Very nice post Jack! No bashing - just the facts. They should all read that well.
This was a link that was posted earlier. Good reading for those interested in what may have been the cause of FTEL's recent stock slide. We were all suspicious of the trades and what appeared to be "short sales" over the past few months. Maybe this will explain what occurred. Maybe!!
Regardless of what happened, we are now on the right track, with money in the bank and nowhere to go but up!
Red Flag Financing
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By RICHARD KORMAN
They call Peter Davis almost daily, strangers who say they want to help
his Xoma Corp. close the gaps in its finances. Many promise an
immediate infusion of cash in exchange for a certain kind of preferred
stock.
But Davis, chief financial officer of the biotechnology company in
Berkeley, Calif., says he is on to their game. "We get calls from all
over the place and try to steer away from these folks," he said.
As if fledgling high-technology companies didn't have enough
problems, now they have to worry about predatory investors who try
to drive down the price of the shares they have bought through
high-volume short-selling -- that is, by selling borrowed shares,
replacing them later at a lower price and pocketing the difference.
These investors are able to turn the financial desperation of
high-technology companies, which often swim in red ink for years
before developing marketable products, into big profits for themselves
at the expense of existing shareholders.
They do so by perverting a complicated financial transaction known as
a convertible-preferred-share placement. Such a transaction can
legitimately serve as a lifeline to promising but financially struggling
businesses, advocates say.
Extremely rare only a few years ago, these deals now number in the
hundreds annually, according to analysts. But the companies that do
them don't always understand the risks.
"Entrepreneurs who manage these companies are creatures of hope
who always believe they can make a profit on the cash from these
financings," said Marcus Robbins, editor of the Red Chip Review, a
newsletter that covers small publicly traded companies. But, he added,
they "don't always know what they are getting involved with."
The transactions work this way: The company sells the investor a new
issue of convertible-preferred shares -- shares that have priority claims
on dividends and assets and can be converted to common shares --
through a private placement.
The placement includes a 1990s twist: Instead of the more usual
practice of fixing ahead of time how many common shares would be
received, these preferred shares are convertible at a floating ratio based
on the stock price.
The lower the stock price happens to be when the investor decides to
convert, the more shares the investor would get. On top of that, the
deals may include a discount of up to 30 percent, giving the converting
investor even more common stock in exchange for the preferred.
Firms that invest in such financings say they are a boon to innovative
but cash-short companies. "This is a huge industry involving many of
the biggest investment banks on Wall Street," said Mitchell Kaye, a
principal of Brown Simpson Asset Management in New York. He
estimated that more than 1,000 deals worth several billion dollars will
be concluded this year.
Even so, some people on Wall Street call such deals "junk equity."
(Issues of debt securities with similar conversion features are also
growing more common, and pose similar risks.)
Robbins of Red Chip Review calls some of them "toxic convertibles"
because they offer an immense incentive for unscrupulous investors to
drive down the share price by selling the stock short. Generally, when
a large number of short positions is taken in a thinly traded stock, the
price falls.
Such short-selling is illegal if used to manipulate the market for profit.
And big profits are clearly possible: Once the price is down, an
investor can convert preferred shares for large amounts of the
company's common stock, use some to repay the borrowed shares,
bank profits from the short sale and own as many shares in the
company as when he started, or more.
To be sure, most investors in convertible preferred securities with such
a protection against falling share prices don't short the stock.
But whether or not short-selling occurs, shareholders upset at price
declines that coincide with such share conversions can react angrily.
Last November, for example, shareholders of the Illinois
Superconductor Corp. in Mount Prospect, Ill., filed a lawsuit against
the company's managers and directors, accusing them of breaching
their fiduciary responsibilities by arranging a $15 million private
placement of preferred convertible shares to Southbrook International
Investments Ltd. under terms that encouraged Southbrook to short
Illinois Superconductor's stock.
According to the lawsuit, Southbrook, which is based in the British
Virgin Islands, or its agents engaged in short sales to drive the price
down and thereby collect more common shares in return for preferred
stock.
As a result, the share price fell from $12.375 to $11 within a few days
last June, then from $9.75 to $7.625 within a similarly short span in
August and finally dipped below $1 by December, the complaint says.
One of the plaintiffs, the money manager Sheldon Drobny of North
Brook, Ill., says he and his investors took a $9 million hit as a result of
the short-selling. He also claims that the operation more than doubled
the number of Illinois Superconductor shares, sharply watering down
their own shares' claim on future profits.
"Last year at this time, there were five million shares outstanding, but at
this year's annual meeting there were 12 million. That's a significant
number," said Steven Shapiro, Drobny's lawyer.
Edward Laves, Illinois Superconductor's chief executive, denied that
he or his fellow managers and directors acted irresponsibly. He
characterized the lawsuit as retaliation for a suit the company filed last
spring against Drobny and other shareholders in a dispute over
financing.
Laves added that the convertible placement was Illinois
Superconductor's only financial option after a failed secondary public
offering. He said the company was now on the rebound, with the stock
now trading at around $2.75.
He attributed the share-price declines of last year to his company's
disappointing results and to general market trends, not to short-selling.
"The market wasn't being nice to microcap technology stocks," he
said.
Illinois Superconductor, which commercializes high-temperature
superconducting technology for the wireless telecommunications
industry, has raised about $50 million in private and public offerings
since it went public in 1993.
Southbrook, which was not named as a defendant, could not be
reached to comment on the accusations made in the lawsuit. Brown
Simpson Asset Management, which participated in the financing,
declined to comment on the complaint or to provide information about
Southbrook.
Whatever the merits of that case, predatory short-selling in conjunction
with junk-equity offerings appears to be on the rise. Gerald T.
Kennedy, president of Kennedy Capital Management in St. Louis, said
his company had taken its lumps several times the last few years.
"We've been hurt; we've been bruised," Kennedy said. "We actually
had this happen in six instances, and almost every time it's a disaster."
Kennedy sends companies in which his fund holds a position a letter,
urging them to be on the lookout for bad convertible preferred-stock
deals. "We are bringing this scam to your attention because we do not
want to see companies in which we invest attacked by these vultures,"
he warns them.
Because private placements need not be disclosed in advance under
Securities and Exchange Commission regulations, existing
shareholders often have no idea what has hit them.
And when the financial transactions are spelled out weeks later in
filings with the SEC, the details are often so complex that an the
average investor can easily overlook the danger.
Even deals in which no short-selling takes place can stir up trouble.
For example, an investor in Bio-Imaging Technologies, a
medical-technology company in West Trenton, N.J., that recently
concluded a bitter battle over board membership, converted a large
chunk of preferred shares for as little as 63 cents, helping drive the
stock price so low that NASDAQ threatened to delist the company.
Another company, Geotek Communications Inc., a wireless
communications company in Montvale, N.J., has scattered its equity
over so many financings that it was forced to acknowledge in a recent
SEC filing that it cannot calculate how many shares it might have to
issue to holders of preferred stock.
Ordinary stockholders who want to avoid being burned by market
manipulators can take some basic precautions: keeping track of new
financings by companies in which they own shares and getting out
when a deal is announced on unfavorable terms.
The Diaz & Altschul Group, a New York firm that arranges and invests
in convertible financings, says it simply shuns deals that encourage
investors to profit from a falling stock price.
Arthur Altschul Jr., a founding partner, said companies could protect
themselves against short-sellers by avoiding deals that allow investors
to convert preferred shares at a deep discount to the market price; by
insisting on the right to redeem an issue without onerous penalties, and
by demanding covenants against short-selling and pledges to comply
with SEC regulations.
Brian Pusch, a securities lawyer, says preferred stock that pays an
automatic dividend is less likely to come under attack by short-selling
investors than stock that does not.
Other specialists counsel companies to limit the size of private
placements and to put a ceiling on the number of shares that may be
obtained through conversion if the stock price falls.
But then again, companies worried about survival will often agree to
just about any terms. "What is implied is that a company is very high
risk, and this is the only financing scheme anybody is willing to
provide funds for," says Robert Natale, a former investment analyst at
Standard & Poor's who is now with Bear, Stearns.
The SEC's guidance in junk-equity financing is a work in progress. The
agency says it is eager to stamp out "abusive practices." But just what
qualifies as illegal stock manipulation depends on the situation, says
David Sirignano, associate director in the SEC's division of corporate
finance.
In any case, most junk-equity deals probably do more good than harm.
"The role they are playing is to fill the gap on high-risk technology,"
says James Donaghy, chief executive of Sheldahl Inc., a computer
technology company in Northfield, Minn., which has made several
private placements of convertible-preferred shares. Sure, he added,
there is always the danger that his company's stock will be shorted.
But, Donaghy said, "People just have to understand they are in that
kind of business."
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