These SEC proceedings arise out of violations of Rule 105 of Regulation M of the Exchange Act by Carlson Capital (CCLP), a registered investment adviser and manager of hedge funds based in Dallas, TX.  The firm paid over $2.6 million in disgorgement, penalties and prejudgment interest.  

Rule 105 prohibits buying an equity security made available through a public offering from an underwriter or broker or dealer participating in the offering after having sold short the same security during a restricted period (generally defined as five business days before the pricing of the offering).

The rule provides an exception for the purchase of an offered security in an account that is “separate” from the account through which the same security was sold short.

CCLP makes investment decisions through various strategies, each with dedicated portfolio managers. On 4 occasions in 2008, CCLP bought offered shares in a public offering after having sold short the same security during the restricted period.  In 3 of these instances, the same CCLP portfolio manager or analyst who directed the short sales also directed the purchase of the offered shares. In the 4th instance, a CCLP portfolio manager from one firm strategy directed the purchase of offered shares after a portfolio manager from another strategy sold short the same security during the restricted period.  These trades do not qualify for the separate accounts exception under Rule 105.  All told, CCLP made unlawful profits or avoided losses to 'the tune of more than $2.25 million'.  For further details, click onto:  [ SEC '34Act Release 62982, 9/23 ]  

    Violative Transactions.   The investment personnel at CCLP who directed the firm’s participation in the below offerings either misunderstood or were unaware of Rule 105’s requirements during the relevant time period.  CCLP’s compliance manual didn't address Rule 105, and the firm conducted no formal firm-wide training addressing Rule 105 during this period.  To comply with Rule 105, CCLP relied on the efforts of one firm trader to coordinate the review of the firm’s prior short sales (“Rule 105 reviews”) before it participated in offerings.  Subsequently, during the SEC investigation, CCLP conducted firm-wide training addressing Rule 105, amended its compliance manual to include the rule, and implemented an automated system to facilitate Rule 105 reviews.

• On 4/30 and 5/1/2008, a total of 100,000 shares of Equitable Corporation was sold short;  the firm portfolio manager who sold short these shares then directed the purchase of 100,000 shares of EQT in a follow-on offering that was announced on 5/5 and priced on 5/6.  By purchasing the offered shares despite having shorted the stock during the restricted period, CCLP improperly obtained a discount from the stock’s market price and avoided losses of $31,600.

• On 6/10-11/2008, 202,500 shares of Rockwood Holdings were sold short.  After the close on 6/11, ROC announced the overnight sale of shares of stock by existing ROC shareholders in an underwritten offering.  The same CCLP analyst who had sold short the ROC shares directed the firm to buy offered shares from the underwriter - and on 6/12 the firm confirmed an allocation from the underwriter of 150,000 shares.  The difference between CCLP’s proceeds from the first 150,000 shares it sold short and the price for the offered shares was $500,200.

• On 9/18-19/2008, over 500,000 shares of Capital One Corp. were sold short.  The portfolio manager responsible for most of these short sales then directed the purchase of 325,000 shares of COF in a follow-on offering that was announced on 9/23, and priced after the close on 9/24.  By purchasing the offered shares despite having shorted the stock during the restricted period, CCLP improperly obtained a discount from the stock’s market price and avoided losses of $665,503.

• CCLP’s Relative Value strategy fund bought 600,000 shares of Wells Fargo in a follow-on offering that was announced on 11/5/2008 and priced after the close of trading on 11/6.  Meanwhile, CCLP's Risk Arbitrage strategy fund had, one month earlier, established a short position in WFC as a hedge to its purchases of the stock of Wachovia Bank, relating to the banks’ intended merger.  After receiving an IM that the Relative Value Fund would be participating in the offering, the Risk Arbitrage Fund manager decided on 11/6 to sell short 398,225 shares of WFC - at prices that exceeded the offering price - and bought additional Wachovia shares at a total dollar value roughly equivalent to the WFC shares it sold short that day.   At the time, the Risk Arbitrage portfolio manager was unfamiliar with Rule 105.  The Relative Value portfolio manager was familiar with Rule 105, but it was not her practice to check the firm’s prior short sales outside of her own portfolio before participating in an offering.   

In the 4th scenario, although the CCLP strategy that participated in the WFC offering was different than the strategy that sold short during the restricted period, the 2 strategies are not “separate accounts” under Rule 105. Because the above-described WFC transactions do not qualify for the separate accounts exception set forth in Rule 105(b)(2), CCLP’s purchase of the offered WFC shares after having made restricted period short sales violated the rule.  In its adopting release, the SEC stated that in order for the separate accounts exception to apply, “there can be no communication of securities positions, investment decisions or other trading matters between accounts.”

First, even assuming CCLP’s Risk Arbitrage and Relative Value strategies may be considered “accounts,” they were not “separate” under Rule 105(b)(2) and the guidance set forth in the adopting release.  (i) info about securities positions and investment decisions was available to all firm employees and sometimes communicated between strategies;  (ii) All portfolio managers received or could access detailed reports of each others’ positions and trades on a daily basis;  (iii) They routinely consulted with each other about companies in which they had overlapping positions or interest.  (iv) CCLP’s Investment Committee had members from each of the strategies who discussed some the firm’s more important positions at its weekly meetings.

Second, CCLP’s CIO supervised the strategies and had ultimate authority over the firm’s positions - an active managerial role, regularly reviewing these positions and consulting with subordinate portfolio managers.  Moreover, he maintained authority to require any portfolio manager to seek his pre-approval for trades if he so desired.  In short, the Chief Investment Officer exercised oversight over the firm’s multiple strategies and did not refrain from influencing trading decisions within the strategies.