Lowest-in, highest-out matching worked trade by trade for a director of a listed portfolio company, and what it means for pre-clearance.
Section 16(b) short-swing profit is calculated by matching the lowest-priced purchase against the highest-priced sale made within less than six months of each other, then the next lowest against the next highest, and adding only the pairs that show a profit. Losses are never netted. A director who bought and sold four times between January and April and lost 4,000 in cash owes the issuer 44,000.
Worked in full in The Private Fund Compliance Officer by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Section 16(b) of the Securities Exchange Act lets the issuer, or a shareholder suing on its behalf, recover any profit an insider realises from a purchase and sale, or a sale and purchase, of the company's equity securities within any period of less than six months. Insiders are directors, officers and beneficial owners of more than 10 per cent. Intent and inside information are irrelevant: it is a strict liability rule, and the profit is computed to be as large as the trades allow. Courts use the method set out in Smolowe v. Delendo, usually called lowest-in, highest-out.
The case is illustrative and simplified, not legal advice. Exemptions under Rule 16b-3 and the other Section 16 rules, derivative transactions and the facts of each trade can change the result; counsel should confirm any matching before a claim is settled or a trade is cleared.
1. List every purchase and sale in the period, ignoring which shares were actually delivered.
2. Match the highest sale price with the lowest purchase price, where the two trades are less than six months apart, for the smaller of the two quantities.
3. Repeat with the remaining shares until no sale price exceeds a matchable purchase price.
Recoverable profit = Σ matched shares × (sale price − purchase price), positive pairs only
A fictional private equity firm took a portfolio company public; one of its partners stayed on the board as a director and traded in the stock personally, ending the period flat. The prices are illustrative.
| Date | Trade | Shares | Price | Amount |
|---|---|---|---|---|
| 12 January | Buy | 10,000 | 20.00 | 200,000 |
| 16 February | Sell | 8,000 | 24.00 | 192,000 |
| 20 March | Buy | 6,000 | 18.00 | 108,000 |
| 24 April | Sell | 8,000 | 14.00 | 112,000 |
| Total | 16,000 bought, 16,000 sold | -4,000 |
In cash the director paid 308,000 and received 304,000: a loss of 4,000.
Step 1, rank. Purchases from the lowest price: 6,000 at 18.00 (20 March), 10,000 at 20.00 (12 January). Sales from the highest: 8,000 at 24.00 (16 February), 8,000 at 14.00 (24 April). All four trades fall within less than six months of each other, so every pair is matchable.
Step 2, first match. The 24.00 sale against the 18.00 purchase, 6,000 shares: 6,000 × 6.00 = 36,000. The purchase comes after the sale; for Section 16(b) that does not matter, a sale followed by a purchase is matched the same way.
Step 3, second match. The 2,000 shares left of the 24.00 sale against the 20.00 purchase: 2,000 × 4.00 = 8,000.
Step 4, stop. The only sale left is at 14.00, below both remaining purchase prices. Its loss is ignored.
| Pair | Shares | Bought at | Sold at | Profit |
|---|---|---|---|---|
| 20 March buy, 16 February sale | 6,000 | 18.00 | 24.00 | 36,000 |
| 12 January buy, 16 February sale | 2,000 | 20.00 | 24.00 | 8,000 |
| Recoverable short-swing profit | 8,000 | 44,000 |
The director owes the issuer 44,000, 48,000 more than the trades actually earned. That gap is the design of the rule, not a quirk: by matching the cheapest purchase with the dearest sale regardless of which shares changed hands, it removes any profit that the insider could have captured, and so removes the incentive to trade in and out at all. Claims can be brought by any shareholder, often prompted by plaintiffs' firms that read the Form 4 filings, generally within two years of the profit being realised.
| Scenario | Section 16(b) profit |
|---|---|
| Base case | 44,000 |
| April sale at 21.00 instead of 14.00 | 52,000 |
| January purchase at 23.00 instead of 20.00 | 38,000 |
| No March purchase and no April sale | 32,000 |
| March purchase moved to 17 August, April sale to 24 September | 32,000 |
At 21.00 for the April sale the trades really do earn 52,000, and the rule takes exactly that. With a 23.00 January purchase the director loses 34,000 in cash and still owes 38,000. Moving the second round of trades past the window does not make the first round safe: the January purchase and February sale are themselves a matched pair, worth 32,000. Only the trades that sit more than six months from any opposite trade drop out.
The code of ethics should route every trade by a director, officer or 10 per cent holder in a listed portfolio company through pre-clearance, and the check is mechanical: has this person made an opposite trade within the last six months, and could they make one within the next six? After the 16 February sale, a purchase on or before 15 August is matchable; 16 August is the first day outside the window, and many programmes add a margin of a few days. The same test applies to the funds when they are 10 per cent holders, or are treated as directors because their partner sits on the board; for a 10 per cent holder, status must exist at both ends of the matched pair. The restricted list and the wall-crossing log, among the working documents of the book, are where these names should already sit.
The pre-clearance log, the restricted list and the conflicts register are among the working documents that come with the free workbook for this book. For another rule where a small act carries a large fixed cost, see what a pay-to-play violation costs in fees.
Yes. Section 16(b) matches purchases and sales to produce the largest profit, not the actual one, and does not net losses against gains. In the worked case four trades lose 4,000 in cash, yet matching the 18.00 purchase and the 20.00 purchase against the 24.00 sale produces 44,000 of recoverable profit.
Directors and officers of a company with a class of equity registered under the Exchange Act, and beneficial owners of more than 10 per cent of such a class. A private equity firm whose partner sits on a listed portfolio company's board, or whose funds hold more than 10 per cent after an IPO, needs both the individual's and the funds' trades checked against the six-month window.
Until the six-month window has passed: a purchase is matchable against any sale within less than six months before or after it. After a sale on 16 February, a purchase on 15 August is still matchable and one on 16 August falls outside. In the illustration that single change, with the later sale moved too, cuts the recoverable profit from 44,000 to 32,000.
This article is one calculation from The Private Fund Compliance Officer. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: regulation, compliance and banking → · All 1340 articles →
If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.