Hedge Fund Shells Out in Shorting Probe

A New York hedge fund manager will pay $16 million to settle allegations arising out of a two-year-old investigation into manipulative trading in the market for private placements by small-cap companies.

The penalty agreed to by Jeffrey Thorp is the largest settlement assessed to date by the Securities and Exchange Commission in the investigation into trading abuses in the $18 billion-a-year market for PIPEs, or private investment in public equity.

The PIPEs investigation is focusing on allegations of abusive short-selling by hedge funds trying to take advantage of the usual decline in shares of companies that sell these deals.

A short-sale is a market bet that a stock will decline in price.

Securities regulators, in a civil complaint filed in federal court as part of the settlement, charged Thorp with carrying out an illegal short-selling scheme involving 23 separate PIPE deals from 2000 to 2002. Regulators allege Thorp profited by engaging in "naked shorting,'' a manipulative practice that enables traders to defy the laws of supply and demand by shorting even when no shares are available to borrow.

In all, the SEC contends, Thorp generated $7 million in illicit profits from his illegal shorting scheme. As part of the settlement, Thorp agreed to forfeit those profits, plus $1.8 million interest. Thorp and his Langley Partners hedge fund agreed to pay $8 million in civil penalties.

The unlawful trading by Thorp, who could not be reached for comment, took place in PIPE deals by a number of well-known biotech firms: AVI BioPharma(AVII), MGI Pharma(MOGN) and Generex Biotechnology(GNBT). Other PIPEs that regulators allege Thorp manipulated were ones by HealthExtras(HLEX) and TiVo(TIVO).

"This case is an example of our ongoing effort to stamp out fraud and abuses by investors in the PIPEs market, and it will continue,'' says Scott Friestad, associate director in the SEC's enforcement division.