Commissioner Mark Uyeda Dissents in Unregistered Dealer SEC Enforcement Action

Over the past few years, we have closely followed the Securities and Exchange Commission (the “SEC” or the “Commission”) as it has brought a parade of actions against lenders that purchase variable-rate convertible notes from public companies. 

• 11/17/2017 – SEC v. Ibrahim Almagarby and Microcap Equity Group LLC (Complaint) 
• 2/26/2020 – SEC v. John D Fierro and JDF Capital, Inc. (Complaint) 
• 3/24/2020 – SEC v. Justin W. Keener D/B/A JMJ Financial (Complaint) 
• 9/03/2020 – SEC v. John M. Fife, Chicago Venture Partners, L.P., Iliad Research and Trading, L.P., St. George Investments LLC, Tonaquint, Inc., and Typenex Co-Investment, LLC (Complaint) 
• 8/13/2021 – SEC v. GPL Ventures, Alexander J. Dillon, Cosmin I. Panait, GPL Management LLC, et. al., (Complaint) 
• 9/24/2021 – SEC v. Carebourn Capital, L.P. and Chip Alvin Rice (Complaint)
• 6/07/2022 – SEC v. LG Funding, LLC and Joseph Lerman (Complaint) 
• 8/02/2022 – SEC v. Crownbridge Partners, LLC, Soheil Adhoot, and Sepas Ahdoot (Complaint) 
• 9/22/2022 – SEC v. Morningview Financial, LLC and Miles M Riccio (Complaint)
• 6/01/2023 – SEC v. Auctus Fund Management, LLC, Louis Posner and Alfred Sollami, and Auctus Fund LLC (Complaint) 
• 6/16/2023 – SEC v. BHP Capital NY, Inc. and Bryan Pantofel (Complaint) 
• 9/28/2023 – SEC v. Adam Long, L2 Capital, LLC., and Oasis Capital, LLC (Complaint)
• 1/23/2024 – SEC v. Aryeh Goldstein, Adar Bays, LLC, and Adar Alef, LLC (Complaint)
• 4/29/2024 – SEC v. Tri-Bridge Ventures, LLC and John Francis Forsythe, III (Complaint)
• 5/7/2024 – SEC v. Curt Kramer, Power Up Lending Ltd., Geneva Roth Remark Holdings, Inc., and 1800 Diagonal Lending, LLC (formerly known as Sixth Street Lending LLC) (Complaint)
• 8/19/2024 – SEC v. GHS Investments, LLC, Mark S. Grober, Sarfraz S. Hajee, and Matthew L. Schissler (Administrative Proceeding) 

In each of the above-listed cases, the SEC targeted the lender because they had engaged in the regular business of acquiring convertible, variable-rate notes from penny stock securities issuers, converting the notes into stock at a substantial discount from the prevailing market price, and selling the resulting newly issued shares of the issuers’ stock into the public market to obtain profits. 

In each case, the SEC argued that this type of action (participating in hundreds of transactions involving dozens of issuers to sell billions of shares of stock and generate millions in profits in their own accounts) qualified the lenders as “dealers” and, thus, required the lenders to register as such under the Exchange Act.  By not registering as “dealers”, the SEC determined that the lenders’ conduct violated the Federal Securities Laws by acting as Unregistered Dealers.

This argument has worked well.  The SEC has already successfully concluded several of the cases brought against the lenders: 

• In the SEC vs. JOHN D. FIERRO et al., Civil Action No. 20-02104 (GC) (JBD), the court ordered the defendants to pay disgorgement of $4,053,148, prejudgment interest of $1,326,440, and a civil penalty of $500,000, for a total judgment of $5,879,588. The court also ordered the defendants to surrender certain stock and conversion rights under existing convertible securities for cancellation. (read more here)
• In the SEC vs GPL VENTURES LLC, et al., 21-cv-6814 (AKH), the court ordered the defendants to pay $29,681,569 in disgorgement and $2,489,799 in prejudgment interest, total civil penalties of $7,000,000 and directed the defendants to surrender for cancelation all remaining unconverted convertible notes still held, with a face value of approximately $11 million. (read more here)
• In the SEC vs BHP CAPITAL NY, INC. and BRYAN PANTOFEL, Case No. 1:23cv22233-GAYLES-TORRES, the court ordered the defendants to pay a total of $2,553,073.44 in disgorgement, prejudgment interest, and penalties and directed the defendants to surrender for cancellation and retirement all remaining warrants, shares, and conversion rights on convertible notes still held by the defendants.
• In the SEC vs. IBRAHIM ALMAGARBY and MICROCAP EQUITY GROUP, LLC, Case No. 17-62255-CIV-COOKE/HUNT, the court ordered the defendants to disgorge $885,126.30 in total net profits and $182,150.69 in prejudgment interest, for a total of $1,067,276.99. The court also ordered the defendants to surrender their remaining shares for cancellation. (read more here)
• In the SEC vs JUSTIN W. KEENER, d/b/a JMJ Financial, Case No. 20-cv-21254-BLOOM/Louis, the court ordered the defendant to pay disgorgement of $7,786,639, prejudgment interest of $1,425,266, and a civil penalty of $1,030,000, for a total judgment of $10,241,905.  The court also ordered the defendant to surrender for cancellation all stock and conversion rights under existing convertible securities. (read more here)
• In the SEC Settlement with GHS Investments, LLC, Mark S. Grober, Sarfraz S. Hajee, and Matthew L. Schissler, GHS was ordered to pay $2,030,806 in disgorgement, prejudgment interest of $221,458.43, and a civil penalty of $173,080.62.  Each of Grober, Hajee and Schissler were ordered to pay a $10,000 penalty and consent to cease and desist from committing or causing any violations and any future violations of Section 15(a)(1) of the Exchange Act. GHS was also ordered to (i) surrender for cancellation all rights to all shares of common stock that it received in connection with convertible, variable rate notes; (ii) surrender all conversion rights under all remaining convertible, variable rate notes; and (iii) surrender for cancellation and retirement all remaining warrants that it received in connection with convertible, variable rate notes. (read more here)

However, the recent GHS settlement came with an interesting dissent from SEC Commissioner Mark T. Uyeda. Uyeda claims the reason for his dissent is because “it appears that the Commission is attempting to achieve policy objectives through enforcement, instead of rulemaking, while also arbitrarily deciding which activities necessitate enforcement action.” 

In his dissent, Uyeda seems to accept the generally accepted description of variable-rate convertible notes as “toxic” and “death spiral” financings that harm the share price of the issuers that participate in them, but he lays the blame squarely on the issuers, stating that “companies generally issue these notes understanding this risk because they have no other sources of financing.“

Uyeda believes that rather than enforcement action to curb the use of variable-rate convertible notes (which are highly lucrative to the lenders that participate in this type of financing but very harmful to the issuers and retail investors), the better course of action is through rulemaking.

The SEC has, in fact, proposed changes to Rule 144, which would eliminate tacking of holding periods for certain types of convertible, variable rate notes, including those at issue in all of the above-mentioned unregistered dealer cases. Without tacking, lenders receiving shares as payment for variable-rate convertible notes would be required to hold the converted shares for at least six months before selling them, which could discourage many of the lenders from purchasing notes at the outset because they would be subject to investment risk while holding the underlying common stock after conversion. However, the Commission has yet to take final action on the proposal.

Uyeda then follows up with reasons why he feels that regulation by enforcement is “extremely problematic.”

• First, he argues that prior to 2017, investors in convertible, variable-rate notes had no reason to believe that their activity could trigger dealer registration obligations since the SEC never used that interpretation of “dealer” prior to 2017. Therefore, in Uyeda’s opinion, the interpretation of “dealer” now being used by the SEC is “novel” and doesn’t meet the standards of “fair notice“.  GHS participated in its last convertible, variable-rate note in 2020. Uyeda clearly feels that at the time GHS participated in its convertible,variable-rate notes, GHS was unaware that it was violating securities regulations (or at least could not have reasonably been expected to know). We aren’t really sure how Uyeda feels about actions taken against other lenders that participated in convertible, variable-rate notes more recently (say in 2022 and 2023).
• Second, he argues that “under the Commission’s broad definition of “dealer,” nearly any activity that involves buying and selling securities outside of the trader exception could require registration under the Exchange Act. Yet the action against GHS is solely focused on its transactions involving convertible, variable rate notes.” To make his point, Uyeda points out how GHS also acquired shares of common stock at a discounted price pursuant to equity lines of credit and then sought to resell them at prevailing market prices pursuant to registration statements under the Securities Act.

It’s that second argument that has us most intrigued. GHS isn’t the only lender that the SEC has taken action against that also participated in Equity Line Financings (financing agreements whereby an issuer enters into an agreement with an investor, pursuant to which the investor agrees to purchase securities pursuant to an agreed-upon pricing formula from the issuer in the future from time to time at the issuer’s request), but in each case, the SEC only mentions the convertible, variable-rate notes in the actions.

If the SEC is relying on Section 3(a)(5) of the Exchange Act, which generally defines the term “dealer” to mean “any person engaged in the business of buying and selling securities … for such person’s own account“, why do convertible, variable-rate notes transactions count, but not equity line financings?  After all, in both cases, the end result is that the investor is purchasing shares from the issuer and selling them into the market.  Instead, as Uyeda puts it, “the Commission appears to make an arbitrary decision that transactions involving convertible, variable rate notes should be subject to different – and harsher – regulatory treatment.“

Uyeda takes this argument a step further and even suggests that the SEC’s selective implementation of the “dealer” definition under the Exchange Act should be analyzed under the Supreme Court’s “void for vagueness” doctrine, which “addresses at least two connected but discrete due process concerns: first, that regulated parties should know what is required of them so they may act accordingly; second, precision and guidance are necessary so that those enforcing the law do not act in an arbitrary or discriminatory way.”

Uyeda believes that “under the Commission’s current interpretation of the “dealer” definition, parties cannot know what is required of them, and the Commission’s lack of precision enables enforcement actions to be undertaken in an arbitrary and discriminatory manner.”  Basically, Uyeda is saying that he believes that all of the SEC judgments against these lenders, which relied on the “dealer” definition, should be voided. 

We can’t say that we agree with Uyeda’s strong stances in favor of the lenders that participated in these convertible, variable-rate notes.  After all, the SEC’s job is, first and foremost, to protect investors and look out for the integrity of the marketplace, but we do think he makes some interesting points.  We agree with his point that rulemaking would be more effective than enforcement if the goal is to eliminate convertible, variable-rate notes (though, in this case, the SEC is saying a rule already exists that can be used to curb the use of convertible variable-rate notes – the “dealer” definition).   But mostly, like Uyeda, we would also like to see the SEC make a better distinction as to why convertible, variable-rate notes are treated one way under the “dealer” definition while equity line financings are treated differently. 

To speak with a Securities Attorney, please contact Brenda Hamilton at 200 E Palmetto Park Rd, Suite 103, Boca Raton, Florida, (561) 416-8956, or by email at [email protected]. This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as and does not constitute legal advice on any specific matter, nor does this message create an attorney-client relationship. Please note that the prior results discussed herein do not guarantee similar outcomes.

Hamilton & Associates | Securities Attorneys
Brenda Hamilton, Securities Attorney
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