SECTION 16(b) EXISTENTIALISM: A JOURNEY TOWARDS THE FULFILLMENT OF 16(b)'s TRUE PURPOSE

By Strauss, Avi | Fordham Journal of Corporate & Financial Law, July 1, 2013 | Go to article overview

SECTION 16(b) EXISTENTIALISM: A JOURNEY TOWARDS THE FULFILLMENT OF 16(b)'s TRUE PURPOSE


Strauss, Avi, Fordham Journal of Corporate & Financial Law


ABSTRACT

Section 16(b) of the Securities Exchange Act of 1934 compels an insider to disgorge short-swing profits earned from a paired purchase and sale of the issuer's securities executed within six months. On one hand, Section 16(b)'s introductory purpose clause seems to limit the statute's application to instances where there might be a risk of speculative abuse. On the other hand, Section 16(b) imposes a strict liability-like standard that triggers disgorgement once the statute's objectively applied criteria are met. The circuit courts, in interpreting Kern County Land Co. v. Occidental Petroleum Corp., the seminal Supreme Court decision on the matter, are divided over whether to adopt an objective or subjective approach and, as such, how and when to apply the Supreme Court's unorthodox transaction exemption from 16(b) liability. This Note analyzes the split and offers a critique of the Second Circuit's pragmatic interpretation of Kern County's ruling.

INTRODUCTION

Under Section 16(b) of the Securities Exchange Act of 1934 ("Exchange Act"),1 short-swing profits earned by a corporate insider from the paired sale and purchase, or purchase and sale, of the issuer's security within a six month period may be disgorged and recovered by the issuer.2 Section 16(b), passed at the dawn of the New Deal era as a restriction on insider trading, has never been a provision that provided fertile grounds for litigation since its impact always lay more in its deterrent, or prophylactic, effect than in its prosecutorial ambitions.3 Operating very much under the radar, and under the shadows of Section 10(b) and Rule lOb-5's own insider trading restriction,4 Section 16(b) has endured the test of time all the same.5

Still, in recent years, its efficacy has been challenged, or at least, complicated by a constantly evolving class of "'unorthodox' transactions"6 and an increasingly complex array of financial instruments, which have threatened to elude classification as Section 16(b) purchases and sales.7 In the face of these challenges, Section 16(b)'s introductory purpose clause, which self-identifies the statute's underlying rationale, has proven to be both a stabilizing force that has guided courts' application of Section 16(b) and a destabilizing force that has compelled courts to engage in the type of ad hoc, case-specific analysis that defies simple administration of the law.8 The same adaptations that have ensured Section 16(b)' s durability have accelerated its demise as a prophylactic measure.9

This Note focuses primarily on the types of transactions that are subject to Section 16(b) disgorgement and, in particular, how the purpose clause dictates the choices that courts and the Securities and Exchange Commission ("SEC") have made regarding the Section 16(b) eligibility of unorthodox transactions and derivative securities. Since the terms "purchase" and "sale" are meant to be construed in a way that advances the statutory purpose, courts typically subject a transaction to the restrictions of Section 16(b) only if treating the transaction as a "purchase" or "sale" is supportable under the statute and if the transaction could give rise to speculative abuse.10

Part I of this Note first presents an overview of Section 16(b) of the Exchange Act, including its statutory elements and basic judicial overlay. This Part then examines the statute's preamble, or introductory clause, which explicitly identifies the statute's goal. After considering the standard, Supreme Court-approved understanding of the statutory purpose, this Part presents two scholars' innovative readings of Section 16(b)'s purpose. Challenging the presumption that Section 16(b) was exclusively designed to protect investors from insider trading, these scholars attribute more nuanced and particular motivations to the lawmakers who drafted the Exchange Act.

Part II assesses the early judicial shift, popularized by the Supreme Court's decision in Kern County Land Co.

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