What Is the Section 16(b) Short-Swing Profit Rule?

The rule is mechanical. Any purchase and any sale within six months of each other are matched, lowest purchase price against highest sale price, regardless of the order they happened in and regardless of which shares were actually sold. The "profit" is the difference, and the company can recover it even if the insider lost money overall. An insider who sells at $50 in January and buys at $40 in May has a recoverable profit of $10 a share on the matched amount, though from their point of view they simply reduced and then rebuilt a position.

The company can sue, and if it does not, any shareholder can sue on its behalf, with the shareholder's lawyers paid out of the recovery. A small plaintiffs' bar reads Form 4 filings for exactly this purpose and sends demand letters within days of a matching trade appearing. Most cases settle with the insider paying the profit to the company, and the company discloses material recoveries in its filings. The SEC does not enforce 16(b) directly; it is a private remedy.

• →Transactions with the company itself that the board or shareholders approve: stock grants, option grants and exercises, and shares withheld for tax. These are the bulk of insider transactions, and Rule 16b-3 keeps them out of the six-month matching.
• →Most derivative transactions are matched with the underlying rather than treated as separate events.
• →Gifts, inheritances and certain conversions.
• →Trades by a 10% holder count only if the holder was above 10% at both the purchase and the sale, so a fund that sells down through 10% and then buys back is usually outside the rule for the later trades.

Open-market purchases and sales by officers and directors are never exempt. Those are the trades the rule was written for.

An officer who buys on the open market has locked themselves out of selling for six months, and knows it. That commitment is part of why a discretionary purchase carries information: it is not a trade the insider can reverse next week. It also explains why insiders who need to sell, for tax or diversification, do it in a window well clear of any purchase, and why a Form 4 purchase followed within months by a sale is rare enough to be worth a second look, since it usually means the insider judged the gain worth handing back, or made a mistake.

InsiderWatch checks each buyer's own filing history when it grades an insider purchase, which is how it can say that a buy is the insider's first in years. The six-month rule is the reason that history is clean enough to read.