For the second time this year, the 11th U.S. Circuit Court of Appeals has accepted the U.S. Securities and Exchange Commission’s expansive view of who must register as a securities dealer, handing a setback to industry groups that had urged the appeals court to clarify the distinction between dealers and investment funds that trade securities on their own behalf.
The appeals court concluded in SEC v. Justin Keener, opens new tab that Keener’s Florida-based company, JMJ Financial, was operating as an unregistered securities dealer when it purchased convertible debt from microcap issuers, converted the debt into common stock and then sold a high volume of shares into public markets.
Judge William Pryor, writing for a panel that also included Judges Adalberto Jordan and Andrew Brasher, said Keener’s firm was acting as a dealer, even though its trades were not executed for customers, because of the “nature, volume, regularity and frequency of Keener’s transactions.”
The firm, which reaped nearly $8 million in profits from selling penny stocks converted from debt, billed itself at “lavish industry conferences” and on its website as a buyer and seller of securities, Pryor wrote. Those activities, the 11th Circuit said, “directly implicate the Commission’s public guidance for defining broker-dealers.”
The 11th Circuit issued its ruling on Wednesday, less than two weeks after the court heard oral arguments on May 16.
Keener’s lawyers from Gibson, Dunn & Crutcher did not respond to a query on the decision. An SEC spokesperson declined to comment.
Several trade groups, including the Managed Funds Association, the National Association of Private Fund Managers and the Alternative Investment Management Association, urged the 11th Circuit in friend-of-the-court briefs to clarify that market participants are not required to register as dealers simply because they routinely buy and sell securities.
The groups asked the appeals court to restrict the definition of a dealer to businesses that trade securities on behalf of customers, arguing that the SEC’s broad definition would otherwise require hedge funds, mutual funds, pension funds and even insurers to register and be subject to the stringent rules for securities dealers.
Amicus counsel Gabriel Gillett of Jenner & Block, who presented oral arguments to the 11th Circuit for trade groups worried about the broad scope of the SEC’s definition of a dealer, said in an email statement that the 11th Circuit’s “narrow, fact-specific opinion” did not, in fact, endorse the SEC’s “limitless interpretation” of who qualifies as a securities dealer.
“Investment advisors, investment companies and investment funds in the business of investing have never been dealers and are not dealers under 11th Circuit precedent,” Gillett said.
The 11th Circuit panel in the Keener case relied heavily on the court’s own three-month-old precedent, opens new tab from the SEC’s case against another penny-stock trader, Ibrahim Almagarby of the Microcap Equity Group. As I told you when the Almagarby decision came out, the appellate panel in that case took pains to acknowledge industry fears that investment advisors and funds might be considered dealers under the SEC’s definition in a sweep of cases against penny stock traders who flooded public markets with common stock converted from debt.
The panel in the Almagarby case, which included Pryor, said the language of the Securities and Exchange Act does not limit the definition of a securities dealer to traders who buy and sell on behalf of customers. The judges did, however, say their conclusion that Almagarby was acting as an unregistered dealer was based on the specific facts of his microcap business.
After the Almagarby decision, Keener’s lawyers at Gibson Dunn argued, opens new tab in a letter to the 11th Circuit that unlike Almagarby, Keener did not immediately convert microcap debt into common shares to be dumped into public markets but acted more like a long-term lender to these small publicly-traded businesses. Gibson Dunn urged the 11th Circuit to stick to its promise in the Almagarby opinion to hew to specific facts rather than adopting the SEC’s expansive definition of a securities dealer.
Trade groups also submitted a letter, opens new tab about the Almagarby decision to the Keener panel, asking the 11th Circuit once again to draw a distinction between Keener’s specific conduct and that of investors whose profits come from escalating prices for the securities in their portfolios rather than from volume trading.
Marc Indeglia of the Small Public Company Coalition, which was an amicus in the Almagarby case, said the Keener opinion is arguably more problematic for small and microcap market participants than the previous decision because the Keener court did not even acknowledge industry arguments about the overly expansive definition of a dealer.
“There are no caveats here,” said Indeglia, a partner at Glaser Weil Fink Howard Jordan & Shapiro. “There is no analysis of the impact of the decision on broader markets.”
Indeglia was more critical of the 11th Circuit’s opinions than Jenner’s Gillett, who represented trade groups in both the Kenner and Almagarby cases. “Neither decision gives guidance on where the line is,” Indeglia said, asserting that under the 11th Circuit’s now-cemented precedent, venture capital and PIPE (or private investment in public equity) funds could be at particular risk of enforcement actions accusing them of acting as unregistered dealers.
“If what [Almagarby and Keener] were doing requires a dealership license,” Indeglia said, “then so does everyone else.”
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