The SEC prevailed on two of five remaining claims against Robert Berlacher and several investment funds he managed following a three day bench trial. The court ordered Mr. Berlacher to pay disgorgement on a net basis on the two claims, but declined to enter an injunction or order the payment of prejudgment interest or a penalty as requested by the Commission. SEC v. Berlacher, Civil Action No. 07-3800 (E.D. Pa. Filed Sept. 13, 2007). See also Litig. Rel. 21648 (Sept. 14, 2010).

The Commission’s complaint claimed that over a five year period Mr. Berlacher and hedge funds for whom he traded implemented an unlawful trading scheme which yielded $1.7 million in ill-gotten gains by investing in PIPE offerings without market risk. The SEC claimed that the defendants: 1) violated Securities Act Section 5 by selling short an issuer’s stock after learning about a PIPE and later covering that position with shares acquired in the offering; 2) engaged in manipulative trading including wash sales and matched orders to conceal the true nature of the transactions; 3) made materially false representations in connection with the offerings; and 4) engaged in insider trading with respect to one offering.

The trial centered on Mr. Berlacher’s trading in connection with four PIPE offerings. The Commission claimed the defendants engaged in insider trading with respect to a PIPE offering by Radyne ComStream. In connection with that offering and three others, he breached oral confidentiality agreements and made misrepresentations in executing the stock purchase agreements, according to the SEC. The district court, which had previously dismissed the Section 5 claim, rejected the claimed breaches of the pre-offering oral agreements, but found the defendants liable for having made two false statements based the execution of the stock purchase agreements.

First, the court rejected the SEC’s claim that Mr. Berlacher engaged in insider trading with respect to the Radyne offering. This was not a typical PIPE transaction because it involved the private sale of existing stock owned by other shareholders. The Commission established at trial that an agent for the issuer called Mr. Berlacher with information that there would be a PIPE transaction. Subsequently, Mr. Berlacher signed a stock purchase agreement in which he represented that he did not have a short position in the shares of the company. In fact he held such a position through the defendant hedge funds. An upcoming PIPE offering is by definition nonpublic, the court noted. Mr. Berlacher misappropriated that information when he traded.

However, the court found that the information was not material. To determine if the information is material under the circumstances here, a post hoc test can be used. Stated differently, the court can look back and see what impact, if any, it had on the share price where there is an efficient market. Using this test, the court accepted the testimony of a defense expert who, based on an event study, concluded that the minor share price changes were consistent with “noise” in the market and failed to demonstrate materiality. The court rejected the testimony of the SEC’s expert who opined that the information was material. That opinion was essentially based on the expert’s general experience – he failed to perform an event study.

Second, the court rejected the SEC’s claims that, with respect to each offering, the defendants breached an oral confidentiality agreement with the agent of the issuer when first being informed of the pending offering. In most respects, the testimony on these conversations was vague. There was little supporting documentation. And, the agent never explained that Mr. Berlacher was restricted from trading in derivatives such as options. In rejecting the claims however the court noted “we suspect that Berlacher understood the trading restrictions … [but] suspicion is not, however, sufficient proof …”

The court did, however, find that Mr. Berlacher made misrepresentations with respect to two of the four offerings in executing the stock purchase agreements. With respect to the Radyne PIPE, Mr. Berlacher executed a stock purchase agreement representing that he did not have a short position. At the time, he controlled 114,000 share short options in Radyne. This is a clear misrepresentation. Similarly, in executing the share purchase agreement for the IDWK PIPE, Mr. Berlacher represented he had not engaged in any transactions in the shares of the company. In fact, he held a 15,000 share long position. Again this is a false misrepresentation. The court rejected the SEC’s claim of a false statement regarding the Holywood PIPE where Mr. Berlacher held a long position in the company shares, but only represented he did not have a short position. Likewise, the court found Mr. Berlacher did not make a misrepresentation in executing the share purchase agreement for the SmithMicro PIPE, since the SEC did not offer any proof that he had engaged in any transactions in the shares of the company.

Finally, the Court rejected most of the SEC’s requested remedies. The court found it unnecessary to enter an injunction in view of the significant disgorgement ordered and Mr. Berlacher’s testimony that he had ceased any trading and would continue to abstain in the future. The court did order the payment of $381,101.50 in disgorgement, but permitted Mr. Berlacher to offset that amount by the premiums paid to create and hold his option positions. In view of the amount of disgorgement, the court also rejected the Commission’s demand for prejudgment interest and a penalty.

Berlacher is one of a series of cases brought by the Commission based on trading in advance of a PIPE offering. Generally, as in this case, the Commission did not prevail on its Section 5 claims. The results on the insider trading and fraud claims are mixed as discussed here. Perhaps the most high profile PIPE offering case is the Cuban insider trading action which is pending appeal following the dismissal of the Commission’s complaint (here).

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