knight, the floorless variety of equivalent securities was created for the shorts. Here is how it works (and in the floorless you can insert either convertible debentures or convertible preferred stock).
A company is with its back to the wall, all normal financing avenues are more or less closed. Finally, they meet a savior angle, and he tell them, look, we will invest in your company, but we need a "secured" position because of the high risk, and furthermore, because of the risk we want to be able to participate in the upside potential. The company says, we understand. So they structure a new deal that says, we will raise for you a convertible debenture, which eventually (long into the future and they smirk into their beard) we will convert to common stock. So, your stock today is let say 5/8, in fairness our conversion ratio should be at a discount to market, so we will have a "ceiling" of $.5 (not to shabby, about a 20% discount). Furthermore, to give us some protection in case your stock falls, our conversion rate will be variable, let say at 80% of the closing bid (average bid) over the last five trading days before conversion. Fine says the company, they really need the money bad, and of course they know that as soon as this pp is announced the stock will skyrocket. Now, that last covenant, is a "floorless", because there is no floor to price at which the company is forced to convert the debenture to stock.
The agreement is agreed and signed, the owners of the debentures receives a piece on paper and agrees to deliver the funds within 10 to 20 days.
The deal is announced, euphoria is in the market the stock doubles within a week to 1.125, and huge volume ensue, but lo and behold, the stock stalls at $1.25 and does not budge. You guessed, the floorless are shorting the hell out of the stock, they have let say $2 face value, good for at least 4 MM shares (upon conversion), so they short "against" the block. If the stock rises, they do not care, they have equivalent securities. They actually hope that the stock will decline. From the weight of their shorting the stock indeed declines. But they have shorted 4 MM shares (or at least could have) giving them the $2 MM in cash that they now deliver to the company. Well, the stock drops back to its original price, where they start covering their short. This bring the price to let say, $.75, where they start shorting again. This shorting causes the price to go down under the original low to let say $.375, where they can now short even more shares (since the conversion ratio has now declined. Well, finally at .25 they start covering again. Now as they start shorting at lower and lower prices, they can short more stock since the conversion ratio increases, so at prices in the pennies (see CAFE, EXSO or CTYS for a case histories) they can short many more millions of shares and if they finally decide to stop the game (usually when the conversion will result in more than the total authorized number of shares of the company), they do their actual conversion and end up with some 75% to 90% of the company while the current holders have been diluted to a master disaster.
Note that they have never put any money into the company, they got the public to pay for the debenture when they shorted the first time. After that they kept making profits everytime they shorted and covered lower. They control the stock at will, since they have this little instrument called a collateral against which they can short not worrying ever about a short squeeze. And to add insult to injury, by the time they are finished, they not only trippled their money but end up with a major portion of the company without ever having to risk a penny of their own.
Zeev |
