Short-Swing Profits

Section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C.S. § 78p(b), limits the ability of corporate insiders and principal stockholders to profit from their access to nonpublic information about their company. Under Section 16(b), profits from two trades of a company's publicly traded securities within six months by a director, officer, or beneficial owner of more than ten percent of a security of the company are owed to and may be recovered by the company. If the company does not retrieve those profits, shareholders may file a derivative action to obtain a court order to have the profits given over to the company.

Section 16(a) of the Act requires periodic reports by officers, directors, and principal shareholders of companies with publicly traded companies detailing the status of their ownership of company securities. Changes in ownership thus can be tracked, and such changes occurring within a six-month period may be reviewed for possible application of Section 16(b).

Short-swing profits include "any profit realized" during a six-month period from a purchase and sale or sale and purchase of stock. If there are multiple stock transactions over a period of time longer than six months, any purchase will be paired with any sale occurring within a six-month time frame even if stock certificates for those paired purchases and sales do not match. This principle has been adopted by the courts to limit the ability of insiders and principal stockholders to avoid the restrictions of Section 16(b).

Recoverable profits are maximized when there are multiple stock purchases and sales by first pairing the lowest purchase price with the highest sale price and then progressing through available pairings with descending amounts of profit. The objective of this lowest in, highest out rule is to force disgorgement of the greatest possible amount of short-swing profits. However, if one of the paired transactions involves exercise of an option, Securities and Exchange Commission Rule 16b-6, 17 C.F.R. § 240.16b-6, exempts that part of any calculated profit that may be attributed to a long-term holding of the option.

A court in its discretion may order payment of prejudgment interest on short-swing profits. In deciding whether to award such prejudgment interest, the court may consider whether the short-swing trading was done with the intent to profit from inside information. If there is no showing of bad faith or unfair conduct by the insider, the court may decide to limit the assessment of prejudgment interest.

Copyright 2012 LexisNexis, a division of Reed Elsevier Inc.