The bull stock market is putting the squeeze on short-sellers.
Short-sellers typically borrow and sell stock they do not own with the hope they can later acquire it at a lower price and profit from the difference. The practice, however, can backfire when a stock price rises unexpectedly--something that often happens when the market hits record highs.
"It's taking a big toll" on these traders, said Rob Martin, new media analyst for Friedman Billings Ramsey.
Nowhere is the pressure more apparent than in allegations contained in a lawsuit filed yesterday by the brokerage firm of Waldron & Company in Irvine, California, against five former employees. The suit, filed in Los Angeles Superior Court, alleges that the group "knowingly and willfully conspired and agreed among themselves" with short-sellers to defame Waldron and Shopping.com (IBUY) after the high-flying Internet stock continued to rise. The defendants could not be reached for comment.
Waldron underwrote the highly successful initial public offering of Shopping.com, which went public in November for $9 per share, raising $10.6 million after fees. Its stock has traded as high as 39 in the past 52 weeks. Shopping.com, backed by Idealab entrepreneur Bill Gross, is an electronic commerce site. Like most Net stocks, it has yet to report a profit but is trading on the promise of the Internet as a commercial vehicle.
The suit seeks $10 million from the five employees, all of whom are now employed at National Securities, another brokerage firm, after allegedly being fired from Waldron. The accusations ultimately wound up on the Internet and on the desk of Sen. Alfonse D'Amato (R-New York).
As reported, the Securities and Exchange Commission suspended trading in Shopping.com's stock two weeks ago, citing a "lack of current and accurate information regarding the securities." The ten-day suspension has since been lifted.
Shopping.com's case is extreme but not unique. A steady climb in Net stocks during the past has led hordes of short-sellers to think that the companies are overvalued. But as the bull market charges on, the shorts are, well, coming up short.
Bruce Lupatkin, research director at Hambrecht & Quist, added that Internet stocks are just the latest sector of stocks to hurt short-sellers. "It wasn't long ago that it was interactive TV stocks," Lupatkin said. "The point is that Wall Street gets infatuated with the promise of an enormous market and the values tend to reflect that infatuation."
Martin estimates that short-sellers of Yahoo have lost some $135 million in the first three months of this year. Yahoo's stock price last week shattered the 100 per share barrier.
The number of shares shorted in Yahoo at the end of 1996 was 846,000, but has risen to 4.5 million at the end of 1997. The same holds true for other Internet stocks, including Lycos, Excite and Onsale.
"There's so much momentum behind these names and there are so many buyers out there looking to catch the next three-point [gain]," Martin said.
Shopping.com's case was more isolated, however, because it is sold through a single market maker that sells at relatively lower volumes rather than those typical of the high-volume markets.
In February, the suit alleges, the five former employees wrote and disseminated letters that accused Waldron and its president, Cery Perle, of "reckless" and illegal behavior in promoting Shopping.com.
The suit goes on to contend that all five employees, who left Waldron in late 1997 or early this year, were conspiring with John Fiero, president of Fiero Brothers in New York City.
"The Fiero Brothers are notorious short-sellers who are currently under regulatory investigation in connection with the demise of Hanover Sterling and its clearing broker Adler Coleman," the suit charges. "In those proceedings it is alleged that the Fiero Brothers engaged in wrongdoing involving violation of the securities laws including efforts to defame and depress the stock of target companies."
According to Waldron's suit, Fiero Brothers is a short-seller of Shopping.com's stock.
As the price of Shopping.com continued to rise, "certain short sellers led by Fiero Brothers began an aggressive campaign to disseminate negative and false information about [Shopping.com] in order to cause the stock price to decline so they could realize profits," the suit alleges.
Although the suit charges wrongdoing on the part of Fiero Brothers, the firm was not named as a defendant. Nor does it implicate National Securities.
Executives from Fiero Brothers and National Securities did not return phone calls seeking comment.
Jeff Pelline and Dawn Yoshitake contributed to this report.