Opinion ID: 272506
Heading Depth: 1
Heading Rank: 2

Heading: Purpose and Scope of Section 16(b).

Text: 13 Section 2 of the Securities Exchange Act of 1934, 15 U.S.C. 78b, states that the Act was designed, inter alia, 'to insure the maintenance of fair and honest markets' in securities transactions. Section 16(b) helps to implement this overriding purpose by making it unprofitable for 'insiders' 6 to engage in short-swing speculation. 'Prior to the enactment of the Securities Exchange Act,' the SEC has said, 'profits from 'sure thing' speculation in the stocks of their corporations were more or less generally accepted by the financial community as part of the emolument for serving as a corporate officer or director notwithstanding the flagrantly inequitable character of such trading.' 10 SEC Ann.Rep. 50 (1944). Among the inequitable short-swing transactions that prompted the enactment of Section 16(b) were transactions in which insiders, with advance knowledge of information that would produce a rise in the market price of a stock of their company, bought stock at the then current market prices and sold it when publication of the information had caused the anticipated rise to occur. And, too, there were transactions in which insiders with advance knowledge of facts that would depress the market price sold their stock at the then current prices and purchased stock when publication of the facts had had the expected depressing effect. Also, on occasion, the desire to obtain such profits had even led insiders to manipulate the market price of their corporation's stock by causing their corporation to pursue financial policies calculated to produce sudden fluctuations in market prices. 7 14 Section 16(b) was enacted to 'bring these practices into disrepute and encourage the voluntary maintenance of proper fiduciary standards.' H.R.Rep.No.1383, 73d Cong., 2d Sess. 13 (1934). The section provides that: 15 For the purpose of preventing the unfair use of information which may have been obtained by such beneficial owner, director, or officer by reason of his relationship to the issuer, any profit realized by him from any purchase and sale, or any sale and purchase, of any equity security of such issuer (other than an exempted security) within any period of less than six months, unless such security was acquired in good faith in connection with a debt previously contracted, shall inure to and be recoverable by the issuer, irrespective of any intention on the part of such beneficial owner, director, or officer in entering into such transaction of holding the security purchased or of not repurchasing the security sold for a period exceeding six months. Suit to recover such profit may be instituted at law or in equity in any court of competent jurisdiction by the issuer, or by the owner of any security of the issuer in the name of and in behalf of the issuer if the issuer shall fail or refuse to bring such suit within sixty days after request or shall fail diligently to prosecute the same thereafter; but no such suit shall be brought more than two years after the date such profit was realized. This subsection shall not be construed to cover any transaction where such beneficial owner was not such both at the time of the purchase and sale, or the sale and the purchase, of the security involved, or any transaction or transactions which the Commission by rules and regulations may exempt as not comprehended within the purpose of this subsection. 15 U.S.C. 78p(b). 16 Section 16(b), it should be emphasized, embodies a rather uncommon regulatory mechanism. The section's underlying purpose, as set forth in its preamble, is to prevent the 'unfair use' of information by insiders. This purpose is effectuated by means of, what has been termed, a 'crude rule of thumb.' 8 In order to insure discouragement of unfair insider short term trading all inside trading within a less-than-six-month period is discouraged. The arbitrary, some might say Draconian, nature of this statute reflects the view of experts who testified at the hearings leading to the passage of the 1934 Act that the unfair use of information by corporate insiders could only be effectively curbed by a law that made it unprofitable for insiders to engage in any short-term trading, whether fair or unfair. 9 It might be said that Congress decided in order to throw out the bathwater that the baby had to go too. In order so to insure that Section 16(b) efficaciously put an end to unfair insider trading, Congress explicitly made irrelevant the intent of any insider who engages in a short-term transaction, and did not condition the section's application on proof of an insider's intent to trade on a short swing. The desire of Congress to prevent unfair insider trading, regardless of its form, is evident in the act's inclusive definitions of several of the section's important terms. Section 3(a)(11) defines the term 'equity security' to include 'any security convertible, with or without consideration, into such a security   ' 10 Section 3(a)(13) broadly defines 'purchase' as including 'any contract to buy, purchase, or otherwise acquire,' 11 and 'sale' is defined by Section 3(a)(14) as including 'any contract to sell or otherwise dispose of.' 12 A reasoned elaboration of Section 16(b),'s underlying purpose, plus the recognition that the section's success as a deterrent was rooted in its simplicity and relatively automatic operation, prompted our court to hold in an early case that proof of an actual unfair use of inside information was not required, saying that 'the only remedy which its framers deemed effective for this reform was the imposition of a liability based upon an objective measure of proof.' Smolowe v. Delendo Corp., 136 F.2d 231, 235, 148 A.L.R. 300 (2 Cir.), cert. denied, 320 U.S. 751, 64 S.Ct. 56, 88 L.Ed. 446 (1943). In order to insure that unfair use of information by insiders is prevented, courts have been equally quick to reject other arguably relevant considerations that would limit the broad reach and relatively automatic operation of the section. See 2 Loss, Securities Regulation, 1041-1042 (2d ed. 1961). 17 It is equally important to emphasize that one issue is not finally resolved by the broad reach of Section 16(b) and the considerable evidence that Congress intended the section to deter unfair insider trading by rendering unprofitable all insider trading within any less-than-six-month period. It is quite apparent that because of the broad definitions of 'purchase' and 'sale' imported into Section 16(b), this section mat be applied not only to routine cash purchases and sales of equity securities but also may be applied to acquisitions and dispositions of equity securities in transactions involving conversions, options, stock warrants, reclassifications and the like. It is perhaps less apparent but nonetheless true that as a matter of fact some of these transactions may not lend themselves in any way to an unfair use of inside information by corporate insiders. 13 Granting that the theory of regulation underlying Section 16(b) requires the application of this section to every transaction that might possibly permit an insider to use inside information unfairly, the unresolved question is whether 16(b),'s regulatory mechanism also requires the application of the section to a conversion transaction such as that involved here, which could not possibly serve as a vehicle for any of the abuses at which Section 16(b) was aimed. Put more generally, the unresolved issue is whether this particular type of regulatory mechanism renders inapplicable a well-known rule of construction: cessante ratione legis, Cessat et ipsa lex. 18 With the background of this far from comprehensive brief restatement of Section 16(b)'s underlying purpose and of the regulatory mechanism Congress chose to effectuate this purpose, we now examine the section's application to each of the transactions which the court below held resulted in the short-seing profits for Lamb and Enterprises that were recoverable by Air-Way. 19