ot:Regulator cracks down on naked short sales
Former fund manager to pay $110,000 U.S.
January 09, 2007
Tara Perkins
business reporter
The former portfolio manager of a $200 million (U.S.) New York-based hedge fund has agreed to pay $110,000 to settle charges that he took part in an illegal trading scheme, in one of a trio of recent fraud cases that involve "naked" short-selling in Canada.
In the last year, the U.S. Securities and Exchange Commission – after receiving help from the Investment Dealers Association of Canada – has filed fraud charges in three separate cases against American hedge funds, based on similar allegations.
It alleges the funds made millions by making bets, in Canada, that certain companies' share prices would fall, and covering the bets using discounted shares they knew they were going to obtain in financing deals.
Each case also involves an unidentified Canadian broker-dealer that is not accused of any wrongdoing.
"The commission's investigation continues as to the role of other entities or individuals into the misconduct alleged in the complaint," Robert Kaplan, of the SEC's enforcement division, said yesterday.
In each case, the hedge fund agreed to invest in a PIPE – private investment in public equity – offering. That's where investors agree to buy restricted shares from primarily U.S.-based companies at a certain, discounted, price and the company, in turn, agrees to file for registration so that the investor can resell the shares to the public. Because the company is left with more shares outstanding, its stock often falls once the discounted shares are resold.
The SEC alleges that in each case, after agreeing to invest in the PIPE financing, the hedge funds sold short the companies' shares through "naked" short sales in Canada. Short-selling, which is legal, is when investors sell borrowed shares in a bet that the price will fall.
At some point, the investors cover the short sale by buying the shares and handing them over. If they can buy the shares at a lower price, they profit. In naked short-selling, the investors have not arranged to borrow the shares, and so are promising to deliver shares they can't guarantee they will obtain. The shares are not covered, or are "naked," at the time of the sale.
Regulators have recently moved to stop naked short-selling. At the time of the allegations against the funds, it was legal in Canada, the SEC said.
Essentially, the hedge funds are accused of being involved on both sides of the naked short sales, which allowed them to make bigger, guaranteed profits. The hedge funds were covering the short sales with the discounted shares from the PIPE offerings, the SEC alleged.
Last week, Joseph Spiegel, a former portfolio manager for New York-based hedge fund Spinner Global Technology Fund Ltd., agreed to pay a penalty of $110,000.
He did not admit or deny the allegations, which accused him of agreeing in 2002 to invest in three PIPE transactions for companies that were listed on the Nasdaq or NYSE, and then selling short the companies' shares through naked short sales in Canada.
"To close out the Canadian short positions, Spiegel engaged in deceptive, pre-arranged trades with his Canadian broker-dealer," the SEC alleged.
"There's a whole lot of speculation as to why they did some of their trading through Canada," said Alex Popovic, the IDA's vice-president of enforcement. He said there is more than one Canadian broker involved.
