The SEC filed two settled administrative proceedings based on selling short in advance of an offering. While the cases themselves are routine, read in conjunction with others, they may confirm that enforcement has adopted a different approach on this issue. In the Matter of First New York Securities LLC, Adm. Proc. File No. 3-13656 (Filed Oct. 20, 2009); In the Matter of Perceptive Advisors LLC, Adm. Proc. File No. 3-13657 (Filed Oct. 20, 2009).

Each case revolves around an alleged violation of Rule 105 of Regulation M, “Short Selling in Connection with a Public Offering.” That regulation provides, in part, that it is unlawful to cover a short sale with securities acquired from an offering for cash made pursuant to a Securities Act registration statement if the short sale occurs during the five business days before the pricing of the offering and ending with its pricing.

New York Securities is alleged to have violated the Regulation in two instances, once in September 2005 and a second time in January 2007. Overall, the firm made profits of just under $40,000. Perceptive Advisors is alleged to have violated the Regulation in five instances during 2005, yielding profits of about $245,000.

Both firms settled. Each consented to the entry of a cease and desist order from committing or causing any violations and future violations of Rule 105 of Regulation M. In addition, First New York agreed to pay disgorgement of just over $39,000, prejudgment interest of about $9,400 and a civil penalty of $20,000. Perceptive Advisors agreed to pay disgorgement of about $245,000, prejudgment interest of about $68,800 and a civil penalty of $125,000. In both instances, the Commission stated that it considered the remedial acts and cooperation of the Respondent.

These cases appear to represent the final evolution of the SEC’s position on selling short prior to an offering. Previously, the Commission brought a series of cases focused on PIPE offerings and hedge funds. In those cases, typically the fund which learned about the offering had some sort of agreement to keep the information confidential. Before the announcement of the offering, the Fund then sold short and later covered that position with the shares from the offering. Since the PIPE could be expected to dilute the value of the outstanding shares, the short could be closed at an advantageous price.

In the PIPE cases, the fund and its operators were typically charged with violations of Exchange Act Section 10(b) and Securities Act Section 5. Most settled. See, e.g., SEC v. Friedman, Billings, Ramsey & Co. Civil Action No. 06-cv-02160 (D.D.C. Jan 4, 2007), discussed here.

In those which were litigated however, the SEC lost the Section 5 claim. See, e.g. SEC v. Mangan, Civil Action No. 06-cv-531 (W.D.N.C. April 25, 2006), discussed here. In some cases, such as Mangan it also lost the fraud claim. In others, the fraud claim settled. See, e.g., SEC v. Lyon, Civil Action No. 06 CV 14338 (S.D.N.Y. Filed Dec. 12, 2006).

Following those losses, the Commission appeared to have dropped the Section 5 claim but persisted with the Section 10(b) insider trading allegation. See SEC v. Ladin, Civil Action No. 1:08-CV-01784 (D.D.C. Filed Oct. 20, 2008), discussed here.

The two administrative proceedings filed today, read against the backdrop of the PIPE cases, appear to represent the current evolution of this type of case. To be sure, these cases do not contain the confidentiality agreements alleged in Mangan and similar cases. Cuban, discussed here, had such an agreement. The Commission’s appeal of its loss there clearly demonstrates the agency will continue to pursue that type of claim. At the same time, the two administrative proceeding brought today may confirm what Ladin suggested. In the future, the Section 5 claim will be omitted in some cases while in others a Rule 105 charge will be used when appropriate.