By Mark S. Nelson, J.D.
The Eleventh Circuit recently issued a divided opinion in which a three-judge panel unanimously held that Ibrahim Almagarby acted as an unregistered “dealer” under federal securities laws, that the SEC did not violate Almagarby’s due process rights, and that the district court properly ordered disgorgement against Almagarby. A two-judge majority then held that the district court properly imposed an injunction against Almagarby regarding future violations of the federal securities laws, but that the district court erred in banning Almagarby from penny stock offerings. As a result, the penny stock bar was vacated. A partial dissenting opinion argued that the majority applied too strict a test regarding the penny stock bar (SEC v. Almagarby, February 14, 2024, Pryor, W.).
High volume trading. According to the court, Almagarby engaged in an investment scheme in which he obtained microcap companies’ debt instruments from third parties and then sought to persuade the issuers to agree to exchange non-convertible debt for convertible debt. Almagarby, the court explained, was careful to acquire “aged” debt that was not subject to registration under Securities Act Rule 144. Upon receiving convertible debt, Almagarby would ask the issuer to exchange the debt for shares, often within 10 days of receiving the debt instrument in order to exit the particular investment as rapidly as possible. Within 14 days of receiving the shares from an issuer, Almagarby would tell his broker to sell them.
Almagarby allegedly acted almost exclusively on his own, although the court’s opinion indicated that he did hire legal counsel and used “finders” as a source of referrals. The SEC charged that Almagarby was a “dealer” under Exchange act Section 15(a) because the high volume of transactions he engaged in implied he was dealing in securities as part of his regular business.
“Dealer.” The court began with the Exchange Act definition of “dealer,” which is “any person engaged in the business of buying and selling securities…for such person’s own account.” The SEC argued that Almagarby was a dealer, and not entitled to assert the “trader” exception, because of the “kind” and “amount” of transactions he engaged in.
Almagarby argued that the district court should not have relied on precedent that focused on the broader definition of “dealer” under the Securities Act (no trader carve-out). The appellate court said the district court’s reliance on the precedent would not alter the result for Almagarby because the volume of trading he engaged in was the equivalent of buying and selling securities in his regular business, something one cannot do if they wish to assert the trader carve-out under the applicable Exchange Act provision.
The court also sought to assuage an amicus’ concern that institutional traders could be swept up by an expanded definition of “dealer.” The court distinguished institutional trading from the high-volume, finder-driven activities of Almagarby.
Due process. Almagarby further argued that the SEC violated his Fifth Amendment right to due process by bringing an enforcement action against him based on a novel legal theory of who is a “dealer” for purposes of the federal securities laws. The court explained that due process requires that the government give fair notice of what the law is.
Although various guidance and no-action letters issued by the SEC did not specifically address Almagarby’s situation, the court said the SEC’s conduct of the matter accorded with due process. The court even noted that Almagarby could have sought a no-action letter reply from the SEC regarding whether his activities complied with federal securities laws.
Said the court: “But we have never held that an agency violates a defendant’s right to due process by bringing an enforcement action based on a legal theory not advanced in noncomprehensive public manuals or party-specific letters.”
Disgorgement. Almagarby argued that the SEC’s disgorgement claim was untimely, inapt, and lacked a causal link to the complained of activities. The court quickly dismissed the timeliness issue by noting that the SEC complied with the five-year limitations period in the then-applicable law.
Almagarby next argued that the disgorgement award violated the principles set forth by the Supreme Court in Liu, which clarified that disgorgement “[can]not exceed a wrongdoer’s net profits” and must be “awarded for victims.” Almagarby asserted that the award would not be for investors. However, the court credited the SEC’s explanation that it could track counterparties to Almagarby’s transactions and that these counterparties could be identified and receive awards distributed by the SEC.
Lastly, Almagarby argued that the was no causal link between his profits and his failure to register as a dealer. The court, likewise, dispatched the issue quickly: “Almagarby was altogether prohibited from making transactions as an unregistered dealer, so any profits generated from his prohibited transactions were causally linked to his failure to register” (emphasis in original; citation omitted discussing that SEC need not show proximate cause in civil enforcement actions).
Injunction. The court also needed little time to affirm the district court’s imposition on Almagarby of an injunction against future violations of the federal securities laws. The court focused on the volume of transactions Almagarby engaged in and the fact that he still has a total of three active business entities.
Penny stock bar. With respect to the penny stock bar, however, a two-judge majority of the appellate panel found that the district court abused its discretion by imposing a penny stock bar that prohibited Almagarby from engaging in both legal and illegal penny stock transactions. Here, the court applied the same “Blatt” factors it did regarding the injunction against future violations.
Under Blatt, the court considers the following: (1) how egregious were the defendant's actions; (2) whether the alleged violations were isolated or recurring; (3) whether the violations involved scienter; (4) whether the defendant provided sincere assurances that he or she will not repeat the violations; (5) whether the defendant grasps the wrongful nature of the violation; and (6) whether the defendant’s occupation may suggest an opportunity to commit future violations.
The court began its analysis by noting that Blatt’s recurrence and occupational opportunity factors weigh in favor of a penny stock bar, as they had weighed in favor of injunctive relief. However, the court found that the district court abused its discretion regarding the remaining Blatt factors.
With respect to scienter, the court said Exchange Act Section 15(a) has no such requirement and Almagarby hired counsel in an effort to comply with the law (the partial dissent suggested that hiring counsel was to “immunize” Almagarby from an enforcement action versus “any desire to follow the law”) (emphasis in original). Almagarby also provided an affidavit in which he said that he would accept the court’s ruling and that he would not repeat the violations.
The wrongfulness factor also put the majority at odds with the dissent, which the majority characterized as seeking to hold Almagarby accountable for denying his wrongdoing because he appealed the “dealer” issue. Said the majority: “So the partial dissent penalizes Almagarby for appealing. Yet making a non-frivolous argument on appeal is not the same thing as refusing to accept and respect the law once it has been settled.”
Lastly, the court said that from its precedents “we discern several facts indicating egregiousness: (1) ‘blatant’ securities-law violations, (2) knowingly or recklessly making material representations or omissions (fraud), and (3) scienter.” The court acknowledged that definitive definitions of the term are lacking, but nevertheless said the district court had misapplied the egregiousness factor. Here, the majority said Almagarby’s actions were not “blatant” nor were they fraudulent, the latter conclusion flowing from the fact that had Almagarby registered as a dealer he could have engaged in the activities lawfully, although the majority said limits on registered dealers’ activities might have resulted in Almagarby taking a different approach to his trading business.
Partial dissent. Chief Judge Pryor wrote separately in a partial dissent that he would have affirmed the penny stock bar and that the majority had set too high a standard regarding imposition of the penny stock bar. According to the dissent: “Although it cites our precedents, the majority nevertheless invents a new test that requires an injunction to either (1) be preceded by a ‘prior adjudicated securities violations’ or (2) involve ‘conduct bordering on (if not amounting to) criminal.’”
In its opinion for the court, the majority preemptively disputed that it had created a “new test” and further responded to the partial dissent’s critique by emphasizing that it merely applied decades of established precedent: “Indeed, no Circuit precedent we’re aware of—including the only cases the district court cited in support of its penny-stock bar—supports the enjoining of otherwise lawful behavior under the circumstances here.”
The case is No. 21-13755.