Of PIPEs, Securities Lawyers, and Criminal Prosecutions: US v. Saltsman

On October 19, the Justice Department announced the indictment of six people for nineteen counts of securities fraud and money laundering. Four of the defendants are former officers and directors of Ramp Corporation and Xybernaut Corporation, including Martin Weisberg, a former partner at Baker & McKenzie law firm. The other two defendants are residents of Israel who were investors in the two companies.

The securities fraud charges are based on a number of PIPE transactions conducted by both companies with the Israeli investors. A description of PIPE transactions can be found in paragraph 16 of the indictment, and also here. The indictment alleges that the Israeli investors were secretly given discounts on their purchases of Ramp and Xybernaut shares in return for kickbacks to the other four defendants. The alleged scheme called for discounted shares to be sold to the investors through various shell corporations.

Disclosure of these transactions typically drives share price of the issuing company down as a result of the dilutive effect on the shares held by other investors. The government alleges that the Israeli investors “established large short positions in Xybernaut and Ramp stock prior to their receipt of the shares.” After the PIPEs were publicly announced and the market price of the two companies dropped, the investors used the shares obtained from the PIPEs to cover their short positions, thus reaping an alleged $16 million in profits.

Weisberg's alleged role in the scheme raises some interesting issues. First, many of the allegations are that he reviewed various filings that contained false disclosure. Thus, Paragraph 59c notes that Ramp filed a 10-K "reviewed by the defendant MARTIN WEISBERG" that failed to disclose a $50,000 gift or the role of certain defendants "in the change in Ramp's Board." The change in the board apparently referred to allegations in paragraph 33 that two of the defendants threatened to withdraw a PIPE transaction unless, among other things, three directors of Ramp resigned and two directors of their choosing were added to the board. Thus, the 10-K prepared by one attorney but reviewed by Weisberg "omitted any mention of SALTSMAN or EITAN's role in the change in Ramp's board of directors."

Other allegations in the indictment included claims that Weisberg made false statements to the SEC in response to a comment letter on a registration statement and that he failed to disclose certain payments received in his capacity as a director. As the indictment noted:

• "The 'Compensation of Directors' section of the 2003 Form 10-K state, in substance and in part, that Xybernaut's directors, including WEISBERG, were paid $1,000 per board meeting and received options to purchase 10,000 Xybernaut shares annually. The 2003 Form 10-K materially omitted any reference to the hundreds of thousands of dollars that WEISBERG and STEVEN NEWMAN received in exchange for causing Xybernaut to enter into the PIPE transactions with the Nominee Entities. These omissions rendered the disclosures made materially false and misleading."

There is not enough information in the indictment to truly assess the case against Weisberg. It is clear that much of what he did was typical of any securities attorney. Moreover, some of the allegedly false disclosure may have involved judgment calls that, in hindsight, were wrong but not criminal. Thus, the indictment notes that three directors resigned because of pressure from Saltsman and Eitan. The company said nothing about this in the Form 10-K. On the other hand, the SEC only expressly requires disclosure of the reasons for a director's resignation where there is a "disagreement with the registrant." See Item 5.02 of Form 8-K. Weisberg, to the extent he knew about the reasons for the change, may have viewed the information as immaterial. After all, it did not involve a change in control. Quite the contrary. The defendants only ended up with two representatives out of five on the board.

Moreover, the annual report did state that "we reduced the total number of directors on our Board of Directors from six to five pursuant to our By-laws, which permits our Board to set the number of directors from time to time. This change was made to avoid the possibility of a deadlocked Board with an evenly split vote." The indictment characterizes this as a false statement. In fact, it may well have been the reason why the board was changed from six directors to five. Moreover, with the defendants obtaining two slots, the change prevented the defendants from having the ability to deadlock the board. As a result, the statement may well be accurate.

The indictment can be found on the DU Corporate Governance website.