By Steven D. Jones
Of DOW JONES NEWSWIRES
VANCOUVER, Wash. (Dow Jones)--A battle of Lilliputians is shaping up on Wall
Street that may have some big consequences for the nation's brokerage
industry.
Little companies that claim to be the victims of aggressive short sellers
are sharing strategies and tactics in an attempt to take back control of
trading in their shares from the shorts.
Circumstances vary widely, but the companies generally share the belief that
short sellers are exploiting the sloppy clearing practices of brokerage houses
to depress a company's stock under the weight of millions of uncertified
shares and transfer millions in value from shareholders to the short sellers.
"A fair estimate is 15 companies have been in contact looking for help,"
says Gary Valinoti, president of Jag Media Holdings Inc. (JGMHA). Jag Media
filed suit last month in a Texas court against the nation's largest brokerage
firms in an effort to halt short selling of Jag Media shares.
"The volume of phone calls on this case has been horrendous," says Tom
Pirtle, Jag Media's Houston attorney.
Short sellers borrow a stock and sell it in hopes of replacing the shares at
a lower price in the future and pocketing the difference.
The Jag Media suit alleges brokerage houses fail to properly close short
sales by identifying and borrowing shares and taking possession of shares as
required by securities regulators. By failing to close the borrowing
transactions, the suit alleges the brokerages enable traders to sell short
more shares than they can legitimately borrow, otherwise known as selling
"naked shorts."
Jag Media, which has 30 million shares outstanding, may have more than twice
as many shares sold short, Valinoti estimates. He hopes to find out precisely
how many in pretrial discovery.
There are no reliable estimates of the number of companies that have been
targets of naked short selling, although estimates range into the hundreds.
Short selling is legal in the U.S. and most foreign markets, but a secondary
distribution of shares in a company, such as selling naked shorts, is not
legal.
More than 100 brokerage firms are named in the Jag Media lawsuit and the
brokers are beginning to respond, says Pirtle. He says he is spending most of
his time explaining the suit to defendants and pursuing "informal discovery"
attempting to identify the number of shares of Jag Media each brokerage house
claims to hold for clients.
"No one has come out guns blazing," says Pirtle of the response from the
brokerage houses. "The big ones know they've got a problem."
Brokerage houses contacted said they either hadn't heard of the suit or
would have no comment on it.
Certificate Solution
GeneMax Corp. (GMXX), a biotechnology company working on therapies for
cancer and infectious diseases, is also battling the shorts.
"We have followed the Jag Media situation, but we are taking a different
approach to the problem," says Grant Atkins, a GeneMax director.
Last week, GeneMax announced that it was amending its by-laws so that its
stock transfer agent would recognize transactions backed by paper stock
certificates only. Such "certificate only" or "custody only" stock
transactions are rare since the advent of electronic trading. By demanding
paper certificates for trading any of GeneMax's 10 million shares, Atkins says
the company intends to weed out the naked shorts.
Atkins estimates that GeneMax's float, or shares available to the public, is
about 250,000 shares, but some weeks more than 300,000 shares changed hands.
Executives suspect naked shorting is the reason.
The switch, which took effect July 30, means the shorts must produce stock
certificates to close trades and those without certificates must buy shares on
the open market to cover their positions.
"Basically," says Atkins, "the music has stopped and there won't be enough
chairs to sit down on."
GeneMax shares traded at about $6.50 a month ago, then plunged below $4 a
share on volume of between 50,000 and 100,000 shares a day before the change
took effect. Since then volume has settled between 10,000 and 15,000 shares
daily. The price has moved up from $3.90 a share to about $4.30.
Atkins says the company is encouraged by the response.
The List Shows They're Naked
Sedona Corp. (SDNA) is attacking the shorts on another front. Sedona, which
makes customer relationship management software for the financial services
industry, is comparing lists of stockowners generated by electronic clearing
mechanisms with lists of owners maintained by its stock transfer agent,
StockTrans Inc.
Big discrepancies will point to naked short sellers and the brokerage houses
where their accounts are housed, says Michael Mulshine, a director of Sedona.
The company then plans to take legal action against those brokerage houses,
says Mulshine.
"We have talked with Gary (Valinoti) at length and we are very interested in
his approach," says Mulshine, because it is aimed at the faulty clearing
process that basically allows traders to make a secondary distribution of
shares without a company's permission.
"This is an ongoing problem," says Jonathan Miller, chief executive of
StockTrans Inc., a privately held stock transfer agent in Philadelphia. The
company provides transfer services for about 130 companies including Sedona.
"I've seen a disconnect between the company and the number of shares moving
around in the market because of the demise of the certificate," he says.
In the days when sellers had to present stock certificates to trade shares,
there was no doubt whose name was on the document, says Miller. Electronic
trading systems changed that, especially in the case of short selling when a
trader must first borrow then sell a stock. Often there is only a
"presumption" that the seller controls those shares, says Miller.
"I've had calls for years from clients asking where all those short sellers
are getting their shares," says Miller. "I can't answer because often they are
not shareholders of record that we can find."
-By Steven D. Jones, Dow Jones Newswires; 360 253-5400;
steve-d.jones@wsj.com |
