Litigation Release No. 21123 / July 10, 2009

SEC v. Colonial Investment Management LLC, Colonial Fund LLC and Cary G. Brody, 07 Civ. 8849 (PKC) (SDNY)

Federal Court Enjoins Cary G. Brody, Colonial Investment Management LLC and Colonial Fund for Illegal Trading; Orders Payment of over $1.4 million in Disgorgement; Orders Brody to Pay a Civil Penalty

On July 7, 2009, the Honorable P. Kevin Castel, United States District Judge for the Southern District of New York, found after a bench trial that Cary G. Brody and two entities he controlled, New York hedge fund Colonial Fund LLC and its adviser, Colonial Investment Management LLC, were liable for illegal trading relating to eighteen registered public offerings. The court permanently enjoined the defendants from violating Rule 105 of Regulation M under the Securities Exchange Act of 1934. Judge Castel also ordered defendants to pay disgorgement totaling more than $1.4 million in ill-gotten gains, plus prejudgment interest, and required Brody to pay a civil penalty of $450,000.

In general, Rule 105 seeks to prevent manipulative trading by short sellers prior to registered public offerings and to promote offering prices that are based upon open market prices, determined by supply and demand, rather than by artificial forces. At the time of the violations, Rule 105 generally prohibited short sellers, regardless of intent, from using securities purchased in registered public offerings to cover short sales that occurred during the five business days before the pricing of the offerings (the restricted period).

The Commission's complaint, filed in federal court in Manhattan on October 15, 2007, alleged that the defendants violated Rule 105 when they used shares purchased in at least eighteen registered public offerings to cover short sales that they made during the rule's restricted period. The defendants allegedly realized profits in excess of $1.4 million from the illegal trades because Colonial Fund typically sold shares short during the restricted period at prices that were higher than the offering prices and then covered the restricted period short positions with shares purchased at lower prices in the offerings. The complaint also alleged the defendants often structured post-offering trades in an effort to conceal their Rule 105 violations.

In his ruling, Judge Castel found, among other things, that the defendants' Rule 105 violations were complete when Colonial purchased offering stock, that the defendants' post-offering trading could not undo the violations, and that those trades were an effort by the defendants to create the false appearance to third parties and regulators that they had not used shares purchased in public offerings to illegally cover the short positions. Judge Castel further found that defendants acted recklessly with respect to five of the offerings, and knowingly, intentionally, and willfully with respect to the other thirteen offerings. The court imposed a $450,000 civil penalty on Brody, finding that Brody's unlawful actions involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement.

For further information, please see LR-20332 (October 15, 2007).

Findings of Fact and Conclusions of Law