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SEC Loses Insider Trading Case Relating to PIPE Offering of CompuDyne Shares
U.S. Securities & Exchange Commission v. Mangan, et al.
No. 3:06-cv-00531, U.S. District Court for the Western District of North Carolina, 08/20/2008
Holding
The U.S. Securities and Exchange Commission ("SEC") lost an insider trading suit against a former hedge fund salesman, John F. Mangan, Jr., in the U.S. District Court for the Western District of North Carolina. The SEC had accused Mangan of directing short sales of stock of CompuDyne Corp.("CDCY") under the expectation that Private Investment in Public Equity ("PIPE") transactions of CDCY stocks would hedge those sales. PIPE transactions are private sales of unregistered stock in public companies. Mangan at that time was employed by a broker-dealer (Friedman, Billings, Ramsey, “FBR”) assigned to be the financial advisor of CDCY’s PIPE sales, and learned of the PIPE prior to the company’s public announcement of the transaction. The SEC asserted that the short sale of CDCY by Mangan prior to the public announcement was made in an effort to fraudulently take advantage of his knowledge of the PIPE. Contrary however to the SEC’s allegation that the information concerning the PIPE was materially negative, the district court found that the market did not devalue CDCY stock price after the trade at issue. Given that the materiality of the information about the PIPE was to be determined as of the time of the trade, there was no materially negative movement in CDCY’s share price between the time of trade and the close of the market on the date the CDCY shares were traded. And because the SEC failed to otherwise raise a genuine issue of fact as to materiality, the district court therefore ruled that summary judgment in favor of defendant Mangan was appropriate.
Detailed Summary
This lawsuit arose out of a short sale of stock in CDCY made by defendant Mangan. Order, p. 1. By way of background, a “short sale” refers to the sale of a security not owned by the seller. Id. It is a technique typically used by an investor to take advantage of an anticipated decline in the price of a stock. The short position is then covered by shares purchased at the lower price. Id.
In 2001, CDCY was a company in the public safety and security business. In the months prior to September 11, 2001, CDCY stock traded at around $8-$9 per share, with daily volume not exceeding 18,400 shares. Between September 17, 2001 (the day the stock market reopened after the terrorist attacks of September 11) and October 8, 2001, CDCY common stock experienced extremely volatile trading at prices ranging from $9.33 to $19.55, in daily volume ranging from 71, 500 shares to 749,400 shares.
After September 11, 2001 CDCY engaged FBR, an SEC registered broker-dealer, to act as a financial advisor and underwriter to assist it in raising capital through a private investment in public equity, otherwise known as a “PIPE.” Id., p. 2.
A PIPE is a private placement to selected accredited investors (usually to selected institutional accredited investors) wherein investors enter into a purchase agreement committing them to purchase a specified number of shares at a specified price, with the closing conditioned upon, among other things, the SEC’s preparedness to declare effective a resale registration statement covering the resale from time to time of the shares sold in the private placement. Id.
Mangan at that time was employed by FBR as a registered representative, and learned of the PIPE prior to the company’s public announcement of the transaction on October 9, 2001. FBR informed its employees that information about the PIPE was confidential and directed those employees to take measures to maintain that confidentiality while soliciting and obtaining accredited investors to invest in CDCY through the PIPE.
The SEC alleged that the October 9th short sale of CDCY by Mangan prior to the public announcement was made in an effort to fraudulently take advantage of his knowledge of the PIPE. By short selling the 25,000 shares of CDCY and ultimately covering the short sale with the discounted shares purchased in the PIPE offering, Mangan received at least $54,000 in profits. Id., p. 3.
The SEC asserted that such alleged conduct violated 17(a) of the Securities Act of 1933 (“Securities Act”), 15 U.S.C. 77q(a), 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. 240.10b-5. Id., pp. 3-4. The SEC brought this action pursuant to §§ 20(b) and 20(d) of the Securities Act, 15 U.S.C. §§ 77t(b), t(d), and §§ 21(d) and 21A of the Exchange Act, 15 U.S.C. §§ 78u(d), 78u-1, and sought civil penalties, disgorgement, and injunctive relief. Id., p.4.
An important issue in this case was the point at which the materiality of the nonpublic information, the CDCY PIPE offering, must be determined. In Radiation Dynamics, Inc. v. Goldmuntz, 464 F.2d 876 (2d Cir. 1972), the Second Circuit approved an instruction to the jury that materiality of inside information “is to be determined as [of] the time when the parties to the transaction are committed to one another.” Id., p. 5, citing Goldmuntz at 891.
Here, the time at which Mangan was “committed” to the transaction at issue, that is, the short sale of CDCY stock prior to the public announcement of the PIPE, was the time at which the trade was fully executed on October 9, 2001, at 9:54 a.m. Thus, the SEC must show that the information concerning the PIPE was material at this time. Id., pp. 5-6.
According to the district court, the stock price movement of CDCY stock from the time of Mangan’s trade until the closing of the market on October 9th, when the experts agreed that the information about the PIPE was fully impounded into the price, was evidence that reasonable investors did not devalue the stock following Mangan’s trade. Id., p. 9.
The trade at issue occurred at 9:54 a..m. at a price of $14.16 per share. Following the trade, the price rose to $14.50 immediately before the public announcement of the PIPE. The market then has a small positive reaction to the release of the PIPE information at 11:45 a.m. Id. By 12:02 p.m., eighteen minutes after the announcement, the price had actually risen to $15.20 per share. By 3:30 p.m., the price was at $14.51, still higher than the announcement and the trade prices. CDCY closed at $14.25 that day, nine cents above the price at which Mangan traded and a mere twenty-five cents less than the price immediately before the announcement. Contrary to the SEC’s allegation that the information concerning the PIPE was materially negative, the market did not devalue CDCY stock after the trade at issue. Id.
Given that the materiality of the information about the PIPE was to determined as of the time of the trade, it was undisputed that there was no materially negative movement in CDCY’s price between the time of trade and the close of the market on October 9th. Id., p. 10.
Moreover, the SEC’s other evidence of materiality failed to raise a genuine issue of fact. Because the efficient market of reasonable investors did not devalue CDCY after the trade at issue and because the SEC failed to otherwise raise a genuine issue of fact as to materiality, summary judgment in favor of defendant Mangan was appropriate. Id. And because the district court had determined that the information about the PIPE was immaterial as a matter of law, it did not see the need to address the issue of scienter. Id.
On the basis of the foregoing, the district court granted defendant Mangan’s motion for summary judgement, and ordered the dismissal of the case.
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