A so-called “toxic” lender was a “dealer” required to register under the Securities Exchange Act of 1934, and disgorgement was an appropriate remedy for his violations, but a divided panel held that a lifetime ban from engaging in penny-stock transactions was an abuse of the district court’s discretion. S.E.C. v. Almagarby, 2024 WL 618517 (11th Cir. Feb. 14, 2024).
Ibrahim Almagarby formed Microcap, LLC while he was in college, and he was the company’s sole owner, employee, and “controlling person.” Almagarby, through Microcap, engaged in so-called “toxic,” or “death spiral” financing, which involves purchasing microcap companies’ convertible debt; converting it to equity, and then selling the equity. The resulting dilution of the issuer’s shares typically makes it even more difficult for the issuer to find investors and financing—hence the “death spiral” appellation. Almagarby’s activity was a variation on the theme: he purchased existing debt instruments from third parties, rather than directly from the debtor-issurers, and then negotiated conversion agreements directly with the issuers. He also bought only “aged” debt, which was not required to be registered under the Securities Act and which he could sell immediately upon conversion, without a waiting period. Microcap contracted formally and informally with “finders” who would locate the debt for purchase, often by making cold calls, and Almagarby’s goal was to conduct transactions quickly and at high volumes. Over a three-and-a-half year period, he made over $885,000 in net profits, engaged in at least 57 purchases of aged debt, and made nearly a thousand individual stock sales. Microcap had no employees besides Almagarby, but did retain counsel, among other reasons to write opinion letters to the effect that the aged debt the company purchased was not required to be registered. Almagarby did not provide professional investment advice, invest money other than his own, or solicit investments from any other party.
In 2017, the SEC filed a complaint against Almagarby, alleging that he was a “dealer” required to register under the Exchange Act because he was “in the business of” buying and selling securities. The district court granted summary judgment in the SEC’s favor; ordered disgorgement of more than $885,000 in net profits; and permanently enjoined Almagarby from selling unregistered securities and from any future participation in penny-stock offerings. The Eleventh Circuit affirmed except as to the penny-stock ban.
Chief Judge William Pryor delivered the court’s opinion except as to the lifetime ban. With respect to Almagarby’s status as a “dealer,” the court reviewed the distinction between the Exchange Act’s definition of a “dealer”—a person who is “engaged in the business of buying and selling securities”—and the Act’s “trader” exemption, which applies to a person who transacts in securities “but not as a part of a regular business.” While the roles have “somewhat converged” as a practical matter, the court noted, “the distinction between dealers and traders remains crucial for regulatory purposes[.]” Almagarby was properly determined to be a “dealer” because “a ‘dealer’ is one who buys to sell,” and that’s what Almagarby did—his business model was predicated on buying and selling for its own sake, rather than on appreciation in value of the securities he bought and sold. Almagarby also brought new shares into the market, thereby engaging in underwriting, which further supported the conclusion that he was a “dealer.” The court was unpersuaded by Almagarby’s arguments that he could not be a “dealer” because he purchased aged debt from third parties rather than from the issuers themselves (a “technicality,” in the court’s view), and that he acted only for himself and had no customers (“a customer requirement has no grounding in the statutory text”). The court also rejected Almagarby’s argument that the SEC violated his due-process rights because he was without sufficient notice that he might be deemed a “dealer.” “[T]he Commission has never issued any guidance on whether toxic lending is a ‘dealer’ activity,” the court observed, adding with respect to Almagarby’s argument based on no-action letters that “no-action letters are limited to the named individuals,” and Almagarby “could have applied for a letter of his own had he been concerned with compliance.”
The court also affirmed the district court’s disgorgement order, rejecting Almagarby’s argument that the “victim-benefit” requirement articulated in Liu v. SEC, 591 U.S. ___, 140 S. Ct. 1936 (2020) had not been met. A Commission expert had testified that it was possible to track the counterparties to Almagarby’s sales, to whom the Commission planned to distribute awards—and “[w]hen the Commission is able to identify investors who have suffered pecuniary harm, disgorgement satisfies the requirement that disgorgement be ‘for the benefit of investors.’”
The court also affirmed the district court’s injunction prohibiting future unregistered securities transactions in violation of section 15(a)(1) of the Exchange Act, but a divided panel reversed the lifetime penny-stocks ban. Judge Robin Rosenbaum, writing for the court on that point, determined that the factors identified in SEC v. Blatt, 583 F.2d 1324 (5th Cir. 1978), concerning the likelihood of a repeat violation, did not support the imposition of a lifetime ban, citing Almagarby’s assurances that he would respect the court’s ruling and not engage in future violations of the securities laws and the fact that his past violations had not involved knowing misrepresentations or other intentional dishonesty. Judge Pryor would have affirmed the lifetime ban, writing in his partial dissent that “the district court implicitly found wanting Almagarby’s sincerity in disavowing future misconduct,” and that the district court’s determination on that point, combined with Almagarby’s years-long past misconduct, showed no abuse of discretion.