Wednesday, April 26, 2006
The SEC filed civil insider trading charges against hedge fund manager Nelson Obus, Peter Black, an analyst at the hedge fund firm, and Thomas Strickland, who formerly worked at GE Capital. The inside information concerned the acquisition in 2001 of SunSource, Inc. by Allied Capital Corp. in a deal financed by GE Capital. According to the SEC complaint (here), Black and Strickland are close friends, and on May 24, 2001, Strickland allegedly told Black about the upcoming transaction, who in turn told Obus, who then called SunSource's CEO to discuss the transaction. According to the complaint, "Obus told the CEO that a 'little birdie' at Capital had told him that SunSource management was planning to sell the company to a financial buyer." The complaint goes on to note that "Black was present when Obus spoke with Sunsource's CEO. When Black heard what Obus told the CEO, he jumped out of his chair and began waving his arms because he was concerned that his friend Strickland would get into trouble. When Obus finished his conversation with Sunsource's CEO, Black told Obus of his concern, and Obus responded that, if GE Capital fired Strickland, Obus would offer Strickland a job or find him a job elsewhere on Wall Street."
To this point, the SEC case describes a fairly mundane insider trading case. The issue in the case will be whether the defendants traded on the inside information, because they did not purchase any shares until June 8, when Obus bought 287,000 shares and apportioned them to three hedge funds his firm manages. When the deal was announced on June 19, SunSource's stock increased by over 90%, and the funds had a profit of over $1.3 million. The tricky part of the case is the following allegation in the complaint: "Following Strickland's May 24,2001, conversation with Black, Strickland continued to work on, and thus receive nonpublic information about, the progress of the proposed transaction between SunSource and Allied. On June 4,2001, Black called Strickland, and they had a four-minute conversation. That conversation provided Black with the opportunity to receive an update on the progress of the transaction and to update Obus." The italicized language does not say that Strickland actually provided additional information to Black and Obus, only that it could have happened. While the complaint has many details about the interactions of the defendants, like the arm waving, it is curiously vague on whether Strickland provided additional information to Black and Obus that can show the transaction was based on material nonpublic information.
Obus and his firm, Wynnefield Capital, have vigorously denied the SEC's allegation. A press release (here) issued in response to the Commission complaint states:
We will detail our factual and legal case in our court filings, but you should know that the allegations are baseless and unsupported by the documentary or testimonial evidence. Our attorneys have advised us that the lawsuit lacks merit. We intend to contest this vigorously in the courts. Specifically, the facts are these:
- We acted ethically and legally;
- We followed and researched the stock for more than 10 years - and repeatedly invested in it for more than five years;
- We did not engage in insider trading;
- Our actions were consistent with our long-standing strategy to build positions in small-cap value investments;
- Our actions were consistent with the protection and enhancement of value for the company's shareholders; and
- Our actions were intended to provide continued excellent results for our funds' investors.
The press release notes that the trading took place nearly five years ago, and they cooperated in the investigation. Obus claims that he and his firm thought the matter had been been dropped, an assumption that should never be made with a government agency.
It is a fair question why the case took so long to come to fruition. None of the three defendants settled the matter, so it does not appear that the Enforcement Division would have received information from a cooperating witness at a late date to propelled the case forward. It may be that, due to staff turnover or other extraneous factors, the investigation became inactive for a period of time and only recently got restarted. Regardless of the reason for the delay, the defendants show no inclination to settle at this point, and given the pace of civil litigation, the trial may not begin until seven or eight years have elapsed since the trading. (ph)