Category: Fraud

Seriously, I do not understand how anyone can read the following and still believe the company from which it comes should be worth $134 million:

We may compete for the time and efforts of our officers and directors.

 

Some of our officers and directors are also officers, directors, and employees of other companies, and we may have to compete with the other companies for their time, attention and efforts. Other than our President, Mr. Nicholas Cucinelli, none of our officers and directors anticipate devoting more than approximately five (5%) percent of their time to our matters. Other than with our President, Mr. Cucinelli, we currently have no other employment agreements with any of our officers and directors imposing any specific condition on our officers and directors regarding their continued employment by us.

Yet that is the market cap of Octillion (OTC BB: OCTL). How can a company at which not even the officers spend time be a viable company? It can’t. Furthermore, the company does not even own what would be considered its sole asset:

We have yet to obtain a license and our intellectual property rights may not provide meaningful commercial protection for our interests in the UIUC Silicon Nanoparticle Energy Technology.

 

Our ability to compete effectively depends in part, on our ability to maintain the proprietary nature of our technologies, which includes the ability to license patented technology or obtain, protect and enforce new patents on our technology and to protect our trade secrets. Since we have not yet obtained a license to either the UIUC Silicon Nanoparticle Energy Technology, it is not clear what rights, if any, we may have under the UIUC Patents.

Not only do they not own the technology, they don’t even have a license. And the company does not have enough money to pay for a license should the technology be proved viable. (I should note that the company has a subsidiary with a similar ‘asset’ that it is about to spin off.) All of the above quotes come from the company’s recent 10K.

Anyone who invests his or her money in such companies is a fool. They would do much better to just stick their money in index funds or a target-date fund.

Disclosure: I am short OCTL. I was not short when I first wrote about this horrid little company. I have a disclosure policy.

My last post reminded me of Gary Weiss’ criticism of Mark Cuban’s website Sharesleuth. Cuban pays a reporter to dish up dirt on public companies, and to fund the venture he shorts the stock of those companies before the articles are published. Cuban calls it a new business model for investigative journalism, Weiss calls it unethical, and I think it is a good thing.

I have in the past been criticized by anonymous message board posters for writing critically about several companies in which I held short positions. I was even called “the scum of the earth” by one poster in response to my criticisms of Document Security Systems [[dmc]]. The coincidental and fitting end to the story of my involvement with Document Security Systems is that while I closed my short position at a loss, the stock later dropped 30%. So was it ethical because I lost money and would it have been unethical if I had made money?

But what is so bad about writing about stocks in which I have an interest? I always disclose a position, as does Sharesleuth. A similar website is CitronResearch.com, run by Andrew Left, who has a blanket statement on his website that he may short any of the companies about which he writes. Is this any different from a mutual fund manager who appears in the pages to talk up stocks in his portfolio? And yet such mutual fund managers get superstar treatment and short sellers like myself earn nothing but the enmity of a bunch of anonymous hooligans.

Is it Unethical to Withhold Information?

While I know that many people frown on writing about stocks in which the writer has a financial interest (at least if that interest is short), what about the opposite situation–someone shorting a stock and unwilling to write about what they know because they are attempting to build up a big short position at a high price or just because they don’t have the time? I have blogged about only a fraction of the companies whose stock I have sold short. I would argue that it is far more unethical for me to withhold my information about unknown companies that I have sold short from the public than it is for me to write about such companies. What do you think?

I think investors in Skins (OTC BB: SKNN) would have wanted to hear a critical view of the company back before the stock dropped by 2/3. Even if they did not want to hear such negative information it probably would have done them some good. The same goes for YTB International (Pink: YTBLA), Hepalife (OTC BB: HPLF), Parkervision [[prkr]], and NNRF (Pink: NNRI). All of these companies I sold short over the last few months and yet I did not publish my analyses. In all cases these stocks have fallen very far since I chose not to write about them. So again I ask the question: which is worse, not writing about these companies or writing about them at the same time I was short?

If a critic says that I should have written about them without being short at all, then that critic misunderstands this blog. I am a trader. I make a portion of my living in the stock market. Nobody pays me to write this blog. Since I have started this blog I have put in hundreds of hours and I have received only about $7 in revenues from my Google Ads. If anyone wishes to pay me to investigate penny stocks, that is fine–I’ll adopt any code of ethics my employer wishes me to adopt. But the reality is that my choice is between me publishing information on some of these stocks (and being potentially biased) and no one but the hype-loving CEOs and shareholders publishing information on these stocks. I do not have the choice of doing this work just for the fun of it.

Is it the Order that Matters?

If it is unethical to write about a stock that I hold, would it be ethical for me to write about it and then after some delay follow my published advice? This is exactly what happened to me with Sun Cal Energy (OTC BB: SCEY). I wrote a negative article about the company and only later I found out that I could short sell the stock. I then sold it short and profited. I cannot imagine that anyone would find this to be unethical. And yet the only difference between this and taking the position before my article is how much profit I make from my work. So is it unethical to make money? Or is it only unethical to do so if I am not paid by a newspaper or financial magazine?

Is the world better off after I expose horrid penny stocks? The obvious answer is yes because I only write the truth and that is usually sorely lacking in the coverage of penny stocks. The good act of publishing the truth and countering untruth is not prevented or stopped just because I profit from it. And the act of profiting is not wrong in and of itself. So I see nothing wrong with profiting in my way from the information I promulgate.

Disclosure: I have no interest in any stock mentioned above. I have a strict disclosure policy. Please note that the last paragraph of this article was replaced after I published it because my first attempt at a closing paragraph was rather bad.

Gary Weiss is a blogger behaving badly. He never published my insightful criticism of one of his arguments that I made in a comment on his blog two months ago. While he likes to dish out the criticism it seems that Gary cannot take it. Like too many journalists he thinks that he is somehow better than everyone else. Take it from me, Gary: there ain’t no such thing as impartiality. Journalistic ethics are not ‘right’–they can be useful sometimes and sometimes they are pointless or foolish.Let me reiterate that I publish all comments that could possibly contribute something and that are not obviously libelous, even if I think their authors are idiots and even if their authors insult me.

Disclosure: Gary Weiss, despite being pompous, rails like me against stock fraud and manipulation. He is one of the ‘good guys’. A previous version of this post criticized Clyde Milton of Cheap Stocks. He has since explained his action and apologized (see comment below). I see no reason to hold a grudge. I do find his blog interesting and useful.

See the press release at Yahoo. The stock of HSOA [[hsoa]] is down big on the announcement. The report is delayed because its auditors need more time to investigate related-party transactions. My bet is that some of them turn out to be sham transactions and much of HSOA’s so-called earnings go up in smoke. If that is the case it’s lender could call its line of credit (which is secured by receivables, some of which are from related-party transactions), forcing HSOA into bankruptcy.

This is another good example of why self-dealing is bad and why cash flow trumps earnings. The classic way to commit accounting fraud to pump up earnings is to make sham deals with pliant customers or related parties. The revenues are accrued, going into accounts receivable, and earnings are pumped up, but no cash is ever paid and the ‘earnings’ turn out to be non-existent. That is why I try to steer away from companies that have too many receivables and greater earnings than cash flows. In these cases, even if there is no fraud, the receivables may turn out to be noncollectable and the earnings are never followed by cash flow. So, even if there is no fraud at HSOA, shareholders will likely continue to be disappointed by the lack of cash the company can actually collect.

Disclosure: I have no position in HSOA, long or short. My disclosure policy committed accounting fraud back in 1984 but has since paid its debt to society and now speaks to corporations about the dangers of insider self-dealing.

I’ve been going over Regulation T (Reg T; you can see it in its full glory here), which is the SEC rule that governs margin loans, as well as the NYSE margin rules for margin accounts. And if I were designing regulations to increase stock fraud, I could think of no better way to do it.

Why is this? The margin requirements for short selling stocks are greater than for buying stocks, at least for cheap stocks (below $2.50 in value). Here is how it works for stocks above $5. You will note the nice symmetry between short and long margin requirements. While the margin requirement for buying stocks is 50%, the requirement for short-selling stocks is 150%. Here’s an example: if I buy a stock for $10 per share (let’s say 100 shares), I only need to put up $500, or half the total value of the stock. If I want to sell the same stock short, I need to put up $500 (plus the $1000 in proceeds from the sale of the borrowed stock). So there is symmetry between short and long margin requirements. (Investopedia has an in-depth explanation of this). If the price of a stock is below $5, there is no margin allowed on either long or short sales. So if I want to buy 100 shares of a stock at $3, I must have $300 in cash (or margin from a higher-priced stock). If I want to short sell the same stock I would likewise need the same amount of cash or margin available.

The symmetry between long and short breaks down, however, with stocks under $2.50 per share. The NYSE has a rule (rule 431 (c) 2) that requires $2.50 in cash or margin for every stock below $2.50 per share sold short. A comparable rule does not exist for long positions. So if I want to buy 1000 shares of a penny stock trading at $0.40, I need $400 in cash or margin ability from marginable stocks. But if I want to short 1000 shares of a $0.40 stock I need $2,500 in cash or margin. So any time someone shorts a stock under $2.50, they have negative leverage: the position value ($400) is but a fraction of the money needed to hold the position ($2,500). For this reason, very few short sellers sell short cheap stocks. Fraudulent companies or worthless shell companies trade at absurd valuations because their share prices are too low to attract short sellers.

Most of the financial fraud in public companies nowadays is with penny stocks. The reason is because short sellers cannot afford to sell short cheap stocks. If the NYSE $2.50 rule were eliminated, more short sellers would be willing to take short positions in such overvalued companies as Hepalife (OTC: HPLF), My Vintage Baby (OTC: MVBY), and YTB (OTC: YTBLA). Pump and dump scams would not be as effective because short sellers like myself would easily be able to short sell the pumped-up stocks earlier, at cheaper prices, reducing the harm to the poor rubes who fall for such scams.

Removing the $2.50 rule would increase the amount of information available about penny stocks as short sellers like myself would write critically about the overvalued stocks they sold short. This would give the poor rubes a chance to learn the truth about the worthless stock they were considering buying and this would further reduce the success of pump and dump scams.

Please, contact the NYSE and urge them to stop supporting scammers and fraudsters. Urge them to remove the $2.50 requirement.

Disclosure: I have no interest in any of the stocks mentioned above.

Today H2Diesel (OTC BB: HTWO) stock dropped 43% on no news. The only news since I wrote critically about the company five days ago is that the company filed a boring proxy statement. So is it just because of me that the stock has dropped? It seems like this, but sometimes overvalued stocks will fall on no news just because a few people realize that the stock is overvalued.

The decline in the stock price is depressing for me because I considered shorting the stock and would now be a lot richer if I had done that. However, the company has more than made up for this lost income in amusement value. I have already been contacted by a hedge fund manager who is long the stock and by some random person who gave me some information about the company and encouraged me to continue to write critically about it. That critic of the company acted like a spy and used only a pseudonym. Ah, the joy of financial blogging.

Disclosure: I am neither long nor short HTWO. I have worked as a spy for Mossad, the KGB, the CIA, The Church of Scientology, The Illuminati, and the Gou’ald. My disclosure policy, unlike me, is not a traitor to the human race.

Company Remains 100-times Overvalued

The problem with so many penny stocks is that they have so few assets and earnings that even after a precipitous drop in the stock price they can remain very overvalued for a very long time. When I last wrote about Continental Fuels (OTC: CFUL) on September 15, its stock price was $1.70 per share and it had a fully diluted market cap of $972 million. At the recent closing price of $.71, the stock has a fully diluted market cap of $406 million. Because the company has a negative book value and no earnings to speak of, I cannot value it using traditional means. Also, I am feeling generous, so I will value the company using its total assets of $3.8 million as of its most recent 10-Q filing. This is the equivalent of $.0067 per share. This, of course, ignores the company’s liabilities. Even using this generous measure of assets to value the company, it still looks over a hundred times too expensive. Needless to say, I still believe that Continental Fuels is one of the worst possible investments that anyone could make right now.

Just for fun, I did a little more research on Continental Fuels and I found out some more interesting information about the company.

Yet Company Spent Money to Hype its Stock

Continental Fuels paid an internet stock tout company, Crosscheck Capital LLC of Arizona, $525,000 to pump up the stock in a mass mailing to 500,000 people. The company states this in its May 2007 10-Q filing. From the filing:

“On March 15, 2007, the Company entered into an agreement with Crosscheck Capital, LLC (“Crosscheck”) to pay aggregate advance retainers of $525,000 to prepare and distribute to no less than 500,000 US residents an advertising/advertorial mailing package that prominently features a report on the company. As of March 31, 2007, the Company has remitted $150,000 of the advance retainers due to Crosscheck. The remaining amount, $375,000, was paid in April 2007.”

The company touted its stock at a time when it admitted elsewhere that its stock was worth much less than the market price. Considering that Continental has acknowledged in many instances that its stock is overpriced, I can conclude only that the company acted immorally in willfully soliciting new investors for its stock so as to maintain the absurdly high share price. Unfortunately, I do not have copies of the materials sent by Crosscheck Capital, so I cannot determine whether the company’s actions crossed the line between misleading statements and lies.

If you have any copies of the materials sent out by Crosscheck Capital, please let me know. If you are a fan of the company or are associated with the company, I would be interested in knowing your opinion as to why the company spent a significant chunk of its assets to promote its stock, then priced at $1.93 per share, when the company itself valued its shares just five months later at $0.008 per share.

Disclosure: I am short CFUL. I have not traded shares of CFUL since I first shorted the stock 12 days prior to my last article on it. I have a disclosure policy.

Thanks to Tracy Coenen for pointing this out.

Joseph Wells has a good article on how you can use time series of financial ratios to spot accounting fraud. He uses ZZZZ Best (Barry Minkow’s fraudulent company) as an example of how this works. When there is fraud, there will usually be excessive accruals, or non-cash items, relative to the actual cash flow of the business. This is because such accruals can be faked, whereas actual cash flows cannot easily be faked. If a company has $10 million in cash in the bank is easy for the auditor to verify. It is much harder to verify sales that have been billed but not yet paid. Any two-bit criminal can falsify a sales record and added big number to the Accounts Receivable line.

Accruals have already been shown to lead to poor stock performance, so this is just one more reason to avoid companies with high accruals.

See the article.