Statement Regarding GHS Investments, LLC

From 2017 through 2022, GHS Investments, LLC (GHS) acquired convertible, variable rate notes from penny stock securities issuers, converted the notes into stock at a substantial discount from the prevailing market price, and sold the resulting shares into the public market to obtain profits. The Commission has issued an order that finds that such activities made GHS a dealer[1] under Securities Exchange Act of 1934 (Exchange Act) and GHS's failure to register as a dealer violated Section 15(a)(1) of that Act.[2] I dissent from this order because it appears that the Commission is attempting to achieve policy objectives through enforcement, instead of rulemaking, while also arbitrarily deciding which activities necessitate enforcement action.

Regulation by Enforcement

Since at least the 1990s, companies have issued convertible, variable rate notes to finance their operations.[3] When investors, like GHS, convert the notes into the company's common stock and resell the stock, there can a "death spiral" of the price of the stock.[4] However, companies generally issue these notes understanding this risk because they have no other sources of financing.[5]

Although 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. However, the appropriate course of action to address these concerns is through rulemaking, not enforcement.

The Commission began a rulemaking process in 2020 when it proposed changes to Rule 144 under the Securities Act to eliminate tacking of holding periods[6] for certain types of convertible, variable rate notes, including those at issue in this case. Without tacking, investors, like GHS, may be required to hold the converted shares for at least six months before selling them.[7] If that were the case, investors may be discouraged from purchasing notes at the outset because they would be subject to investment risk while holding the underlying common stock after conversion. Thus, if tacking were prohibited, the Commission may achieve its unspoken policy objective regarding convertible, variable rate notes. However, the Commission has yet to take final action on the proposal.[8]

Since 2017, the Commission has brought a series of enforcement actions against investors engaged in activities similar to GHS with respect to convertible, variable rate notes. These cases introduced a novel interpretation that such activities meant that investors were "dealers" and needed to register under the Exchange Act. While the Commission has been successful in some of these actions,[9] the facts of this case demonstrate why regulation by enforcement is extremely problematic.

Prior to 2017,[10] investors in convertible, variable rate notes had no reason to believe that their activity could trigger dealer registration obligations. One might claim that market participants should have been on notice about the Commission's previously undisclosed interpretation of "dealer" when it filed the first complaint in 2017. However, it is unreasonable to expect market participants to be continuously scanning court dockets in pending litigation across the country for new legal theories from the Commission, and on which a court has never ruled.[11]

District courts began issuing opinions analyzing the Commission's interpretation of "dealer" in late 2019 and in 2020.[12] However, a court of appeal would not rule on the issue until 2024.[13] The Supreme Court has recognized "[t]he fundamental principle that laws regulating persons or entities must give fair notice of what conduct is required or proscribed."[14] The Commission's action against GHS did not satisfy this principle. As the Commission acknowledges in its order, GHS ceased purchases of new convertible, variable rate notes in 2020, and converted and sold only small amounts of stock from existing inventory after 2020.[15] In other words, GHS stopped the conduct in question around the time that the first judicial opinions stating that such conduct triggered dealer registration requirements was issued. In light of this, holding GHS to a standard not articulated until after its conduct occurred is fundamentally unfair.

The Commission should not be implementing policy objectives for convertible, variable rate notes through enforcement of novel theories under the "dealer" definition. Instead, the Commission should achieve its objectives through the rulemaking process, such as its proposal to change Rule 144's tacking requirements.

Arbitrary Enforcement

Under the Commission's broad definition of "dealer," nearly any activity that involves buying and selling securities outside of the trader exception could require registration under the Exchange Act. Yet the action against GHS is solely focused on its transactions involving convertible, variable rate notes.

In addition to notes, GHS also acquired shares of common stock at a discounted price pursuant to equity lines of credit and then sought to resell them at prevailing market prices pursuant to registration statements under the Securities Act.[16]

However, the Commission's order makes no mention of the common stock obtained through these equity lines of credit. Instead, the Commission appears to make an arbitrary decision that transactions involving convertible, variable rate notes should be subject to different - and harsher - regulatory treatment.

Why does the acquisition and resale of stock from convertible, variable-rate notes require GHS to register as a dealer while the acquisition and resale of discounted stock from equity lines of credit raise no such registration requirements? Is it because issuances of such notes, which are often made as last-ditch financing by near-bankrupt companies, implicate the Commission's unspoken policy concerns but issuances of common stock may not? Unfortunately, the order is silent on this question.

Singling out of notes transactions as requiring dealer registration appears to be an arbitrary application of the "dealer" definition. This type of arbitrary implementation was a concern to the Supreme Court when it overturned the Chevron doctrine in Loper Bright Enterprises v. Raimondo.[17] As Justice Gorsuch explained in his concurring opinion, "because the reasonable bureaucrat may change his mind year-to-year and election-to-election, the people can never know with certainty what new 'interpretations' might be used against them."[18] Actions like the one the Commission takes today invite heightened judicial scrutiny of the Commission's interpretation of the term "dealer."

The Commission's actions also further raise questions as to whether its implementation of the "dealer" definition under the Exchange Act should be analyzed under the Supreme Court's "void for vagueness" doctrine, which "addresses at least two connected but discrete due process concerns: first, that regulated parties should know what is required of them so they may act accordingly; second, precision and guidance are necessary so that those enforcing the law do not act in an arbitrary or discriminatory way."[19] Under the Commission's current interpretation of the "dealer" definition, parties cannot know what is required of them, and the Commission's lack of precision enables enforcement actions to be undertaken in an arbitrary and discriminatory manner.

Conclusion

In enforcing the federal securities laws, the Commission has an obligation to express its views prospectively, ex ante, to provide fair notice to persons of the conduct that will run afoul of the law. The Commission has failed to do so in this action against GHS.