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NEWS: The Short And Distort - Stock Manipulation In A Bear Market
http://www.investopedia.com/articles/analyst/030102.asp
March 1, 2002 | By Rick Wayman


A less publicized and more sinister version of short selling can take place on Wall Street. It's called "short and distort". There is nothing inherently wrong with short selling, which is permissible under the regulations of the Securities & Exchange Commission (SEC). But the short-and-distort type of short seller uses misinformation and a bear market to manipulate stocks. Short and distort is as illegal as the pump and dump, but is mainly used in a bear market. It is important for investors to be aware of the dangers and to know how to protect themselves.

Short selling is the practice of selling borrowed stock in the hopes that the stock price will soon fall, allowing the short seller to buy it back for a profit. The SEC has made it a legal activity for several good reasons. First, it provides the markets with more information. Shorters (traders who practice selling short for a living) often complete extensive and legitimate due diligence to try and discover facts and flaws that support their suspicion that the target company is overvalued. Because most shorters are scrupulous and ethical, their actions are conducive to the health of the market. Finally, short selling also provides investors who own the stock (have "long" positions) the ability to generate some extra income by lending their shares to the shorts.

On the other hand, short and distort (S&D) traders manipulate stock prices in a bear market by taking short positions and then using a smear campaign to drive down the price of the targeted stock. This is the inverse version of the "pump and dump" tactic, whereby crooks buy stock (take a long position) and issue false information that causes the target stocks price to increase.

Generally, it is easier to manipulate stocks to go down in a bear market and up in a bull market. The pump and dump is better known than the S&D because of the long bull market and the media. The stock market has been in a general up-trend since the early 1980s, which provided ample fodder for "pumpers". Movies like Wall Street and The Boiler Room helped educate investors about the risk of this type of stock manipulation.

The S&D schysters try to profit by stimulating fear. They will use online screen names that imply either that they are associated with the SEC or the National Association of Securities Dealers, or that they can regularly spot worthless stocks. Their goal is to convince investors that every proponent of the stock has ties to the company and that the SEC is watching and will halt the stock. S&Ds also intimate that they are looking out for investors' interests. Short and distort players clutter message boards, so optimistic information cannot easily be found. "Get out before it all comes crashing down" and "Investors who wish to enter a class action lawsuit can contact…" are typical posts, as are their projections of $0.00 and loss projections of 100%. If their strategy is suspected by "longs", they attack the person that has caught them. The market manipulator will do everything in his/her power to keep buyers out of the stock and keep the price heading south.

The net effect is that the investors who initially bought stock at higher prices sell at low prices because of their mistaken belief that the stock is worthless, caused by an effective distortion campaign. At the same time, the S&Ds cover at low prices and lock in their gains.

In light of Enron and current market conditions, investors are more susceptible to this type of manipulation now than during the boom of the '90s. In this current market, the first appearance of impropriety causes investors to run for the hills. As a result, many innocent, legitimate and growing companies are getting burned, and investors are getting burned along with them.

A few tips to help prevent this in the future:
1) Do not believe everything you read - verify the facts.
2) Do your own due diligence and discuss it with your broker.
3) Hypothecate your stock - take it out of street name to prevent the short sellers from borrowing and selling it.

The best way you can protect yourself is to do your own research. There are many potentially great stocks out there, but Wall Street is ignoring them. And even if the S&Ds attack your stock, you will be better able to detect their distortions and be less likely to fall prey to their distortions by selling the stock at a loss.

Another tool is to know the seven key characteristics of a good research report. Here is a brief summary of how to spot them:

1. Is there a disclaimer?
The SEC requires that everyone providing investment information or advice must fully disclose the nature of the relationship between the information provider (i.e. research analyst) and the company that is the subject of the report. If there is no disclaimer, investors should disregard the report.

2. What is the nature of the relationship?
Investors can get some good information from pieces published by investor relations firms, brokerage houses and independent research companies. Using all of these sources will provide information and perspectives that can help you make better investing decisions. However, you need to evaluate their conclusions in light of the compensation (if any) that the information provider received for the report.

Can a Wall Street analyst who is even partially compensated by trading generated by the report be more objective than a fee-based research firm that is paid a flat monthly rate with no "performance" bonus? The answer to this question is left for each investor to decide, but both reports are available to use for evaluating a potential investment. The nature of the compensation will provide information to help you evaluate a report's objectivity.

3. Is the author identified and is his/her contact information provided?
Generally speaking, if the author's name and contact information is on the report, it is a good sign because firstly it shows the author is proud of the report and secondly it gives you a way to contact the author for additional information. Research reports from legitimate brokerage firms post the author's name and contact information near the top of the front page. If the author's name is not given, investors should be very skeptical of the report's contents.

4. What are the author's credentials?
Letters after a name do not necessarily mean that the author of the report is a better analyst, but they do indicate that the analyst has undertaken additional studies to expand his or her knowledge of finance and investing.

5. How does the report read?
If the report contains a lot of grandiose words and exclamation points, beware. I'm not saying that good analysts are boring, but good reports don't read like the National Enquirer. We try to make it interesting, but a reputable analyst would never use exaggerations like "sure things" or "rockets", and they would never suggest that you mortgage your home to buy a stock.

Objective research reports provide reasoned arguments to buy or sell a stock. Key factors such as management expertise, competitive advantages and cash flows are cited as evidence to support the recommendation.

6. Is there an earnings model and target price with reasonable assumptions?
The bottom line for any recommendation is the earnings model and target price. The assumptions upon which the earnings model is based should be clearly stated so that the reader can evaluate the reasonableness of the assumptions. The target price should be based upon valuation metrics, such as P/E or P/B, that are also based upon reasonable assumptions. If a report lacks these details, it is generally safe to assume that the report lacks a sound basis, and investors should ignore the report.

7. Is there ongoing research coverage?
A commitment to providing ongoing research coverage (at least one report per quarter for a period of at least one year) indicates that there is a solid belief in the fundamental strengths of a company. It takes a lot of resources to provide this type of coverage, so a firm providing ongoing coverage is a sign that the firm legitimately believes in the long-term potential of a stock.

This contrasts one-time reports that are used to manipulate stocks. In these cases, supposed research firms will suddenly issue "reports" on stocks they have never reported on before. Generally, these reports can be identified as an attempt at stock manipulation because they will not contain the attributes of a legitimate research report (discussed above).

To get more information on stock manipulation, you can visit the following sites:

* NASDR.com
* FraudBureau.com
* Sec.gov


By Rick Wayman