The arithmetic is one line. The contested input is the post-disclosure price, and it moves the exposure by over a million.
Loss avoided is the number of shares sold while in possession of material non-public information multiplied by the difference between the sale price and the market price once the news has been absorbed. On an illustrative sale of 200,000 shares at 24.50 ahead of bad news, with the stock closing at 18.20 after the announcement, the loss avoided is 1,260,000. In a US case brought by the SEC, disgorgement, prejudgment interest and a civil penalty of up to three times that amount take the maximum monetary exposure to 5,256,291.
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 →
Private markets firms meet this problem more often than they expect. A credit team that sits on the private side of a syndicated loan receives lender materials, a portfolio company's board seat brings in forecasts, and an expert network call strays into a listed competitor's numbers. Section 204A of the US Investment Advisers Act requires advisers to establish, maintain and enforce written policies and procedures reasonably designed to prevent the misuse of material non-public information. When a trade slips through the restricted list, the compliance officer has to size it, and the size starts with loss avoided or profit gained.
| Input | Value |
|---|---|
| Shares sold by Fund A the day before a profit warning | 200,000 |
| Average sale price | 24.50 |
| Previous close, for reference | 24.80 |
| First close after the announcement | 18.20 |
| Five-day / ten-day average close after the announcement | 17.40 / 16.90 |
| Prejudgment interest, illustrative rate, compounded quarterly, two years | 8.0% |
| Fund A net assets | 600,000,000 |
Loss avoided = shares sold × (sale price − post-disclosure price)
Base measure: 200,000 × (24.50 − 18.20) = 200,000 × 6.30 = 1,260,000, a 25.7% fall on proceeds of 4,900,000.
Prejudgment interest = 1,260,000 × [(1 + 8% ÷ 4)8 − 1] = 1,260,000 × 17.17% = 216,291.
Maximum civil penalty under Section 21A of the Exchange Act = 3 × 1,260,000 = 3,780,000.
In Excel: =Shares*(SalePx-PostPx), then =LossAvoided*((1+Rate/4)^(4*Years)-1).
Profit gained works the same way in the other direction. Had the fund bought 50,000 shares at 11.20 ahead of good news and the price settled at 15.60, the profit gained would be 50,000 × 4.40 = 220,000, and the maximum penalty 660,000.
| Component | Amount |
|---|---|
| Loss avoided (disgorgement) | 1,260,000 |
| Prejudgment interest, two years | 216,291 |
| Civil penalty, up to three times | 3,780,000 |
| Maximum monetary exposure | 5,256,291 |
A trade that kept 1,260,000 in the fund, 21 basis points of its net assets, can cost up to 4.17 times that amount. The penalty multiplier is a maximum, not a formula: the court sets the amount in light of the facts and circumstances. But the arithmetic explains why the first internal estimate matters. It sets the tone of the escalation memo, the self-report decision and the conversation with the fund's investors, whose money was the beneficiary of the trade.
| Post-disclosure price measured as | Price | Loss avoided | Interest | Penalty, up to 3x | Maximum total |
|---|---|---|---|---|---|
| First close after the announcement | 18.20 | 1,260,000 | 216,291 | 3,780,000 | 5,256,291 |
| Five-day average | 17.40 | 1,420,000 | 243,756 | 4,260,000 | 5,923,756 |
| Ten-day average | 16.90 | 1,520,000 | 260,922 | 4,560,000 | 6,340,922 |
The choice of post-disclosure price is where most of the argument happens. The purpose is to capture the price after the market has absorbed the information, and a stock that keeps falling for a week after the announcement makes a longer window larger. Here the spread between the first close and the ten-day average is 260,000 of loss avoided, and over a million of maximum exposure. Compute all three, state which the firm treats as primary and why, and do not pick the smallest because it is the smallest.
Short-swing profit under Section 16(b) is a different, strict-liability calculation that matches purchases and sales within six months regardless of information, worked in how Section 16(b) short-swing profits are calculated. The same compounding logic is used for client refunds in how to calculate a trade error reimbursement.
For the escalation memo: shares and prices from the trade blotter, the time the information entered the firm, the post-disclosure price on at least three windows, the resulting range, and who benefited. Involve counsel before any figure leaves the compliance team: this is an illustration of the arithmetic, not legal advice, and the measure applied in a real matter is for counsel and, ultimately, the regulator or court. Then fix the control that failed: if the listed shares should have been on the restricted list the day the lender materials arrived, that gap is the finding, whatever the amount.
Loss avoided is simple arithmetic with one contested input, the post-disclosure price. On this illustrative trade it ranges from 1,260,000 to 1,520,000, and the maximum exposure from 5,256,291 to 6,340,922. The book's approach to turning compliance judgement calls into numbers is in the free workbook for this book.
Under Section 21A of the Exchange Act the SEC can seek a civil penalty of up to three times the profit gained or loss avoided, on top of disgorgement and prejudgment interest. On an illustrative loss avoided of 1,260,000 that is a penalty of up to 3,780,000 and a maximum monetary exposure of 5,256,291 with two years of interest.
A price that reflects the market having absorbed the news, commonly a close shortly after disclosure or a short average. The choice moves the result: on 200,000 shares sold at 24.50, the first close of 18.20 gives 1,260,000, the ten-day average of 16.90 gives 1,520,000.
Shares bought times the difference between the post-disclosure price and the purchase price. Buying 50,000 shares at 11.20 before the price settled at 15.60 gives a profit gained of 220,000, and a maximum Section 21A penalty of 660,000.
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.
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