Unsigned Report Blamed in Stock-Trading Frenzy
Trading in Southland Communications’ stock, which was suspended Wednesday by the Securities and Exchange Commission, became volatile after March 2 when a critical, unsigned research report about the firm was circulated on Wall Street, brokers said Thursday.
The report recommended that brokers sell the stock short, or speculate that the price would go down because of the Santa Ana-based company’s weak financial state. Instead, the price nearly doubled in a month and investors who held short positions in the paging services firm’s stock now stand to lose millions of dollars.
The report allegedly was issued by K.A. Knapp & Co., the firm which helped take Southland Communications public in 1987, according to several brokers who shorted the stock based on the report’s recommendation.
Officials with Knapp, which is under bankruptcy court protection, could not be reached for comment. The company is based in Grand Rapids, Mich.
Knapp & Co.’s former owner, Kirk A. Knapp, was permanently barred from doing business in the securities industry in January after the SEC and the National Assn. of Securities Dealers brought charges of fraud and other regulatory violations against Knapp.
The federal judge that barred Knapp alleged that the former broker bilked investors out of thousands of dollars in activities that date back to 1985. The firm closed in November, 1987, citing a capital shortfall after the stock market crash on Oct. 19, 1987.
It reopened in December, 1988, when it was purchased by longtime Knapp associate John Pehrson, and last year filed for protection from creditors under Chapter 11. In pointing out why the company’s stock was likely to fall, the report noted that Southland’s auditors stated that there was substantial doubt that the company could continue to function as a going concern.
After the report appeared, the trading volume of Southland stock grew to frenzy levels--rising from a normal level of 10,000 shares a day to more than several hundred thousand on several recent days. The stock price, meanwhile, climbed from about $9 a share on March 2 to $17 on April 3, despite the lack of any positive news about the company and its financial condition.
The “suspicious” trading drew the scrutiny of over-the-counter market officials, securities dealers and the SEC. The agency said it halted trading because of questions about the identity of the owners of the company’s common and preferred stock, about an accumulation of large volumes of the stock by several broker-dealers and their customers, and a possible failure to disclose a change in control of the company.
In documents filed with the SEC on Oct. 31, auditor KPMG Peat Marwick, Main & Co. issued a qualified opinion that said Southland’s “recurring losses from operations and working-capital deficit raises substantial doubt about the company’s potential to continue as a going concern.”
The company’s first quarter financial performance also was dismal. For the three months ended Jan. 31, 1990, the company lost $323,529 on revenue of $1.9 million, compared to a net loss of $258,975 on revenue of $1.4 million in a like period the previous year.
Based on such weak fundamentals, brokers said there was no logical market reason why the stock volume increased sharply and the price rose 86% from early March to $16.75 when trading was halted for 10 days.
“The trading pattern is suspicious,” said David Schechter, a vice president with Homans, McGraw, Trull, Vallejo & Co., a broker-dealer in Boston.
Ahmad Bayaa, Southland’s president, did not return calls for comment. In mid-March, he issued a statement saying that the company had “no idea” what caused the volatile trading and price rise.
Dealers described the trading after the research report surfaced as a “classic short squeeze.” In that scenario, brokers who speculated that the stock would go down were caught in a jam as the stock price rose. The price increase forced them to “cover” their positions with more expensive shares and further escalated the stock price.
The squeeze is ended either by taking losses or regulatory action.
The SEC suspects that several brokerages may have held concentrated positions in Southland stock without disclosing that they controlled more than 5% of the company’s stock as required by federal securities law, several brokers said.
One of the major market makers involved with the Southland trading was B.C. Financial in Atlanta, several brokers said. A principal with B.C. Financial, Stuart Cohen, was indicted in February by a federal grand jury in Las Vegas in an unrelated securities-fraud case involving penny stocks. He could not be reached for comment.
The unusual trading activity in Southland’s stock came to a head Tuesday when the company said it wanted to increase the exchange rate on its convertible preferred stock. After that announcement, the SEC stepped in.
Southland, which provides electronic paging services for individual and business subscribers, does business in Orange County as National Paging Co. It was founded by Bayaa in 1981.
The company stated in March that it was seeking to raise $5 million through a private stock placement to foreign investors, but Bayaa later said the deal would not be completed as expected by the end of March.
Part of the funds were to be used to acquire A+ Beepers of California in Torrance, but Pacific Bell has filed a complaint with the California Public Utilities Commission seeking to block the merger.
