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Corporations • Federal Securities Laws
CORP#071
Legal Definition
Section 16(b) applies to a reporting company's officers, directors, and shareholders who own more than 10 percent of the corporation's outstanding shares (at all relevant times), and requires such individuals who profit from buying or selling the corporations stock within any 6 month period to disgorge such profits to the corporation. Profit is determined by matching the highest sales price against the lowest purchase price during the 6 month period.
Plain English Explanation
The government has an interest in protecting investors from the greedy shenanigans of those who have unfair access to insider information. Section 16(b) basically says, "If you are either (a) an officer, (b) a director, or (c) a shareholder who owns more than 10% of a corporation, then you likely have the ability to know things about a company's internal operations that outsiders do not. In fact, it is so likely that you have more access to more information that we will suspect shenanigans if you make any money within 6 months of any stock trade."
In other words, if a director/officer/shareholder who owns > 10% of a company buys 1 share of HypoCorp today for $1, they are effectively prohibited from selling the stock for 6 months if the value of the stock increases beyond $1. If they fail to abide by this rule and sell before 6 months, then any profit from the sale must be given back to the company. The logic here is that 6 months is a decent window of time to handicap any advantage the insider may have had from their advantage/knowledge and helps to even the playing field among all investors.
But note that the 6 month window need not start with a low price purchase and end with a high price sale. The rule will always look to match trades within a window, even if it seems a bit backwards. For example, if a director/officer/shareholder who owns > 10% of a company sells 1 share of HypoCorp today for $1, they are effectively prohibited from buying shares of HypoCorp for less than $1 for the next 6 months. If they do, the rule will apply and they will have to pay back the company. This may seem a bit confusing, but think of it this way: stocks fluctuate in price all the time, and someone with inside information is more likely to know when a stock is going to peak in price (a good time to sell) as well as know when it is a good time to buy the stock when it is underpriced (sometimes known as "buying the dip").
The key to working out these types of problems is to create a timeline of the trades, and if you can find any sale of stock that is priced higher than any purchase of stock within 6 months of each other, this rule is triggered and you should do the math to see how much money needs to be paid back to the corporation.
In other words, if a director/officer/shareholder who owns > 10% of a company buys 1 share of HypoCorp today for $1, they are effectively prohibited from selling the stock for 6 months if the value of the stock increases beyond $1. If they fail to abide by this rule and sell before 6 months, then any profit from the sale must be given back to the company. The logic here is that 6 months is a decent window of time to handicap any advantage the insider may have had from their advantage/knowledge and helps to even the playing field among all investors.
But note that the 6 month window need not start with a low price purchase and end with a high price sale. The rule will always look to match trades within a window, even if it seems a bit backwards. For example, if a director/officer/shareholder who owns > 10% of a company sells 1 share of HypoCorp today for $1, they are effectively prohibited from buying shares of HypoCorp for less than $1 for the next 6 months. If they do, the rule will apply and they will have to pay back the company. This may seem a bit confusing, but think of it this way: stocks fluctuate in price all the time, and someone with inside information is more likely to know when a stock is going to peak in price (a good time to sell) as well as know when it is a good time to buy the stock when it is underpriced (sometimes known as "buying the dip").
The key to working out these types of problems is to create a timeline of the trades, and if you can find any sale of stock that is priced higher than any purchase of stock within 6 months of each other, this rule is triggered and you should do the math to see how much money needs to be paid back to the corporation.
