SG Cowen

is paying about $1 million to settle a lawsuit involving allegations the New York investment bank manipulated shares of


( HLEX) prior to a private sale of the company's stock to a group of hedge funds.

The settlement, disclosed last week by HealthExtras in a regulatory filing, stems from a $12 million private investment in public equity transaction that Cowen arranged for the health benefits provider in the autumn of 2001. Such transactions, which are known on Wall Street by the acronym PIPEs, have recently drawn scrutiny from regulators who believe they often disadvantage existing investors and can be abused through short-selling strategies.

In the weeks prior to the SG Cowen PIPE, shares of HealthExtras plunged 36%, wiping out $90 million in market capitalization. The company blamed much of that decline on a secret shorting strategy by Cowen, which sought to score a quick profit from an anticipated decline in HealthExtras shares when the deal was sold.

Lawyers for Cowen and HealthExtras declined to discuss the specifics of the settlement, citing a confidentiality agreement. But in a regulatory filing, HealthExtras says it expects the payment to result in an after-tax gain of about $1 million in the second quarter. The sum is slightly more than the $766,000 placement and retention fee Cowen earned for arranging the transaction.

Resolution of the lawsuit is the latest chapter in an unfolding story about the shadowy, $14 billion-a-year PIPEs market.

previously reported that the

Securities and Exchange Commission

sent subpoenas and requests for documents to 20 brokerages that are major players in arranging PIPE deals for cash-strapped companies and finding hedge funds to invest in them.

The potential for danger in such financing has long been known. Indeed, before retaining Cowen to arrange the transaction, HealthExtras claims it told the investment bank it was wary of doing a PIPE deal because of the inherent risk that "PIPE investors, or others who learn of a PIPE offering, will improperly hedge or sell short the company's stock prior to the closing of the transaction."

Cowen, part of the French banking concern Societe Generale, is a perennial leader in arranging PIPE deals for fledgling health care and technology companies. This year, Cowen has raised $241 million in 10 deals, putting it in fifth place among placement agents, according to, a PIPEs market research firm.

Other top PIPE arrangers include the securities arm of

Bank of America

(BAC) - Get Report


Roth Capital Partners


Rodman & Renshaw


Sunrise Securities

, according to PlacementTracker. There's no evidence the SEC has sought information from any of those firms, and officials at each of them either declined to comment or did not return telephone calls.

PIPEs are popular with hedge funds, because the buyers can get preferred stock or bonds that convert into shares at a discount to market prices. The deals often include sweeteners, such as warrants, that permit the private investors to buy additional shares at prices well below what ordinary investors would pay and then quickly resell them. The deals are put together quickly and usually don't undergo the SEC scrutiny to which most initial public offerings and bond deals are subject.

The losers are often long-term shareholders, who see their ownership stakes reduced by the conversion of bonds or preferred stock into common shares. Moreover, hedge funds that invest in PIPEs often have an incentive to short the company's stock, since the discounted shares they receive make it less costly to close out any open short positions they have on the company's stock.

Sources familiar with the SEC investigation say regulators are looking for situations in which a hedge fund that is simply considering investing in a PIPE deal misuses non-public information and places short bets on the stock.

Regulators also are said to be taking a close look at PIPE deals that contain covenants that prohibit investors from excessively shorting a company's stock. The SEC believes some hedge funds are violating these provisions by using either shell partnerships or other entities to place bets on shares falling.

This year, there have been 52 PIPEs with anti-shorting provisions, or roughly 10% of the 547 deals brought to market, according to Some of the companies issuing PIPEs with anti-shorting provisions include online medical information provider



; integrated circuits manufacturer


( TGAL); and experimental cancer drug manufacturer

Vion Pharmaceuticals

( VION).

But despite these anti-shorting safeguards, the litigation between Cowen and HealthExtras demonstrates just how susceptible PIPEs are to abuse and why regulators are paying close attention to them.

In the lawsuit, which was filed in New York federal court, HealthExtras charged that Cowen officials knew that Guillaume Pollet, a managing director at the investment bank, was improperly shorting the insurer's shares. Cowen denied the allegation, but it fired Guillaume Pollet in December 2001 for violating firm policy following an internal investigation. The investment bank maintains that Pollet misled Cowen management about his trading activities.

The health care concern alleges that Pollet was placing those short bets on behalf of Cowen, which itself purchased a large block of stock in the PIPE deal along with a half-dozen hedge funds. Over a 24-day period, the company said, Pollet and Cowen were "a net seller of 432,416 shares of HealthExtras stock" before the PIPE was finalized.

HealthExtras contends that Pollet and Cowen shorted the shares even though the investment bank said it had "polices and procedures" that would prevent significant shorting of the company's stock in advance of the offering. Cowen executives assured HealthExtras management they also would monitor trading in the company's stock for any unusual activity.

HealthExtras decided to go ahead with the transaction on the basis of Cowen's assurances that it would take steps to limit any shorting of the company's stock.