The Second Circuit had never squarely decided whether a contractual blocker actually defeats a claim for short-swing profits under Section 16(b) of the Securities Exchange Act. On July 7, 2026, it did.

In 20230930-DK-Butterfly-1, Inc. v. HBC Investments LLC, a unanimous panel affirmed the dismissal of a claim seeking to disgorge more than $300 million in trading profits, holding that a comprehensive, self-executing cap keeps an investor below the ten-percent beneficial-ownership threshold that triggers strict liability. The plaintiff was the post-bankruptcy successor to Bed Bath & Beyond. The defendants were the investment manager and fund that anchored the retailer's last capital raise before it failed.

The holding matters well beyond this case. Blockers are standard equipment in distressed capital raises, private placements, and convertible structures across the restructuring market. Until now, a plaintiff in this Circuit could argue that a blocker was a paper formality that a court should look past in favor of how the arrangement functioned in practice. The panel rejected that invitation and told plaintiffs exactly what they must plead instead.

By the early 2020s, Bed Bath & Beyond was in a position familiar to anyone who has worked a prepetition liquidity crisis. Pandemic-related store closures, supply disruptions, and management missteps had pushed a national home-goods retailer toward the edge. In desperate need of cash, the company went to the capital markets and issued three classes of derivative securities: convertible preferred stock, preferred-stock warrants, and common-stock warrants. Each was a route to freely tradable common stock at a potential discount, whether by converting preferred into common, exercising warrants for preferred and then converting, or exercising warrants directly for common. Hudson Bay bought up almost all of it and anchored the offering in exchange for the right to acquire heavily discounted, freely tradable stock.

That structure carried a problem Hudson Bay wanted no part of. An investor with the right to acquire more than ten percent of a public company's common stock takes on regulatory responsibility, including the disclosure and disgorgement obligations that Section 16 imposes on insiders. To stay clear of that line, Hudson Bay wrote blockers into every instrument. The blockers capped its beneficial ownership at 9.99 percent, and they did so with teeth. Any conversion or exercise that would carry it over the cap was, by the contract's own terms, null and void and treated as if never made. Hudson Bay had no power to vote or transfer any shares issued above the threshold. And every time it converted preferred stock or exercised a warrant, it had to certify that the transaction would not push its beneficial ownership past 9.99 percent.

One further document shaped the dispute. Hudson Bay and BBBY signed a side letter providing that the public-offering documents set out the complete set of procedures for exercising warrants and converting preferred, that BBBY would not demand additional information or instructions when Hudson Bay invoked those rights, and that BBBY would honor Hudson Bay's requests in accordance with the terms of the offering documents. The side letter also stated, in terms, that it neither superseded nor altered those documents. That last point became the hinge of Butterfly's final theory, and it did not hold.

The cash infusion was not enough. BBBY filed for Chapter 11 in April 2023. By then, according to the complaint, Hudson Bay had made more than $300 million by acquiring newly issued stock at a discount and reselling it into the market, over and over. On the trading records attached to the complaint, Hudson Bay's end-of-day beneficial ownership stayed below the ten-percent threshold throughout.

Section 16(b) is not a fault-based rule. The Second Circuit calls it a blunt instrument, and the label is precise. To remove any temptation to trade on inside information before it can arise, the statute imposes strict liability on corporate insiders who profit from buying and selling a company's securities inside a six-month window. Intent is irrelevant. The insiders it reaches are a public company's directors and officers, and its most powerful shareholders: anyone who is, directly or indirectly, the beneficial owner of more than ten percent of a class of equity security.

The reach extends past current holdings to potential ones. So long as an investor has the right to acquire beneficial ownership of the underlying security, it falls within the statute's field of view. That is why warrants, options, and convertible preferred stock are squarely within Section 16's ambit, and why an investor holding large volumes of those instruments has to think carefully about where the ten-percent line sits.

A blocker is the tool built to neutralize that exposure. Drawing on Levy v. Southbrook International Investments, its seminal decision in this area, the panel described a blocker, or conversion cap, as a contractual provision that denies an investor the right to acquire more than ten percent of an issuer's equity at any one time. The operative words are any one time. Beneficial ownership under the statute is measured at a single moment, not cumulatively. A blocker lets an investor move enormous cumulative volume through a position while never crossing the line at any given instant. By extinguishing the right to acquire beneficial ownership above the cap, the blocker takes the investor outside the statute. Butterfly's whole case was an effort to prove that Hudson Bay's blockers did not really do that.

Courts disregard blockers that are a sham or illusory. The difficulty, as the district court noted and the panel accepted, is a genuine dearth of case law on when a blocker crosses that line. Levy supplies the framework the Second Circuit applied, and it reduces to three commonsense questions. Can the investor waive the blocker in its sole discretion? Does the blocker lack a means of ensuring compliance? And has the investor, as a practical matter, ever actually exceeded the cap?

Those three questions were not conjured for this appeal. The Securities and Exchange Commission had once proposed a longer list of factors in an amicus brief in Levy, but most courts have never expressly applied the Commission's criteria, and the three Levy factors largely track three of the SEC's own: whether the blocker lacks an enforcement mechanism, whether it is easily waivable, and whether it has been adhered to in practice. Butterfly argued all three. On each, the blockers held.

Sole-discretion waiver

Butterfly's theory was that the blockers were wafer-thin because they could be waived or amended like any other contract. The panel had a short answer. Every contract can be amended by its parties, so a rule that equated amendability with illusoriness would turn every clause of every agreement into a sham. That is not what Levy asked. Levy asked something narrower: whether the investor alone could waive or nullify the cap in its sole discretion. Hudson Bay could not. Changing the deal required BBBY's consent, and that is the difference between a real constraint and a phantom one.

Means of ensuring compliance

Butterfly next argued that enforcement depended entirely on Hudson Bay policing itself, and that the side letter made matters worse by stripping BBBY of any ability to monitor compliance in real time. The panel was unpersuaded, and the reason repays attention. The court has never held that a clause is illusory simply because one party cannot audit the other's compliance as it happens. Levy asked only whether the contract contained mechanisms that would prevent the investor from crossing ten percent, and it found that an investor's own ability to revoke an over-cap conversion was enough. Hudson Bay's blockers went a step further. They did not depend on anyone electing to revoke anything. An over-cap acquisition was void automatically, treated as if it had never occurred, and every exercise carried a fresh certification that the cap remained intact.

Adherence in practice

The final factor asks whether the cap was ever actually breached, and here the complaint's own exhibits cut against the plaintiff. The trading records attached to the pleading showed Hudson Bay's end-of-day beneficial ownership staying below the threshold throughout. To argue otherwise, Butterfly had to do some arithmetic that the panel did not credit, and that arithmetic is where the case turned.

Butterfly's sharpest factual argument was a single snapshot. At 9:27 a.m. on February 10, 2023, it alleged, Hudson Bay had 10.1 percent of BBBY's outstanding common stock sitting in its brokerage account. If ownership is about what is in the account at a given instant, that number is over the line.

But that is not what beneficial ownership measures. The controlling question is investment power: the power to dispose of a security or to direct its disposition. Hudson Bay had no such power over shares it had already agreed to sell. To reach 10.1 percent, Butterfly counted shares that Hudson Bay had already committed to sell but still technically held for the moment they transited its account. As the case law makes clear, it is the moment the trading decision is made, rather than the mechanics of settlement or the passing of title, that governs Section 16(b). The panel called Butterfly's method dubious, and the complaint undercut it directly. Butterfly conceded that Hudson Bay's exercise requests were staggered with intervening sales, and the pleading's own chart tracked advance sales of millions of shares. Where a share happens to be sitting for an instant is not the test. Whether the holder still controls its disposition is.

Beneath the factual dispute ran a methodological one, and this is the part of the opinion that will matter most to future litigants. Butterfly argued that the district court had fixated on the text of the blockers and ignored how they functioned in practice. It pointed to a footnote in Levy stating that the commercial substance of a transaction, rather than its form, must be considered to guard against sham transactions, and it read that line as an endorsement of a substance-over-form standard that looks past the contract language to how a blocker could have operated ineffectively.

The panel closed that door. The Levy footnote was itself quoting an older decision for an uncontroversial principle: an insider may not disguise the effective transfer of stock through devices like shell companies or proxies. That is a rule against artifice, not a license to rewrite an unambiguous contract. The panel then anchored itself in Supreme Court guidance. Section 16(b) imposes liability without fault only within its narrowly drawn limits, and courts should not exceed a literal, mechanical application of the statutory text in deciding who is subject to it. Given that guidance, the court declined to trade the plain text of the offering documents for an uncertain standard focused on how the blockers could have functioned ineffectively in practice, absent specific allegations that they in fact did.

Out of that reasoning came the rule. A comprehensive and legally binding blocker should generally insulate a defendant from Section 16(b) liability. Only when the parties have ignored their own contract and allowed the investor to exceed the cap will a court look past the blocker's language. To survive a motion to dismiss, a plaintiff must allege that a facially unambiguous, self-executing blocker actually failed in practice. Speculation that the parties could have waived it, or that the investor could have breached it without the counterparty knowing until after the fact, does not state a claim.

Butterfly's last theory invoked SEC Rule 13d-3(b), which treats a person who uses any contract, arrangement, or device to prevent the vesting of beneficial ownership as if that person actually owned the security, where the purpose is to evade the statutory reporting requirements. Read broadly, that language could swallow every blocker, since a blocker is precisely a contractual device that prevents ownership from vesting.

The panel drew the line that keeps the Rule coherent. There is a difference between a scheme that conceals ownership the investor effectively holds and a provision that prevents the investor from holding it in the first place. Judge Winter's concurrence in CSX Corp. v. Children's Investment Fund Management, which both sides cited approvingly, supplied the map. Rule 13d-3(b) reaches transactions that carry the substantial equivalence of the rights of ownership relevant to control, or that stop short of or conceal the vesting of ownership while nonetheless ensuring that ownership will vest at the signal of the would-be owner. Its targets are secret side deals, straw buyers, and proxies dressed up to hide control. It does not reach an arrangement that genuinely denies the investor the substance of ownership.

That distinction aligns with Supreme Court precedent, which expressly permits an investor to structure a transaction with the intent of avoiding Section 16(b) liability, and with the Second Circuit's own approval of effective blockers. An investor is free to limit its ownership rights so as not to take on regulatory responsibility. What it may not do is conceal the vesting of ownership in order to evade its duties.

That principle disposed of Butterfly's reading of the side letter. Butterfly argued that the side letter quietly rewrote the offering documents and handed Hudson Bay an unlimited right to acquire, despite the ten-percent cap. The document said the opposite. It required BBBY to honor Hudson Bay's requests only in accordance with the terms of the offering documents, blockers included, and it stated that its terms did not supersede or alter those documents. Far from poking a hole in the blockers, the side letter expressly preserved them. Because the blockers prevented Hudson Bay from ever enjoying the substantial equivalence of beneficial ownership, Rule 13d-3(b) had no role to play.

The opinion resolves a question the Second Circuit had left open, and it resolves it on the text of the blocker rather than on how the arrangement might have operated in practice. A comprehensive, self-executing blocker is now a defense that holds at the pleading stage in this Circuit. Courts will read the blocker's text first, and they will treat a facially unambiguous cap as doing what it says unless the plaintiff pleads that it actually failed. A nine-figure profit and an intraday snapshot showing 10.1 percent did not clear that bar.

The panel was equally careful about what it did not decide. It reserved the case in which the parties ignore the cap in practice and let the investor exceed it. A plaintiff who can plead specific facts showing an actual over-cap holding that the investor controlled, or a concealed side arrangement that vests control on demand, still has a path under both Levy and Rule 13d-3(b). The opinion narrows the theories available to a Section 16(b) plaintiff facing a well-drafted blocker. It does not eliminate them. And because this is a court of appeals decision issued only days ago, the ordinary avenues of further review remain theoretically open.

For the practitioner, the opinion draws a usable map, and it points in different directions depending on where you sit.

If you are advising a distressed issuer raising rescue capital, the case confirms that you can offer an anchor investor deep discounts and large cumulative volume without saddling it with the insider status that would deter the investment in the first place. The condition is that the blocker has to do its work on its own. A cap that reads as a self-executing nullity, rather than one that merely gives the investor an option to pull back, is the version that survives a challenge from a successor estate later.

If you are the anchor investor, the drafting lesson is specific. The blockers that carried the day here shared three features worth reproducing: over-cap acquisitions that are void and treated as if never made, an express denial of any power to vote or transfer excess shares, and a certification at every conversion or exercise that the cap remains intact. Each of those is stronger than a bare right to revoke, and together they leave a plaintiff with very little to attack. Just as important, keep any ancillary agreement consistent with the cap. The side letter here did not sink the structure precisely because it honored the offering documents and disclaimed any power to alter them. A side letter drafted less carefully is exactly the kind of concealed arrangement that Rule 13d-3(b) is meant to catch.

If you are a successor estate, litigation trust, or plan administrator weighing a Section 16(b) claim against a prepetition anchor investor, the opinion sets the bar higher than a large profit and a suggestive snapshot. You need to plead that the cap actually failed: an over-cap position the investor genuinely controlled, or a side arrangement that quietly restored the ownership the blocker purported to remove. A theory built on what the parties could have done, or on shares briefly transiting an account after they were already sold, will not survive a motion to dismiss in this Circuit. That is a hard message for an estate sitting on an apparent nine-figure recovery, and it is the right time to test the theory against the pleading standard before committing estate resources to the claim.

The larger point is that the value in this decision lies in separating a real constraint from a paper one. A blocker that genuinely denies the substance of ownership is enforceable and worth the effort to draft with precision. A blocker that leaves the investor with effective control, or an ancillary agreement that quietly gives it back, invites exactly the scrutiny this plaintiff could not muster. As the law stands today, the burden sits with the plaintiff to show the cap gave way in fact rather than in theory.