SEC Files Enforcement Action Against Hedge Fund Manager Jeffrey Thorp and Three Hedge Funds for Engaging In Illegal "Pipe" Trading Scheme
U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 19607 / March 14, 2006
SEC v. Langley Partners, L.P., North Olmsted Partners, L.P., Quantico Partners, L.P., and Jeffrey Thorp, Civil Action No. 1:06CV00467 (JDB) (D.D.C.)
SEC Files Enforcement Action Against Hedge Fund Manager Jeffrey Thorp and Three Hedge Funds for Engaging In Illegal "Pipe" Trading Scheme
Defendants Consent to Permanent Injunctions and Agree to Pay $15.8 Million to Settle Charges
The Securities and Exchange Commission filed securities fraud and related charges today against three New York-based hedge funds, Langley Partners, North Olmsted Partners and Quantico Partners (collectively, "Langley Partners"), and their portfolio manager, Jeffrey Thorp, in the U.S. District Court for the District of Columbia. Langley Partners and Thorp agreed to settle the Commission's charges that they perpetrated an illegal trading scheme to evade the registration requirements of the federal securities laws in connection with twenty-three unregistered securities offerings, that are commonly referred to as "PIPEs" (Private Investment in Public Equity), and engaged in insider trading. As part of the settlement, Langley Partners will disgorge $8.8 million in ill-gotten gains and prejudgment interest, and Langley Partners and Thorp will pay civil penalties totaling $7 million.
The Commission alleges in its complaint that Langley Partners and Thorp, after agreeing to invest in a PIPE transaction, typically sold short the issuer's stock, frequently through "naked" short sales in Canada. Among other things, the Commission's complaint alleges that:
Once the Commission declared the resale registration statement effective, Thorp used the PIPE shares to close out the short positions a practice Thorp knew was prohibited by the registration provisions of the federal securities laws. To avoid detection and regulatory scrutiny, Thorp employed a variety of deceptive trading techniques, including wash sales and matched orders, to make it appear that he was covering his short sales with legal, open market stock purchases. In fact, the covering transactions were not open market transactions because Thorp was on both sides of the trades.
In each of the transactions, Thorp made materially false representations to the PIPE Issuers to induce them to sell securities to Langley Partners. As a precondition of participation in a PIPE, Langley Partners had to represent that it would not sell, transfer or dispose of the PIPE shares other than in compliance of the registration provisions of the Securities Act of 1933. This representation was material to the PIPE Issuers, who, as the stock purchase agreements made clear, relied on the investors' representations in connection with qualifying for an exemption from the registration requirements for their private offering. At the time Thorp signed the securities purchase agreements, however, he intended, if he had not already done so, to distribute the restricted PIPE securities in violation of the registration provisions of the Securities Act.
On seven occasions, Thorp also engaged in insider trading by selling the securities of PIPE Issuers on the basis of material nonpublic information prior to the public announcement of the PIPEs. Thorp engaged in this conduct notwithstanding his express agreement to keep information about the PIPE confidential and/or to refrain from trading prior to the public announcement of the PIPE.
To settle the Commission's charges, without admitting or denying the allegations in the complaint, Langley Partners and Thorp consented to the entry of a final judgment permanently enjoining them from future violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder and Sections 5 and 17(a) of the Securities Act of 1933. In addition, the final judgment orders Langley Partners, North Olmsted Partners and Quantico Partners to pay, jointly and severally, disgorgement of $7,048,528, prejudgment interest of $1,769,400, and a civil penalty totaling $4,700,000. The final judgment also requires Thorp to pay a $2,300,000 civil penalty.
The Commission acknowledges the assistance of the Investment Dealers Association of Canada. The Commission's investigation is continuing.
SEC Complaint in this matter
sec.gov
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UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF COLUMBLA
SECURITIES AND EXCHANGE COMMISSION
100 F Street, N.E.
Washington, DC 20549,
Plaintiff, CASE NUMBER 1:06CV00467
JUDGE: John D. Bates
DECK TYPE: General Civil
LANGLEY PARTNERS, L.P., NORTH OLMSTED
PARTNERS, L.P., QUANTICO PARTNERS, L.P., DATE STAMP: 03/14/2006
AND JEFFREY THORP
C/O Andrew G. Gordon, Esq.
Paul, Weiss, Rifkind, Wharton & Garrison LLP
1285 Avenue of the Americas
New York, NY 100 1 9-6064,
COMPLAINT
Plaintiff Securities and Exchange Commission ("Commission") alleges:
SUMMARY OF ALLEGATIONS
1. Defendant hedge h d s Langley Partners, L.P., North Olmsted Partners, L.P. and
Quantico Partners, L.P. (collectively, "Langley Partners"), and their portfolio manager, defendant
Jeffrey Thorp ("Thorp"), perpetrated an illegal trading scheme to evade the registration requirements
of the federal securities laws in connection with twenty-three unregistered securities offerings, which
are commonly referred to as "PIPES" (Private Investment in Public Equity). From 2000 to 2002,
defendants realized more than $7,000,000 in ill-gotten gains as a result of the unlawful trading
scheme, which violated the antifraud and registration provisions of the federal securities laws.
2. Typically, after agreeing to invest in a PIPE transaction, Thorp sold short the issuer's
stock, frequently through "naked" short sales in Canada. Later, once the Commission declared the
resale registration statement effective, Thorp used the PIPE shares to close out the short positions -
a practice Thorp knew was prohibited by the registration provisions of the federal securities laws. To
avoid detection and regulatory scrutiny, Thorp employed a variety of deceptive trading techniques,
including wash sales and matched orders, to make it appear that he was covering his short sales with
legal, open market stock purchase when in fact the covering transactions were not open market
transactions because Thorp was on both sides of the trades.
3. Langley Partners' unlawful PIPE investment strategy and deceptive trading scheme
involved twenty-three issuers that sought PIPE financing (collectively, "the PIPE Issuers"). During
the relevant period, the common stock of each PIPE Issuer was registered with the Commission
pursuant to either Section 12(b) or Section 12(g) ofthe Securities Exchange Act of 1934 ("Exchange
Act") and traded on either the NASDAQ National Market, the New York Stock Exchange, or the
Over-The-Counter Bulletin Board.
4. In each of the transactions, Thorp also made materially false representations to the
PIPE Issuers to induce them to sell securities to Langley Partners. As a precondition ofparticipation
in a PIPE, Langley Partners had to represent that it would not sell, transfer or dispose of the PIPE
shares other than in compliance of the registration provisions of the Securities Act of 1933
("Securities Act"). This representation was material to the PIPE Issuers, who, as the stock purchase
agreements made clear, relied on the investors' representations in order to qualify for an exemption
from the registration requirements for their private offering. At the time Thorp signed the securities
purchase agreements, however, he intended, if he had not already done so, to distribute the restricted
PIPE securities in violation of the registration provisions of the Securities Act.
5. On seven occasions, Thorp also engaged in insider trading by selling the securities of
PIPE Issuers on the basis of material nonpublic information. Thorp engaged in this conduct
notwithstanding his express agreement to keep information about the PIPE confidential andlor to
refrain fi-om trading prior to the public announcement of the PIPE.
6. By engaging in the acts alleged herein, the defendants engaged in, and unless
permanently restrained and enjoined by the Court will continue to engage in, transactions, acts,
practices and courses ofbusiness that violate Section 10(b) of the Exchange Act [15 U.S.C. 8 78j(b)]
and Rule lob-5 promulgated thereunder [17 C.F.R. 5 240.10b-51, Section 17(a) of the Securities Act
[15 U.S.C. 8 77q(a)], and Section 5 of the Securities Act [15 U.S.C. 8 77el.
7. The Commission seeks a judgment from the Court: (a) enjoining the defendants fi-om
engaging in future violations of the above sections of the federal securities laws; (b) ordering
defendants Langley Partners, L.P., North Olmsted Partners, L.P. and Quantico Partners, L.P., jointly
and severally, to disgorge, with prejudgment interest, the illegal profits and proceeds they obtained as
a result of the actions described herein; and (c) ordering defendants Langley Partners, L.P., North
Olmsted Partners, L.P., Quantico Partners, L.P. and Thorp to pay civil money penalties pursuant to
Section 20(d) of the Securities Act 115 U.S.C. 8 77t(d)] and Section 2l(d) of the Exchange Act [15
U.S.C. $78(u)(d)].
JURISDICTION AND VENUE
8. The Court has jurisdiction over this action pursuant to Sections 20(b), 20(d) and 22(a)
of the Securities Act [15 U.S.C. $$ 77t(b), 77t(d), 77v(a)] and Sections 21(d), 21(e) and 27 of the
Exchange Act [15 U.S.C. §$78u(d), 78u(e), 78aal.
9. The defendants made use of the means and instrumentalities of interstate commerce
or of the mails in connection with the acts, practices, and courses of business alleged herein. Venue
is proper in this District pursuant to Section 22(a) of the Securities Act [15 U.S.C. § 77v(a)] and
Section 27 of the Exchange Act [15 U.S.C. § 78aal.
DEFENDANTS
10. Jeffrey Thorp, age 42, is a resident of New York, New York.
11. Langley Partners, L.P., a Delaware limited partnership, is a hedge fund with its
principal place of business at 535 Madison Avenue, New York, New York. Langley Capital, LLC
("Langley Capital") is the general partner of Langley Partners, and Thorp is the managing member of
Langley Capital. During the relevant period, Thorp was the portfolio manager of, and only
authorized trader for, Langley Partners.
12. North Olmsted Partners, L.P., a California limited partnership, is a hedge fund with
its principal place of business at 535 Madison Avenue, New York, New York. During the relevant
period, Thorp was the portfolio manager of, and only authorized trader for, North Olmsted Partners.
13. Ouantico Partners, L.P., a Delaware limited partnership, was a hedge fund with its
principal place of business at 535 Madison Avenue, New York, New York. Langley Capital was the
general partner of Quantico Partners. During the relevant period, Thorp was the portfolio manager
of, and only authorized trader for, Quantico Partners. Quantico Partners has been merged into
Langley Partners.
STATEMENT OF FACTS
PIPEs Background
14. Issuers utilize the PIPEs market when more traditional means of financing, such as a
registered repeat offering, are for various reasons impractical. PIPE securities are generally issued
pursuant to Section 4(2) of the Securities Act or Regulation D under the Securities Act, which
provide an exemption fiom registration for a non-public offering by an issuer. Because PIPEs are
unregistered offerings, PIPE investors receive restricted securities when a transaction closes. Before
investors can trade those restricted securities, the issuer must file, and the Commission must declare
effective, a resale registration statement, a process that may take 60 to 120 days to complete. PIPE
investors therefore must wait a certain period of time before they can fieely trade the securities that
they received in the PIPE. The sale of the securities to the PIPE investor is typically conditioned
upon effectiveness of the resale registration statement. To compensate investors for this temporary
illiquidity, PIPE issuers customarily offer the restricted securities at a discount to market price.
15. Many PIPE investors "hedge" their investment by selling short the PIPE issuer's
securities before the resale registration statement is declared effective. The size of the "hedge" is
limited by the investor's ability to locate shares of the PIPE issuer's securities to borrow in order to
sell short. A PIPE investor that wishes to hlly "hedge" its investment therefore typically wants to
purchase in the offering only as many shares as it knows it can locate to borrow. In thinly-traded
securities (such as many of those at issue in this case), where locating shares can be difficult,
investors wishing to "hedge" must limit their investment, which correspondingly limits their ability
to profit fiom the PIPE transaction.
16. Thorp violated Section 5 by covering his pre-effective date short positions with the
actual shares received in the PIPE. This is because shares used to cover a short sale are deemed to
have been sold when the short sale was made.
17. Thorp knew the lawful way to "hedge" PIPE investments, but chose instead to close
out his pre-effective date short positions with PIPE shares. This unlawhl trading scheme permitted
him to profit fiom outsized allocations of PPE offerings without incurring corresponding market
risk.
The Unlawful Trading Scheme
18. During the period 2000 through 2002, Thorp implemented the unlawful trading
scheme that enabled Langley Partners to invest in PIPE offerings without incurring market risk. His
strategy was simple: to short sell Langley Partners' entire restricted PIPE allocation as quickly as
possible before the Commission declared the resale registration statement effective and then to close
out those short positions using the PIPE shares.
19. In each of the twenty-three transactions listed below (except TiVo, Inc. ("TiVo")), in
which Thorp and Langley Partners engaged only in illegal insider trading), Thorp and Langley
Partners employed an unlawful trading strategy in violation of the antifraud and registration
provisions of the federal securities laws:
- -
1 lrvine Sensors 0811 4/00
2 Amtech 0911 3/00
R- NaPro 1 111 6/00 . -.
4 EcTel 03/25/01
5 PhotoMedex 0312 710 1
I 7 1 Guilford I 06/08/01 I
8 Generex 07/30/01
g HealthExtras 09/25/0 1
10 Visionics 1 0/05/01
11 SlGA 1 011 210 1
12 MGI Pharma 10/31/01
14 Gentner 11/15/01
15 InteliData 1 1 12810 1
16 Viisage 12/14/01
17 Rail America 1 211 810 1
18 lmpco 0111 1/02
19 PurchasePro.com 0211 3/02
1 20 1 Matritech I 03/04/02 I L
21 AVI BioPharma 03/25/02
22 Cell Pathways 03/26/02
I I I 23 1 TiVo (insider trading only) 08/28/0 1 I
20. Although the manner of establishing and covering the short positions differed from
deal to deal, the MGI Pharma, Inc. ("MGI Pharma") PIPE offering that closed on October 31,2001
illustrates defendants' basic trading strategy: Langley Partners invested $1,100,000 in the offering,
receiving 100,000 restricted MGI Pharma shares at $1 1 per share -a discount of approximately 15%
fiom MGI Pharma's then-market price of approximately $13 per share. Langley Partners quickly
short sold all 100,000 of its restricted shares (50,000 at $13.15 and 50,000 at $13.56), garnering
proceeds of $1,335,500. Thus, Langley Partners had purchased 100,000 shares in the PIPE and
shorted 100,000 shares before the resale registration statement was effective. Once the Commission
declared the resale registration statement effective, Langley Partners, through the deceptive and
nearly undetectable methods described below, used its fieely tradable PIPE shares to close out its
100,000 share short position. Langley Partners' profit was therefore locked in at the moment its
short sales were executed: the $1,33 5,500 short sale proceeds minus the $1,100,000 investment, for
a net profit of $235,500.
2 1. Langley Partners engaged in the same illegal trading scheme in connection with each
of the PIPE offerings (except for TiVo), garnering a total of approximately $7,000,000 in ill-gotten
gains.
22. Langley Partners employed several different methods -often used in combination for
the same PIPE -to establish its short positions. Because Langley Partners wanted to complete its
short selling as quickly, and as cheaply, as possible, it often executed its pre-effective date short sales
through a Canadian broker-dealer.
23. Using its Canadian broker-dealer, Langley Partners executed "naked" short sales by,
among other things, selling short without either owning unrestricted shares or borrowing unrestricted
shares to deliver. "Naked" short selling was permissible in Canada during the relevant period, so
Langley Partners attempted to establish its short positions in Canada because it did not own
unrestricted shares and did not want to incur the cost of borrowing unrestricted shares of the PIPE
Issuers' securities. Because Langley Partners therefore had no borrowing limitations, and because it
knew that it would be using its PIPE shares illegally to close out its pre-effective date short positions,
Langley Partners was able to make larger PIPE investments than other investors and, asa result, was
able to earn larger profits. In addition to its "naked" Canadian short selling, Langley Partners also
engaged in short selling in the United States through domestic broker-dealers or by executing short
sale orders itself through electronic communications networks.
24. Once Langley Partners had established its short position, it waited until the
Commission declared effective the resale registration statement and then began to use its PIPE shares
to cover (or "unwind") the short positions in violation of Section 5 of the Securities Act.
25. To close out Canadian short positions, Langley Partners either directly transferred its
PIPE shares to its Canadian account or engaged in deceptive, pre-arranged matched orders with its
Canadian broker-dealer. To execute the matched orders, Thorp would call or instant message his
Canadian broker to inform him that Langley Partners intended to sell a certain number of its PIPE
shares fiom its domestic prime brokerage account at a particular time and price using a particular
exchange, and would instruct the broker to enter a buy order for Langley Partners' Canadian account
for the same number of shares at the same time and price and on the same exchange. The buy and
sell orders would meet on the specified exchange, and the Canadian broker-dealer would use the
PIPE shares that he had just purchased fiom Langley Partners' domestic account to close out Langley
Partners' Canadian short positions.
26. When Thorp established his short positions in his domestic prime brokerage account,
he used two unlawfid trading methods to close out those short positions: "closing the box" and wash
sales. To "close the box," Langley Partners simply journaled its PIPE shares fiom its cash account to
its short account with instructions for its prime broker to close out the short position using the PIPE
shares.
27. In other instances, Thorp asked broker-dealers to register as market makers in
particular PIPE securities to assist Langley Partners in washing its PIPE shares. With the help of
these broker-dealers, Langley Partners sold its PIPE shares to the brokers, which then sold the exact
same shares back to Langley Partners. Once Langley Partners had received its PIPE shares back
from the broker-dealers, Langley Partners used those PIPE shares to close out its domestic short
positions.
28. As a necessary part of the unlawful trading scheme, Thorp intentionally made
materially false representations to the PIPE Issuers to induce them to sell their securities to Langley
Partners. Each securities purchase agreement between the PIPE Issuers and Langley Partners
contained a provision in which Langley Partners represented that it was purchasing the PIPE
securities in compliance with Section 5 of the Securities Act. In each offering, Langley Partners
represented, among other things, that it was purchasing the securities for its own account and without
any present intention of distributing the securities.
29. Thorp signed these securities purchase agreements despite knowing that Langley
Partners (i) was not purchasing the PIPE securities for its own account, and (ii) had a present
intention to distribute the PIPE securities through its short selling and to cover with the PIPE shares
in violation of Section 5. In a number of instances, not only did Langley Partners have a present
intention to distribute the PIPE shares at the time it signed the securities purchase agreements, it had
in fact already distributed the shares through short sales that it intended to cover, and did in fact
cover, with its PIPE shares.
Insider Trading
30. Thorp also engaged in insider trading in connection with seven PIPE offerings
(Gentner Communications, Inc.; Irvine Sensors Corporation; Matritech, Inc.; MGI Phanna, Inc.;
PhotoMedex, Inc.; TiVo, Inc.; and Visionics Corporation) by selling short the PIPE Issuers'
securities prior to the public announcement of the offering. Advance news of a PIPE offering can be
valuable and material nonpublic information since the announcement typically precipitates a decline
in the price of a PIPE issuer's securities as the market absorbs the dilutive effect of the offering. In
connection with each of the seven deals, Langley Partners received offering documents fiom PIPE
Issuers with language requiring it to maintain the information contained therein in confidence andlor
to refiain from trading on that information prior to the public announcement of the offering.
3 1. Notwithstanding these agreements to the contrary, Langley Partners breached its duty
to maintain the information about the PIPES in confidence, misappropriated the confidential
information concerning these seven offerings and traded on the basis of that material nonpublic
information by selling short the PIPE Issuers' securities prior to the public announcement.
FIRST CLAIM FOR RELIEF
INSIDER TRADING AND FRAUD
Violations of Section 10(b) of the Exchange Act and Rule lob-5 Thereunder
32. The Commission realleges and reincorporates paragraphs 1through 3 1as if fully set
forth herein.
33. From at least 2000 to 2002, the defendants, by use of the means or instrumentalities of
interstate commerce or of the mails, in connection with the purchase or sale of securities: (a)
employed devices, schemes, or artifices to defraud; (b) made untrue statements of material fact or
omissions to state material facts necessary in order to make the statement made, in light of the
circumstances under which they were made, not misleading; andlor (c) engaged in acts, practices or
courses of business which operated or would operate as a fraud or deceit.
34. By reason of their actions alleged herein, the defendants each violated Section lO(b)
of the Exchange Act [15 U.S.C. 4 78j(b)] and Rule lob-5 thereunder [17 C.F.R. 5 240.10b-51.
SECOND CLAIM FOR RELIEF
INSIDER TRADING
Violations of Section 17(a) of the Securities Act
35. The Commission realleges and reincorporates paragraphs 1 through 34 as if hlly set
forth herein.
36. From at least 2000 to 2002, the defendants, by use of the means or instrumentalities of
interstate commerce or of the mails, in the offer or sale of securities: (a) employed devices, schemes
or artifices to defraud; (b) obtained money or property by means of untrue statements of material fact
or omissions to state material facts necessary in order to make the statements made, in light of the
circumstances under which they were made, not misleading; and/or (c) engaged in acts, practices or
courses of business which operated or would operate as a fraud or deceit upon the purchasers of the
securities offered and sold by the defendants.
37. By reason of their actions alleged herein, the defendants violated Section 17(a) of the
Securities Act [15 U.S.C. 5 77q(a)].
THIRD CLAIM FOR RELIEF
REGISTRATION AND PROSPECTUS DELIVERY
Violations of Section 5 of the Securities Act
38. The Commission realleges and reincorporates paragraphs 1through 37 as if fully set
forth herein.
39. Defendant, directly or indirectly: (a) without a registration statement in effect as to
the securities, (i) made use of the means or instruments of transportation or communication or the
mails to sell such securities through the use or medium of a prospectus or otherwise, or (ii) carried or
caused to be carried through the mails, or in interstate commerce, by any means or instruments of
transportation, such securities for the purpose of sale or for delivery after sale; (b) carried or caused
to be carried through the mails or in interstate commerce securities for the purpose of sale or for
delivery after sale without being accompanied or preceded by a prospectus; and (c) made use of the
means or instruments of transportation or communication in interstate commerce or of the mails to
offer to sell or offer to buy through the use or medium of -a prospectus or otherwise securities for
which a registration statement had not been filed as to such securities.
40. By reason of their actions alleged herein, the defendants violated Section 5 of the
Securities Act [15 U.S.C. 5 77el.
PRAYER FOR RELIEF
WHEREFORE, the Commission respectfully requests that the Court enter a judgment:
I.
Finding that the defendants each violated the securities laws and Rule promulgated
thereunder as alleged herein;
11.
Enjoining permanently defendants Langley Partners, L.P., North Olmsted Partners, L.P.,
Quantico Partners, L.P. and Jeffkey Thorp from violating Section 10(b) of the Exchange Act [15
U.S.C. $ 78j(b)] and Rule lob-5 thereunder [17 C.F.R..§ 240.10b-51, and Sections 5 and 17(a) of
the Securities Act [15 U.S.C. $$77e and 77q(a)];
111.
Ordering defendants Langley Partners, L.P., North Olmsted Partners, L.P. and Quantico
Partners, L.P. jointly and severally to disgorge the profits and proceeds they obtained as a result
of their actions alleged herein and to pay prejudgment interest thereon;
IV.
Ordering defendants Langley Partners, L.P., North Olmsted Partners, L.P. and Quantico
Partners, L.P. and Jeffkey Thorp to pay civil monetary penalties pursuant to Section 20(d) of the
Securities Act [15 U.S.C. 5 77t(d)] and Section 21(d) of the Exchange Act [15 U.S.C. $
7 8 ( ~ ) 1 ; and
v.
Granting such other relief as this Court may deem just and proper.
Dated: March 14,2006 Respecthlly submitted,
Scott W. Friestad
Robert B. Kaplan
Daniel T. Chaudoin (Bar No. 458659)
Anthony S. Kelly
Julie M. Riewe (Bar No. 472470)
Attorneys for Plaintiff
Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C. 20549
(202) 551-4952 (Chaudoin)
(202) 772-923 1 (fax) (Chaudoin)
chaudoind@sec.gov
(Thanks to Truthseeker for this one.) |
