What Is the Short-Swing Profit Rule?
The short-swing profit rule is a Securities and Exchange Commission (SEC) regulation that requires company insiders to return any profits made from the purchase and sale of company stock if both transactions occur within a six-month period.
A company insider, as determined by the rule, is any officer, director, or shareholder who owns more than 10% of the company's shares.
Key Takeaways
- The short-swing profit rule, also known as the Section 16b rule, is an SEC regulation that prevents insiders in a publicly traded company from reaping short-term profits.
- The short-swing profit rule requires company insiders to return to the company any profits made from the purchase and sale of company stock if both transactions occur within a six-month period.
- The rule applies to any shareholder who owns more than 10% of a class of the company's equity securities registered under the Securities Exchange Act, and to the company's officers and directors.
Understanding the Short-Swing Profit Rule
The short-swing profit rule comes from Section 16(b) of the Securities Exchange Act of 1934. The rule was implemented to prevent insiders, who have greater access to material company information, from taking advantage of information for the purpose of making short-term profits.
For example, if an officer buys 100 shares at $5 in January and sells these same shares in February for $6, they would have made a profit of $100. Because the shares were bought and sold within a six-month period, the officer would have to return the $100 to the company under the short-swing profit rule.
Section 16 of the Securities Exchange Act also prohibits company insiders from short selling any class of a company's securities.
Criticism of the Short-Swing Profit Rule
There are some contentions regarding this rule. Some believe it alters the nature of shared risk between company insiders and other shareholders. In short, because this rule bars insiders from engaging in a type of trading activity that other investors may participate in, they are not prone to the same risks as other shareholders who engage in transactions as the value of securities rises and falls.
For example, if a non-insider investor places buy and sell orders in quick succession, they face the usual risks associated with the market. An insider, on the other hand, is compelled to stagger their investment decisions in regards to the company they have access to information on. While this can prevent them from taking advantage of that information, it also can prevent them from the immediate risks ofthe market alongside other investors.
Special Considerations
Exceptions to the short-swing profit rule have been cited in court. In 2013, the U.S. Second Court of Appeals ruled in the case of Gibbons v. Malone that this regulation did not apply to the purchase and sale of shares within a company by an insider as long as the securities were of a different series. Specifically, this referred to securities that were separately traded, nonconvertible stocks. These different securities would also have different voting rights associated with them.
In the Gibbons v. Malone case, a director for Discovery Communications within the same month sold series C shares and then bought series A stock with the company. A shareholder took issue with the transaction, but the courts ruled that, along with other reasons, the shares were separately registered and traded, making the transactions exempt from the short-swing profit rule.
FAQs
The short-swing profit rule is a Securities and Exchange Commission (SEC) regulation that requires company insiders to return any profits made from the purchase and sale of company stock if both transactions occur within a six-month period.
What are the exceptions to the short-swing profit rule? ›
Other transactions that are exempt from short-swing profit recovery are bona fide gifts or transfers pursuant to a will or the laws of descent and distribution, and certain transactions in a merger, reclassification or consolidation. These transactions remain reportable on the Form 5.
What is short-swing profit? ›
Short-swing profits occur when a company insider buys and sells stock within a six-month period.
What requires that any profits made by a statutory insider on transactions involving short-swing profits belong to the corporation? ›
Section 16(b) of the Securities Exchange Act of 1934 requires that any profits made by a statutory insider on transactions involving short-swing profits (trades involving equity securities occurring within six months of each other) belong to the corporation.
What is disgorgement of short-swing profits? ›
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.
What is exempt from Section 16 B? ›
Both the acquisition and the disposition of equity securities shall be exempt from the operation of section 16(b) of the Act if they are: (a) Bona fide gifts; or (b) transfers of securities by will or the laws of descent and distribution.
What are the exceptions to insider trading? ›
Some of these exceptions are as follows: Applying for or acquiring securities, managed investment products or foreign passport fund products under an underwriting agreement or a sub‑underwriting agreement.
What is a short term swing strategy? ›
It involves capturing short-to-medium-term gains in financial instruments over a few days to several weeks, primarily using technical analysis. As a swing trader, the strategy's beauty lies in its flexibility, allowing you to capitalize on both upward and downward price swings.
What is the 1% rule in swing trading? ›
The 1% rule is a key risk management strategy for swing traders, where a trader aims to limit each loss to 1% of their portfolio's value. traders have enough capital to keep trading and avoid significant losses that could wipe out their account.
What is Section 16 of the Exchange Act? ›
Section 16 imposes filing standards for "insiders," and defines insiders as any officers, directors, or stockholders who possess stock that directly or indirectly results in beneficial ownership of more than 10% of the company's common stock or other class of equity.
The short-swing profit rule is a Securities and Exchange Commission (SEC) regulation that requires company insiders to return any profits made from the purchase and sale of company stock if both transactions occur within a six-month period.
What is the insider swing trade rule? ›
The short-swing profit rule is a federal statute that requires insiders to forfeit any trading profit earned from a combined purchase and sale that occurs within a six-month period.
When a person is convicted of insider trading the amount of any profit achieved or loss avoided must be paid? ›
Anyone found liable for trading on inside information must pay the federal government an amount equal to any profit made or loss avoided. Under Section 21A of the Securities Exchange Act of 1934, he or she may also face a penalty of up to three times that amount.
What is an example of a short-swing profit? ›
Similarly, if an executive sells 500 shares of company stock in May and then buys them back in August for a profit, they would also be required to return that profit to the company. These examples illustrate how short-swing profits work.
What is the 6 month rule for stocks? ›
Section 16(b) mandates that any profits garnered by company insiders from any non-exempt matching two-way transactions of company shares within a six-month period must be returned to the company.
What is a disgorge profit? ›
Disgorgement is a remedy requiring a party who profits from illegal or wrongful acts to give up any profits they made as a result of that illegal or wrongful conduct. The purpose of this remedy is to prevent unjust enrichment and make illegal conduct unprofitable.
What are short term swing rules? ›
The short-swing profit rule comes from Section 16(b) of the Securities Exchange Act of 1934. The rule was implemented to prevent insiders, who have greater access to material company information, from taking advantage of information for the purpose of making short-term profits.
What are the limitations of swing trading? ›
Disadvantages of Swing Trading Strategies
Limited flexibility to exit trades due to trading hours and overnight market changes is a significant drawback. Missing Long Term Opportunities: Swing trading, focused on short term price swings, may lead to missing out on lucrative long term investment opportunities.
What is the short sale stock rule? ›
Under the short-sale rule, shorts could only be placed at a price above the most recent trade, i.e., an uptick in the share's price. With only limited exceptions, the rule forbade trading shorts on a downtick in share price. The rule was also known as the uptick rule, "plus tick rule," and tick-test rule."
