By THOMAS E. RICKS

Staff Reporter of THE WALL STREET JOURNAL

WASHINGTON-The Securities and Exchange Commission adopted a temporary rule aimed at addressing unusual situations before stock offerings in which short sellers can try to set the price of the stock they eventually use to cover their short positions.

Separately, the chairman of the House subcommittee on consumer and monetary affairs said his panel recently launched "a general inquiry" into short selling.

In a letter to the National Association of Securities Dealers, which operates the over-the-counter market, Rep. Doug Barnard Jr. (D., Ga.) accused the association of regulating short sales by brokerage firms far more leniently than it handles those by public customers.

Joseph Hardiman, the NASD's president, said he shares Rep. Barnard's concerns. He said his organization already has acted on some of them, and expects further changes in certain NASD rules regarding short selling later this year.

Mr. Hardiman also applauded the SEC's new rule, which is aimed at a situation SEC officials have discerned only in over-the-counter markets. "They've come up with a solution to a problem that was

costing issuers and shareholders a great deal," he said.

The SEC's new rule prohibits a short seller from going short on a stock just before a secondary offering and then covering his short position with securities issued in that offering. "It identifies...a particular circumstance in which the incentives for manipulation are quite large, and the risks normally entailed in manipulation aren't there," said Richard Ketchum, chief of the SEC's market-regulation division. Expectation of Drop

In a short sale, an investor reverses the old Wall Street saw about "buy low, sell high" and instead tries to sell high and then buy low. To do that, he sells stock he doesn't own in the expectation that the stock's price will later drop. If it does decline, the investor buys the stock-that is, covers his short position-at a lower price than he sold it for. But if the price doesn't drop, the short seller takes a loss.

The price of a secondary offering-or the sale of additional stock in a company that is already publicly traded-usually is determined by the stock's market price on a given date. Heavy short sales often have the effect of driving down a stock's price. Thus, an investor could go short on a stock heavily just before the offering is priced, in an attempt to ensure that he can buy the stock at a price lower than he sold it for. The NASD, in recommending the rule to the SEC, said its studies found just such a pattern occurring in over-the-counter stocks.

Rule Is Called 'Fair'

One way that companies and brokerage firms fight short sellers is to attempt a "short squeeze" to prevent short sellers from finding stock to buy at a lower price. But, Mr. Ketchum said, it is difficult to do that at the time of an offering, with more shares coming into the market. "The whole key of this is the shorts know the stock will be there, and at a fixed price," he said.

Joseph Feshbach, a general partner in Feshbach Brothers, a Palo Alto, Calif.based investment partnership that specializes in short selling, called the rule "fair." But he said his firm doesn't engage in the practices the rule attacks, and added that he doubts whether short sellers really are able to manipulate the offering price of over-the-counter stocks as easily as the SEC and the NASD allege.

"These stocks are so volatile, you don't know where the offering's going to be priced," he said. "It's a hard way to make money."

SEC Chairman David Ruder called the rule, which will go into effect around the end of next month, "rather narrowly drawn." It says only that investors can't short a stock between the time an offering is filed with the SEC and when it becomes effective, and then cover their position with the newly issued stock. But it doesn't ban the practice of going short during that period.

The SEC voted to designate the rule as temporary, but didn't attach an expiration date, saying instead that the NASD should study the issue further and the commission should revisit it in about two years.

"Wh

emerged from the experience somewhat poorer but with genuine esteem for Federal Express. "They were just so good at keeping the channels of communication open- for bulls and bears alike," says Chanos. "They handled it professionally."

G. Edmond Clark, Federal Express' current investor relations manager, wasn't in that job in 1985, but he says Chanos would get the same reception today under similar circumstances. "We frequently deal with people we know are shorting the stock," Clark explains. "Our instructions are to treat everybody the same."

Heated emotions

That policy may sound perfectly logical, but in practice few companies under the pressure of a bear raid are able to respond with such equanimity. Companies that find themselves attacked by shorts have a difficult time not taking such assaults personally, especially since the targets often are small, unlisted companies still closely identified with their founders. Arnold Minsky, president of Corporate Studies, a stock-watch consultant, says some chief executives get so upset that "they want to take a gun out of the drawer and go shoot somebody."

Indeed, companies will do just about anything short of homicide to get professional bears off their backs. Often the tactics are defensive: They threaten lawsuits, complain to anyone in Washington who'll listen and attack the journalists who've based their stories on short-seller tips. Despite the fact that such measures occasionally help, most bear-raid victims would do better to keep their powder dry.

Michael Murphy, editor and publisher of Overpriced Stock Service, a newsletter written for short-sellers, says that a calm, measured reaction from the target company's management is almost certain to make the short-seller rethink his position. When the company responds with precision rather than panic, says this experienced bear, "you know you're in trouble. If they're that smart, they probably know how to run their company."

Historically, stock market crashes and panics are usually followed by a wave of public demand for short-selling to be abolished, though futures trading took most of the heat for the meltdown October 19, 1987. Nonetheless, market regulators and congressional leaders have always rccognized that short-selling serves a worthwhile purpose the same sort of purpose, notes one observer, "that the garden snake serves in your garden; it keeps beetles away." Al Krause, who docs public rela

tions work for Murphy's newsletter, also points out that while short-selling is viewed as a neutral act in commodities markets, it takes on more emotion when applied to stocks. "Soybeans have no investor constituency," says Krause. "A company like Reebok docs."

William Borchert, whose New Yorkbased investor relations firm, Cameron Associates, sponsored a conference on short-selling in May, tells of one client whom short-sellers accused of fraudulent accounting. Upon looking into the charges, Borchert discovered that the accusations, while "97 percent a lie," also contained a "3 percent grain of truth." It turned out that Borchert's client, on the advice of its accountant, had yet to make a significant accounting change that had already been adopted by the rest of the industry. The company clearly had not intended to defraud anyone, says Borchert, who concludes that "abusive short-sellers will find a grain of truth and build a big lic around it."

Dirty tricks

Obviously, the only solution for companies under attack is to deal with the kernel of truth on which the shorts have built their attack. But too often the reaction from the company is shrill and defensive. Clinton. Howard, chief executive officer of Carrington Laboratories, a Dallas pharmaceutical company, sounded exactly that way when he addressed the Cameron Associates short-selling conference. "We know that new ideas, new products, new businesses are like tender plants, that they're easily destroyed by anyone intent on trampling on them," complained Howard, whose company develops medicines from the aloe vera plant. He added, "If we continue to let short-selling vultures prey on the new, emerging companies with no accountability, we may forever destroy the opportunity for American capitalism to revive and put this country back on a more sound economic footing."

Howard went on to tell the conference about a number of "dirty tricks" the short-sellers had played on his company and criticized reporters "who found that they could sell more papers and magazines with Hollywood-type gossip columns and witty sarcasm than with honest research and balanced analysis.”

Those kinds of allegations, even if true, usually do nothing but raise additional suspicions. And if such allegations are followed by poor company performance, management may suffer permanent damage to its credibility. A 1986 report on short-selling, written by former Sccurities and Exchange Commissioner Ir

ving Pollack for the National Association of Securities Dealers, found that company complaints about excessive short-selling are usually exaggerated. Pollack further concluded that the shorts rarely act out of malice; they usually have good fundamen tal reasons for betting against a stock Sometimes, he noted, short-selling and sharp price declines follow "periods of equally unusual price increases, unex plainable by company fundamentals." And at other times, companies bring short-selling on themselves because of shortcomings in financial disclosure.

Rather than complain about shortsellers, most IR counselors suggest that companies simply accept them as inevita ble. To do otherwise just feeds whatever negative psychology already exists. "Don't play victim," warns J. Desmond Towey, al New York IR consultant whose company bears his name. "If you're a public compa ny, you're fair game. Particularly if you're a high flier, you know it's going to

come."

Besides, companies that kick and scream about short-selling only make short-sellers feel that much more secure. in part because they magnify the negative publicity and depress the share price further. For example, in February 1987, USA Today ran a negative article about Possis Corp., a Minneapolis producer of hightechnology medical equipment. Soon thereafter, a company lawyer sent a threatening letter to newsletter publisher Mur phy, whom the newspaper had quoted Murphy shot back a retort and wrote: about the exchange in the next edition of his newsletter. He told readers that the angry letter from Possis had "increased our belief that there's far less to this company than meets the eye. Short the heck out of it." He never heard another word from the company.

Sin of silence

By the same token, keeping silent is a dubious tactic when a company is under pressure from short-sellers. Lawyers tend to tell companies to keep quiet when al most any kind of problem arises, but when there is short-selling, that simply sends signals of fear and weakness to the marketplace.

Another stock Murphy loves to short (and which shows up in practically every issue of his newsletter) is CopyTele, a Huntington, New York, development. stage company that is working on a new kind of video display screen. CopyTele has a policy of not talking to the press (this magazine included). "It looks suspicious," says Murphy. "It makes it easy for the shorts to say whatever they want. It's the

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lie around it."

worst thing you could possibly do. If you're going to do that, be a private company."

The best antidote to short-selling is, of course, a good, ongoing IR program that is in place long before the crisis develops. An honest dialogue between the company and the investment community usually precludes the kind of hype and overpricing that attract short-sellers in the first place. Moreover, maintaining healthy relations with analysts and influential portfolio managers can be extremely helpful in instances when short-sellers get really nasty and start calling up the company's major shareholders to spread damaging gossip.

It also helps to maintain rapport with the financial media. Thorough, accurate press coverage can greatly aid a company in keeping its credibility during a mean rumor campaign. In fact, that kind of crisis can even become a boon to financial relations because, as Cameron Associates' Borchert cheerfully points out, "You build better credibility with the media with ncgative news than with positive news."

Borchert suggests that companies routinely plan for a short-selling crisis as part of their investor relations program. "All companies should have a crisis-management program. You've got to know what you're going to do when a crisis hits, like Tylenol scares or Bhopal," he says. "And you've got to add a bear raid to that list" The plan should provide for involvement by top management, company attorneys, investment bankers and investor and public relations specialists. It should also designate one official crisis spokesperson. Otherwise, cautions Borchert, shortsellers will make hay out of even the most innocent discrepancies between what dif ferent company representatives are saying

Friday phone calls

Another part of being prepared is knowing what to do about a negative mention in Alan Abelson's "Up & Down Wall Street" column in Barron's. At last May's short-selling conference, dispirited CEOS told story after story about receiving lateFriday-afternoon phone calls from Barron's. Invariably, the executives had felt a rush of excitement about the sudden media interest in their companies, only to discover the next day that they had been publicly eviscerated by Abelson.

"If you get a call after 5:00 in the afternoon on Friday," consultant Towey cautions, "it's got 'bear raid' written all over it. And if you know it's a bear raid, you put your tape recorder on." Having helped two different clients survive mention in Abelson's column, Towey has some additional advice. "Don't subscribe

to Barron's," he tells IR officials. "Buy it on Saturday morning. You need to be prepared. The worst thing that can happen is to be blindsided on Monday morning."

Towey also suggests taking the simple precautionary step of keeping a list of all important phone numbers at home, so that the company's reaction can be thoroughly planned before the market opens on Monday. That might well entail a Sunday afternoon meeting with top management. More than once, Towcy says, he's made the Sunday afternoon trek into Manhattan from the Hamptons.

Despite the negative connotations of a late-Friday-afternoon phone call from Barron's, Towcy and other IR practitioners still recommend that companies cooperate with the publication if only so they can later ask for a chance to reply. Joseph Feldschuh, the CEO of Daxor Corp., a New York-based company that runs blood and sperm banks, did that last year and wound up satisfied. “I basically had an okay experience with Barron's because they printed our rebuttal in full," Feldschuh says.

The best defense

Obviously, the best defense against short-sellers is to prove them wrong. Reebok International is often cited by shortsellers as a textbook example of a company that responds adeptly to an attack. Murphy conceded in his newsletter after a bear raid last year, "The stock has been a disaster from a short point of view, and the only question is when to cover."

Reebok chief financial officer Paul Duncan reviewed his investor relations strategy in an interview with Institutional Investor last fall. The key to the program, he said, was expanding communications without making any direct reference to any short attack. "You absolutely lose once you start fighting head-to-head," Duncan counseled. "You don't want to give them any additional publicity."

Duncan also said he had spurned re-. quests from other companies that he complain about short-sellers to members of Congress. "I just feel that we're in the business of selling shoes," Duncan said. "The shorts will take care of themselves over time." Besides, Duncan professes to have such confidence in his company that he can look forward to the day when the shorts will have to run for cover. "If what they're saying about you is not true," he says, smiling, "they will create a tremendous growth in your stock in the future."

Another athletic-shoe company, L.A. Gear, was taking a similarly blasé approach to a spate of short-selling last summer. "We're just going about business as usual here," maintained Elliot Horowitz, the chief financial officer. "What it's really

going to come down to is performance."

There are times, of course, when companies may be forced to become more aggressive, especially if they become convinced that short-sellers are manipulating their stock illegally. Occupational-Urgent Care Health, a Sacramento processor of workers' compensation claims, filed a $90 million lawsuit carly this year against San Francisco's Sutro & Co. because of what it considered a vicious rumor campaign by a Sutro broker. President James Cameron told the short-selling conference last May how his company endured months of increasingly damaging rumors, including claims that management had criminal records. Then, he got his first "real break," a call from a former New York broker with a big position in OUCH who had recently taken a job at Sutro. "He called to let me know that something was really wrong and that he felt illegal activities were being encouraged... in an effort to hammer down the stock," Cameron related. Shortly after OUCH filed suit, said the president, the rumors "came to a screeching halt." The lawsuit is pending in federal

court.

In 1985 Daxor's Feldschuh became convinced that his company was the victim of naked shorting (in which shorts don't borrow actual shares of stock, as required by law). He promptly spread word that he was planning to write all of Daxor's shareholders a letter advising them to ask for their stock certificates. Because stocks cannot legally be shorted without first being borrowed, which requires a temporary transfer of the stock certificate, such a move would have created a shortage of Daxor stock and caused a major short squeeze.

"If we had put it through completely, we could have wiped a few brokerage firms out," Feldschuh claims. "We put out the word that we were not to be trifled with." He warns, however, that the strategy wouldn't work with "garbage stock" — that is, a stock without a consistent shareholder base. "If you've developed a loyal shareholder following, then you control your company."

When circumstances require it, there's nothing wrong with fighting aggressive short-selling aggressively unless, that is, the short-sellers are right about your stock. Kynikos Associates' Chanos advises companies to let truth be their guide. "Find out exactly what's being said in the marketplace," he says. "If it's a false or misleading statement or rumor, go after it. Prosecute, sue, whatever. On the other hand, if as is the case 95 percent of the time- it's a fact, then you'd better address it squarely. It's going to be found

out. There are too many bright people out there." i