It is no secret that most members of the plaintiffs’ bar become aware of short-swing trades through software programs that track Forms 4 and, when the program alerts the attorney to a potential claim, cause an affiliated plaintiff to purchase issuer securities to establish the plaintiff’s standing to assert a claim. If the claim succeeds, the plaintiff receives none of the recovery, but the plaintiff’s attorney receives a fee.
Insiders in some early cases argued that this process amounts to champerty on the part of the plaintiff’s attorney, but courts rejected the argument, noting that the statute necessarily contemplates a system under which a shareholder plaintiff does not participate in the recovery, creating an incentive only for the plaintiff’s attorney. In a case pending in the Southern District of California, an insider has asserted as an equitable defense that a claim originating through this process means the plaintiff has “unclean hands.” Specifically, the insider alleges that the plaintiff utilized a computer program which resulted in the assertion of a claim within minutes of his filing of a Form 4 and then purchased only one share of the issuer’s stock, demonstrating “an entire business model of litigation via blackmail.”
The plaintiff filed a motion to strike these allegations on the ground that equitable defenses are not available under Section 16(b). That motion is pending, but in the meantime the insider sought to conduct discovery to establish how the plaintiff became aware of the 16(b) claim and retained an attorney to pursue it. The plaintiff then sought a protective order to prevent the discovery, and a federal magistrate granted the protective order on the ground that, even if the insider’s allegations are true, they seek to establish an equitable defense and equitable defenses are not available in an action under Section 16(b).
Insiders regularly grumble that the 16(b) claims process rewards no one but a small group of lawyers, and at one time commentators suggested that enforcement should reside with the SEC. Along similar lines, insiders have occasionally challenged the constitutionality of security-holder enforcement of the statute on the ground that the plaintiff has so little economic interest in the case that the action does not constitute an Article III “case or controversy.” So far, and not surprisingly given the language of the statute, the courts have countenanced the prevailing claims process.
— Alan Dye, June 1, 2022, Section16.net
