From Washington Post, April 26,2006
2 Firms Claim Conspiracy in Analyst Reports
Short-Sellers and Researchers Colluded, the Companies Say
By Brooke A. Masters
Washington Post Staff Writer
Wednesday, April 26, 2006; Page D01
Are Biovail Corp. and Overstock.com Inc. promising companies victimized by unscrupulous investors illegally conspiring with stock analysts and journalists? Or are they troubled firms whose executives have turned to wild conspiracy theories to divert attention from underlying business problems?
That question is at the heart of two lawsuits and a couple of Securities and Exchange Commission investigations into whether there is an improper link between negative reports issued by Gradient Analytics, a Scottsdale, Ariz., research firm, and short-selling investors who have bet that Biovail and Overstock share prices will go down.
Internet retailer Overstock.com says research firm Gradient conspired with hedge funds to produce negative reports benefiting short-selling funds. (By Daniel Acker -- Bloomberg News)
Sources familiar with the SEC's investigation caution that it is in its early stages and that most SEC investigations do not result in formal charges. At any given time, the agency's enforcement division has 2,000 open probes, but it brings only about 600 cases a year. The SEC also is probing Biovail's accounting, a development the company blames on analysts and news reports. Overstock officials say the company is not facing regulatory scrutiny.
But the allegations highlight the growing impact of hedge funds that sell stocks short -- that's Wall Street's way of selling for today's price a promise to deliver a stock in the future, by which time, the seller hopes, the price will have fallen.
Hedge funds, lightly regulated investment pools that traditionally have promised high returns, have attracted more and more money, growing to about 9,000 funds with more than $1 trillion in assets from about 600 funds with $38 billion in assets in 1990. While many hedge funds use exotic trading techniques designed to make money no matter which direction the overall market is going, others specialize in placing bets on stocks they think are headed down.
Critics argue that short-sellers are harming overall prospects for long-term growth in their quest for quick profits, while fans say short-sellers bring a much-needed critical eye and are often among the first to spot fraud and other corporate troubles.
Some facts in the controversy are clear. Both Biovail and Overstock have struggled to keep investors enthusiastic about their prospects. Stock in Biovail, a Toronto-based pharmaceutical manufacturer, topped $55 in mid-2003 but now trades at about $25. Overstock is a Salt Lake City Internet retailer whose stock peaked in late 2004 at nearly $73 and now trades around $27.
Eight of nine analysts who cover Biovail have "hold" ratings, and one calls it an "underperform," according to Zacks Investment Research. Of 10 analysts who follow Overstock, six recommend holding and four recommend selling the stock. Representatives of both companies say they can live with most of the negative coverage by analysts.
But Overstock and Biovail executives argue that Gradient's coverage of their companies crossed a legal line.
In independent lawsuits filed in New Jersey by Biovail and in California by Overstock, both companies accuse Gradient and a predecessor company called Camelback of conspiring with hedge funds to produce negative research reports containing misleading or false information. The lawsuits further allege that Gradient then held off releasing the reports for several days to give the hedge funds a window in which to establish their short positions.
Each lawsuit draws heavily on affidavits from former Gradient employees who say they witnessed fellow employees allowing hedge fund clients to order negative reports, to ghostwrite the content, to add false or misleading information and to then arrange delayed release dates to give the hedge funds time to establish short positions. Overstock's lawsuit alleges that Gradient's principals also were shorting the stock themselves through hedge funds they controlled.
"This suit is about what I think is clearly illegal activity between a research firm and some hedge funds," said Overstock's outspoken chief executive, Patrick M. Byrne. "When the full story comes out, I think the American people are going to be lined up on Wall Street with pitchforks."
