The Securities and Exchange Commission filed charges against hedge fund manager Robert A. Berlacher, Lancaster Investment Partners L.P. and eight related entities, alleging that Berlacher engaged in insider trading and an illegal trading scheme involving PIPEs — the acronym for a private investments in public equity.

In charges filed last Thursday, the SEC alleged that from 2000 through 2005, Berlacher, Lancaster and the other entities (including Northwood Capital Partners, Cabernet Partners, Chardonnay Partners, Insignia Partners, VFT Special Ventures, LIP Advisors, NCP Advisors, and RAB Investment Company) took in more than $1.7 million in what amounted to an illegal trading scheme. According to the SEC, Berlacher, learning about a PIPE transaction, would sell short the issuer’s stock. Once the SEC declared the resale registration statement effective, Berlacher allegedly used the PIPE shares to cover the short positions, a practice that the SEC says is prohibited by the registration provisions of the federal securities laws.

“The allegations of the SEC’s complaint are not supported by the facts or the law,” said attorney Perrie Weiner, of the Los Angeles office of DLA Piper US LLP, who represents Berlacher and all of the entities named in the SEC charges. “At best, this is a completely ill-defined area of the law, leaving an entire industry to guess at what specific conduct the SEC is attempting to prohibit. And more to the point, these legal issues, or should I say ‘theories’ of the SEC, have never been adjudicated to a legal conclusion by any court of law.”

PIPEs, used primarily by small companies in need of cash, involve a private-placement transaction in which investors buy securities directly from a publicly traded company, usually at a discount from the market price of the common stock. Hedge funds have been big investors in PIPEs.

The SEC accuses Berlacher of engaging in illegal PIPE transactions involving 10 companies — Amtech Systems, NaPro BioTherapeutics, Orthovita, Conductus, Central European Distribution, Neoware, Meade Instruments, Radyne ComStream, Cento Corp. and Smith Micro Software.

According to the SEC, Berlacher and the other entities named it the suit made materially false representations to the PIPE issuers to induce them to sell securities. Typically, investors may not participate in a PIPE until they agree not to sell or transfer PIPE shares in a manner that would violate securities laws. That’s important to PIPE issuers, who rely on those promises in order to qualify to have the private offering be exempt from SEC registration.

To avoid detection and regulatory scrutiny, the SEC claims, Berlacher and the other entities named in the SEC’s suit used a variety of deceptive trading techniques, including wash sales, matched orders, and pre-arranged trades, to make it appear that he was covering short sales with open market shares, when, in fact, Berlacher was on both sides of the transactions and was covering the sales with its PIPE shares.

Further, the SEC claims that on at least one question, Berlacher and the other entities engaged in illegal insider trading by selling short the securities of a certain PIPE issuer prior to the public announcement of the PIPE, while using nonpublic information they received when being solicited to invest in the PIPE. Investors in a PIPE typically must agree not to trade on inside information, an agreement that the SEC claims Berlacher made.

The SEC says the actions by Berlacher, Lancaster, and the other entities represent violations of the registration provisions of the Securities Act — known as Ssection 5 — as well as the anti-fraud provisions.

“We are confident that we will defeat the Section 5 claims dealing with the purported use of PIPE shares to cover pre-effective (registration statement) short sales, as they are unlikely to survive even a motion to dismiss much less a trial on the merits,” said Weiner. “As to the insider trading claims, none of the alleged information our clients received was non-public, nor was the PIPE transaction at issue material. There is no decided case law in this area supporting the SEC’s theories. If any of these claims survive a motion to dismiss, which is a very big ‘if,’ we are confident that we will win at trial. Our clients intend to vigorously defend against these spurious claims. And, most of all, our clients look forward to a complete vindication on the merits.”

According to Sagient Research Systems, during the first six months of this year, there were 645 PIPE transactions totaling $22.42 billion in equity and equity-linked capital raised (excluding structured equity lines and Canadian issuers). Although the number of transactions declined slightly compared with the first half of last year, the amount raised represented a 38 percent increase over the total amount raised during the first half of 2006.

Nearly three years ago, TheStreet.com reported that the SEC issued subpoenas and requests for documents to about 20 brokerage firms and 10 hedge funds in connection with PIPE transactions.

In May 2006, the SEC settled civil charges involving PIPEs against hedge fund adviser Deephaven Capital Management, LLC and its former portfolio manager Bruce Lieberman.

The Commission alleged that they engaged in insider trading from August 2001 to March 2004 on the information that 19 PIPE offerings were about to be publicly announced. In each case, the company’s stock price fell on the announcement of its PIPE offering, the commission charged. The SEC accused Deephaven and Lieberman of learning about confidential material nonpublic details about the upcoming PIPE offerings from placement agents for the companies and then selling the company shares short.

Deephaven agreed to disgorge $2,683,270 in unlawful profits and pay $343,418 in prejudgment interest and a $2,683,270 civil penalty. Lieberman agreed to pay a $110,000 civil penalty and signed on to a commission order barring him from associating with any investment advisers for at least three years.

In April 2005, Friedman Billings Ramsey offered to pay $7.5 million to the SEC and the National Association of Securities Dealers to settle charges related to trading in a company account and the October 2001 offering of a PIPE on behalf of CompuDyne Inc.