SEC Action on Wrap Around Agreements – Debt to Equity Conversions
Last month, Cameron Linton, a Florida based attorney consented to a SEC Administrative Proceeding (SEC Release No. 67912 / September 21, 2012, Administrative Proceeding File No. 3-15040) that suspended him from appearing or practicing before the Commission as an attorney. This enforcement action originally caught my attention back in early May when the SEC issued Litigation Release # 22353 charging an attorney and clients in scheme to unlawfully sell billions in penny-stock shares through the use of “wrap around agreements.” The original press release stated that these wrap around agreements were illegal debt to equity conversions.
This made for some very interesting reading, as it turned out the attorney, Cameron Linton, had been charged with same violations of SEC rules and regulations a few years earlier
The original complaint is a rather interesting read in part because in paragraph 26 of the complaint it provides a detailed explanation as to how the wrap around agreements worked in that particular case. In that particular case the defendants were charged with violations of Sections 5(a) and 5(c) of the Securities Act of 1933 for the sale of unregistered shares into the public markets. This is also interesting because in its efforts to prosecute the case, the SEC was able to obtain an emergency TRO freezing the assets of the defendants in this case.
In the 2012 enforcement action, the SEC not only went after the distributors of the stock utilizing the wrap around agreements, but it also went after the attorney who wrote the legal opinions, Mr. Linton. Again, this complaint provides a good explanation of what a wrap around agreement is, and how it basically works. The short version of how these wrap around agreements work is that a company will allow the assignment of debt to a third party and allow the debt to become convertible into its common stock at a discount to the market, the new holder of the newly convertible debt will then request the conversion of the debt into common stock, following the debt conversion an attorney, Linton, would provide fraudulent legal opinions claiming the shares were exempt from registration under Section 5 of the Securities Act of 1933 via the exemption provided through Rule 144. This allowed the shares to be issued without restrictive legend, the stock distributors would then sell the shares into the public markets. This complaint is a little more interesting read because it actually sites the portion of Rule 144 that the SEC claims was fraudulently misrepresented in the legal opinion letters by Mr. Linton, and that he failed to make a determination that the stock distributors were not underwriters within the meaning of Sections 4(1) and 2(a)11 of the Securities Act of 1933.
These wrap around agreements, the conversion of debt to equity by public companies have become common since the SEC revised Rule 144 in early 2006. They have become a favorite tool of people looking to get free trading shares that can be quickly sold into the market. However it is important to note two (2) important items from the SEC’s complaints on this matter. The 1st being that if the debt in question has not been convertible for a period in excess of 1 year, then it cannot be converted into free trading shares. Secondly, and very importantly these illegal stock issuances could not occur without the services of an attorney willing to write a fraudulent legal opinion for removal of the restrictive legend under Rule 144. Securities attorneys are key gate keepers in preventing fraudulent acts from being committed. The SEC needs to go after the attorneys who are willing to bend the rules or ignore them all together in order to make a quick buck writing a bogus legal opinion for the removal of restrictive legend. Generally when shares issued under these circumstances are sold into the public markets it hurts all the shareholders of a company by sending the price of the company’s shares drastically lower.
The 1st 2012 Press Release by the SEC can be found at: http://www.sec.gov/news/press/2012/2012-80.htm
The 2012 SEC Litigation Release can be found at: http://www.sec.gov/litigation/litreleases/2012/lr22352.htm
A copy of the SEC’s 2012 complaint can be found at: http://www.sec.gov/litigation/complaints/2012/comp-pr2012-80.pdf
The Order Instituting Public Administrative Proceedings Pursuant to Rule 102(e) of the Commission’s Rule s of Practice, Making Findings, and Imposing Remedial Sanctions against Cameron Linton, Esq. can be found at: http://www.sec.gov/litigation/admin/2012/34-67912.pdf
The 2010 Litigation Release by the SEC can be found at: http://www.sec.gov/litigation/litreleases/2010/lr21632.htm
A copy of the SEC’s 2010 complaint (SEC v. K&L International et al. 6:09-cv-1638-orl-31krs Md. Fla.) can be found at: http://www.sec.gov/litigation/complaints/2009/comp21224.pdf
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We do applaud the SEC ‘s efforts to police this type of activities.