SEC Charges “Toxic” Lender for Failing to Register as a Dealer Under Volume-Based Theory

On March 24, 2020, the Securities and Exchange Commission (“SEC”) charged Justin W. Keener, doing business as JMJ Financial, with violating Section 15(a)(1) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), for effecting millions of dollars’ worth of transactions in billions of shares of penny stock while failing to register as a securities dealer.

Registration of Securities Dealers

Section 15(a)(1) of the Exchange Act requires that any person engaged in the business of buying and selling securities for his or her own account as part of a regular business must register as a dealer with the SEC or associate with a registered dealer.

Registration with the SEC requires dealers to provide information to the SEC and self-regulatory organizations like the Financial Industry Regulatory Authority (“FINRA”) and national securities exchanges. This information aids the SEC and these other organizations in regulating the activities of registered dealers to ensure compliance with federal securities laws.

Facts of the Keener Complaint

The SEC alleged that, during a three-year period, Mr. Keener repeatedly negotiated terms of convertible promissory notes, referred to by some as “toxic” notes, with more than 100 different penny stock issuers that allowed Mr. Keener to convert the promissory notes into shares of the issuers’ stock at a significant discount to the then-prevailing market price, generating large profits for Mr. Keener, but typically causing the issuer’s stock price to significantly decline.

Mr. Keener, as described by the SEC, would negotiate convertible promissory notes terms allowing him to convert such notes at a specified discount generally between 35% and 50% less than the lowest closing price for the stock underlying the promissory notes during the last 10 to 25 trading days prior to the conversion. The SEC alleged that this 35% to 50% discount from a recent low closing price generally resulted in large profits to Mr. Keener, even when his own sales depressed the prevailing market price.

According to the SEC, Mr. Keener operated his business directly at offices located in Miami Beach, Florida, and occasionally acted indirectly through commission-based employees located in California. During this three-year period, the SEC alleged that Mr. Keener held himself out to the public as willing to buy convertible notes as part of his regular business, including attending and sponsoring conferences where Mr. Keener and his employees would solicit penny stock issuers. As set forth in the SEC’s complaint, Mr. Keener and his employees regularly used interstate communications to operate this business plan.

Throughout all of these alleged activities, Mr. Keener was not registered as a dealer with the SEC and had been barred from associating with any FINRA member since 2012.

Mr. Keener allegedly sold over 17.5 billion shares of newly issued stock of more than 100 different issuers, generating approximately $21.5 million in profits.

The SEC’s Theory of Liability

Notably, the SEC did not allege that Mr. Keener violated the registration provisions of the Securities Act of 1933, as amended (the “Securities Act”). In fact, the SEC’s complaint explains that Mr. Keener sold the stock issued upon conversion of the promissory notes pursuant to the exemption from registration provided by Rule 144 under the Securities Act.

However, the SEC believes Mr. Keener was required to register with the SEC as a dealer due to the large volume of newly issued stock that Mr. Keener sold in these transactions. According to the SEC, nearly all of the stock sold by Mr. Keener was previously unissued and not outstanding, as opposed to previously issued and outstanding stock purchased in the secondary trading market. As stated in the SEC’s complaint, “[s]elling large quantities of newly issued shares into the market is a common attribute of a securities dealer.”

What You Should Know Going Forward

Many commenters in the securities industry view the type of funding operated by Mr. Keener as “toxic lending.” Due to the steep discounts and large volumes of converted stock entering the secondary trading market only a short period of time after the stock is initially issued, lenders like Mr. Keener often dilute existing stockholders and drive down the price of the issuer’s stock. However, for penny stock issuers quoted on the over-the-counter markets, available financing is often difficult to obtain and toxic lending may be one of the only options available to such issuers.

The SEC, by asserting a volume-based theory of an Exchange Act Section 15(a)(1) violation, may be seeking to indirectly protect existing investors from dilution as the result of toxic lending, but this will have the impact of reducing the capital raising options available for penny stock issuers.

As of the publication of this newsletter, no settlement or further action has been taken with respect to this charge. The SEC’s complaint against Mr. Keener is available at this link.

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