United States Sec. & Exch. Comm'n v. Morningview Fin.
| Docket Number | 22 Civ. 8142 (VM) |
| Decision Date | 07 November 2023 |
| Parties | U.S. SECURITIES & EXCHANGE COMMISSION, Plaintiff, v. MORNINGVIEW FINANCIAL LLC and MILES M. RICCIO, Defendants, and JOSEPH M. RICCIO, JR., Relief Defendant. |
| Court | U.S. District Court — Southern District of New York |
DECISION AND ORDER
When it passed the Securities Exchange Act of 1934 (the “Exchange Act” or the “Act”) nearly 90 years ago, Congress defined “dealer” as “any person engaged in the business of buying and selling securities for his own account, through a broker or otherwise.” Ch. 404, tit. I, § 3(a)(5), 48 Stat 883 (1934) (). The Court is now asked a question about the Act whose answer is not clearly settled under the law of this Circuit: whether the Act's definition of “dealer” encompasses a business that purchases convertible notes from penny stock issuers, converts the notes into stock at large discounts from prevailing market prices, and sells the converted stock into the public markets for profit.
The question arises in the context of a motion filed by defendants Morningview Financial, LLC (“Morningview Financial” or “Morningview”) and Miles M Riccio to dismiss this U.S. Securities and Exchange Commission (“SEC” or “Commission”) enforcement action. (See Dkt. No. 1 [hereinafter “complaint” or “Compl.”]; Notice of Motion to Dismiss, Dkt. No. 21.) Because the Court holds that the Act's definition of “dealer” does encompass the alleged behavior and related transactions of the defendants, and for additional reasons stated below, the Court DENIES the motion to dismiss.
Miles M. Riccio (“Riccio” and, together with Morningview, “Defendants”) and his uncle Joseph M. Riccio Jr. (“Riccio Jr.”) founded Morningview Financial in July 2017 under Wyoming law. As of September 23, 2022, Morningview's principal place of business was Burbank, California, although it operated out of an office in New York City for a portion of the period between July 2017 and at least December 2021 (the “relevant period”). It has had one employee (the “Morningview employee”) working on its behalf. Morningview was principally engaged in the convertible notes business,[2] and the company never registered with the SEC in any capacity.
Riccio was Morningview's managing member and owned 64 percent of the company. He exercised ultimate decision-making authority over Morningview's business and managed its operations. Riccio received periodic distributions from the company during the relevant period. He never registered with the SEC in any capacity.
Riccio Jr. was also a member of Morningview Financial. He owned the remaining 36 percent of the company. Riccio Jr. contributed most of the company's starting capital and, like Riccio, received periodic distributions during the relevant period.
Morningview was a well-known lender to public companies seeking financing through convertible note transactions. Almost all of those companies were penny stock issuers trading on over-the-counter markets.[3] To identify those companies, Riccio and the Morningview employee attended investor conferences to develop industry contacts, and those contacts referred convertible note deals to Morningview. Riccio and the Morningview employee also cold-called and cold-emailed issuers regarding potential investment. Nearly half of the issuers that Morningview financed through convertible notes sought additional financing from Morningview, with some selling Morningview six or more convertible notes during the relevant period.
For Riccio, the most important attribute in determining which issuers to cold-call regarding investment was the issuer's trading volume. The primary responsibility of the Morningview employee was to identify issuers with strong trading volume on over-the-counter markets and to solicit such issuers for investment. In one two-week period in March 2019, the Morningview employee made approximately 100 calls to over-the-counter issuers identified as having strong trading volume. Riccio, however, had primary responsibility for selecting issuers for funding, conducting diligence on convertible note opportunities, and maintaining relationships with issuers that Morningview had previously financed.
During the relevant period, Morningview and Riccio executed stock purchase agreements with 35 issuers, purchasing at least 68 convertible promissory notes and four warrants[4] directly from the issuers. The notes typically had a one-year maturity period, a principal amount between $5,000 and $262,500, an interest rate between 4 and 12 percent, and steep prepayment penalties. The notes' conversion terms significantly favored Morningview, allowing the company in its sole discretion to convert the debt into common stock at a significant discount from the prevailing market price after the lapse of the holding period required under 17 C.F.R. § 230.144, also known as “Rule 144.”[5] The discounts normally ranged from 30 to 50 percent off the lowest closing or trading price of the stock during the 10 to 40 days before the conversion.
It was important to Defendants that the terms of the convertible notes provided for a reserve of shares to ensure that there would be enough shares available to be converted pursuant to the notes. Each note expressly included a provision regarding the number of shares the issuer was required to have authorized and reserved. Approximately 66 percent of the notes were fully or partially repaid through share conversions.
Defendants usually converted the notes in several increments. They often began the conversion process soon after the expiration of the Rule 144 holding period by submitting a conversion notice to the issuer, its transfer agents, and Morningview's broker. Defendants paid processing rush fees to ensure that shares were deposited quickly into trading accounts.
Riccio had final decision-making authority for all convertible note and warrant financings made by Morningview, and he signed all relevant stock purchase agreements and conversion notices. He determined when Morningview should fully or partially convert a note or warrant and when to sell the post-conversion shares. Riccio was the only person with authority to bind Morningview with respect to its convertible notes and warrants, and he was the only person with access to Morningview's brokerage accounts.
Once the shares were deposited into Morningview's brokerage accounts, Defendants typically sought to sell shares as quickly as the market would bear, usually within a few days or weeks of conversion, at Riccio's direction. With respect to Defendants' 213 conversion transactions, the average time between the conversion date and the first corresponding sale of converted shares was between eight and nine calendar days. For 79 percent of those conversions, Defendants sold some of the converted shares within zero to seven days of the conversion date.
During the relevant period, Defendants sold more than 3 billion newly issued shares of common stock into the public markets and earned approximately $14.8 million in profit from the sales of such shares. Those profits were attributable primarily to the discount applied to the convertible notes that Morningview received on the converted stock rather than to an appreciation in share price. Nearly all the shares that Defendants sold in their business were acquired directly from issuers through note conversions and warrants rather than from purchases made in the secondary market.
Defendants' public sales of unrestricted, newly issued shares significantly increased the amount of shares trading publicly, the issuers' unrestricted share totals, and the number of the issuers' shares in the hands of public investors. Defendants' sales accordingly diluted the equity positions of existing shareholders and often depressed the prices of issuers' stock. Defendants' sales of post-conversion shares frequently constituted a material percentage of the volume of total relevant trades on given days.
In one instance, Defendants funded a note with HealthLynked Corp. (“HLYK”) whose issue date was June 3, 2019 and whose net principal amount was $154,000. Morningview was entitled to convert the debt at a discount rate of 39 percent from the lowest closing bid price during the fifteen days before conversion. The note included a prepayment fee of 125 percent of the amount prepaid for the first 180 days after the issue date, after which prepayment was not allowed. The note additionally included a provision that the issuer was required to have authorized and reserved five times the number of shares issuable upon full conversion of the note.
On December 4, 2019, Defendants converted $24,000 of principal into 306,595 shares of HLYK. On four days over the following month, they converted the remaining $130,000 of principal into more than 2.2 million shares of HLYK. Between December 6, 2019 and January 30, 2020, Defendants sold all the shares converted pursuant to the note, which resulted in net proceeds to the Defendants of approximately $127,906.
Defendants entered into a total of six notes with HLYK over the relevant period. They converted three of the notes; HLYK repaid Morningview with respect to the other three. Defendants received almost $265,000 in net proceeds from the sale of converted HLYK shares. On 42 trade dates, Morningview Financial was responsible for more than 20 percent of the total HLYK trading volume, and Morningview on at least one date was responsible for 46.5 percent of HLYK's total trading volume.
The SEC filed this action on September 23, 2022, asserting three claims for relief. (See Compl. ¶¶ 77-86.) First, the SEC...
To continue reading
Request your trial