A decision by the SDNY earlier this week demonstrates that actual awareness of inside information is irrelevant to whether an insider’s open market transactions are subject to Section 16(b), even if a trader crosses the 10% threshold only briefly and never has contact with the issuer. The case involves trading by an individual (Guy Gentile) through his wholly owned Bahamian company (MintBroker) in the securities of two issuers, Avalon Holdings and New Concept Energy. According to the complaints, MintBroker engaged in 2,331 transactions in Avalon stock during a one-week period in 2018, crossing the 10% threshold and falling back below it during that time, and similarly engaged in “several thousand” transactions in New Concept common stock during a four-day period in 2018, again crossing the 10% threshold and then falling back below it. The complaint alleges that the defendants manipulated the stock of the two companies, driving up the price and yielding short-swing profits of $7 million from trading in Avalon stock and $6 million from trading in New Concepts stock.
The defendants moved to dismiss the complaint on the ground, among others, 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.
The result is unsurprising and should serve as a warning to anyone having a computer-driven trading strategy who hasn’t capped long positions at 10% or less. The defendants apparently were aware of Section 16, having filed a Form 3 and a few Forms 4 during the short-swing periods. The Forms 4 I saw on EDGAR report only sales, though, while the 13Ds the defendants filed, reporting that they had gone over 5% but fallen back below 5% before filing, reported all of their purchases and sales within the preceding 60 days. Unless I missed something in the Forms 4, the plaintiff’s attorneys must have discovered the short-swing trading based on the 13Ds, not the Forms 4.
The defendants have raised other defenses, so the case isn’t over yet.
-Alan Dye, Section16.net September 27,2019