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

Background

The United States Securities and Exchange Commission brought this action against Carebourn Capital, L.P. and Chip Alvin Rice, alleging that they acted as unregistered securities dealers in violation of Section 15(a)(1) of the Securities Exchange Act of 1934. Carebourn Partners, LLC was named as a relief defendant. A relief defendant is not accused of the underlying wrongdoing but may be required to surrender funds received from that wrongdoing when it has no legitimate claim to them.

The Exchange Act requires dealers to register with the Commission or associate with a registered dealer. It defines a dealer to include a person engaged in the business of buying and selling securities for that person’s own account through a broker or otherwise, unless the activity is not part of a regular business.

From 2017 through September 2021, Carebourn purchased convertible promissory notes from multiple microcap issuers and from third parties. The notes allowed Carebourn to convert debt into newly issued stock, often at a discount. Carebourn deposited billions of converted shares into brokerage accounts and sold billions of shares through brokers. The record also showed that Carebourn advertised convertible-debt opportunities, contacted issuers, attended microcap conferences, used finders and referral sources, and generated substantial revenue and profits from the transactions.

Carebourn Capital, Carebourn Partners, and Rice were not registered with the Commission as securities dealers, and the opinion states that none was associated with a registered dealer during the relevant period. The Commission also presented evidence that Carebourn Partners received more than $1.1 million in transactional-expense fees charged to issuers.

Parties’ Arguments

The Commission sought summary judgment on Count I, alleging unregistered dealer activity by Carebourn and Rice, and on Count II, seeking liability against Carebourn Partners for receiving ill-gotten gains. Defendants argued that they were lenders rather than securities dealers, that they did not “buy and sell” securities, and that their compliance with the six-month holding period in Securities and Exchange Commission Rule 144 eliminated the need for dealer registration. They also relied on affirmative defenses involving due process, estoppel, the statute of limitations, and advice of counsel.

Defendants separately sought summary judgment on liability and argued that the complaint did not adequately support disgorgement. They contended that the Commission had not shown a sufficient connection between the alleged violation and the funds sought, and that disgorgement was unavailable because there were no victims to receive the money.

Court’s Analysis and Ruling

Judge Katherine Menendez concluded that there was no genuine dispute of material fact that Carebourn and Rice bought and sold securities as part of a regular business. The Court treated the purchases of convertible notes, conversions into stock, and subsequent market sales as buying and selling securities. It relied on the volume of transactions, the billions of shares sold, the profits and fees generated, the advertising and solicitation efforts, the use of finders, and attendance at conferences to identify potential issuers.

The Court rejected Defendants’ arguments concerning defaults, electronic repayment provisions, the absence of stock certificates, and Rule 144. It explained that Rule 144 provides a safe harbor concerning underwriter status but does not eliminate the separate Exchange Act requirement that a person acting as a dealer register. The Court also rejected Defendants’ advice-of-counsel defense. It stated that the defense likely would not affect liability for a registration violation that does not require a specific intent, but held that, even if the defense were available, Defendants had not shown complete disclosure of relevant facts or advice addressing their dealer-registration obligation.

The Court held that the Commission was entitled to summary judgment on Count I against Carebourn Capital and Rice and on Count II against Carebourn Partners. It also granted the Commission summary judgment on Defendants’ First, Second, Third, Fourth, and Fifth Affirmative Defenses. The Court did not address Defendants’ defenses concerning remedies because the Commission sought summary judgment on liability only.

The Court denied Defendants’ summary-judgment motion regarding liability on Counts I and II. It denied without prejudice Defendants’ motion concerning the availability of disgorgement, expressly reserving that issue for the remedies phase. The Court stated that no trial on liability was necessary.