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SEC Finally going after Toxic Convertible Note Debt Lenders

Updated: Sep 5

The OTC Market is plagued with thousands of small public companies taking thousands of small loans in the form of convertible debt. If an issuer takes one of these loans, or several, be prepared in most cases for the company to go sub-penny in 6-12 months. Toxic convertible notes have been the Achilles heel for thousands of OTC Markets issuers. The very nature of the loan is toxic because after 6 months the notes principle and interest can be converted into stock at substantial fixed discounts to trading prices. I have seen discounts as high as 80%, but most average between 30% and 60%.


These “investors” or “lenders” are operating unregulated other than the obligatory SEC filings if they own more than 5%, and more than 10% of a public company, but they strive to avoid the “scrutiny” and have for the most part successfully operated under the SEC’s radar – until now.

While there are dozens of aggressive toxic convertible note investors who offer and provide this type of funding, the walls seem to be closing in on them very quickly now. Within the last 2 months, the SEC commenced two actions against two known toxic lenders seeking 1) disgorgement of all monies made on these stock sales, 2) civil fines, 3) cease and desist order and other relief that the SEC is entitled to under the 1934 Securities and Exchange Act. In the cases of SEC v. JDF Capital, Inc. and John D. Fierro, case no. 3:20-cv-2104 (USDC-New Jersey), and SEC v Justin W. Keener d/b/a JMJ Financial, case no. 20-cv-21254 (USDC SD Fl.), the SEC has accused those defendants with failing to register (oversight) under the ACT while Keener allegedly made $21.5M and Fierro allegedly made $2.3M in profits on purported improper stock sales. The Securities and Exchange Commission, along with the Department of Justice have targeted these toxic lenders simply because they are buying and selling newly issued securities, as a business, without first registering as a “Dealer” as the ACT requires.

Many of these “Investors” or “lenders” are not registered with FINRA, and if they are not registered under the ACT, all transactions they enter into are – VOID - by federal statute. This allows the SEC to sue those entities, stopping them from buying and selling securities and seeking disgorgement as well as huge civil fines along with cease and desist orders.

But the fun doesn’t stop there – since the 1934 Securities and Exchange Act makes these transactions void (15 US §78cc), OTC Market issuers may now be able to sue every one of their toxic convertible note lenders to rescind all of those transactions if they failed to register as a dealer under the ACT. The federal courts recognize a private right of action for issuers to not only sue to rescind those transactions (meaning the court enters a judgment nullifying the transaction), but under the 1933 Securities Act, those same issuers may have grounds to bring claims for securities fraud under 10b-5 and seek actual money damages, especially from the principles of those funds all because those groups did not register as a dealer with FINRA. Had they registered as a dealer under the ACT, they would be subject to much tighter government scrutiny, oversight and controls that have been developed to protect the investing public and their books could be turned inside out by the regulatory authorities.

I understand that the SEC may now be turning its focus on lenders from New York and Massachusetts. If they do, this will all play out publicly and the real winners are the issuers and their shareholders, at least the ones who have suffered crushing losses because of these types of transactions.

If you are the CEO of a public company and have taken convertible floorless toxic debt, sold warrants, or entered into an equity line of credit and you want to know more about your rights in connection with this new development, feel free to reach out to me at mark@thebasilelawfirm.com

The Basile Law Firm, P.C.

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Email: mark@thebasilelawfirm.com
Tel: 516-455-1500 

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