Despite a recent district court’s dismissal of SEC claims that a hedge fund manager was guilty of insider trading in connection with his knowledge of private investments in public equity (PIPEs) of issuers in whose securities he also took short positions, advisers should remain cognizant of the trading restrictions and potential insider information associated with PIPEs.
In Securities and Exchange Commission v. Berlacher, et al., 2010 WL 3566790 (E.D. Pa. Sept. 13, 2010), a district court dismissed the SEC’s insider trading charges against a hedge fund manager, along with several of his investment advisory entities and various hedge funds he managed. The SEC brought the insider trading claims because the manager made trades, including indirect short positions, in securities of companies that he was informed were engaging in PIPE offerings. A PIPE allows a publicly-traded company to raise capital privately through the issuance of restricted stock that cannot be traded until the registration statement becomes effective, generally a few months later. The general public is usually unaware of a PIPE offering during the negotiation period with investors. Certain PIPE events, such as the public announcement of the PIPE offering, have a tendency to depress the price of the issuer’s stock because the issuance of new shares typically causes dilution.
In this case, after learning about certain PIPEs through placement agents looking for potential investors, the manager established a “barrier option” position on a “basket” of securities (i.e., a portfolio of underlying assets), including a short position in one of the issuers of the PIPEs. The court found that the manager possessed non-public information regarding the PIPE issuer’s securities and “within minutes engaged in transactions involving [the PIPE issuer’s] stock through his barrier options basket account.” The manager, however, was found not guilty of insider trading because the information he received and on which he acted was determined to be immaterial based on expert witness testimony and statistical studies that concluded that the price of the PIPE issuer’s stock had not moved a material amount upon the disclosure of the PIPE. The Third Circuit, in which the district court sits, bases its determination of whether information is material on a post hoc measurement of movements in the price of the stock at issue.
While the insider trading charges were dismissed, the hedge fund manager was found guilty of fraud in connection with representations he made in certain PIPE special purchase agreements, which stated that he did not hold a short position (directly or indirectly) in the company’s shares.