Don’t poke the hornet’s nest
21 January 2014
The SEC has not been kind to those found violating its Rule 105. Law firm Herrick Feinstein warns firms about the danger of non-compliance
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Enforcement aimed at preventing price manipulation has kicked up a notch in recent months, and one law firm is attempting to shed light on the consequences of ignoring the US Securities and Exchange Commission.
A publication by Irwin Latner and Patrick Sweeney of law firm Herrick Feinstein LLP, pointed to the recent charging of Charles Langston III as evidence that the SEC was ramping up its actions against those who violated Rule 105 of Regulation M, which condemns price manipulation in advance of stock offerings.
In December 2013, the SEC brought a complaint against Charles Raymond Langston III, charging him with insider trading and illegal short selling.
The SEC alleged that Langston conducted insider trading in advance of a public announcement that significantly decreased the price of AutoChina International Ltd’s stock.
Langston, the complaint read, received material, non-public information concerning a registered follow-on offering of AutoChina’s stock and then used that information to sell short 29,000 shares of AutoChina in advance of the company’s public announcement on 24 March 2010 that it had completed the offering.
He made more than $193,108 in trading profits based upon the material, non-public information.
Langston is a resident of Miami Beach, Florida, who actively traded securities through numerous accounts owned by CRL Management and Guarantee Reinsurance at several broker-dealers. He managed to settle with the SEC by way of paying a fine, neither admitting nor denying the charges.
Latner and Sweeney gave an overview of regulation M, Rule 105 in their article, which states that it broadly prohibits the purchase of securities in follow-on and secondary offerings when the purchaser has taken a short position in the securities within a specified restricted period, typically five business days before the pricing of the offering.
“Rule 105 is a strict liability rule, and the SEC need not demonstrate manipulative intent or scienter (intent of wrongdoing) on the part of the purchaser to prove a violation,” said the authors in their article.
To comply with the rule, traders who have sold short shares of a security that are the subject of an offering during the restricted period must refrain from purchasing in the offering, unless one of the limited exceptions to the rule applies.
The article added that there had been a recent surge in SEC enforcement actions. In September 2013, the SEC charged more than twenty firms with violations of Rule 105, signalling a “renewed focus on enforcement”, said the authors. The firms, including private equity firms, hedge funds, and registered broker-dealers, were alleged to have participated in firm commitment offerings after selling short securities that were the subject of the offerings.
A mismatched punishment
However, Latner and Sweeney seemed dubious at the severity of the commission, saying that there had been little regard to the magnitude of the violation or remedial efforts undertaken by firms following inadvertent violations.
The lawyers quoted a recent case, whereby a money management firm was given a $65,000 penalty, even though the firm took just $4,091 in profits as a result of the violation, took prompt remedial action, and fully cooperated with the SEC.
Another firm was required to disgorge profits of nearly $600,000 and pay a civil penalty of roughly $215,000 despite relying on the advice of outside counsel during its participation in the offering that was the subject of the violation, said the authors.
“Indeed, a National Exam Program Risk Alert recently issued by the SEC’s National Examination Program and Office of Compliance Inspections and Examinations stresses that ‘[a]fter-the-fact remediation [does] not absolve a firm or individual from the violation of Rule 105’.”
Best practices
Given the rather extreme severity of non-compliance with Rule 105, added to the fact that the SEC has historically not been kind to those who violate the rule (even if they have taken remedial action), Latner and Sweeney stressed any asset management firm or private fund which participates in public offerings—whether or not the firm is registered with the SEC—should review its compliance policies to ensure ongoing compliance with Rule 105.
“Firms should develop policies and procedures to ensure that adequate means exist for trading personnel to confirm that no short positions were added during the restricted period prior to participating in an offering. In addition to ensuring adequate policies are in place, thorough training of employees regarding the application of Rule 105 should be the benchmark of any firm’s compliance programme.”
“Earlier SEC orders have noted that violations are apt to occur where personnel either misunderstand or are unaware of the rule, and compliance manuals or other firm policies fail to address the rule.”
A publication by Irwin Latner and Patrick Sweeney of law firm Herrick Feinstein LLP, pointed to the recent charging of Charles Langston III as evidence that the SEC was ramping up its actions against those who violated Rule 105 of Regulation M, which condemns price manipulation in advance of stock offerings.
In December 2013, the SEC brought a complaint against Charles Raymond Langston III, charging him with insider trading and illegal short selling.
The SEC alleged that Langston conducted insider trading in advance of a public announcement that significantly decreased the price of AutoChina International Ltd’s stock.
Langston, the complaint read, received material, non-public information concerning a registered follow-on offering of AutoChina’s stock and then used that information to sell short 29,000 shares of AutoChina in advance of the company’s public announcement on 24 March 2010 that it had completed the offering.
He made more than $193,108 in trading profits based upon the material, non-public information.
Langston is a resident of Miami Beach, Florida, who actively traded securities through numerous accounts owned by CRL Management and Guarantee Reinsurance at several broker-dealers. He managed to settle with the SEC by way of paying a fine, neither admitting nor denying the charges.
Latner and Sweeney gave an overview of regulation M, Rule 105 in their article, which states that it broadly prohibits the purchase of securities in follow-on and secondary offerings when the purchaser has taken a short position in the securities within a specified restricted period, typically five business days before the pricing of the offering.
“Rule 105 is a strict liability rule, and the SEC need not demonstrate manipulative intent or scienter (intent of wrongdoing) on the part of the purchaser to prove a violation,” said the authors in their article.
To comply with the rule, traders who have sold short shares of a security that are the subject of an offering during the restricted period must refrain from purchasing in the offering, unless one of the limited exceptions to the rule applies.
The article added that there had been a recent surge in SEC enforcement actions. In September 2013, the SEC charged more than twenty firms with violations of Rule 105, signalling a “renewed focus on enforcement”, said the authors. The firms, including private equity firms, hedge funds, and registered broker-dealers, were alleged to have participated in firm commitment offerings after selling short securities that were the subject of the offerings.
A mismatched punishment
However, Latner and Sweeney seemed dubious at the severity of the commission, saying that there had been little regard to the magnitude of the violation or remedial efforts undertaken by firms following inadvertent violations.
The lawyers quoted a recent case, whereby a money management firm was given a $65,000 penalty, even though the firm took just $4,091 in profits as a result of the violation, took prompt remedial action, and fully cooperated with the SEC.
Another firm was required to disgorge profits of nearly $600,000 and pay a civil penalty of roughly $215,000 despite relying on the advice of outside counsel during its participation in the offering that was the subject of the violation, said the authors.
“Indeed, a National Exam Program Risk Alert recently issued by the SEC’s National Examination Program and Office of Compliance Inspections and Examinations stresses that ‘[a]fter-the-fact remediation [does] not absolve a firm or individual from the violation of Rule 105’.”
Best practices
Given the rather extreme severity of non-compliance with Rule 105, added to the fact that the SEC has historically not been kind to those who violate the rule (even if they have taken remedial action), Latner and Sweeney stressed any asset management firm or private fund which participates in public offerings—whether or not the firm is registered with the SEC—should review its compliance policies to ensure ongoing compliance with Rule 105.
“Firms should develop policies and procedures to ensure that adequate means exist for trading personnel to confirm that no short positions were added during the restricted period prior to participating in an offering. In addition to ensuring adequate policies are in place, thorough training of employees regarding the application of Rule 105 should be the benchmark of any firm’s compliance programme.”
“Earlier SEC orders have noted that violations are apt to occur where personnel either misunderstand or are unaware of the rule, and compliance manuals or other firm policies fail to address the rule.”
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