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Foremost-McKesson, Inc. v. Provident Securities Co. | 423 U.S. 232 (1976)
Section Sixteen (b) of the Securities Exchange Act of 1934 reflects Congress’s desire to curb insider trading. Anyone with sizable holdings in a corporation’s stock is presumed to have inside information and must hand over profits made on short-swing transactions of the stock. In Foremost-McKesson, Incorporated versus Provident Securities Company, a short-swing transaction was made, but the company didn’t have sizable holdings of the stock beforehand. Should the insider trading provision still apply?
Provident Securities planned to liquidate its assets, and Foremost-McKesson emerged as a purchaser. Provident wanted cash, but Foremost wanted to pay with its own securities. They worked out a compromise. Foremost would purchase Provident’s assets using a mix of cash and debentures, debt instruments that were immediately convertible to Foremost stock. Prior to closing, Provident didn’t own a substantial share of Foremost stock. But after delivery of the debentures, Provident owned more than 10 percent of Foremost’s common stock. Four days later, Provident sold the debentures, distributed the proceeds from the sale to its stockholders, and dissolved.
Provident sued Foremost, seeking a declaratory judgment that it wasn’t subject to Section Sixteen (b) of the Securities Exchange Act. The provision is designed to prevent unfair use of insider information by corporate directors, officers, and beneficial owners holding more than 10 percent of a corporation’s stock. If a director, officer, or beneficial owner realizes profits on short-swing securities transactions, the corporation may recapture the profits. Rather than require individualized proof, the provision creates a presumption that if a person in these classes profited from a short-swing transaction, that person misused insider information.
The provision covers both purchase-and-sale sequences and sale-and-repurchase sequences occurring within a six-month time frame. There’s also an exemption. A beneficial owner isn’t liable unless he exceeded 10 percent ownership, quote, “at the time of the purchase and the sale,” unquote, of the stock.
The district court granted summary judgment to Provident. The Ninth Circuit affirmed, reasoning that liability doesn’t attach unless the investor holds 10 percent of the corporation’s stock before beginning a purchase-and-sale sequence. The Supreme Court granted cert.
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