The Investor

Sold Short

The sad saga of Greg Manning.

By 8.14.09

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The SEC recently enacted a permanent rule designed to curb the practice of naked short selling, which is when a short seller -- who usually borrows a stock, sells it, and then buys it back at later date -- fails to locate and borrow the stock. The SEC's new rule requires short sellers to buy or borrow the stock within four days of execution. For many, the development is long overdue. But for Greg Manning, it is far too late.

The sad tale of Greg Manning and his homegrown stamp company, Greg Manning Auctions, sheds a human light on naked short selling and stock manipulation. Manning's story is a classic feel-good tale of American passion and entrepreneurship that eventually leads to financial ruin and despair. 

Greg Manning founded the Greg Manning Company in 1961, which eventually established itself as one of largest stamp dealers in the world. In 1993, the company, renamed Greg Manning Auctions, went public under the ticker symbol GMAI, and in 1994 had revenues exceeding $25 million. The small company grew quickly, acquiring Teletrade and establishing an Internet price that drove up the price of GMAI by multiples. 

Then in 2003, Greg Manning Auctions entered into a business relationship that would someday haunt the company. It agreed to serve as the sole stamp supplier to Afinsa Bienes Tangibles, SA, a Spanish company that held and traded investments, including stamps. Later that year, Greg Manning Auctions reported record quarterly revenues of $34.5 and net income of $2.5 million.

In December of 2003, Afinsa and Greg Manning tightened their relationship, as Afinsa became the majority shareholder of Greg Manning Auctions after acquiring 68 percent of the company. It changed the name of Greg Manning Auctions to Escala in September 2005. Escala and Afinsa combined to make up the world's third largest auction house behind Christie's and Sotheby's, and, in March of 2006, Citigroup proposed an approximately $1.8 billion IPO to Afinsa's board of directors. 

Shortly thereafter, though, things went awry, and a series of suspicious events unfolded. Suddenly, Escala's share price began plummeting in early May 2006. There were no significant public announcements, indicating that inside information may have been percolating below the surface. 

Then, on May 9, 2006, Spanish police raided the offices of Afinsa and arrested several employees for allegedly running a pyramid scheme, an allegation that has never been proven and vigorously denied. Spanish police apparently expected not to find any stamps that Afinsa claimed it held in its offices, but everything was physically present. The allegation was based on the fact that Afinsa sold stamp collections to investors, held them in its vault on premises, and guaranteed a minimum rate of return over a specific time period, at the end of which Afinsa would either purchase the collection back or sell to a third party based on the minimum return. Authorities alleged that the business depended on bringing in more investors, lest Afinsa no longer be able to guarantee the minimum rate. Alternatively, others claimed that Afinsa's business model made it a financial institution, given the reliance on customer deposits.

Surrounding facts indicated that certain traders almost certainly knew of and traded on the information in advance, as the decline in Escala's share prices preceded the raid of its parent company. Furthermore, on the same day as the police raid, class action lawsuits were filed against Escala, and on the following day, a Madrid law firm filed a petition in Spanish court that placed Afinsa into involuntary bankruptcy. The timing of the filings was highly suspicious given that they coincided with the raid.

Trading patterns of Escala stock also exhibited irregularities. For example, Escala had a small public float of shares.  Prior to the raid and eventual collapse of Escala's share price, the stock price of Escala increased even as the number of shares shorted increased significantly and steadily -- an odd combination that seemed to indicate confidence on the part of short sellers that a negative event loomed. This practice was exacerbated by the naked shorting. In May of 2006, there were 9,037,738 shares on deposit at the Depository Trust and Clearing Corporation, but only 1,521,984 of those were available in the public float to settle long and short sales. The rest were either held in cash, non-marginable accounts, or were already shorted. 

But suddenly May trading volume in Escala shares exploded to 97 million shares, up from 2.7 million the previous month. Most of the volume was traded over the course of 11 days, meaning every single share would have turned over multiple times in this period -- a virtual impossibility -- and failure to deliver transactions rose to 57.2% of the May shorts. With millions of shares not delivered, significant evidence existed that short sellers were not borrowing for legitimate delivery and were manipulating the stock price downward. The practice also created "phantom shares" of stock, which artificially increased the public float and put further downward pressure on the share prices.

Short sellers had targeted Escala's share before, but not nearly to the same degree. In 2004, Neil Martin of Barron's wrote a critical article about Escala's financial position, saying that Escala's success may have depended too heavily on parent company Afinsa, which was also Escala's biggest customer, and that short sellers were bearish on the company. 

Interestingly enough, Congress issued a report in 1991 on short selling in which it stated that the publication Barron's was used by short sellers to spread negative information about companies.  Louis Corrigan from Kingsford Capital, a hedge fund with heavy short positions, also reportedly told Spanish authorities that Afinsa was a fraudulent company. 

Following these reports and protests by Escala, the brokerage firm Oppenheimer looked into the company and reported on November 29, 2005 that "two financial publications published false, negative stories on Escala Group, driving the shares down 25%. Based on our research, the implied allegations in the stories are false."  It also said that "the articles of November 22 again imply that the authors worked in conjunction with these same hedge fund managers. The fact that both articles were published on the same slow news day further raises our suspicions."

Escala reported possible manipulative trading to the SEC and NASDAQ, but neither launched an investigation.  In May of 2006, on the day that Afinsa's office was raided in Spain, Escala's shares lost the majority of their trading value and never recovered. 

In December 2006, Escala shook up its management and announced that it was restating prior earnings going back to 2003. In December and into January of 2007, the market for Escala shares again exhibited signs of potential manipulation, as volume exploded, along with fails to deliver.   

Eventually, Escala was delisted from NASDAQ. Greg Manning, whose assets were mostly made up of equity in the company he built, lost nearly everything. In March of 2009, the SEC filed suit again him and Escala alleging improper accounting and disclosure of related party transactions with Afinsa. The complaint also alleged that Manning dictated the stamp prices that were published in the supposedly independent and influential Brookman Catalogue. For Manning, it is an unfortunate irony that the body charged with ensuring fair marketplace trading declined to investigate prior trading irregularities but is now pursuing him. 

In March, Steve Forbes wrote an op-ed in the Wall Street Journal discussing some of the causes of the financial crisis. He said, "What sellers soon realized was that the SEC was turning a blind eye to naked short-selling, thus adding even more pressure to beleaguered bank equities.…They picked their targets and relentlessly sold financial stocks short."

Greg Manning may be one of those final victims of the old naked short regime. Unlike the larger companies that survived the bear raids, Manning's story is a sad one about the American dream crushed. I hope it one day involves a tale of redemption as well.

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About the Author
Brett Joshpe is an attorney and entrepreneur in New York City. He is Of Counsel to the American Center for Law & Justice and co-authored the book Why You're Wrong About the Right (Simon & Schuster, 2008).