Ibrahim Almagarby Loses Unregistered Dealer Appeal

On February 14, 2024, the United States Court of Appeals for the Southern District of Florida made its ruling in the case of the Securities and Exchange Commission versus Ibrahim Almagarby and Microcap Equity Group, LLC, ruling in favor of the Commission that Almagarby was an unregistered “dealer” under the Exchange Act.

Almagarby was appealing a lower district court ruling in favor of the Commission from September 29, 2021, which ordered Almagarby 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 district court also permanently enjoined Almagarby from selling unregistered securities and from any future participation in penny-stock offerings.

Background

Ibrahim Almagarby was a college student when he formed Microcap Equity Group LLC, a Florida limited liability company, in January 2013. Almagarby was the sole owner, employee, and “controlling person” of Microcap, and its profits were his sole means of financial support. Almagarby’s business model involved purchasing the debt instruments of penny-stock (also called micro-cap) companies, converting that debt into common stock and selling the stock rapidly.

In the investment industry, Almagarby’s conduct is called “toxic” or “death spiral” financing. A toxic lender provides financing in the form of convertible debt—that is, debt that can be converted into common stock, almost always at a discount to market price. The lender then converts and sells in large volumes, typically liquidating only a fraction of its debt holdings at a time to ensure that an entire tranche is sold before the next is converted at a discount to the new, still lower price. The influx of shares causes prices to plummet, the share dilution drives good-faith investors out of the market, and the issuing microcap company, or “issuer,” can no longer access legitimate financing, a fact that may be the death knell of its business operations.  Although not illegal, this behavior is disfavored by issuers, investors, and self-regulatory organizations.

Almagarby engaged in a variation of typical toxic lending. Instead of obtaining convertible debt directly from an issuer, he purchased existing instruments held by unaffiliated third parties. Many of the instruments he purchased did not have an existing conversion feature. So Almagarby negotiated directly with the issuers to obtain agreements that allowed him to exchange existing, non-convertible debt for convertible instruments. These agreements provided for conversion at a significant discount to market price— most often 50 percent—and many provided a “reset” feature, allowing him to reset the instrument’s debt-to-stock conversion rate if the issuer’s stock price dropped below a certain level. 

Almagarby purchased only “aged” debt—that is, debt old enough to be exempt from the registration requirements of the Securities Act of 1933 under the Commission’s Rule 144. He accordingly did not need to register his holdings, and he could sell immediately upon conversion without a further waiting period.

Almagarby’s goal was to conduct transactions rapidly and at high volumes. He did little to no research on the issuers of the shares he acquired because his goal was “to turn [his] money around as fast as possible.” He testified that he would “try [to] be in and out of it as soon as possible” and that his “idea wasn’t to hold on.” Soon after purchasing or negotiating an exchange agreement for any convertible debt instrument, Almagarby would send a conversion notice to the issuer; he converted most instruments within 10 trading days of receiving them.  Almagarby would then immediately instruct his broker to sell the shares—ordinarily, within 7 to 14 days of receipt.

The quick turnarounds paid off. From January 2013 to July 2016, Almagarby made over $885,000 in net profits. He purchased over $1.1 million worth of outstanding aged debt and received over $2.8 million in proceeds from stock sales, which he used to fund further transactions. Almagarby engaged in at least 57 purchases of aged debt, from the debtholders of 38 issuers. He received deposits in his brokerage accounts on at least 167 occasions totaling around 8.5 billion shares, and he made at least 962 individual stock sales totaling over 7.6 billion shares.

To assist in his business of buying aged debt to use to convert into shares he could immediately sell into the market, Almagarby entered into formal and informal agreements with “finders” who provided him with referrals. These finders were essentially telemarketers who located debt instruments available for purchase or cold-called issuers with outstanding aged debt who might be willing to enter into convertible debenture agreements.  Almagarby’s most significant finder cold-called 40 to 60 companies a day pursuing referrals.  As compensation for their work, Almagarby paid his finders a percentage of the amount that he paid for debt acquired from a referral but did not pay them any of the proceeds from stock sales.

Almagarby also engaged at least 10 attorneys to provide opinion letters attesting that the shares he obtained from converting aged debt were exempt from the registration requirements of the Securities Act under Rule 144.

But apart from finders and attorneys, Almagarby operated independently. He did not provide professional investment services or engage in most of the conduct described in the public guidance for defining broker-dealers. Almagarby never advertised or publicly held himself out as a buyer or seller of securities; never took on clients, provided investment advice, or invested money other than his own; never attended investment conferences or meetings with issuer representatives; never promoted or solicited any other investor to invest in the securities of any issuer; never extended credit, or issued or originated securities; and never loaned securities, conducted repurchase transactions, or guaranteed or in- demnified any other party. 

On November 17, 2017, the Commission filed an enforcement action in the U.S. District Court for the Southern District of Florida against Ibrahim Almagarby and his company, Microcap Equity Group LLC. Both defendants were charged with two counts: effecting transactions, or inducing or attempting to induce the purchase or sale of securities using the instrumentalities of interstate commerce while not registered with the Commission of a dealer; and, as to Almagarby only, violating the Securities and Exchange Act of 1934 (“Exchange Act”) through his control of Microcap Equity.

In Almagarby’s case, the district court granted summary judgment for the Commission. It ruled that Almagarby, as the “controlling person” liable for Microcap, operated as an unregistered dealer because he was “in the business of” buying and selling securities. In that case, the district court relied on a previous decision by the United States Court of Appeals for the Southern District of Florida in Securities & Exchange Commission v. Big Apple Consulting USA, Inc. to conclude that the quick turnaround and sheer volume of Almagarby’s sales proved that he was in the securities “business.” 

The district court ordered Almagarby to disgorge $885,126.30 in total net profits and $182,150.69 in prejudgment interest, for a total of $1,067,276.99. It also permanently enjoined him from selling unregistered securities and from any future participation in penny-stock offerings. The court also ruled that Almagarby and Microcap would have to surrender their shares for cancellation.

Almagraby appealed the ruling. His appeal was supported by two sets of amici curiae filed briefs. First, Trading and Markets Project, Inc., an industry group representing public and private funds, investment advisors, and others, filed a brief and participated in oral arguments as amicus curiae on behalf of Almagarby. Second, the Small Public Company Coalition, Alternative Investment Management Association, and National Association of Private Fund Managers filed an amicus brief.

The case was presented before William Pryor, Chief Judge, and Rsenbaum and Abudu, Circuit Judges.

Decisions and Reasoning

The United States Court of Appeals for the Eleventh Circuit Court for the Southern District of Florida weighed four key arguments. First, whether Almagarby operated as an unregistered securities dealer.  Second, whether the district court’s enforcement action violated Almagarby’s right to due process. Third, whether the district court abused its discretion by ordering disgorgement.  Fourth, whether the district court abused its discretion by enjoining Almagarby from future violations of section 15(a) of the Exchange Act and its discretion in enjoining Almagarby’s participation in future penny-stock offerings.

Whether Almagarby operated as an unregistered securities dealer

Almagarby argued that the district court erred by relying on Big Apple because that decision interpreted the meaning of “dealer” under the Securities Act, see 15 U.S.C. § 77b(a)(12), not the Exchange Act and that because he never purchased aged debt directly from issuers, he is not bound by any precedent that describes underwriting as the purchase of new securities “from” issuers.

However, the Appeals Court pointed out several key factors in upholding the ruling of the lower court that Almagarby was indeed acting as an unregistered securities dealer:

• A dealer’s business model depends on his volume of buying and selling because he profits from executing trades—that is why he is “in the business of buying and selling securities,”
• By converting aged debt, Almagarby created new securities and was responsible for the proliferation of issuers’ shares in the market. His conduct more than doubled the share count of at least five of the issuers with whom he transacted.
• By sending conversion notices to issuers and triggering the creation of new shares that he then distributed, Almagarby behaved like an underwriter.
• The volume and regularity of Almagarby’s transactions support the ruling that he was “in the business” of buying and selling securities. The “centerpiece” of the Exchange Act’s dealer definition is the word “business,” which is “a particular occupation or employment habitually engaged in for livelihood or gain.”
• Flipping penny stocks was Microcap’s “sole source of funds.” Like Big Apple, Microcap’s entire business model relied on buying and selling securities, and its only source of profit was purchasing aged debt and obtaining repayment in discounted shares.
• Microcap’s profits were Almagarby’s sole livelihood.
• A “dealer” is “one who buys to sell—not one who buys to keep, or makes to sell.” Almagarby engaged in the kind of activity characteristic of securities dealers: he acquired the shares of microcap companies by converting debt at a discount, and then immediately resold the shares he obtained for a profit. Almagarby testified that his goal was to turn his “money around as fast as possible” and that he sold most of his holdings within days or weeks of receipt. He explained that his “business model made money” by “buying the stock at a discount, selling it at mar- ket[,] and the difference [was] the profit.” Unlike a trader or private investor, Almagarby did little to no research, had no longer-term views on the value of his holdings, and was not interested in taking on price risk. Instead, he relied on high volumes of trade execution to profit.
• Almagarby does not dispute that he engaged in high-volume resales of microcap shares. Over a three-year period, he received 167 stock deposits totaling around 8.5 billion shares of stock and made at least 962 individual sales totaling more than 7.6 billion shares. He engaged in the distribution of 38 different issuers’ securities. And he made over $885,000 in net profits.
• Almagarby also operated a professional business with contractors: he retained a “network of deal finders” who “ha[d] been cold calling” companies and “bringing deals in consistently.” The process of acquiring new shares from an issuer “for the purpose of reselling them” is called “underwriting.”
• The process of acquiring new shares from an issuer “for the purpose of reselling them” is called “underwriting.”  And Almagarby is not bound by any precedent that describes underwriting as the purchase of new securities “from” issuers.

After weighing the facts of the case, the court agreed with the Commission that Almagarby was a “dealer” under the Exchange Act due to both the kind and the amount of his transaction activity. Specifically, buying convertible debt for the purpose of immediate conversion and resale and underwriting microcap share issues are activities characteristic of dealers. And that the volume and regularity of Almagarby’s transactions and the fact that his entire business was predicated on flipping penny stocks preclude him from qualifying for the trader exemption. 

Whether the district court’s enforcement action violated Almagarby’s right to due process

Almagarby argued that the Commission violated his Fifth Amendment right to due process by bringing an enforcement action under a novel interpretation of the term “dealer” that contradicts longstanding agency guidance and policy. He protested that the activity that allegedly rendered him a “dealer” is not described in the Broker-Dealer Guide or in no-action letters. Further, Almagarby argued that the Commission failed to give him fair notice by relying on a novel enforcement theory that contradicts longstanding agency guidance about who qualifies as a “dealer. ” But the Commission has never issued any guidance on whether toxic lending is “dealer” activity.

After weighing the facts, the Appeals Court ruled that the district court did not violate Almagarby’s right to due process because:

• The Broker-Dealer Guide does not purport to be legally binding or exhaustive.
• The Commission’s complaint against Almagarby accords with precedents interpreting the Exchange Act.
• Almagarby is a “dealer” under section 15(a) of the Act.
• Almagarby had notice that he might be subject to agency action.

Whether the district court abused its discretion by ordering disgorgement

Almagarby argued that the district court abused its discretion by ordering disgorgement because the Commission’s enforcement action was untimely; disgorgement was not “appropriate or necessary for the benefit of investors,” 15 U.S.C. § 78u(d)(5); and there was no causal link between Almagarby’s failure to register and the profits that he was ordered to disgorge.

After weighing the facts, the Appeals Court ruled that the district court did not abuse its discretion by ordering disgorgement because:

• The Commission’s action was timely.
• Disgorgement accords with the requirement that an equitable remedy under the Act be “appropriate or necessary for the benefit of investors.”
• Almagarby’s profits were causally linked to his failure to register.
• Since Almagarby was altogether prohibited from making transactions as an unregistered dealer, any profits generated from his prohibited transactions were causally linked to his failure to register.

Whether the district court abused its discretion by enjoining Almagarby from future violations of section 15(a) of the Exchange Act and its discretion in enjoining Almagarby’s participation in future penny-stock offerings

After weighing the facts, the Appeals Court determined that the district court did not abuse its discretion by enjoining Almagarby from future violations of section 15(a) of the Exchange Act, but it did abuse its discretion in enjoining Almagarby’s participation in future penny-stock offerings.

In making its decision to reverse the penny stock ban against Almagarby, the Appeals Court weighed the following factors:

• A permanent penny stock bar would prohibit both unlawful and lawful penny stock transactions.
• The egregiousness of the wrong-doing. 
• The likelihood that the wrong will be repeated should be heavily weighed. 

Two of the Judges decided that the wrong-doing in this case and the likelihood of Almagarby repeating the wrong-doing did not meet the necessary standard to justify a permanent penny-stock ban, and one judge dissented.

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.

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