Convertible Note Dealers Settle SEC Charges for Registration Violations

Steven Lofchie Commentary by Steven Lofchie

A convertible note financing business and its owners settled SEC charges for failing to register as a securities dealer.

In a Complaint filed in the US District Court for the Southern District of Florida, the SEC alleged that the dealer loaned money to small public companies ("penny stock companies") under a convertible debt agreement that allowed the defendants, in the event of non-payment, to convert the unpaid debt and interest into newly-issued deeply discounted stock (often 30-50 percent from the lowest market price) in the weeks before the conversion. The SEC alleged that the dealer violated Exchange Act Section 15(a)(1) ("Registration and regulation of brokers and dealers").

The dealer agreed to settle the charges. The settlement included (i) an injunction against further regulatory violations, (ii) disgorgement of $1,044,252 plus prejudgment interest of $100,748, (iii) payment of a civil money penalty of $105,000, (iv) an Order to surrender for cancellation all remaining shares they obtained through conversion of notes, as well as conversion rights under any remaining convertible notes and (v) a five-year penny stock bar against each defendant.

The SEC stated that the settlement is subject to court approval.


This is one of a number of enforcement actions that the SEC has brought against firms that are in the business of establishing arrangements that allow them to acquire shares from small cap companies at a large discount to the market price and then flip those shares to the retail public without registration.  (See, e.g., SEC Charges Firm Buying and Selling Convertible Notes with BD Registration Failures.)

A number of market participants have raised concerns that these enforcement actions extend the meaning of a "dealer" beyond the intent of the Securities Exchange Act. But the whole purpose of the business in this case was to distribute shares of small cap companies to retail investors at a huge markup. That was the dealer activity.

That said, the SEC's enforcement action in this and similar cases has no bearing on the recent SEC rule proposal that seeks to expand the interpretation of the term "dealer" beyond its currently understood meaning. And that proposal, as has been argued, is beyond the SEC's statutory authority under the Securities Exchange Act. See SEC Proposes Expanding "Dealer" Registration Requirement.

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