A high-frequency trader who engaged in thousands of transactions in the stock of two companies during a single week and did not hold any shares for longer than a week was found to be an “insider” for purposes of the short-swing trading prohibition under Section 16(b) of the Exchange Act. Because the trader’s holdings exceeded the 10 percent beneficial ownership threshold during that week, he was barred from short-swing trading under the clear language of the statute. Therefore, the companies were allowed to proceed in their action to require the trader to disgorge short-swing trading profits of over $13 million (Avalon Holdings Corporation v. Gentile, September 24, 2019, Broderick, V.).
High-frequency trading. Between July 24 and July 31, 2018, Guy Gentile, the sole owner of trading firm MintBroker International, Ltd. and a resident of Puerto Rico, engaged in 2,331 purchase and sale transactions of common stock in Avalon Holdings Corporation, a publicly held corporation listed on NYSE. During that week, Gentile purchased approximately 2,325,244 shares and sold approximately 2,351,858 shares. Due to a spike in the stock price that week from $2.20 to $36.00, the defendants gained over $7 million in profits from these transactions. On July 31, the defendants sold 5,000 shares, reducing their ownership to less than 10 percent of all outstanding shares.
Similarly, the defendants engaged in several thousand purchase and sale transactions in the common stock of New Concept Energy, Inc. between June 29 and July 3, 2018, exceeding the 10 percent ownership threshold during that time and gaining approximately $6 million in profits.
Venue. The court first found that the defendants’ alleged trading of the companies’ stock on the NYSE provided a basis for venue in the Southern District of New York. In actions asserting violations of the Exchange Act, venue is governed by 15 U.S.C. § 78aa. The Second Circuit has held that the execution of relevant trades on the New York Stock Exchange is sufficient to establish venue in the Southern District of New York under § 78aa.
The court rejected the defendants’ argument that, since 2010, the “vast majority” of trading at the NYSE no longer takes place on the floor of the exchange on the corner of Broad St. and Wall St. in Manhattan, but rather in data centers located in northern New Jersey. Even if it were appropriate for the court to consider evidence from news articles, the articles did not unequivocally state that all the relevant NYSE operations had moved out of the district such that no “act or transaction constituting the violation” could have occurred there.
Short-swing trading. Next, the court found that the plaintiffs adequately established that the defendants’ trades fell within the short-swing trading prohibitions in Exchange Act Section 16(b). Although the defendants did not contest that they satisfied the definition of “insider”—a “person who is directly or indirectly the beneficial owner of more than 10 percent of any class of any equity security”— they argued that “Section 16(b) was clearly not designed to recover profits made from high-frequency trading positions by briefly-tenured shareholders with no connection to an issuer and no conceivable opportunity to obtain inside information.” The court found no support for this argument.
Assuming arguendo that the defendants did not have access to inside information during their brief period of beneficial ownership, this did not relieve the defendants of liability. Under precedent including the Second Circuit ruling in Donoghue v. Bulldog Inv’rs Gen. P’ship (2012), Section 16(b) imposes a “strict-liability rule” for disgorgement of profits, which operates without regard to whether the statutory fiduciaries were actually privy to inside information or whether they traded with the intent to profit from such information. Nor is any exception made for brief periods of 10 percent beneficial ownership.
The court quoted:
§16(b) operates mechanically, and makes no moral distinctions, penalizing technical violators of pure heart, and bypassing corrupt insiders who skirt the letter of the prohibition.Accordingly, because the transactions fell within the terms of Section 16(b), the court denied the defendants’ motion to dismiss.
This is case No. 18-CV-7291 (VSB).