What is the Short-Swing Profit Rule
The short-swing profit rule is a Securities & Exchange Commission 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 holder of more than 10% of the company's shares.
BREAKING DOWN Short-Swing Profit Rule
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, he or she 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.
The rule comes from Section 16(b) of the Securities Exchange Act of 1934.
How the Short-Swing Profit Rule Affects Trading Activity
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 rise and fall.
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 of the market alongside other investors.
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 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.