On August 8, 2011, the U.S. District Court for the Southern District of New York dismissed the plaintiff’s claims in Michael D. Gibbons v. John C. Malone and Discovery Communications, Inc. and issued an opinion clarifying the scope of short swing profit liability under Section 16 of the Securities Exchange Act of 1934. In the action, the plaintiff alleged that profits in connection with purchases and sales of Discovery Communications voting and non-voting common stock by entities related to a Discovery director were subject to disgorgement under the statute. The director-defendant argued that purchases and sales of non-voting and voting stock, which confer different voting rights on the holders and trade under different ticker symbols and at different prices, are not matchable under Section 16(b). Accordingly, the director-defendant argued that transactions across such classes are not subject to disgorgement of profits.

Whether Section 16(b) allows the matching of purchases and sales of a class of non-voting stock with those of a class of voting stock of the same company was an issue of first impression, as prior to this decision, no court had ever addressed whether purchases and sales involving different classes of common stock possessing different voting rights could be matched for purposes of Section 16(b). The Southern District has now firmly held that such matching is not captured by the statute. In its decision, the court held that:

  • the plain text of the statute requires that the purchase and sale be of the same equity security;
  • a significant correlation between the prices of two equity securities is insufficient to permit a court to treat them as the same equity security when neither security is convertible into or exercisable for the other; and
  • where two equity securities have different voting rights and stock dividend preferences, they are not the same class for purposes of Section 16(b).

The court’s ruling provides a clear guideline for corporate insiders of companies that have both voting and non-voting stock outstanding. Based upon this ruling, insiders should now be able to trade in the two classes of stock without the threat that trades of voting stock may be matched with trades of non-voting stock to create Section

16(b) liability.