Rapid Rise of Former Penny Stock Grabs SEC Attention

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It’s been a wild drive down Wall Street of late for shareholders of eConnect Inc., a San Pedro-based designer of devices to allow ATM cards to be swiped at keyboards or through Palm Pilot-type devices for Internet transactions.

Last week, a barrage of boilerplate class-action suits were filed against eConnect, after the SEC charged that management of the bulletin board-listed company had made misleading representations to the public. In particular, a company announcement allegedly made reference to a licensing agreement with Palm Pilot that did not exist.

In a reflection of today’s tech-crazy, day-trading market, eConnect, previously a penny stock, shot to $21.88 a share in early March before trading was halted for 10 days by the SEC on March 13. It opened up for trading again last week, and promptly cratered to under $2 a share. At one point it was trading for as little as 25 cents.

The company achieved a market cap of more than $3 billion at its peak in early March despite having lost more than $10 million on no significant revenues in the first nine months of 1999, according to the latest figures filed with the SEC.

Thomas Hughes, eConnect chief executive, did not return calls last week, and is under a temporary restraining order issued by federal court in Los Angeles concerning any future public statements.

A company spokesman last week said eConnect officials have been advised by legal counsel against talking to the press.

According to one newswire report, Web postings by an inexperienced stock trader which were re-posted on the Ragingbull.com Web site by an eConnect official contributed to the feverish stock speculation even more than the company announcements.

SEC scrutiny is not new for eConnect. The company previously had been rebuked by the federal regulatory agency for not filing quarterly and annual financial statements Form 10-Qs and 10-Ks in a timely manner in 1997 and 1998.

The company is now operating under a 60-day temporary restraining order while the SEC prepares to seek civil penalties and a permanent injunction against Hughes. At least one source thinks the investigation could widen or even move to concentrate on Web-based stock touts.

The SEC has made repeated forays against stock fraud on the Web, but as an administrative agency can only bring civil claims and then usually only against people working at brokerages or publicly held companies. Those posing as independent analysts on the Web are much more difficult to prosecute, and sometimes not really fearful of civil charges anyway.

Preferred Treatment

One of the more unusual financial shops in the area, Pasadena-based Flaherty & Crumrine Inc. manages two publicly traded, closed-end funds (listed on the Big Board) that invest in preferred stock the Preferred Income Fund and the Preferred Income Opportunity Fund.

Peter Stimes, vice president and principal, concedes that preferred stock which usually features first claim on company profits and pays a fixed dividend has not exactly set Wall Street on fire, especially since 1998.

One reason is that preferred stocks are often thought of as close cousins to bonds.

The “flight to quality” in 1998 had yield-seeking investors looking for security above all else, and that meant U.S. Treasury bonds, not preferred stock.

Through late 1999, other factors were causing investors to steer clear of preferred shares. Those factors included Fed Chief Alan Greenspan’s incremental but relentless war on inflation waged through higher interest rates and the Y2K scare.

But now conditions may be right for taking another look at preferred shares, Stimes says.

Stimes’ funds offer good yields approaching 10 percent for the Preferred Income Opportunity Fund and are trading for 10 percent below the net asset value of the holdings. In short, if the funds were liquidated today, investors would get 10 percent more than the share prices.

Like so many investors who favor non-tech or blue-chip stocks, preferred stocks are relative bargains, Stimes said, offering 400 basis points more in yield than similar-maturity Treasuries. “There are some definable bargains out there,” he said. “You may see people come back to investments like this, which pay a real return, if the tech sector takes a dive.”

Ready to Blow?

Charles Biderman, founder of Santa Rosa-based TrimTabs.com investment advisory service, is a guy who likes to look at “macro” flows in the stock market. That can involve how much money is pouring into mutual funds; the cumulative volume of stock outstanding, as influenced by initial public offerings; corporate buybacks; and insider selling.

Of late, Biderman is looking at the amount of sell off by corporate insiders, a term that usually refers to management or early investors in a publicly held company.

From 1994 to late 1999, the amount of such insider selling was eclipsed by the amount of corporate stock buybacks “in other words, you had a shrinking amount of shares” for investors to snap up, for most of the latter half of the decade, according to Biderman.

But since October 1999, corporate insiders have been large net sellers of stock, increasing the supply. Meanwhile, Biderman points out, the amount of buying on margin with borrowed money has been on the rise.

A bearish Biderman, a former editor for Barron’s, also notes that many companies have enormous market capitalization, the result of all-time record high price-earnings ratios (now about 30 for the average S & P; 500 stock).

“These guys (corporate insiders) are selling out at a market top,” says Biderman. “As long as new cash was coming into the market, and there was decreasing shares, it worked. It was like a giant Ponzi scheme.”

Biderman concedes that, at least for now, Americans are still pouring money into mutual funds, so demand is at least not faltering. But should investors ever quiver, “many companies have nowhere to go but way down,” he warns.

Contributing columnist Benjamin Mark Cole writes about the local investment community for the Los Angeles Business Journal. He can be reached at [email protected].

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