For the second time in two years, a slew of hedge funds and other investment firms have been fined by the Securities and Exchange Commission for running afoul of a rule related to short-selling.
However, this time none of the hedge fund firms was among the very largest — a possible indication that well-heeled firms with extensive legal and compliance departments that can devote the needed time to monitor this sort of activity are heeding the SEC’s warnings.
The SEC on Tuesday said that 19 firms and one individual trader were charged with violating Rule 105 of Regulation M, which prohibits investors from selling short shares of stock within five days of a public offering of the shares — generally a secondary offering — and then purchasing the same securities in the offering. The regulator made a similar crackdown last year, citing a number of large firms for violating Rule 105, including D.E. Shaw & Co., Appaloosa Management, Carlson Capital and Bain Capital’s Brookside Capital. (The SEC also cited now-defunct Level Global Investors, whose co-founder Anthony Chiasson was sentenced to six and a half years in prison stemming from his role in the government’s insider trading probe, and Philip Falcone’s Harbinger Capital Partners. Last year, Falcone and Harbinger agreed to pay more than $18 million, admit wrongdoing and be barred from the securities industry for at least five years as part of a settlement with the SEC over enforcement actions in June 2012.)
At the time, the SEC also warned the investment community that it planned to continue looking for these kinds of violations, stressing in its announcement that “The benchmark of an effective enforcement program is zero tolerance for any securities law violations, including violations that do not require manipulative intent.” The regulator also said its National Examination Program, the agency’s division responsible for conducting regular examinations of the firms it oversees, issued a risk alert to firms regarding noncompliance with Rule 105.
The fines and gains that the firms cited in Tuesday’s announcement agreed to relinquish are sizable for those firms. For example, New York–based Advent Capital Management, which manages $8.3 billion in hedge funds and other products, agreed to disgorge more than $75,000 and pay a $65,000 penalty as well as a small amount of prejudgment interest. Advent was accused of violating the rule on two different occasions.
Another of the biggest firms to settle charges was Minneapolis-based Whitebox Advisors, which manages $8.4 billion in hedge funds as well as mutual funds. It agreed to disgorge nearly $789,000 and pay prejudgment interest of more than $48,000 and a penalty of $365,592.83 stemming from five different trades. New York–based Solus Alternative Asset Management, which manages $4.4 billion, agreed to pay disgorgement of $39,600 and a penalty of $65,000 stemming from one trade involving the shares of J.C. Penney Co. in September 2013.
The crackdown on Rule 105 violations sort of resembles last week’s announcement by the SEC that it charged 28 officers, directors or major shareholders for failing to make required securities filings about their holdings and transactions on a timely basis. In making that announcement, the SEC in effect said that even though the violations are not of the seriousness or magnitude of many of its insider trading, Ponzi scheme or fraud cases, they are still being taken very seriously.
“The reporting requirements in the federal securities laws are not mere suggestions, they are legal obligations that must be obeyed,” Andrew Calamari, director of the SEC’s New York Regional Office, warned at the time of the announcement. “Those who fail to do so run the risk of facing an SEC enforcement action.”
In fact, in the reporting cases announced last week and the short-selling violation cases announced Tuesday, the fines amounted to the low six figures or less and involved relatively smaller hedge fund firms. But they still should serve as a strong warning to many of the smaller firms.
As the principal of one of the smallish firms cited in the past week by the SEC told me, this is a lot of money for managers that need appreciation of their own capital, and not just fee income, to survive.
