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Thou, Director, shalt not Profit

(Article published in the Sept 21,2011 issue of Manila Standard Today) 

It is understandable for Philex or any of its stockholders, be they holding interests for themselves or on behalf of others, to hestitate seeking to claw back the profits made by the Honourable Roberto V. Ongpin (RVO) from his insider transactions in 2009 relating to his Philex holdings.  In addition to the widespread belief that nobody messes with RVO, it is really difficult to put a figure on the profits that RVO made on the eve of his insider sale of shares to Manny Pangilinan’s Two Rivers.

The fault is not in RVO but is in the law.  Section  23.2 of our Securities Regulation Code permits the claw back of “any profits” but does not give any guidance on how to identify, much less quantify, such profits.  In our adversarial system, where the parties are considered going into battle with whatever preparations they can on their own muster, it is the responsibility of the plaintiff to prove his case.  But if the plaintiff is unable, for reasons beyond his control, to put a figure on his claim, how can the Philippine courts and quasi-judicial bodies give him redress?

In the United States, however, where people are more litigious, there have been cases which could serve as our guide (after all, the Philippine Supreme Court had blessed the practice of looking at American precedents as non-binding indications of the meaning and purpose of laws copied from the land of the free and home of the brave) in applying American law that by our copying we had also made part of the law of the land. The possible approaches have been extensively explored in the case of Smolowe v. Delendo Corporation (36 F. Supp. 790 [1940]) decided by District Judge Clark of the District Court in New York as the year was drawing to a close. 


The first option, which ought to be disregarded without too much discussion, is to determine the profit by identifying the shares that were actually bought and sold within the six-months period.  In other words, the plaintiff ought to be able to say that the exact shares that were bought less than 6 months ago were exactly the same as sold within said period.  The problem which such an approach meets is the phenomenon of the “smart” trader.  He can buy a block of the shares and keep the same as a buffer for short-swing transactions.  For example, Trader “A” puts up a store of stocks in the target corporation and puts them in a “box”.  Then, in order to conduct his trading in a legal but economical way, he selects and gives to the buyer the certificates of stock which he had held in the box for more than 6 months.  That would make the intent to curb the trading for the short-swing too easy to circumvent. 

Another suggestion, just as unacceptable as the identify approach discussed above, is the use of the FIFO accounting method of identifying the shares sold.  In other words, in determining which shares were sold out first, the suggested method would present the early purchases as the source.  The problem with such an approach is the fact that FIFO is a rule in the stratified world of accounting and therefore does not make, in the application of the rule, any presence as to the concession of the analysis to the reality.   

A third approach is to use the “average”, i.e. the average profit from the buying and selling prices within the six-month period are calculated, and an infringement is declared when the average selling price exceeds the average buying price for the period.  The problem of this approach is that calling on the “average” as the bench mark requires the losses to be calculated in order to determine the  gains.  While seemingly logical, it does conflict with the wording of the statute that requires the claw back of “any gains” as distinguished from “net gains.”  Hence, it clearly cannot be what the intent of the law was.   

The Smolowe solution is, to say the least, cuts the Gordian knot.  It proceeds, correctly I must say, from the premise that the law is remedial in nature, intended as it was to remove any incentive to circumvent the rule; something akin to the petition to “not lead us unto temptation.”  What the law wants is “to be thoroughgoing, to squeeze out all possible profits out of stock transactions [of insiders] and thus to establish a standard so high as to prevent any conflict between the selfish interest of a fiduciary officer, director or stockholder and the performance of his duty.” Hence, as we local lawyers are wont to say, “any and all” profits must be disgorged in favour of the issuer. 

In order words, directors and other insiders are supposed to be like eunochs attending to the wives of the sultan in his harem.  They are permitted to be so close to the prize but are prevented, by reason of their being so close, by a most cruel device known in modern times as mutilation from giving in, even if they wanted to, to the lusts of their heart.  They can dream and perhaps engage in non-conceptual activities, but that is as far as they can go.  Absolutely, no possibility of causing the conceiving in sin, much less giving birth in hell. 

        Really, it’s no fun being a director of a public company nowadays, is it?