v.
Mintz
IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW JERSEY CAMDEN VICINAGE
U.S. SECURITIES AND EXCHANGE COMMISSION, Plaintiff, Civil Action No. 23-3201 (RMB/AMD) v. OPINION HAL D. MINTZ and SABBY MANAGEMENT, LLC, Defendants.
APPEARANCES: Daniel J. Maher Edward J. Reilly U.S. SECURITIES & EXCHANGE COMMISSION 100 F. Street NE Washington, D.C. 20549
On behalf of Plaintiff U.S. Securities & Exchange Commission
Jay S. Auslander (pro hac vice) Aari Itzkowitz (pro hac vice) Michael Van Riper WILK AUSLANDER LLP 825 Eighth Avenue, Suite 2900 New York, New York 10019
On behalf of Defendants Hal D. Mintz and Sabby Management LLC RENÉE MARIE BUMB, Chief United States District Judge:
This is a civil enforcement action by the U.S. Securities and Exchange Commission (“SEC” or “Commission”) against Defendants Hal D. Mintz (“Mintz”) and Sabby Management, LLC (“Sabby”) (collectively, “Defendants”) for violations of federal securities laws. In the main, the SEC alleges that between March 2017 and May 2019 Mintz orchestrated a “naked” short-selling scheme involving the securities of 10 issuers in circumvention of Regulation SHO, to the tune of $2 million of ill-gotten
gains. [Compl. ¶¶ 1–8, Docket No. 1.] Before the Court is Defendants’ Motion to Dismiss pursuant to Federal Rule of Civil Procedure 12(b)(6). [Docket No. 10.] Seeking partial dismissal of the SEC’s Complaint, Defendants argue that a subset of the SEC’s allegations—the “additional abusive trading” identified in paragraphs 96 through 99 of the Complaint, and Appendix A attached thereto (and to this
Opinion)—fails to comply with the heightened pleading standards of Federal Rule of Civil Procedure 9(b). They also contend that the SEC’s claims for civil monetary penalties and disgorgement are time-barred, in part, pursuant to 28 U.S.C. § 2462. Having considered the parties’ submissions, the Court resolves the Motion without oral argument. Fed. R. Civ. P. 78(b); L. Civ. R. 78.1(b). For the reasons expressed
herein, the Motion will be GRANTED, in part, and DENIED, in part. * * * I. FACTUAL BACKGROUND1 As the SEC summarizes, “From at least March 2017 through May 2019, Mintz,
a highly experienced trader, through Sabby, used his knowledge to game the markets and carry out Defendants’ fraudulent scheme by repeatedly circumventing trading rules involving at least 10 issuers on behalf of two private funds managed by Defendants.” [Compl. ¶ 1.] In particular, the SEC accuses Defendants of carrying out a fraudulent scheme involving two forms of abusive trading in violation of Regulation
SHO and applicable federal securities laws. First, Defendants allegedly mismarked sales of securities as “long,” when they should have been marked as “short,” because Defendants were not “deemed to own” the securities being sold at the time and did not have a net long position in such securities. [Id. ¶ 2.] This enabled them to disguise certain sell orders and avoid
complying with Regulation SHO’s “locate” requirements. [Id. ¶¶ 2–3 (citing 17 C.F.R. § 242.200–242.204).] Second, Defendants allegedly marked and sold certain shares “short” when they knew or were reckless in not knowing that they had not borrowed or located such shares, as required. [Id. ¶ 2.] These trades also failed to comply with the “locate” requirements of Regulation SHO and, for positions in which Defendants
1 As explained below, see infra § III.A., the Court draws all factual allegations from the Complaint and accepts all well-pleaded allegations as true. See Evancho v. Fisher, 423 F.3d 347, 350–51 (3d Cir. 2005) (“When considering a Rule 12(b)(6) motion, we are required to accept as true all allegations in the complaint and all reasonable inferences that can be drawn therefrom, and view them in the light most favorable to the plaintiff.”) (citations omitted). failed to deliver the securities by their settlement date, constituted “naked” short selling. [Id.] Defendants’ scheme allegedly enabled them to reap at least $2 million of ill-gotten gains. [Id. ¶ 3.] While their scheme is described in greater detail below, the Court only recites those factual allegations that it deems necessary to resolve the pending Motion to Dismiss. The parties agree that Defendants’ Motion is not claim- or case-dispositive. A. The Defendants. Sabby is a Delaware limited liability company that was established in 2011. [Compl. ¶ 16.] Since July 12, 2013, Sabby has been registered with the SEC as an investment adviser. [Id.] During the period relevant to this action, Sabby maintained an office in Saddle River, New Jersey. [Id.] Sabby’s business consists of managing two private funds—Sabby Healthcare Master Fund, LTD (the “Healthcare Fund”) and Sabby Volatility Warrant Master Fund, LTD (the “Warrant Fund”) (collectively, the “Private Funds”)—from which it earns management and performance fees. [Id.] The Healthcare Fund, a Cayman Islands entity, is a master hedge fund. [Id. ¶ 17.] At the beginning of the relevant period, it had a gross asset value of $400 million. [Id.] As of its most recent public filing, the Healthcare Fund had a gross asset value of $16 million and 28 beneficial owners. [Id.] As of September 30, 2022, Mintz held a 7.3% equity interest in the Healthcare Fund. [Id.] The Warrant Fund, also a Cayman Islands entity, is a master private equity fund. [Id. ¶ 18.] At the beginning of the relevant period, it had a gross asset value of $60 million. [Id.] As of its most recent public filing, the Warrant Fund had a gross asset value of $182 million and 73 beneficial owners. [Id.] As of September 30, 2022, Mintz held a 39.9% equity interest in the Warrant Fund. [Id.] Mintz, now a resident of Miami, Florida, was the principal and managing partner of Sabby during the relevant period. [Id. ¶ 15.] He had “primary responsibility for making investment decisions, including daily securities trading decisions, for the Private Funds.” [Id.] The SEC alleges that, because of his position, “Sabby is liable for Mintz’[s] conduct.” [Id.] During the relevant period, Sabby’s investment strategy involved participating in secondary offerings by issuers, including common and convertible securities. [Id. ¶ 37.] On October 14, 2015, the SEC instituted cease-and-desist proceedings against Sabby for violations of Rule 105 of Regulation M of the Securities Exchange Act of 1934. [Id. ¶ 16.] The SEC imposed a cease-and-desist order, disgorgement of $184,747.10, and a civil penalty of $91,669.95. [Id.] B. Short Selling and Regulation SHO. As this action regards an alleged “long[-]running fraudulent scheme involving abusive ‘naked’ short selling, order mismarking, and other violative trading” by Defendants, [Compl. ¶ 1], the Court provides a brief overview of short selling and Regulation SHO.[2] A “short sale” is defined as “any sale of a security which the seller does not own or any sale which is consummated by the delivery of a security borrowed by, or for the account of, the seller.” 17 C.F.R. § 242.200(a). “Short selling can be a logical trading strategy for a trader who believes that the price of shares is likely to decline over the near-term.” SEC v. Colonial Inv. Mgmt. LLC, 659 F. Supp. 2d 467, 470 (S.D.N.Y. 2009) (citing Levitin v. PaineWebber, Inc., 159 F.3d 698, 700 (2d Cir. 1998)). In a fairly recent case, the Supreme Court summarized the mechanics of a short-sale transaction: A typical short sale of a security is one made by a borrower, rather than an owner, of stock. In such a transaction, a person borrows stock from a broker, sells it to a buyer on the open market, and later purchases the same number of shares to return to the broker. The short seller’s hope is that the stock price will decline between the time he sells the borrowed shares and the time he buys replacements to pay back his loan. If that happens, the seller gets to pocket the difference (minus associated transaction costs). Merrill Lynch, Pierce, Fenner & Smith Inc. v. Manning, 578 U.S. 374, 377 (2016). In principle, there is nothing wrong with short selling. See ATSI Commc’ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 101 (2d Cir. 2007) (“[S]hort selling—even in high volumes— is not, by itself, manipulative.”). “The Commission has long held the view that short selling provides the market with important benefits, including market liquidity and pricing efficiency.” SEC Release No. 34-59748, 74 Fed. Reg. 18042, 18044 (Apr. 20, 2 This background material is drawn from the Complaint, [see Compl. ¶¶ 24– 36], and the Court’s review of applicable law. 2009). Still, “[a]lthough short selling serves useful market purposes, it also may be used to illegally manipulate stock prices.” Id. In a “naked” short sale, by contrast, “the seller has not borrowed (or otherwise obtained) the stock he puts on the market.” Manning, 578 U.S. at 377 (emphasis added); accord Compl. ¶ 24 (“A ‘naked’ short sale generally refers to selling short without having borrowed or arranged to borrow securities to make delivery to the buyer within the standard settlement period [three days].”). Sometimes, sellers “intentionally fail to deliver securities as part of a scheme to manipulate the price of a security, or possibly to avoid borrowing costs associated with short sales.” “Naked” Short Selling Antifraud Rule, SEC Release No. 34-58774, 73 Fed. Reg. 61666, 61667 (Oct. 17, 2008). This abusive practice can serve to “drive down a company’s stock price.” Id. at 61670. In 2004, the SEC adopted Regulation SHO “in part to address problems associated with persistent fails to deliver securities and potentially abusive ‘naked’ short selling.” Id. at 61667. Regulation SHO thus requires broker-dealers to comply with a series of obligations. First, Rule 200(g) of Regulation SHO requires broker-dealers to mark all sell orders of any equity security as “long,” “short,” or “short exempt.” 17 C.F.R. § 242.200(g). The Court refers to this provision as the “marking” requirement. A sell order may be marked “long” only if the seller of the security is “deemed to own” it, see id. § 242.200(b)–(f) (outlining the circumstances under which a person shall be “deemed to own” a security), and the security to be delivered “is in the physical possession or control” of the broker-dealer or the broker-dealer reasonably believes that it will be. Id. § 242.200(g)(1). A seller of convertible securities is not “deemed to own” the underlying security until that person “has tendered such security for conversion or exchange.” Id. § 242.200(b)(3). “A sale order shall be marked ‘short exempt’ only if the provisions of § 242.201(c) or (d) are met.”3 Id. § 242.200(g)(2). Otherwise, any sale of a security that the seller does not own must be marked “short.” See id. § 242.200(a) and (g). Second, before accepting a short sale order or effecting a short sale for its own account (with certain exceptions not relevant here), broker-dealers must document the source of the securities being sold. 17 C.F.R. § 242.203(b)(1)(iii). Specifically, a broker-dealer must have borrowed the security, have entered into a bona-fide arrangement to borrow the security, or have reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due. See 17 C.F.R. § 242.203(b)(1)(i)–(iii). This is generally referred to as the “locate” requirement. See Elec. Trading Grp., LLC v. Banc of America Sec. LLC, 588 F.3d 128, 135 (2d Cir. 2009). Third, Regulation SHO requires participants of a registered clearing agency to immediately purchase shares to close out of a fail-to-deliver position in “threshold securities” if the fails to deliver persist for 13 consecutive settlement days. See 17 C.F.R. § 242.203(b)(3). Threshold securities are generally equity securities with large 3 The Court observes that this action does not involve any “short exempt” securities. [See generally Compl.] and persistent “fails to deliver.” Id. § 242.203(c)(6). This is generally referred to as the “delivery” requirement. See Elec. Trading Grp., 588 F.3d at 135–36. C. Mintz’s Role in Sabby’s Operations. As noted above, Mintz had primary responsibility for making investment decisions for the Private Funds. [Compl. ¶¶ 15, 37.] The SEC further alleges that Sabby’s policies and procedures vested Mintz with responsibility for “knowing whether the Private Funds had a net short or long position in an issuer’s stock and whether each sale of an issuer’s stock was a short sale or a long sale.” [Id. ¶ 38.] In fact, Sabby’s policies and procedures required Mintz or his trading designee to consult Sabby’s trading records before a short sale order could be place, including (i) “a list of available locates provided on a daily basis from Prime Broker 1”;4 (ii) “Sabby’s trading log to see how many shares of the issuer had been sold short so far that day”; and (iii) “short sales executed through brokers not reflected in Sabby’s trading log.” [Id. ¶ 39.] “Mintz was responsible for reporting any instance where a locate was not properly obtained, for reviewing all short sale reports for accuracy, and for ensuring that all orders, including short sale orders, were marked correctly.” [Id. ¶ 40.] 4 “Prime Broker 1” is alleged to be “a broker-dealer used by Sabby to maintain custody of the securities of both the Warrant Fund and the Healthcare Fund.” [Compl. ¶ 21.] D. The Alleged Fraud.
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APPENDIX A Issuer Fund(s) Locates Number Total Naked Short Sales Total Naked Profit After Acquiring Date Range Reset Engaged in of Orders With False Short Sale Orders Short Sales Shares For Delivery Provision Trading Occasion Representations Mismarked as Shares & s Locates Concerning Long Sales Proceeds Denied Locates Issuer 1 Warrant 67,760 1,100 68,860 $202,810 3/15/2017 – No Fund and 3/17/2017 Healthcare $438,578 Fund
Issuer 2 Warrant 877,540 0 877,540 $347,270 7/26/2017 No Fund and Healthcare $1,470,521 Fund Issuer 3 Warrant 45 280,150 0 280,150 $307,390.75 7/28/2017 – No Fund and 7/31/2017 Healthcare $727,818 Fund Issuer 4 Warrant 0 381,642,544 381,642,544 $204,169.89 6/25/2018 – No Fund 7/6/2018 $922,689 Issuer 5 Warrant 0 527,778 527,778 $81,691 7/11/2018 – Yes. Naked Fund 7/12/2018 short sold $412,241 400,150 shares in advance of a warrant conversion price reduction effective July 12, 2018, and exercised warrants after the conversion price reduction. Issuer 6 Warrant 7,638,623 0 4,596,514 $83,222 7/20/2018 – No Fund 7/23/2018 $329,597
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APPENDIX A
Issuer 7 Warrant 210,939 0 196,262 $341,184 2/25/2019 – No Fund 3/5/2019 $343,226 Issuer 8 Warrant 119,181 0 119,181 $345,242. 5/1/2019 – No Fund 5/6/2019 $944,101.