Second Circuit Holds That Two Series Of Common Stock Are Not Matchable Under The Short-Swing Profit Rule

On January 7, 2013, the United States Court of Appeals for the Second Circuit declined to take an expansive reading of Section 16(b) of the Securities Exchange Act of 1934 (as amended, the "Act") in Gibbons v. Malone1, ruling that an insider's profits are not recoverable under that provision when the insider 2sells shares of one series of registered common stock of a company and purchases shares of a different series of registered common stock of the same company.

Under Section 16(b) of the Act, an insider of an issuer with equity securities registered under Section 12 of the Act must disgorge profits to that issuer realized "from any purchase and sale, or any sale and purchase, of any equity security of the issuer ... within any period of less than six months."3 Such profits are often referred to as "short-swing profits." Lawsuits to recover short-swing profits may be brought by the issuer or by any stockholder of the issuer in the name and on behalf of the issuer.

The facts in Gibbons are straightforward and uncontested. Between December 4, 2008 and December 17, 2008, John Malone, a director and large shareholder of Discovery Communications, Inc. ("Discovery"), engaged in nine sales of Discovery's Series C common stock and ten purchases of its Series A common stock. Each of the Series A common stock and the Series C common stock was registered under Section 12(b) of the Act, and thus each was an "equity security of the issuer" for purposes of Section 16(b) of the Act. After Discovery declined to seek recovery of short-swing profits from Malone, Michael Gibbons, a Discovery stockholder, brought suit under Section 16(b) of the Act seeking disgorgement of profits from Malone. Gibbons alleged that Malone profited by more than $300,000.00 from these transactions.

As noted above, Discovery's Series A and Series C common stock are separately registered and traded on the NASDAQ stock exchange under different ticker symbols. The Series A stock comes with voting rights, but the Series C stock does not. Neither stock is convertible into the other. The Series A and Series C stock are entitled to almost the same dividend and liquidation rights 4, and the trading prices of the two series were alleged to be highly correlated. However, the correlation was not perfect as the Series A stock had closing prices on the nine relevant dates that varied between approximately four to eight percent higher than the Series C stock.

The United States District Court...