In August 2024, then SEC Commissioner Mark T. Uyeda made a public statement against the rampant enforcement proceedings against small cap investors claiming violations of the dealer registration requirements (see HERE). Fast forward to today, now Chair of the SEC, Mr. Uyeda, is sticking by his contentions and finally, after eight long years of numerous enforcement proceedings, is directing the SEC to roll back its position.
What Happened
This week, the SEC enforcement division entered into two joint motions halting ongoing litigation claiming violations of the dealer registration rules. The U.S. District Court for the District of Massachusetts entered an order in the case involving Auctus Fund Management staying the case while the parties wrap up an agreement to end the litigation. Under the agreement Auctus will not seek attorney fees from the government or pursue a review of the enforcement action.
In the filing, Auctus said “[T]he parties have reached an agreement in principle to dismiss this action with prejudice, on the condition that defendants agree to waivers and releases, including any rights under the Equal Access to Justice Act or the Small Business Regulatory Enforcement Fairness Act of 1996 and any claims against the Commission and its officers or employees,”
The federal Equal Access to Justice Act lets parties who prevail against the federal government seek attorney fees and expenses when the government’s position wasn’t “substantially justified.” The Small Business Regulatory Enforcement Fairness Act allows parties to seek judicial review of agencies’ actions if it appears the government didn’t consider the impacts of new regulations.
Also, this week, the District Court for the Northern District of Illinois entered an order granting a joint motion staying the case between the SEC and Chicago Venture Partners while the parties finalize a settlement of the proceedings. Although less is publicly known about the terms of the settlement, presumably it is similar to that with Auctus.
In another win earlier this year, on November 21, 2024, a Texas federal judge overturned the recent SEC rule that expanded the definition of “dealer” under the Exchange Act. At the time, the SEC appealed the court’s ruling. However, on February 19, 2025 the new administration dropped the appeal effectively ending the legal battle and the rule change. For a review of the final rule see HERE. As more background, the new rule declined to provide regulatory clarity related to convertible security investors in the small-cap and penny stock space. It appears, logical minds are prevailing and the industry is finally getting the clarity it needs to re-open funding for the small cap space.
Background
In November 2017 the SEC shocked the industry when it filed an action against Microcap Equity Group, LLC and its principal, alleging that its investing activity required licensing as a dealer under Section 15(a) of the Exchange Act. Since that time, the SEC has filed numerous additional cases with the sole allegation being that the investor acted as an unregistered dealer. In each case, the investor entity purchased convertible promissory notes from micro-cap OTC Markets issuers (or other existing note holders), which, after the applicable Rule 144 holding period, were converted into shares of common stock and sold on the open market. As the securities were generally low priced, the conversions resulted in large quantities of additional shares being sold into the marketplace.
The primary defense has been that the enforcement actions are an arbitrary and capricious interpretation of the dealer statute and that the defendants had no reasonable grounds in which to conclude their activity could require licensing as a dealer.
The SEC certainly knew of the proliferation of convertible note and other market adjustable securities financings over the years. Rule 415 governs the registration requirements for the sale of securities to be offered on a delayed or continuous basis, such as in the case of the take down or conversion of convertible debt and warrants. In 2006 the SEC issued guidance on Rule 415 that the rule would not be available for re-sale registration statements where in excess of 30% of the company’s float was being registered for re-sale. The SEC indicated it would view such registrations as indirect primary offerings, that could not be priced at the market. The SEC action was in direct response to the proliferation of market adjustable equity line of credit financings during that time. Although there were a few large investors that did the majority of the financings, the SEC did not raise the dealer issue.
Moreover, back in 1997, the SEC amended Rule 144 to specifically allow for the tacking of a holding period when converting convertible securities. At that time, the rule amendment contained an in-depth discussion of convertible note (and convertible preferred stock) financing. The rule did not mention that investors could be considered “dealers” as defined by the Exchange Act. Likewise, the 2008 Rule 144 amendments that reduced the holding periods to six months and one year also addressed convertible financing and added a provision to clarify that tacking is also allowed upon the exercise of options and warrants where there is a cashless exercise feature. Again, the SEC did not raise an issue that the most prolific investors could be acting as an unlicensed dealer. To the contrary, the SEC recognized the importance of this type of financing.
Nothing in the prior SEC rule making, interpretive guidance, or enforcement actions foresaw the current dealer litigation issue. The SEC litigation put a chill on convertible note investing and has left the entire world of hedge funds, family offices, day traders, and serial PIPE investors wondering if they can rely on previously issued SEC guidance and practice on the dealer question. The SEC only filed actions for unlicensed dealer activity against investors that invest specifically using convertible notes in penny stock issuers. Although there is a long-standing legal premise that a dealer in a thing must buy and sell the same thing (a car parts dealer is not an auto dealer, an icemaker is not a water dealer, etc.), there is nothing in the broker-dealer regulatory regime or guidance that limits broker-dealer registration requirements based on the form of the security being bought, sold or traded or the size of the issuer (i.e. penny stocks).
Specifically, there is no precedent for the theory that if you trade in convertible notes instead of open market securities, private placements instead of registered deals, bonds instead of stock, or warrants instead of preferred stock, etc., you either must be licensed as a dealer or are exempt. Likewise, there is nothing in the broker dealer regime that suggests that if you invest in penny stock issuers vs. middle market or exchange traded entities you need to be licensed as a dealer.
The Author
Laura Anthony, Esq.
Founding Partner
Anthony, Linder & Cacomanolis
A Corporate and Securities Law Firm
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony, Linder & Cacomanolis, PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALC legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
Ms. Anthony is a member of various professional organizations including the Crowdfunding Professional Association (CfPA), Palm Beach County Bar Association, the Florida Bar Association, the American Bar Association and the ABA committees on Federal Securities Regulations and Private Equity and Venture Capital. She is a supporter of several community charities including the American Red Cross for Palm Beach and Martin Counties, Susan Komen Foundation, Opportunity, Inc., New Hope Charities, the Society of the Four Arts, the Norton Museum of Art, Palm Beach County Zoo Society, the Kravis Center for the Performing Arts and several others.
Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.
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