Death by Death Spiral

What is a Death Spiral loan?

A death spiral convertible note is simply one that converts into common stock at a percent discount to the stock's market price. The conversion price varies according to the dollar market price of the stock, without a floor on the conversion price. These securities are also called “future priced securities” as their dollar conversion price is set in the future when the conversion occurs.

It is called a death spiral because when the holder converts and sells, it typically depresses the price of the common stock. The more the holder converts, the lower the price of the stock.

The lower the price of the stock, the more stock the holder gets to sell.

For example, the lender buys a note convertible into common stock at 50% of the then market price.

When the holding period for purposes of Rule 144 is up, the holder can convert. The holding period for companies registered with the SEC is six months, and for non-registered companies it is one year.

Assume the price is $10 per share. The holder converts into the stock a portion of the note and sells it. The selling drives the price down to $9.

The holder then converts more stock and sells, driving the price to $8.

After several iterations of this, the price can fall to the cellar – zero bid.

With the stock depressed, the company has trouble raising money because it has to sell more stock to get the same amount of money. At $10, it has to sell one million shares to get $10 million. At ten cents, it has to sell one hundred million shares. This further dilutes the equity of the common stock and drives the price down. This is how the massive dilution is possible.

I recently studied the loans made by one particular Death Spiral lender, loans to 31 companies in all. It is important to note that these companies got Death Spiral loans from many lenders, not just one. These loans had also aged enough to allow the lender to use Rule 144 to convert and sell the loan.

In a two-year period or less, virtually all of these companies lost 99% or more of their stock price and a large percentage of them went to zero bid.

From the point of view of a short seller, two points are important to note here:

Shorting companies that have accepted Death Spiral loans is like shooting fish in a barrel. Almost all of them will have total or near total destruction of their stock price.

Alas, these companies tend to be small companies with limited capitalization giving the short seller a small market to sell into.

Nifty New Tool to Fight Short Sellers

Shareholder Intelligence Services, LLC – (ShareIntel) is a service for public companies to obtain, aggregate, track and analyze shareholder trading information. Find it at ShareIntel.com.

They have a proprietary patent pending web-based application they call the “Data Repository Information Link” system DRIL-Down^TM.

This allows public companies to track broker-dealer, clearing firm and shareholder position movements. With ShareIntel you can track equity flows and identify suspicious, aberrant and/or unusual trading activity in your stock.

You can also historically aggregate repository data from reporting entities, broker-dealers, and shareholders.

You can effectively identify, interpret and communicate shareholder and broker-dealer movement to the market.

Companies can see stock price manipulation, insider trading, "naked" short-selling, market timing, violations of Rule 144, and corporate governance and compliance violations. 

Truly successful stock trading and investor relations depends on getting all the data you can. The system is affordable and a must for public companies seeking to see below the surface of their stock price movement.

Email Bradley Kline <bkline@globalselectadvisors.com> to get a demo. Tell him John Lux sent you. No, I am not being paid anything for this.

Reg A+ Portal Opportunity for Short Sellers?

As a former IPO market maker for a Wall Street investment bank and as one who found short sales for short sellers, I would like to comment on Reg A+ IPO portals. 

As I understand the model, the portal gets companies to list on the portal. The portal then helps the company beat the drum to attract investors. So far so good.

Presumably, the Reg A+ offerings will be smaller and more speculative. Institutional investor interest may be limited and the deal will be placed in some part with small, speculative individual investors. 

Next, when the deal is ready, the investors buy the stock. 

The issues raised are (1) when all the demand is filled, who buys the stock in the aftermarket, and (2) small holders are not necessarily the most stable. 

Historically , there are two IPOs that show the result of these factors.

First, Facebook filled all the demand for stock that it saw. Normally, for a hot issue, you make an indication of interest beyond what you actually want so you can wind up getting what you want. So if you want 100,000 shares, you may request 200,000. Now Facebook was a hot issue so people were making indications for many times what they actually wanted, believing that they would be greatly cut back.

Facebook increased the offering at the last minute to fill all this demand, with the result that not only was there no buying power left, people had more than they actually wanted. The stock price dropped like a stone to nearly half price in a few months. There was no one left to buy in the aftermarket. No demand = price drop. 

Second, Vonage sold to many customers who were small, perhaps even new, investors. The shorts, who love to look for vulnerable IPOs anyway, loved this and drove the price down in the aftermarket to panic these small investors into selling. 

Thus, a process that fills all the demand by selling to small investors, is likely to be bait for short sellers.

By the way, both these deals attracted plaintiffs' attorneys when the price fell. This is automatic. If the stock goes way down, the attorneys show up. Fortunately, they were both successful companies and went on to do well. 

IPO underwriters generally have something called a Green Shoe – https://en.wikipedia.org/wiki/Greenshoe -- which allows the underwriter to buy more stock in a deal. They can go short as much stock is covered by the Green Shoe with no risk because they can always cover the short with the Green Shoe. Thus, the underwriters can afford to support the stock in the immediate aftermarket.

I do not believe any portals will have Green Shoes. 

Time will tell if Reg A+ deals attract short sellers. The offerings may not be large enough. 

The smart company will pay attention to its aftermarket.  

Reg A+ Trumps Reverse Merger

Death Spiral Loan Securities Fraud

The Case Against Herbalife

http://thehill.com/blogs/congress-blog/judicial/244288-pyramid-scheme-disguised-as-a-business-opportunity

June 08, 2015, 01:00 pm

Pyramid scheme disguised as a business opportunity

By Johanna Amaya

Washington is more concerned with politics and fighting than protecting hardworking people. If someone blew the whistle on a company making billions of dollars by scamming low-income Latinos, you would expect the government would be more focused on stopping it. When it comes to the pyramid scheme called Herbalife, the only thing anyone in Washington wants to talk about is the Wall Street investor who brought the company’s predatory business practices to light. As someone who has lost a lot of money to Herbalife, I’m standing up and asking why does nobody seem to care about the victims of this pyramid scheme?

I became involved in Herbalife because I was promised the American dream. I was told I would own my own business and make a good income by selling protein powder and vitamins and getting others to sell as well under me. That dream turned into a nightmare and I ended up with a mountain of credit card debt. It troubles me to hear people say that the situation with Herbalife is a battle between Wall Street and Washington, DC. This takes the focus off the real issue, the individual victims of Herbalife.

It’s not easy to talk about being a victim of a scam, but I am speaking out because I don’t want people to forget what is at stake here. Real people have lost money, some even lost their life savings, because they joined a pyramid scheme disguised as a business opportunity. I joined Herbalife after I was told I would “earn what I was worth” by starting a “micro-franchise.” But this “home-based business,” as it was called, cost me thousands in credit card debt and countless hours of hard work that I will never get back. I was required to invest in packages that promised to help me find customer leads who would then buy my Herbalife products. These packages were extremely expensive and worthless. I ended up with over $30,000 in credit card debt and nothing to show for it!

I am hardly alone as a victim of Herbalife’s scam. There are thousands of victims like me, people who were simply trying to make ends meet and ended up in a scam. Most people who join Herbalife will earn nothing and many will actually lose money. In fact, according to the company’s own data,88 percent Herbalife’s distributors never receive a payment from Herbalife. The business scheme forces more than 1,000 distributors to drop out daily. How much longer will I hear about people who can’t pay their mortgage, put food on the table, or make ends meet before someone does something to stop this company?

I bet few people in Washington know about the stories of Herbalife victims. Herbalife tries to change the subject by focusing on Bill Ackman, a hedge fund manager who could make lots of money if the government shuts down Herbalife. For years, Herbalife has made sure that our story didn’t get told. It took the attention of a hedge fund before people realized that Herbalife is intentionally targeting low-income communities like mine. If Bill Ackman makes money out of this that’s ok by me because it will mean that Herbalife is no longer taking advantage of people like me. 

At the end of the day, I hope that by sharing my story, people in Washington start to realize that this isn’t about a hedge fund—it’s about real people who have suffered real loss because they were duped into a scam. Until people start talking about the victims, how can we stop Herbalife from continuing to harm the vulnerable communities with their lies and deceptions?

Amaya is a Southern California resident and victim of Herbalife’s business structure. She filed a consumer complaint against Herbalife Ltd with the California Attorney General’s office in April, 2015

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HLF Deflates

Chart courtesy of StockCharts.com

Herbalife shed over six points in the last two sessions, on increasing volume.

Often you will find that a stock moves without apparent reason, only to find the reason appear in the news after the move.

Speaking as a former market maker, this stock looks set up for more selling and I would expect news to later explain why.

HLF Herbalife Counter Counter Attack

Now in the news, CNBC reports that federal law enforcement agencies recently contacted 10 or so mostly top Herbalife members for information about their own business practices.

CNBC also says Herbalife has received inquiries about irregular trading in its stock as part of a broader investigation into possible market manipulation.

This is significant because it is a great counter to the recent report that the FBI was questioning people who were advocating for the shorts, which itself was a brilliant counter attack on the shorts. 

As I understand this type of marketing, the leading distributors have spent years developing networks of distributors under them. If any of them leave, they could take a huge team of marketers with them. However, where would they go if they left? They may be tied in to Herbalife with no place to go. 

Now hear the brilliant counter to the counter to the counter. When asked for a comment Herbalife spokesman told CNBC that there is reportedly an ongoing federal criminal investigation into the Ackman campaign against Herbalife "for stock manipulation and law enforcement and regulators have recently sought information from Herbalife and others relating to that investigation as well as trading in Herbalife shares and allegations about our business practices. We are cooperating with these requests for information, remain confident in the integrity of our business practices, and are hopeful Ackman's long-term campaign of distortion will be found to be illegal."

In other words if you believe Herbalife, and we make no judgment on the merits of one side or another, Ackman is the lawbreaker and the manipulator being investigated, not HLF. 

It is often very effective to accuse your enemy of what he accuses you of. If people will listen to his allegations of one type of misconduct, they will listen to your allegations of that same type of conduct. This will at least produce a stalemate. 

As one who investigates stock market misconduct, when a suspect makes bitter allegations against someone that are unfounded, we immediately look for the accuser's misconduct of the same type. The accusers accuse others of doing what they are doing. This is a wonderful investigative tool. 

Again we make no judgment here on one side or another. We are not enough familiar with the facts and we note both sides are making similar allegations. 

We simply note these things as being of interest to those shorting or fighting shorts. 

Attack, HLF is illegal, counter attack is that Ackman is illegal, counter counter is HLF is being investigated by federal law enforcement authorities, and counter to the counter counter, Ackman is the one being investigated. 

Great game!

Short Selling Strategy -- Starting a Panic

One goal of a predatory short seller may be to cause a panic among the enemy.

Let us define the state we want to create. We want a state of fear that is so intense, so frantic, that it overwhelms and dominates thinking to create the actions we want. We want this to be a contagious group state.

So imagine the stampede for the exits when someone yells “Fire!” in a crowded theater. The audience panics and clogs the exits with bodies.

Would you not like the shareholders to panic and run for the exits by selling such that this stampede of selling at any cost drives the stock to next to nothing?

Would you not like managers to be paralyzed and not know what to do? Wouldn't you want them to stop their duties and start frantically circulating resumes?

Wouldn't you want the customers to jam the phones with requests for refunds?

Note that this has to be a sudden, overwhelming attack from which recovery is impossible. Over time, anyone can get used to anything, change, adapt and eventually recover. No! You want smashing direct hit destruction of all systems.

Note also that if the mind is totally taken up with panic, logical thought, productive thought is impossible and wild action, even that which would cause the destruction of the entity involved can happen. The people rushing to the exits can be trampled to death, not having the presence of mind to realize that they need to take other action.

Short sellers can attack various groups: target shareholders, company management, company employees, and customers. They can attack all of these at once.

What causes the type of panic we want?

Real or imagined immediate threats to survival. Not seeing any hope, being unable to move or respond, being surrounded, all are things that can cause panic. Not seeing any prospect for help or rescue. Having too much to handle. Stress. Weakness. Confusion. For unethical companies, the threat of prosecution. The fear that others will sell before you can. 

While a team can help provide its members with courage, panic is a herd disease that infects groups rapidly. Being part of a herd makes you more susceptible.

Being in a new situation makes one more susceptible.

Note also that you can have buying panics. The short sellers are panicked about their losses and want to cover at any price.

Can you protect against panic? At some level, no. Even the most well trained soldiers can fall into panic. However, good training can ward off most panic. Good leadership can stop a panic. Good leaders are immune from herd instinct.

It is interesting to me that some soldiers in a threatening situation will hunker down and fight to the death they know must come, while others panic and run (only to be killed without killing any enemies). Recall the determination of the Spartan 300 at Thermopylae.

In my opinion you find short selling opportunities when you have a bubble caused by investor herd behavior that drives prices beyond all reality, and you the find that this herd is that much more susceptible to panic on the way down. One a herd, always a herd. Herds can be stampeded.

Herbalife HLF Counter Attack

Events are as reported as follows:

Bill Ackman of Pershing Square has been shorting Herbalife (HLF). 

He has been involved in formal investigations of HLF already opened and ongoing by the SEC and FTC.

Now the FBI and federal prosecutors are interviewing people related to Ackman and asking for documents, looking for potential Herbalife stock manipulation, according to The Wall Street Journal. 

It appears that prosecutors in the Manhattan U.S. attorney’s office and New York field office of the FBI are looking into whether people, including some hired by Mr. Ackman, made false statements about Herbalife’s business model to regulators and others in order to spur investigations into the company and lower its stock price. 

The result of this report was immediate and dramatic:

Chart courtesy of Stockcharts.com 

Global Strategy Group, the consultancy firm hired by Ackman, said they are not the target of any investigation into potential manipulation of Herbalife's stock, and Ackman told CNBC's Scott Wapner on Friday that he was aware that Global Strategy Group, a consulting firm he hired, had been contacted by the FBI. Ackman made very clear, however, that neither he nor his hedge fund had been contacted by the FBI or Department of Justice. He reiterated to Wapner his conviction Herbalife was a pyramid scheme and he explicitly said he had made no false statements about Herbalife. 

A lawsuit against HLF for fraud was also dismissed. While it will no doubt be re-filed, but this adds to the bad news for the shorts. The shorts are now on the defensive and find themselves having to explain things. Hence, the stock is strong. 

My analysis:

Ackman has attacked a company with huge cash flow. HLF has had to defend itself over the years against many attacks, including a congressional investigation. HLF is therefore experienced at defense and well fortified.

If you are going to attack a well defended fortress, you do not do it with a frontal attack. 

The proof of this is that even though Ackman was successful in getting investigations going he did so at great cost in terms of his lobbying bill and having to endure being squeezed in the market. 

HLF has outspent him in their lobbying efforts. After all their survival is at stake. 

We think perhaps that now some bulls in the stock are making a counter attack on the bears and have gotten the authorities interested in investigating the bears. Who could have planted, I mean leaked this news to The Wall Street Journal?

The result of this investigation being announced were evident in the jump in price. 

Here we have a case where the company actually counter-attacked. They got a noisy investigation going that has a strong element of threat to the shorts. It is not a defense of their business model, it is a direct threat to the shorts. Public investigations are always a wonderful tool.

The result of this counter attack has been very beneficial for the company. Where denials issued by the company have been ineffective, this public attack on the enemy has been effective. Let this be a lesson to all companies under attack by short sellers. 

We still doubt that this will be much more another temporary back and forth battle between two well financed adversaries. 

HLF is slowly bleeding out  but Ackman is not getting a return on his investment. We think the smart money is on Ackman to win a very long and costly war. Ackman has enough money to keep his short position forever.

The moral of the story is to win by overwhelming the enemy. One overwhelms by making a huge attack that cannot be countered or handled. Surprise is key. You have to attack by getting there "firstest with the mostest."

Trench warfare stalemates are not productive of high return on investment for short sellers.

Short Selling Technique of Market Makers

Why the Short Sellers Attack Your Stock

Stopping the Company from Uplisting

I believe short selling is an epidemic in the OTC markets just now.

While some listed companies can escape short sellers if they have merit, a low price, and are not otherwise suitable for attack, OTC companies generally are under a cloud.

First, the general opinion, not without merit, is that most OTC stocks are a short sellers dream because:

These companies are not managed by persons experienced in the treachery of the stock markets. These managers do not realize that a short attack means a life and death battle. Thus, the company sits there without taking any defensive action and so bleeds to death under the continual attack of a predatory short. Even if a defense is mounted, defense is a losing game -- only attacking back will drive off a short seller. I do not recall seeing any such attack on a short seller, although counter attacks are common in hostile takeover fights over listed companies.

These small companies often are not managed by experienced executives. Successful management of a growing company is a art and a very difficult one at that. One wrong turn and the company falls prey to the vultures.

The entire OTC market is under a cloud with investors and regulators because of frequent abuses by promoters.

Many institutions and other sophisticated investors will not consider low priced or unlisted securities.

The resources of the shorts often exceed the resources of the company.

OTC companies are often long on dreams and short on substance.

OTC companies often lack positive cash flow.

Generally, longs do not rise to the defense of an OTC company when it is attacked. It is their opinion that being sold short is a sign of something wrong and they do not want to take any unnecessary risk. Why swim upstream?

Thus, it is natural for a growing company to want to uplist, to go to a higher exchange or trading venue.

However, such markets require for listing a minimum stock price. Often the company's stock is well below this price. Management orders a reverse split to get the price over the required threshold.

The shorts, as with anything that would benefit the company, immediately try to kill the uplisting effort by blasting the stock back down below the threshold. This will prevent the uplisting. Hopefully, it will demoralize the longs and management as well and cause them to realize that the stock is caught in quicksand -- the more you struggle in quicksand, the more you sink in.

This post is written with one recent example in mind. I will not embarrass management by naming it or showing you the chart.

This was a Pink Sheet company, a product of a reverse merger. The operating company has millions in revenue and even paid a dividend. The idea was to get the stock over $1.00 and make the company fully reporting, a worthwhile goal for a worthwhile company.

A one for 50 reverse split was done and the stock traded over $2.50 per share. At that point the company must have figured they were all set to meet with $1.00 target.

Yet their joy was short lived. Seven months later the stock hit $0.25 -- dropping 90% and putting it below the $1.00 target.

And this company had a stock repurchase program!

Short Selling -- Stopping the Company from Raising Money

One of the great techniques of predatory short sellers is to keep the price of the company stock down.

Now you might think that a short seller would want to increase the price so he could increase his line at a high price.

However, for a company that has negative cash flow, or a company that needs to raise money, a los stock price will cause the company to raise money at lower prices causing more dilution and thus decreasing the value of the stock.

If the price is low enough, it may stop financing altogether. Some institutions have rules about avoiding low priced stock and if you push the price down below their lower limit, finance dries up.

A declining stock price can also cause morale problems among shareholders, employees, and even customers. A declining stock price or a low stock price is taken as evidence of some defect. Key employees with stock options are sensitive to the stock price.

Thus, aggressive predatory short sellers want the price to go down, to continue to do down and to stay down.

As the short seller only recognizes taxable gain when he closes out his position, he may not want the company to fail entirely, just to stay comfortably and surely in the land of the living dead with a price in the cellar and no chance of jumping back to life.

This was a wonderful technique in the days of naked short selling as you could short more than the outstanding stock and by using the laws of supply and demand push the stock into oblivion by destroying all attempts to get new money.

Personally, I find it too predatory to destroy companies with potential just by pushing the price down. We are here to benefit people, not hurt them. We only want to hurt scammers and bums.

This is why it is so wonderful to find some real crooks out there working a manipulation and crush them. You can attack without reservation. Where else do you have this license?

Short Selling -- The One Thing that Crushes the Enemy

What most people, in fact all the people I know of, do not realize is that there is always one thing that causes your enemies to collapse.

So if you are a short seller wanting to crush a stock price or a company, you can find, even if you think not, one thing that causes them to collapse instantly.

Short selling should not be a battle of years, a war of attrition.

Remember you are going for a fast return on your investment as that maximizes return on investment -- ROI is measured as a percentage per year, not a percentage per millenia.

50% ROI in one year is great, 50% ROI in ten year sucks -- think of all the risks you took to get there.

You will know when you find the one thing because the stock price dives and terminates in a total win.

The one thing causes the enemy to flee the battlefield, causes them to retreat in a panic.

The one thing cause the stock to drop like a burst balloon.

The one thing takes a hardened enemy with all guns blazing and makes them collapse into a fast and unconditional surrender. From machine gun blasts to white flag as fast as the flag can be shown.

Unless your attack causes these results you have not found the one thing.

The same is true of companies fighting off short sellers -- the one thing causes the shorts to cover and go away fast.

A careful study of stock market and military battles shows that the one thing, when found, works magic.

What causes soldiers to panic and flee and what causes boards of directors to head to Brazil? There is your answer.

Now if you don't know there is always one thing, you are going to be trying all sorts of moderately useful solutions, but you will not get the result you want.

Find the one thing from experience, from thought, from testing. Find it any way you can, but find it.

You do not need huge resources to win, only the one thing.

FOIA Request for SEC's Naked Short Files

http://www.marketwatch.com/story/journalist-sues-sec-to-get-naked-short-selling-files-2014-05-29

Mark Mitchell, who writes on www.deepcapture.com, has filed a Freedom of Information Act lawsuit against the Securities and Exchange Commission (SEC) to obtain the agency’s investigative files relating to more than a dozen aborted investigations and cases involving naked short selling.

This will be interesting. First, the SEC never released results of the investigation into the Bear Stearns case. Second, there have not been many naked shorting cases brought, yet it seems like there were more than a few cases of this abuse.

Stay tuned for further developments. . . .

Short Selling -- Research and Destroy

If you had not noticed, or if you have not participated, there is a technique I call "research and destroy."

A stock researcher finds a short sale candidate. This stock may have some hidden fraud, or weak holders, or some other vulnerability. He does his homework and if he does not have his own short fund, he tells those who do.

They all short the stock and once they have a good position, with great fanfare they publish the hit piece on the stock with huge publicity.

The stock craters and the shorts have one of the best trades in the world -- a sure thing and a short term sure thing at that.

Never mind the merits of the company or that the research of the shorts is questionnable, the important thing is scaring the weak shareholders into dumping the stock.

With a fast hit like this, a drive by shooting, no one has a chance to dig into the real facts.

The media, hungry for news, and loving stories that invalidate things and people, give the researcher's claims a wide distribution.

This starts the stampede of the longs to the exits and with the resulting short term imbalance in supply and demand the price goes into free fall.

Only after a month or two can the stock recover if the selling is unwarranted.

But who cares, the shorts have their fast profits and time to cover at leisure.

Risk to the shorts = almost zero. The only question is how far the stock will go before it is time to close out the trade.

Now it helps if the stock is that of a Chinese company traded in the United States as these companies are under a cloud and they do not know how to defend themselves from short sellers.

The big shorts have someone else act as the front man in the media. The big boys like privacy and why put yourself out there to be sued when you can pay someone else to be the public mouthpiece and take the heat.

Where else are you going to find a short term sure thing like this? You put up 50% of the price to go short. If the stock drops about 50%, so you have a 100% profit in a few months. What is the worst that can happen? The stock does not drop on the hit? So you cover even and lose nothing.

Research and destroy.

Herbalife - HLF - conflict wastes time

Much news this week on Herbalife (HLF).

The New York Times put up a well written piece covertly criticizing Ackmann for lobbying and revealing the million of bucks spent  by HLF on counter-lobbying : The Herbalife War

Both sides are hiring people who are connected in an attempt to influence the regulators.

Ackmann scored a big win when the FTC opened an investigation, yet HLF's allies say the result of this FTC action will not be very expensive to HLF. 

Here is the chart showing the surprise hit, the eventual comeback to higher prices that caused Ackmann to take a huge loss, and the recent hit when the FTC investigation is announced.

HLF -- Chart courtesy of Stockcharts.com

Missing the Point 

I maintain that both sides are missing the point.

The idea is not to expend massive resources for huge battles. These resources are expensive. Expensive advisers, even though they may be people of great reputation and integrity, have a built in interest in keeping the battle going, do they not?

Huge battles between two well financed adversaries are seldom conclusive; they just wound both sides.

Continuing the battle is expensive for the company as it continues to be under a cloud, stifling its survival.

Continuing the battle is expensive for the short as he has to pay interest on the money to carry his position,, has to pay to borrow stock, and still has to make a return for its investors. This all adds up.

The trick is to find that one point that causes the enemy to lose power and collapse like a balloon stuck with a pin.

This is why you look for air bubble stocks to short, they are easy prey. Chinese companies have been fun shorts as they do not know how to defend themselves and there has been a number of scams that inflict the reputation of the whole sector. One wonders if anyone is enthusiastic about protecting Chinese companies trading in the U.S. given these past scandals.

This is why you do not short stocks that have many millions in cash flow. While you may get a fast win that feels good, like the attack on Pearl Harbor, the enemy becomes enraged and comes after you with all their resources, like bombing two cities with nukes. See the chart above. Notice that Ackmann had his fast drop from his surprise attack, and then HLF came back and caused him huge losses.

Now if you are locked in one of these battles, you still need to find that one point that will deflate the enemy instantly.

You will know you have found it when the enemy runs away so fast you cannot folllow him.

Then it is not a war any more than stepping on a cockroach in your kitchen is a war.

Yet you had better find this attack point fast or you will be slowly losing energy while you expend big bucks holding your position while the enemy gains strength.

I am not going to tell you any more valuable trade secrets in public. If there are those expending many millions to fight these battles, hiring the smartest and most powerful people out there, and they still have not found it, it must be rare and valuable information, yes?

This may give you food for thought -- what type of thing could this be, how do I find it, how do I exploit it?

Herbalife and the Short Sellers

Herbalife (HLF) has been under attack for months by short sellers but the stock has performed well, urged on by long traders like Carl Icahn. 

It is now announced that Senator Mackey of Massachusetts has written to the SEC and the FTC asking them to investigate HLF.

California Atty. Gen. Kamala D. Harris' staff has agreed to meet today Friday in Los Angeles with a coalition of critics who believe that Herbalife Ltd. preys on poverty-stricken immigrants with false hopes of easy money.

When you have predatory or activist short sellers, you can expect a public relations battle to begin.

Just as the lion kills its prey by grabbing the prey's throat in its mouth and squeezing off blood to the brain, a predatory short seller will gradually cut all supp0rt for its victim.  

We have in HLF an interesting situation because the company's case is flawed at best -- 88% of its distributors do not make a dime, because the company has almost $800 million in EBITDA, and because we have an investor with relatively unlimited resources, Carl Icahn, buying up the stock with the intention of squeezing the lead short seller, Bill Ackman, with whom he has a grudge.  Carl is an expert at using the media to publicize his investments. 

We see the resources each side has, we can expect an excellent public relations contest.

The shorts, with almost 20 million shares short as of the end of the year, are probably pushing these latest two announcements. 

In retaliation, HLF has said it is "eager" to address the Senator's concerns at his earliest convenience. This is a good reply by a competent staff that is used to defending the company and its business.

The shorts seem intent on recruiting powerful allies in the government, both in California and with two federal agencies. 

As a short you want the attack vectors focused on the target. You want force multipliers from entities that are more powerful than your target. 

These attacks come at a good time for the shorts as the stock seems to have been high priced even if its business model is a valid one.

Chart courtesy of Stockcharts.com

Thus we see a lovely move from over $80 to almost $60. I am sure the shorts are hoping this will start some momentum on the downside. No doubt they would like to panic and institutional holders into seeking a safer stock and one that is not accused of preying on the public. In fact I doubt that the stock will ever see $80 again. I believe the shorts will eventually bring it down but the battle will take years and be very costly. 

What seems unusual to me is that the shorts would attack a company with billions in revenues and almost $900 million in cash to protect itself. 

After all, lions, crocodiles and other predators all go after the weakest member of the herd, not the strongest. In war, you attack where the enemy is weak. You do not make a frontal assault on a heavily defended position. 

As a short seller, you want stocks that tank fast after a big hit, not a long, drawn out expensive war. 

There are many tools left for both sides to use. I believe it is a mistake not to use them all at once. 

The power of Herbalife is that it can recruit new distributors. All this publicity cannot be helping. While it is good to try to recruit the government, to rely on that as your only attack is a big mistake as you cannot control it. 

On the other side, the longs just seem intent on talking up their position. I do not see them directly attacking the shorts, other than making the price go up.  As we saw this week, it is a mistake to rely only on this. 

In a life or death battle, shorts only stop attacking when you are almost dead. 

We look forward to being a spectator on this one. 

Shorting Pump and Dump Stocks

One of the wonderful things about shorting stock promotions, or pumps and dumps, is the chance that the regulators might come in and nail them while you are short.

This makes for instant profits.

Let's take the example of Life Stem Genetics, Inc.  LIFS.

I received in the mail a promotional brochure telling me that buying LIFS is like owning stock in the fountain of youth.

Checking the chart, I found that the stock was making a steady climb, indicating a successful promotion.

However, things seemed to have gone astray:

SECURITIES EXCHANGE ACT OF 1934

Release No. 70933 / November 25, 2013

The Securities and Exchange Commission ("Commission") announced the temporary

suspension, pursuant to Section 12(k) of the Securities Exchange Act of 1934 (the "Exchange Act"), of trading in the securities of Life Stem Genetics Inc. ("Life Stem"), of Beverly Hills, California, commencing at 9:30 a.m. EST on November 25, 2013, and terminating at 11:59 p.m. EST on December 9, 2013.

The Commission temporarily suspended trading in Life Stem because of questions regarding the adequacy and accuracy of information about Life Stem, including, among other things, its business operations.

_____ 

Oops!

Here is the chart, courtesy of those nice folks at Stockcharts.com:

Naturally, an aggressive, professional short seller will be happy to inform the regulators of the fruits of its research. 

However, this does not always work. In fact, it may be more often that it does not work. Regulators are overloaded and may not feel motivated to attack your particular stock. Companies fight back and will be ready to counter any presentation you may make. You may even be sued by the company for slander. 

Nonetheless, informing the regulators of a documented fraud is a good thing to do. It serves the public good and your pocketbook. There is little downside risk and the profit potential is enormous.