SEC Commissioner Crenshaw Criticizes Dismissal of Convertible "Dealer" Lawsuits
Commentary by Steven Lofchie
SEC Commissioner Caroline A. Crenshaw criticized the agency’s dismissal of three lawsuits involving alleged unregistered dealers in convertible bonds.
Commissioner Crenshaw argued that, by dismissing the cases, the agency was abandoning its enforcement role. She stated the move "ignore[s] the laws enacted by Congress – namely fundamental registration requirements of the federal securities laws – as well as long lines of judicial precedent." She said these dismissals and other actions – including enforcement actions involving exchanges, brokers, dealers, and offerings – marks a fundamental retreat from the SEC’s role, stating flatly that it "undermines the mission."
The Commissioner said that the dismissed cases involved businesses that bought debt from small issuers, converted it into stock, and sold the stock at high volumes. The SEC had alleged that the business violated securities laws by failing to register as dealers. Ms. Crenshaw stated that the entities transacted in billions of shares and generated millions in profit; "[t]hat sure sounds like being in the regular business of buying and selling securities," she said. Ms. Crenshaw called the move to dismiss one of the cases - SEC v. Almagarby - "astonishing" and a departure from the agency’s duty to enforce the law. In that case, the alleged dealer was in the business of buying up freely tradeable bonds, negotiating with the issuers to change the terms of the bonds to allow for them to be converted into stock at a deep discount to the market price, and then converting the bonds into stock and reselling the stock to the general public at a substantial profit.
She dismissed fears that enforcing the dealer requirement broadly would wrongly capture investment advisers or hedge funds. Citing SEC v. Almagarby, she emphasized the court’s conclusion that "significant differences exist" between traditional asset managers and entities like the defendants, who relied on "dilution financing or the rapid resale of microcap share issues as their sole source of income." She responded to the argument that such enforcement actions stifle capital formation, stating the idea is "illogical." She also argued that courts had already upheld the SEC’s claims in two of the cases, and she rejected the idea that "dealers" must have "customers," stating, "[a] customer requirement is simply not part of the definition."
Commentary
This is not as simple a matter as Commissioner Crenshaw suggests. To appreciate the substance of the debate, it is necessary to read not only Commissioner Crenshaw's dissent from the dismissals of these actions by the current SEC, but also Commissioner Uyeda's dissent from the enforcement actions previously brought by the SEC under the former Chair.
Commissioner Crenshaw likens the dismissal of these enforcement actions on convertible bonds to the SEC's dismissal of enforcement actions brought against entities that were accused of being dealers in cryptocurrencies.
That analogy is inappropriate because the flaw in the SEC enforcement actions against the cryptocurrency "dealers" that were dismissed is that they were all founded on the premise that the cryptocurrencies were "securities." If the cryptocurrencies were not securities, and the "new" SEC had issued very persuasive legal statements as to why many cryptocurrencies were not, then it does not matter whether the accused were issuers, underwriters or dealers: the SEC only has jurisdiction with respect to activities in securities. So the cases against dealers in cryptocurrencies that are not securities are per se outside the jurisdiction of the SEC.
In the case of the recent dismissals, there is no question, but that the transactions involved securities, and therefore there is no question that the SEC has jurisdiction. And as Ms. Crenshaw argues, there is a case to be made that the accused were acting as dealers. So why then should the cases be dismissed? Commissioner Uyeda best answers that question in dissent. He says that there are strong legal arguments under existing SEC precedent that the relevant activities were not "dealer' activities, and that, where the law is unclear as to the permissibility of an activity, the burden of persuasion falls heavily on the Government, not on the accused. It is not merely that the tie goes to the runner; a tie and half step go to the runner.
This brings up the way in which Commissioner Crenshaw's analogy between these cases and the crypto cases is appropriate, although to the disadvantage of her argument. The SEC, under the previous administration, failed to consider any differentiation among activities or to use words with any degree of precision. The SEC simply never tried to explain why, for example, bitcoin and ether were not securities, but other cryptocurrencies were. The SEC simply assumed that courts would go along with the agency's brute force assertion that cryptocurrencies were securities, and that the SEC did not need to be bothered with making any distinctions. So In bringing the Almagarby case on convertible bonds, there was reason for the SEC to believe that it would win its case without making the legal argument. The judge, in that case, was clearly convinced that the business that Almagarby did was distasteful, referring to it as "toxic," and not favored by the regulators. The problem, of course, is that just because the SEC (or a judge) may find behavior distasteful, does not mean it is a violation of the law.
It is unfortunate - whether it was with respect to cryptocurrencies or to convertible bonds - that the former SEC made no attempt to respond to law-based dissents by the minority. The assumption that the courts would rule in the SEC's favor, if the conduct was of a type that could be denigrated, has led to the present SEC actions which now demand real legal analysis.
The dismissal of the convertible bond cases, notwithstanding, the SEC's former indifference to such careful consideration of "law" was manifest in many different instances, as well. It has resulted in various courts throwing out SEC rulemaking and enforcement actions. In short, the SEC's exercise of regulatory power, by virtue of "because I say so," has been stopped short by courts, and now by regulators, who say that is not the way that the US government is supposed to work. Rather, where the law is fundamentally unclear, the rights of the accused take precedence over the arbitrary power of the government.