What Is the Short-Swing Profit Rule?
The short-swing profit rule is a Securities and Exchange Commission (SEC) 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 shareholder who owns more than 10% of the company's shares.
Key Takeaways
- The short-swing profit rule, also known as the Section 16b rule, is an SEC regulation that prevents insiders in a publicly traded company from reaping short-term profits.
- The short-swing profit rule requires company insiders to return to the company any profits made from the purchase and sale of company stock if both transactions occur within a six-month period.
- The rule applies to any shareholder who owns more than 10% of a class of the company's equity securities registered under the Securities Exchange Act, and to the company's officers and directors.
Understanding the Short-Swing Profit Rule
The short-swing profit rule comes from Section 16(b) of the Securities Exchange Act of 1934. 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, they 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.
Section 16 of the Securities Exchange Act also prohibits company insiders from short selling any class of a company's securities.
Criticism of the Short-Swing Profit Rule
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 rises and falls.
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 ofthe market alongside other investors.
Special Considerations
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 a 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.
FAQs
Other transactions that are exempt from short-swing profit recovery are bona fide gifts or transfers pursuant to a will or the laws of descent and distribution, and certain transactions in a merger, reclassification or consolidation. These transactions remain reportable on the Form 5.
What is the concept of short-swing profit? ›
The short-swing profit rule is a Securities and Exchange Commission (SEC) 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.
Which of the following best defines short-swing profits? ›
Short-swing profits refer to the profits made by a corporate insider when they buy and sell or sell and buy company stock within a period of six months. These profits are subject to being returned to the company.
What is the short-swing trading policy? ›
The short-swing profit rule is a federal statute that requires insiders to forfeit any trading profit earned from a combined purchase and sale that occurs within a six-month period.
What is the short exempt rule? ›
"Short exempt" refers to a short sale order exempted from the uptick rule regulated under the Securities and Exchange Commission's (SEC) Regulation SHO. What Is a Tick in Securities Trading and How Does It Work? A tick is a measure of the minimum upward or downward movement in the price of a security.
Why is short sell exempt? ›
A trade may be labeled "short exempt" and executed at a price lower than the national best price if one of the following applies: The seller owns the shares being shorted but is restricted from delivering them at the time that the short-sale order is placed.
What is short-swing profit disgorgement? ›
The so-called “short-swing profit rule” under Section 16(b) of the Securities and Exchange Act of 1934 provides for disgorgement of profits that corporate insiders gain from the purchase or sale of a company security in less than six months from the transaction.
What is the difference between swing trading and short term investing? ›
The primary difference in the trading strategies is that day traders trade many stocks during a day, while swing traders trade many stocks over a longer time frame, typically two days to a few weeks.
What is the profit target for swing trading? ›
Bottom Line. The Swing Trading strategy can lead to profits in the short term, usually in the range of 10% to 30%. However, as most things investing usually are, it is a risky bet. About 90% of traders report losses during trading.
What are the exemptions for Section 16 B? ›
Both the acquisition and the disposition of equity securities shall be exempt from the operation of section 16(b) of the Act if they are: (a) Bona fide gifts; or (b) transfers of securities by will or the laws of descent and distribution.
(B)The term “10-percent shareholder” means— (i)in the case of an obligation issued by a corporation, any person who owns 10 percent or more of the total combined voting power of all classes of stock of such corporation entitled to vote, or (ii)in the case of an obligation issued by a partnership, any person who owns 10 ...
What is 5% ownership of a company? ›
Owning 5% of a company means that you own 5% of the total outstanding shares of the company. This gives you a 5% ownership stake in the company and entitles you to a portion of the company's profits and assets proportional to your ownership percentage.
What is the 1% rule in swing trading? ›
The 1% rule is a key risk management strategy for swing traders, where a trader aims to limit each loss to 1% of their portfolio's value. traders have enough capital to keep trading and avoid significant losses that could wipe out their account.
Why is swing trading risky? ›
Swing trading involves taking trades that last a couple of days up to several months in order to profit from an anticipated price move. Swing trading exposes a trader to overnight and weekend risk, where the price could gap and open the following session at a substantially different price.
Is swing trading good or bad? ›
Is Swing Trading Risky? Swing trading is less risky than other forms of short-term trading. By relying on technical analysis and holding positions for a short period of time, there is a lower risk that you get stuck holding an unliquidated position.
Does a short sale allow investors to profit from a decline in a security's price? ›
Short selling occurs when an investor borrows a security and sells it on the open market, planning to repurchase later for less money. Short sellers bet on and profit from, a drop in a security's price.
What is the short sales rule? ›
3 Rule 3b-3 under the Exchange Act, 17 CFR 240.3b-3, defines a short sale as "any sale of a security which the seller does not own or any sale which is consummated by the delivery of a security borrowed by, or for the account of, the seller." Pursuant to Rule 3b-3, a seller of an equity security subject to Rule 10a-1 ...
What is the minimum target for swing trading? ›
Rather than targeting 20% to 25% profits for most of your stocks, the profit goal is a more modest 10%, or even just 5% in tougher markets. Those types of gains might not seem to be the life-changing rewards typically sought in the stock market, but this is where the time factor comes in.
What should be profit in swing trading? ›
The Swing Trading strategy can lead to profits in the short term, usually in the range of 10% to 30%. However, as most things investing usually are, it is a risky bet. About 90% of traders report losses during trading.
