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The standard for enforcing the statute of limitations on actions by investors to recover wrongfully realized short-swing profits from corporate insiders has been clarified by the U.S. Court of Appeals for the Second Circuit. Addressing the two-year limitations period for bringing claims under Section 16(b) of the Exchange Act of 1934, the court said that the clock does not start to run until insiders have met their disclosure obligations on short- swing profits � which are any profits from the purchase or sale of securities within a six-month period. The question in Litzler v. CC Investments, L.D.C., 03-5022, was the reporting requirement of �16(a), which is met by the filing of notice of a change in ownership interest in a so-called Form 4. The court said the two-year period should be equitably tolled until the Form 4 is filed, an event that allows investors to discover short-swing profits “without any investigation other than the putting together of two and two.” “We hold that the incentives of Section 16 are best served if tolling is triggered by noncompliance with the disclosure requirements of Section 16(a) through the failure to file a Form 4,” Judge Dennis Jacobs wrote for the court. “Such tolling should continue only until the claimant or (depending on the circumstances) the company gets actual notice that a person subject to Section 16(a) has realized specific short-swing profits that are worth pursuing.” The issue arose when the bankruptcy trustee for Data Race, Inc. a defunct San Antonio, Texas, firm, entered a suit brought by an investor to recover short-swing profits from equity shareholders. The equity shareholders claimed they did not meet the threshold for filing requirements under �16(a), which mandates that directors, officers and beneficial owners of over 10 percent of a company’s stock disclose their transactions. The defendants claimed that they were not acting as a group when they converted preferred stock to common stock and made the sales because the sales were made to benefit them as individuals and none owned more than 10 percent of Data Race. Southern District Judge Alvin K. Hellerstein ruled that the failure to file the forms tolled the two-year period. The judge then certified an interlocutory appeal on the issue of equitable tolling to the U.S. Court of Appeals for the Second Circuit. At the Circuit, Judge Jacobs said “The running of the statute of limitations in Section 16(b) is not expressly conditioned upon compliance with Section 16(a). He also said the Circuit declined to resolve this issue eight years ago in Tristar Corp. v. Freitas, 84 F.3d 550 (1996), but it was not necessary to do so. “We declined to decide whether tolling applied to Tristar’s claims because we concluded that the claim would have been untimely even if the statute had been equitably tolled during the approximately two and half years by which the filing of Form 4′s was delayed,” he said. “We reached that conclusion by computing a hypothetical tolling period based on the two-year statute of limitations, less the statutory grace period � at that time, ten days � that insiders had to file Form 4s under Section 16(a)(2).” The result, he said, was that Tristar’s �16(b) claim was dismissed for being eight days past the limitations period. “Not surprisingly, Tristar has been read to imply that the limitations period in Section 16(b) is subject to tolling if a required Form 4 is delayed,” he said. “In the intervening seven years, three courts in this Circuit have indicated that tolling the statute of limitations in Section 16 (b) is sometimes necessary to effectuate the goals of the statute.” “Ordinarily, inquiry notice is sufficient to defeat or end equitable tolling,” he added. However, Section 16 compels disclosure (through a Form 4) that is so clear that an insider’s short-swing profits will be discovered without any investigation other than the putting together of two and two.” The court remanded the case to Judge Hellerstein because he did not “clearly decide whether the notice received by Data Race (a 1999 shareholder letter demanding the company try to recover alleged short-swing profits from the transactions) ended the tolling period.” Judges Chester J. Straub and Barrington D. Parker joined in the opinion. Peter Buscemi of Morgan, Lewis & Bockius represented defendants Olympus Securities, Ltd., Nelson Partnership and Citadel Limited Partnership. Scott Edelman of Milbank, Tweed, Hadley & McCoy represented defendants CC Investments, LDC and Castle Creek Partners, LLC. Paul Wexler of Bragar Wexler Eagel & Morgenstern and Glenn F. Ostrager of Ostrager, Chong & Flaherty represented bankruptcy trustee John H. Litzler.

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