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Second Circuit Keeps Narrow Scope Of Short-Swing Trading Claims Arising Under Section 16(b)
06/03/2025On May 23, 2025, in a significant decision with implications for future short-swing trading claims, the United States Court of Appeals for the Second Circuit Court affirmed two district court decisions holding that a controlling shareholder’s sales of an issuer’s common stock cannot be matched with the issuer’s repurchases of its common stock for purposes of Section 16(b) of the Securities Exchange Act (“Exchange Act”). Roth v. LAL Family Corp., et al., No. 24-2464 (2d. Cir. 2025); Roth v. Patrick Drahi, et al., No. 24-2761 (2d Cir. 2025). The three-judge panel rejected a novel legal theory advanced by a plaintiff-shareholder, who alleged that the controlling shareholders of two corporations improperly profited $56.7 million and $17.3 million respectively as a result of those corporations’ stock buybacks.
Plaintiff sought to hold the controlling shareholders in each case liable for short-swing profits allegedly accrued from equity securities transactions in violation of Section 16(b) of the Exchange Act. Plaintiff alleged that the controlling shareholders have a pecuniary interest in the shares subject to the issuer stock repurchases, and therefore those purchases should be matched under Section 16(b) with the controlling shareholders’ sales of the issuers’ securities. Plaintiff brought these claims derivatively seeking to compel the controlling shareholders to disgorge their alleged short-swing trading profits to the issuers.
The Court ruled that Section 16(b)—which requires corporate insiders to disgorge any short-swing profits made within six months—does not apply when the buyer is the corporation itself. In doing so, the Court noted that Section 16(b) applies only where the transactions involve “substantively identical equity securities.” The Court clarified that the shares sold by the controlling shareholders materially differed from the securities the corporation repurchased because those repurchased shares “automatic[ally]” become “treasury shares” under Delaware law, and such transformation divests those shares from “any incidents of ownership,” thus rendering them “valueless.” Accordingly, plaintiffs could not establish that the controlling shareholders realized any profit from the nonpairable transactions. The Court also noted that plaintiff’s theory is nonsensical because, if allowed, issuers could pursue claims against insiders based on the issuer’s own conduct, such as a stock repurchase program, and then compel the insiders to disgorge alleged profits (the sole remedy available under Section 16(b)) to the issuer. Lastly, the Court held that plaintiff’s theory is inconsistent with the strict liability nature of Section 16(b) and would make Section 16(b) “trap sprung” with every transaction.
Judge Guido Calabresi, concurring in the result, cautioned that although the law does not currently support plaintiff’s claims, the potential for abuse exists. He noted that “there are certainly ownership situations in which parties in control can make use of inside information to make huge profits by doing what was done here.” To address such concern, he suggested that Congress or the SEC might consider clarifying the rules around insider gains and corporate repurchases in the future.
Notably, in early May 2025, the Eleventh Circuit heard oral argument on an appeal of a Florida District Court’s opinion rejecting exactly the same legal theory brought by the same plaintiff against a controlling shareholder of a different corporation.
