Lawyers at the Securities and Exchange Commission could not recall any other such warrant. “It’s an odd situation,” Mr. Garcia said. “Ultimately with the logistics they’ve proposed, a refusal by the company to issue the distribution to a stockholder of record of the company could be problematic under Nevada law.”
A Bet Against Those Who Bet Against the Company
The New York Times
September 1, 2006
Insider
nytimes.com
A Bet Against Those Who Bet Against the Company
By JENNY ANDERSON
IMAGINE if a company said it would give you a dividend but would make you do cartwheels to get it.
Pegasus Wireless, a technology company in Nevada, announced an unusual plan on Aug. 4 to reward loyal shareholders. For every 10 shares of stock, investors would receive a “property dividend” which the company described as a stock warrant.
But there was a catch. The warrants would be issued only to shareholders whose stock was held in “beneficial name” — in other words, in the name of the shareholder. Pegasus would not issue any warrants to brokerage firms to be passed on to clients, which is what normally happens when dividends are paid.
The warrant, as explained in the Pegasus news release, appeared to suggest that brokers — who can lend out stock they hold in certain client accounts — might have to recall the shares so that investors could prove they were the owners. Such action would require those who sell short to give the stock back to the brokers, pushing the price up and creating a short squeeze.
Pegasus said it was only trying to reward investors, but regulators, back-office officials and traders saw another possible motive — to punish short sellers. (Short sellers bet that a company’s stock price will fall, selling shares, usually borrowed from a brokerage firm, and later buying them back at a lower price and pocketing the difference. If the price rises, the plan backfires.)
“It squeezes the shorts, but it also squeezes the brokers,” said David A. Garcia, a principal at the Nevada-based law firm of Hale Lane.
Although the chief executive of Pegasus, Jasper Knabb, said that short sellers had “attacked” his company — amassing 9 million of the 16.5 million shares — he says the warrant was not intended as retribution.
“I am not Overstock.com,” Mr. Knabb said, referring to the company whose chief executive recently compared short sellers with Al Qaeda (Overstock.com is among a handful of companies suing hedge funds they believe to be behind a short-selling conspiracy).
Mr. Knabb said the board issued the warrant in an effort to get an accurate snapshot of shareholders. He was concerned, he said, that someone had created phantom or fake stock — upward of 22 million shares — and was trading them in the marketplace. One British shareholder, he said, had documentation of a private placement that the company never conducted, evidence that fake shares had materialized in the market.
Whatever the goal of the warrant, the impact was clear. Pegasus’s stock rose almost 30 percent after the warrant was announced, reaching a high of $7.60 on Aug. 22 — bad news for any short seller who expected shares to fall. The stock since has fallen again and closed yesterday at $3.43.
Yesterday, the stock fell 33 percent on volume of 4.6 million. The company usually trades about 130,000 shares a day.
Whatever the reason it was released, such a warrant is highly unusual. Lawyers at the Securities and Exchange Commission could not recall any other such warrant. “It’s an odd situation,” Mr. Garcia said. “Ultimately with the logistics they’ve proposed, a refusal by the company to issue the distribution to a stockholder of record of the company could be problematic under Nevada law.”
John Courtade, a Texas lawyer advising Pegasus, said: “I don’t see how it prejudices any shareholders. The goal was to reward shareholders of Pegasus who have seen their value shredded by short manipulation.”
Mr. Knabb said he was working with regulators, including Nasdaq, on the mysterious share imbalance. But regulators seem more focused on the legality of the warrant.
“Nasdaq is working with other regulators to ensure that securities laws are being appropriately applied,” a Nasdaq spokeswoman, Silvia Davi, said. “This is a process that is independent of the company.” The S.E.C. is also examining the issue, said one person briefed on the inquiry.
As to the fake stock, Mr. Knabb says he believes he has evidence that it exists — proof provided by the Depository Trust Clearing Corporation, which holds in custody about 85 percent of all shares in the marketplace.
Mr. Knabb said after the announcement of the warrant, the clearinghouse reported Pegasus had 16.5 million shares. He said it later reported 38 million shares, which it detailed in a one-page report sent to Mr. Knabb.
“We have a bunch of phantom stock,” Mr. Knabb said.
But Steven Letzler, director of corporate communications for the clearinghouse, said the second report was an internal document — one that Mr. Knabb should not have seen — that reflects all of the Pegasus shares the clearinghouse holds, including shares in custodial space rented by brokerage houses. The first report, Mr. Letzler said, accurately reflects the number of shares, that being 16.5 million.
Attacking short sellers is in vogue these days. Several companies, including Overstock.com, have sued short sellers, accusing them of market manipulation and conspiracy. Pegasus’s warrant seems to be a more innovative attempt to hurt those who bet against the company.
Mr. Knabb says Pegasus has a “stellar” record of performance. Company filing and extensive conversations with Mr. Knabb reveal a confusing corporate structure created through repeated reverse mergers with shell companies that have involved businesses ranging from water treatment technology to software development.
For shareholders, it seems a no-win situation. If there is indeed phantom stock, Pegasus will have difficulty ending the problem. If there is not, Mr. Knabb may have to explain to shareholders why he has spent so much time bestowing such rewards upon them and less time running his company.
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