Legal woes for research firms may mount
Tue Feb 28, 2006 11:57 AM ET
By Anna Driver
NEW YORK (Reuters) - Independent research firms like Gradient Analytics Inc., which is accused of conspiring with short-sellers to drive down share prices, may end up in court more often as companies step up defense of their stock.
Gradient -- a Scottsdale, Arizona-based research firm, which promises clients the use of forensic accounting to uncover fraud -- has been sued by Canadian drug company Biovail Corp. (BVF.TO: Quote, Profile, Research) (BVF.N: Quote, Profile, Research) and online retailer Overstock.com Inc. (OSTK.O: Quote, Profile, Research), accused of conspiring with short-sellers to drive down share prices by issuing negative research reports.
The U.S. Securities and Exchange Commission is also looking into the accusations that Gradient and hedge funds worked together to manipulate share prices. The government's inquiry came to light after journalists received subpoenas from the SEC earlier this month for their notes on stories about Overstock.
"There has been simmering concern about abusive short-selling practices," said Paul Kamenar, of the nonprofit Washington Legal Foundation.
"It's tricky because this is a more sophisticated area of trading. As people become more educated, I think you will see more lawsuits and enforcement actions."
Short-sellers profit when a stock price declines. They borrow shares and sell them, hoping to buy them back later for less.
PINPOINT WRONGDOING
Moin Yahya, a law professor at the University of Alberta who has written about short-sellers and the law, said this is an issue getting the attention of lawyers.
He noted that short-selling can be beneficial to investors when hedge funds and research firms suspect something is amiss at a company and are found to be right.
For example, David Tice, who heads the $411 million Prudent Bear Fund (BEARX.O: Quote, Profile, Research), was among the first in 1999 to suspect accounting fraud at Tyco International Ltd. (TYC.N: Quote, Profile, Research). Last year, former Tyco CEO Dennis Kozlowski and former CFO Mark Swartz were convicted of stealing more than $150 million from the company.
But Yahya said problems occur when hedge funds and research firms "are in cahoots" and act out of maliciousness.
"The problem is there are a lot of gray areas," he said, adding that although companies may be more likely in the future to use lawsuits to hit back at short-sellers, these types of cases are murky and hard to prove.
Overstock.com has accused Gradient of editing research to be more negative at the behest of its client, noted short seller David Rocker of Rocker Partners LP.
In the past year, Overstock.com shares have dropped almost 60 percent to be trading at $22.45 on Tuesday.
In the Biovail case, the Canadian drugmaker accuses Gradient and its predecessor Camelback Research Alliance Inc. of distributing negative research reports containing information obtained from hedge fund SAC Capital Management.
Biovail shares have fallen from a 52-week high of $27.28 last November to be trading at $25.29 on Tuesday on the New York Stock Exchange.
"These reports-for-hire were referred to internally at Camelback and Gradient as 'hatchet jobs' and typically were released at the behest of short-selling hedge funds," said the Biovail lawsuit filed in New Jersey State Court.
A spokeswoman for Gradient confirmed that Rocker is a Gradient client and said that SAC used to be.
Gradient would not comment on the SEC investigation but said through a spokeswoman via e-mail that its policy is to cooperate fully with any regulators who contact the company.
Gradient has denied all charges in the lawsuits, most recently saying the charges in the Biovail lawsuit were malicious and made by a company with a "history of questionable accounting practices and book-cooking incidents."
Biovail's accounting practices are under investigation by the SEC and by Canadian authorities.
And on Tuesday, Overstock.com said in a regulatory filing that it will restate its financial results back to 2002, citing an error related to the booking of freight costs.
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