I blogged a couple of years ago about Avalon Holdings v. Gentile, in which the plaintiffs alleged that a Bahamian broker-dealer (MintBroker) and its sole owner (Guy Gentile) became 10% owners of two microcap companies, Avalon Holdings and New Concept Energy, when their high-volume trading took them over 10% of each company’s stock and then, within days, back below 10%. While over 10%, the defendants engaged in thousands of algorithmic purchases and sales.
In its prior ruling, the court denied a motion to dismiss which argued that, because Section 16(b) was designed to address trading by persons presumed to be in possession of material nonpublic information, it does not apply to high-frequency transactions by “briefly tenured shareholders with no connection to an issuer and no conceivable opportunity to obtain inside information.” The court rejected the argument, holding that once a trader crosses the 10% threshold, Section 16(b) “operates mechanically,” without regard for whether the insider has access to inside information.
Both the plaintiffs and the defendants later moved for summary judgment, and the court has now granted the plaintiffs’ motion. The defendants argued that, because the volume of trading in both companies’ stock while the defendants were over 10% exceeded the number of shares outstanding (as much as four-times the number of shares outstanding traded within a few days, at increasingly higher prices), many of the shares sold must have been sold by “naked short sellers” who didn’t own stock and who would have been forced to borrow shares or fail to deliver. As rapidly as the defendants were trading in and out of the stock, they argued, it is unlikely the stock they purchased ever landed in their accounts on the settlement dates, meaning the defendants never beneficially owned the stock. Instead, share transfers were merely reflected in DTC’s electronic book entry system.
The court rejected the argument, holding that beneficial ownership is acquired on the date a person’s rights and obligations become fixed and irrevocable, which in an open market transaction is the trade date. While the defendants were able to show that a significant number of trades in the securities of the two companies during the relevant time period resulted in failures to deliver, the defendants did not produce any evidence that their own transactions did not settle. Accordingly, the defendants became beneficial owners of all shares they purchased.
— Alan Dye, Section16.net, April 18, 2022