A federal appeals court recently considered whether Section 16(b) of the Securities Exchange Act of 1934 applies to transactions in which a Section 16 insider buys or sells shares of one type of equity security of an issuer and engages in an opposite-way transaction in another type of equity security of the same issuer within six months of the initial purchase or sale. If Section 16(b) applies, shareholders can initiate actions to demand disgorgement of illicit profits from a Section 16 insider without demonstrating scienter. See “Establishing, Maintaining and Exiting a Minority Equity Position: U.S. Securities Law Considerations for Hedge Funds
,” Hedge Fund Law Report, Vol. 2, No. 2 (Jan. 15, 2009). While the case did not involve a hedge fund, it will nonetheless impact the securities trading of most Section 16 insiders, which include, among others, hedge funds that (1) beneficially own ten percent or more of a class of a public issuer’s equity securities or (2) beneficially own less than ten percent of a class of a public issuer’s equity securities if the hedge fund is a member of a “group,” defined as two or more persons that agree to act together for the purpose of acquiring, holding, voting or disposing of an issuer’s equity securities. See “Second Circuit Decision Sends CSX and Hedge Fund Suitors TCI and 3G Back to District Court to Examine When Funds Formed a ‘Group’ to Acquire CSX Stock
,” Hedge Fund Law Report, Vol. 4, No. 25 (Jul. 27, 2011). The decision will impact the investment activities of, among others, many activist hedge funds and their managers. For more on activist strategies, see “Lawsuits and Letters: TPG-Axon’s Playbook for Unseating a Recalcitrant and Underperforming Board of Directors
,” Hedge Fund Law Report, Vol. 6, No. 2 (Jan. 10, 2013); and “Dealing with Mr. Big: Recent Developments in Transactions Involving Controlling Shareholders
,” Hedge Fund Law Report, Vol. 3, No. 4 (Jan. 27, 2010). This article describes the factual background and the court’s analysis and holding in the case. The article also discusses the potential impact of the case on hedge funds and their managers deemed to be Section 16 insiders.