September 20, 2007
Below you will find the recent Litigation Release and Complaint in SEC v. Berlacher et al. The Complaint is another in a series of actions brought by the SEC against fund managers who, in connection with PIPEs transactions, are alleged to have violated the registration provisions of Section 5 of the Securities Act of 1933 and the anti-fraud provisions of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. As in previous complaints of this type (e.g., Spinner(http://www.sec.gov/litigation/complaints/2006/comp19639.pdf) and Gryphon (http://www.sec.gov/litigation/complaints/2006/comp19942.pdf)), the SEC does not challenge the defendants' short sales of the PIPE issuer's stock before the resale registration statement is declared effective, but instead alleges that the defendants' use of the PIPE shares to cover those short positions constituted a violation of Section 5. The critical language in this respect is in paragraph 26 of the Complaint, which reads as follows:
"Berlacher knew or was reckless in not knowing that the lawful way to cover those short positions that were established to 'hedge' PIPE investments was to purchase open market shares, but he chose instead to cover his pre-effective date short positions with PIPE shares in order to avoid exposing the trades to market risk."
As in some of the earlier PIPEs proceedings, in Berlacher the defendants are alleged to have "engaged in deceptive trading techniques -- i.e., wash sales, matched orders and pre-arranged trades -- to create the false appearance that the PIPE shares being used to cover the short positions were market shares" (Complaint ¶32). Although the Complaint does not contrast these deceptive trading techniques with what the SEC would describe as lawful covering purchases in the open market, it is fair to say that each of the deceptive trading techniques described in the Complaint has the common element of eliminating any market risk between the defendants' sale of registered shares and their purported separate purchase of the same number of shares in the open market.
Please feel free to contact any of your regular contacts at the firm or any of our partners and counsel listed under Capital Markets in the "Our Practice" section of this website if you have any questions.
CLEARY GOTTLIEB STEEN & HAMILTON LLP