Schaffer v. CC INVESTMENTS, LDC, 153 F. Supp. 2d 484 - Dist. Court, SD New York 2001

III. PREFERRED STOCK

Defendants also contend that nonvoting convertible preferred stock is exempt from the term "equity securities" as defined under § 13(d) of the Act. They argue that a § 13(d) group is formed only when there is an agreement with respect to voting securities and that even if Defendants acted together with regard to nonvoting convertible preferred stock, as Schaffer alleges, Defendants would not constitute a § 13(d) group for purposes of § 16(b) liability. This Court is not persuaded, as Defendants suggest, that it is necessary to compartmentalize classes of securities or to hold non-voting securities as per se exempt from the term "equity securities" under § 13(d).

In Morales v. New Valley Corp., 936 F.Supp. 119 (S.D.N.Y.1996), aff'd, Morales v. Freund, 163 F.3d 763 (2d Cir.1999), the plaintiff, like Schaffer, brought an action pursuant to § 16(b) of the Act, seeking disgorgement of short-swing profits earned in transactions involving Class B cumulative convertible preferred stock of New Valley Corporation. The defendants moved to dismiss the complaint arguing, like Defendants here, that the convertible shares did not constitute a "class" of security for purposes of § 16(b) and that they were not liable under that section as "beneficial owners of any class of security." See id. at 122. The defendants claimed that overall voting control is what subjects 487*487 an owner of securities to liability under § 16(b). See id. at 123.

Judge Haight of this Court disagreed with the defendants and held that a class of convertible preferred stock constituted a separate "class" of securities for purposes of § 16(b) of the Act imposing liability for short swing profits, and therefore denied defendants' motion. The district court also noted the following section from an SEC release, which suggested that the preferred stock at issue did not preclude the defendants from being beneficial owners of common stock of the Company:

In contrast to a convertible debt, a security that is an equity security in its own right, as well as on account of a conversion feature, would require a double calculation. For example, if a class of voting preferred stock registered under Section 12 is convertible into Section 12 common stock, the beneficial owner of the preferred stock is deemed the owner of both the preferred stock and the underlying common stock...If the convertible preferred stock is non-voting, the preferred stock is not a separate class of equity securities for the purposes of the ten-percent holder calculation, because Rule 13d.3(d)(1) excludes non-voting securities; therefore, the beneficial owner of the non-voting preferred stock, like a holder of convertible debt, performs the ten percent holder calculation only with respect to the underlying stock.

Id. at 124 (citing Ownership Reports and Trading by Officers, Directors and Principal Security Holders Exchange Act Release No. 28, 869, 48 SEC Dock. 216, 220 n. 6, Fed.Sec.L.Rep. (CCH) ¶ 84, 709 (Feb. 8, 1991)) (emphasis added).

Based on the foregoing document, the Morales court concluded that calculation of how much stock the defendants beneficially owned would be determined by the amount of common stock that such nonvoting preferred stock would yield upon conversion. Therefore, it appeared unlikely that the SEC meant to exclude nonvoting securities indefinitely from term "equity securities" under § 13(d). Rather, the underlying common stock which is yielded from non-voting securities is the only stock which is calculated for purposes of § 16(b) liability, whereas, there is a double count for convertible voting preferred stock. See id.

On appeal, the Second Circuit affirmed the district court's ruling. See Freund, 163 F.3d at 765-66. The Circuit Court additionally noted:

The existence of a group under § 13(d) and § 16(b) is not confined to the particular security that makes it a group; it extends to all securities issued by the issuer of that security. Veritovtrade and the Holders made an agreement regarding the Acquisition of New Valley common stock; they are therefore a group with regard to all of New Valley's equity securities, including the B preferred.

Id. at 766.

Applying the Second Circuit's ruling in Morales, this Court holds that the stocks in question here are not per se exempt from § 13(d). Espousing Defendants' suggestion would be inconsistent with the purpose of § 13(d). That objective is to "alert the marketplace to every large, rapid aggregation or accumulation of securities, regardless of technique employed, which might represent a potential shift in corporate control." See Quintel, 249 F.3d at 122 (citing GAF Corp. v. Milstein, 453 F.2d 709, 717 (2d Cir.1971)); accord SEC v. Savoy Indus., Inc., 587 F.2d 1149, 1167 (D.C.Cir.1978). The group activity Schaffer alleges, the acquiring and dispensing of a considerable quantity of preferred stock, would present a potential 488*488 shift in corporate control, which reflects a paramount concern of § 13(d).