United States Securities and Exchange Commission v. Carebourn Capital, L.P.

Background

The Securities and Exchange Commission (SEC) alleged that Carebourn Capital, L.P. and Chip Alvin Rice violated Section 15(a) of the Securities Exchange Act of 1934 by acting as unregistered securities dealers. From 2017 through 2021, they used convertible promissory notes to buy and sell billions of newly issued shares of microcap securities, also called penny stocks. The activity generated several million dollars in revenue. The SEC also alleged that transaction fees charged to penny-stock issuers were paid directly to Carebourn Partners, LLC, a relief defendant.

On September 27, 2023, the Court denied the defendants’ summary-judgment motion and granted summary judgment for the SEC on liability as to all three defendants. This order addressed the SEC’s later motion for remedies. The defendants agreed to surrender their remaining shares and conversion rights. They otherwise argued against the requested injunctions, penny-stock bars, disgorgement, prejudgment interest, and civil penalties.

The Court rejected the defendants’ requests to strike an interested party’s letter, sanction that party’s counsel, hold an evidentiary hearing, or stay the liability ruling. The Court stated that the letter did not require resolution of disputed facts or reconsideration of the prior summary-judgment decision.

Permanent injunction

The Court found a reasonable likelihood that future violations would occur without injunctive relief. It relied on the recurrent nature of the conduct, Rice’s lengthy participation in financial markets, the defendants’ significant economic stake, Rice’s role as the central decision-maker, Carebourn Capital’s continued operation as an investment business, and inconsistencies in Rice’s testimony that reduced the weight of his assurances against future violations.

The Court also found that the defendants did not act with scienter, meaning an intent or state of mind involving wrongful knowledge or recklessness, and that the SEC had not shown the violations were egregious. Those findings did not prevent an injunction because the dealer-registration violation was treated as a strict-liability offense and the other circumstances supported a reasonable likelihood of recurrence.

The motion was granted to the extent it sought a permanent injunction. Carebourn Capital and Rice were permanently restrained from violating Section 15(a)(1) by conducting covered securities transactions as dealers through interstate commerce unless registered with the SEC as dealers or associated with a registered dealer. The injunction also binds specified persons who receive actual notice, including the defendants’ partners, members, officers, agents, employees, attorneys, and persons acting in concert with them, as provided by Federal Rule of Civil Procedure 65(d)(2).

Penny-stock bar

The Court found that the underlying transactions involved penny stocks and that a bar was authorized. It declined to impose the permanent bar sought by the SEC because the record did not establish a reasonable likelihood that the defendants could never lawfully participate in penny-stock offerings. The Court instead barred Carebourn Capital and Rice for three years from participating in penny-stock offerings, including activities with brokers, dealers, or issuers involving the issuance, trading, or attempted purchase or sale of penny stocks.

Disgorgement and prejudgment interest

Disgorgement is an equitable remedy intended to take away profits obtained through unlawful conduct. The Court concluded that the SEC provided a reasonable approximation of the defendants’ net profits causally connected to the unregistered-dealer activity. It rejected the defendants’ arguments that the SEC relied on insufficient records, should have deducted additional bad-debt expenses, or had failed to establish causation.

The Court also rejected the argument that disgorgement required proof linking specific losses to specific investors. It found that the SEC identified evidence of price declines for stocks sold by Carebourn Capital and stated that it intended to create a fair fund for investors and issuers harmed by the conduct, subject to Court approval of a distribution plan. The Court further concluded that the 2021 statutory amendment authorizing disgorgement gave it additional flexibility concerning the disposition of collected funds.

Carebourn Capital and Rice were held jointly and severally liable, meaning each is responsible for the full amount, for disgorgement of $10,135,738.71 and prejudgment interest of $950,173.40, totaling $11,085,912.11. Carebourn Partners was held separately liable for disgorgement of $1,109,306.50 and prejudgment interest of $103,924.66, totaling $1,213,231.16. The Court found that the fees paid to Carebourn Partners were directly connected to the convertible-note transactions and therefore to the unregistered-dealer activity.

Civil penalties

The SEC sought a civil penalty of $642,500 against each of Carebourn Capital and Rice. The Court denied that request. It relied on the absence of scienter, the lack of a showing that the violations were particularly egregious, the absence of evidence that the defendants had previously been found to violate the dealer-registration requirement or other regulations, their financial condition, and the substantial disgorgement award. The Court also found that the SEC had not shown a civil penalty was necessary to punish the defendants or deter future violations.

Other ordered relief and disposition

The SEC’s motion for remedies was granted in part and denied in part. Within ten days after judgment was entered, the defendants were required to surrender for cancellation their remaining shares in the issuers listed in the SEC’s motion and their remaining conversion rights under the convertible securities, and to send the SEC documentation showing that surrender.