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Securities and Exchange Commission v. Berlacher

September 13, 2010


The opinion of the court was delivered by: Goldberg, J.


The Securities and Exchange Commission (hereinafter "SEC") commenced this civil action against Defendant Robert A. Berlacher and several investment funds he oversaw, claiming Defendants engaged in insider trading and securities fraud.*fn1 The essence of the SEC's claims is that Berlacher, after receiving non-public information regarding four (4) separate Private Investment in Public Equity offerings (hereinafter "PIPEs"), engaged in unlawful and deceptive trading.

A bench trial was held on March 9-11, 2010. After considering the evidence and written submissions, we conclude that the SEC has not sustained its burden of proof on the insider trading count and two of the fraud claims. We find, however, that the SEC has met its burden on two separate fraud claims. Our findings of fact and conclusions of law are set forth below.


A. General Background

1. Berlacher managed and oversaw several investment funds. These funds have also been named as Defendants and are: Lancaster Investment Partners, L.P.; Northwood Capital Partners, L.P.; Cabernet Partners, L.P.; Chardonnay Partners, L.P.; Insignia Partners, L.P.; VFT Special Ventures, Ltd.; LIP Advisors, LLC; and RAB Investment Company, LLC. (Stip. Facts, ¶ 1.)

2. Prior to the transactions at issue, Berlacher had participated in what is known as PIPE transactions. These transactions typically allow publicly traded companies that are seeking an immediate infusion of funds to raise capital privately. In exchange, investors receive restricted stock in the companies issuing the PIPEs at a discounted price. Typically, three to four months after a PIPE is issued, the SEC permits the registration statement for the PIPE to become effective. Once the registration statement becomes effective, the previously restricted PIPE shares lose their restricted status and can be publically traded. (Stip. Facts, ¶¶ 2-3.)

3. The general public is unaware of PIPE offerings during the negotiation period with investors until the transaction is closed and announced. (Stip. Facts, ¶ 3.) The public announcement of an issuer's PIPE offering can depress the price of the company's stock because the public company is issuing new shares of stock, which typically decreases the price per share due to dilution.(N.T. 3/11/10, pp. 10-11.)

4. As with any investor in a PIPE, Berlacher typically did not receive specific information such as the number of shares to be offered or price per share until the PIPE transaction was to close. (N.T. 3/10/10, p. 82.)

5. The four PIPE transactions at issue here involve the following companies: Radyne ComStream, Hollywood Media, International Display Works (hereinafter "IDWK"), and SmithMicro. The SEC further alleges that Defendants engaged in insider trading regarding only the Radyne PIPE. The SEC also alleges Defendants made material, fraudulent misrepresentations in all four transactions. (Stip. Facts, ¶¶ 4-5.)

6. During the relevant period (early 2004), Berlacher received calls from Brian Sognefest, a placement agent with Roth Capital Partners (hereinafter "Roth"), regarding the Radyne, Hollywood, and IDWK transactions. (Ex. 67, pp. 56-66.)

7. When those calls were placed, it was Roth's policy to advise potential PIPE investors they would be restricted from disclosing information about the PIPE or trading in the issuer's securities. (Ex. 67, pp. 54-56, 58.)

8. Regarding the Radyne and Hollywood transactions, Sognefest's testimony was unclear as to whether he read Roth's policy regarding PIPE transactions to Berlacher. Although somewhat equivocal as to exactly what he relayed to Berlacher regarding the Radyne and Hollywood transactions, Sognefest did advise Berlacher he was "restricted from trading in the stock or speaking about the deal." The SEC introduced an "over the wall" form signed by Sognefest, signifying that he had generally spoken to Berlacher about the restrictions associated with both PIPE transactions. (Exs. 2, 9, 12; Ex. 67, pp. 57-66.)

9. On the IDWK transaction, Sognefest did not speak to Berlacher regarding the PIPE transaction restrictions, nor is there any evidence such a conversation took place. (Ex. 67, pp. 59-60.)

10. During all of his discussions with Berlacher, Sognefest did not supply specific details regarding the number of shares to be offered, or the stock price for each respective PIPE transaction. (N.T. 3/11/10, pp. 40, 46-48; Ex. 67, pp. 39-40.)

11. In February of 2005, Berlacher received an email from Joseph Reda at CE Unterberg, a brokerage firm, about a SmithMicro PIPE. Aside from what is contained in the SmithMicro stock purchase agreement, there is no evidence Reda and Berlacher had a conversation or came to a meeting of the minds via some other form of communication, regarding the confidentiality of the SmithMirco PIPE. (N.T. 3/11/10, pp. 116-24; Ex. 13.)

12. After expressing interest in the PIPEs to the placement agent, but before signing the stock purchase agreements (hereinafter "SPAs") with these companies, Berlacher undertook certain trading, discussed in greater detail infra, on behalf of the Defendant entities. Berlacher traded through a company called CDC Securities, Inc. (hereinafter "CDC"), a broker/dealer with whom he contracted to establish barrier option positions. (N.T. 3/10/10, pp. 29-30; Exs. 82-84, 87-90, 93-94, 99, 104-16, 119-26.)

13. Berlacher referred to all of the transactions at issue, traded through CDC, as "barrier options" on a "basket" of securities, which he explained provided Defendants with an option regarding each underlying position reflected in the "basket." Pursuant to these options, Defendants had the contractual right (i.e., "the option") to have CDC deliver to them an actual long or short position in each security that was the underlying asset for the barrier option for a definite period of time in the future. (N.T. 3/10/10, pp. 30-31.)

14. Berlacher would typically initiate the "barrier option" transactions himself, either through CDC or another broker, based upon which broker he believed would provide the best price in executing the transaction. (N.T. 3/10/10, pp. 46-47; N.T. 3/11/10, p. 10.)

15. CDC required Berlacher to pledge that he would not undertake any trading in options while in possession of material, non-public information with respect to any issuer whose stock was the asset underlying the option. (Ex. 128, p. 10, ¶ 15(j).)

16. Berlacher used the means or instruments of interstate commerce, or of the mail, or of the facilities of the national securities exchange, in connection with the transactions at issue. (Stip. Facts, ¶ 6.)

17. The acts, practices, transactions at issue, and course of business, occurred within the Eastern District of Pennsylvania. (Stip. Facts, ¶ 7.)

B. The Radyne Transaction

18. Berlacher was contacted by Sognefest on January 28, 2004 regarding the Radyne PIPE. (Ex. 2.)

19. The Radyne PIPE transaction was not a "typical" PIPE wherein the issuing company actually issued new shares. Rather, the transaction involved the private sale of existing stock owned by the company's majority shareholder to other shareholders. Thus, the Radyne transaction did not dilute the equity interests of existing shareholders. (Stip. Facts, ¶¶ 9, 17-20; N.T. 3/10/10, p. 143.)

20. Berlacher entered into a special option agreement through CDC for Radyne stock on January 28, 2004, January 30, 2004, and February 2, 2004, which provided the right to receive a 114,000 share short position between $11.87 and $12.58 per share in Radyne during the period of the agreement. Thirteen minutes after Berlacher was contacted by Sognefest on January 28, 2004, Berlacher created his first short position in Radyne through his CDC basket. (N.T. 3/10/10, pp. 63-66; Exs. 25, 82-84, 87-90, 93-94, 97.)

21. On January 29, 2004, the following message appeared on a Yahoo! Finance message board regarding Radyne:

I just heard Roth Capital will begin a road show next week to try to sell 9.7 million shares of unregistered RAN shares. It sounds like the largest holder-Stetsys Pt. Ltd. Wants out. I agreed with the RADN lovers but I believe the easy short term money has been made--once these shares are placed (I heard $9-$10 is the range), and the shares become registered (usually 40-60 days), the float will increase from 4.6M to 14.3M . . . (Stip. Facts, ¶ 21.)

22. On February 12, 2004, Berlacher signed a SPA for the Radyne PIPE, agreeing to purchase 137,500 shares of Radyne at $9.25 per share. The Radyne SPA contains the representation that "Such Purchaser (including its affiliates that are entities) does not hold a short position, directly or indirectly, in any shares of the Company's common stock." (Ex. 1, ¶ 2.3(j) (emphasis added); Exs. 82-84, 87-90, 93-94.)

23. Despite the specific language contained in the SPA, Berlacher, through the Defendant entities, did in fact indirectly hold a short position in Radyne's common stock during the relevant time period. (Ex. 1, ¶ 2.3(j).)

24. The Radyne PIPE was publicly announced on February 17, 2004. (N.T. 3/10/10, p. 141.)

25. On April 7, 2004, the SEC declared the resale registration statement relating to the Radyne PIPE shares effective. That declaration permitted PIPE purchasers like Berlacher to sell those shares to the public. (Ex. 5.)

26. Dr. Prowse, Berlacher's expert witness, was accepted as an expert in statistical economic analysis and PIPE transactions. Prowse's background and experience includes a Ph.D. in economics from UCLA, as well as being a Chartered Financial Analyst, which requires a three year course in the valuation of financial securities. Prowse previously worked for the Federal Reserve Bank for ten years and is currently the Senior Managing Director of FTI Consulting. (N.T. 3/10/10, pp. 133-37.)

27. Prowse conducted an event study regarding the Radyne PIPE. Such a study is a generally accepted scientific method to determine whether certain stock price movement is due to the release of material information into the public domain. (N.T. 3/10/10, p. 139.) We accept and credit the following testimony offered by Prowse:

- Pertinent dates to analyze the movement of Radyne's stock price in relation to information released about the Radyne PIPE are: January 30, 2004, which is the day after the first Yahoo! posting occurred; February 9, 2004, when a second Yahoo! posting occurred; February 17, 2004, when the official press release regarding the PIPE was issued; and February 19, 2004, when Radyne's CEO had a conference call with market analysts about the PIPE. (N.T. 3/10/10, p. 141.);

- If material information released about a company is generally good news, then the stock price will increase. Conversely, if the material information is bad news, then the stock price will go down. If the stock price does not move in a significant manner, then the information released was not material. (N.T. 3/10/10, pp. 147-48.);

- "Noise" is the day-to-day market volatility of a stock. Material information can cause stock price movement which is distinguishable from "noise." (N.T. 3/10/10, pp. 152-53.);

- Radyne's "noise" over the course of a year is 5%, up or down, per week. (N.T. 3/10/10, pp. 154-55.);

- Historically, Radyne stock tends to react to material news on the immediate trading day or the day after. (N.T. 3/10/10, p. 155.);

- After accounting for market and industry movement, Radyne's movement was - 1.9% on January 30, 2004; - 6.25% on February 9, 2004; - 5.17% on February 17, 2004; and 4% on February 19, 2004. (N.T. 3/10/10, pp. 154, 160.); and

- The stock price movements on February 17, 2004, and February 18, 2004, were more akin to "noise" than material movements and were statistically indistinguishable from the normal volatility of Radyne's stock price movements. (N.T. 3/10/10, p. 159.)

28. Based on the above data and conclusions, Prowse concluded that the Radyne PIPE was not material ...

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