Section 16(B)—If at First You Don’t Succeed…

Phillip Goldstein is the co-founder of Bulldog Investors.

If an officer, a director or a large (10% or more) shareholder of a public corporation realizes a profit from buying and selling stock within a six-month period, Section 16(b) of the Securities Exchange Act of 1934 (the “Act”) authorizes the corporation to recover from such statutory insider any so-called “short swing” profits. If the corporation fails to act, Section 16(b) authorizes any of its security holders to sue the statutory insider on its behalf to recover the profits from those trades. (In practice, anyone can qualify to sue the statutory by purchasing a single share of stock after the short swing trading has occurred.) And, because Section 16(b) is a strict liability statute, there is no need to allege the existence, let alone misuse, of inside information at the time of any trade and no equitable defenses are permitted. In their treatise on securities regulation, [1] Professors Jennings and Marsh concluded: “Judging solely from the facts stated in the opinions in the decided cases, the function of Section 16(b) would appear to be to impose unjust liability upon entirely innocent persons.”

Eight years ago, in a posting on this website [2] I argued that Section 16(b) of the Act could not withstand constitutional scrutiny because the issuer suffered no injury in fact from short swing trading. A few years later, our investment management firm was sued by a shareholder of a corporation for “violating” Section 16(b). We argued that the corporation did not suffer a concrete injury and thus lacked Article III standing. The District Court circularly reasoned that Section 16(b) grants a corporation the right to confiscate our short swing profits and therefore it suffers an injury in fact by our refusal to hand them over. The Second Circuit Court of Appeals affirmed on other, but equally specious, grounds, holding that our short swing profits impaired the corporation’s “reputation of integrity [and] continued public acceptance and marketability of its stock.” [3] It did not provide any supporting facts or attempt to reconcile that assertion with the contrary observation of an earlier Second Circuit panel that “any 16(b) award to the corporation is essentially a windfall, since the corporation has suffered no harm for which it is being recompensed.” [4] We then filed a cert petition which was denied. However, in 2016, the Supreme Court issued a seminal opinion in which it held that the mere violation of a statute is insufficient to establish Article III standing and that a plaintiff must allege (and prove) a concrete and individualized injury that is not merely speculative [5] so our standing argument could be reasserted in another Section 16(b) case.

Nevertheless, based upon our experience in the Second Circuit, we think that courts are unlikely to be receptive to constitutional arguments against Section 16(b). They may be less inclined to brush aside a statutory argument like the one summarized below. The complete argument is contained in a letter we recently submitted to the Acting General Counsel of the SEC seeking interpretive guidance.

While Section 16(b) authorizes an issuer or any shareholder of the issuer to sue to recover a statutory insider’s short swing profits, Section 28(a) of the Act limits the amount recoverable in any lawsuit for damages brought under the Act to “a total amount [not] in excess of the actual damages to that person on account of the act complained of.” Thus, there is tension between those two sections that, to our knowledge, no court has addressed. Curiously, Romeo and Dye’s treatise on Section 16 devotes a mere two paragraphs to Section 28(a), stating that “[i]n theory…an award of punitive damages under Section 16(b) is precluded by Section 28(a),” but concluding, without citation or discussion, that, despite “this inconsistency, the courts have never considered [Section 28(a)] a barrier to [awarding ‘quasi-punitive’ damages to a plaintiff].” [6] That conclusion seems unwarranted because, as far as we know, the question of whether Section 28(a) trumps Section 16(b) has never been squarely presented to a court.

The only cases in which courts have addressed the meaning of the term “actual damages” in Section 28(a) seem to have involved a violation of Rule 10b-5. In those cases, courts have applied the plain meaning assigned by the Supreme Court, i.e.,

“Compensatory damages and actual damages mean the same thing; that is, that the damages shall be the result of the injury alleged and proved, and that the amount awarded shall be precisely commensurate with the injury suffered….” [7]

Moreover, a number of courts have construed Section 28(a) to bar recovery of punitive damages. In particular, the U.S. Supreme Court noted that “§28(a) … is deemed to bar punitive damages.” [8] And, since a statutory insider that realizes short swing profits without misusing any inside information has not violated any law, committed any wrongdoing, or harmed anyone, the disgorgement mandated by Section 16(b) is clearly punitive. The Seventh Circuit Court of Appeals stated the obvious:

The prime purpose of [Section 16(b) of] the Act is punitive, to discourage dealings of this type by persons having inside information as to the affairs of the corporation. Clearly the purpose is not compensatory. Damage to the remaining stock is not a prerequisite to recovery. [9]

I have no idea why Section 28(a)’s prohibition on windfall monetary awards has never been raised in a Section 16(b) case. Whether or not the short swing profits recoverable under Section 16(b) are classified as punitive damages, it seems indisputable that they are a windfall for a corporation and not its actual damages. Could a Section 28(a) defense alleviate what the Supreme Court has called “the harsh result of imposing §16(b)’s liability without fault?” [10] All fair-minded persons should certainly hope so.


1Richard W. Jennings & Harold Marsh, Jr., Securities Regulation 1402 (David L. Shapiro et al. eds., 6th ed. 1987)(go back)

2Driving a Constitutional Stake through Section 16(b), March 2, 2009.(go back)

3Donoghue v. Bulldog Investors Gen. P’ship, 696 F.3d 170 (2d Cir.2012), cert. denied, ___ U.S., 133 S.Ct. 2388, 185 L.Ed.2d 1104 (2013)(go back)

4Blau v. Rayette-Faberge, Inc., 389 F.2d 469 (2d Cir. 1968)(go back)

5Spokeo, Inc. v. Robins, 136 S. Ct. 1540 (2016)(go back)

6Peter Romeo and Alan Dye, Section 16 Treatise and Reporting Guide (1994).(go back)

7Birdsall v. Coolidge, 93 U.S. 64, 64, 23 L.Ed. 802 (1876).(go back)

8Randall v. Loftsgaarden, 478 U.S. 647, 661 (1986) (emphasis in original.)(go back)

9Commissioner of Int. Rev. v. Obear-Nester Glass Co., 217 F.2d 56 (1954).(go back)

10Foremost-McKesson, Inc. v. Provident Securities Co., 423 U.S. 232 (1976).(go back)

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One Comment

  1. John A Olagues
    Posted Tuesday, May 2, 2017 at 12:30 pm | Permalink


    Some thoughts on the Prosecution of Section 16 (b).

    Many of the 16 b) suits deal with officers and directors trading with the company, where both the the insider and the issuer have the same inside information but only the insider can use the inside information. This situation arises for example when the issuer is required to accept the discretionary decision of the insider.

    In this situation, a 16 (b) suit can be filed to recover the profits, where the issuer was damaged by the officer or director.

    The SEC staff also believes that when the issuer has discretion whether to accept a disposition of shares from the insider for taxes or exercise, there is no exemption from 16 b) since the required specifics for the transaction to achieve an approval under Rule 16 b-3(e) is not achieve.

    Also that lack of specificity applies to the discretion when the insiders deliver shares or cash for exercise price or tax withholding.