The SEC looks to shatter PIPE dreams

by by Shanon D. Murray in Washington
March 15, 2003

The agency fears the financing instruments are becoming tools of stock market manipulators.

As if the Securities and Exchange Commission wasn't busy enough, the agency has added one more item to its plate -  cleaning up abuses in PIPEs.

A PIPE, or private investment in public equity, is an infusion of capital into a company made either as a private placement, convertible debenture or structured equity line. Companies that need later-stage capital as an alternative to a secondary stock offering generally seek it.

In 2001, The Deal first focused on how PIPEs could subject companies to stock manipulation. Based on that reporting, an unnamed market professional submitted a 300-page report to the SEC, other agencies and a congressional subcommittee, alleging the use of PIPEs in money laundering and tax evasion schemes.

"We're aware of various schemes, abuses and potential problems related to PIPEs ," one SEC official says. "We are looking at all corners of the market."

A recent case involving Rhino Advisors Inc. and Sedona Corp. has come to exemplify the dark side of PIPEs.

Rhino and its president, Thomas Badian, agreed in February to pay $1 million to settle an SEC complaint that Rhino improperly manipulated Sedona shares.

New York-based Rhino manages money for two overseas clients, including Amro International SA, a Monaco- and Panama-based investment fund. The SEC alleged that Rhino and Badian manipulated Sedona's stock price to enhance Amro's economic interest through a $3 million PIPE convertible debenture.

Sedona, a King of Prussia, Pa.-based maker of customer relationship management software, suspended payment on its convertible debentures pending its request for a probe into the trading of its stock. "That investigation is continuing," the SEC official says. "We will continue to bring cases in this area as long as we find evidence of violations."

The SEC is particularly concerned with the mechanics of PIPEs, including disclosure, whether parties are complying with deal terms and how shares are trading, the official explains.

Certain types of PIPEs, such as equity lines and so-called floorless convertibles (debentures where no minimum share price is set for conversion) have been criticized for allegations that they are associated with short-selling that sends the issuing company into a "death spiral."

"I have no doubt that Rhino is not alone in that type of transaction," says Rob Deutschman, president of Cappello Partners LLC, a boutique investment bank based in Santa Monica, Calif. "There are also certain hedge funds that are very adept at exploiting that part of the market. Regulators are keyed into looking for those type of elements."

To that end, regulators have paid more attention to various "hot buttons" in PIPE deals, observers say. Any deal with a re-set provision that lacks a floor is said to be a red flag. Regulators are also concerned about PIPE deals involving advisers who aren't registered broker-dealers.

Some transgressions are clearly unlawful. A company can't issue more than 20% of its outstanding shares at a discount without prior shareholder approval. Some PIPEs flout this rule.

Increased regulator attention to PIPEs, combined with tough market conditions and more hesitant corporate leadership, have caused such financings to flag, observers say. There have been 123 PIPE deals totaling $11 billion in the U.S. so far this year, according to Over the course of the year, that would be close to 500 such financings, far less than the 969 PIPEs done for $36.3 billion in 2001 and the 1,232 deals that raised $80.1 billion in 2001.

"There's a natural aversion on the part of issuers to get involved in any equity-based transactions right now," Deutschman says. "There are also some misconceptions about what a PIPE is. Some structures are very complex and raise various levels of concern."

PIPEs do come in all shapes and sizes, including traditional PIPEs (those not structured as 144-A convertible placements or Reg S placements); and structured PIPEs, which include floating convertibles, reset convertibles, common stock with resets and structured equity lines.

"There are plenty of ways for a company to structure a PIPE with the same bells and whistles, but which would short-circuit a death spiral," Deutschman says.

Precisely. Which is why a busy SEC is taking on the task now.

ęCopyright The Deal, LLC. All Rights Reserved.