Hedge Funds Smoking In PIPES, Signal Potential Problems

Date: Thursday, February 1, 2007
Author: Dailyii.com

Hedge funds have become big players in the private investments in public equities market, with PIPEs investments totaling $28 billion last year alone, and that may present a problem for the industry and regulators. It certainly has captured the attention of Forbes magazine, which in a Feb. 12 article titled "Sewer Pipes" suggests that "Hedge funds are posting nice returns from deals that may involve ex-cons, stock scammers...even the mob." According to Forbes, hedge funds are attracted to the deals, which allow them to invest in public companies in dire need of cash, for various profitable reasons. The hedge funds, says Forbes, do quite nicely for themselves, what with deals that give them 2% of assets, 20% of the profits and an average 3.5% as a closing fee for each deal. Forbes notes that in return for their investment hedge funds receive shares of a company’s stock at a deep discount, as a compensation for the fact that the shares can’t be traded until they’re registered with the Securities and Exchange Commission. As a result, Forbes reports, "hedge funds can value those PIPE warrants and options pretty much any way want and calculate their net asset value accordingly." The higher the NAV, the more attractive the investment. The somewhat shady side of PIPEs – Forbes cites one hedge fund sued by an investor who was promised he could double his assets with penny stocks, and ended up losing most of it, and another run by a manager convicted of wire fraud – has prompted the Securities and Exchange Commission to turn the spotlight on them. "Improper trading practices in connection with PIPEs is a concern," David Markowitz of the SEC’s office in New York, told Forbes. "It’s an area that SEC enforcement is looking at."