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What is liability under “Section 16” of the 1934 Act?
Section 16 of the ’34 Act governs the sale or transfer of securities by “insiders” of the corporation. An insider is an officer, director, or large shareholder (holding 10% or more of outstanding securities). Insiders must generally register with the SEC an indicate their ownership interest at the time of filing the registration statement or within 2 days of becoming an insider (i.e., acquiring a large ownership of shares). Section 16 prohibits insiders from making “short-swing” profits by trading their shares within 6 months of the registration or acquiring the shares. There is an assumption that insiders have material, non-public information during this period. As such, any trades during this period are per se illegal. Any profits derived from the sale are forfeited to the corporation.
- Note: The SEC does not enforce the short-swing profit rule; rather, this rule is enforced through civil action by the company or shareholders.
- Discussion: Why do you think the securities laws absolutely prohibit insiders from earning short-swing profits from trading the business securities? Do you think that allowing for private civil actions for such profits is an effective manner of policing this practice? Why or why not?
- Practice Question: McKenzie is the Chief Operating Officer of ABC Corp. She recently acquired a large block of stock as part of her executive compensation. There is a rumor in the market that 123 Corp is interested in partnering with ABC Corp for an international joint venture. The speculation has pushed up the stock price. McKenzie is considering selling most of the stock she recently acquired, which will yield a handsome profit for her. Does she face potential civil liability for this action?