Securities regulators are turning up the pressure on Dallas-based HBK Investments in an ongoing investigation of abusive trading by hedge funds in the market for private placements. The Securities and Exchange Commission is looking into a series of short sales made by the $7 billion hedge fund in the days before HBK invested in a $58 million private sale of stock by a company called Plug Power ( PLUG), say people familiar with the inquiry. In the November 2003 deal, HBK was one of eight hedge funds that paid cash to acquire millions of shares of the Latham, N.Y., fuel-cell maker at a 14% discount to the then-market price of $5.79 a share. The Plug Power transaction is the second private placement involving HBK that securities regulators are looking into. TheStreet.com
previously reported that the SEC is reviewing another 2003 transaction in which PFSWeb ( PFSW), a Plano, Texas, outsourcing firm, raised $3.5 million from investors, including HBK. HBK, a multistrategy money manager with offices around the world, is one of the largest hedge funds to draw scrutiny in the two-year-old investigation into manipulative trading in the $20 billion-a-year market for PIPEs, or private investments in public equity. Founded in 1991 by former Merrill Lynch ( MER) managing director Harlan B. Korenvaes, the fund employs more than 250 people and is perennially one of the biggest investors in private stock placements by public firms. In a typical PIPE deal, a small, cash-strapped company raises cash by selling discounted stock, or a bond that converts into discounted shares, to a group of hedge funds. Shares of a company doing a PIPE usually decline in anticipation of a flood of discounted stock coming into the market. Regulators are looking into allegations of improper short selling by hedge funds in advance of a PIPE being publicly announced. A short sale is a market bet that a stock will fall in price.
To date, the PIPEs investigations has resulted in $22 million in fines against two hedge funds: Langley Partners and Knight Capital's ( NITE) Deephaven Capital Management. More fines are anticipated in coming months. TheStreet.com
previously reported that at least three other hedge funds, Alexandra Investment Management, Cornell Capital Partners and Gryphon Partners, are being investigated by regulators. But HBK is by far the largest and best-known hedge fund to surface as a potential SEC target in the inquiry. Jon Mosle, HBK's general counsel, declined to comment for this article, noting that the hedge fund has a policy of not talking to the media. The hedge fund has hired lawyers with Kirkpatrick & Lockhart Nicholson Graham, a large Boston-based law firm, to plead its case with the SEC. A Plug Power spokeswoman declined to comment on the investigation, referring all inquiries to regulators. The SEC also declined to comment. People familiar with the Plug Power inquiry say regulators do not suspect any wrongdoing on the part of the company. These sources say at least one other hedge fund investor in the November 2003 deal also is under scrutiny. The Plug Power deal, technically, is not a PIPE. It was structured as part of a so-called shelf offering, a transaction in which a company registers with the SEC to sell shares from time to time in privately negotiated sales. But a shelf offering is similar to a PIPE, in that the terms of the transaction, including the number and price of the shares sold, aren't made public until after the deal is closed. Regulators contend that once a potential investor hears about a PIPE or shelf offering, he shouldn't short the issuer's shares until after the deal has been sold. In the course of the investigation, the SEC has charged hedge funds with engaging in illegal insider trading by trying to profit from knowledge that a company is about to sell shares at a discount.
SEC's perspective, if there was a term sheet and people were trading ahead of the term sheet, then the fact that it is a publicly registered deal is irrelevant,'' says Robert Mazzeo, a partner with Mazzeo Song, which represents hedge funds, many of which invest in PIPEs. "That's material nonpublic information.'' The SEC also has fined hedge funds for using the discounted shares purchased in a private placement to close out, or cover, an existing short position. The regulators argue that an investor who can cover an existing short position with discounted shares gets an unfair advantage over other traders who must buy those shares in the open market. In an ordinary short sale, a bearish investor borrows stock from a broker, sells it and hopes to replace it with shares purchased later in the market at a lower price. The short-seller then pockets the difference. The trading in shares of Plug Power around the time of the shelf offering does raise eyebrows. In the deal, which was managed by Citigroup ( C) and Stephens Inc., the company sold 11.7 million shares at a price of $5 each to HBK and the other hedge funds. The day before the deal was announced on Nov. 11, 2003, shares of Plug Power closed at $5.79. But by the close of trading on Nov. 11, the stock had fallen 13% to $5.04. More than 6 million shares were traded on Nov. 11, a ninefold increase in volume compared with the prior day. Meanwhile, in the weeks leading up to the deal's announcement, shares of Plug Power were steadily falling. For most of October, the stock traded around $6.50 a share. On Oct. 15, it closed as high as $7.06 a share. Investment firms typically will begin shopping a shelf offering, or a PIPE, to prospective investors at least a month or two before the deal is publicly announced. In the wake of the PIPEs investigation, most investment firms now require hedge funds to sign documents saying they will not make any trades in a company's stock before a deal is announced. But those documents were not in wide use in 2003.