Thursday, March 1, 2007

Lawyer Charged in PIPE Securities Fraud

Former McGuireWoods LLP partner Louis W. Zehil was charged with securities fraud in a criminal complaint filed in the Southern District of New York, and the SEC filed civil securities fraud charges.  Zehil is accused of defrauding corporate clients by taking shares from so-called "private investment in public equity" (PIPE) transactions, which are used by small companies (and those with substantial financing problems) to raise money by selling securities at below-market prices.  As part of the deal, the securities issued are restricted, with a legend placed on them that prohibits sales to the public for a period of time.  According to the charges, Zehil acquired the shares through two front companies, Chestnut Capital Partners and Strong Branch Investors, without informing his clients about these transactions.  A press release issued by the U.S. Attorney's Office (here) describes how the shares were acquired:

ZEHIL, as counsel for the issuers in the Charged Transactions, sent opinion letters to the issuers’ stock transfer agents directing that all of the issued shares should bear restrictive legends except the shares issued to ZEHIL’s nominees,Strong and Chestnut. ZEHIL’s letters falsely claimed that the shares issued to Strong and Chestnut satisfied legal criteria permitting them to be issued without a restrictive legend. As a result, ZEHIL was able to receive shares without restrictive legends and, almost immediately thereafter, he sold them in the public market. In all cases, he did this before the issuers had filed registration statements with the SEC. By obtaining stock free of the restrictive legends, ZEHIL was able to sell these shares immediately in the public market at a profit in advance of the other PIPE investors. The Complaint alleges that ZEHIL reaped over $10 million in profit through these illicit sales.

The SEC Litigation Release (here) estimates the loss to the corporate clients at over $17 million, while prosecutors peg it at $10 million -- either way, this is a substantial fraud.  Because the transactions were related to Zehil's legal representation, I suspect McGuireWoods and its malpractice carrier are figuring out how much they are on the hook for to the clients.  Unfortunately for the firm, malpractice policies usually exclude criminal conduct from coverage, so there may be a fight in the offing about who bears the loss from the conduct of the former partner. (ph)

Fraud, Prosecutions, Securities | Permalink

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