DENISE COTE, United States District Judge.
The Securities and Exchange Commission ("SEC") has shown that it is likely to succeed on the merits of its claims that defendants Andy Altahawi, Suresh Tammineedi, and Dorababu Penumarthi sold unregistered securities in violation of Section 5 of the Securities Act of 1933 ("Securities Act") between December 15, 2017 and March 28, 2018. The SEC has shown that it is likely to prove at trial that these defendants participated in an unregistered, illegal public offering of the stock of Longfin Corp. ("Longfin"). Accordingly, the SEC's motion for a preliminary injunction is granted.
On April 4, 2018, a court order froze the proceeds of these defendants' sales of Longfin shares, among other things. The SEC has sought a preliminary injunction to extend that freeze pending trial. On April 19, this case was reassigned to this Court. The preliminary injunction motion became fully submitted on April 23. The SEC has submitted three declarations attaching numerous exhibits in support of its motion. The three defendants whose assets have been frozen submitted declarations and supporting exhibits, as well as declarations from defendant Venkata Meenavalli, the CEO and founder of Longfin, and non-party Philip Magri, an attorney retained by defendant Altahawi with respect to his sales of certain Longfin shares. Having considered this evidence, this Opinion constitutes the Court's findings of fact and conclusions of law.
Longfin first received SEC approval to publicly offer its shares on June 16, 2017, and engaged in a public offering after that date. This public offering took place pursuant to provisions in the Jumpstarting Our Business Startups Act of 2012 ("JOBS Act"), which amended our nation's securities laws. Pub. L. No. 112-106, 126 Stat. 306. Before describing the events at issue here, the pertinent statutory framework created by the JOBS Act will be outlined. A more detailed description of the relevant legal standards follows the findings of fact.
The JOBS Act was designed in part to permit early-stage companies to raise capital from public offerings with less expense than normally accompanies initial public offerings ("IPOs"). Title IV of the JOBS Act directed the SEC to create an exemption from the registration requirements of Section 5 of the Securities Act for companies to publicly sell shares in an offering of securities in an amount up to $50 million with fewer requirements than those applicable generally to companies undertaking an IPO. 126 Stat. 306, 324 (codified at 15 U.S.C. § 77c). It provides in relevant part that:
The SEC promulgated amendments to its Regulation A to provide for such offerings.
Regulation A+ also streamlines the path to register shares that will be traded on public exchanges for Tier 2 offerings. To register a class of securities under Section 12 of the Exchange Act of 1934 ("Exchange Act") pursuant to Regulation A+ for a Tier 2 offering, the company need only file a short form registration statement ("Form 8-A") concurrently with the filing and qualification of other forms a company is required to file under Regulation A. 17 C.F.R. § 249.208a. Once a Form 8-A is effective, the company becomes subject to the Exchange Act reporting obligations required of all companies that trade on the public stock exchanges, and ceases to have duties to file the financial reports otherwise required under Regulation A+.
Longfin's founder Meenavalli describes Longfin as an "independent financial technology company that specializes in trade commodity solutions." Longfin was incorporated on February 1, 2017 in Delaware, with Meenavalli, who is a citizen of India and a resident of the Republic of Singapore, as its CEO. Longfin is now headquartered
The day Longfin was incorporated it entered into a consulting agreement ("Agreement") with Altahawi's company Adamson Brothers Corp.
According to the Agreement, Altahawi specializes in "Reg `A' drafting and filings" and will assist Longfin "to initiate a "Reg `A+' tier II Direct Public Offering (`DPO')."
For Altahawi's services, Longfin agreed to pay Altahawi $65,000 and stock in four components:
Accordingly, Altahawi's services pursuant to the Agreement required him to "draft" and manage the SEC process for a Regulation A offering worth up to $50 million, including the duty to file a Tier 2 qualification statement with the SEC.
In a filing with the SEC made on March 10, 2017, Longfin disclosed the existence of the Agreement, and described it in the following terms.
(Emphasis supplied.)
On March 10, 2017, Longfin made a Form 1-A filing with the SEC indicating its intent to offer up to 20 million shares of its common stock on a "best efforts" basis. With each share priced at $2.50 per share, it intended to raise a maximum of $50 million for Longfin. The filings explained that the sale of shares would commence two days after the Offering Statement filed with the SEC "is qualified." It warned that there was currently no trading
In that same filing, Longfin announced that it had entered into an agreement to acquire a Singaporean company, Stampede Tradex Pte Ltd. ("Stampede Tradex"), through a "share swap." Longfin was to issue 100 million shares of its common stock to shareholders of Stampede Tradex in exchange for 100% of Stampede Tradex's stock, making Stampede Tradex a subsidiary of Longfin. The SEC filing explained that Stampede Tradex had been operating since 2014, and had experienced a "significant" growth in its business. Longfin added that its "core business plan" was to utilize Stampede Tradex's technology, strategy, infrastructure and its business model, which was employed in the Asia Pacific region, for markets in the Americas, Europe, and Africa. The filing described Stampede Tradex as 55% owned by Stampede Capital Limited and 45% owned by Meenavalli.
Attached to the filing was an independent auditor's report for Longfin for the month of February. The auditor was identified as AJSH & Co. LLP of New Delhi, India.
In a May 23, 2017 filing with the SEC, Longfin indicated that its offering would be for up to 10 million shares at $5 per share. It also indicated that the share swap arrangement had changed, such that Longfin would issue 50 million shares to Stampede Tradex's shareholders for 100% ownership in Stampede Tradex. The May 23 filing indicated that, after the share swap, the Longfin founders would hold 7.5 million shares, the Stampede Tradex shareholders would hold 50 million shares, and an additional 10 million shares would be held by the public, assuming that the IPO sold out.
On June 16, 2017, the SEC qualified Longfin's Regulation A+ offering. The SEC authorized Longfin to begin selling up to 10 million shares to the public at a price of up to $5 per share. Therefore, if Longfin had completely sold out its offering, it would have raised $50 million, the maximum permissible under Tier 2 of Regulation A+.
The share swap arrangement with Stampede Tradex closed three days later, on June 19, 2017. After the share swap arrangement, Longfin had 67,500,000 total shares outstanding.
In June 2017, Longfin asked Altahawi to become its corporate secretary, and Altahawi accepted. Altahawi was issued a company e-mail address and began signing corporate resolutions on behalf of Longfin. In a July 6 Offering Circular, Longfin disclosed that "Mr. Altahawi became an affiliated [sic] with the company and he is being considered to be part of our management team." On July 15, Altahawi, as corporate secretary, signed the certificate of adoption of the bylaws of Longfin. An August PowerPoint presentation listed Altahawi as a director of Longfin and point of contact for the company. On September 14, as corporate secretary, Altahawi signed a corporate resolution transferring 3% of Longfin's stock to himself, amounting to just over 2 million shares of Longfin, "for the professional services rendered to the company since inception" (the "Consulting Shares"). The resolution authorized Longfin's transfer agent, Colonial Stock Transfer Co., Inc. ("Colonial Transfer"), to issue
Although Altahawi has submitted in opposition to this motion a resignation letter bearing the date September 1, 2017, which indicates that he resigned as corporate secretary as of September 1, 2017, that resignation letter was not effective.
According to the control log and escrow account records for Longfin, shares began to be issued to individual purchasers in small increments on September 1, 2017, with another batch issued in even smaller increments on October 16, 2017.
On September 15, Longfin disclosed that it had engaged Network 1 Financial Securities, Inc. ("Network 1") as lead underwriter for its DPO. As Longfin reported to the SEC, on September 25, it also agreed with Altahawi that Longfin would be listed on www.ipoflow.com, a website owned by Adamson Brothers, for "no additional compensation." Although Longfin had been authorized by the SEC in July to sell up to 10 million shares, between September 1 and December 11, 2017, Longfin claims to have issued only 1.14 million shares through its Regulation A+ DPO, and to have raised approximately $5.7 million.
After a series of amendments to its SEC filings, but without disclosing any new financial information since February 2017, on November 22, 2017, Longfin registered its securities on a Form 8-A pursuant to Section 12(b) of the Exchange Act. The Form 8-A became effective on November 24, 2017. With that registration in place, Longfin became eligible for listing on a public stock exchange.
On December 4, 2017, Altahawi sent an e-mail with a subject line of "RE: Longfin - Shareholders List" to Colonial Transfer, asking it to share Longfin's current shareholder list with Network 1. Colonial Transfer responded by including not only the shareholder list, but also the records of payments received for those shares. It states:
Network 1 then responded: "Perfect. Thank you. Can you also send me a shareholders list as of today for NASDAQ."
On December 6, Altahawi sent the last e-mails in the record from the Longfin email address issued to him as secretary of Longfin. These emails were sent in the December 4 e-mail thread, with Altahawi
Two of the individuals who were issued shares on December 6 without any record of payment were defendants Penumarthi and Tammineedi. Penumarthi has known Meenavalli since childhood, having grown up with him in India. Penumarthi now resides in Dorset, United Kingdom. Penumarthi entered into a consulting arrangement with Longfin on July 1, 2017, which he asserts ended on September 30, 2017. Penumarthi's Facebook page stated that he was the Head of Operations for Longfin's United Kingdom operations. Penumarthi now states in his declaration that "[w]hile I was acting as a consultant, I referenced my role on my Facebook page inaccurately. In fact, I have never been the `Head of Operations' of Longfin Corp." His subscription agreement is dated September 2, 2017. Penumarthi was issued 40,000 shares of restricted Longfin stock on December 6. Colonial Transfer has no record that Penumarthi paid for these shares. Penumarthi's subscription agreement required payment to the escrow account maintained by Colonial Transfer for Longfin.
Tammineedi is a director of Stampede Capital Limited, a company that Meenavalli founded and that is Longfin's largest shareholder. Stampede Capital Limited owns well over 10% of Longfin's shares, and Meenavalli himself has a substantial interest in Stampede Capital Limited.
On December 13, 2017, Longfin was listed on the NASDAQ stock exchange. The stock began trading at between $5-7/share.
On December 13 and 14, Tammineedi purchased 67,000 shares of Longfin on NASDAQ through a company called "Source Media" (the "Source Media Shares"), at an average price of approximately $5.50/share. Tammineedi is the sole officer and owner of Source Media.
On December 15, 2017, two days after public trading began, Longfin announced that on December 11, it had acquired "Ziddu.com," an entity at least 92%-owned by Meenavalli. Longfin had not disclosed to the SEC during the Regulation A+ process that it intended to make this acquisition. Longfin publicly represented that Ziddu.com had expertise in blockchain and
Longfin's stock price and trading volume sky-rocketed. That day, December 15, Longfin's stock closed at $22.01/share, more than four times the previous day's closing price. On December 18, 2017, Longfin's stock price reached a high of $142.82/share before closing at $72.38/share, which valued Longfin at over $3 billion. Over the next few months, Longfin shares generally traded in the $40-$60/share range. Longfin later advised the SEC that Ziddu.com had no revenue historically and its carrying value was zero.
On December 18, 2017, Altahawi sent an e-mail to Colonial Transfer directing the issuance of 2.5 million Longfin shares to the entities owning Ziddu.com. Colonial Transfer promptly issued the shares. There is no indication that Altahawi did not have the authority to act in this manner on behalf of the company.
In late December 2017 and in January 2018, Altahawi had discussions with the SEC's staff on behalf of Longfin. The topics of these conversations included whether it would be possible for Longfin to increase the size of its offering, and seeking guidance on Longfin's Form 8-A.
On January 12, 2018, Altahawi acquired 121,000 shares of Longfin through purchases from ten of the twenty-four individuals who acquired shares on December 6 (the "Private Transaction Shares"). These shares were purportedly acquired at $30/share, but no payment records appear in this record. $30 is approximately $10/share below their then-market price. Each of the ten individuals who transferred their shares to Altahawi apparently signed the same piece of paper. Counsel have represented that these ten individuals live in India. Altahawi then began selling the Private Transaction Shares on the NASDAQ in January and February 2018.
Tammineedi sold the Source Media Shares over the NASDAQ between December 15, 2017 and February 6, 2018 for approximately $2.7 million in profits. Between March 21, 2018 and March 28, 2018, Tammineedi sold 2,200 of his December 6 Shares on the NASDAQ of Longfin for $127,535 in proceeds.
On January 23, 2018, Penumarthi sold 4,000 shares of his December 6 Shares over the NASDAQ for $168,495. Penumarthi later bought and sold open market shares. On a net basis he sold approximately 36,000 shares, some of which included the December 6 Shares, and made an additional $2 million on those trades.
In preparation for his sale of the Consulting Shares, Altahawi engaged Magri Law LLC on February 16, 2018, "to review my acquisition of the Consulting Shares." According to Phillip Magri, he reviewed three documents that Altahawi provided to him: (1) Altahawi's representation letter, dated March 5, 2018; (2) the Agreement Altahawi signed with Longfin; and (3) Amendment No. 9 to Longfin's Form 1-A, filed on November 3, 2017. In his letter, Altahawi states that "I am not now an affiliate of the issuer as defined under Rule 144(a)(1) and have not been an affiliate during the preceding three months." He also asserts that the Consulting
Magri's opinion letter stated that "we have assumed and not verified ... the accuracy as to the factual matters of each document we have reviewed." The letter opined "that the offer and sale of the [Consulting] Shares by [Altahawi] in the manner contemplated ... does not require registration under the Securities Act." After Altahawi forwarded the letter to Colonial Transfer, and Meenavalli sent an email to Colonial Transfer "confirming" that Altahawi acquired the Consulting Shares on February 1, 2017, it removed the restrictive legend
By March 23, 2018, Altahawi had sold 475,751 shares of Longfin over the NASDAQ and received $25.5 million in proceeds from the sales. This represents nearly 5 times the amount Longfin had raised through the DPO Altahawi was hired to conduct. At times, Altahawi held over 60% of the publicly trading shares of Longfin.
In late March and early April 2018, Longfin's price fell to under $10/share, before climbing back up to approximately $28/share. NASDAQ then suspended trading in the stock. On April 2, 2018, Longfin filed a 10-K report, the first time it had filed either a 10-Q or a 10-K. In the 10-K report, Longfin represented that it was delinquent in its reporting obligations under the securities laws of the United States.
The complaint in this action, filed on April 4, 2018, asserts that defendants Longfin, Meenavalli, Altahawi, Penumarthi, and Tammineedi sold securities of Longfin in violation of the registration requirements of the Securities Act. Pending the resolution of this case on the merits, the SEC seeks a preliminary injunction to continue to freeze assets arising out defendants Altahawi, Tammineedi, and Penumarthi's unregistered sales of securities in Longfin.
On April 4, 2018, a judge of this Court issued a temporary restraining order (the "TRO") which,
The TRO has been extended with respect to defendants Altahawi, Tammineedi, and Penumarthi. The TRO was vacated as
All parties have appeared, and both sides have submitted briefs and declarations in support of their positions. The Court held oral argument on the preliminary injunction motion on April 20, and a conference on April 30.
The SEC has sought a preliminary injunction in the form of an asset freeze. To obtain an extension of the asset freeze pending trial, the SEC must show a likelihood of success at trial on the merits of its claims.
The SEC's case is brought under Section 5 of the Securities Act, ch. 38, 48 Stat. 74 (codified as amended at 15 U.S.C. §§ 77a-77aa (2012)). Section 5 of the Securities Act provides, in pertinent part:
15 U.S.C. § 77e(a) (emphasis supplied).
The SEC must satisfy three elements to prove a prima facie case of a violation of Section 5: "first, that no registration statement was in effect as to the securities; second, that the defendant sold or offered to sell these securities; third, that there was a use of interstate transportation, or communication, or of the mails in connection with the sale or offer of sale."
If a prima facie violation of Section 5 has been shown, the burden shifts to the defendant to show their entitlement to an exemption from Section 5.
In connection with the status of underwriter, the SEC has provided a safe harbor. If a seller of securities demonstrates compliance with SEC Rule 144, then that seller is not deemed an underwriter with respect to those securities.
Under Rule 144, shares acquired directly from an issuer not involving any public offering are "restricted" securities. Restricted securities may nonetheless be sold under Rule 144's safe harbor if the seller complies with its conditions. Rule 144, as described below, also implicitly creates a second category of securities known as "control" securities, for securities held by "affiliates" of the issuer. These securities are not necessarily "restricted" securities, but nonetheless are subject to limitations on their resale.
Rule 144 is not the exclusive method by which a person can demonstrate entitlement to a Section 4(a)(1) exemption.
A second exemption to Section 5's prohibitions at issue here is the Regulation A+ exemption, codified at Section 3(b) of the Securities Act. As explained at the beginning of this Opinion, the SEC was directed to create an exemption to Section 5's registration requirement for public offerings of securities under $50 million. JOBS Act, 126 Stat at 324 (codified at 15 U.S.C. § 77c(b)(2)). Regulation A+, promulgated under the JOBS Act, provides that "[a] public offer or sale of eligible securities... pursuant to Regulation A shall be exempt under section 3(b) from the registration requirements of the Securities Act of 1933." 17 C.F.R. § 230.501. It further provides that any securities acquired in a Regulation A+ offering "shall not be restricted securities within the meaning of the Federal securities laws and the regulations promulgated thereunder." 15 U.S.C. § 77c(b)(2)(C). There are numerous requirements for compliance with Regulation A+. 17 C.F.R. § 230.501
If a violation of Section 5 is found, and there is no exemption available, the SEC's available remedies include disgorgement.
The SEC has carried its burden of showing a likelihood of success of proving at trial that the three defendants violated Section 5 in selling their shares. There are four sets of shares at issue here. Altahawi acquired and sold the Consulting Shares and the Private Transaction Shares. Tammineedi and Penumarthi acquired and sold December 6 Shares. And Tammineedi acquired and sold the Source Media shares. With respect to each of these four sets of shares, the SEC has shown that it is likely to succeed on the merits of its claim that the sales of these shares were unregistered transactions in violation of Section 5.
There was no Securities Act registration in place for any Longfin shares.
Altahawi relies on two exemptions to defend his sales of the Consulting Shares and win recovery of his frozen assets. In each instance, Altahawi contends that he has met his burden to show that he was not an underwriter in connection with the sales of the Consulting Shares. First, Altahawi relies on the Rule 144 safe harbor, and alternatively, he relies on Section 4(a)(1) itself. The analysis for each of these exemptions differs depending on whether Altahawi was a Longfin affiliate at the time he acquired the Consulting Shares or for a relevant period of time thereafter. Accordingly, this Opinion will first address his status as an affiliate. Then it will turn to the Rule 144 exemption, followed by the Section 4(a)(1) analysis.
Altahawi was an affiliate of Longfin throughout the time relevant to his sales of the Consulting Shares in March 2018.
Altahawi was a Longfin affiliate through at least March 2018. Altahawi designed and managed the DPO for Longfin, creating a public market for Longfin's shares that had never existed before, and then dominated that market.
Altahawi was Longfin's secretary until, at the very least, September 2017. As secretary he signed the resolutions adopting Longfin's corporate bylaws, and transferred 3% of its shares to himself. He marketed the DPO on his website, ipoflow.com, and represented Longfin in its critical discussions in December 2017 with the NASDAQ exchange to get Longfin registered on that exchange. Altahawi managed the unusual distributions of Longfin shares on December 6, 2017, only to acquire a substantial portion of those shares for himself in even more unusual circumstances less than a month later for below market value. Altahawi communicated with the SEC staff in late December through early February 2018 on behalf of Longfin, seeking guidance on matters such as increasing the size of Longfin's offering and Longfin's Form 8-A, and gave instructions to Colonial Transfer on behalf of Longfin in December 2017. Finally, in March 2018, once he arranged for the removal of the restrictive legend from his shares, Altahawi dominated the public marketplace for shares of Longfin. He controlled approximately 60% of the public "float." Keeping in mind the remedial purpose of the Securities Act,
Altahawi contends principally that he was not an affiliate within 90 days of March 14, 2018, because he was not an officer, director, or 10% shareholder of Longfin within the 90 days period prior to March 14, 2018. These three attributes are hallmarks of an affiliate status.
Rule 144 provides two distinct sets of requirements for selling "restricted" or "control" shares. Each of these categories also has different requirements, depending on whether the seller is an affiliate or a non-affiliate. Application of the requirements for the sale of restricted stock will be sufficient to analyze Altahawi's sale of his Consulting Shares; the requirements for the sale of control shares impacts the analysis of Altahawi's sale of the Private Transaction Shares.
Pursuant to Rule 144, restricted securities include "[s]ecurities acquired directly or indirectly from the issuer, or from an affiliate of the issuer, in a transaction or chain of transactions not involving any public offering." 17 C.F.R. § 230.144(a)(3). Control securities, by contrast, arise from the definition of an affiliate in Rule 144. Rule 144(b)(2) provides that:
17 C.F.R. § 230.144(b)(2) (emphasis supplied).
Thus, Rule 144 provides limitations on the sale of two classes of securities held by affiliates (and those who were affiliates within the 90 days before their sale of securities): an affiliate's sale of restricted securities, and the affiliate's sale of "any other securities" that are sold for them. These "any other securities" are generally referred to as "control" securities.
Rule 144 sets out five general conditions for affiliates to sell restricted or control securities: the filing of current public information by the issuer (Rule 144(c)), a holding period for the seller, but only for restricted securities (Rule 144(d)), a limitation on the amount of securities sold (Rule 144(e)), requirements on the manner of sale (Rule 144(f) and (g)), and notice to the SEC (Rule 144(h)). 17 C.F.R. § 230.144. If the applicable conditions are met, an affiliate can sell both restricted and control securities and "shall be deemed not to be an underwriter of those securities." 17 C.F.R. § 230.144(b)(2).
For a non-affiliate, Rule 144 imposes two limitations on the sale of restricted stock that are of importance here: a reporting requirement for the issuer and a holding period for the seller. Rule 144 provides that, for a company that is a reporting company under the Exchange Act and has been a reporting company for the 90 days immediately before the sale of shares at issue, the person "who sells restricted securities of the issuer for his or her own account shall be deemed not to be an underwriter ... if the conditions of [current public information] and [the holding period] are met." 17 C.F.R. § 230.144(b)(1)(i).
The sale of restricted stock by a non-affiliate does not run afoul of the law, however, if the stock has been held for one year. The rule provides that the current public information requirement
The holding period, however, can be as short as six months for both an affiliate and a non-affiliate if the issuer is a reporting company. Rule 144(d) provides that
17 C.F.R. § 230.144(d).
Thus, the length of seller's holding period depends on whether the issuer is a reporting company. If it is a reporting company for the previous 90 days, then the holding period is six months. Otherwise, it is one year. In either case the holding period begins to run from the payment of full consideration. Rule 144(d) provides that "if an acquirer takes the securities by purchase, the holding period shall not begin until the full purchase price or other consideration is paid or given by the person acquiring the securities from the issuer." 17 C.F.R. § 230.144(d)(1)(iii).
Where a company has registered its shares under the Exchange Act, such as those that have registered their shares under Section 12(b) of the Exchange Act (as did Longfin on November 22, 2017), and when it has been a reporting company for 90 days, it must file all required Exchange Act reports to be in compliance with Rule 144(c). The "current public information" requirement under Rule 144(c) provides as follows:
17 C.F.R. § 230.144(c) (emphasis supplied).
When Longfin submitted its Form 8-A on November 22, 2017, and that form became effective on November 24, it registered its shares pursuant to Section 12(b) of the Exchange Act. By March 14, 2018, the first day the Consulting Shares were sold, Longfin had been a reporting company
One of those obligations is provided by Rule 13a-13, codified at 17 C.F.R. § 240.13a-13. The rule provides that:
17 C.F.R. § 240.13a-13(a) (emphasis supplied). Therefore, after a company registers its securities, it generally has 45 days to file a 10-Q.
Rule 13a-13 unambiguously required Longfin to file a 10-Q within 45 days after it registered its securities under Section 12(b) on the Exchange Act on November 24, 2017. Thus, Longfin had a duty to file a 10-Q by January 8, 2018, which it did not do.
Indeed, Longfin had a duty to file 10-Qs for each of its first three quarters within 45 days after its Exchange Act registration, which it also did not do. Although the regulation does not precisely address a situation where the issuer does not have at least one full fiscal year of financial statements included in the registration statement, the natural reading of the regulation is that the issuer is required to update its financial information for each quarter since the inception of the company. The only time Longfin provided the market with its financial statements was with its offering statements and circulars, which included financial information for the month of February 2017.
Even if the regulation were ambiguous on this point, the SEC has provided persuasive guidance leading to the same conclusion. The SEC has interpreted Rule 13a-13 in the context of Regulation A+ both in guidance documents and in its submission to this Court. A "court must defer to an agency's `interpretation of its own regulations unless that interpretation is plainly erroneous or inconsistent with the regulation.'"
In Question 182.23, as part of its Compliance and Disclosure Interpretations, the SEC posed the question:
Securities and Exchange Commission,
This guidance is an entirely reasonable interpretation of Rule 13a-13. The SEC's interpretation in Question 182.23 is also consistent with the position it advances before this Court. Accordingly, to the extent there is any ambiguity in Rule 13a-13, this Court defers to the SEC's interpretation of its own regulation.
Altahawi's Consulting Shares were restricted shares under the terms of
Altahawi's arguments for why Longfin was in compliance with its reporting obligations are without merit. First, Altahawi contends that financial statements need not be included in a registration statement for a Regulation A+ offering. But, Rule 13a-13 does not tie its filing requirements to any requirement or lack of a requirement that financial data be included in the registration statement. Rule 13a-13 provides that, to the extent financial statements are not included in the registration statement, the company must report updated financial information on a quarterly basis.
Second, Altahawi claims that he had conversations with an SEC attorney in January and February 2018 in which he was advised that Longfin was in compliance with its reporting obligations
Altahawi's argument is essentially one for equitable estoppel. But, "estoppel cannot be asserted against the Government `on the basis of ... oral advice.'"
In sum, Altahawi sold restricted shares when Longfin was not in compliance with the current public information requirement. It is also undisputed that Altahawi did not file the required notice to the SEC for an affiliate's sale of shares pursuant to Rule 144(h).
Altahawi makes one additional argument in support of the legality of his sales of the Consulting Shares. As described above, a non-affiliate may sell shares acquired more than one year earlier, even if the issuer is out of compliance
A person acquires shares by purchase for the purposes of Rule 144 only when the "full purchase price or other consideration is paid or given by the person acquiring the securities from the issuer." 17 C.F.R. § 230.144(d)(3). A person who works for an issuer in exchange for stock compensation is a purchaser of securities.
Applying the full-purchase-price principle, Altahawi did not acquire the Consulting Shares until June 16, 2017, at the earliest. This conclusion is compelled by the terms of the Agreement itself, as well as by the statements Longfin made to the SEC. Altahawi was retained as a consultant to obtain qualification for Longfin's DPO, among other tasks, which occurred on June 16, 2017.
Altahawi, in support of a February 1, 2017 acquisition date, points to statements made by Meenavalli to Longfin's stock transfer agent on March 6, 2018 to the effect that Altahawi's shares were fully earned by February 1, 2017. These statements do not override the terms of the Agreement, which in any event was an integrated contract. Meenavalli's statement is also inconsistent with the nature of the transaction. It would make no sense for Longfin to enter into an arrangement whereby Altahawi had fully earned the Consulting Shares on February 1, 2017, even if he chose not to perform any future services for the company. Accordingly, the earliest possible date on which Altahawi could prove that he acquired his shares was June 16, 2017.
Because Altahawi did not acquire the Consulting Shares until, at the very earliest, June 16, 2017, he did not hold the shares at least one year before he sold them in March 2018. Under Rule 144, in order to sell the Consulting Shares as a non-affiliate in less than a year after acquisition, Longfin would have had to be in compliance with its Exchange Act reporting requirements. As discussed above, it was not. The SEC is likely to show, therefore, that Altahawi's sales of the Consulting Shares did not comply with Rule 144 even if he is deemed to be a non-affiliate.
Altahawi contends that even if he does not qualify for Rule 144's safe harbor, his sales of the Consulting Shares are exempt under Section 4(a)(1) itself. But, as explained above, it is likely that Altahawi will be found at trial to have been an affiliate of Longfin for Rule 144 purposes. If so, he will be deemed an "issuer" for the purpose of the definition of an underwriter under Section 2(a)(11).
Even if Altahawi were not an affiliate, however, his sales would not be exempt under Section 4(a)(1). Section 4(a)(1) exempts sales from Section 5's prohibition when the sales are from persons other than an issuer, underwriter, or dealer in securities. As already noted, Altahawi has
Section 2 of the Securities Act sets forth the definitions of the key terms of the statute. These definitions create three categories of individuals who qualify as underwriters: (1) persons who purchase from an "issuer" with a view to distribution; (2) persons who offer or sell for an "issuer" in connection with the distribution of a security; and (3) persons who participate directly or indirectly in those tasks.
Altahawi has failed to carry his burden to show that has was not a statutory underwriter. In determining whether a person acquired shares with a view to distribution, courts look to objective evidence, such as the length of time the shares were held and whether there has been an unforeseeable change in circumstances of the holder.
There is abundant evidence that Altahawi always intended to sell the Consulting Shares and not to hold them as an investment. First, there was no effective public market for the Longfin shares until December 2017, when trading began on the NASDAQ. Thus, he had no market for his shares until that date. Altahawi began to sell the Consulting Shares not long thereafter, on a date in March which was six months to the day after he had arranged for the shares to be issued to him. Because the Rule 144(d) six-month holding period expired on that day, this strongly indicates that Altahawi intended from the time he received them to distribute his shares rather than invest in them.
Notably, in his declaration, Altahawi never claims that he took the shares of Longfin with an investment purpose. Nor does he attempt to set out any change of circumstance that required a speedier than originally contemplated sale, a circumstance that might entitle him to an exemption under the statute. Although subjective
The next tranche of assets the SEC seeks to freeze are assets derived from Altahawi's sale of his Private Transaction Shares. The Private Transaction Shares were among the shares purportedly issued by Longfin to twenty-four individuals on December 6, 2017. Altahawi asserts that he acquired 121,000 of those December 6 Shares from ten individuals on January 12, 2018. He sold them in January and February 2018 over the NASDAQ. Like the Consulting Shares, these shares were not sold pursuant to a Securities Act registration statement, and therefore, the SEC has carried its initial burden of showing a violation of Section 5. Altahawi contends that the shares were purchased pursuant to the Regulation A+ offering, and thus that the shares were not restricted securities.
In the first instance, because Altahawi is likely to be deemed an affiliate, even if the shares were originally acquired pursuant to the Regulation A+ offering, when they came into Altahawi's possession they became "control" securities under Rule 144. As such, in order to resell the shares pursuant to Rule 144's safe harbor, among other things, Longfin had to be current in its Exchange Act filings and Altahawi had to provide appropriate notice to the SEC. Neither requirement was met.
Because Altahawi sold at least some of the Private Transaction Shares before 90 days had expired since Longfin became an Exchange Act reporting company on November 22, 2017, the "current public information" requirement under Rule 144 differs somewhat from the analysis just conducted with respect to the Consulting Shares. As described above, the 90-day period called for by Rule 144(c)(1) ended on February 22, 2018.
Rule 144 precludes the sale of control shares in an issuer that is required to file Exchange Act reports until 90 days following registration.
Even if Altahawi is not found at trial to be an affiliate, however, Altahawi is unlikely to show that the Private Transaction Shares were acquired through a Regulation A+ offering. Accordingly, the Private Transaction Shares would have been restricted shares, for which at least two provisions of Rule 144 were not complied with: the current public information requirement
Meenavalli claims that each of the ten individuals from whom Altahawi acquired the Private Transaction Shares had themselves purchased their shares from Longfin through its Regulation A+ offering and paid Longfin directly for those shares. But, there is no documentation to show that Longfin received any payment for those shares.
Altahawi has also not explained how he managed to purchase these shares from ten separate individuals living in India by obtaining their signatures on the same piece of paper, much less why they agreed to sell the shares at below-market value. Nor has Altahawi provided documentation to confirm he paid even this below-market price for the shares.
Because Altahawi is unlikely to show that the Private Transaction Shares were acquired in the Regulation A+ offering, they were obtained directly from the issuer outside of any public offering, and thereby were restricted shares under Rule 144.
There are two sets of shares at issue with respect to defendants Tammineedi and Penumarthi. Both acquired and sold December 6 Shares, and Tammineedi sold shares purchased through the Source Media account. The SEC has frozen proceeds from the sales of both sets of shares.
The SEC has established that it is likely to succeed in showing that Tammineedi and Penumarthi sold unregistered shares in violation of Section 5 of the Securities Act when they sold shares they
Tammineedi and Penumarthi have not shown that their sales of Longfin shares in December 2017 and January 2018 were protected by Rule 144's safe harbor, or that they are entitled to an exemption under Section 4(a)(1) of the Securities Act. There is strong evidence that their December 6 Shares were acquired directly from the issuer outside the Regulation A+ offering. There is no documentary evidence that either defendant paid for their December 6 Shares. Their subscription arrangements were apparently driven by the desire to provide the NASDAQ with a shareholder list and thereby meet the NASDAQ's listing requirements. Their shares are in fact marked on the control log as restricted shares.
Tammineedi and Penumarthi's explanations for how they paid for their shares are unlikely to be found credible. Penumarthi claims that he became aware Longfin was contemplating an IPO, and purchased 40,100 shares pursuant to two subscription agreements. He then says that he
Penumarthi has not produced any documentation supporting these claims.
Similarly, Tammineedi claims that he purchased his shares with funds transferred to him from Kling Enterprises Limited and that he used those funds to pay Stampede Enterprises Limited in March 2017. He then claims that Stampede was to remit the money on his behalf after the DPO qualification. He also says that Stampede Enterprises Limited confirmed to him that they remitted the funds to Longfin on July 18, 2017. Again, he has produced no documentation to that effect.
Moreover, both of these defendants purchased at least a small number of shares from Longfin in the normal course, with their payments recorded in the Colonial Transfer records, without resort to the roundabout method they purportedly used to acquire the December 6 Shares marked as restricted. Accordingly, it is likely that the trial will establish that both Tammineedi and Penumarthi acquired the shares outside the Regulation A+ offering, and that their shares were restricted shares under Rule 144.
As restricted shares, under Rule 144, Penumarthi and Tammineedi were required to hold the December 6 Shares for a minimum period of one year, as described above. Because the December 6 Shares were clearly not held the required one-year period, the sales were not protected by Rule 144.
The SEC also contends that both Tammineedi and Penumarthi are affiliates of Longfin. A finding that they were affiliates would provide additional grounds for freezing the proceeds of their sales of the December 6 Shares. The record for this hearing provides strong support for finding that each of them was an affiliate of Longfin.
Tammineedi is a director of Stampede Capital Limited, a company that Meenavalli founded and that is Longfin's largest shareholder. Stampede Capital Limited owns well over 10% of Longfin's shares, and Meenavalli himself has a substantial interest in Stampede Capital Limited.
Penumarthi acknowledges that he has worked as a consultant for Longfin. He has identified himself as well as a Director of Longfin's UK operations.
Finally, Penumarthi and Tammineedi do not attempt to demonstrate compliance with Section 4(a)(1) of the Securities Act beyond their claim of compliance with Rule 144. Given the minimal length of time between their acquisition of the December 6 Shares and their resale of those shares, they would not be able to establish that the shares were not acquired with a view to distribution. Accordingly, the proceeds of their sales of the December 6 Shares will remain frozen.
The SEC is also likely to establish that Tammineedi was ineligible to sell the shares he purchased through his company, Source Media, shortly before the Ziddu.com announcement. The analysis turns on whether Tammineedi was an affiliate of Longfin. It is undisputed that the shares were acquired on the public market by Tammineedi, and sold thereafter. Based on the facts outlined above, the SEC is likely to show that Tammineedi was an affiliate of Longfin at the time he purchased the shares.
Although the Source Media Shares were acquired on the public market, once an affiliate of Longfin acquired them, they became control shares under Rule 144. As control shares, in order to make a sale of these shares legal, Longfin had to have "current public information" filed with the SEC and Tammineedi had to provide notice to the SEC. For the reasons described above, there was no current public information filed, and it is undisputed that Tammineedi did not provide the required notice to SEC. And, as an affiliate, Tammineedi is ineligible for the Section 4(a)(1) exemption. Therefore, the proceeds from the sale of the Source Media Shares will remain frozen.
The SEC's April 4, 2018 motion for a preliminary injunction is granted with respect to defendants Altahawi, Tammineedi, and Penumarthi. The temporary restraining order, as modified by the April 23 Order, shall continue in effect until further Order of the Court.
SO ORDERED.