By Liz Moyer
August 29, 2006
Louisiana State Attorney General Charles Foti is trying to force UBS, the Wall Street investment bank, to turn over vast quantities of information on its trading, stock lending and other activities related to shares of software firm Sedona Corporation.
The Louisiana Department of Justice filed documents in a state court Tuesday to compel UBS to hand over the information in ten days.
The state is probing naked short-selling, which is the practice of selling shares short without borrowing them. It is an issue that has already been raised in reference to Sedona in an ongoing civil lawsuit against a number of brokers and hedge funds and in a Securities and Exchange Commission federal court case filed in April in New York against one brokerage and several individuals.
Several other states, including Illinois and Connecticut, are said to be looking into the issue. Possible abuses in stock trading and in the stock-lending business, which brings in $10 billion in annual profit for Wall Street firms, has started to attract the attention of federal regulators as well.
Foti's exhaustive list of demands for documents include all of UBS' electronic and paper communications files relating to Sedona stock, its trading records, monthly stock inventories, stock loan documentation, information regarding commission payments, customer account records and research done in house related to Sedona.
He also wants information related to the bank's market-making activities and its clearing and settlement procedures.
Louisiana is home to approximately 100 shareholders in Sedona, a Pennsylvania software company whose stock has been pummeled in the last six years, it contends because of manipulative short-selling by hedge funds and collusive brokers. Shares started out January 2000 at $10.25 and are now trading on the pink sheets at 20 cents.
Among these Louisiana-based shareholders is David Vey, a wealthy real estate developer who provided rescue financing to Sedona in 2003, joined its board and now owns about 44% of its outstanding shares.
Wes Christian, a Houston lawyer representing Sedona in a four-year-old civil suit against brokerage firms and hedge funds, says, "We are gaining momentum, finally."
It would be Louisiana's second demand for information from UBS. In September 2003, the state issued a subpoena seeking information on failed deliveries of Sedona shares in trades handled by UBS.
A spokesman for UBS had no immediate comment.
Lawyers who have defended Wall Street firms against naked short-selling allegations say the problem is overblown and that companies that complain about manipulation are generally weak and looking to blame financial problems on outsiders.
Still, that hasn't stopped many states and even Canada from investigating the allegations. Utah's state legislature went so far as to pass a law that would impose stiff penalties on brokers that didn't promptly report trade settlement failures to the state's securities division. After an intense behind-the-scenes Wall Street industry lobbying effort this summer, however, the governor relented and agreed not to enforce the law until next June.
"It seems like every jurisdiction wants to get in on naked short-selling," says Perrie Weiner, an attorney who has represented Wall Street against the naked short-selling crusaders.
In April, the Securities and Exchange Commission filed a civil lawsuit against broker Pond Securities and several individuals. The SEC suit, filed in New York federal court, says the brokers aided or failed to prevent a short-selling scheme carried out for Rhino Advisors, a now-defunct New York money management firm. Rhino is accused of setting up the scheme with one of its hedge fund clients, Amro International, to profit from a 2001 private placement in Sedona.
It is one of the so-called private investment in public equity, or PIPE, transactions regulators have been examining for illegal trading activity.
Three years ago, the then-president of Rhino Advisors, Thomas Badian, settled SEC charges of using offshore accounts to short shares of Sedona. He and the firm paid $1 million.
The SEC contends in its most recent case that Thomas Badian's brother, Andreas Badian, an official at Rhino, directed three brokers who were affiliated with Refco Securities, (two of them were also affiliated with another brokerage that was named in the case) to sell short massive amounts of Sedona shares with "unbridled levels of aggression," intending to "clobber" Sedona's stock price until it collapsed.
During March 2001, Badian's scheme to organize short-selling in Sedona represented 40% of the stock's trading volume for the month, the SEC contends, and the stock dropped from $1.43 to 75 cents. The shares were being sold short for Amro without borrowing them.
Sedona was founded in 1987 as a maker of image scanners. But nine years later it acquired database management software from Lockheed Martin and started selling the technology under license to small banks, to help them manage their customer accounts.
Rhino Investors, representing Amro and others, pumped $2.5 million into Sedona in November 2000 by way of a convertible debt offering, which is a bond that converts to shares at a designated point. Before the Internet bubble burst, such deals were a common way for small tech companies to raise capital without issuing a lot of potentially dilutive shares. They have since been criticized as desperate maneuvers by desperate companies--what is known as a "death spiral convertible."
The Amro agreement was arranged so that it would get more shares of Sedona on the conversion date if Sedona shares dropped in the period leading up to it. Sedona made the investors agree not to sell short the shares.
The company began to notice a pattern of heavy selling volume in its shares coinciding with positive news of new software sales, including two alliances with IBM announced in late 2000 and early 2001.
Its shares continued to fall and the company faced a cash crisis in late 2002 that prevented it from making payroll for nine weeks.
Its employees remained loyal, however, and CEO Marco Emrich reached out to investors for help. A Louisiana businessman named David Vey stepped in with an initial $1.4 million in convertible debt financing. He pumped more money into the company in 2003 and 2004, also in the form of convertible debt.
Vey now owns 43.7% of Sedona shares and is its biggest shareholder, according to the company's proxy. He is chairman of the board, along with his sister, Victoria Looney, a Louisiana businesswoman who owns less than 1% of the company's shares.
A spokesperson for Sedona was not available.
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