Hedge Funds, "Shorts," Deny Collusion

— In the not-so-divine comedy of investing, short sellers (often simply called "shorts") usually get the short end of the shtick. Whether they are right or wrong, they are reviled because they bet stocks will go down. Just ask Herb Greenberg of Carmel Valley. He is a senior columnist for the online investment newsletter MarketWatch, owned by Dow Jones. While he doesn't short stocks himself, he uses short sellers as sources because they generally do better research than their opposites, the "longs," who bet stocks will go up. The purpose of Greenberg's column is to alert investors to stocks that are overpriced, often because the companies are monkeying with the books.

Or ask Donn Vickrey, who is a former tenured professor of accounting at the University of San Diego and has a Ph.D. in accounting. From Carlsbad, he supervises the analyst reports for stock research firm Gradient Analytics of Scottsdale, Arizona. Like Greenberg, Gradient looks for red flags in stocks.

In two civil lawsuits, Gradient has been charged with tailoring its research on companies to please well-heeled short sellers, including hedge funds, that want to drive a stock down. In an affidavit in one of the cases, Greenberg is charged with playing footsie with Gradient -- timing his columns so that so-called coconspirators can strike it rich on their short positions.

Gradient, Greenberg, and the hedge funds strongly deny the charges of collusion, and their denials ring true. It appears they are being singled out because they dare to deflate overhyped stocks. Chief executives, securities analysts, and investors think shorting is un-American, if not anti-American. But it has been the short sellers and analysts looking for hanky-panky who have helped spot the frauds at Enron, Tyco, Conseco, and other swindles. Recent testimony in the criminal Enron case indicates that top management was afraid of short sellers who might have smelled out the fraud being perpetrated.

In the marketplace, actually, the deck is stacked against short sellers. They borrow stock and sell it, hoping to replace the borrowed shares with stock they buy more cheaply. But their timing has to be perfect: they can be correct that a stock is a dog, but if the longs keep buying it, the shorts can be forced to surrender at big losses. The longs, who hope to buy low and sell high, can make 400 or 500 percent if they are lucky. But the shorts can make only 100 percent, while their losses can be unlimited.

As David Rocker, head of a New Jersey hedge fund, told Congress three years ago, there is "structural bullish bias" in the market, or built-in upward bent. Consider: for every buyer there is a seller. But buy recommendations are 10 to 20 times more numerous than sell recommendations. Such factors "coupled with a cheerleading media" created the bubble of the 1990s, Rocker told Congress.

On January 10, 2000, Rocker wrote in Barron's that the market at that time was even more overpriced than it had been at the 1929 peak, speculation was rampant, companies were reporting phony earnings, and the Federal Reserve should warn the markets by raising interest rates. The Fed did nothing, and the bubble shortly burst, eventually costing investors $7 trillion. Six years later, stocks are still a long way from recovery.

Only a few journalists such as Greenberg have consistently warned investors about the fraud-infested market. He began shaking up the Bay Area in 1988 as a columnist for the San Francisco Chronicle. Ten years later he joined an online news outlet, TheStreet.com, and was told he could operate from anywhere. He chose San Diego. Two years ago, he joined MarketWatch.

In San Francisco he uncovered the fraud at Media Vision, which eventually sent two executives to the slammer. Monitoring San Diego stocks, he spotted the accounting problems at onetime high-flying health-care glove maker Safeskin, which sold out to Kimberly-Clark, and similar woes at SureBeam, a maker of irradiation systems that went into liquidation bankruptcy in early 2004.

For Gradient, Greenberg, and Rocker, the major imbroglio involves one Patrick Byrne, head of Overstock.com, a money-losing online retailer in Salt Lake City whose stock has been plunging, along with its results. Since late 2004, Greenberg has issued several commentaries on the company's problems.

Last year, Overstock filed suit against Gradient, charging that it tweaked its research to the negative to please its alleged client, Rocker's hedge fund, while Greenberg timed his negative columns to accommodate Rocker's pocketbook. This was done, according to an affidavit in the suit, while Greenberg was writing for TheStreet.com, of which Rocker Partners is a minority owner. Rocker is a defendant, but Greenberg is not.

In August, Byrne declared publicly that the mastermind behind the conspiracy was the "Sith Lord," in reference to a character from Star Wars movies. Later, he claimed, "Some of the people I'm up against are mobsters" who might plant a dead body or heroin in his car. On TV, Byrne blamed "a crooked research firm [Gradient] conspiring with a crooked reporter [Greenberg]." Other comments about those supposedly conspiring against his company have been sprinkled with expletives.

Initially, Greenberg responded gently, telling CNBC (for which he is a contributor) that Byrne should stay away from squirrel-filled oak trees. But as the invective heated up, Greenberg got more specific, calling Byrne "an emotional nutcase," a description close to that of CNNMoney.com's "a bit of a nut job."

As the civil suit moved forward, the Securities and Exchange Commission began an investigation. Recently, the agency shocked the journalism profession by subpoenaing information from Greenberg, another Dow Jones writer, and Jim Cramer of TheStreet.com and CNBC's frenetic Mad Money show. Greenberg says his subpoena sought all unpublished communications, including e-mails and phone records, between him and four organizations he had quoted and one he had never quoted.

However, there was such a brouhaha that Christopher Cox, chairman of the securities commission, rebuked his staff. It had failed to tell the commissioners about the subpoenas. The subpoenas have been put on hold while the agency establishes an internal policy on subpoenaing journalists.

Byrne claimed that the agency did not initiate the investigation of journalists at his behest. But Greenberg rejoins, "They wouldn't be investigating if he hadn't stirred the pot.

"This guy [Byrne] is trying to distract people from the reality of his business," says Greenberg. "Performance is getting worse and worse." If he gets away with what he is trying to do in the civil suit and with the Securities and Exchange Commission, "He will silence critics, independent analysts, and the press." Investors and the entire capital markets will be the losers.

Byrne released to the media affidavits by three former Gradient employees. Greenberg says they were shot full of errors. For example, he never wrote about Overstock while he was with TheStreet.com. He hadn't even heard of Vickrey and Gradient until he joined MarketWatch in April 2004.

Other companies are sniffing out conspiracies in the same places. Last month, Biovail, a Canadian drugmaker whose accounting was earlier probed by the securities commission, sued Gradient and a different hedge fund alleging the same kind of collusion.

Vickrey's lawyers won't let him talk, but Gradient has called the Overstock and Biovail claims false and malicious and says the research firm's ex-employees who gave the affidavits were fired for cause. As usual, the securities commission isn't talking about its investigation. Vickrey is "very smart, very good -- like a Boy Scout," says Greenberg, who continues to use Gradient research.

One person who is tired of Patrick Byrne is his father, John "Jack" Byrne, a respected insurance executive who is chairman of Overstock. The elder Byrne, noting that his son has been on a jihad against analysts, hedge funds, and the press, told Dow Jones, "I wish Patrick would use the time he spends on the jihad to pay attention to the details of the business." The company has never made a profit since going public in 2002. The elder Byrne may resign from Overstock.

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