SEC Says Ibrahaim Almagarby and Microcap Equity Group Are Unregistered Dealers
We’ve previously written about Securities and Exchange Commission (“SEC”) enforcement actions pending against John Fierro and Justin Keener alleging unregistered dealer activity. Filed in February and March 2020 respectively, they are similar to a lawsuit the agency brought against Ibrahaim Almagarby and his company Microcap Equity Group LLC (“Microcap Equity”) in late 2017. The Almagarby suit moved slowly, but the order handed down by Judge Marcia Cooke on August 17, granting the SEC’s motion for summary judgment and denying the defendants’ cross-motion for summary judgment, will bring the matter to an end quickly.
The recent ruling in the SEC action against Ibrahim Almagarby and Microcap Equity addresses unregistered dealer activity by businesses engaged in the purchase of notes and/or bonds convertible at a discount to the market price of the underlying security. These types of transactions are most often the result of toxic note financings provided to penny stock companies; they sometimes feature conversion ratios as dramatic as an 80 percent discount from the issuer’s trading price.
In its complaint, the SEC alleged that Almagarby and Microcap Equity acted as “dealers” without registering with the SEC, as both brokers and dealers are required to do under the Securities Exchange Act of 1934 (the “Exchange Act”). The agency also charged Almagarby with control person liability under Section 20 of the Exchange Act based on Microcap Equity’s alleged violation of Section 15(a). Among other things, Ibrahim Almagarby and Microcap Equity contend that they were acting outside the scope of the definition of a “dealer,” because their conduct was that of a “trader,” which is excluded from the SEC’s dealer registration requirements.
We have analyzed hundreds of convertible notes on behalf of issuers who sell them to toxic lenders operating as unregistered dealers. In almost every instance, the unregistered dealers raise the same flawed defenses offered by Ibrahim Almagarby, Justin Keener, and John Fierro. This week the Court in the SEC action against Almagarby and Microcap Equity confirmed the long-standing position of the SEC and federal courts: if a business is engaged in the purchase and sale of securities on a regular basis, it is not a “trader,” and must be registered as a dealer.
Why don’t the dilution funders simply register as a dealer? It isn’t easy and, in some instances, they may not qualify. The registration requirements are significant. Dealers must register with the SEC by electronically filing a Form BD (for “broker-dealer”) application, become a member of a self-regulatory organization such as the Financial Industry Regulatory Authority (“FINRA”), and must join the Securities Investor Protection Corporation (“SIPC”). Further, dealers are required to be licensed in all the states where they conduct business, and individuals must also pass certain securities examinations, such as the Series 7. Form BD requires expansive disclosures about the background of the dealer and its principals, controlling persons, and employees. The dealer must meet the statutory requirements to engage in a business that involves high professional standards, and quite often includes the more rigorous responsibilities of a fiduciary. Within 45 days of filing a completed application, the SEC will either grant registration or begin proceedings to determine whether it should deny registration. Then, the dealer must file an independent membership application to FINRA, and FINRA must accept it. Dealers must comply with relevant state law as well as federal law and applicable FINRA rules. Timeframes for registration with individual states may differ from the federal and FINRA timeframes. In addition to stringent registration and FINRA membership requirements, the SEC and FINRA impose standards of conduct and recordkeeping obligations. Registered dealers are also subject to onsite inspection by the SEC and FINRA.
SEC v Microcap Equity Group and Ibrahim Almagarby
During the period relevant to the SEC charges, Ibrahim Almagarby was a 29-year-old college student who formed Microcap Equity Group in January 2013. Microcap Equity’s business model was to acquire “aged debt” owned by third parties in a variety of microcap issuers. He’d negotiate a debt purchase agreement with the note holder to acquire the debt at face value. “Face value” did not, of course, include the hefty discount to market he’d receive when he converted. At the same time, he’d negotiate an agreement with the issuer, by the terms of which he would be permitted to convert the note to “free trading” stock immediately.
The issuer’s transfer agent would issue unrestricted stock and deposit in in one of the six trading accounts in the name of Microcap Equity he used for that purpose. Upon receipt, he’d sell the stock into the public market as soon as possible.
Unlike Justin Keener and Justin Fierro, Ibrahim Almagarby didn’t advertise that he was willing to buy or sell securities. The court notes that during the relevant period, Almagarby and Microcap Equity engaged in convertible note transactions with at least 38 different issuers.
The SEC’s complaint charges Almagarby and Microcap Equity with violating Section 15(a) of the Exchange Act by acting as unregistered securities dealers.
Section 15(a) makes it unlawful, inter alia, for an unregistered dealer to purchase or sell securities. Section 3(a)(5)(A) of the Exchange Act defines dealer as “any person engaged in the business of buying and selling securities . . . for such person’s own account through a broker or otherwise.” Section 3(a)(5)(B) excludes from the definition of dealer any “person that buys and sells securities . . . for such person’s own account, either individually or in a fiduciary capacity, but not as part of a regular business.” This statutory exception from the definition of dealer is typically referred to as the trader exception. Section 3(a)(5) does not enumerate any specific activities that separate a dealer from a trader; when read together, the two subsections of the statute simply require that those who buy and sell securities as part of a “regular business” must register with the Commission as securities dealers.
This Court states that the issue of unregistered dealer activity by Almagarby and Microcap Equity turns on whether Microcap Equity is engaged in the “business of” buying and selling securities for its own account. It notes that business is defined as “[a] commercial enterprise carried on for profit, a particular occupation or employment habitually engaged in for livelihood or gain.”
The Court relies cites the Eleventh Circuit’s decision in S.E.C. v. Big Apple Consulting USA, Inc., 783 F.3d 786, 809 (11th Cir. 2015) in its analysis. There, the Eleventh Circuit upheld a decision granting summary judgment based in part on the definition of dealer under the Exchange Act. Affirming the district court’s finding that the entities were dealers, the appellate court wrote “the centerpiece to [the definition of dealer] is the word ‘business,’” and found that where a company’s business model is based entirely on the purchase and sale of securities, that fact constitutes conclusive proof that the company is a dealer”.
“While evidence of merely some profits from buying and selling securities may alone be inconclusive proof, Defendants’ entire business model was predicated on the purchase and sale of securities. [The Defendants] depended on acquiring client stock to support operations and earn a profit… As further evidence of their dealer status, [Defendants] purchased [an issuer’s] stocks at deep discounts pursuant to its contractual agreement with [the issuer] and then sold those stocks for profit.”
The Court also states that the number of deals and the profit Almagarby and Microcap Equity generated gives credence to the proposition that they were engaged in the “business” of buying and selling securities. SEC v. Ridenour, 913 F.2d 515, 517 (8th Cir. 1990), (defendant “was a dealer because his ‘high level of activity . . . made him more than an active investor’.”) Taken together, it is indisputable that Defendants were “in the business of. . .buying [and] selling securities. . .” and, therefore, they do not meet the § 4(1) exemption to the registration requirement. SEC v. Offill, Case No. 3:07-CV-1643-D, 2012 WL 246061 at *8-9 (N.D. Tex. Jan. 26, 2012) (granting summary judgment on a Section 15(a) claim for failure to register and holding that the defendant “bought and sold securities as part of his regular business, making him a dealer under 15 U.S.C. § 78c(a)(5)”).
The Court also notes that Almagarby and Microcap Equity cite various factors and activities identified in SEC releases or SEC staff no-action letters as “[e]vidence of those activities are required for the SEC to prove that Defendants were engaged in the business of buying and selling as part of a regular business, and the absence of any such evidence warrants finding summary judgment in favor of Defendants.” The Court disagreed:
“The foregoing factors are merely examples of activity or actions that might render one a dealer and that there is nothing in any of the cited releases or no-action letters that implies that the listed factors are an exclusive or exhaustive checklist that creates a burden of proof for the SEC. Moreover, SEC no-action letters are not binding pieces of legislation, rather they are “informal advice given by members of the Commission’s staff” that “state with respect to a specific proposed transaction that the staff will not recommend to the Commission that it take enforcement action if the transaction is consummated exactly as it has been described.” They are “not rulings of the Commission or its staff on questions of law or fact and are not dispositive of the legal issues raised as to the applicability of the federal securities laws to a given transaction.”
Anyone who’s ever invested in penny stocks knows how much damage toxic funders can do, first to the company itself, by forcing dilution that’s sometimes so catastrophic management has no choice but to do to a very large reverse split. As the dilution continues quarter over quarter, a second and then a third split may be required. Investors lose faith in the company, and everyone but the toxic lender loses money. Right now, the SEC seems interested in putting the toxic funders out of business by forcing them to register as dealers. Judge Cooke’s favorable ruling on the SEC’s motion for summary judgment against Almagarby and Microcap Equity may well be the first of a series of decisions that will effectively drive the diluiton funders out of the marketplace.
For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email at [email protected] or visit www.securitieslawyer101.com. 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 and compliance 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.
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Brenda Hamilton, Securities Attorney
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