Touradji Capital is the latest hedge fund to run afoul of a rule prohibiting short selling of stock during a restricted period prior to a public offering and then purchasing the same securities in the offering.
The hedge fund founded by Tiger Cub and commodities specialist Paul Touradji on Friday agreed to pay about $1.3 million to settle the charges. According to the Securities and Exchange Commission, Touradji Capital made nearly $834,000 as a result of its violations of Rule 105. It did note the violations were made by two former employees of Touradji Capital who left the firm in late 2008.
In its complaint, the SEC noted that Touradji Capital “did not have policies, procedures and controls in place sufficient to prevent or detect Rule 105 violations,” the SEC stated in its complaint. The rule bars investors from selling short shares of stock of company within five trading days of a public offering of shares from the same company. Before the rule was changed in 2007, you could short the stock but couldn’t use the shares from the underwriting to cover the short.
According to the SEC, on October 31, 2007, Touradji sold short 3,472 shares of McMoran Exploration at $12.18 per share. The following day, McMoran announced a follow-on offering of 16.25 million shares at $12.40 a pop. Touradji received 3,227 shares in the offering. The SEC did stress that because the offering price was higher than the price at which it sold short during the restricted period and the market price on the day of the follow-on offering, Touradji did not make money as a result of this violation.
However, it did make money in two other cases. For example, on March 25, 2008, Touradji sold short 277,800 shares of Chesapeake Energy for between $46.2674 and $46.4147. Two days later, Chesapeake announced a follow-on offering of 20 million shares at $45.75 per share. Touradji Capital received 400,000 shares in that offering.
The regulator notes that the difference between Touradji Capital’s proceeds from the restricted period short sales of Chesapeake Energy shares and the price for 277,800 shares purchased in the offering was $171,423. The SEC also said Touradji improperly made $19,809 by purchasing the remaining 122,200 offering shares at a discount from Chesapeake Energy’s market price.
In a second instance on July 11, 2008, Touradji sold short 47,900 shares of GMX Resources at $81.7903 per share. On July 17, 2008, GMX priced two million shares at $70.50 per share. Touradji Capital received 100,000 shares in the offering. The difference between Touradji Capital’s proceeds from the restricted period short sales of GMX shares and the price for 47,900 GMX shares purchased in the offering was $540,805. Touradji Capital also improperly received a benefit of $101,939 by purchasing the remaining 52,100 offering shares at a discount from GMX’s market price, according to the SEC.
A Touradji spokesman would not comment.
Touradji, which runs $1.5 billion, is the sixth company this year to be charged by the SEC for violating the rule. The other firms are Level Global, Bain Capital’s Brookside Capital, Aristeia, Horseman Capital and Fontana Capital. Level Global agreed to pay more than $3.2 million in disgorgement, prejudgment interest and a civil penalty, while Brookside Capital agreed to pay more than $2 million to settle the charges. The other firms paid between $1.2 million and $1.3 million.
According to law firm Schulte Roth & Zabel, another nine firms were sued by the SEC for similar violations last year, including Carlson Capital, L.P., which agreed to pay more than $2.6 million to settle SEC charges, and David Tepper’s Appaloosa Management L.P., which agreed to pay $1.3 million. Five other firms were accused of violations in 2009.
The SEC believes the rule prevents short selling that can reduce proceeds received by companies and shareholders by artificially depressing the market price shortly before the company prices its public offering.
However, the rule has become very controversial. Critics complain that the SEC is going after firms even when there is no intent to manipulate the market, since it needn’t show that such intent existed. In fact, the rule doesn’t even require the same person to have sold short the stock and bought it in the offering. For example, when Carlson was accused of violating Rule 105 the portfolio manager who sold short the stock and the portfolio manager who bought the offering shares were different. “Investment advisers must recognize that combined trading by different portfolio managers can still constitute a clear violation of Rule 105 when short selling takes place during a restricted period,” said Antonia Chion, Associate Director of the SEC’s Division of Enforcement, in a press release at the time. “This is true even when the portfolio managers have different investment approaches and generally make their own trading decisions.”
Marc E. Elovitz, a partner in Schulte Roth & Zabel, says firms sometimes get blind-sided because companies these days frequently bring follow-on offerings to market abruptly, without advance notice or a road show. “The SEC can go after an unwary market participant who has not crossed every ‘t’ and dotted every ‘i,’” he adds, “since secondaries happen overnight.” In these cases, he insists, there is no evidence of market manipulation.
In its complaint against Toradji Capital, the SEC pointed out that after the firm learned of its Rule 105 violations, it developed and implemented policies, procedures and controls to prevent or detect future violations, and that the commission took these remedial efforts into account when agreeing to the settlement’s terms.
