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NASD Brings Action against Former Hedger

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NEW YORK (–The NASD has brought a formal disciplinary action against Hilary Shane, a former hedge fund manager, for unlawful insider trading.

The complaint, signed by Cameron K. Funkhouser, the NASD’s senior vice president, department of market regulation, asks the NASD disciplinary panel to order Ms. Shane to disgorge all profits realized from the trades in question, as well as the costs of the proceedings.

Ms. Shane could not be reached for comment.

This dispute arose out of a private placement in the public equity (PIPE) of Compudyne Corp., in October 2001. Compudyne sells security-related products and services to jails, prisons, courthouses and other government buildings.

On Sept. 28, 2001, a representative of Compudyne’s placement agent informed Ms. Shane of the anticipated PIPE in a telephone conversation. That representative asked for, and received, her assurance that his communications were confidential. On the same date, the agent, Friedman Billings Ramsey & Co. Inc., Arlington, Va., sent a copy of the purchase agreement and the private placement memorandum to Ms. Shane by courier. Also beginning that date, after the telephone conversation, Ms. Shane began to sell CDCY short on two accounts of her own and in the accounts of two hedge funds whose trading she controlled. By the end of trading on Oct. 1, her total short position for the four accounts was 17,200 shares, according to the complaint. A spokeswoman for FBR said that firm wouldn’t comment on the complaint or the underlying transaction.

A short position on a stock just before a large PIPE is a safe bet on supply/demand equilibrium grounds.

On Oct. 2, Ms. Shane attended a road show conducted by Compudyne’s chief executive and chief financial officers, at the offices of her employer, First New York Securities LLC. At that road show, Compudyne reiterated that the private placement was confidential. Later that day and the following day, Ms. Shane increased her total short position in the four accounts to approximately 88,100 shares.

She covered these short positions by purchases on Oct. 4 and 5. The profits from her trading in CDCY between Sept. 28 and Oct. 5 were approximately US$56,151.

On Oct. 8, Ms. Shane agreed to purchase 237,000 shares of CDCY on an account of her own and another 238,000 shares for one of the hedge funds she managed, FNY Millennium Partners LP.

“Had FBR or Compudyne learned that [Ms.] Shane had already sold CDCY short or intended to sell short in the immediate future, [Ms] Shane likely would not have been allowed to arrange to purchase 475,000 shares of CDCY,” the complaint states. Its reference to the “immediate future” refers to the following morning, beginning at 8:22 am. The terms of the PIPE transaction became public at 11:44 am that day. During the period before that announcement, she amassed a new total short position of approximately 122,900 shares.

It alleges that this and other behavior amounted to a scheme to defraud. Furthermore, the regulation department maintains that Ms. Shane caused her firm, FNY, to “fail to make and annotate an affirmative determination that shares were available for settlement in each of hundreds of transactions.”

In December 2004, an NASD arbitration panel found that FNY owed Ms. Shane US$4.2 million for her membership interest in that firm, which she left in 2002.

The regulation department filed this complaint Dec. 21, 2004.

Although a spokesman at the Securities and Exchange Commission declined any comment on the existence of a parallel SEC investigation into the Compudyne PIPE specifically, he did acknowledge that the SEC is reviewing the extent to which hedge funds and other qualified investors trade on non-public information about PIPES in general.

“We’re concerned about instances in which hedge funds executed profitable short sales in an issuer’s underlying equity after learning about a pending PIPE transaction from a placement agent prior to any public announcement of the PIPE transaction, ” said spokesman John Nester.

Contact Bob Keane with questions or comments at: [email protected].


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