Short-Swing Profit Rule - Explained
What is the Short-Swing Profit Rule?
Written by Jason Gordon
Updated at April 15th, 2022
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Table of Contents
What is the Short-Swing Profit Rule?How does the Short-Swing Profit Rule Work? How the Short-Swing Profit Rule Affects Trading ActivityAcademic Research on the Short-Swing Profit RuleWhat is the Short-Swing Profit Rule?
The short-swing profit rule is a rule that states that company insiders should return profits realized from trading the stock of a company. Profits made from purchase and sale of a company's stock within a period of six months must be returned to the company.
The Securities and Exchange Commission (SEC) made the short-swing profit rule as a way of regulating profits made by company insiders. Anyone that holds more than 10% of a company's shares is an insider. Officers of a company such as director, manager and other executives are company insiders by law.
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How does the Short-Swing Profit Rule Work?
In the United States, the short-swing rule was a federal securities law enforced by the SEC. It was established to prevent company insiders from making profits within a short-term to the detriment of the company. Insiders are individuals who have greater access to a company's information, hence, they can use the information to achieve personal gains.
The short-swing rule requires that company insiders return or forfeit profit earned from the purchase and sale of a company's stock within a period of six months. The short-swing profit rule is in Section 16 (b) of the 1934 Securities Exchange Act. According to this rule, if an insider buys and sells shares within a six-month period, the profit realized would be returned to the company.
How the Short-Swing Profit Rule Affects Trading Activity
The short-swing rule affects trading activities in a company, this rule implies that company insiders cannot participate in trading of stock like other shareholders. Since the short-swing rule restricts insiders from certain trading activities, these insiders are also not exposed to the same level of risk that other shareholders are exposed to.
This rule prohibits an insider from leveraging on access to information about a company to make short-term profits from the purchase and sale of stocks. For instance, a shareholder can purchase stocks and sell them quickly and in turn face certain risks, since the short-swing rule prevents an insider from doing the same, they are also prevented from the underlying risks.
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