SEC Dismisses Convertible Bond Dealer Suits

The SEC’s dismissal of recent “unregistered dealer” enforcement actions cements a scaling back of the dealer definition and reflects a policy shift from the prior SEC.

On May 22, 2025, the Securities and Exchange Commission (Commission or SEC) announced that it filed stipulations to completely dismiss with prejudice three civil enforcement actions in which the SEC’s sole claim was that the defendants acted as unregistered dealers in violation of Section 15(a) of the Securities Exchange Act of 1934 (Exchange Act). In a fourth action that involved multiple claims, the SEC sought dismissal of an unregistered dealer claim while keeping the remaining claims intact (collectively, the Unregistered Dealer Dismissals.)¹

The Unregistered Dealer Dismissals all involve investors engaging in what is commonly referred to as “toxic” or “death spiral” financing. This practice involves a small-cap company (the issuer) selling convertible debt to an investor as a means of raising capital. The investor then converts this debt into the company’s common stock at a price below the prevailing market rate, subsequently selling the stock in the secondary market.

As the SEC described in one of the complaints, such practice enabled the investor to “capture as much of the spread between its discounted acquisition price and the market price as possible.”² Selling large amounts of shares on the open market, although profitable for the seller when the shares are converted at discount to the market price, can be fatal to an issuer. It depresses the stock price and reinforces further selling by market participants and can prevent the company from raising more capital, leading to insolvency or bankruptcy.

In none of the original complaints did the SEC allege fraud or market manipulation, presumably because “toxic” financing is not technically illegal. The enforcement actions, however, may have indicated that as a policy matter, the SEC sought to discourage “toxic” financing via unregistered dealer allegations.³

Dismissals Follow a Federal District Court’s Rejection of the SEC’s Expansive Definition of Dealer

On February 6, 2024, the SEC adopted new rules 3a5-4 and 3a44-2 (the Rules) further defining the phrase “as part of a regular business” — which is an integral part of the Exchange Act’s definition of “dealer.”

The Exchange Act defines a dealer as “any person engaged in the business of buying and selling securities […] for such person’s own account.” However, it excludes persons buying and selling securities for their own accounts but “not as a part of a regular business”. The SEC has long recognized this proviso in the “dealer” definition as the “trader exception” and has indicated in its informal guidance that certain indicia are relevant to drawing this distinction, including whether the firm is carrying an inventory, has regular clientele, quotes the market, buys and sells the same security simultaneously, engages in securities activities that are relatively minor as measured against its other business, holds itself out as willing to buy and sell particular securities on a continuous basis, or acts as a de facto market maker whereby market professionals or the public look to the firm for liquidity.

The Rules placed increased emphasis on the regularity of buying and selling securities as a core component of a business. Thus they would likely have captured many market participants as “dealers” that, due to advancements in electronic trading, were previously able to play a significant role as liquidity providers. The test was designed to capture persons operating as dealers through their “expression of trading interest” on both sides of the market for the same security. It therefore would have encompassed persons or entities who otherwise may have been able to avail themselves of the trader exception, and would have thus effectively eliminated the trader exception for persons or entities that controlled total assets valued above $50 million or that had not registered as an investment company under the Investment Company Act of 1940 (for more information, see this Latham blog post).

The Rules drew strong opposition from a broad spectrum of market participants, including the private fund and digital asset sectors. They immediately faced legal challenges from the Blockchain Association and the Crypto Freedom Alliance of Texas (on behalf of the digital asset sector), as well as the National Association of Private Fund Managers, the Managed Funds Association, and the Alternative Investment Management Association (on behalf of the private fund sector).

On November 21, 2024, Judge Reed O’Connor of the US District Court for the Northern District of Texas held in two separate opinions⁴ that “the SEC exceeded its statutory authority” in adopting the Rules. The court noted that Congress defined the term “dealer” “against a pre-existing historical backdrop […] indicative of an understanding that dealers have customers.”⁵

The Rules, according to the court, were therefore “untethered from the text, history, and structure of the [Exchange] Act,” and represented “unlawful agency action taken in excess of [the SEC’s] authority.”

As for remedies, the court concluded that because the SEC promulgated the Rules beyond its statutory authority, “[v]acatur of the rule in its entirety is appropriate.”

On January 17, 2025, in one of its final actions during the waning days of the Biden administration, the SEC appealed the decisions in the US Court of Appeals for the Fifth Circuit.

On February 20, 2025, under a new administration and new agency management, the SEC voluntarily dismissed its appeal of Judge O’Connor’s vacatur (for more information, see this Latham blog post).

Judge O’Connor’s Holdings and the Unregistered Dealer Dismissals

None of the enforcement actions underlying the Unregistered Dealer Dismissals was brought under the expanded definition of dealer as finalized in the Rules. However, Judge O’Connor’s two separate opinions are critical to understanding the likely underpinnings for the SEC’s Unregistered Dealer Dismissals.

Notably, in none of the original complaints of the Unregistered Dealer Dismissals did the SEC allege that the defendant had effected securities transactions for customers. Judge O’Connor’s position that a customer nexus is fundamental to the statutory definition of dealer may have provided the SEC with the relevant legal reasoning it needed to dial back the broad definition of dealer that it had used for the claims filed under the prior SEC.

Judge O’Connor’s decision therefore not only preserved but rendered more black-and-white the trader exception to the dealer definition. The decision vacated the Rules and went further than historical SEC guidance by effectively stating that a customer relationship is a necessary element to the Exchange Act’s definition of “dealer.”⁶

Conclusion

The Unregistered Dealer Dismissals signal the SEC’s abandonment of the strategy it had previously adopted to pursue enforcement actions against those who engage in “death spiral” financings by alleging unregistered dealer activity (in the absence of fraud). They also signal a recalibration of how the SEC interprets the definition of dealer to align with Judge O’Connor’s approach, rather than the expansive approach that the SEC formerly took in its convertible bond enforcement actions, and its failed attempt to expand the dealer definition. It also indicates that the trader exception to the dealer definition remains alive and well, at least for the moment.

1. The four cases in which the SEC dropped its unregistered dealer claims are:
   · SEC v. Adam R. Long, et al., Case No. 1:23-cv-14260 (N.D. Ill. filed Sept. 28, 2023);
   · SEC v. Tri-Bridge Ventures, LLC, et al., Case No. 3:24-cv-05711 (D.N.J. filed Apr. 29, 2024);
   · SEC v. LG Capital Funding, LLC, et al., Case No. 1:22-cv-03353 (E.D.N.Y. filed June 7, 2022); and
   · SEC v. River North Equity LLC, et al., Case No. 1:19-cv-01711 (N.D. Ill. filed Mar. 11, 2019). 
2. LG Capital Funding at 21. 
3. Commissioner Mark T. Uyeda issued a dissent in a convertible bond enforcement action in 2024 (similar to the fact pattern in the complaints of the Unregistered Dealer Dismissals) stating that the SEC tacitly frowned upon “death spiral” financing: “[a]lthough the Commission has not publicly expressed it, its enforcement actions suggest policy concerns with investors’ actions relating to convertible, variable rate notes and such actions’ impact on the share prices of companies that issue them.” He noted, however, that rather than engage in notice and comment rulemaking to achieve its policy objectives, the SEC was bringing enforcement actions under the premise that such investors and traders in convertible bonds were unregistered “dealers” for the purpose of the Exchange Act. 
4. Crypto Freedom Alliance of Texas, et al. v. SEC, et al., No. 4:2024cv00361 (N.D. Tex. 2024); National Association of Private Fund Managers, et al., v. SEC, No. 4:2024cv00250 (N.D. Tex. 2024) 
5. The court held in the private fund managers’ case that “[t]he Exchange Act’s text does not regulate trading entities without customers as dealers.” The court analyzed the term dealer, and found that when Congress enacted the Exchange Act, the term “had accumulated a settled meaning . . . ‘limited to one who . . . buys and sells securities to customers.” In its opinion in the case brought by the digital asset industry, the court held that the “‘business’ of dealing has always included ‘services offered’ to investors, ‘not merely engaging in trading activities for a person’s own investing or trading objectives.’” 
6. SEC Commissioner Caroline A. Crenshaw severely criticized the dismissals in a published statement, arguing that “[t]hose who have advocated for dismissals of these types of cases seem to read a non-existent requirement – that dealers have customers – into the statutory definition.” Commissioner Crenshaw relies primarily on SEC v. Ibrahim Almagarby, et al., 92 F.4th 1306 (11th Cir. 2024) and SEC v. Justin W. Keener, 102 F.4th 1328 (11th Cir. 2024) (both cases that involved convertible note “death spiral” financing practices) for her arguments. Judge O’Connor, however, considered these two cases and held that they “do not settle the [dealer definition] question.” Judge O’Connor held that:
   · The court in Almagarby did not broadly conclude that merely engaging in extensive trading alone qualifies someone as a “dealer.”
   · Like Almagarby, the Eleventh Circuit [in Keener] did not hold that regularly buying and selling securities alone renders someone a dealer.
   · Almagarby explicitly limited its “holding” to the defendants’ “specific conduct,” which the court characterized as “underwriting.”
   · At best, these cases [Almagarby and Keener] demonstrate that courts examine a wide variety of indicia to determine whether someone is “engaged in the business of buying and selling securities” and thus a dealer.