The Hedge Fund Law Report

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

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By Topic: Registered Direct Offerings

  • 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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