ARK Invest is an ETF-provider and fund manager with a vision. Its website speaks in glowing tones about “disruptive innovation”, “genomic revolution” and even making the world a better place. By placing outsized bets on names such as Tesla, Spotify and Zoom, the firm aims to not just generate great returns, but revolutionise technology via the medium of the secondary markets.

It’s quite a lot to swallow for a business that makes its money by clipping fees off its investors, but it’s almost impossible to argue it hasn’t worked. Through to the end of January this year, its main ETF — ARK Disruptive Innovation (ticker: ARKK) — had outperformed the Nasdaq by 136 per cent since launch.

Flows followed, with the ARK family of funds garnering more assets in January than passive vehicle providers BlackRock and State Street. By the end of the month, it managed just under $50bn in assets, up from a tenth of that the year before. In the process, ARK’s success made its founder and chief investment officer Cathie Wood one of the most high profile names on Wall Street. And a regular on financial television.

Yet late-February has been a different story all together.

Over the past fortnight, ARK’s ETFs has been clobbered by a reversal in US technology stocks, seemingly started by a steepening in the yield curve. Outflows have followed, with the fund losing $690m last week as the market cratered, according to Bloomberg, before stabilising early this week.

This has led to some bears speculating that if outflows continue to arrive in size, ARK might struggle to meet redemptions, as it holds several large positions in relatively small market capitalisation companies. FT Alphaville is no expert in ETF liquidity (our boss, however, is) so we’d prefer not to comment on that particular idea.

But there’s another possible leak in the ARK which we have not seen discussed anywhere: the SEC’s short swing rule.

Taken from Section 16(b) of the Securities Exchange Act, the rule is designed to stop company insiders trading their own shares for a quick profit. Fair enough. But what’s interesting is the SEC’s definition of an insider. It is, perhaps unexpectedly, pretty broad.

From a Latham & Watkins one pager on the subject:

Note the final point here — any investor with a stake at about 10 per cent of the company’s securities counts as an insider. According to Bloomberg’s ETF expert, Eric Balchunas, the ARK Invest funds have 29 stakes in companies that are over this limit.

FT Alphaville has been through the SEC disclosures, and have identified 25 of these positions as of the last disclosure date, which was at the end of December.

(An important point to make here is that ARK’s beneficial ownership positions could have changed significantly since, but there is no complete data to our knowledge.)

The stakes include a 22 per cent position in $1.5bn Israeli 3D printer company Stratasys, a 18 per cent holding in $2.7bn online learning business 2U and 14 per cent stake in $9bn Swiss-American biotech Crispr Theraputics.

The question is though, what does the short swing rule mean for ARK with regards to such positions? If you flicked through the Latham and Watkins brief above, you’ll have read this at the bottom:

To summarise: any profits made by an insider within a six-month trading window must be returned back to the company. To boot, these trades are matched to make the most profitable trade possible.

For instance, if a beneficial owner (say, a fund with a 10 per cent holding or more) bought 100 shares at $10, and then bought another 100 at $12 before selling 100 at $16 within a six-month period, the profit to be returned would be $600 (6 dollars profit times 100 shares).

What’s less clear, is by what mechanism this happens. We spoke to Ann Lipton, a securities and corporate litigator who teaches at Tulane Law in Louisiana, and she told us the most common way the profits were forfeited was for an investor to sue the beneficial owner. It is less common, apparently, for a company to sue a shareholder as it would sour the cordial relations between the two.

The central question is whether ARK is liable for returning any of their trading profits in these 29 companies? Of course, it has to scale up or down their positions depending on the flows into its various investment products. So, there is a strong likelihood that there’ll be some trading activity within a six-month period which can be “matched” as being profitable. This is the case even if ARK made net losses on these investments in the end.

While we do not have a detailed breakdown of all of its trading activity, ARK does disclose the trading in its 7 ETFs every day. That data has been helpfully collated on a site called Cathie’s Ark. (What else?)

Cast your eyes down the page, and you’ll see that ARK sold 201,400 shares in Stratasys (shareholding: 22 per cent) on March 1. Now we do not know whether it made a purchase of its shares in the prior six-month period, but if it did, ARK might have to forfeit its profits on the trade to the company. This pattern could repeat itself over all of the plus 10 per cent shareholdings in its portfolio.

We were keen to hear if ARK were aware or had been subject to the short swing rule and, if so, what steps it was taking to mitigate it.

Their representative replied thusly in an email (our emphasis):

Which is to imply that ARKK is a passive vehicle that is also run by a self-described star stock picker? Curious.

The email went onto say:

Of course, this is all theoretical. But all it would take is one angry, litigious investor, perhaps jilted by losses, for this idea to come under some scrutiny.

Judging by the 20 per cent plus falls in several of these stocks over the past month, that moment might come sooner than later.