Securities regulators allege a former hedge fund manager generated up to $1.1 million in profits from unlawful trading in shares sold by a Maryland security company in a private placement.

The NASD charged Hilary Shane, a former hedge fund manager at First New York Securities, with employing a "scheme or artifice to defraud," in a civil complaint filed on Dec. 21, 2004.

Regulators contend Shane profited from a series of short trades she made using inside information about a $12 million private stock sale by Compudyne ( CDCY) in October 2001. The complaint alleges Shane improperly bet against shares of Compudyne in advance of the stock sale both for her own account and the hedge fund she formerly managed, First New York's FNY Millennium Partners fund. (The hedge fund is not affiliated with Israel Englander's better-known Millennium Partners.)

The charges against Shane, which are still pending before an NASD disciplinary panel, are the first to be filed against a hedge fund manager in the investigation into manipulative trading in the market for private investments in public equity, known on Wall Street by the acronym PIPEs. A copy of the complaint against Shane, which the NASD has not sought to publicize, was obtained by

Last spring, the Securities and Exchange Commission issued subpoenas and requests for documents to 20 brokerages that have arranged PIPE deals for cash-strapped companies. Regulators subsequently issued subpoenas to about 10 hedge funds. The SEC is working in tandem with a parallel inquiry by the NASD.

This is not the first time the Compudyne PIPE deal has attracted regulatory scrutiny.

In November, Friedman Billings Ramsey ( FBR), the Virginia-based investment firm that served as the placement agent for the stock sale, disclosed that the SEC and NASD both are investigating the firm's activities in the transaction. Sources say the regulators are looking into allegations of improper trading in Compudyne shares by Friedman Billings' proprietary hedge funds.

A spokeswoman for Friedman Billings declined to comment. The NASD also refused to comment on the investigation.

Shane, who left First New York in 2002, recently won a $4.2 million arbitration award from her former employer in a compensation-related dispute. Reached by phone at her New York City home, Shane, who has a doctorate in finance from the Wharton School, said she "can't comment on anything."

An attorney for First New York, which is not charged in the NASD complaint, declined to comment. Compudyne, which is not accused of any wrongdoing, has repeatedly declined to comment on the matter.

The investigation into the $14 billion PIPEs market is focusing on allegations of stock manipulation by hedge funds, which tend to be the biggest investors in these shadowy stock sales, and allegations of wrongdoing by the Wall Street firms that find buyers for the deals. 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.

Regulators are looking for evidence that a select group of investors took unfair advantage of the usual decline in a company's share price after a stock placement is announced. The regulators are concerned that some hedge funds might have found out prematurely that a company is considering a PIPE deal. With that inside information, a hedge fund can then set up a short position on stock, betting that a flood of discounted shares will drive down the price.

Indeed, that's the scenario depicted in the complaint against Shane. The NASD alleges that a Friedman Billings broker approached the hedge fund manager in September 2001 to see if she would be interested in investing in the PIPE. The broker told Shane that he could only discuss the Compudyne deal with her if she agreed to keep the information confidential.

Shane, according to the NASD, agreed to the broker's terms. She also agreed to purchase the shares as an "investment" and not immediately sell them.

But the day after Shane learned of the impending Compudyne stock sale, the NASD alleges, she began to sell the stock short, both for her own account and the hedge fund she managed. The complaint says in the days before the PIPE closed, Shane's trading profit from shorting Compudyne shares totaled $56,000.

In a short sale, a trader borrows shares and sells them, hoping to pocket a profit later by repaying the lender with cheaper shares.

Ultimately, Shane purchased a total of 475,000 shares in the PIPE, of which 237,000 were for her own account, at $12 apiece. The combined 475,000-share purchase was one of the largest blocks of stock sold to an investor in the PIPE, which closed on Oct. 9, 2001.

Again, the NASD contends, Shane began shorting Compudyne shares as soon as she bought a stake in the PIPE, but before the deal was announced to the public. By the time the deal got the SEC's approval on Oct. 29, 2001, Shane's combined short position in the stock totaled 455,000 shares. The prices at which she shorted the stock ranged from as low as $12.41 a share to $17 a share.

Shane's main alleged profit from the scheme came from using the shares she purchased in the PIPE to cover the short positions. The NASD says she made approximately $315,216 from covering short positions she opened just hours before the PIPE deal was announced. She made another $764,818 from short positions she opened in the three weeks leading up to Oct. 29, the day the SEC formally signed off on the stock sale, regulators allege.

On Oct. 8, 2001, the day before the PIPE was disclosed, Compudyne's shares closed at $17.38. On Oct. 29, 2001, the day the NASD says Shane covered all of her open short positions with the stock obtained in the PIPE, the stock closed at $13.90.

"Shane falsely represented that she and Millennium were buying (Compudyne) for investment purposes and had no present intention of distributing the share," the NASD said in the complaint.

Regulators also contend she made the trades while "in possession of material, non-public information ... that the new shares would soon become available for sale to the public at a cost to purchases of $12 per share, considerably below the market price."

In the action, the NASD is seeking sanctions against Shane, including the disgorgement of the trading profits.

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