodies (all) of the significant characteristics typically associated with (that) instrument" (421 U.S. at 851). Forman also stated that the instrument involved there did not qualify as an "investment contract," and in reaching that conclusion said (421 U.S. at 852): the basic test for distinguishing the transaction from other commercial dealings is "whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others." Howey, 328 U.S. at 301. This test, in shorthand form, embodies the essential attributes that run through all of the Court's decisions defining a security. As noted above, however, that observation appeared in the part of the opinion that dealt with the question whether the instrument -- although not "stock" -- nonetheless qualified as a security in the form of an "investment contract." /7/ If the term "security" were to be limited to those instruments that satisfy the Howey test for investment contracts -- as the language in Forman has been viewed to suggest -- almost all of the statutory definition would be rendered superfluous. /8/ As this Court recognized in Tcherepnin v. Knight, 389 U.S. 332, 338 (1967), investment contracts are properly viewed as only one of the "several types of instruments designated as securities" under the definitional sections of the securities laws. An examination of the legislative record accompanying the securities laws supports the court of appeals' conclusion that the stock at issue here falls within the statutory definition. Congress was concerned about protecting businessmen, and not only ordinary investors. United States v. Naftalin, 441 U.S. 768, 776 (1979) (quoting 77 Cong. Rec. 2935 (1933)). Although it does not appear to have considered the sale of business issue, "the fact that Congress was concerned primarily with large-scale fraud in the capital markets does not mean that it would disapprove of statutory protection against small-scale fraud as well." Daily v. Morgan, 701 F.2d 496, 502 (5th Cir. 1983). 2. The courts of appeals are nevertheless sharply divided over the sale of business doctrine, rejected by the Second Circuit here. /9/ Most decisions approving the doctrine have done so on the theory that in order to qualify as a "security," any instrument -- regardless of whether it falls within an enumerated term in the statutory definition -- must meet the test stated in Howey and Forman for investment contracts. /10/ Using this reasoning, some courts have expanded the doctrine beyond the 100% stock sale, and denied the antifraud protections of the securities laws to purchasers or sellers of a 50% or less stock interest in a corporation where the plaintiff was found to have a role in the management of the business. /11/ Indeed, it has even been suggested that such reasoning logically would extend to tender offer transactions that seek a majority or controlling interest. /12/ Exclusive reliance upon the investment contract test may also undercut the protections of the securities laws with respect to types of interest other than stock, particularly notes and other debt instruments. /13/ Such an erosion of the scheme established by Congress for the regulation of securities transactions is cause for concern. As the examples given above indicate, the issues presented here and in other areas on which this case bears directly are ones that have arisen with considerable frequency since this Court's decision in Forman. /14/ The interest sought to be vindicated by respondent -- contrary to what the Seventh, Ninth, Tenth, and Eleventh Circuits have held (see note 9, supra) -- comes within the fundamental congressional purpose of protecting purchasers and sellers of securities. "(T)he coverage of the antifraud provisions of the securities laws is not limited to instruments traded at securities exchanges and over-the-counter markets * * *." Marine Bank v. Weaver, 455 U.S. 551, 556 (1982). These provisions have "always been understood to apply to transactions in shares of close as well as publicly held corporations and to negotiated as well as market sales and purchases of shares." Golden v. Garafalo, 678 F.2d at 1146-1147. Indeed, by the very act of "choosing to deal in stock, the parties may have created an expectation, deserving of some consideration, that the securities laws would apply." Daily v. Morgan, 701 F.2d at 503. /15/ Neither should the application of the antifraud provisions depend on whether the purchaser buys a small interest, a controlling interest, or all of the stock of a corporation. "Such a standard would be difficult to apply and (would) create a capricious basis for dispensing the protection" of the securities laws. /16/ Moreover, application of the investment contract test to purchases of common stock could lead to uncertain and anomalous results. For example, some investors in a corporation might be deemed to have a cause of action under the antifraud provisions while other investors in the same transaction would not. /17/ Such uncertainty and caprice are likely to persist until this Court affords a final answer to the issue presented here. CONCLUSION The petition for a writ of certiorari should be granted. Respectfully submitted. REX E. LEE Solicitor General LOUIS F. CLAIBORNE Deputy Solicitor General JOHN H. GARVEY Assistant to the Solicitor General DANIEL L. GOELZER General Counsel PAUL GONSON Solicitor JACOB H. STILLMAN Associate General Counsel ROSALIND C. COHEN Assistant General Counsel ELIZABETH E. ASHCRAFT Attorney Securities and Exchange Commission APRIL 1984 /1/ Sections 12(2) and 17(a) of the Securities Act, 15 U.S.C. 77l(2) and 77q(a), Sections 10(b) and 18(a) of the Securities Exchange Act, 15 U.S.C. 78j(b) and 78r(a), and Rule 10b-5, 17 C.F.R. 240.10b-5. The complaint also alleged claims based on state common law fraud (C.A. App. 29-30). /2/ Under the terms of the sales agreement, petitioners warranted that they had delivered to respondent "true and complete copies" of their annual report on Form 10-K as filed with the Securities and Exchange Commission and that petitioners had no knowledge of any additional liabilities which would have been subject to Commission disclosure requirements (C.A. App. 11-14, 202-203). /3/ In W.J. Howey Co. the Court set out the criteria for determining when an instrument would be considered an "investment contract," another type of instrument which appears in the statutory definition of security. The Howey test requires (1) an investment in a common venture, (2) with a reasonable expectation of profits, (3) to be derived solely from the efforts of others. 328 U.S. at 301. /4/ The Securities and Exchange Commission filed amicus briefs in both Golden and this case, urging rejection of the sale of business doctrine. /5/ The court of appeals remanded the case to the district court for a determination of whether the instruments possessed the common characteristics of stock (Pet. App. 3a). On remand the district court, based upon facts stipulated by the parties, found that the instruments did possess the characteristics of conventional stock (Pet. App. 25a). /6/ Section 3(a)(10) of the Securities Exchange Act, 15 U.S.C. 78c(a)(10), provides: When used in this chapter, unless the context otherwise requires -- The term "security" means any note, stock, treasury stock, bond, debenture, certificate of interest or participation in any profit-sharing agreement, * * * investment contract, * * * or in general, any instrument commonly known as a "security." Section 2(1) of the Securities Act, 15 U.S.C. 77b(1), is virtually identical. /7/ The quoted language does not mean "that the Howey criteria apply to all securities, but was merely describing (the Court's) past decisions, all of which dealt with unusual instruments where the Howey test would be applicable." Daily v. Morgan, 701 F.2d 496, 499-500 (5th Cir. 1983). /8/ If Congress intended the statute to cover only investment contracts, "reference to (other) specific types of instruments, and common variations of them, would have been inappropriate because a substantial portion of each class of instrument would, in fact, not be within the definition." Golden v. Garafalo, 678 F.2d at 1144. /9/ Compare Golden v. Garafalo, 678 F.2d 1139 (2d Cir. 1982); Coffin v. Polishing Machines, Inc., 596 F.2d 1202 (4th Cir.), cert. denied, 444 U.S. 868 (1979); Daily v. Morgan, 701 F.2d 496 (5th Cir. 1983); Cole v. PPG Industries, Inc., 680 F.2d 549 (8th Cir. 1982) (relying on federal securities law to construe Arkansas Securities Act), and the decision of the court of appeals below, all rejecting the sale of business doctrine, with the following decisions upholding that doctrine: Frederiksen v. Poloway, 637 F.2d 1147 (7th Cir.), cert. denied, 451 U.S. 1017 (1981); Landreth Timber Co. v. Landreth, No. 81-3446 (9th Cir. Mar. 7, 1984); Chandler v. Kew, Inc., 691 F.2d 443 (105h Cir. 1977); King v. Winkler, 673 F.2d 342 (11th Cir. 1982). There is also disagreement among the commentators. Compare L. Loss, Fundamentals of Securities Regulation 211-212 (1983) (criticizing the sale of business doctrine), with Seldin, When Stock is Not a Security: The "Sale of Business" Doctrine Under the Federal Securities Laws, 37 Bus. Law. 637 (1982) (approving the sale of business doctrine). /10/ See, e.g., Frederiksen v. Poloway, 637 F.2d at 1152-1153; Chandelr v. Kew, Inc., 691 F.2d at 444; King v. Winkler, 673 F.2d at 344-345. /11/ Goodman v. DeAzoulay, 554 F. Supp. 1029, 1031-1035 (E.D. Pa. 1983) (one-third stock interest); Oakhill Cemetery of Hammond, Inc. v. Tri State Bank, 513 F. Supp. 885, 890 (N.D. Ill. 1981) (50% stock interest). /12/ Daily v. Morgan, 701 F.2d at 503. /13/ Some lower court decisions have concluded that notes paying a fixed interest do not meet the "profits" element of the investment contract test. See note 3, supra. See, e.g., Spinuzza v. Wenske, No. 82C 2221 (N.D. Ill. June 3, 1983), appeal pending, No. 83-2256 (7th Cir.); Hunssinger v. Rockford Business Credits, No. 82 C 3323 (N.D. Ill. May 25, 1983), appeal pending, No. 83-2169 (7th Cir.). /14/ A number of pre-Forman decisions, by contrast, had held that the definition of security extends to the transfer of a controlling interest in a corporation. See, e.g., Occidental Life Insurance Co. v. Pat Ryan & Associates, Inc., 496 F.2d 1255 (4th Cir.), cert. denied, 419 U.S. 1023 (1974); Matheson v. Armbrust, 284 F.2d 670 (9th Cir. 1960), cert. denied, 365 U.S. 870 (1961). /15/ The Daily court further noted (701 F.2d at 504): (T)here are special risks involved in the sale of stock in a corporation that might justify special protection. Generally speaking, one who purchases the assets of a business is not liable for its debts and liabilities, while one who purchases the stock in a corporation -- a separate legal entity -- assumes ownership of a business with both assets and liabilities. See, 11, 15 W. Fletcher, Cyclopedia of the Law of Private Corporations, Sections 5100, 7122 (1971, 1973); H. Henn, Law of Corporations, Section 341 n.30 (1970). Liabilities, alas, are often the subject of inaccurate or incomplete disclosures. /16/ Occidental Life Ins. Co. v. Pat Ryan & Associates, Inc., 496 F.2d at 1263. /17/ See Seldin, supra note 9, at 650 (advocating such a result). For example, under Seldin's approach, a purchaser of a controlling interest might be found not to have purchased a security on the theory that he had not expected profits to be generated through the efforts of others, while a buyer of a minority interest in the same transaction might be found to have purchased a security. Similarly, if the sellers of securities were each disposing of a small interest but the buyer was purchasing a controlling interest, the securities laws could be held applicable to sellers of stock but not to the buyer in the same transaction. See McGrath v. Zenith Radio Corp., 651 F.2d 458 (7th Cir.), cert. denied, 454 U.S. 835 (1981), in which the plaintiff, one of the sellers of the company's stock, was allowed to bring an action under the securities laws against the buyer. According to controlling precedent in that circuit the securities laws would not be available to the buyer, since it had purchased 100% of the company's stock. See 651 F.2d at 467-468 n.5.