As many of you already know, and for those CEOs of small public companies that do not know, the United States Securities and Exchange Commission (SEC) has been investigating the convertible toxic note industry for a few years and has recently filed several high profile enforcement actions against several of these “lenders” for violations of certain federal securities laws, particularly failure to register as a “dealer”, as is required by the Securities Exchange Act of 1934 ("Act"). Just last month, the United States District Court for the Southern District of Florida ordered that a known toxic lender pay more than $1 million dollars in disgorgement and an $80,000 civil fine, in addition to a penny stock bar and cancellation of the remaining securities, including the convertible notes. (See SEC v Almagarby, et al. case no. 0:17-cv-62255 (SDFL).
This signals that the courts are starting to recognize that, in most instances, purveyors of toxic convertible notes must register as a “dealer”—defined in the Act as a person who is engaged in the business of buying and selling securities—or risk all of their transactions being cancelled by the courts. Most of the litigation our firm has engaged in with toxic convertible note holders reveals that these lenders are not registered with the SEC, FINRA or any other self-regulatory body, as is required under the Act.
A troubling pattern has emerged. Many of these lenders are probably seeing the writing on the wall as it is only a matter of time before the SEC comes after them. It seems that while panic is slowly setting in, lenders are becoming more and more aggressive in attempting to settle outstanding and unpaid notes and/or claim default and commence lawsuits for the same. Why? We think they are trying to collect as much money and build up a capital reserve to help offset anticipated legal fees and/or future disgorgement orders in SEC enforcement actions. Stated differently: on the one hand, unregistered note lenders are attempting to enforce unlawful securities transactions against small public companies and squeeze out every penny they can, while on the other hand, they are using those ill-gotten funds to pay legal fees and court ordered penalties for their unlawful behavior, which supposedly will be returned to the companies and its stockholders? This is almost as offensive as it is ridiculous.
We are seeing an increase in this behavior as many of these toxic lenders have been served with SEC administrative subpoenas seeking information on purported unregistered dealer activities prior to the SEC commencing enforcement actions. The purpose of the SEC enforcement actions is to protect the issuers and its' stockholders, and to financially penalize these unlawful securities laws violators. One must ask why the SEC does not routinely seek to stay note enforcement attempts and actions by these lenders they are suing for the same unlawful behavior when they first commence an enforcement action. At least one SEC field office has in the Southern District of New York did, wherein the SEC sought and secured a temporary restraining order and a consented to preliminary injunction in SEC v. GPL Ventures, LLC et al. (Case No. 1:21-cv-06814) at the initial stages of its enforcement action. That court entered an order preventing any attempt by GPL Ventures to enforce any securities transactions pending the outcome of that matter.
So where does that leave OTC Markets companies that have existing and potentially unlawful notes on their books that are currently being converted or are subject to a new rash of lawsuits by those lenders?
It’s still every man (company) for itself. If an OTC Markets company has potentially unlawful notes in its books, it should consider taking action now before it is further victimized by unregistered note holders. Indeed, some OTC Markets issuers CEOs have adopted an aggressive “take the fight to them” approach on behalf of their companies and their stockholders, and commenced lawsuits to rescind those agreements and have all of the stock that was unlawfully issued returned to the company or, instead, the dollar value of that stock paid to the company.
It would be a mistake to wait for the toxic lender to sue you first, forcing the company to react to their lawsuit. In the meantime, there are hundreds of OTC Markets issuers that suffer daily conversions of potentially unlawful notes crushing their company’s stock price and shareholder value. Issuers’ management teams owe a fiduciary duty to protect the company and its stockholders from such destructive, unlawful acts. Accordingly, we strongly suggest that you review all convertible notes on your books with your corporate counsel or securities attorney, do a simple SEC broker-dealer check (click here to check) and determine whether you need to take action to further protect your company and stockholders
Christopher M. Basile, Esq. is Partner at The Basile Law Firm P.C. and is part of the firms New York securities litigation team. Christopher can be reached at chris@thebasilelawfirm.com . To learn more about what we can do for you, please call us today at 516.455.1500 ext. 115
to request your free initial consultation. With offices in New York, Texas and Florida, we serve wronged public companies nationwide.
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