Knickerbocker Stock Headed for Showdown : Trading: In a classic ‘short squeeze,’ sellers scramble to recover from bets that the O.C. firm’s share price would fall. At least one brokerage demands return of borrowed shares.
Trading in L.L Knickerbocker Co.’s soaring stock appeared headed for a showdown today as certain traders scrambled to recover from ill-fated bets that the share price would fall.
So-called short-sellers, traders who borrow and sell stocks they believe are wildly overpriced, had been betting big that shares of the Orange County maker of collectible dolls were headed for a plunge.
Now, in a classic “short squeeze,” at least one of the brokerages that had lent short-sellers Knickerbocker stock to sell is demanding that they repay up to 100,000 shares--10% of the company’s available stock--by today, market sources said.
That is putting pressure on short-sellers to buy the stock in the open market, which may drive the price even higher.
“I’ve never seen anything like this,” said one trader at a large investment banking firm that is attempting to cover its short position. “Just look at this stock. I think people borrowed too much.”
Knickerbocker, whose products are touted by celebrities such as Marie Osmond, saw its stock rocket from about $4 in mid-June to a high of $52 last week.
After a 20% drop to $37.50 on Monday, the price has rebounded, adding $1.375 to $44.375 on Wednesday in Nasdaq trading.
The trading activity is quickly becoming a textbook case of how a relatively tiny stock can be subjected to spectacular swings when it is caught in a battle between short-sellers and the investors backing the shares.
In a short sale, a trader borrows stock--usually from a brokerage’s inventory--and sells it on the open market. The trader is betting that by the time the shares must be returned to the lender, the stock price will have declined, allowing the trader to buy replacement shares at a lower price.
But in Knickerbocker’s case, traders who have shorted the stock since June have seen the price continue to rise instead of slide. As long as the price is rising, short-sellers’ potential losses grow, because they face the prospect of buying replacement shares at prices higher than where they sold.
Some market observers say that what is happening now is a classic short squeeze: The short-sellers are being forced to repay their stock loans by nervous lenders. To get the shares, the short-sellers must buy in the open market, putting additional upward pressure on the price and thus compounding the shorts’ losses.
Sources say brokerages that have lent Knickerbocker stock to short-sellers are concerned because of the rapid increase in the stock price and the fact that traders may have borrowed as many as 500,000 to 800,000 more shares than exist--essentially shorting the same shares more than once.
It is an especially tight squeeze in the case of Knickerbocker, a thinly traded stock with only about 2.4 million shares outstanding. An estimated 1.4 million shares are owned by the company president, Louis Knickerbocker, and he says he is not selling.
“The system is being manipulated by shorts,” said Rafi M. Khan, a controversial trader and promoter of small stocks who began aggressively touting Knickerbocker in June. “They have created their own death.”
Mark Yu at Newport Beach-based Norman L. Yu & Co., an investment adviser who bought more than 147,450 shares of Knickerbocker after Khan called to recommend the stock, also said a short squeeze in Knickerbocker stock is occurring.
Yu said the company was not a short-seller because the firm and its clients own Knickerbocker shares outright, thus precluding anyone from borrowing their stock.
Some brokers and regulatory officials hinted Wednesday that short-sellers may have illegally borrowed stock they were not authorized to borrow, in an attempt to drive the price down.
But some also questioned whether there may have been unfair touting of the company’s financial performance, issues the Securities and Exchange Commission and the National Assn. of Securities Dealers may be examining.
Company President Knickerbocker, who has previously expressed his lack of knowledge of the stock market, said: “I don’t have any knowledge of these short-sellers. I still don’t understand how they do what they do.”
In another development, Texas securities regulators confirmed Wednesday that they would not allow Knickerbocker to issue stock there in January because of disclosure and fairness concerns.
The regulators said they were so alarmed by the company’s original filing for its initial public offering that they raised a series of questions. Because Knickerbocker didn’t respond to regulators’ questions, the company wasn’t given approval to sell its initial public offering in Texas.
Specifically, Texas regulators found that the company did not meet state criteria for fairness to investors and complete disclosure of the company’s financial position.
“The only way they could have sold stock would have been to make serious changes,” said Securities Commissioner Denise Voigt Crawford, who regulates sales of securities in Texas. “Some of the problems were pure disclosure issues and others were our minimum standards of fairness.
Texas officials, for example, questioned the marketing expenses for the initial stock offering--an estimated 20.5% of the offering expenses. That percentage exceeded the limit imposed by Texas regulations.
Regulators also said the prospectus should have given more prominent display to “the fact that 10% of all net profits of the company will be paid as a bonus to three of the officers of the company.”
Louis Knickerbocker said he was not aware of the questions on the filing by Texas regulators. Officials at the California Department of Corporations, which regulates securities sales here, did not return phone calls.
Times staff writer James S. Granelli contributed to this article.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
What Is Short Selling?
Instead of buying stock and hoping the price will rise, short-sellers borrow what they believe is overvalued stock, usually from a brokerage, and sell it in the hope its price will decline and allow them a profit when they buy it back and repay the brokerage. Here’s an example of how short-selling works:
1. Trader borrows 100 shares of Company X, sells them for current price, $60 each
2. Trader gets $6,000
3. Stock drops to $30
4. Trader buys 100 shares for $3,000, replaces the borrowed shares and keeps the $3,000 difference as profit
Note: If the stock “sold short” rises, the short-seller loses. For example, if a stock sold at $60 per share rises to $90, the trader has a $3,000 loss if forced to buy stock at the higher price to replace the borrowed shares.
* Regarding Knickerbocker: According to some traders, Knickerbocker is in the midst of a “short squeeze.” This occurs when a stock price rises sharply and short-sellers who borrowed the stock are forced to buy at high prices to cover their loss. This sudden surge of buying leads to even higher prices for the stock, which makes it even more costly for short-sellers who haven’t covered losses.
Researched by DEBORA VRANA / Los Angeles Times
Knickerbocker Stock Trend
L.L. Knickerbocker’s stock rose again Wednesday, increasing by $1.38 a share. Daily closing prices: Wednesday’s close: $44.38 Source: Dow Jones; Researched by JANICE L. JONES / Los Angeles Times
Key Dates at L.L. Knickerbocker
L.L. Knickerbocker founders Louis and Tamara Knickerbocker started out with cosmetics and ended up selling collectible dolls, toys and various celebrity-endorsed products on home shopping networks. How the firm evolved:
* 1986: Knickerbockers found International Beauty Supply Ltd., begin marketing “Orchid Premium” cosmetic line to beauty supply and retail stores.
* 1987: Second corporation forms to develop and market Creme de La Vie facial cream to department stores.
* 1988: Knickerbockers make first foray into TV shopping, marketing Creme de La Vie on Home Shopping Network with spokesman Michael Elam, a Corona del Mar doctor whose medical license was revoked in 1990, and comedian Phyllis Diller.
* 1989: Third corporation uses Elam and Farrah Fawcett to develop Fawcett jewelry line.
* 1990: Knickerbocker Creations Ltd. begins with series of celebrity product lines, using actresses Rue McClanahan, Joan Collins and Angie Dickinson on QVC network.
* 1991: Marie Osmond Fine Porcelain Collectible Dolls launched on QVC.
* 1993: Operations consolidated under name L.L. Knickerbocker Co. Inc.
* 1994: ECT environmental control system introduced; revenue reaches $7.8 million.
* January, 1995: L.L. Knickerbocker initial public stock offering at $5 per share generates $4.3 million.
* June: Stockbroker Rafi M. Kahn says L.L. Knickerbocker undervalued, begins offering shares to investors.
* July: Knickerbocker stock increases to $10-$18 range.
* August: Stock price jumps to more than $48. Investors say frenzied trading is due to short-selling; SEC contacts company.
Source: L.L. Knickerbocker Co., Times reports; Researched by JANICE L. JONES / Los Angeles Times
