What is a Stock Broker? The answer is more complicated than people think. On August 2, 2022, the SEC announced that it had reached an agreement with a Long Island company, Crown Bridge Partners, LLC (“Crown Bridge”) and the two brothers who own the company Soheil and Sepas Ahdoot, not to have registered as a reseller. As part of the settlement, the defendants agree to pay restitution and prejudgment interest of $8,390,601.27 and a civil penalty of $810,307, as well as a five-year penny stock bar.
According to the SEC complaint, Crown Bridge purchased about 250 convertible notes from about 150 penny stock issuers. In total, during the relevant period, Crown Bridge sold on the public markets approximately 35 billion shares of post-conversion unlimited shares of penny stock issuers, for millions of dollars in profit. Soheil and Sepas first found companies interested in issuing convertible notes by reviewing OTCMarkets.com, a website that includes a newsfeed of SEC filings and press releases from equity issuers. to a penny. They used the website to identify issuers who appeared to need or had expressed a need for funding. They then cold called the senders directly. Over time, as Crown Bridge grew its business and gained recognition in the industry, issuers, brokers and finders approached Soheil and Sepas directly to seek funding.
In the absence of their apparent failure to register Crown Bridge as a concessionaire under Section 15(a) of the Exchanges Act [15 U.S.C.§ 78o(a)], Soheil and Sepas executed what appears to have been a very shrewd and successful business plan. Crown Bridge purchased convertible notes directly from penny stock issuers. They negotiated the terms of the notes which generated millions of dollars in profit when the notes were converted into shares. The Notes generally contained terms highly favorable to Crown Bridge and reduced Crown Bridge’s exposure to market risk, such as a conversion discount ranging from 25% to 50% off the prevailing “market price”, a term the notes generally define as the lowest price. closing bid price or the lowest closing bid price of the common shares of the issuer during the 10 to 25 days preceding or following the date of the notice of conversion. Crown Bridge’s right to convert the notes in increments was also essential, allowing Crown Bridge to convert what it could sell immediately, while protecting the remaining balance from exposure to market price fluctuations.
Crown Bridge generally held the tickets for six months, or until it could seek the SEC Rule 144 registration exemption. [17 C.F.R. § 230.144]. SEC Rule 144 allows non-affiliates who acquire restricted stock directly from the issuer in a private transaction to resell it unrestricted in the market after observing a hold period, among other requirements.
The SEC complaint very specifically points out that Crown Bridge converted the notes for the purpose of distributing the underlying shares in the public markets for a profit based on the difference between the market price and the discounted acquisition price, instead of holding the shares for appreciation. . The SEC noted that “[t]its limited exposure to market risk is a common feature of a stockbroker. He derived those profits primarily from the discounted acquisition price, not from the appreciation in the market price of the issuer’s common stock. The SEC also stated that “[t]its limited exposure to market risk is a common attribute of a stockbroker.
Section 3(a)(5) of the Act generally defines a “broker” as “any person engaged in the business of buying and selling securities for his own account through a broker or otherwise . . . . ” The SEC website states that “[t]Brokers are excluded from the definition of a “dealer” because while they may buy and sell securities for their own account, they do so “not in the course of a regular business”. So what does it mean to be “in the business” of buying and selling securities versus being an ordinary investor? What if a substantial portion of someone’s income comes from day trading? Does it matter, as stated above, that Crown Bridge’s profits do not come from share price appreciation? What if Crown Bridge held the securities longer and was exposed to more market risk, but still made a profit on the discounted acquisition price?
The SEC’s “Guide to Broker Dealer Registration” provides the following guidance on whether someone is a broker:
a person who presents himself as willing to buy and sell a particular security on an ongoing basis;
a person who manages a book with repurchase agreements; Where
a person who issues or creates securities that he also buys and sells.
Here are some of the questions you should ask yourself to determine if you are acting as a broker:
Do you advertise or let others know that you are in the business of buying and selling securities?
Do you deal with the public (whether retail or institutional)?
Do you make a market or quote prices for purchases and sales of one or more securities?
Do you participate in a “selling group” or otherwise underwrite securities?
Do you provide services to investors, such as money and securities management, granting credit or providing investment advice?
Do you write derivative contracts that are securities?
It seems that the Ahdoot brothers could credibly answer “no” to all of these questions and also state that the first three points do not describe their business model. Yet the SEC deemed them dealers rather than traders based almost solely on the fact that they had limited exposure to market fluctuations.
The SEC seems to understand that there is some ambiguity in the current statutory definition of dealer. In March 2022, the SEC proposed a new rule that more precisely defines the term “in the course of regular business” as used in the definition. The new rule primarily targets market participants who are not registered dealers and yet “engage in a routine pattern of buying and selling securities for their own account that has the effect of providing liquidity.” With 35 billion shares sold on the market in four years, it certainly seems that Crown Bridge falls squarely within the definition of a broker if the regularity of trading and the effect of providing liquidity to the market are the factors keys.