Avalon Holdings Corporation v. Gentile

597 F.Supp.3d 640

AVALON HOLDINGS CORPORATION, Plaintiff,

v.Guy GENTILE and MintBroker International, Ltd., Defendants.

New Concept Energy, Inc., Plaintiff,

v.Guy Gentile and MintBroker International, Ltd., Defendants.

18-CV-7291 (VSB), 18-CV-8896 (VSB)

United States District Court, S.D. New York.

Signed April 8, 2022

David Lopez, Law Office of David Lopez, Southampton, New York, Miriam Deborah Tauber, Miriam Tauber Law, New York, New York, Counsels for Plaintiffs.

Danielle M. McLaughlin, Adam C. Ford, Robert Seabrook Landy, Ford O'Brien Landy LLP, New York, New York, Counsel for Defendants.

OPINION & ORDER

VERNON S. BRODERICK, United States District Judge:

Before me are (1) the motions for summary judgment filed by Avalon Holdings Corporation ("Avalon") and New Concept Energy, Inc. ("New Concept") (together, "Plaintiffs") in the two related cases, both filed against Guy Gentile and MintBroker International, Ltd. (together, "Defendants"), (No. 18-cv-7291 ("Avalon Action") Doc. 75 and No. 18-cv-8896 ("New Concept Action") Doc. 68); and (2) the cross-motions for summary judgment filed by Defendants, (Avalon Action, Doc. 71 and New Concept Action, Doc. 64). For the reasons below, Plaintiffs’ motions for summary judgment are GRANTED and Defendants’ cross-motions for summary judgment are DENIED.

I. Factual Background ¹

A. Avalon Action

Avalon is an Ohio-based provider of waste management services. (Defs. 56.1 I ¶ 1.)² The shares of Class A Common Stock issued by Avalon were registered pursuant to § 12(b) of the Securities Exchange Act of 1934 (the "Exchange Act") and were listed on the New York Stock Exchange ("NYSE"). (Pl. 56.1 I ¶ 1.)³ Avalon shares, as with the majority of the publicly traded shares in the United States, were held in "street name," i.e., they were registered in the name of Cede & Co., the nominee of the Depository Trust Company ("DTC"), instead of in the names of the individual investors who bought the shares. (Defs. 56.1 I ¶¶ 15, 17.) Transactions of street name shares are conducted through DTC's electronic "book-entry" system, where the investors’ DTC accounts are debited or credited in accordance with the purchase or sale they make. (Id. ¶ 16.) In other words, DTC stock trades are all in the form of book-entries; there is no movement of actual physical stock certificates, which are typically stored in DTC's vault. (Id. )

Defendant MintBroker International, Ltd. (a/k/a Swiss America Securities Ltd.) ("MintBroker") was a Bahamian entity and broker-dealer registered under the Bahamas securities laws. (Pl. 56.1 I ¶ 3.) On June 15, 2018, MintBroker, through its broker, Interactive Brokers, Inc. ("Interactive Brokers"), opened a position in Avalon securities. (Defs. 56.1 I ¶ 3; Pl. 56.1 I ¶ 4.) On July 27, 2018, MintBroker filed with the Securities and Exchange Commission ("SEC") its "Initial Statement of Beneficial Ownership" (SEC Form 3),⁴ the form that stockholders are required to file under § 16(a) of the Exchange Act when they become the beneficial owner of more than 10% of the equity shares of the issuer company ("more-than 10% beneficial owners"). (Defs. 56.1 I ¶ 8.) The SEC Form 3 shows that MintBroker had taken a position of 1,922,095 shares in Avalon. (McLaughlin Decl. I Ex. 5.)⁵ On August 2, 2018, MintBroker netted its position in Avalon shares to zero. (Defs. 56.1 I ¶ 4.) The following is MintBroker's trading activities in Avalon shares from July 24, 2018 to August 1, 2018:

 Date 7/24 7/25 7/26 7/27 7/30 7/31 8/1
Buy Position      624,073     703,602       690,184       327,406
  Sell Position     99,086      118,277       215,677       192,340       719,885       799,720     200,280
  Net Position      524,987     1,110,312     1,584,819     1,719,885     1,000,000     200,280     0
  (end of day)6

[Editor's Note: The preceding image contains the reference for footnote⁶ ].

(Pl. 56.1 I ¶ 9.) Between its opening and closing positions, MintBroker made thousands of trades in Avalon shares. (Defs. 56.1 I ¶ 7.) During this period, there were roughly 3,000,000 Avalon shares outstanding,⁷ (Id. ¶ 14; Pl. 56.1 I ¶ 2), and only around 1.7 million of them were available for public trading,⁸ (Defs. 56.1 I ¶ 19). MintBroker's trading was part of the significant trading activities that Avalon stock experienced from late July to early August 2018, during which time the price of the stock skyrocketed. (Tauber Aff. I Ex. I, at 3).⁹ For the first seven months of 2018, up until July 24, Avalon's closing share price ranged from approximately $2.00 to $2.40. (Defs. 56.1 I ¶ 2.) However, on July 27, 2018, Avalon's closing share price was $10.25; during its peak trading on July 30, Avalon shares were traded at $20.20. (Tauber Aff. I Ex. I, at 1.)

Avalon now brings this action against MintBroker and Guy Gentiles, the sole owner of MintBroker and the person who directed MintBroker's trading activities. (Pl. 56.1 I ¶ 3). Avalon alleges that from July 24, 2018, when MintBroker became a more-than 10% beneficial owner of Avalon, up until July 31, 2018, when MintBroker's ownership of Avalon shares dropped below 10% (Short-Swing Period I),¹⁰ MintBroker made huge profits through trading Avalon shares. (Avalon Action, Doc. 19 ¶¶ 6–8.). Avalon seeks disgorgement of these profits under § 16(b) of the Exchange Act as profits obtained by corporate insiders during a short-swing trade. (Id. ¶ 40.)

B. New Concept Action

The New Concept Action involves a similar fact pattern. New Concept is a Texas-based oil and gas drilling and exploration company. (Defs. 56.1 II ¶ 1.)¹¹ The shares of Common Stock issued by New Concept were registered pursuant to § 12(b) of the Exchange Act and were listed on the NYSE. (Pl. 56.1 II ¶ 1.)¹² Like the Avalon shares, the New Concept shares were also held in street name and traded through DTC's book-entry system. (Defs. 56.1 II ¶¶ 16–18.)

On May 24, 2018, MintBroker, through Interactive Brokers, opened a position in New Concept securities. (Id. ¶ 3.) On June 29, 2018, MintBroker filed an SEC Form 3, which shows that it had taken a position of 1,073,713 shares in New Concept. (Id. ¶ 8.) On September 25, 2018, MintBroker closed its position in New Concept. (Id. ¶ 4.) The following is MintBroker's trading activities in New Concept on June 29, July 2, and July 3, 2018 (excluding June 30 and July 1, which was a weekend):

 Date 6/29 7/2 7/313
Buys              1,804,833     0           0
  Sells             780,348       113,576     960,137
  Net Position      22,848        57,631      0
  (end of day)14

[Editor's Note: The preceding image contains the reference for footnotes^{13 ,14} ].

(Pl. 56.1 II ¶ 9.) Between its opening and closing positions, MintBroker engaged in thousands of trades in New Concept shares. (Defs. 56.1 II ¶ 7.) During this period, there were roughly 2.1 million New Concept shares outstanding and available for public trading. (Id. ¶¶ 15, 20; Pl. 56.1 II ¶ 2.) The New Concept stock experienced significant trading activities from late June to early July 2018, (Tauber Aff. II Ex. I, at 3),¹⁵ and its share price surged. For the first six months of 2018, up until June 29, New Concept's closing share price ranged from approximately $1.26. to $1.89. (Defs. 56.1 II ¶ 2.) However, on June 29, 2018, New Concept's closing share price was $4.22; during its peak trading on July 2, New Concept shares were traded at $12.75. (Tauber Aff. II Ex. I, at 1–2.)

New Concept brings this action against Defendants, alleging that from June 29, 2018, when MintBroker became a more-than 10% beneficial owner of New Concept, up until July 3, 2018, when MintBroker's shares dropped below 10% (Short-Swing Period II, together with Short-Swing Period I, "Short-Swing Periods"), MintBroker made huge profits through trading New Concept shares, and such profits should be disgorged under § 16(b) as profits obtained by corporate insiders during a short-swing trade. (New Concept Action, Doc. 7. ¶¶ 12–29.)

C. Trade Settlement and "Naked" Short Selling

Under SEC Rule 15c6-1(a), as amended by the SEC on May 22, 2017, the standard settlement cycle for broker-dealer securities transactions is "trade date plus two business days," also referred to as the "T+2" schedule. (Defs. 56.1 I ¶ 57.) This means that when an investor buys or sells a security, the brokerage firm must receive payment or delivery of the security (i.e. "settle") no later than two business days after the trade is executed. (Id. ¶ 58.) All of MintBroker's transactions on Interactive Brokers occurred under the T+2 schedule. (Id. ¶¶ 59–60; see also Defs. 56.1 II ¶¶ 44–55.)

When a customer places an order for shares, Interactive Brokers routes the order to an exchange, where the order will be filled by a counterparty. (Defs. 56.1 I ¶ 70.) There are certain situations, however, where a trade is executed, but the shares are not readily available by the settlement day. (See SEC Key Points 2 (explaining reasons for the seller's failure "to deliver securities to the buyer when delivery is due").)¹⁶ One of these situations is created by a type of trading activity called "naked short selling," where investors short the shares without first locating the shares available for borrowing.¹⁷ (Defs. Mem. I 18; see also SEC Key Points 2.)¹⁸ In other words, there can be multiple brokers shorting the same "pot" of shares over and over again, which will result in the number of shares shorted exceeding the number of shares available. (See Defs. Mem. I 18; Defs. 56.1 I ¶¶ 68–69.) Therefore, when an investor purchases shares from a "naked short seller," those shares may not be deliverable within two days after the trade date, and the trade will "fail to settle" under the T+2 schedule. (SEC Key Points 2.)

Interactive Brokers does not place any securities into the customer's account until the trade is settled. (Defs. 56.1 I ¶ 72.) Moreover, it does not know, when the order is filled by a counterparty, whether the counterparty actually has the shares it purports to be selling, i.e., it does not know whether...