CRYBABY CRUSADE By CHRISTOPHER BYRON
nypost.com
June 26, 2006 -- THIS week's issue of Barron's warns that a bear market could be on the way. It's the sort of forecast that normally brings smiles to the faces of Wall Street's short sellers, who profit when stocks go down.
But you won't find many smiling short sellers on Wall Street. It's getting harder and harder to find anyone willing to admit being a short seller, period.
It's all because of escalating attacks from Wall Street and Washington, where a whole new generation of stock market crybabies have turned to "the shorts" as their piñatas of choice for just about any investment that goes bad.
Their current hobbyhorse: a whiskered issue called "naked short selling," which the Securities and Exchange Commission first looked at 18 years ago after complaints began to circulate about a well-known group of short sellers from that era, the Feshbach brothers of Palo Alto, Calif.
Naked shorting, the short sale of unborrowed stock, was judged by the SEC not to be a menace and pushed aside. But now the issue is back, in part due to complaints by groups like the National Coalition Against Naked Short Selling, and this time around the SEC has been listening.
Eighteen months ago, a new SEC rule intended to crimp short selling, Regulation SHO, went into effect. We'll look at one of its unintended consequences: the creation of a huge new speculative bubble in otherwise worthless companies - many of them penny stocks - that are being propped up by the regulation.
First, however, a brief review of what short selling is all about, and why it's important to the orderly functioning of the market - or at least, let us say, to the orderly functioning of a market that is based on more than just the relentless upward march of stock prices to attract investors.
Stock prices are supposed to be based on the ability of public companies to turn a profit. Upon that premise has been erected the entire edifice of the U.S. equity markets.
The research reports of Wall Street's brokerages and investment banks, the audited financial statements of their corporate clients and the policing and enforcement apparatus of the regulators all essentially serve a single purpose: to give investors as accurate a picture as possible of a company's ability to make an honest buck.
IN this system, short sell ers function like self-ap pointed ombudsmen, constantly searching for stocks with inflated prices based on anything from fraudulent financial statements to misleading press releases to the distorting enthusiasms of the market.
When a short seller spots such a stock, he'll call up his broker and "sell" it, even though he doesn't actually yet own it. Instead, his broker will "borrow" it for him, often from the brokerage firm's own inventory of stock.
In the arrangement, the short seller hopes that, when the time comes for him to close out his short position, he'll be able to do so by buying new shares for cheap on the open market. He is betting that the difference between what he pockets from the original sale and what he has to shell out subsequently to purchase the shares back in the open market will yield him a nice profit.
Short selling is entirely legal, but it hardly sounds kosher. Selling something you don't actually own puts one in mind of former New York Post columnist Pete Hamill's description of stealing: what happens when you find something before it is lost.
Short sellers have thus been convenient whipping boys in every market downturn since the 1930s. But in recent years, the attacks have grown more pointed and menacing as the market has begun to change from one based on trends in earnings into one dominated increasingly by a handful of hedge funds and other large institutional investors that buy stock based solely on the upward momentum of its price.
In this new world of so-called "momentum investing," short sellers have no place at all, with their criticisms of a company's financials or business practices seemingly at best irrelevant and at worst designed to destroy the company for the short seller's own gain.
When short seller Manuel Asensio of Asensio & Co. published the first in a series of well-researched and insightful attacks on the business fundamentals of an overpriced nanotech outfit called NVE Corp. in early 2004, he earned the ire of Wall Street's increasingly noisy anti-short selling crowd for popping the balloon in a stock that had soared from $6 to $66 in the previous six months on momentum trading alone. The stock has since collapsed back to about $13.
The SEC's Regulation SHO, which went into effect in January of last year, makes it increasingly difficult for short sellers to practice their craft. The rule requires the Nasdaq and the various exchanges to publish a daily list of stocks based on a complex set of calculations involving the number of shares that are sold short but wind up never actually being delivered to the buyers. Under the rule, any such stock on the SHO list cannot be sold short unless the broker can affirmatively state that he has obtained borrowed shares for the seller.
The idea behind the rule is to prevent the short sale of more shares in a company's stock than actually exist, which would, of course, destroy the market for any company's shares.
In practice, the rule has removed the downward pressure on the shares of a number of doubtful companies and sent their prices soaring the very instant they turn up on the SHO list, which momentum traders watch like hawks.
CONSIDER GHL Tech nologies, Inc., which attracted the interest of short sellers after an Internet-based research group called Stocklemon.com published a research report in late May noting that the company had no current financials, and that its Web site listed no corporate address or phone number.
Six days later, GHL, which trades under the ticker symbol GHLT, landed on Nasdaq's SHO list and the stock soared from $2.32 to nearly $9, creating a market cap of roughly $315 million for a company whose only available audited financial statement (for the year that ended Dec. 31) shows balance sheet cash of $7,683.
At the height of the momentum feeding frenzy in GHLT last Monday, an astounding 5 million shares, or 73 percent of the stock's total public float, changed hands in a single day, suggesting that even as momentum players were piling into the stock, insiders were bailing out in a classic pump and dump.
Or how about Atlanta-based Charys Holding Co., which began as a Minnesota hardware business in 1959, drifted into the Internet search engine business, and has now morphed into a holding company with a business plan based vaguely on acquiring "various companies" in telecommunications.
Charys was selling for $1.25 a share on the OTC Bulletin Board when it landed on the SHO list on April 17. By June 6, it had hit a recent high of $10.75.
Every company is unique, but overall, it is hard to escape the conclusion that Regulation SHO has turned out to be free money for shaky companies with uncertain futures - at least so long as they can stay safely ensconced on the list and out of the clutches of Wall Street's official new bogeymen: the shorts.
cbyron@nypost.com |
