Friday, March 25, 2005

A Picture's Worth a Thousand Words

Anyone that hasn't seen it should go to http://tinyurl.com/5vq8y and check out the news piece that features among others Dr. Patrick Byrne of Overstock.com, Dr. James Angel, one of the foremost authorities on the capital markets, and Bob O'Brien - the protagonist in this little unfolding drama.

The piece has been called an infomercial by some. Not so. Commercials are paid advertising. You pay to have them aired. And they sell something, or solicit donations - there's a call to action at the end, usually designed to separate you from your money. This has no call to action other than for our regulators to enforce the rules, and stop the fail to deliver problem - or we can't conscience privatizing social security.

This is a news piece that was created by friends of mine from around the country - New Jersey, Texas, Nevada, California. Is it an "independent news piece?" Huh. Show me one of those. The same 3 or 4 conglomerates own all the outlets. A better question is does it accurately portray the issue? That answer is yes. Professor Angel, Dr. Byrne, Mary Campbell, your's truly - all answered the questions asked truthfully, and it doesn't matter who held the camera - the truth is still the truth, and news is still news.

Now there are those that will howl that this is somehow unfair, and propaganda, and bad. Funny, given that there are financial "news" sites devoted to writing hatchet jobs on some hedge funds' picks. No one is howling that they are propaganda machines. At least no one in the mainstream media. Everything is just fine, until a piece that puts a human face on the illegalities of Wall Street surfaces, and then you can hear the howling coast to coast. God forbid the little guy figures out that he is getting screwed by the system designed to protect him.

It would have been nice to get an SEC representative on, but time constraints and their general reluctance to talk about this issue are such that it wasn't practical.

I figure that a CEO, a professor, an investor and a masked man will have to do this go around. But what do I know?

Send the URL to every elected official you can think of, folks - the Web is far more powerful than TV these days anyway. Let's show them some footage of the people this is impacting - they need to understand this isn't rich white guy A losing a little money to rich white guy B.

This is America. And we are being fleeced. And the Video says "make them stop." Just like the ad did. Make the regulators do their job, make Wall Street obey the rules, and stop the cover up. Now.

How can anyone be against that? How can anyone take the position that asking our regulators to enforce the rules that were written to protect us is bad, or despicable, or some sort of a scam? The only folks I could think of that would want to let illegal behavior continue are those engaging in and profiting from that behavior. Then again, perhaps I've got it all wrong.

If you go to the NFI message boards you will find that since I posted the link to this video there, we have seen an unprecedented number of posts designed to clog the boards and bury the information. Why would someone throw so much effort into clogging the message boards on a day when the stock isn't even trading? I even noted 2 or 3 obvious computer generated messages saying that the stock is about to plunge in the next half hour - on a day the market is closed. I couldn't make this stuff up. And yet where are the SEC agents looking at these people attempting to systematically manipulate the share price? Isn't it illegal to spend time and money disseminating false and misleading information, essentially to stage a disinformation campaign, to tarnish a company's reputation and stymie the ability of their shareholders to communicate?

I don't understand those that are critical of demanding that the SEC enforce the rules and that the DTCC be forced to disclose the size of the fail problem, so that illegal market manipulators can't get away with their nefarious business any longer - but I'm sure there are those that will find a way.

And by their deeds shall you know them...

3 Comments:

Blogger rvac106 said...

Found another blog to spread the word on. ANT & SONS. At WWW.ANTANDSONS.COM. Kudos to them, for adding their voice, and continuing Kudos to you. I know why you started, and how the fight often finds you, rather than the other way around.

3:15 PM  
Blogger link said...

Why some don’t “get it”?

This is a question that’s been bedeviling an increasing number of investors lately, re naked short selling and persistent fails to deliver. There’s certainly been some ink spilled both pro and con in the media about it, and that’s a good thing. But it deserves more.

Naked short selling is clearly and unequivicably illegal-except in the case of broker/dealers in their role of providing liquidity to the marketplace- and yet apologists for it are legion. It makes the head spin. Maybe it’s a sort of perverse reaction against the bubble mentality of yore, when it was believed that trees really could grow to the sky, and that Worldcom and Enron were shining examples of the brave new economy. No one wants to repeat the mistakes of that too recent, inglorious past. Short sellers, hedge funds, and skeptics warned of lunacy early and often, and when the dust settled, some had even profited from it. Now they are considered to be the new voices of reason, and many of these self-styled “masters of the universe” are eager to cement that status by generously sharing their wisdom and “talking their book”, sometimes anonymously as “unnamed sources” out of a sense of modesty, no doubt. Naked short sellers, ironically, are probably modest to a fault. Which is a shame, really, as we are told they have nothing to hide. There is no “there” there, etc…

Or is there?

I noticed Jeff Matthews has a peculiar obsession with Patrick Byrne and Overstock, almost rivaling that of Herb Greenbergs’. Why? Maybe this will shed some light. I don’t know, judge for yourselves. This is what he had to say at Street Insight, a subscription service of thestreet.com:



Paranoia, The Destroyer
2/02/05 10:00 AM EST
Bearish OSTK

When companies spend time bashing shorts, it's usually worth wondering what they're worried about.
As Hamlet's mother, Queen Gertrude, might have said, "The Doctor doth protest too much, methinks."

It's been a busy earnings season and I've only just now heard out the entire replay of the Overstock (OSTK) earnings call from last week. (Overstock's CEO, Dr. Patrick Byrne is something of both a control freak and an erudite, so he likes to take a long time, and use big words, to answer simple questions. Hence, the conference calls contain a great deal of what my teenage daughter would term "overshare." And not particularly relevant "oversharing" at that.) In any event, Overstock's call is one for the ages, and I urge all to listen to a replay or read the transcript, to the bitter end. And it is quite a bitter end. Doctor Byrne, whose lot in life is that he is the son of a famously A+ insurance executive, Jack Byrne (one of Warren Buffett's faves), does not spend as much time as usual hectoring the short-sellers who seem to get under his skin (despite the fact that his stock has tripled in the last year), although he does get in the usual zings about ace financial columnist Herb Greenberg and other journalists whose main fault appears to be that they do not believe the Overstock story. Instead, a caller named Bob O'Brien hijacks the Q&A, with Dr. Bryne politely listening, and describes a massive conspiracy against Overstock and other small companies by short-sellers led, in this case by David Rocker of Rocker Partners. "I know this probably sounds a lot like the X-Files," Mr. O'Brien says, before launching into an X-Filian conspiracy theory that concludes that these companies "have been gang raped by mountain men... " [i.e. Rocker]. Well, I worked at Rocker Partners from 1989 to early 1994 before starting my own long/short fund, and I know the amount of research he and Marc Cohodes have done on frauds such as Lernout & Hauspie. I also know Herb Greenberg and some of the terrific work he has done on frauds like Media Vision. And it is my experience that any time a CEO spends as much time as Doctor Byrne attacking short-sellers, rather than simply running a really good business ... then it is usually -- not always, but usually -- the short-sellers who are on the right track, not company-defending "X-Files" type conspiracy theorists such as Bob O'Brien. As a result of the Overstock conference call, I am moving OSTK to the front of the line in potential short sale candidates I am monitoring, and have bought puts in case things unravel more quickly than I suspect at the moment. As Ray Davies of the Kinks sang a long time ago, "Paranoia is a great destroyer." In fact, it's a trait I like to see in potential short candidates. And there was paranoia galore on that Overstock call. OSTK puts


Why some don’t “get it”?

This is a question that’s been bedeviling an increasing number of investors lately, re naked short selling and persistent fails to deliver. There’s certainly been some ink spilled both pro and con in the media about it, and that’s a good thing. But it deserves more.

Naked short selling is clearly and unequivicably illegal-except in the case of broker/dealers in their role of providing liquidity to the marketplace- and yet apologists for it are legion. It makes the head spin. Maybe it’s a sort of perverse reaction against the bubble mentality of yore, when it was believed that trees really could grow to the sky, and that Worldcom and Enron were shining examples of the brave new economy. No one wants to repeat the mistakes of that too recent, inglorious past. Short sellers, hedge funds, and skeptics warned of lunacy early and often, and when the dust settled, some had even profited from it. Now they are considered to be the new voices of reason, and many of these self-styled “masters of the universe” are eager to cement that status by generously sharing their wisdom and “talking their book”, sometimes anonymously as “unnamed sources” out of a sense of modesty, no doubt. Naked short sellers, ironically, are probably modest to a fault. Which is a shame, really, as we are told they have nothing to hide. There is no “there” there, etc…

Or is there?

I noticed Jeff Matthews has a peculiar obsession with Patrick Byrne and Overstock, almost rivaling that of Herb Greenbergs’. Why? Maybe this will shed some light. I don’t know, judge for yourselves. This is what he had to say at Street Insight, a subscription service of thestreet.com:

“Paranoia, The Destroyer
Bearish OSTK
When companies spend time bashing shorts, it's usually worth wondering what they're worried about.
As Hamlet's mother, Queen Gertrude, might have said, "The Doctor doth protest too much, methinks."
It's been a busy earnings season and I've only just now heard out the entire replay of the Overstock (OSTK) earnings call from last week. (Overstock's CEO, Dr. Patrick Byrne is something of both a control freak and an erudite, so he likes to take a long time, and use big words, to answer simple questions. Hence, the conference calls contain a great deal of what my teenage daughter would term "overshare." And not particularly relevant "oversharing" at that.)
In any event, Overstock's call is one for the ages, and I urge all to listen to a replay or read the transcript, to the bitter end. And it is quite a bitter end.
Doctor Byrne, whose lot in life is that he is the son of a famously A+ insurance executive, Jack Byrne (one of Warren Buffett's faves), does not spend as much time as usual hectoring the short-sellers who seem to get under his skin (despite the fact that his stock has tripled in the last year), although he does get in the usual zings about ace financial columnist Herb Greenberg and other journalists whose main fault appears to be that they do not believe the Overstock story. Instead, a caller named Bob O'Brien hijacks the Q&A, with Dr. Bryne politely listening, and describes a massive conspiracy against Overstock and other small companies by short-sellers led, in this case by David Rocker of Rocker Partners.
"I know this probably sounds a lot like the X-Files," Mr. O'Brien says, before launching into an X-Filian conspiracy theory that concludes that these companies "have been gang raped by mountain men... " [i.e. Rocker].
Well, I worked at Rocker Partners from 1989 to early 1994 before starting my own long/short fund, and I know the amount of research he and Marc Cohodes have done on frauds such as Lernout & Hauspie. I also know Herb Greenberg and some of the terrific work he has done on frauds like Media Vision. And it is my experience that any time a CEO spends as much time as Doctor Byrne attacking short-sellers, rather than simply running a really good business ... then it is usually -- not always, but usually -- the short-sellers who are on the right track, not company-defending "X-Files" type conspiracy theorists such as Bob O'Brien.
As a result of the Overstock conference call, I am moving OSTK to the front of the line in potential short sale candidates I am monitoring, and have bought puts in case things unravel more quickly than I suspect at the moment.
As Ray Davies of the Kinks sang a long time ago, "Paranoia is a great destroyer." In fact, it's a trait I like to see in potential short candidates. And there was paranoia galore on that Overstock call.”


Well, I can appreciate Jeff’s gracious opinions concerning his old friends and collegues, and his loyalty to them is understandable. But others may equally understandably have differing views, views unencumbered by old loyalties and collegial elbow rubbing. This from a fellow hedge fund manager, Tom Brown at bankstocks.com:

“TheStreet.com’s Peter Eavis has been so spectacularly, utterly, and completely wrong on Capital One for so long, it’s hard to chalk up his mistakenness to simple incompetence. There must be something more: even know-nothings will eventually come to the conclusion they don’t know what they’re talking about, and move on.

But not Peter. He keeps blazing away quarter after quarter, year after year, with the same twaddle, even after it’s been shown to be twaddle. And he keeps making stuff up, concocting baseless managements smears—seemingly for the sake of smearing. And the stock just keeps going up!

Why does he keep at it? My guess—and it’s only a guess—is that he’s under orders from David Rocker, the short seller and major shareholder in The Street.com, to keep bashing the stock to help Rocker’s short position. But we may never know that for sure. The Street.com’s backers refuse to disclose their short positions, and Eavis himself, sanctimonious when it comes to disclosure by others, is quick to exempt himself from his own standards.

(For the record, by the way, the investment partnership I run has a large position in Capital One, and I have owned the stock personally since the company came public in 1994.)

In all of his ravings, Eavis fails to include a number of facts that one would think would be relevant to an interested investor. Like, for instance, that Capital One’s earnings have grown at a compound annual rate of 30% since the company came public, and that its stock price has risen at a 31% compound annual rate over that time. Neither has Peter mentioned that Capital One’s performance record over the past decade has ranked among the very elite in corporate America.

No, all Peter sees is doom, gloom, and imaginary unethical business practices. It’s hard to imagine how he could be more wrong.

To see just how off base Peter has been on this company, go back and read what he wrote following the company’s first-quarter earnings report a year ago. Capital One, recall, had reported spectacular results, up 62%, to $1.35 from 82 cents the year before—a whopping 32 cents ahead of expectation. But Peter, missing the boat completely, complained that the earnings blowout was “low quality” and accused the company of skimping on reserves and underspending to artificially inflate result. “The company stretched in more directions than one might think humanly possible to make its earnings number,” he wrote, “Most important about these antics is that they can't be sustained for more than a couple of quarters, which implies the company is trying to project the impression of strong earnings to attract buyers.” Peter added that Cap One was worth no more than $25 in a buyout.

Yet here we are four quarters later--and Capital One has consistently met or beat the Street’s expectation every quarter! And was the company sold? Not exactly. Instead, the stock, which was trading at $43 a year ago, has since zoomed to $75 recently, before setting back to $65 in the past week or so. A $25 buyout, indeed.

So what was Peter’s take on Cap One's first-quarter earnings this year? A rerun of 2003! The company, recall, earned $1.84 in the quarter, up from $1.35 a year ago and 21% ahead of Street expectations. Sure enough, just as in 2003 Peter complained he thought the company artificially under-reserved (which it didn’t), skimped on marketing (it didn’t do that, either), and resorted to other tricks to make its number (wrong, wrong, wrong.)
Peter was proved clueless about the first-quarter 2003 results, and he’ll shortly be shown to be clueless about the 2004 first quarter as well.

While Peter was complaining about what he saw as under-reserving at Capital One last year, he neglected to tell his readers that earnings in 2002 were understated because of the huge loan loss reserve additions the company was required to make, thanks to the formulaic reserving approach regulators require. No, back then Peter’s view—or rather, in my opinion, the view that David Rocker instructed Peter to have, —was that the big reserve additions were an ominous sign that the company’s credit quality was deteriorating fast. He turned out to be wrong about that, too.

This isn’t disinterested reporting analysis, it’s a long-term hatchet job, carried out at the expense of readers solely in an attempt to enrich the owner of Peter’s employer.
There is no level so low that Peter won’t stoop to it. Last week he accused Capital One’s management of violating SEC disclosure rules by announcing internally the company would reduce headcount at certain of its facilities. That is a slander. Peter (naturally) sees the layoffs as the sign of a ruinous expense squeeze. He’s wrong. Capital One is trimming headcount at certain facilities for several reasons, one of which is outsourcing, a long-time Cap One practice. Beyond that, the layoffs reflect the fact that the company has purposely slowed portfolio growth over the past year. Peter, who’s long complained that Cap One’s rapid growth was unsustainable, can’t possibly complain about that. But he does anyway: the plan, he says, “. . . has the air of panic about it. It reads like the company won’t hit its earnings forecast unless it takes a big ax to its expenses.” Please note the absence of any evidence to back up that assertion.

Mind you, Capital One has never reported full year earnings growth less than 20%, nor has management ever failed to meet or exceed its annual earnings forecast. For ten years! Peter has predicted several times that it would fall short--and has been wrong every time! Who do you think is a better forecaster?

In his last two pieces on RealMoney.com, Peter has lost any semblance of tone of disinterested analyst, and has begun to sound like a man with a vendetta. Why? My guess: David Rocker, who is reportedly short Capital One, is leaning on him hard. Peter is bought and paid for by Rocker, I believe, and has apparently made the choice to serve that one man rather than his RealMoney readers. It’s the worst kind of journalistic betrayal; I’m at a loss to understand why his editors put up with it.

Peter and I often exchange emails after he writes one of his outrageous columns. They’re not always friendly. It’s clear that, for whatever reason, he is bitter, doesn’t know details of the company, and will not be confused by the facts…”

http://www.bankstocks.com/article.asp?id=9880253

It seems David Rocker is someone who elicits very different responses from different people, to say the least. Anyways, its always healthy to view things from more than one side.

I don’t pretend to know whether illegal naked short selling exist on a large scale or a small, but it seems pretty seedy to me just the same. Where ever profits are easily had or competition is fierce, temptation lurks like a siren call to lead men astray.

Any doubts?

Death by Finance
This article is from the April 1, 2001, issue of Red Herring magazine.
L. David Sikes was desperate. The CEO of Ramtron International (Nasdaq: RMTR) watched helplessly as the publicly traded chip maker lost $1 million a month during the height of the Asian financial crisis of 1998. Ramtron needed $17 million to stay in business, but couldn't turn to the traditional capital markets -- not with its balance sheet and its dependence on the Asian market. With nowhere else to turn, Mr. Sikes contacted a consortium of 12 individual investors and came up with the $17 million at terms that would make a credit card company green with envy. It was, Mr. Sikes concedes, a roll of the dice.
What Mr. Sikes did was take a toxic convert, a financing measure of last resort that is becoming increasingly popular in the wake of the Nasdaq crash on April 14, 2000 -- and is coming under increasing scrutiny. In exchange for the $17 million, Mr. Sikes was required to turn over about $19 million's worth of Ramtron common stock. The catch: the investors were entitled to the $19 million in stock, regardless of the price per share.
And it was likely that Ramtron stock would drop enough so that the investors would eventually take control of the company on the basis of their $17 million infusion. In fact, when a company takes a deal like this, the odds are overwhelming that its stock will drop. Within six months, Ramtron's share price dropped from $5 to $0.25. Of the 220 such toxic convert deals that took place in 2000, only five companies wound up in better shape -- most of them tanked.
It happened to eToys. It happened to MicroStrategy (Nasdaq: MSTR). It happened to Quokka Sports (Nasdaq: QKKA). And it happened to hundreds of other startups on the verge of extinction. Still, hundreds more clamor for a similar deal. And for every company in need there is an organization willing to lend a hand -- for a stiff price: Promethean Asset Management, the Citadel Investment Group [Kenneth Griffin], Marshall Capital Management, and Angelo, Gordon & Company. There's a reason they aren't household names. They like to stay under the radar, says Steve Bruce, an attorney who represents the Citadel Investment Group, explaining why his clients and their competitors would be unwilling to discuss their business.
THE QUICK AND THE DEAD
Toxic converts are a form of private investment in public equity (PIPE) and are known in the industry as the grimmest of reapers. Companies accept the financing because it is fast -- typical deals close within a month -- and the sums are generally below the $30 million minimum for secondary offerings. A last-ditch infusion of capital tied to stock price is an entrepreneur's way of gambling on a long shot -- that the struggling company can quickly turn around. Far more frequently, however, it is merely an invitation to the short-sellers -- often the PIPE investors themselves -- and throws the company's stock into an irreversible death spiral.
Meanwhile, the investors get fat at the expense of long-term individual and institutional investors. Promethean Asset Management founder and president James O'Brien boasted in the pages of a conference agenda that his $140 million fund has returned 126 percent since 1996, when the financing mechanism was first unleashed. Six years ago, 36 death-spiral deals worth a combined $264 million were consummated, according to private equity tracker DirectPlacement.com. In 2000, death-spiral deals were taken by 220 companies and accounted for $2 billion of the $18 billion overall PIPE industry. This popularity comes despite the fact that the death-spiral investors, motivated by a seller's market, stack the odds higher and higher with increasingly onerous contract demands.
As the technique grows in popularity, so does the controversy surrounding the profiteering. And now some companies and long-term investors are fighting back. The State of Wisconsin Investment Board, which manages a $60 million portfolio, has threatened to sue any of its portfolio companies that get involved with PIPEs. Several other companies have sued or are suing their PIPE investors. The growing ranks of dissatisfied companies include Log On America (Nasdaq: LOAX), Ariad Pharmaceuticals (Nasdaq: ARIA), and Ramtron, where Mr. Sikes struggled to extricate his company from the deadly deal's tight grip. That was the most miserable year of my life, he says.
Ramtron, based in Colorado Springs, Colorado, lives on today only because the deal went so horribly sour. The investors demanded more shares than the company had issued. Using that as leverage, Mr. Sikes engineered a five-for-one reverse stock split and paid the investors 50 cents on the dollar to settle several lawsuits. But Mr. Sikes, who retired last year, was one of the few lucky ones.
DEVIL'S FOOD
When Mr. Sikes signed his deal with the devil, he was able to explicitly ban his investors from short-selling the company's stock. It did little good. The company was hit hard by unidentified short-sellers who helped send the company's stock into a six-month nosedive. Things can happen offshore that you can't prevent, he says.
Today's PIPE deals don't prohibit short-selling by the investors. In fact, companies sign contracts that explicitly allow the investors to sell stocks short. The companies resist the clause in the first four or five drafts of the contract, says securities lawyer Robert Friese. But by the sixth draft, it's in there.
When it comes time to recoup their investments, death-spiral dealmakers garner enough stock in the companies to cover large short positions and have enough left over to take control.
Another benefit of short-selling for toxic-convert investors: as the stock drops in price, not only do they get a larger share of the company, but the company's valuation makes it an attractive takeover candidate -- enabling the investors to make money on both ends.
Judson Schmid, chief financial officer of health care content provider ProxyMed (Nasdaq: PILL), points out that for dot-coms that went public too soon, there often is little choice -- take the tainted money or turn off the lights. When you get desperate, you're willing to overlook things, he says.
Ramtron's 1998 agreement called for it to repay the death-spiral investors with common stock discounted 7 percent from the prevailing market rate. Now, companies are consenting to repay the investors with stock discounts ranging from 10 percent all the way up to 30 percent.
In December 1999, ProxyMed raised $15 million in a death-spiral deal with several investors. Among other concessions, ProxyMed agreed to voluntarily delist from the Nasdaq in the event that the investors were owed more than 20 percent of the company and its long-term shareholders refused to allocate additional stock. At the time ProxyMed signed the deal, its stock traded at $10 a share.
When the investors came calling for repayment last year, the company's stock had collapsed to below $3 a share. By May, the company owed the investors close to 40 percent of all its common stock. Rather than delist, ProxyMed's shareholders agreed to a radical dilution of the company's stock. They doubled the company's stock allocation from 50 million to 100 million, in essence devaluing their investments by half to pay off the death-spiral deal. The company also needed additional funding in 2000, taking a $24.3 million investment that further diluted the company's ownership.
ProxyMed now trades at around $1 a share.
PROMETHEAN UNBOUND
These deals are also referred to as corporate loan-sharking, payday advances, or pawnshops for dot-coms. Mr. O'Brien, an industry pioneer, established Promethean in 1994 after serving as managing director of Fletcher Asset Management in New York. Last year, Promethean invested nearly $108 million in 11 companies. The stock of every one of those companies lost value after the investment. According to PlacementTracker.com, the stocks of companies that Promethean has invested in since 1995 have dropped an average of 36.5 percent just six months after closing the deals and 17.3 percent after a year.
Last year, Promethean chipped in $25 million of the $100 million in death-spiral convertibles invested in eToys and $20 million of the $125 million invested in MicroStrategy. EToys stock plummeted from around $5 at the time of the deal to almost zero this year and at press time was facing bankruptcy and Nasdaq delisting. MicroStrategy stock traded at $38 when its deal was announced in June, almost four times what it was trading by February. Promethean's partners in those two deals were Citadel in Chicago and Angelo, Gordon in New York.
Citadel [Kenneth Griffin] is a $4.5 billion hedge fund that invested $141 million in seven companies last year, including $60 million in MicroStrategy and $30 million in eToys. Citadel's portfolio companies decline an average of 21 percent a year after closing its death-spiral deals, according to PlacementTracker.com.
Angelo, Gordon's portfolio companies fared somewhat better, dropping a mere 6 percent a year after closing its deals. But Angelo, Gordon doesn't do as many death-spiral deals as Citadel [Kenneth Griffin] and Promethean. Last year, Angelo, Gordon closed seven death-spiral deals for a combined $125.7 million, of which $90 million was divided equally between investments in eToys and MicroStrategy.
Clearly, companies signing up for such financing are generally poor performers and doomed for failure anyway -- with or without additional cash. The death-spiral deals themselves don't necessarily kill an already dying company. But they definitely hasten death.
The investors are assured automatic profits because they demand repayment in common stock, sold to them below the prevailing market price. They face little downside in shorting the stock, especially since the companies are usually in financial trouble and their stocks were destined to tumble anyway.
TOXIC AVENGERS
As more death-spiral deals go bad, some long-term investors and even the companies themselves are fighting back.
In banning its portfolio companies from taking toxic converts, the Wisconsin Board of Investment warned: The investors have gone through great lengths to appear thorough and genuine in their interest in the companies. However, they may actually be assessing the odds of failure. Adding a toxic security to the financial structure increases the odds.
If a company in the portfolio succumbs to temptation, We will sell the company or seek some kind of [legal] action, says board analyst Mark Traster. The investment board also threatened to pull its business from a large investment bank that is trying to get into the death-spiral business. With the growth of this financing technique -- and the drying up of traditional investment banking services -- prestigious investment banks are entering the market. For example, Credit Suisse First Boston now controls Marshall Capital Management, which specializes in death-spiral convertibles.
Meanwhile, several companies have sued their death-spiral investors, alleging fraud and market manipulation. Ariad sued Promethean in 1999, a year after Promethean invested $5 million in the company. The suit accused Promethean of shorting 2.5 million shares -- 10 percent of the company -- soon after closing the deal. This massive short-selling helped send Ariad's stock from $3 a share to just $0.59 in a few weeks, say executives at Ariad.
The companies settled last year. Ariad agreed to issue just under 1.1 million new common shares so Promethean could cover [its] total outstanding short position, according to a document filed with the U.S. Securities and Exchange Commission. The company also agreed to pay Promethean $6.9 million.
Citing a nondisclosure agreement, lawyers for both sides declined to discuss the case. But Log On America, a small Rhode Island ISP, is using the Ariad settlement as a centerpiece for its own suit against Promethean, Citadel, and CSFB's Marshall Capital.
Log On America accuses the investors of stock fraud. The investors, Log On America alleges in its suit, funded the company simply to launch an unlawful scheme to short-sell its stock in sufficient volume to drive down its price, knowing that they would be in a position to cover the short sales by converting their preferred stock at depressed market prices. The investors' alleged short-selling, according to the lawsuit, allowed them to reap millions of dollars in profits from short-selling while simultaneously allowing them to reap tens of millions of dollars in profit and seize control of the company as the ultimate result of the PIPE deal. Since Log On America entered into the deal in January 2000, its stock price has dropped from $17 to $2.50, and the company has lost about $120 million in market capitalization.
None of the investors returned telephone calls. But in court documents, they deny all of the accusations. In fact, every investor except Marshall Capital denies that they sold short a single share of Log On America stock. Besides, they say in court papers, even if they did sell short, they did nothing illegal.
Indeed, the contract explicitly allows the investors to sell short. Their bottom line: Log On America is trying to get out of having to live up to its obligations under the agreement.
LIFE AFTER DEATH
What the lawsuit doesn't fully explain is why Log On America entered into the deal in the first place. That's saved for a separate suit against CSFB, which served as Log On America's financial adviser and helped negotiate the death-spiral deal. The suit alleges, and Log On America CEO David Paolo asserts in a separate interview, that CSFB led them astray with bad advice and that the advice was given because CSFB was concerned primarily with sending business to its subsidiary, Marshall Capital.
Mr. Paolo says his company had $20 million in cash on hand and a burn rate of $4 million a year when CSFB persuaded Log On America to take the deal. We should never have done that deal, Mr. Paolo says now. We didn't need the money. At press time, the investors were attempting to have the suit thrown out.
Meanwhile, most of the companies that took these deals weren't like Log On America. They were young companies teetering on the brink of extinction. Death-spiral investors were the only places these companies could raise more capital. Some decided against taking a death-spiral deal and chose to shut off their lights instead. An investor, who asked not to be identified, asked rhetorically, Who was better off, Pets.com or eToys? EToys lasted longer and gave it a shot. Pets.com didn't, and shareholders in both companies are now in the same position. Which is worse?
Julie Wainwright, CEO of the now-departed Pets.com, did, in fact, turn down offers from the toxic-convert crowd as the company sank into oblivion late last year. She apparently didn't want Pets.com tossed into a vortex that would end with toxic-convert investors walking away with the company's carcass. Instead, Ms. Wainwright filed for bankruptcy under Chapter 7, choosing to liquidate Pets.com and pay off the company's creditors and long-term investors as best she could. Ms. Wainwright apparently reasoned that the act of putting down Pets.com without taking a toxic convert was a more dignified death.
But there's another benefit to avoiding the financial grim reaper. By not selling out the interests of long-term investors to Johnny-come-latelies, executives like Ms. Wainwright stand a chance of burning fewer bridges -- increasing their odds of staying in the game.
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8:16 PM  
Blogger bob obrien said...

Link - the reason for the duplicity is simple. If you listen to the apologists and defenders for the short cabal, they freely intermingle legitimate short selling with illegal naked short selling. Herb does it all the time. In his small mind, they are interchangeable, as apparently they are in Jeff Mathews'. The problem is that while doing the predictable and obligatory shuffle in homage to Rocker, citing now 8 year old cases where some of his research turned out to be correct, and ignoring the dozens of companies he was wrong on, they mix illegal activity with legal activity. And they do so with good reason - the more they can get Byrne to seem as though he is attacking legal short sellers vs. illegal failing to deliver, the more unbalanced and reckless they can make him appear. Ditto for me. If they can make me seem like a loon rather than a guy describing the anatomy of a stock manipulation, then they can get people to discount the possibility that what they are hearing is fact rather than fancy. And that is ultimately the objective - demonize the messenger.

It's not a new technique. Rather time honored, actually.

7:41 AM  

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