SEC Could Be Broadening PIPEs Probe

An asset-management company receives a Wells notice in connection with alleged fraudulent reporting of private investments in public equities.

Deephaven Capital Management LLC, a hedge-fund specialist, is the latest company to be dragged into a federal probe of the market for private investments in public equities (PIPEs).

Deephaven — the asset-management subsidiary of Knight Capital Group Inc. — and a former Deephaven employee have received Wells notices from the Securities and Exchange Commission’s Division of Enforcement, according to a regulatory filing by Knight. The issuance of the notice means that the SEC staff is thinking about recommending a lawsuit against Deephaven for alleged fraudulent trading of PIPEs from June 1, 1999, through March 2004.

PIPEs, which constitute a market of about $14 billion per year, are used mostly by small companies in need of cash, according to the TheStreet.com. More than a year ago, the SEC issued subpoenas and requests for documents to 20 brokerages that have arranged PIPE deals, according to the Web site.

Further, about 10 hedge funds received subpoenas seeking information about their trading activity in certain PIPE transactions, the Web site added. Hedge funds have been big investors in PIPEs, in which private investors buy securities directly from a publicly traded company in a private-placement transaction, usually at a discount from the market price of the common stock. One trading strategy is to sell the common stock short.

In a letter to investors, Deephaven chief executive officer and chief investment officer Colin Smith emphasized that the company’s PIPEs activities represented an “insignificant portion” of the assets held by the Deephaven Market Neutral Master Fund LP. The fund reportedly discontinued PIPE investments by August 2004.

Noting that Deephaven is cooperating fully with the SEC probe, Smith wrote, “We believe the Wells notice we received is a result of an industrywide review that began last summer related to PIPE transactions.”

Knight is apparently the second company to become a publicly revealed target of the SEC’s PIPE probe. Two months ago Friedman, Billings, Ramsey Group Inc. (FBR) offered to pay $7.5 million to the SEC and the National Association of Securities Dealers (NASD) to settle insider trading and other charges related to the company’s trading in a company account and the offering of a PIPE on behalf of CompuDyne Inc. in October 2001. So far, neither regulatory body has responded to the settlement offer. In the same month, Emanuel Friedman retired as co-chairman and co-CEO of FBR.

FBR also announced then that Friedman, as well as head trader Scott Dreyer and chief compliance officer Nicholas Nichols — both of whom also retired — were in discussions with the SEC and NASD regarding the CompuDyne offering. TheStreet.com reported that after resigning, Friedman learned that he could be charged with “aiding and abetting” insider trading. It said the SEC and the NASD served Friedman with a Wells notice, citing a recently updated copy of his brokerage registration statement.

In another recent PIPE-related investigation last month, hedge fund manager Hilary Shane agreed to pay about $1.45 million to the SEC and NASD to settle insider-trading and registration violations involving the short selling of CompuDyne securities before the public announcement of a PIPE offering and before the effective date of the resale registration statement for the PIPE shares.

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