Dow Jones Business News -- December 20, 1996
Some Small Cos. Charge Offshore Hldrs With Stk Manipulation
By MICHAEL SANTOLI
Dow Jones News Services
NEW YORK -- For some small companies and their investors, convertible securities aren't always.
In a dim corner of the securities markets, where small issuers tap mysterious offshore money, companies almost routinely stop allowing investors to exercise their rights to convert securities into stock.
Nearly a dozen times in recent months, publicly traded companies have suddenly ceased issuing common shares for their convertibles, enraging investors who hold the securities and sometimes spurring bitter lawsuits.
In every case, management has said it is taking the action to head off ''unusual trading activity'' fueled by the conversion of its securities at a discount to their stock's market price. The companies' position is always that their stock price has been driven down by the orchestrated maneuvering of sophisticated offshore investors.
The investors, they say, improperly collude to convert shares en masse, while they and privy market makers sell the company's common shares short. The short sales are a bet that the impending dilution from newly converted shares will further depress stock prices and will make more stock available to cover short sales.
More pointedly, companies charge that holders of the convertibles sell borrowed shares short and then immediately acquire more at a discount through conversion, pocketing the difference. By driving down the stock price, they are entitled to more shares and thus have more stock to use to cover short sales.
The mass conversions produce ''incredible dilution based on the fact that these (investors) are flippers,'' said Ronald Feldman, investor relations officer at Response USA Inc. (RUOK), which stopped conversion on some securities and is in a legal tussle with its investors.
In some cases, there certainly seems to have been suspicious trading activity. Feldman said in researching deals with similar groups of investors he found others in which the issuer's stock lost nearly one hundred percent amid conversions.
Larry Armstrong, president of oil-services provider Ponder Industries Inc. (PNDR), said it was apparent to him that concerted manipulation was occurring when trading volume in Ponder shares, then at a daily average of 65,000 shares, soared to 3 million in a single week in July. The stock currently trades around 1 1/2, down from a 52-week high of 6 1/4 in March. Ponder is suing its placement agent and investors for fraud.
But that may not be the whole story. Bankers and investors claim that companies with flimsier claims of manipulation, seeing the prevalence of halted conversions, are using the tactic to avoid distributing more stock, while keeping investors' money and possibly boosting their stock.
The most recent public announcement by a company halting conversion of securities came from National Health & Safety Corp. (NHLT), a troubled Warminster, Pa., marketer of health-care products that earlier this month said it had hired special counsel to look into the trading in its shares.
Dennis R. Bowers, chief executive of National Health & Safety, said, ''Our belief is there was some concerted and controlled trading and dumping (of shares) that collectively, if you put the profile together, is market manipulation.'' Trading volume did indeed crest in the weeks before conversion was stopped Dec. 9, with share prices hovering at 10 cents to 15 cents, compared with a six-month high of 50 cents and a 52-week high of 2 7/16 on the over-the-counter bulletin board.
Bowers added that some holders of the company's convertible debentures ''may not have been thoroughly fitting of SEC guidelines for a foreign company.''
In SEC filings, the company said the SEC and National Association of Securities Dealers have since 1993 had their own inquiries into the trading in its stock unrelated to the recent private placements. The SEC made its inquiry a formal investigation in 1994. As yet, those inquiries have yielded no findings or charges that the company is aware of.
Also in those filings, the company details its need to raise further funds, saying it is ''actively pursuing interim financing to provide working capital and to increase marketing activities.'' Efforts to get financing from a succession of firms, ''some of which date back to 1994, have been discontinued,'' it said. Negotiations with certain foreign investors for additional equity financing were continuing at the time of the filing in November.
The ability to continue as a going concern, the filing warned, ''is directly dependent on the success of its future operations and ability to obtain additional financing.''
As for operations, in the nine months ended Sept. 30, National Health & Safety lost $1.3 million on just $183,000 in sales. A major expense contributing to that loss came from guaranteed compensation agreements with Bowers and two other top executives that total more than the company's annualized sales.
The difficult financial position of the company has fueled accusations by investors that National Health & Safety has halted conversion of its debentures only as a stall tactic either to attempt to raise more money or to goose the stock higher.
Bowers called such claims ''patently untrue.''
The stock, whether because it was freed from short sellers or due to encouragement about the company's assertiveness, jumped to 20 cents from 12.5 cents the day conversion was halted.
The disputes animate an obscure end of the securities markets, where desperate companies meet secretive investors who will throw them a cash lifeline only in exchange for exceedingly favorable terms that all but guarantee the buyers a big profit. The deals tend to be sold in the form of either Regulation D or Regulation S private placements, designed for secrecy, speed and, in the case of Reg S, foreign investors.
The notes or preferred shares can usually be converted into common shares at a 15% to 50% discount to the common stock's market price.
While conceding that some deals do result in stock manipulation, some who deal in the market say companies are now using alleged manipulation as a ruse. George Sandhu, an officer at Baytree Associates Inc., a New York private-placement firm in the offshore-finance business, said, ''There's now a whole cottage industry of lawyers that go to these companies and say, 'You don't have to convert the stock.'''
Baytree and a group of investors have fought back at a client, StarTronix International Inc. (STNX), which halted conversion in early November on a private placement.
Ken Bloom, an attorney with Gartner & Bloom who is representing StarTronix, countered that there is now ''a cottage industry of placement agents ... that make a habit of explaining to investors how to subvert Reg S.''
Greg Gilbert, StarTronix chief executive, said, ''It got so that we could predict the day when a tranche (of securities) was coming in (to be converted) because our stock would drop 20%'' just beforehand.
Bloom, who said his firm is ''developing a specialty'' in these cases, also made a charge a few companies have made: that placement agents are illegally selling Reg S offerings to U.S. investors who simply deal through an offshore shell company.
Abuses of Reg S have been an issue of concern at the Securities and Exchange Commission, which recently added greater disclosure requirements on issuers. But the reforms don't directly address the heart of these contentious deals, which has more to with trading activity than disclosure.
Sandhu conceded that many of the deals in the private-placement market are rigged and are funneled to less-scrupulous investors. But he adamantly insists that the StarTronix offering is not one of them, and said the company is using a pressure tactic aimed at squeezing better terms out of the buyers.
One other time recently that a Baytree client halted conversion of an issue was when Medical Industries of America Inc. (MIOA) was forced to do so because it ran out of authorized common shares to issue, not because of alleged manipulation. The company held a shareholder vote to raise the share authorization and a Medical Industries official said they are pleased with Baytree and their investor base.
Swartz Investments LLC in Atlanta, run by investment banker Eric Swartz, was placement agent on at least two deals for companies that in recent months accused investors of manipulating their shares. One of the companies, oil-services provider Ponder Industries, is currently suing Swartz. Swartz's name was mentioned repeatedly in interviews with company executives and bankers who said he is a prolific deal-maker who specializes in shunting securities to a small universe of trading-oriented investors.
Repeated calls to Swartz weren't returned.
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