A MUST READ !!!! For any Uluru subscriber
The downturn in the stock market was especially severe in the third quarter, as sovereign debt fears in Europe and recession concerns in the United States caused the S&P 500 to decline 14%, the worst quarterly performance since the financial crisis of 2008. While equities suffered globally, no more pain was felt than by those who owned small and microcap stocks. The Russell Microcap Index plunged more than 20% in the third quarter, and is down more than 20% for the year. However, out of declines come opportunities, and the downturn in tiny stocks has spawned a new breed of predatory investors who prey on small, unsophisticated cash-starved companies the same way that some animals eat their young. Although funds like NIR Group have shut down due to SEC lawsuits and issuer litigation, other groups such as JMJ Financial, Ironridge Global Partners and Southridge Capital Management have taken their place. We’ll take a brief look at each and why when you see them in your portfolio you should run the other way.
JMJ Financial
The group, founded by Justin Keener, who bills himself as a “lifetime entrepreneur” according to its web site, typically invests $400,000-$1,250,000 up-front in small companies. The structures are generally convertible transactions, in which Notes are converted into equity at a time of JMJ’s choosing. So far, so good. The “toxic” part however is that there is no floor. When JMJ converts, it is almost always at prices between 50-80% of the market price for the stock, wherever the stock is at the time it chooses to convert. The “good news” for investors is that the conversion opportunity doesn’t generally occur for six months, as it purchases securities that are restricted. However, once the conversion opportunity occurs, the results are often not pretty.
One such company who appears to be a “repeat offender” with JMJ is Cord Blood America (OTCBB: CBAI), a company that provides collection and storage of stem cells. On January 12, 2011, the Company issued a $1,050,000 "Convertible Promissory Note" to JMJ according to regulatory filings with the SEC. The three-year Note bears interest in the form of a one- time interest charge of 10%, payable on the maturity date. The problem is that the Note is also convertible at any time into common stock at a per share conversion price equal to 85% of the average of the 5 lowest traded prices for the Company's common stock in the 20 trading days previous to the effective date of each such conversion. In essence, regardless of when JMJ converts, the lender is assured of at least a 15% discount to the price at the time of conversion, and likely a lot more than that as it can pick the lowest prices during the conversion price. Not surprisingly, the company said in the same regulatory filing with the SEC it owed the investor liquidated damages from a previous transaction. The penalties included a reduced conversion price, and an increase in principal of more than 30%. The stock has lost more than 90% of its value since the middle of May this year, just two months before JMJ could start converting. Unfortunately, many of the other stocks that JMJ has funded have experienced similar results.
Ironridge Global Partners
Perhaps the most predatory of all groups is the newest. Co-founded earlier this year by John Kirkland, an attorney who worked for Marc Dreier, currently serving 20 years in jail after pleading guilty to a $700 million fraud and Brendan T. O’Neil who has run two funds that have folded in the last three years, Ironridge bills itself, according to its web site, as “supplying innovative financing solutions and flexible capital, as it seeks to unlock the full potential of cash-constrained businesses.” There is certainly some truth to that statement, as the companies it has completed deals with seem on the verge of going out of business. Ironridge usually doesn’t fund the company until after it sells the stock, as the filings show that payments are often not made until at least 20 days after they have received free-trading shares (imagine borrowing money from somebody and having to provide them with the money to make your loan before you receive any proceeds from them). The destruction in stocks they have completed transactions with makes the devastation from Hurricane Irene seem tame by comparison. Just two weeks ago, Uluru (NYSE: ULU) announced a “$1.6 million financing at a premium to market with Ironridge.” The problem is that the company neither received $1.6 million, nor was the deal done at a premium. The details in the 8-k suggest that the press release was misleading, as the company will receive proceeds only after a certain dollar amount of stock trades, and Ironridge’s actual cost to buy the stock is a fraction of the advertised price. Investors don’t seem fooled, as ULU’s stock is down nearly 50% in two weeks since the deal was announced. Less than two weeks after announcing the deal with Ironridge, the regulatory arm of the NYSE AMEX notified Uluru that it was not in compliance with listing standards and that it faced delisting. Uluru, like all of the companies Ironridge has completed transactions with, currently has a nominal market capitalization, in this case less than $2 million.
Uluru is not the only company in Ironridge’s portfolio facing delisting. PositiveID Corporation (OTCBB: PSID) was delisted from the Nasdaq less than five weeks after entering into “Strategic Financings for Up to $13.8 Million at a Premium to Current Share Price” with Ironridge. Shortly after the announcement, however, the company acknowledged in an 8-k filing that it did not receive the funds it had anticipated and that the price of the deal was being revised lower (think floorless financing). According to the filing made nearly two months after the deal was announced, the company has still not received the $1.5 million it was anticipating receiving as the first part of the funding. Approximately one month after the deal was announced, the CEO resigned. The stock has lost approximately 60% of its value in two months since the deal was announced.
Apparently inking a deal with Ironridge is not a career-enhancing move for a CEO. Less than three weeks after announcing an initial round of funding of approximately $1.12 million from Ironridge, the CEO of High Plains Gas (OTCBB: HPGS) resigned in the wake of the stock’s loss of more than 65% of its price. Like other companies which have done business with Ironridge, neither High Plains nor its creditors had received funding weeks after the deal was completed. Imagine losing your job, destroying your stock and not receiving proceeds after all of that. On average, from the time a regulatory filing was made announcing a deal with Ironridge, companies saw their stocks lose more than half their value within one month.
Southridge Capital Management
While Ironridge in a short period of time has become notorious for destroying small companies, Southridge has been at it for much longer. Apparently, the SEC decided that if companies couldn’t protect themselves from the group that it would step in and attempt to halt the predatory investment practices. Less than one year ago, both the SEC and Connecticut filed suit against the fund, accusing it of filing “ false financial statements and other violations of the funds’ private placement memoranda and charging excessive fees to the funds’ investors,” according to the state’s complaint, “based on misleading and fraudulent valuations of the assets Southridge managed on behalf of the funds and their investors.”
The fund’s investors are not the only ones however taking it to court. Hyperdynamics sued Southridge in a Georgia court charging that it “conspired to engage in fraud and market manipulation involving toxic convertible financing transactions with companies seeking private placement investors. According to Hyperdynamics, Southridge used an offshore financial structure to conceal both the true identity of, and the relationship between, the Defendants when preying upon unsuspecting businesses seeking financing. The Defendants are alleged to enter into toxic convertible financing agreements with the then-present intent to surreptitiously use short sales and naked short sales to manipulate the value of the company's stock by driving the price downward, and to then acquire a majority position in the company upon the conversion of the investor's preferred securities to common stock. Hyperdynamics is just one of many companies who has sued Southridge for destroying its business.”
Limited access to the capital markets has made for tough times for small companies. Many large and small companies have seen significant declines in the price of their stocks. But dealing with these groups seems to represent the last step before a company shuts its doors, leaving investors holding worthless securities. If you see one of the companies in your portfolio announce a deal with one of these groups, beware that it is likely not one it appears to be and that the stock and your bankroll is likely to suffer significant damage. Caveat emptor!
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