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Enforcement News: Penny Stocks and the Importance of Registering as a Broker

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  • Posted on: Nov 21 2022

By: Jeffrey M. Haber

As a general matter, a “broker” must register with the SEC in order to transact business on behalf of another person. It is, therefore, unlawful for any person to “effect any transactions in, or to induce or attempt to induce the purchase or sale of, any security” unless that person is registered with the Securities and Exchange Commission (“SEC”).1 Whether a person is acting as a “broker” is governed by Section 3(a)(4)(A) of the Exchange Act, 15 U.S.C. §78c(a)(4)(A). Under that section, a “broker” is defined as “any person engaged in the business of effecting transactions in securities for the account of others.” 

Today, we examine SEC v. Gel Direct Trust, et al., Case 1:22-cv-09803 (S.D.N.Y. Nov. 17, 2022). Gel Direct involved the sale of penny stocks by defendants Jeffrey K. Galvani (“Galvani”) and Stuart A. Jeffery (“Jeffery”) through GEL Direct, LLC, the managing trustee of GEL Direct Trust (“GEL”), an entity the individual defendants created to facilitate securities transactions for its customers.

According to the SEC, the vast majority of GEL’s trading activity related to the sale of penny stocks that its customers obtained through various sources, including the acquisition of convertible promissory notes or other forms of microcap financing. 

The SEC alleged that, although the individual defendants were affiliated brokers of a registered broker-dealer during the period in question, their GEL-related activities were conducted separate and apart from their affiliation with that broker-dealer. Both defendants listed their GEL-related activities as “Other Business Activities” that were separate and apart from their affiliation with that broker-dealer. 

The SEC said that in February 2022, the individual defendants attempted to include their GEL-related activities with their affiliated broker-dealer – the first time they tried to do so. However, alleged the SEC, the broker-dealer did not supervise any of GEL’s trading activity before May 2022, at the earliest.

According to the SEC, from 2019 through at least May 2022, the individual defendants, acting through the GEL entities, provided brokerage services to approximately 60 customers involving at least 19,000 securities trades, primarily in penny stocks. The brokerage services they allegedly provided included taking possession of customer securities, directing trades to executing brokers, facilitating trade settlements, and disbursing trading proceeds to customers.  In return for these services, defendants allegedly received at least $12 million in transaction-based and other compensation.

The SEC charged defendants with operating as unregistered broker-dealers that facilitated more than $1.2 billion of securities trading. The SEC filed its complaint in the U.S. District Court for the Southern District of New York. The SEC charged defendants with violating the registration requirement of Section 15(a) of the Exchange Act and charged defendants Galvani and Jeffery as “control persons” of the GEL entities under Section 20(a) of the Exchange Act. The SEC seeks permanent injunctions, disgorgement, prejudgment interest, civil penalties, and penny stock bars against all defendants.

A copy of the press release announcing the action can be found here.

A copy of the complaint that the SEC filed can be found here.


Footnote

  1. Section 15(a)(1) of the Securities Exchange Act of 1934, 15 U.S.C. §78o(a) (“Exchange Act”).

Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP.

This article is for informational purposes and is not intended to be and should not be taken as legal advice.

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