In April, 1987, when federal regulators were investigating suspicious dealings at American Continental Corp., three brothers in Palo Alto were laying a bet that the regulators would find trouble.
The Feshbach Bros.--Joe, Kurt and Matt--are owners of the nation’s largest short-selling investment firm and were actively building a short-stock position in American Continental, selling shares they did not own in the belief that the stock would fall and that they could buy the shares back later at a much lower price.
Today, American Continental’s stock has more than fallen, it has collapsed. The parent company of the failed, Irvine-based Lincoln Savings & Loan Assn. is under investigation for possible fraud and stands as the most glaring example of the thrift crisis.
The thrift’s collapse is expected to cost taxpayers up to $2.5 billion to clean up, but for the Feshbach brothers it was a gold mine. The brothers shorted the company at an average of $7 a share and covered, after regulators seized the thrift in April, 1989, at 87.5 cents. Although the brothers will not disclose their exact profit on the deal, it was in the millions of dollars.
“Short sellers were on to that many, many months before federal regulators really took any effective action,” Joe Feshbach said. “We don’t short stock out of public service . . . but it does have a byproduct of serving as a warning sign that something is awry.”
The Feshbachs thrive on bad news. With partner Tom Barton, they search for companies with overinflated stock prices and “go short.”
In short selling, a person sells stock he does not own, usually borrowed from margin accounts at stock brokerages, in hope of buying it back later at a much cheaper price, allowing him to pocket the difference.
Short selling is an extremely risky investment strategy. A short seller can lose his shirt if a stock does not fall as he expects and he has to cover for the shares he borrowed.
Most investment groups do a little short selling on the side, if at all, to hedge against market downturns. The Feshbachs do nothing else.
With calls like American Continental and the now-defunct carpet-cleaning scam ZZZ Best, the company has an excellent track record since its founding in October, 1982, during one of the greatest bull markets in history. Last year was not a particularly strong year, but the firm’s investments were up 21%, before fees.
The company is the largest firm in the country devoted strictly to short selling, with about $500 million under management. The Feshbach brothers, none of whom went to college, look for companies that have signs of either management fraud or whose stocks have been driven up by unrealistic expectations.
“They are really the most fundamental of fundamentalists,” said Jeff Friedman, president of the Dreyfus Convertible Securities Fund for Dreyfus Corp. in New York. “They take advantage of the market’s bullish tendencies.”
“We’re hype-busters,” Feshbach said.
At American Continental, researchers spotted a dangerously high level of real estate loans and direct real estate development. Digging deeper, analysts discovered a number of “paper transactions” among the company’s various operations that accounted for much of its earnings.
Some company managers hate short sellers. Charles Keating Jr., head of American Continental, once urged stockholders to withdraw their stock from brokerage accounts so short sellers could not borrow it. Feshbach said his business ferrets out fraudulent companies: “I can tell you, I’m never embarrassed to go home and have dinner with my kids,” Feshbach said.