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Thursday, 06/07/2001 12:40:28 AM

Thursday, June 07, 2001 12:40:28 AM

Post# of 80
if there's a floorless debenture being discussed,
this article is a good one:

http://www.law.com/cgi-bin/gx.cgi/AppLogic+FTContentServer?pagename=law/View
&c=Article&cid=ZZZTDP4AUFC&live=true&cst=1&pc=0&pa=0

Toxic Convertibles, Poisoned Financing
Stacy Mosher
The Deal

November 22, 2000


Shareholder backlash is building against "floating" or "floorless"
convertibles, a type of so-called vulture capital financing that benefits an
investment bank if a company's share price drops.
Public companies are increasingly resorting to lawsuits to nullify these
agreements when their implications become clear. And individual shareholders
are exploring their own legal options -- both against investment banks and
the executives who agree to the flawed financing -- to compensate them for
loss in shareholder value.
Shareholders are also putting pressure on the Securities and Exchange
Commission to require more stringent disclosures that could nullify the most
harmful effects of these instruments.
These financing instruments, often referred to as "toxic convertibles," work
as follows:
Preferred shares are issued to investment banks that can be converted later
into common stock at a discount to the prevailing market rate. Under the
terms of many floating convertible financing agreements, the conversion can
take place earlier and more shares can be converted if the company's share
price drops.
Toxic convertibles are more commonly sold by smaller and less prominent
investment banks, but larger institutions have also on occasion used them.
Companies entering into these arrangements often find that their share price
heads due south soon afterwards. The dilution resulting from conversion of
large quantities of shares puts downward pressure on the share price,
sometimes sending the stock into a death spiral.
Some companies claim the devaluation of their share price is caused by more
than just dilution, and they have taken the financing firms to court,
alleging market manipulation.
Two cases were settled in 1999 and early 2000, and another case is pending,
against the same investment firm, New York-based Promethean Investment Group
LLC, which has been charged (along with other firms) with conspiring to
drive share prices down through short-selling.
The first case, involving Intelect Communications Inc. of Richardson, Texas,
alleged that Promethean and the other small firms, Angelo, Gordon & Co. LP
and Citadel Investment Group LLC, pushed the price of Intelect stock down
from $1.88 Feb. 24, 1999, to 66 cents per share April 21. During that same
period, the short-interest position in Intelect stock shot up from less than
1.5 million shares to more than 3 million shares.
After Intelect announced a moratorium on conversions of preferred shares,
the price of the common stock rebounded to $1.97 within days -- evidence,
argued Intelect, that the price drop resulted from market manipulation by
the firms.
The case was settled unusually quickly -- a month after the complaint was
filed in June 1999. Under the terms of the settlement, Intelect issued a
portion of the common stock claimed by the investment firms and cancelled
the remainder of the preferred shares.
The investment firms also agreed to a prohibition on involvement in short
sales or other transactions through which they would benefit from a drop in
Intelect shares, as well as agreeing to restrictions on the quantity of
Intelect shares to be traded on any single day.
The second case was filed by Ariad Pharmaceuticals Inc. of Cambridge, Mass.,
at the end of October 1999 against Promethean and a related company, HFTP
Investment LLC. Ariad alleged that Promethean admitted to shorting 2.5
million shares of Ariad common stock -- more than 10 percent of the total
outstanding shares -- and that the short-selling drove the Ariad stock price
down from $1.81 June 2, 1999, to 56 cents by Oct. 11, 1999.
Ariad charged that if Promethean continued to manipulate Ariad's stock "like
a yo-yo," it stood to realize a 300 percent return on its investment within
one year.
The case was settled in January, shortly after Ariad submitted a request for
all trades carried out by the investment firms through a New York brokerage,
Cathay Financial LLC. In the settlement, Ariad agreed to convert 612
preferred shares into roughly 1.08 million shares of common stock, which
Promethean then agreed to trade in the public market to cover its short
position.
In the most recent case, Log On America Inc. of Providence, R.I., alleges
that Promethean, Citadel and Marshall Capital Management Inc., an affiliate
of Credit Suisse First Boston, shorted Log On stock and drove the price from
$17 per share in February down to $2.50 by Sept. 26. The price plunge made
the firms eligible to purchase approximately half of Log On's common stock.
Marshall allegedly informed Log On that all of the investing firms held
"massive" short positions in Log On stock.
Court filings also list 12 other public companies in which Promethean and
Citadel have allegedly engaged in similar market manipulation.
Promethean released a statement describing Log On's claims as "outrageous"
and "the product of either reckless speculation or ... deliberate malicious
intent."
As shareholders are becoming more aware of the shortcomings of floating
convertibles in relation to shareholder value, Promethean's string of
lawsuits has brought it under increasing investor scrutiny.
In late August, executives of Nashville-based Shop At Home Inc. were quoted
in The Tennessean saying that an increasing number of investors had
expressed misgivings over a recently announced preferred stock arrangement
with Promethean.
"In the case of Promethean and certain other companies, you can't see
anything good in these deals," says Aaron Brown, founder of New York-based
eRaider.com, a mutual fund set up to unite shareholders against stock fraud
and poor management. "There's no protection written in, and the terms are so
inequitable that you can hardly believe company management ever discussed
them or even read them before signing."
Brown has been using Internet bulletin boards to rally investor pressure
against toxic convertibles. "We've been accumulating the necessary data to
show that these arrangements almost never work," Brown said. "But there is a
definite gradation of quality. Agreements involving Shoreline Financial
Corp. in California are the best you can find, with the necessary safeguards
and limits built in. Then you get the big investment banks like PaineWebber
Inc., which are usually not the worst."
Brown believes there's not enough money at stake in most of these cases to
attract the contingency-based law firms that typically take on class
actions, and inquiries with some leading class-action law firms indicate
that, in fact, toxic convertibles have not yet appeared on their radars.
But some lawyers who have conducted lawsuits against investment banks such
as Promethean on behalf of public companies believe that in theory similar
lawsuits could be brought by ordinary shareholders. "There would be a lot of
technical hurdles, but if shareholders asked me to get involved, I'd look
into it," one attorney said.
ERaider has targeted a toxic convertible signed by Transmedia Asia Pacific
Inc. as a particularly egregious case. "It was a good business with good
potential, but once it signed the agreement it lost 90 percent of its market
cap," Brown said.
Transmedia presents an example of the difficulties faced by this kind of
shareholder activism. Brown said he originally had the support of
institutional shareholders, but many of them sold off their stock, and
others went off and negotiated their own side deals. Worst of all, "The
people who were scammed are blaming us for exposing it and driving the price
down further," he said.
Brown says eRaider has decided to fight toxic convertibles in general in
recognition of the difficulties of winning individual cases. The group has
submitted proposals to the SEC to improve disclosure of toxic convertibles.
An SEC spokesperson said at present floating convertibles do not need to be
disclosed until the point where the investor wants to convert the preferred
shares into common stock for resale. At that point, the full risks of the
investment, including possible dilution and decline in share price, has to
be disclosed in a prospectus. There is no requirement to outline these same
risks to existing shareholders at the time the agreement is signed.
The spokesperson declined to comment on the possibility of more stringent
disclosure requirements in the future, but added, "It's a priority for us to
look at ways to make investors more aware of risks in investing."
The National Association of Securities Dealers Inc. calls for disclosure and
shareholder approval for what it terms "Future Priced Securities," but
shareholder approval is not necessary if the agreement caps conversion of
the security at 20 percent of the common stock, or if a floor is placed on
the conversion price. The 20 percent cap is easily evaded if conversion is
made in stages, and if the floor of the conversion price is low enough,
shareholders can still suffer significant depreciation of their holdings.
At the same time, any prudent reader of the NASD rules can detect a strongly
cautionary note toward this type of financing: "[T]he issuance of Future
Priced Securities may be followed by a decline in the common stock price,
creating additional dilution to the existing holders of the common stock."
But Brown believes the NASD rules do little to protect shareholder interest.
"Threatening to delist the company makes things even worse for
shareholders," he said.
Copyright (c)2000 TDD, LLC. All rights reserved.

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