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SPCC Statement on Eleventh Circuit Decision

Marc Indeglia, President of the Small Public Company Coalition (SPCC), issued a statement today in response to the 11thCircuit Court of Appeals decision in the Securities and Exchange Commission v. Ibrahim Almagarby.

“The Eleventh Circuit’s decision that Ibrahim Almagarby, a college student, was a “dealer” under the federal securities laws is a step in the wrong direction and only serves to further bolster this runaway Commission and its novel and radically expansive view of its authority.  Mr. Almagarby, like so many others that the SEC has decided to target, was a small investor investing in small businesses under the widely-accepted understanding, in effect for decades, that his investment activity did not require registration as a broker-dealer.

“SPCC members, as well as family offices, hedge funds, and even venture capital funds across the country, are now subject to regulation by enforcement under an entirely novel understanding of what constitutes a securities dealer. Small businesses, now more than ever, at risk of losing access to vital capital because investors simply do not want to risk engaging in onerous lawfare with the Commission.

“The SPCC, in tandem with partners across various industries, stands ready to support a legislative solution to codify the definition of dealer as has been understood for decades and allow law-abiding market participants to inject capital where it is needed most: American small businesses.”

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The Small Public Company Coalition represents small businesses and investors in the small and microcap markets.

Commissioner Uyeda Criticizes SEC’s Dealer Approach

Securities and Exchange Commissioner Mark Uyeda delivered a speech today in London where he criticized the SEC’s approach to enforcement generally and specifically with respect to the dealer cases.

While delivering the fifth annual Scott Friestad Memorial Lecture, Uyeda said, “While it is important for government regulators to pursue bad actors, the ease at which an official investigation can be launched suggests that there ought to be objective and articulable standards to guide the exercise of such power by enforcement staff.

“A key concept under the rule of law is that similarly situated people should be treated similarly. However, when there is a low threshold to launching an investigation that lacks sufficient guardrails, the potential for abuse increases. For instance, it would be inappropriate to single out otherwise lawful financial products that might be viewed disfavorably. Targeting lawful, but disfavored, products and conduct with investigations and administrative subpoenas based on the “official curiosity” standard runs the risk of turning the SEC into a merit regulator – which was an approach that the U.S. Congress did not take in enacting the federal securities laws.

“At times, it may be appealing to set regulatory policy through enforcement actions. But the SEC ought to be reluctant to pursue that approach, especially when it effectively creates new definitions or interpretations that affect conduct not previously deemed unlawful. If there are regulatory provisions that are unclear and/or ambiguous, the Commission and its staff can and should provide clarity to market participants, which can occur in the form of rules, interpretations, guidance, and no-action letters. This clarity should be provided before resorting to enforcement actions. The SEC’s enforcement efforts should be limited to enforcing the rules as written, and should not create novel and innovative interpretations that broaden the scope of these rules and the Commission’s jurisdiction over markets and their participants.”

He later addressed dealer specific cases.

“Today, I want to discuss three areas where insufficient clarity may result in a lack of understanding, and potentially fair notice, of novel interpretations that the SEC has undertaken in recent enforcement actions. These areas are: (1) the scope of the definition of a dealer under the Securities Exchange Act of 1934…”

While using Crown Bridge as an example, Uyeda said, “It would be understandable if Crown Bridge, after reviewing the Guide, were to conclude that their conduct did not require them to register with the Commission as a dealer since they were using their own money and did not provide services to clients or do business with the public.

“Nonetheless, the SEC sued Crown Bridge for unregistered dealer activity. The case was ultimately settled.[11] Was fair notice of this interpretation given to market participants? Would there have been better ways to communicate the SEC’s views prior to instituting an enforcement action? Questions and challenges to this approach have been raised. The Crown Bridge case is only one of a number of similar cases brought by the SEC in recent years, some of which are currently pending in the judicial system.”

The entirety of Commissioner Uyeda’s remarks can be read here.

 

 

Forbes: “The Government Is Quietly Suing Its Way To Broader Powers Over Traders”

The Government Is Quietly Suing Its Way To Broader Powers Over Traders

Brandon Kochkodin

Forbes Staff

Jul 12, 2023,06:30am EDT

 

In reshaping 89 years of rules governing who’s required to register their business with the government, the SEC is using the courts to wage a campaign to vastly widen its regulatory reach.

 

No one would ever mistake Ibrahim Almagarby for a Wall Street power player. No one except, perhaps, the U.S. government.

 

Almagarby’s story is a cautionary tale for anyone who trades securities in the U.S. It’s an example of a federal agency, in this case the SEC, deciding to change how it enforces its rules on who needs to register as a dealer but telling no one, then pursuing and winning a lawsuit against an entrepreneur for not figuring out, somehow, that the game was suddenly different. The new interpretation wasn’t only a personal disaster for Almagarby, whose punishment was forfeiture of over three years of profits and a ban on penny-stock trading. It would also give the SEC such vast oversight that it could end up making trading a lot more difficult for just about anyone in the country.

 

In 2013, Almagarby was a 20-something student living in Tamarac, Florida, when he started a business called Microcap Equity Group. It had no clients, just Almagarby buying what’s called convertible debt from penny-stock companies, converting it to stock — hence the name — and selling it.

 

Over the next three-and-a-half years, Almagarby conducted 38 transactions for a profit of $1.5 million, according to court documents that detail his trading. Not exactly ocean-view-penthouse money, but apparently a pile high enough to draw the attention of the SEC.

 

No doubt, convertible debt is controversial. It’s legal, but you probably wouldn’t see a Mother Teresa making this trade. Because it feeds the bittersweet narcotic of high-interest loans to desperate companies, it’s been called “death-spiral financing,” and its conversion to stock often causes the company’s share prices to tumble.

 

But the unsavory nature of the trade wasn’t the government’s objection when the SEC came calling. The agency sued Almagarby and Microcap Equity Group in November 2017 for “acting as unregistered securities dealers.” To hear securities lawyers and other experts tell it, this was unprecedented. Since 1934, when the definition for “dealer” was written into law, nobody who traded only for their own account, like Almagarby did, was required to register as one.

 

It’s plausible that the SEC played a strategic hand, selecting Almagarby as its opening salvo in a campaign to extend its tendrils into every last financial crevice. The agency chose a convertible-securities trader who was not only less than sympathetic because of how he makes his money, but because, by Wall Street standards, he’s small fry. Each of Almagarby’s transactions averaged a modest $30,000 or so — hardly the kind of clout that can sustain a long legal battle with the U.S. government.

 

So there were few headlines in August 2020 when the U.S. District Court for the Southern District of Florida agreed with the SEC that Almagarby — and Microcap Equity — had run afoul of the agency’s rules by not registering as a dealer. The court said that his trading frequency “had made him more than an active investor” and agreed with the government that a trader with a business model based entirely on purchases and sales of securities had to go through the hassle of registration and the increased scrutiny of being a dealer. That includes background checks, compliance checklists, escalated record-keeping costs and capital requirements.

 

“For 90 years, it’s been well understood that a dealer is one who takes the other side of a customer’s trade using their own account,” Brian Richman, an attorney at Gibson, Dunn & Crutcher who represents a defendant in a similar case, told Forbes. “What the SEC says now is forget about all of that. It says if you’re a business and buy and sell for your own account and do it regularly, you’re a dealer. That sweeping interpretation has never been advanced by the SEC or anybody else over the past several decades.”

 

A Sword of Damocles now hangs over trading firms, home offices, crypto accounts and any individual whose work time is primarily spent buying and selling securities. Critics fear the legal precedent will cast a threatening shadow over trading in Treasuries and could even be used to nudge some of the 1.5 million Americans who day-trade to register with the regulator.

 

Whether the SEC will expand its enforcement beyond convertible-debt traders remains a mystery. The agency isn’t saying, and it declined to talk to Forbes for this story. One thing we do know: the government is charging ahead. It’s got nearly a dozen cases, and more to come, similar to Almagarby’s that are working their way through the courts, with one penalty potentially topping $10 million and another that could exceed $100 million.

 

There’s already been fallout. The same court in Florida that in 2020 went against Almargarby ruled against another trader, Justin Keener, founder of lender JMJ Financial, for the same reason in December. Keener was ordered to pay $10.2 million in disgorgement of profits and penalties and will have to refrain from buying and selling penny stocks for five years. Key point: Keener was also trading convertible debt.

 

“What the SEC is doing here is unfair to real people in the real world,” Keener told Forbes in an email forwarded by his lawyer. “After the 2008 financial crisis, the SEC encouraged people like me to loan money to small businesses in the form of convertible notes. The SEC even reviewed and approved registration statements for many of my trades. But now, the SEC is trying to change the law on these transactions, not on a forward-looking basis through Congress, but backwards-looking through the courts, and against the people the SEC encouraged to provide capital to small businesses in the first place.”

 

Regulators have overlooked “death-spiral financing” in the past when it came to requiring traders to register as dealers. In 2014, Auctus Fund Management, a defendant in a case similar to Almagarby and Keener’s, provided FINRA, the industry’s trading supervisor, with a sample contract for its convertible-debt agreements, according to documents seen by Forbes. FINRA didn’t question whether Auctus should have been registered as a dealer at that time, according to a person familiar with the matter.

 

The SEC has apparently changed its mind, and the decision was hailed by advocates of convertible-debt borrowers. Brenda Hamilton, a Boca Raton, Florida-based securities attorney who has represented companies shocked into reality by the devastating impact convertible debt can have on their share prices, says the agency’s maneuvering is nothing more than an effort to attach a leash to those she regards as shady operators.

“We’ve seen people turn $100,000 on a note into a million in a short period of time,” Hamilton told Forbes. “If they were making lower amounts, I don’t think the SEC would be expending the resources on this.”

UCLA law professor James Park concurred. “I’m not entirely sure that these cases will mean that a wide range of funds will have to register as dealers,” Park told Forbes in an email. “These rulings can be limited to the particular context of these cases.”

 

Whether the SEC is targeting only unsavory traders or not, there are other ways to redefine the role of dealers, said Gabriel Gillett, a partner at Jenner & Block.

 

“If the problem is the definition of a dealer, ask Congress to change it,” Gillett, the author of an amicus brief in support of Keener, told Forbes.

 

Instead, the SEC has instituted a “we’ll-know-it-when-we-see-it” criterion for what constitutes a dealer. One amicus brief in support of Almagarby highlights the absurdity, saying the SEC “claims to have discovered in a long-extant statute an unheralded regulatory power.”

 

In March 2022, more than four years after it sued Almagarby, the SEC finally got around to saying publicly that it was interested in broadening the definition of dealer. In its announcement, the commission appeared to demolish the argument that it was only moving against convertible-debt traders. Rather, the new interpretation would include just about anyone making a dime in almost any market.

 

The idea stirred up a hornet’s nest of resistance across financial circles. Venture Capital fund a16z cautioned in a comment letter that the rule could dry up appetite for digital assets, amplify volatility and put the brakes on “digital asset infrastructure” progress. Market-maker Virtu Financial chided the regulator for overreaching without justification. Republican lawmakers joined the choir. Senator Bill Hagerty of Tennessee and Congressman French Hill of Arkansas asserted that the proposal could drain the lifeblood from the vital U.S. Treasury market.

 

Critics suggest the regulator is pulling a fast one, bypassing the usual red tape and getting new procedures approved through the courts instead. Should the SEC keep scoring victories, it could, by establishing precedents, effectively create a new legal order.

 

“Major changes such as this must involve Congress and should involve the public,” Suzan Rose of the Alternative Investment Management Association trade group, told Forbes. “Right now we’re looking at cases where they’re going after people with such a small threshold. I don’t see how it couldn’t grab everyone.”

Both Almagarby and Keener are appealing the decisions against them.

SPCC President Marc Indeglia Quoted in Bloomberg Law Article on “Dealer” Definition

Finance Firms Wary of Being Swept Up in Creeping SEC Dealer Rule

By Matthew Bultman 2023-03-31

  • SEC’s court positions casting a wide net, groups say
  • Comes as agency has proposed rule expanding criteria

    The SEC is quietly expanding its definition of “securities dealers” subject to tighter agency oversight, triggering a pushback from some private funds and investment advisers that are leery of more regulations.

    The Securities and Exchange Commission is finalizing a rule that, as proposed, would clarify and expand the definition to include some financial firms—such as high-frequency traders—that have traditionally not been considered a dealer.

    Industry advocates say the agency also is using recent lawsuits against penny-stock flippers to go further than it’s likely to do in its rulemaking—to stake out the position that a “dealer” is any company whose business model is based on buying and selling securities.

    The agency’s statements in court filings represent a sweeping interpretation of federal securities law, critics say. The expansive definition of “dealer” has the potential to capture numerous businesses, including hedge funds and venture capital funds, that are already subject to regulations, they said.

    “The type of language that is coming out of the Commission in its briefing in these various cases is so expansive that it would be one of the largest nets one might cast with respect to this industry,” said Marc Indeglia, a partner at Glaser Weil LLP and president of the Small Public Company Coalition.

    Dealers generally have to register with the SEC and join an organization like Financial Industry Regulatory Authority (FINRA). They’re subject to various rules, like trading reporting obligations and net capital requirements.

    Funds facing registration could change their investment strategies to avoid being labeled a dealer, industry reps say.

    Critics of the SEC’s approach have zeroed in on a case the agency won against a Florida man, Ibrahim Almagarby, and his company, Microcap Equity Group, who are accused of acting as unregistered dealers. The US Court of Appeals for the Eleventh Circuit is expected to rule on it this year.

    The SEC in court filings denies there’s anything radical about its interpretation of “dealer” and said critics are ascribing to the agency a position that it hasn’t taken. The agency declined to comment beyond its filings.

    “Almagarby engaged in classic dealer activity by acquiring discounted securities from issuers and selling them as quickly as possible,” SEC lawyers said in court filings.

    Flipping Stocks

    Almagarby was a 29-year-old student at Palm Beach State College in South Florida when he started MEG out of his home, according to court documents.

    MEG would buy aged debt from penny stock issuers. After converting the debt into equity for discounted prices, MEG sold the new shares for a profit, the SEC alleged in a 2017 complaint. Almagarby and MEG were alleged to have made over $1.4 million.

    Finding MEG was a dealer, the district court said the company’s business model was predicated on quickly unloading shares. MEG also had a network of deal finders, including a boiler room of telemarketers who cold called dozens of companies per day, the court said. MEG appealed to the Eleventh Circuit.

    “He was doing all the things that dealers do,” said Cheryl Nichols, a Howard University law professor and former SEC attorney.

    But financial trade groups—like the Alternative Investment Management Association and Small Public Company Coalition—have balked at what they argue are sweeping statements from the SEC that suggest a dealer is any business that buys and sells securities for profit.

    “The approach that they’ve taken here, it encompasses anyone who invests in companies as part of a business, without regard to any other considerations,” Indeglia said. “Our view is that is radically different than what the world thinks it is.”

    In a brief against Almagarby, the SEC indicated that the fact that his business model was based entirely on buying and selling securities could be “conclusive proof” that MEG is a dealer.

    That type of statement is a trend in recent cases, industry trade groups say. In a lawsuit against Carebourn Capital, LP, the SEC said the only “definitional requirement is that a dealer engages in the business of buying and selling securities.”

    In another case, against LG Capital Funding LLC, the SEC emphasized that “LG Capital is a business: it has offices, employees, keeps accounting records, and carries on for profit. And its business model is to buy and sell securities.”

    That kind of theory could have vast implications for financial markets, AIMA, SPCC, and the National Association of Private Fund Managers said in an amicus brief supporting Almagarby.

    “If a dealer is any company whose ‘business model’ is based on the ‘purchase and sale of securities,’ the only thing standing between nearly every financial firm and an enforcement action is the ‘benevolence’ of government lawyers,’” the groups said.

    Daniel Austin, AIMA’s director of US policy and regulation, said the SEC’s interpretation is “simply inconsistent with the statutory text and the general understanding from the commission and market participants for the past almost 90 years.”

    Rulemaking Impact

    The Eleventh Circuit is considering Almagarby’s case as the SEC is working to finalize a rule that, as proposed in March 2022, would require more companies to register as dealers.

    The proposal outlines certain standards that can trigger dealer status. That includes regularly making comparable purchases and sales of the same securities in a day.

    The standards the SEC outlined ‘build upon and are consistent with past Commission regulations and case law for defining a dealer” under the Exchange Act, the non-profit group Better Markets said in a letter supporting the proposal.

    But Republican lawmakers and other industry organizations are pushing back.

    Sen. Bill Hagerty (R-Tenn.) and Rep. French Hill (R-Ark.), have asked the SEC to justify including private funds in the proposal. Private funds have signaled they’ll change or abandon some investment strategies if forced to register as dealers, they said.

    The Eleventh Circuit’s decision in Almagarby’s case could impact the rulemaking, lawyers said.

    “When the court says what the Exchange Act means, and what the word ‘dealer’ means, that could constrain or have an effect on the commission’s authority to interpret that in its rulemaking,” Gibson Dunn & Crutcher LLP attorney Brian Richman said recently on AIMA’s podcast.

    The case is SEC v. Almagarby, 11th Cir., No. 21-13755 .

Congress Questions SEC Enforcement of “Dealer” Definition

On July 19, the House Financial Services Subcommittee on Investor Protection, Entrepreneurship and Capital Markets held a hearing to conduct oversight of the SEC’s Division of Enforcement. Several Members of Congress raised the dealer issue directly, and others hammered Enforcement Director Gurbir Grewal on the SEC’s burdensome and broad enforcement actions and proposed rules that are impacting capital formation.

Transcripts of noteworthy exchanges are below. The hearing can be viewed here.

Ranking Member Bill Huizenga (R-MI): “Director Grewal, concerned about a couple of things and I’m going to try to hit this quickly: Unprecedented attempts by the SEC to slip drastic market changing interpretation of securities laws into otherwise routine enforcement cases and two, a lack of internal consistency when it comes to the SEC’s own ideas about basic, foundational elements of market regulation.  In a recent case, the SEC, rather than relying on decades of existing caselaw and legal precedent, presented a case in which it defined a ‘dealer’ as ‘any business that purchases and sells securities for its own account.’ So if I’m interpreting this correctly, it quite literally means that every market participant in the country, which means under the SEC definition regardless of business model or current regulatory regime, they would somehow now be subject to a wildly different, and inappropriate in my opinion, regulatory framework. That quickly. Overnight. And that’s not all. At the same time, in the same SEC, there’s a controversial proposal underway in which the SEC is attempting to dramatically expand the definition of this core term, dealer, but this time in a wholly different manner than how your enforcement team defined the term. So two different definitions, being presented by the same SEC, are in fact wholly inconsistent with each other. So it seems to me that the SEC is, frankly, brazen about it and thinks that it can rewrite the most basic elements of securities law whenever it wants to fit whatever purpose it needs at the current moment, with no regard to the effect on markets or the economy or even internal consistency.

 

“I’m a guy from Michigan. So I think in car terms. This is a little like we’re asking people to build a car but we won’t tell them what the speed limit is going to be, we won’t tell them what the car should or shouldn’t do, what the safety products ought to be on it, but we’re going to determine that later. And we’re just going to mail you a ticket for speeding. We’ve got a responsibility to set speed limits, and/or then to make sure that there’s a consistent approach and application of that. So please, illuminate me. What is this approach?”

 

  • Grewal: “Thank you for that question Ranking Member. With respect to the enforcement action you referenced, that’s a litigated matter, and we’re confident that our position will survive scrutiny in that litigation. We’ve succeeded in other…[Huizenga interject: “how about the inconsistency of it?”] I can’t speak to the rulemaking that’s being done by the rulemaking division and I think its in a different context so I’d refer you to my colleagues in those divisions who are responsible for that rulemaking.”

 

 

Rep. Bryan Steil (R-WI): “I want to echo my colleague Mr. Huizenga’s comments regarding the Division of Enforcement adopting [sic] a historically broad understanding of what the term ‘dealer’ means. I listened to your answers and so I won’t ask you my questions but I just would note, and I think I echo my colleague here, that I want to caution that these broad definitions and aggressive enforcement approaches come with a real cost. Specifically, classifying everyone as a dealer could chill investment, in particular in small public companies. My concern is that will hurt innovation and competition. So I won’t ask you a question because it was covered previously and I know there’s ongoing litigation in that space.”

 

Other highlights:

 

Rep. Tom Emmer (R-MN): “Mr. Grewal, you frequently acknowledge that public trust and confidence in our capital markets has eroded. In fact, on October 13, 2021 you stated, ‘The decline in trust undermines the investor confidence needed for the fair, efficient, and orderly of our capital markets. Put simply, if the public doesn’t think the system is fair, they are not going to invest their hard-earned money.’ I agree. But time and time again, you place the cause of blame for this erosion of trust squarely on the shoulders of industry participants and companies. Mr. Grewal, the SEC is in no way blameless here. Chair Gensler’s political regime at the SEC carried out by its Division of Enforcement has been characterized by a focus of using enforcement to expand SEC jurisdiction at the expense of public resources, public investment in our country, and public trust in our markets. It seems clear to everyone, except maybe those at the commission, that the SEC is not regulating in good faith.”

 

Huizenga followed up at the end of the hearing to denounce Grewal for refusing to answer his and others’ questions by deferring to other departments or declining to comment altogether. “We better start getting some answers.”

SPCC Files Amicus Brief in Microcap Equity Group Case

On July 8, the Small Public Company Coalition (SPCC) filed an amicus brief in support of Ibraham Amalgarby and Microcap Equity Group, LLC in the Eleventh Circuit Court of Appeals.

The Alternative Investment Management Association and the National Association of Private Fund Managers joined the SPCC in supporting Mr. Amalgarby and Microcap Equity Group to overturn the decision of the district court.

The filing is available below.

Contact:

info@thespcc.com

SEC Could Revisit Rule 144 This Autumn

In June, The SEC updated its regulatory agenda to say that it intends to issue a new Notice of Proposed Rulemaking (NPRM) in October 2022 regarding potential amendments to Rule 144.  There is no indication how the SEC intends to propose to amend Rule 144. The SEC would therefore not be in a position to adopt a final rule until sometime in 2023.

Commissioner Hester Peirce issued a statement a few weeks ago, criticizing Chairman Gary Gensler’s regulatory agenda, both as to substance and process. Among many other complaints, Pierce argued that “[t]hese rules contemplate far-reaching changes to our regulatory regime, the breadth of which is hard to glean from merely reading their titles,” citing the new proposed dealer rule as an example.  She also noted that “[t]he Commission plans to propose many new rules, contemplating further extensive changes within the next five months,” citing as one example among many that the Commission intends to propose new rules relating to “the Rule 144 safe-harbor.”

 

Contact:

info@thespcc.com

SPCC Files Comments with SEC on Further Definition of “As a Part of a Regular Business” in the Definition of Dealer

Today, the SPCC filed comments on the SEC’s proposed “dealer” definition.

The SEC’s enforcement activity threatens to throw the broader securities market into disarray. The commission’s enforcement theory calls into question the legality of most of modern American finance, as a large proportion of firms that trade securities—including as their sole business activity, such as hedge funds—are not, and have never been, registered as “dealers.”

Already, the commission’s enforcement activity has caused enormous hardship for the SPCC’s members. The SPCC is the voice of small public companies—firms that employ thousands of Americans developing new and innovative products and services. The Coalition’s mission is to protect this industry, and the financial professionals who serve it, from harmful government interference that suppresses growth, hinders capital formation, and eliminates jobs. Unfortunately, the Commission’s enforcement staff has wielded its expansive conception of “dealing” in an attempt to eliminate a vital source of financing for small public companies: market adjustable convertible securities.

The SPCC will continue to work on this issue and abate burdensome enforcement activity from the commission.

Contact:

info@thespcc.com