The Commission alleges that Rhino and Badian manipulated Sedona's stock price to enhance a client's economic interests in a $3 million convertible debenture that Sedona issued to Rhino's client. The purchase agreement for the debenture expressly prohibited Rhino's client from selling short shares of Sedona's stock while the debenture remained "issued and outstanding." According to the Commission, despite this contractual provision, Rhino engaged in extensive short selling on behalf of its client prior to exercising the conversion rights under the debenture and this short selling depressed Sedona's stock price.
Without admitting or denying the allegations in the SEC's complaint, Rhino and Badian have consented to the entry of an injunction for violations of the anti-fraud provisions of the federal securities laws and to pay, on a joint and several basis, a $1 million civil penalty. In addition, Rhino has consented to a court order requiring it to respond to an order directed to it by the Commission pursuant to Section 21(a) of the Securities Exchange Act of 1934 and to hire an independent consultant, acceptable to the Commission, to review its compliance policies and procedures and to implement the Independent Consultant's recommendation. The settlement terms are subject to court approval.
"Certain convertible securities, particularly those referred to as 'toxic' or 'death spiral' convertibles, present the temptation for persons holding the convertible securities to engage in manipulative short selling of the issuer's stock in order to receive more shares at the time of conversion," said Thomas C. Newkirk, Associate Director for the Division of Enforcement. "This case demonstrates this risk to issuers and investors. The $1 million penalty imposed here shows the Commission's determination to address these abuses."
Companies accessing the capital markets using financing alternatives are reminded to evaluate carefully the terms and risks of the securities being sold, including the impact on the company and the market for its securities. Certain types of financings, particularly those having conversion or issuance mechanisms tied to a company's fluctuating stock price, pose particular risks to companies and investors alike. These risks include dilution, as the result of the company issuing more shares, and, in some instances, downward manipulation of the company's stock price.
In deciding whether to enter into particular financing arrangements or make investment decisions, companies and investors should weigh the benefits of any alternative financing against the potential risks to the company and the value of the company's securities in the market. For more information, companies and investors should read "Convertible Securities" on the Commission's Web site at http://www.sec.gov/answers/convertibles.htm..
