2nd Circuit Limits Short-Swing Insider Trading Claims
In a case of first impression, the 2nd Circuit in Gibbons v. Malone, 703 F.3d 595 (2d Cir. N.Y. 2013) ruled that federal securities laws do not require executives to disgorge profits earned by buying and quickly selling shares of different types of stock in the same company. The so-called “short-swing profit rule” under Section 16(b) of the Securities and Exchange Act of 1934 provides for disgorgement of profits that corporate insiders gain from the purchase or sale of a company security in less than six months from the transaction. The 2nd Circuit held that this rule does not apply to transactions involving separately traded, nonconvertible stocks with different voting rights.
Gibbons involved a director and large shareholder in Discovery Communications, Inc., who over a two-week period made several purchases of “Series C” voting stock and several sales of “Series A” nonvoting stock, each of which was separately registered and traded on the stock exchange. Neither series was convertible to the other. A company shareholder sued under Section 16(b) seeking disgorgement of the director’s profits from the transactions. Applying the plain language of the statute, and noting that the SEC had not issued any guidance on the issue, the 2nd Circuit found that Section 16(b) does not apply to transactions involving stocks that are “meaningfully distinguishable.” Because the transactions at issue involved one stock with voting rights and another stock without voting rights, the Court found the stocks “readily distinguishable” and not subject to the short-swing profit rule in Section 16(b).
The Gibbons decision has a number of important ramifications. Most critically, the decision clarifies the scope of Section 16(b) liability by refusing to extend its reach to different types of stock in the same company that are “meaningfully distinguishable.” In this context, so long as an insider can demonstrate that the securities at issue have meaningfully distinct rights, Section 16(b) liability should not attach. Moreover, the 2nd Circuit signaled that, “absent SEC direction,” it would strictly adhere to the statutory text of the federal securities laws.