SEC Slaps Biotech Hedge Fund for Short-Selling Violations

One of the easiest ways for hedge funds to make money is to short the stock of a company seeking to raise money through an equity financing. The hedge fund then buys shares in the company's offering -- at a lower price -- and covers its short for a quick profit.

Easy money, but also against the rules. The Security and Exchange Commission's Rule 105 prohibits investment firms or individuals from shorting a stock within five business days of participating in an offering for that same stock. According to the SEC, "such dual activity typically results in illicit profits for the firms or individuals while reducing the offering proceeds for a company by artificially depressing the market price shortly before the company prices the stock."

On Tuesday, the SEC nabbed 19 investment firms for violating Rule 105. Among the offenders was RA Capital, a Boston-based healthcare hedge fund with more than $1 billion under management.

On 17 occasions between June 2009 and July 2013, RA Capital bought shares in drug and biotech company financings after having sold short shares of the same company when it was supposed to be restricted from doing so, the SEC said

Collectively, the violations of Rule 105 during this time period resulted in RA Capital profits of more than $2.6 million. The SEC has ordered RA to give back those profits, plus interest of $73,000 and a penalty of $904,000.

From the SEC's order against RA Capital, here's how the hedge fund violated Rule 105 when Keryx Pharmaceuticals (KERX) raised money in an offering in January 2013:

On January 28, 2013, RA Capital sold short 100,000 shares of Keryx Biopharmaceuticals Inc. ("KERX") during the restricted period at a price of $5.00 per share. On January 30, 2013, RA Capital sold short 36,450 shares of KERX during the restricted period at a price of $9.34 per share. On January 30, 2013, KERX announced the pricing of a follow-on offering of its common stock at $8.49 per share. RA Capital received an allocation of 300,000 shares in that offering. The difference between RA Capital's proceeds received from the restricted period short sales of KERX shares and the price for the 300,000 shares received in the offering was $30,967.88. Respondent also improperly obtained a benefit of $207,940.95 by purchasing the remaining 263,550 shares at a discount from KERX's market price. Thus, RA Capital's participation in the KERX offering netted total profits of $238,908.83.


Among the other stocks identified in the SEC's order against RA Capital: Sangamo Biosciences ( SGMO) , Cell Therapeutics ( CTIC) , Insmed ( INSM) , Immunogen ( IMGN) , Mela Sciences ( MELA) and Exact Sciences ( EXAS) .


Adam Feuerstein writes regularly for TheStreet. In keeping with company editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet. He also doesn't invest in hedge funds or other private investment partnerships. Feuerstein appreciates your feedback; click here to send him an email.

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