Feds Rap Hedge Fund
Liz Moyer, 12.12.06, 7:10 PM ET
Another hedge fund is being taken to task for alleged naked short-selling and insider trading in dozens of unregistered securities.
Gryphon Partners, the $310 million Dallas hedge fund run by Edwin "Bucky" Lyon, is the target of a federal civil lawsuit filed Tuesday by the Securities and Exchange Commission, alleging securities fraud in trading of shares in 35 unregistered securities offerings.
The companies caught up in the alleged scheme are hardly household names: Medis Technologies, Generex Biotechnology, Immune Response and PhotoMedex, to name a few. But that is generally the pattern of many cases involving allegations of manipulative trading.
It is part of the SEC's crack-down on illegal trading in deals known as PIPEs, or private investments in public equities, a popular financing tool used by small companies. Regulators have alleged all kinds of abuses related to PIPE deals, including insider trading and naked short-selling.
In September, former New York hedge fund manager Hilary Shane was indicted on five counts of securities fraud for naked short-selling and insider trading in connection with a PIPE transaction for Maryland-based CompuDyne. Shane pleaded not guilty. She had already settled a civil case with the SEC in May and paid a $1.4 million fine.
The CompuDyne case is still active, as are regulatory probes into dozens of other PIPE transactions in the last six years.
In Gryphon's case, the SEC says the illegal trading between 2001 and 2004 resulted in $6.5 million in "ill-gotten" gains. The suit, filed in U.S. District Court in Manhattan, names Lyon, the firm, and several of its funds.
Christopher Clark, an attorney at LeBoeuf Lamb Greene & MacRae who represents Gryphon, says there are a number of factual errors in the complaint and that the claims aren't supported. "We look forward to addressing the allegations in court and being fully vindicated."
The type of PIPE transactions involved in the Gryphon case were pretty simple. Investors receive restricted shares, typically at a price that is below the current market price of the company. The shares can't be traded until the restriction is lifted, which comes after the issuer has an effective registration statement, a process that takes up to 120 days. The discount to the market price compensates the PIPE investors for waiting.
PIPE investors can hedge their investments by selling short the company's shares in the open market before the registration statement is effective. But to do a short sale, a trader has to properly borrow the shares before selling them, and the trader can't use the PIPE shares.
With very small companies that have limited shares issued and available to borrow, PIPE investors that want to fully hedge their investments have to limit their PIPE deals to share amounts they know can be covered with real borrowed shares. This puts a damper on the amount to be gained from PIPE investing, for those who play by the rules.
But, as the SEC has found increasingly lately, there are plenty of traders who seem willing to ignore those rules. Gryphon sold short shares of the companies in the PIPE deals, only it did so without borrowing them, a practice called naked short-selling, according to the SEC. The trading took place in Canada. Once the registration was effective, the fund used the shares issued to cover its short positions, which would also be illegal under federal securities laws.
What's more, the firm made these short sales even after agreeing not to sell, transfer or dispose of the PIPE shares, in essence lying to the companies involved in the PIPE deals as an inducement to get them to go ahead with them, the SEC says.
Gryphon allegedly used a number of deceptive trading tactics to carry out this scheme, including wash-sales, in which trades are made among affiliated parties but are designed to look like they are happening in the open market. The company is also accused of pre-arranged trades and matched orders, making it appear as though it was covering its short position with open market shares when they were not.
And it traded using non-public information about the deals, the SEC says, even though the firm's lawyers told it not to trade in advance of the public announcement.
Send stock manipulators to: enforcement@sec.gov-and to jail.
