is naked shorting by broker-dealers and there are abuses, because when a short seller or institutional guy gets bought in, he has a broker-dealer short new shares to him. That broker can short it and keep the position forever. Now, in the regulation in front of the SEC, we have asked them not to allow anyone to short a stock without borrowing unless you are a market maker." If approved, this will be a major reform and the NASD and its market makers deserve great praise for suggesting it. Companies should offer their support in getting these changes approved by the SEC.

Next, DaPuzzo took the mystery out of how regular brokers (but also many big-time shorts) trade shares among themselves and create artificial shares to borrow so short positions can exceed a company's float or even its total shares outstanding. This of course permits what company presidents see as overshorting, since the borrowed share requirements don't mean much to those who practice this.

One of the ways it appears more stock is shorted than the float is if firm A is long 100,000 and firm B borrows A's shares and shorts the stock. One short position has been created. However,

firm C bought those shares sold short by B and is now long 100,000 shares. So firm D borrows C's shares and shorts the stock, and now firm E which bought D's shares is long so firm F can borrow them and short to ... "So the original 100,000 shares can go through the borrowing loop several times perfectly legally and nothing is wrong with that," explained DaPuzzo. "Often it is executive stock on margin, creating the liquidity so that one share can become five or more for borrowing."'

Out of the audience rose Chairman Robert Krauser of Viral Response Systems (2-VRSI). "When you talk about firms A, B, C, D and E creating securities, I hope the SEC is listening," he began. Krauser pointed out there was a finite number of his company's shares outstanding and when firms create more shares only those of firm A are real and registered with the SEC. Aren't the broker-dealers dealing in unregistered securities with the rest? Also, what good is a borrowing rule to prevent an unreasonable number of a company's shares from being shorted if an unlimited number of artificial shares to be borrowed can be created, even more than the real float? Daxor President Feld

schuh added since the original borrowed shares and the four created shares exist, who gets to use the one vote at a shareholder meeting and who gets disenfranchised? He believes some brokerage firms vote only a proportional amount of their shares.

The afternoon legal panel advised companies attacked in a bear raid to gather information immediately to defend themselves from an almost certain shareholders' suit based on the shorts' charges. The lawyers handling OUCH's RICO lawsuit did not advise companies to sue automatically. Suits are costly and take years. They should only be a last resort. They did note that companies being attacked with falsehoods or interference with operations must take the initiative in defending themselves. Those who wait for the SEC to act will be out of business first. NASDAQ chief economist Gene Finn reassured the audience that the proposed changes would restrict the opportunity for abuses.

Cameron Associates President William Borchert, on the investor relations panel, suggested managements under attack should not adopt a no-comment siege mentality, but get their side of the story out to the public, as OUCH did. In the long run, a company's operating performance, not its public relations, will determine its fate. But misinformation should be corrected. A company doesn't have to be a sitting duck.

Did the symposium settle all questions about short selling? No. But it made abundantly clear that this is no fake controversy. There are two sides to the story, even though journalists and players often give only one.

Anyone desiring information about acquiring tapes of a particular panel or of the entire Short Symposium should contact OTC REVIEW's cosponsor, Cameron Associates Inc., One Madison Avenue, The Tower, 18th floor, New York, NY 10010-3690; telephone (212) 683-4545.

10

"We're unloading our stock in Walt Disney. And don't you make one crack about short sellers!"'

OTC REVIEW JULY 1988

NASD Reviewing Trading Activity In Golden Valley

By WILLIAM POWER

Staff Reporter of THE WALL STREET JOURNAL NEW YORK-The National Association of Securities Dealers is reviewing recent trading activity in shares of Golden Valley Microwave Foods Inc., based on unusual price and volume movements, as well as complaints from short sellers.

Golden Valley, a Minneapolis-based market leader in microwave popcorn, has seen its stock more than triple in less than two years, making it one of the hottest performers on the over-the-counter market since it went public in September 1986.

The company's sales and earnings have ballooned 100% annually. This growth rate has attracted a large group of short sellers who are betting it will tail off. Golden Valley stock has one of the largest short positions on the OTC market, of 1.1 million shares at last count in mid-June. Short sellers, who borrow and then sell a company's stock, stand to profit by a fall in a stock's price, because such a fall makes it cheaper to replace the borrowed shares.

Officials at the NASD, the self-regulatory body for the OTC stock market, yesterday confirmed the review but offered few details. Although the NASD apparently hasn't come to any conclusions about recent Golden Valley trading, the review is sure to heat up the bitter battle that has raged between bullish and bearish traders in the stock.

"There's a real war going on" between some brokerage firms and short sellers in Golden Valley stock, said an official at one brokerage firm that makes a market in Golden Valley. The official spoke on the condition he not be named. "These guys (the shorts) are doing anything they can to knock down the stock."

For example, short sellers are claiming that the $9.25-a-share plunge in Golden Valley stock, to $23 Wednesday since last Friday-sparked by the company's estimate of a 25% increase in sales and earnings for the second quarter ended June 25, rather than the 40% growth analysts had predicted-is evidence that the stock was too high to begin with. The shorts are trying to convince the NASD that Golden Valley's stock price has been artificially supported by certain brokerage firms.

Shares of the company, which went public at the equivalent of $7 a share, closed yesterday in national over-the-counter trading at $25 each, up $2, on heavy volume of 785,300 shares-five times the stock's average daily turnover.

Richard J. Moen, Golden Valley legal counsel, yesterday said complaints from short sellers is a case of "the pot calling the kettle black." He said the company, for its part, has complained to the NASD about the "negative information, rumors and disinformation and other efforts made by unknown persons to manipulate" its stock price down since late last week.

Wall Street Journal

July 8, 1988

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 recognized 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 does."

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 lic," 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, a 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, US4 Today ran a negative article about Possis Corp., a Minneapolis producer of hightechnology medical equipment. Soon thereafter, a company lawyer sent a threalening 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 an gry 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 Copy Tele, 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