Frivolous Investigations of victim companies by the SEC is a surefire way to drop the stock price. In 2004 the shorts allegedly compiled a list of approximately ten target companies they actively and aggressively attacked. This list included Overstock, Krispy Kreme, NovaStar, Pre-Paid Legal and others. After the shorts had taken large positions in these ten companies, eight of them were investigated by the SEC. Preliminary inquiries are supposed to remain secret because the unproven allegations could have a devastating effect on the stock price. Yet, within a matter of days, the news of the investigation would appear in short-friendly media outlets, to be followed almost instantly by a class-action shareholder suit(s).

The case of Universal Express is even more disturbing. Packaging Plus Services was a logistics and transportation firm that emerged from a Chapter 11 reorganization in May 1994 as Universal Express. In 1998, Universal needed financing for an acquisition, so they approached an investment banking firm, who they believed to be legitimate, to arrange PIPE (private investment, public exit) financing.

The lenders, who received bonds that could be converted into stock, got their loan repaid from the conversion and sale of their stock. A “toxic” PIPE continuously resets the conversion price at a fractional percentage of the market value share price. As the share price drops, the company issues more shares to the lender. Because the newly- issued additional shares are less than the market value, the lender immediately dumps them at a profit while further depressing the stock price with the flood of new shares.

Concurrently, the lenders short heavily with a flood of counterfeit shares, resulting in additional profit to them and putting more downward pressure on the stock price. This is called a “death spiral”, and this type of financing is called a toxic PIPE. It almost always succeeds in putting the company out of business. One of the most nefarious PIPE lenders, Steve Hicks, put virtually all of his borrowers out of business before the Department of Justice put him out of business.

Toxic PIPE lenders prey upon emerging or weak credit companies who do not have access to more traditional capital markets. Universal fell into this category, although, by their own admission, they were completely unaware of what they were dealing with.

The investment banker arranged the PIPE financing with about ten off-shore hedge funds. In a matter of thirty days, they drove Universal's share price from $2 to 2¢. Volume was the equivalent of the whole company changing hands every three days. Universal's General Counsel suspended conversion of the bonds into stock by the hedge funds and complained to the SEC, who twice declined to do anything.

The company filed suit against the hedge funds in 1998, and obtained a jury verdict in July 2001 for $389 million. In April 2003, a second verdict was obtained, this against the agent for the hedge funds in the amount of $137 million. Due to the off-shore domicile and layers of shell corporations, collection of these judgments proved to be difficult. A subsequent company press release raised the obvious question: If a Florida jury can figure this out, why can't the SEC?

According to Chris Gunderson, general counsel for Universal, the SEC reacted to these embarrassing revelations by harassing Universal with thirteen subpoenas for documents, including one to “prove the existence of naked shorting.” The SEC also allegedly contacted Universal's prospective acquisition and some of the transaction lenders, “scaring” them from doing business with Universal.


On March 2, 2004, Universal countered by suing the SEC, for harassment and failing to regulate naked shorting. Three weeks later, the SEC sued Universal, (falsely) alleging that they sold unregistered (counterfeit) securities as part of a bankruptcy- court- approved employee stock incentive program. Universal alleges that the SEC has intentionally withheld information from the court and has unjustly attempted to deny the company's right to a jury trial.

As of the last writing available, the cases are still pending, but it is reported that some SEC officials have been relieved of duty as a result of their participation in this.