SEC scrutinizes PIPE deals, but is it enough?

A shadowy arena where cash-strapped public companies annually raise hundreds of millions of dollars from profit-hungry hedge funds was briefly illuminated this past week by a Securities and Exchange Commission lawsuit. But some who follow this world of so-called PIPEs (for private investment in public equities) say what's needed is a steady and intense spotlight.

The watchdog agency on Monday settled civil charges that a Chicago-area hedge fund had defrauded Seattle biotechnology company Targeted Genetics during a 2004 sale of shares to a group of private investors. The SEC alleged that the hedge fund violated an agreement not to engage in short selling of Targeted stock — a bet that the stock will go down — while that private share deal was pending. Crestview Capital Partners and its co-founder will pay a combined $514,640 in surrendered profits and civil penalties but did not admit any wrongdoing.

In a few other cases since 2005, the SEC has accused hedge-fund managers of insider trading, a more serious offense, for shorting stocks involved in PIPE transactions.

But industry watcher David Miller, president of Seattle-based Biotech Stock Research, says the SEC ought to be pursuing the manipulation in such deals much more vigorously because it's "very, very widespread."

"It's a safe and easy way to print money, as a hedge fund ... For all intents and purposes, it's almost impossible not to make money," he says.

The losers, Miller says, are companies that conduct PIPE deals, and their shareholders. For a company raising sorely needed capital, "the difference is almost always millions of dollars."

Here's how that can happen. Rather than go through the delay and expense of a secondary public offering, a company arranges for big investors, such as hedge funds, to buy a chunk of stock in a private transaction, usually at a discount of 5 to 20 percent from the current market price. Some hedge funds, Miller says, short the stock as soon as they learn a PIPE deal is in the works. That means they sell shares they have borrowed, planning to return the borrowed stock later with shares acquired at a cheaper price.

They benefit in two ways. First, shorting the shares tends to drive down the market price, so the fund will likely pay less per share in the PIPE deal. Second, once the company reveals it has issued a bunch of new shares at a discount, the market price nearly always drops further to match the discount — and the hedge fund can expect to profit on the short sale.

(Lawyers make distinctions between PIPE deals and registered direct offerings such as Targeted's deal — but anyone not billing $200 an hour for their time can ignore the difference.)

The SEC alleged Crestview shorted 255,000 Targeted shares beginning the day after it was contacted about investing in the PIPE deal. The case, filed in federal district court in Chicago, alleged it also shorted shares in a PIPE sale by Introgen Therapeutics of Austin, Texas.

A Crestview statement says shorting "was a common industry practice and had been approved by Crestview's attorneys at that time." It also notes that the SEC looked at more than 100 of the firm's PIPE deals and only sued over two. Its attorney adds that the deals took place before "heightened scrutiny and enforcement activity involving hedge funds" altered the "constantly evolving legal landscape."

Targeted CEO H. Stewart Parker issued a statement expressing "grave concern" about Crestview's activities, promising to "determine the appropriate course of action."

Conceivably, that could include suing PIPE investors who shorted the stock. But Miller, who owns Targeted shares, says the many companies that rely on PIPE deals may have little choice but to tolerate the practice. Suing would be a tricky and expensive task — especially for a company likely to return to the well for more money. Targeted did just that in January, with another private offering that raised $8 million.

The irony, Miller says, is that the manipulation in PIPE deals makes them all but risk-free for hedge funds, so fresh capital is available even to the companies least likely to succeed.

"If you wink-wink, nudge-nudge with this, all these guys are able to get money."

State is ready for latest economy

You don't hear so much talk about the "New Economy" these days — the term is a bit too redolent of Y2K, insta-millionaires and Pets.com. — nonetheless the lower-case "economy" all around us is relentlessly becoming more technology- and knowledge-driven, more globalized.

Now comes a report assessing how prepared states are for the brave new economy, and Washington places a solid fourth. That was also the state's ranking in the 1999 and 2002 reports.

The report was compiled by the Ewing Marion Kauffman Foundation and the Information Technology and Innovation Foundation. It measured 26 separate indicators in five broad categories: knowledge-based jobs, globalization, entrepreneurialism, innovation and the prevalence of digital technology.

Overall, the Evergreen State ranked behind Massachusetts, New Jersey and Maryland.

Although Washington placed first in just one indicator (value of exports per manufacturing and service worker), it ranked high in most others as well. The state was below the U.S. average in just four indicators: employment in high-wage traded services, foreign direct investment, value of IPOs and industry investment in research and development.

Washington's high ranking was not just due to Boeing and Microsoft, the report said, "but also because of the entrepreneurial hotbed of activity that has developed in the Puget Sound region and the very strong use of digital technologies by all sectors."

Among other Northwest states, Oregon placed 17th and Idaho was 24th. West Virginia and Mississippi held down the bottom spots.

— Drew DeSilver

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Rami Grunbaum: rgrunbaum@seattletimes.com