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Addressing Issue Of First Impression, Southern District Of New York Dismisses Action Seeking To Impose Short-Swing Liability Against Broker-Dealer For Packaged Securities Trades
03/25/2025On March 14, 2025, Judge John P. Cronan of the United States District Court for the Southern District of New York granted summary judgment in favor of defendants in an action brought under Section 16(b) of the Securities Exchange Act against a broker-dealer and its CEO. Clarus Corp. v. HAP Trading, LLC, —F. Supp. 3d—, 2025 WL 833453 (S.D.N.Y. 2025). Plaintiff Clarus Corporation (“Clarus”) alleged that defendants’ so-called “packaged trades” for Clarus securities generated insider short‑swing profits in violation of Section 16(b) of the Exchange Act. Addressing a question of first impression, the Court held that the transactions at issue fell within the exception in Section 16(d) for purchases and sales of securities incident to a dealer’s involvement in over-the-counter (“OTC”) market making.
The allegations concerned that aspect of defendants’ market-making business in which the broker-dealer entered into packaged trades with brokers, with each such trade including interrelated component transactions in multiple individual securities, referred to as “legs”—e.g., a buy or sell trade in calls, puts, and/or common stock. Id. at *5. While the individual legs used national exchanges for certain processes (including order submission, execution, clearing, and confirmation), the packaged trades themselves were not traded on any exchange. Id. Defendants also traded in plaintiff’s stock directly but maintained that they did so to hedge their exposure created by their market-making packaged trades.
The parties agreed that, during a particular two-month period, the broker-dealer beneficially owned more than ten percent of plaintiff’s common stock, making it a statutory insider, and thus requiring it to disgorge any short-swing profits under Section 16(b), unless its trades were subject to a statutory exception. The statutory exception at issue here was Section 16(d), which in pertinent part excepts from short-swing liability transactions “by a dealer in the ordinary course of his business and incident to the establishment or maintenance by him of a primary or secondary market (otherwise than on a national securities exchange …) for such security.” Id. at *7.
The Court began its analysis by explaining that Section 16(b) is a prophylactic measure designed to deter insiders from taking unfair advantage of confidential company information to realize short-swing profits on trades in company stock. The statute therefore imposes strict liability without the need to show any actual misuse of inside information. The Court further explained that, as a corollary to its strict liability nature, Section 16(b) must be narrowly applied and carefully confined to its limited areas of clear and unambiguous liability. And although the Court noted there was limited caselaw discussing Section 16(d), it stressed that in C.R.A. Realty Corporation v. Tri-South Investors, 738 F.2d 73 (2d Cir. 1984), the Second Circuit had explained that Section 16(d)’s exemption was intended to prevent the risk of Section 16(b) liability from causing a reduction in market-making activities. Further, the Court read C.R.A. Realty as establishing that a market maker which uses the facilities of a national exchange to execute trades can still qualify for the protections of Section 16(d) if (1) the market maker is engaging in OTC market-making and (2) the trades utilizing the facilities of the national exchange are “incident to” those OTC market-making activities. 2025 WL 833453 at *12.
Against this backdrop, the Court first rejected plaintiff’s argument that defendant broker-dealer did not qualify as a market maker under Section 3(a)(38) of the Exchange Act. Id. at *17. The Court determined that defendant broker‑dealer met the statutory definition because it held itself out as willing to continuously buy and sell plaintiff’s securities for its own account. Id. at *18. The Court also observed that it is unclear whether, in any case, Section 3(a)(38) could limit the applicability of Section 16(d), given that it was adopted after Section 16(d). Id. at *17.
The Court then assessed whether defendants’ packaged trades were “incident to the establishment or maintenance … of a primary or secondary market” for plaintiff’s stock—as required for the exemption in Section 16(d) to apply—or whether Section 16(d) did not apply because the individual legs of the packaged trades were executed “on a national securities exchange.” Id. at *18. The Court held that the fact that the individual components of the packaged trades were completed on an exchange was not determinative, and what mattered was whether the packaged transactions as a whole were negotiated over-the-counter.
In reaching this conclusion, the Court held that Section 16(d)’s applicability only to transactions occurring “otherwise than on a national securities exchange” referred to the location of the market-making activity, not to the location of the trading activity. Id. at *18–19. Here, the Court found that the market for the securities at issue was not the market for the individual legs of the packaged trade, but rather the market for the combined package. Id. at *21. In reaching that conclusion, the Court pointed to the evidence demonstrating that defendant broker-dealer was approached specifically to enter into packaged transactions, that prices were provided for the package as a whole, that the individual components of the package were negotiated only after the executable package was communicated, and that the final package in its entirety would need to be approved by a customer prior to trade execution. Id. Accordingly, the Court concluded that “relevant market participants all understood that what was being negotiated was an aggregated trade composed of [plaintiff’s] securities, set with a specific executable price, with the legs of the transaction contingent on their execution together.” Id. The Court emphasized that the components of the packages were not traded on the same exchange and that the packages could not be entered into on any single national exchange, so these packages reflected securities that were executed outside of a national securities exchange. Id. at *22. The Court also explained that the counterparties defendant dealer-broker dealt with had “no other obvious counterparty for the interrelated trades they wanted to execute” and found these packages “provided a separate benefit to the market by linking together the exchanges for stock and options.” Id. at *23. The Court further held that to the extent it was unclear whether this conduct fell within the ambit of Section 16(b) liability, it would err on the side of facilitating market-making activity and not imposing liability. Id.
With respect to defendants’ transactions in plaintiff’s stock outside of packaged trades, the Court noted that, while the parties disagreed about the type of hedging defendants were engaging in, plaintiff conceded these trades were done for risk mitigation purposes. Id. at *24. The Court held that because these trades were intended to mitigate the risk of defendants’ market-making activity and were not disproportionate to the related packaged trades, they qualified for Section 16(d) protection as “incident to” defendants’ market-making activity. Id. at *24–25.
