Washington Law Review


Andrew Chin


Section 16(b) of the Securities Exchange Act of 1934 allows for the recovery of short-swing profits realized by certain insiders from trading in a corporation’s stock within a period of less than six months. Three generations of corporate law students have been taught the “lowest-in, highest-out” formula that is intended to maximize the disgorgement of short-swing profits under section 16(b). Arnold Jacobs’s 1987 treatise presented two hypothetical examples where the formula fell short of the intended maximum, but courts, commentators, and practitioners have largely ignored these theoretical challenges to the formula’s validity. This Article identifies Gratz v. Claughton as the first reported real-world example of the formula’s failure. Ironically, Gratz has been taught and cited for more than sixty years as a leading authority for the formula’s use, not least because of its distinguished author, Judge Learned Hand. This Article argues that Gratz has been misunderstood and that Hand wisely adjudicated this complex case without prescribing or endorsing the formula in any way. It also shows that the formula has no need of Gratz’s endorsement, as long as the formula is correctly interpreted as limited to simpler cases where it is mathematically valid. It formalizes and extends Jacobs’s results by showing that the formula may fall short of the maximum by up to fifty percent when misused in more complex cases, and has actually fallen short in another more recent case. Finally, it provides online tools to enable practitioners and judges to calculate short-swing liability correctly in all cases.

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