In September, we wrote about the SEC’s enforcement actions against 23 investment firms for violations of Rule 105 of Regulation M (“Rule 105”) in an effort to crack down on the potential manipulation of offering prices of follow-on and secondary offerings. In the last two months, the SEC has furthered Co-Director of Enforcement Andrew Ceresney’s promise to send a “clear message that firms must pay the price for violations.”

On Dec. 3, the SEC filed a complaint against Charles Raymond Langston III for insider trading. In addition to the insider trading violations, from which Langston made more than $193,108 in profits based upon the receipt of material, nonpublic information, the commission also charged Langston and two companies he owned and used to actively trade securities (“Defendants”) with three violations of Rule 105.

To prevent short-selling in connection with a public offering, 17 C.F.R. § 242.105(a)(1) provides:

In connection with an offering of equity securities for cash pursuant to a registration statement … filed under the Securities Act … it shall be unlawful for any person to sell short the security that is the subject of the offering and purchase the offered securities from an underwriter or broker or dealer participating in the offering if such short sale was effected during the period (“Rule 105 restricted period”) that is the shorter of the period:

(1) Beginning five business days before the pricing of the offered securities and ending with such pricing; or (2) Beginning with the initial filing of such registration statement … and ending with the pricing.

The SEC alleges that between November 2008 and March 2009, the Defendants engaged in three transactions where they sold short securities that were the subject of the offerings during the Rule 105 restricted period and purchased the offered securities from an underwriter, broker or dealer participating in the offering. The SEC seeks declaratory relief to find that the Defendants committed the violations of federal securities laws, a permanent injunction enjoining the Defendants from violating Rule 105, disgorgement of all profits or losses avoided as a result of the Rule 105 violations, and a civil money penalty pursuant to both the Exchange and the Securities Act. Glenn Gordon, associate director for enforcement in the SEC’s Miami Regional Office stated, “Langston and his companies executed short sales that gamed the system and resulted in illegal profits … The SEC is resolutely committed to pursuing those who violate Rule 105.”

A few months later, on Jan. 31, the SEC filed a complaint against Revelation Capital Management Ltd., a Bermuda-based exempt reporting adviser, and its chairman, CEO, CIO, founder and sole shareholder, Christopher P.C. Kuchanny. The complaint alleges that Kuchanny directed the majority of the trades that saw Revelation Capital purchase over four million shares of stock in a Canadian, closed-end fund listed on the NYSE and Toronto Stock Exchange, during a publicly marketed firm commitment follow-on offering. During the Rule 105 restricted period relating to this offering, Revelation Capital sold short nearly 1.5 million shares of the Canadian fund, with Kuchanny placing 751 of Revelation Capital’s 919 short-sale trades, resulting in a profit of nearly $1.4 million gained from illegal trading. The SEC is seeking: to permanently enjoin both Revelation Capital and Kuchanny from violating Rule 105; to order both Revelation Capital and Kuchanny, jointly and severally, to pay disgorgement, together with prejudgment interest; and the payment of civil penalties.

It is important that firms take action to promote training of their employees regarding the application of Rule 105. Firms should also develop and implement policies and procedures designed to achieve compliance with Rule 105. Once these policies and procedures are in place, firms should be very aggressive with their oversight and in-house enforcement.