Investing in micro-cap, thinly traded public companies with one or two products in the pipeline can be injurious to your wealth, as some local investors , and companies , have discovered.
Shorts borrow stock from a brokerage, sell it in the hopes they can repurchase the stock at a lower price at some point in the future. They make their profits on the difference between the sell and buy price.
San Diego’s Avanir Pharmaceuticals Inc., which is having challenges getting its new product Neurodex past the federal Food and Drug Administration, is learning all about the shorts, especially a particularly nasty breed who indulge in what’s called “naked short selling.”
That is they sell stock they don’t own by manipulation of the electronic trading systems that now dominate the stock markets.
It’s not exactly illegal, but it’s not exactly legal either, though most consider it unethical. There is a push in Congress to outlaw the practice.
Professional short sellers are constantly on the prowl. Like jackals, they pounce in packs when they find a likely target. And with shorts, as jackals, the results are not pretty.
Profits are limited to 100 percent of their investment, which is not too shabby.
The danger is that they have unlimited exposure on the upside. They could be wiped out in a hurry if the price of the shares they’ve shorted takes off.
I learned all about shorts at the feet of the masters in 1990, when I helped Joe Feshbach of the notorious Feshbach brothers pen a first draft of an insider’s book on short selling.
The Feshbachs parlayed a $15,000 loan into a highly successful $1 billion fund in less than a decade, only to lose half of it in a few short (pun intended) weeks after the start of the first Gulf War.
It was a crushing period for short sellers as the stock market began its remarkable run of the ’90s, and was most gut-wrenching for the Feshbachs. Though the Feshbachs survived, many of their contemporaries were wiped out, never to be seen, or heard from, again.
One minor result: Our book never got published.
In their defense, not all shorts wear black hats. They balance the hype on the upside that often surrounds companies and their share price.
Many short sellers are involved in legitimate hedge, or private investment, funds that often take short positions in shares to offset long positions, and minimize losses or to lock in gains. The Feshbachs often traded for other professional mustors who left the strategy of short selling to the experts.
Here’re a few final thoughts on the ongoing controversy revolving around shorts.
When it comes to short selling, almost any company can become a target, especially smaller companies, and when shorts get wind of a good shorting opportunity, the others come scampering.
Watch out, and step aside.
The fact that shorts have so much power to impact the price of a stock should make every investor cautious about putting their life savings into a single company in the hopes of making a big profit.
It’s as risky as pouring too much lighter fluid on the barbecue, then striking the match. You’re bound to get burned.
Thomas York is editor of the San Diego Business Journal.
