Stupid Human Tricks, Part 2
Let's take a closer look at what really happened to NewKid's big play in CRAP.
Legitimate companies can raise money all sorts of ways. They can sell shares to private investors at a fixed price, get a bank loan or even sell bonds if a reputable firm will underwrite the issue. Only crappy little companies resort to discount convertible financing. Many never survive the consequences.
The convertible holders in CRAP's case knew they would get at least 10 million shares for their $10 million investment. The agreement came with a 20% discount built in (the convertible holders would get 10 million shares at $1 if the market price was $1.25).
If the price dropped below $1.25, say $1, they would get 12.5 million shares at .80. The 20% profit is guaranteed up front. But what's the difference if CRAP has to repay $10 million regardless?
A lot for shareholders like NewKid whose shares are worth less and less as CRAP issues more new shares. An extra 2.5 million shares would be more than 10% of the total outstanding. And the convertible deal was going to dilute current shareholders more than 50% already (from 18 million shares outstanding to 28 million shares).
On top of that, the convertible "investors" had no intention of selling their shares that cheaply anyway. NewKid was about to get nailed in the discount convertible financing racket.
Once the Internet news came out on CRAP, the convertible holders called up their offshore brokers in the Caymans and had them start shorting CRAP as fast as they could. Ordinary retail traders in the US usually can't short a BB stock. But that limitation doesn't apply to offshore operations.
The brokers knew that the discount convertible firm would get at least 10 million shares from CRAP for their original investment (which they would use to cover their short position). So they shorted several million shares "naked" at prices ranging from $4 to $7.50. The brokers never bothered trying to borrow the shares from somewhere else. Which is good – because the shares didn't exist yet.
As for CrapMan's exhortation to "call your certs," it wouldn't have made any difference to the Cayman Islands shorters. They were shorting against their discount convertible shares, not existing shares.
The proceeds from the short sales went straight into the convertible holders' accounts. Instant profit before the conversion ever took place. Imagine a business where you can put up $10 million and take home $30 million just a few months later – and still have half your investment left to redeem.
No one knows exactly how many shares are shorted this way. Offshore firms cannot be held accountable by the SEC, only US-registered companies.
The other "illegal short position" that CrapMan hyped on the chat thread probably never existed. If it did, NewKid could not have verified that either. Only company officials can get the actual trading reports for their stock.
The "transfer agent," who keeps track of who holds the outstanding shares, will confirm only how many shares of a company are supposed to be trading. The "TA" wouldn't notice the extra shares until the next monthly report.
And it's not illegal for Market Makers to short "naked" anyway. In fact, it's part of their job.
When CRAP took off and orders to buy millions of shares flooded in, the MM's didn't have that much CRAP stock in their inventory to sell. To continue "making a market" they sold shares they didn't have and ended up in a net short position.
That is why CRAP suddenly pulled back from $7.50 to $5. Daytraders started to take profits over $7. The buy orders dried up as traders sold their CRAP shares. The MM's dropped the bid as fast as they could to buy back cheap shares (under $7) compared to where they had already sold them.
One trader I know calls this high-volume blow-off top "spinning," like a washing machine in a spin cycle.
NewKid was caught in a crossfire. The convertible holders were dumping millions of new shares into the market, shares which he didn't know existed. And the convertible holders would sell for any price they could get. Anything over $1 was pure profit.
Needless to say, companies that resort to convertible financing stand little chance of sustaining the minimum bid (usually $4) required to get a listing on the formal NASDAQ exchange. The convertible holders will destroy the share price as they short as many shares as possible.
Once CRAP's share price went under $1.25, the convertible holders could short even more because they knew they would get more shares. They kept driving down the price until they sucked the last drop of blood out of CRAP shares.
Shorting a million shares at $1 and replacing them with shares bought at .80 is still a cool $200,000 profit. Tax-free in offshore havens like the Cayman Islands.
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NewKid also made a big mistake believing the Internet story in the CRAP press release. Companies with rotten track records almost always continue to be rotten companies with rotten management, no matter what business they are in. Any group which hasn't turned a profit after several years in business doesn't deserve your investment dollars.
In CRAP's case, the whole Internet system was a fraud to begin with. CRAP had a database of dumpsites around the country and started to use E-mail to stay in touch with city governments about their waste disposal needs. Whenever CRAP managed to connect a dump with space and a city that needed extra waste disposal capacity, it was a sale for the CRAP.COM "system".
Beware of new "systems" with low barriers to entry (i.e. anyone can easily copy their business and compete). They are the opposite of "incredible gizmos" like instant cures for cancer and AIDS, or perpetual motion machines.
CRAP's competitors were already using the Internet to link up customers and dumpsites; they just hadn't thought about touting it in a press release.
Most established companies already have an in-house Investor Relations department. They don't pay outside firms with cheap stock to tout the company on Internet chat boards. They also don't need to hype up their share price for the benefit of offshore financiers.
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Finally, NewKid believed the myth that anyone who "bashed" CRAP on the Internet was a tool of the "evil shorts" with the "illegal naked short position." Most US traders can't short Bulletin Board stocks to begin with, and those who can rarely bother shorting stocks under $3. The professional shorters I know won't touch ‘em until they run up, like CRAP did to $7 after it traded near a buck for a long time.
"Penny" stocks like CRAP go down because no one wants to buy a lousy business with management that loses money year after year. The "illegal short position" is usually a figment of a hypester's vivid imagination. It happens to sound good to naïve investors like NewKid.
BB stock hypesters like CrapMan are the real villains in this story. Without them, newbies like NewKid probably won't get sucked into buying stocks like CRAP. They certainly won't hang on while their profits turn into losses amidst the chaos and confusion that always follows the first big press release.
When a hypester says that heavy volume in a BB stock is institutional buying, he is lying, pure and simple. Most funds aren't allowed to buy stocks under $10, much less BB stocks trading under $5 like CRAP. The big blocks you see when stocks like CRAP are "in play" are usually insiders and convertible holders shorting all they can into the heavy daytrading volume.
Was CrapMan a paid hypester for CRAP? The only way NewKid could find out would be to sue "CrapMan" and get the online service to divulge his real identity. But NewKid didn't have the money for a lawsuit like that.
If you are long a BB stock and someone shows up who says "Look at the press release, they just got $10 million in discount convertible financing!" you should listen. Check the SEC filings (if they exist) and get an accurate picture of the company. If the company doesn't file with the SEC, sell your shares and run like hell.
If a "naysayer" points out that existing company management hasn't sold anything except stock for several years, take a step back and think about it. Would you buy a company that never makes money? Probably not. So don't buy stock in a company that does unless you have a very clear plan to sell quickly for a profit.
All of these gimmicks are designed to make you want to BELIEVE in the hype. If the story sounds too good to be true and the guy making the offer is someone you would cross the street to avoid, save yourself some anxiety and some money. Move on to the next stock.
Go find a decent company with SEC filings and buy some shares. You may not get rich overnight buy you will sleep better.
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Epilogue: CRAP was delisted six months after NewKid sold his shares at a $5000 loss. NewKid closed his online trading account and took a second job. The CRAP CEO left the company shortly before it went bankrupt. He moved to the Cayman Islands, where his new partners in the venture capital firm he joined helped him settle in to a comfortable new lifestyle. He never liked the smell of landfills anyway. And the weather was a lot warmer than Hoboken.
Any resemblance between Certified Regional Administration and Planning (CRAP) and actual stocks currently trading on the OTC: BB is purely coincidental. Uncanny, perhaps, but coincidental.
Do you have a comment or a suggestion for a future 50% Gains Investing column? E-mail me at dabmu@yahoo.com.
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