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Counterfeit Shares & Market Manipulation in the Public Markets

There has been an abundance of discussion regarding “counterfeit shares” flooding the public markets amongst retail investors for quite some time now. The average retail investor understands that this kind of activity is detrimental to companies for obvious reasons such as shareholder dilution and sinking share prices due to increased selling activity. Unfortunately, I think it is not so clear to the average retail investor as to what they can do to prevent or mitigate this kind of conduct. This article will explain the ins and outs of who is doing it, what exactly it is that they are doing and what steps a retail investor can take to try and prevent it from happening to a company they’re invested in.

An overwhelming amount of this activity is being conducted by unregistered dealers through toxic convertible promissory notes. A dealer, by definition, is one who buys and sells securities as part of a regular business for one’s own account. Under the Securities Exchange Act of 1934 (the “Act”), it is unlawful to engage in securities transactions if one is acting as a dealer and is not registered as such. If a contract is made in violation of any provision of the Act, it is considered void. In sum, when a dealer that is subject to registration due to its dealer activity engages in a securities transaction, that securities transaction shall be considered void.

Here is an non-exhaustive list of unregistered dealers that are often engaging in the detrimental and unlawful conduct described in this article. See If ANY of these unregistered dealers pop up in a company’s public filing, and you are a shareholder in that company, it should be a priority to do everything you can to get the company to cut all ties with that unregistered dealer. It is a recipe for disaster. The only thing that could result from a relationship with one of these unregistered dealers is astronomical shareholder dilution and steep declines in stock price.

“...’toxic lenders’: individuals who profit enormously by buying convertible securities (and Warrants) in penny stock companies and selling the shares they obtain through conversion of their promissory notes, warrants or preferred stock.”

Public companies are often in need of capital and, due to their circumstances, the funds they raise is generally not on the most favorable terms. One example of this is through a convertible note. If you are unfamiliar with what a convertible note is, here is a good explanation.

Before getting into the rights that companies might have against lenders who hold certain convertible notes and warrants, it is important to explain how these notes and warrants may lead a retail investor to believe “counterfeit shares” flood the market. One way a lender might do this is by taking short positions against the stock with unidentified shares (i.e., naked shorting) prior to exercising a conversion or warrant under the convertible note, which would inevitably cause the share price to sink. Remember, the conversion rights under the convertible note (and attached or associated warrants) are market-adjustable with a significant discount to market, therefore, the lower the stock price = the higher the number of shares they acquire through conversion. That said, if lenders wanted to maximize profits, after they acquire stock through conversion they could use it to cover the short positions that were taken pre-conversion and then sell the shares they acquired in excess of the short position for a profit. Therefore, upon the expiration of the Rule 144 holding period, when a convertible note (or warrant) holder is allowed to begin converting under the note (or warrant), it is not uncommon for millions of newly-issued shares to flood the market on a weekly basis which could potentially lead a retail investor to believe that the newly-issued shares are “counterfeit”. While this activity is egregious, unlawful, and downright immoral, the real issue is not necessarily that the new shares are “counterfeit” because they do eventually come into existence. The real issue is that the entities engaging in this conduct are doing it unlawfully as they are in the business of buying and selling securities for their own account while evading registration requirements.

How does this all apply to publicly trading companies that may be dealing with toxic convertible notes or adjustable warrants? While allegations above may be sufficient to withstand a market manipulation claim under SEC Rule 10b-5, a complaint under that rule is subject to a heightened pleading standard. This makes it more difficult to assert than a claim for a dealer registration violation, hence why it’s the course of action we prefer to advise our clients to take. When an unregistered dealer purchases a convertible note from a company, that is a transaction in securities and, therefore, that transaction is void. Once the transaction is declared void, the holder of the convertible debt no longer has a right to convert under the note and newly-issued shares can no longer flood the market. Whether the company acts affirmatively and brings an action against the note holder, or whether it raises the argument as a defense against a lawsuit commenced by a note holder, the same analysis applies: the holders of these notes are unregistered dealers who engage in securities transactions unlawfully and, therefore, the transactions shall be deemed void.

All in all, the moral of the story is that if you think the stock of a company you own shares in is being manipulated by potentially counterfeit shares, there’s a good chance that the company has funding from a lender on this list. You can verify this by looking at the disclosures (10-Ks, 10-Qs, 8-Ks, etc.) filed by a company. If a lender’s name pops up on one of your company’s filings, there’s a good chance that it is because of convertible debt financing. In the event that one of these lenders pop up, it would be smart to contact the company’s CEO and ask them to take a stand against these lenders, that is as long as they haven’t commenced an action against the company already.

Here is a link to the SEC’s EDGAR database where you can do a text search of a company's disclosures that it filed. Type in your company’s ticker symbol and the names of the lenders on the list to come up with a search.

Mark R. Basile, Esq. is the Senior Attorney at The Basile Law Firm P.C. Mark can be reached at To learn more about what we can do for you, please call us today at 516.455.1500 ext. 110 to request your free initial consultation. With offices in New York, Texas and Florida, we serve wronged public companies nationwide.


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