Beware of the short-swing profits rule!

Francisco Ed. Lim

In broad strokes, the short-swing profits rule provides that any profit realized by insiders of an issuer from the purchase and sale, or any sale and purchase, of any equity security of the issuer 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 (Section 23.2, Securities Regulation Code).

The insiders covered by the rule are officers, directors and beneficial owners or those holding more than ten percent of any class of any equity security of the issuer.

The short-swing profits rule is separate and distinct from the insider trading rule, which is governed by a different provision under section 27 of the Securities Regulation Code (SRC).

To be clear, the short-swing profits rule is not intended to prohibit the named insiders from transacting and earning profits from such securities. It was put in place to prevent them from unfairly using and benefiting from information that may have been obtained by reason of their relationship with the issuer and in order to ensure a fair and honest market. In the words of the SRC, it is [f]or 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.

It is a strict liability, prophylactic rule designed to prevent the possibility of insider trading. Neither intent nor actual use of inside information is required. All that is required is that profit was made from a combined purchase and sale of equity securities within a period of six months by the insiders in question.

The SRC provides that an action to recover such short-swing profits may be instituted before a regional trial court by the issuer, or by the owner of any security of the issuer in the name and in behalf of the issuer if the latter shall fail or refuse to bring such suit within 60 days after request or shall fail diligently to prosecute the same thereafter. The suit should be brought within two years from the date the profit was realized.

Although not popular, the short-swing profits rule is part of our statute books.

One day, it can be used against the directors, officers and beneficial owners of our listed companies. Short swing transactions can easily be proven as these persons are required to disclose the change of their shareholdings to the Securities and Exchange Commission and the Philippine Stock Exchange. They are advised to be aware or conscious of it.

They stand to lose the profits and it can be a prelude to a criminal case for insider trading, both of which may cause massive damage to their reputation.

This content is legally protected and covered by copyright. Copying of this content is prohibited.

How can we help you?