On March 15, 2010, the United States Attorney for the Southern District of New York, Preet Bahrara, announced that Florida-based attorney Louis W. Zehil pleaded guilty to a criminal Information charging one count of Securities Fraud and one count of Conspiracy to Commit Securities Fraud arising out of a fraudulent scheme in which Zehil obtained unregistered, restricted securities that he subsequently falsely sold as registered and freely tradable. As part of his guilty plea, Zehil forfeited $17 million and to agreed to pay restitution to his victims.
During all relevant times, Zehil was a law partner with the firm of McGuire Woods, where he specialized in both representing small companies seeking to become public through reverse mergers and obtaining capital for those companies through private placement transactions. McGuire Woods describes itself has having over 900 partners and 18 worldwide offices. The firm's website references it as ranking third by monetary value in the United States among top law firms for serving as issuer's counsel for global equity issuances on behalf of issuers in 2009. Zehil resigned from the law firm on February 16, 2007.
Zehil's small firm clients would typically enter into a "PIPE" (Private Investment in Public Equities) private placement transaction to generate financing for their newly merged public company. Under the terms of the PIPE transactions, the stock issued to the PIPE investors was not freely tradeable because it was not registered with the United States Securities and Exchange Commission ("SEC"). Consequently, all shares issued in the PIPE transactions were required to bear restrictive legends until such time as those shares were registered with the SEC and the SEC declared the registration statements for those securities effective. The PIPE investors typically entered into "registration rights" agreements that allowed them, at a future date, to register the securities they obtained in the PIPE transactions for resale.
Between January 2006 and February 2007, Zehil represented the following seven companies that issued stock pursuant to PIPE transactions:
Zehil invested in each of the Charged Transactions through nominee entities he controlled ("Zehil's Entities"). Investors in each of the Charged Transactions and Zehil's Entities entered into subscription agreements for each such transaction, pursuant to which they agreed that the shares they received would be issued with restrictive legends (that would prevent their resale) until such time as the issuers filed registration statements with the SEC and the SEC declared the registration statements effective.
Acting as counsel for the issuers in the Charged Transactions, Zehil sent opinion letters to the issuers' stock transfer agents directing the issuance of restricted shares to the PIPE investors. Zehil's letters instructed that all of the issued shares should bear restrictive legends except the shares issued to Zehil's Entities. Zehil's letters stated, falsely, that the shares issued to Zehil's Entities satisfied legal criteria permitting them to be issued without a restrictive legend. As a result, Zehil was able to receive shares without restrictive legends.
Almost immediately after Zehil obtained these free trading shares of the issuers' stock, he deposited them in securities trading accounts and sold them before the issuers had filed any registration statements with the SEC. By obtaining stock free of the restrictive legends, Zehil was able to sell these shares immediately in the open market at a profit, in advance of the other PIPE investors. Zehil reaped approximately $17 million dollars in profit through these illegal sales.
Zehil faces a maximum penalty of five years in prison on the conspiracy count and a fine of the greater of $250,000 or twice the gross gain or gross loss from the offense. On the securities fraud count, he faces a maximum penalty of 20 years in prison and a fine of the greater of $5 million or twice the gross gain or gross loss from the offense.
In February 2010, I published a blog detailing the unsavory practices involving PIPEs Gross Abuse: Broken PIPES http://www.brokeandbroker.com/index.php?a=blog&id=317. Pointedly, I observed that
BILL SINGER'S COMMENT: PIPE transactions continue to be a troubled and troubling vehicle for financing. . . . PIPEs offerings are often predatory transactions that excessively dilute pre-existing shareholders. . .While recent changes to securities laws and rules have sought to ameliorate some of the dangers posed to shareholders by PIPEs, there are still widespread reports of abuse.
Regulatory lawyer Bill Singer has analyzed and posted the latest crop of FINRA disciplinary cases. Frankly, it's not a pretty sight.