The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

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By Topic: PIPEs

  • From Vol. 6 No.12 (Mar. 21, 2013)

    Recent District Court Decision in Mark Cuban’s Ongoing Insider Trading Case Clarifies the Application of the Misappropriation Theory to Interactions between Investment Professionals and Corporate Insiders

    On March 5, 2013, the U.S. District Court for the Northern District of Texas (Court) allowed the SEC to proceed to trial in its civil enforcement action against Dallas Mavericks owner Mark Cuban for insider trading.  The SEC accused Cuban of selling his shares in after learning material nonpublic information about the company’s planned private investment in public equity (PIPE) offering, thereby avoiding a $750,000 loss.  The Court held that the SEC presented enough evidence to convince a reasonable jury that Cuban could be held liable on the misappropriation theory of insider trading because he agreed, “at least implicitly, to maintain the confidentiality of’s material nonpublic information and not to trade on it or otherwise use it.”  See “When Does Talking to Corporate Insiders or Advisors Cross the Line into Tipper or Tippee Liability under the Misappropriation Theory of Insider Trading?,” The Hedge Fund Law Report, Vol. 6, No. 2 (Jan. 10, 2013).  For reasons described in more detail in this article, this decision helps to further clarify what hedge fund investment professionals should and should not say and do when talking to corporate insiders.  This article summarizes the factual background in the matter and the Court’s legal analysis, and enumerates some of the salient implications of this decision for the investment research process.

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  • From Vol. 5 No.39 (Oct. 11, 2012)

    Former Federal Prosecutors Share Perspectives on Insider Trading Hot-Button Issues and Enforcement Trends Relevant to Hedge Fund Managers

    At an October 1, 2012 event co-sponsored by The National Law Journal; MoloLamken LLP; Wachtell, Lipton, Rosen & Katz; and Wilmer Cutler Pickering Hale & Dorr LLP, an illustrious panel of former federal prosecutors discussed the current state of insider trading enforcement and reviewed numerous hot-button issues of interest to hedge fund managers and other investors.  This article summarizes the key insights from the panel discussion.

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  • From Vol. 5 No.31 (Aug. 9, 2012)

    SEC Flexes Enforcement Muscle with Respect to Stock Offering Abuses Involving Reverse Merger Company China Yingxia International and Settles Enforcement Actions with Hedge Fund Manager Peter Siris and Others

    The Securities and Exchange Commission (SEC) has commenced civil enforcement proceedings against various individuals and entities involved in U.S. stock transactions involving China Yingxia International, Inc. (China Yingxia or Company), which went public via a 2006 reverse merger.  In one action, hedge fund manager Peter Siris (along with two affiliates) is accused of insider trading, acting as an unregistered broker and selling unregistered securities.  He is also accused of insider trading in the shares of a number of other small capitalization companies.  The SEC reports that he has settled those charges.  In a separate action, an investment relations firm employed by China Yingxia is accused of acting as an unregistered broker, and the company’s chief financial officer (CFO) is accused of fraud and a number of reporting violations.  The SEC has also entered into consent orders with three other individuals to resolve enforcement proceedings against them relating to their roles in the Company’s stock sales.  This article identifies the various players and their roles in China Yingxia’s capital markets activities; summarizes the charges against Siris, the CFO and the investment relations firm; and summarizes the settlements with the individuals.  See also “Questions Hedge Fund Managers Need to Consider Prior to Making Investments in Chinese Companies,” The Hedge Fund Law Report, Vol. 4, No. 21 (Jun. 23, 2011).

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  • From Vol. 4 No.36 (Oct. 13, 2011)

    SEC Accuses Corey Ribotsky and Hedge Fund Manager NIR Group, LLC of Misappropriating Assets and Misleading Investors in Connection with PIPEs

    On September 28, 2011, the SEC filed a civil complaint in the United States District Court for the Southern District of New York against an unregistered hedge fund management firm, The NIR Group, LLC (NIR), its sole managing member, Corey Ribotsky, and an NIR analyst, Daryl Dworkin (together, defendants).  This article details the allegations in the SEC’s complaint and briefly outlines NIR’s press release in response.  See also “New York Appellate Division Dismisses Investors’ Complaint Against Corey Ribotsky and Hedge Fund AJW Qualified Partners, Holding that Fund’s Decision to Suspend Redemptions Did Not Constitute a Breach of the Fund’s Operating Agreement or a Breach of Fiduciary Duty,” The Hedge Fund Law Report, Vol. 4, No. 16 (May 13, 2011); “Investors Sue Hedge Fund Managed By N.I.R. Group and Corey Ribotsky in Redemption Dispute,” The Hedge Fund Law Report, Vol. 2, No. 32 (Aug. 12, 2009).

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  • From Vol. 4 No.21 (Jun. 23, 2011)

    SEC’s Fraud Suit Against Principals of Palisades Master Fund for Overvaluation of “Side Pocket,” Misappropriation of Assets and Improper Short-Selling Survives Motion to Dismiss

    In October 2010, the Securities and Exchange Commission (SEC) brought civil securities fraud charges against defendants Paul T. Mannion, Jr., and Andrew S. Reckles, and the investment advisers they controlled, claiming that they defrauded investors in hedge fund Palisades Master Fund, L.P. (Fund) by lying to investors about the value of the Fund’s stake in World Health Alternatives, Inc. (WHA), stealing and exercising WHA warrants owned by the Fund, failing to disclose their private sales of WHA stock and concealing a short position in Radyne Corporation at the time that the Fund invested in that corporation’s PIPE offering.  For a detailed summary of the SEC’s complaint, see “SEC Brings Civil Securities Fraud Action Against Principals of Hedge Fund Palisades Master Fund, Alleging Fraud, Self-Dealing, Misuse of Fund Assets and Use of a ‘Side Pocket’ to Misrepresent the Fund’s Value to its Investors,” The Hedge Fund Law Report, Vol. 3, No. 42 (Oct. 29, 2010).  The Defendants moved to dismiss the entire complaint on the ground that it failed to state any cause of action against the Defendants.  The District Court generally permitted all counts of the complaint to proceed.  We summarize the factual background and the Court’s legal analysis.

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  • From Vol. 3 No.37 (Sep. 24, 2010)

    SEC Obtains Partial Victory in Securities Fraud Civil Action against Hedge Fund Manager Robert Berlacher and the Lancaster Hedge Funds for Insider Trading on Nonpublic “PIPE” Offering Information

    As part of a broader federal investigation into hedge funds that use non-private information obtained during Private Investment in Public Equity (PIPE) offerings in order to short-sell the stock of those companies – a technique that virtually guarantees profits since a PIPE typically drives down the price of public shares – the SEC recently accused hedge fund manager Robert A. Berlacher, and eight hedge funds he managed or advised (the Defendants), of insider trading and securities fraud in connection with four such transactions.  Specifically, it alleged that the Defendants unlawfully traded on non-public information obtained by Berlacher in a PIPE issued by Radyne ComStream, and made material misrepresentations in the PIPE stock purchase agreements (SPAs) Berlacher had signed with Radyne, Hollywood Media, International Display Works (IDWK), and SmithMicro.  On September 13, 2010, the U.S. District Court for the Eastern District of Pennsylvania concluded, following a bench trial, “The SEC has not sustained its burden of proof on the insider-trading count and two of the fraud claims” but “has met its burden on two separate fraud claims” in connection with the Radyne and IDWK transactions because the SPAs for those transactions had prohibited the types of trading in which Berlacher had engaged.  The court ordered Berlacher to disgorge net profits of $352,363.68, but refused to impose civil penalties, pre-judgment interest, or injunctive relief, as sought by the SEC.  We detail the background of the action and the court’s legal analysis.

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  • From Vol. 3 No.34 (Aug. 27, 2010)

    Manhattan District Court Writes Final Chapter in Litigation Between Internet Law Library and Hedge Fund Adviser Southridge Capital Management; Orders Tech Firm to Pay Adviser Almost $1.2 Million in Attorney’s Fees on Top of Damages

    On August 9, 2010, the United States District Court for the Southern District of New York (Southern District) effectively ended the decade-long litigation between Internet Law Library, Inc. (INL), its executives and several of its shareholders, and Southridge Capital Management, LLC (Southridge), its principals and affiliates, including hedge fund Cootes Drive, LLC, and its broker, Thomson Kernaghan & Co., Ltd. (TK & Co.).  The litigation arose out of a “floorless” or “toxic” convertible securities purchase agreement between INL and Cootes Drive.  The agreement allowed Cootes Drive to demand conversion of its INL preferred stock into common stock based on a floating conversion ratio tied to the common stock’s market price, and obligated Cootes Drive to float a $25 million line of equity, so long as INL common stock remained priced above a certain level.  This arrangement arguably provided Cootes Drive and its affiliates with an incentive to aggressively short-sell INL common stock, because the further they decreased its price, the more common stock Cootes Drive could obtain on conversion (which it could use to cover its short positions and profit from the difference), and because that decrease would eliminate its obligation to provide a line of equity.  The agreement proved disastrous for INL, just as it has for many other companies with similar financing arrangements.  Its common stock price fell precipitously after it signed the agreement, allegedly due to Cootes Drive and its broker, TK & Co., short selling its common stock.  INL filed a lawsuit against Southridge and its affiliates in a Texas district court for fraud and market manipulation.  Cootes Drive filed a countersuit for breach in the Southern District after INL refused to redeem its preferred shares and to honor a promissory note.  The Southern District accused INL of forum shopping, consolidated the actions, found INL’s complaint legally sufficient to survive a motion to dismiss, but then dismissed that complaint as a sanction for its flagrant disregard of court orders and discovery abuses.  It then granted summary judgment to Cootes Drive, because INL had failed to provide evidence that Cootes Drive committed a material breach that would excuse INL from redeeming its preferred shares or honoring the note.  It emphasized that Cootes Drive’s short-selling of a “small amount of” INL shares was only “a technical violation” of their agreement and that INL had failed to supply evidence showing that TK & Co. had shorted significant quantities of common stock at the behest of Cootes Drive.  It also refused INL’s request for additional discovery to establish that connection, due in large part to its prior discovery abuses.  The Court then awarded over $1.1 million in damages to Cootes Drive, and required INL to pay Cootes Drive over $1.2 million in attorney’s fees.  This article surveys many of the opinions in the litigation to provide a detailed analysis of the factual background and legal analyses of various courts.  The article also identifies and discusses the legal principles established by the litigation that have broad, ongoing application to private investments by hedge funds in private or public companies.

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  • From Vol. 3 No.25 (Jun. 25, 2010)

    Registered Direct Offerings Enable Hedge Funds to Make Advantageously-Structured Investments in Public Equity While Avoiding the Illiquidity and Other Downsides of PIPEs

    Investment structuring can profoundly affect investment outcomes – an insight that accounts, in large part, for the growing participation by hedge funds as investors in registered direct offerings (RDOs).  As explained in more detail below, an RDO involves the sale by a public company of registered securities via a placement agent to institutional investors, such as hedge funds.  Since the securities purchased in an RDO are registered, the purchaser can sell them immediately.  By contrast, the securities purchased in a private investment in public equity (PIPE) are restricted and generally cannot be sold for 60 to 90 days following the purchase.  The illiquidity of PIPEs can adversely affect investment returns.  For example, assume hedge fund A purchased 10,000 shares of common stock of Company X in an RDO on January 1, 2010 for $50 per share and sold those shares a week later for $51.  Hedge fund A would have a pre-tax profit of $10,000.  Now assume that hedge fund A purchased those same 10,000 shares of common stock of Company X in a PIPE on January 1, 2010 for the same $50 per share.  And assume that during the two months following the purchase, the fortunes of Company X declined, such that as of March 1, 2010, the price of Company X common stock had fallen to $35 per share.  Under the terms of most PIPEs, hedge fund A would be legally prohibited from selling the shares it purchased in the PIPE during those two months, and would watch without recourse as its investment in Company X lost $150,000.  Efforts by hedge funds to offset such losses via short sales have often backfired, resulting in allegations of insider trading and violations of Regulation M.  See “Confidentiality, Standstill and Insider Trading Considerations Relevant to Hedge Funds Investing in PIPEs,” The Hedge Fund Law Report, Vol. 2, No. 45 (Nov. 11, 2009); “SEC Obtains Permanent Injunction Against Hedge Fund Colonial Fund LLC for Illegal Short Sales; Opinion Addresses Fund Manager’s Faulty Internal Compliance and Accounting Systems,” The Hedge Fund Law Report, Vol. 2, No. 29 (Jul. 23, 2009); “District Court Preserves PIPE Insider Trading Claims Against Gryphon Hedge Fund,” The Hedge Fund Law Report, Vol. 2, No. 15 (Apr. 16, 2009).  Beyond liquidity, RDOs offer additional benefits to hedge funds, some relative to PIPEs and others independently.  With the goal of helping hedge funds evaluate whether RDOs offer an attractive investment structure and opportunity, this article details the mechanics of RDOs; includes statistics on RDO and PIPE activity; catalogs 13 distinct benefits to hedge funds of participating in RDOs; and identifies and discusses insider trading concerns in connection with RDOs.

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  • From Vol. 2 No.45 (Nov. 11, 2009)

    Confidentiality, Standstill and Insider Trading Considerations Relevant to Hedge Funds Investing in PIPEs

    In November 2007, Scott Friestad, Associate Director of the SEC’s Enforcement Division, announced that trading abuses would be a priority for the then-newly-launched Hedge Fund Working Group.  He defined “trading abuse” to include abuses of private investments in public equity (PIPE) transactions, as well as insider trading and improper short sales under Regulation M.  But the advertised crackdown was already underway.  For example, that September, the SEC had initiated an enforcement action against Robert A. Berlacher and others alleging that the defendants had engaged in unlawful insider trading in connection with the Radyne ComStream Inc. PIPE offering of 2004, by selling short Radyne securities prior to the public announcement of the PIPE.  As an alternative theory of liability, the SEC also alleged that the trading violated Section 5 of the Securities Act of 1933 (Securities Act).  Section 5 generally requires that every offer or sale of securities must be either registered or exempt from registration.  The SEC claimed in Berlacher and analogous cases that the use of PIPE shares after the effective date of the relevant registration statement to cover short sales made prior to the effective date of the relevant registration statement effectively constituted an unregistered sale of securities that required registration.  The SEC has since suffered a series of setbacks in connection with PIPEs, especially with respect to its Section 5 theory of liability.  The various dismissals of claims under Section 5 are, in turn, part of a broader pattern of setbacks for the SEC in its enforcement efforts in connection with PIPEs, and the decisions that have resulted from this effort have affected the practices of issuers, placement agents and investors.  This article reviews the mechanics of PIPE transactions and the informal confidentiality arrangements traditionally entered into by PIPE issuers and investors.  The article then surveys the insider trading caselaw applicable to investors in PIPEs (many of whom are hedge funds); the insider trading claims against Mark Cuban, which were dismissed in July of this year, including insights from the lawyer who successfully represented Cuban in that matter; the changing dynamics of the PIPE marketplace, including the entry of more sophisticated issuers, and the concomitant new emphasis on the terms of confidentiality and standstill agreements; and the materiality of PIPEs in any insider trading analysis.

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  • From Vol. 2 No.15 (Apr. 16, 2009)

    District Court Preserves PIPE Insider Trading Claims Against Gryphon Hedge Fund

    On March 23, 2009, the United States District Court for the Southern District of New York  decided that a lawsuit brought by the Securities and Exchange Commission against hedge fund manager Edwin “Bucky” Buchanan Lyon, IV, and the Gryphon family of hedge funds (Gryphon Funds) he managed (collectively, the defendants), may advance to trial.  The SEC accused the defendants of securities fraud and insider trading for allegedly short selling shares in four companies after obtaining confidential non-public solicitations to participate in those companies’ upcoming private investments in public equities (PIPE) transactions.  The trial court declined to enter summary judgment on behalf of either party, holding “issues of material fact remain in dispute – namely, whether defendants accepted a duty of confidentiality with regard to each of the four PIPE offerings” which they subsequently breached.  We explain how a PIPE transaction works, and detail the facts of the case and the court’s holding and analysis.

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