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Securities and Exchange Commission v. Lyon

March 23, 2009

SECURITIES AND EXCHANGE COMMISSION, PLAINTIFF,
v.
EDWIN BUCHANAN LYON, IV, GRYPHON MASTER FUND, L.P., GRYPHON PARTNERS, L.P., GRYPHON PARTNERS (QP), L.P., GRYPHON OFFSHORE FUND, LTD., GRYPHON MANAGEMENT PARTNERS, L.P., GRYPHON MANAGEMENT PARNTERS III, L.P., AND GRYPHON ADVISORS, L.L.C., DEFENDANTS.



The opinion of the court was delivered by: Sidney H. Stein, U.S. District Judge.

OPINION & ORDER

Table of Contents

A. The "Celsion Offering"........................................................................................... 5

B. The "Gentner Offering" .......................................................................................... 7

C. The "MSL Offering"............................................................................................... 8

D. The "PhotoMedex Offering"................................................................................... 9

A. The Summary Judgment Standard........................................................................ 11

B. Insider Trading...................................................................................................... 12

I. BACKGROUND ....................................................................................................... 3

II. ANALYSIS .......................................................................................................... 11

1. The Information Defendants Received Was Both Material and Nonpublic...... 13

a. SEC's Summary Judgment Motion .............................................................. 15

i. Rule 406 "Routine Practice" Evidence.................................................... 16

ii. Existence of a Duty of Confidentiality .................................................... 18

b. Defendants' Motion for Summary Judgment ............................................... 21

2. Duty of Confidentiality....................................................................................... 15

3. Breach of Duty (Misappropriation)................................................................... 24

4. Lack of Personal Benefit to Defendants............................................................. 26

C. SEC's Alternate Theory of Liability..................................................................... 29

5. Personal Involvement of Defendant Lyon.......................................................... 28

III. CONCLUSION ................................................................................................... 30

The Securities and Exchange Commission ("SEC" or "Commission") brings this action for securities fraud, insider trading, and unlawful distribution of unregistered securities against Edward Buchanan Lyon, IV, and seven entities-Gryphon Master Fund, L.P., Gryphon Partners, L.P., Gryphon Partners (QP), L.P., Gryphon Offshore Fund, Ltd., Gryphon Management Partners, L.P., Gryphon Management Partners III, L.P., and Gryphon Advisors, L.L.C. (collectively, "Gryphon Entities")-for which Lyon serves as managing partner and chief investment officer. On January 2, 2008, this Court granted in part and denied in part defendants' motion to dismiss, dismissing the SEC's unlawful distribution claims. S.E.C. v. Lyon, 529 F. Supp. 2d 444 (S.D.N.Y. 2008). Each side now seeks summary judgment on the remaining insider trading and securities fraud claims.

The action stems from the defendants' involvement in the offering of a series of Private Investments in Public Equities ("PIPEs") and their contemporaneous trading in the stock of the issuing entities. The surviving claims allege defendants committed insider trading by acting on confidential, nonpublic information that four companies intended to issue PIPEs, thereby violating duties of confidentiality owed to each of the issuing entities. Defendants maintain they owed no duties to any of the issuers involved and were therefore free to trade on the information in question. Each side asserts that the factual record developed through discovery is sufficient for the Court to grant summary judgment in its favor.

Because the Court finds that issues of material fact remain in dispute, it concludes that a grant of summary judgment for any party would be inappropriate. Both motions, therefore, are denied.

I. BACKGROUND

The following facts are not in dispute: Edwin Buchanan Lyon, IV is the managing partner and chief investment officer of the Gryphon Entities, a collection of onshore and offshore hedge funds and related companies involved in the investment management business. (Pl.'s Local Civil Rule 56.1 Statement of Undisputed Facts ("Pl.'s 56.1") ¶¶ 5-12.) Lyon, who is experienced in the securities industry, made investing decisions for the Gryphon Entities with the help of a small staff, including former analyst Ryan Wolters. (Defs.' Local Civil Rule 56.1 Statement of Undisputed Facts ("Defs.' 56.1") ¶¶ 10, 13; Dep. of Ryan Wolters dated July 17, 2007 ("Wolters Dep.") at 17:11-20:16, Ex. F to Decl. of Christopher J. Clark dated June 10, 2008 ("Clark Decl.").)

Among the types of securities Gryphon Entities invested in were Private Investments in Public Equities, which are frequently referred to by their acronym as "PIPEs." (Dep. of Edwin Lyon dated Apr. 26, 2006 ("Lyon Dep. I") at 17:11-18:16, Ex. B to Clark Decl.) PIPEs are unregistered securities issued by companies whose stock is already publicly traded. Because PIPEs are unregistered, they cannot be offered to the market generally, and once issued, they cannot be resold or traded for a set period of time, usually 60-120 days. Issuers, through placement agents, target qualified potential investors who are offered PIPEs at a significant discount from the common stock's market price as compensation for the temporary illiquidity. (Pl.'s 56.1 ¶¶ 13-14.)

The fact that a company intends to issue PIPEs is not initially public information. Issuing companies, through their placement agents, solicit qualified investors until the full offering is purchased, at which point the transaction is completed and "closed." Only then will the issuer announce full details about the offering to the public market. (Lyon Dep. I, at 63:7-21.)

The SEC contends that public announcement of a PIPE offering often leads to a significant drop in the trading price of the issuer's stock. (Compl. ¶ 51.) The decline occurs for two reasons. First, the offering of additional shares means that each share represents a smaller percentage of the issuer's total outstanding equity, i.e., each share is "diluted" in value. (Id.) Second, as noted, PIPE shares are usually offered at a price below the prevailing market for publicly traded shares of the issuer's stock because, as restricted shares, PIPE shares are not freely tradable for a set period of time. (Id. ¶ 7, 51.) The record in this case reflects that in each of the offerings relevant to this litigation, public announcement of the offering correlated with a drop in the issuer's stock price. (Pl.'s 56.1 ¶¶ 15, 23; Def's Resp. to Pl's Local Rule 56.1 Statement of Undisputed Facts ("Def's Resp. 56.1") ¶ 23.)

As noted above, once they are issued, PIPE shares are considered restricted and cannot be publicly traded for a set period of time. In the interim, however, PIPE investors often "hedge" their investments-i.e., attempt to reduce their risk-by selling "short" the issuer's stock. (Compl. ¶ 22.) An investor sells "short" when he borrows a security from someone else (typically a broker) and then sells it, hoping the stock will fall so that, at a later date, when the investor "covers" the short position by purchasing the security and returning it to the lender, he can capitalize on the price differential. See ATSI Communs., Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 96 n.1 (2d. Cir. 1998) (citations omitted); see also Lyon, 529 F. Supp. 2d at 454.

Investors in PIPEs frequently short the issuers stock after having invested in the PIPE, thereby seeking to capitalize on the difference between the stock's market price and the reduced offering price the investor paid for the PIPE. The practice is common, and provided the investor establishes his short position in the issuer's stock after the PIPE offering has closed and been publicly announced, the parties agree there is nothing illegal about it. (Pl.'s Resp. to Def's Local Rule 56.1 Statement of Undisputed Facts ("Pl.'s Resp. 56.1") ¶ 16.) In this case, however, defendants shorted the stock of four companies after being informed of those companies' intentions to issue PIPEs but before the offerings were publicly announced to the market. The SEC contends that, in so doing, defendants committed securities fraud.

In particular, the SEC alleges defendants obtained information about the four offerings only after agreeing to keep that information confidential and then breached those duties of confidentiality by using the information to short the issuers' stock, thereby committing fraud in connection with the purchase or sale of securities. Defendants deny they promised to keep information about the offerings confidential or that they breached any duties owed when they traded the issuers' stock.

The following facts are not in dispute regarding the four transactions in question:

A. The "Celsion Offering"

In the spring of 2003, the Celsion Corporation retained outside placement agent Sterling Investment Group to solicit prospective investors in a PIPE offering. (Pl.'s 56.1 ΒΆ 29.) Sterling, through its employee Jamie Alpharo, contacted defendants, and in particular, Wolters, regarding the offering. Alpharo has only a "vague" memory of his communications with defendants but testified that the "process" for contacting investors was to do so "without divulging the name of the [issuer]" and that if the investor was interested, "we may have said something like, do you mind if we bring you over the wall, and if he [gave] the affirmative, then we would go ahead and divulge the name of the company." (Dep. of Jaime Alfaro dated Mar. 24, 2008 ("Alfaro Dep.") at 17:22-20:13, Ex. G to Clark Decl.) Being brought "over the wall," as Alfaro explained, meant the potential investor understood he "would be privy to confidential information." (Id. 20:14-17.) Alfaro further testified that the "process" was to send additional ...


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