Stupid Human Tricks, Part 1
Today's column started out as a collection of stupid things people do in the stock market. A few hours later it had turned into a full-blown mini-series. Here's Episode One.
Not long ago, in a stock market not far away at all…
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Imagine a fictitious company called Certified Regional Administration and Planning (CRAP). CRAP bills itself as a "business consulting firm which helps its clients solve complex byproduct transportation and disposal issues." In other words, cities and companies pay CRAP to help them find places to dump their garbage and industrial waste. Not a very sexy business.
And not a very profitable one. In several years of operations, CRAP lost millions of dollars wining and dining potential clients and building a fancy corporate headquarters. They didn't generate much revenue but the new corporate "campus" was beautiful.
Eventually the banks refused to loan CRAP any more money. So CRAP's directors decided to share their good fortune by taking their company public.
There was no way CRAP could meet the standards for a formal IPO on the NASDAQ. No respectable Wall Street firm would touch them.
CRAP had their lawyers file the necessary papers to trade "over the counter" on the OTC Bulletin Board instead. CRAP stock was born at $5 per share, with 5 million shares publicly traded "in the float" and another 10 million shares held by company insiders. The Market Makers – NASDAQ firms that buy and sell stocks to "maintain a market" for a company – were small operators in regional centers far from Wall Street.
Fast forward to two years later – CRAP had fallen to $1.25 per share. Heavy cash burn (spending a lot without generating any real cash earnings) left the company with less than a million bucks in the bank. Without new financing, CRAP would have to close its doors by the end of the next fiscal quarter.
A generous company options plan had already increased the outstanding shares to 18 million with 8 million in the float. Most insiders exercised their options to buy shares at .10 and sold for $2-3 as soon as they could. Company insiders took home more than $6 million while the company they managed was losing money.
This is where the real fun begins. First CRAP management spoke discreetly with some professional "financiers" based in the Cayman Islands, who offered CRAP $10 million in financing in return for "discount convertible" stock payable in six months, and a hefty interest rate in the meantime. If the price of CRAP stock went down, the financiers would get even more shares to convert and sell.
The press release announcing the new financing was extremely vague about the discount convertible aspects of the deal. Nothing was filed with the SEC since the rules forcing BB companies to disclose their finances won't go into effect until late 1999 or even next year for some companies.
It was CRAP's next press release that really grabbed everyone's attention.
"CRAP.COM ANNOUNCES PROPRIETARY SYSTEM TO MANAGE CIVIC WASTE DISPOSAL OVER THE INTERNET". CRAP announced an "interactive database and inter-government communications program aimed at helping communities cope with the growing solid waste challenge in America."
CRAP stock rose from $1.25 to $2.50 the next day. An obscure "investor relations" firm issued an "investment opinion" rating CRAP a Strong Buy with a 12-month price target of $10 based on their "innovative, groundbreaking use of the Internet to link thousands of local governments with waste disposal problems." Under new regulations, the IR firm had to disclose that CRAP had paid them 100,000 shares of stock for their services, plus another 100,000 warrants.
Stock chat boards all over the Internet buzzed all day and most of the night about CRAP's future chances.
One of the posters who noticed the CRAP excitement went by the name of "NewKid". He was actually not a kid any longer, with a job, two kids of his own, a mortgage and a 1988 Oldsmobile Cutlass which badly needed a $1200 engine job to avoid ending up in the scrap yard.
NewKid hadn't been trading for very long. Some of his buddies at the office kept talking about making lots of money in the stock market, so he took his limited savings and opened an online brokerage account. So far, he had done OK with tips from Internet chat boards. He couldn't "afford" the expensive stocks so he mostly looked for companies under $5.
NewKid would hold a stock for a few days and try to sell for a small profit. He seemed to lose money as often as he made it, but he remained optimistic.
NewKid liked what he saw about CRAP. The company was described as a leader in the waste management field – NewKid was an accountant who hated taking his trash to the curb and didn't know anything about the waste management industry.
But he also received an E-mail from a free Web site he subscribed to, MoonShotStocks!, saying that CRAP would be a big gainer for people who got in soon.
One busy poster with the clever moniker "CrapMan" kept talking about a "secret, illegal short position" which several "crooked Market Makers" would have to cover when CRAP's Internet system took off and they finally got a NASDAQ listing. "Naked" shorts occur when a Market Maker or trader sells stock that they haven't actually borrowed from someone else first.
CrapMan claimed that was the only reason CRAP had gone from $5 to $1.25, "evil naked shorts."
Between the Internet announcement and a clear short squeeze on the horizon, NewKid felt lucky to buy 2000 shares at $4.50.
He was even happier when CRAP opened at $6 (that's a $3000 profit!) the next day and ran as high as 7 ½ ($6000 ahead now!). The sudden drop back to $5 took NewKid by surprise, but CrapMan and some other posters on the CRAP thread had warned everyone about a "shakeout." The same crooked Market Makers would try to grab cheap shares to cover their growing short position.
No way NewKid was going to fall for that old trick. He was still $1500 ahead by market close, with CRAP at 5 ¼.
CRAP traded 12 million shares that day. "Institutional buying," CrapMan cooed. "Wait until the NASDAQ listing is public. I won't sell until CRAP hits $50!" Volume the day before was 3 million shares, still more than 20 times higher than the 125,000 daily average CRAP had seen for the past year.
CrapMan also posted an E-mail that looked like it came from the CRAP CEO. The CEO promised a "nationwide system rollout" in the very near future and a "quick application for a NASDAQ listing." NewKid went to bed happy.
The next day, NewKid was tied up in meetings all morning so he didn't check CRAP's share price until almost lunchtime - $2.50! CRAP had opened at 4 5/8, down 5/8. From there it went straight down.
NewKid frantically skimmed the hundreds of new messages on the CRAP thread but no one seemed to know what had happened. NewKid only knew he was down $4000 and couldn't decide whether to hold or sell at a loss.
Someone said he should have used a "stop loss" order, but he didn't know what that was. Anyway, CrapMan said that the posters knocking CRAP's new Internet system were paid shills, sent by the illegal shorters to knock the company and hold down the share price until they could cover.
CrapMan said that all the CRAP longs should "call their certs" to stop the shorts. Taking delivery of an actual stock certificate means the shares can't be borrowed by someone taking a legitimate short position in a stock.
NewKid was too confused to think about "calling his certs." He kept thinking about the engine job for the Cutlass and how he would pay for it now.
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(To Be Continued)
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