IndyMac Bank was shuttered by regulators more than 18 months ago, but just last week hundreds of thousands of its shares changed hands.
The same goes for shares of FirstFed Financial, which continue to trade even though the thrift was seized by regulators in December and its assets sold off.
Each is a zombie stock – a name given to the shares of insolvent or near-insolvent companies. And so why anyone would be willing to trade them is something that leaves traditional stock market watchers dumbfounded.
“I’m always baffled by that,” said Dennis McCarthy, president of Aries Management Inc., a financial services firm in Los Angeles.
Actually, there are reasons why they trade.
While most mainstream investors won’t go anywhere near the zombies, some risk-takers are attracted to the literal penny stocks, which are known to swing 20 percent, 40 percent or more in a single day.
Some are short sellers who buy them to close out their positions. Others may simply be earnest investors hoping there will be some residual value when a bankruptcy is finalized. But many are likely day traders who buy large blocks of the stock – often 100,000 or more shares at a time – and through this high volume generate decent returns on changes of just a few cents.
Regardless, the stocks can be huge gambles.
“There’s a tremendous amount of risk,” said John Gannon, a senior vice president at the Financial Industry Regulatory Authority, the brokerage industry’s self-regulatory body.
FINRA recently felt the need in conjunction with the Securities and Exchange Commission to clear up confusion surrounding the stock of General Motors Corp., which filed for bankruptcy and was reformed as a new company that does not publicly trade.
The alert issued by the agencies noted that “buying common stock of companies in Chapter 11 bankruptcy is extremely risky.”
The SEC, in fact, recently began exploring whether it has the authority to ban or restrict the trading of zombie stocks, though it has not yet come to any conclusion.
Since the companies traded typically have no underlying fundamentals or operating business, the shares can rally on seemingly no news. IndyMac, which has traded for much of the past year for less than a nickel, surged to 14 cents in late September, mimicking rallies by higher-profile zombies such as investment bank Lehman Bros.
Indeed, there is no lack of investors willing to play the game as long as they see some stocks making investors a profit.
“What it comes down to is what you would call a trading vehicle,” McCarthy said. “If you can make enough money on a penny or two move off of a very low base, and you can buy lots of shares, maybe you can make a little money out of it.”
Los Angeles has no shortage of these undead stocks in the aftermath of the financial and real estate meltdown.
In addition to Pasadena-based IndyMac, which declared bankruptcy after being closed in July 2008, and L.A.-based FirstFed, which filed bankruptcy papers this month, there is L.A. real estate outfit MerueloMaddux Properties Inc. Downtown L.A.’s largest landlord of industrial space is available for 1.2 cents a share after filing Chapter 11 in September.
These and a number of local stocks have been targeted by short sellers, who borrow shares and sell them on the hope that the price will drop. Eventually they must close out their positions by buying shares to return them to the original owner.
Ed Wedbush, president of Wedbush Morgan Securities Inc. in downtown Los Angeles, said this is likely what is driving a portion of the activity in zombie stocks.
“The fundamental reason why they continue to trade,” he said, “is because there are buyers out there that (need to) cover their short positions.”
The stocks are a perpetual topic of conversation on investment message boards such as Investors Hub. A Dec. 26 post by “qstock” recommended investing in FirstFed’s stock but “only to do so under 4 cents,” while a post by “jimmy james” the following day said, “This stock is oversold it will rebound soon but won’t be anything but a day trade.”
But zombies can be long-term holds.
As companies work their way through bankruptcy proceedings, some investors may hold the stock in the hope that there will be some value left for shareholders once creditors are paid off.
“Sometimes when a bankruptcy is concluded and the organization is ongoing, the former equity shareholders might end up with a small percent – maybe 2 to 5 percent – of the company,” Wedbush said.
In that case, traders who bought shares for a few cents could stand to make a profit, but even that is highly unlikely.
The problem is stockholders are the last in line to be repaid behind secured and unsecured creditors, subordinated debt holders and, in the case of banks and thrifts, depositors.
While MerueloMaddux listed assets of $153 million and liabilities of $166 million in its bankruptcy filing, the outlook is even bleaker for creditors of the two thrifts. FirstFed listed assets of $5 million and liabilities of $160 million; IndyMac’s assets totaled $20 million to liabilities of $443 million.
“Having been involved in a couple of bankruptcy situations,” said McCarthy of Aries Management, “I would be stunned if there was enough (money) at the end to make any significant difference.”
And it can be a long haul. Wedbush said he has seen some zombies stick around for up to three years after the company goes under – only to be declared worthless.
In the case of IndyMac, the bankruptcy case and enduring lawsuits have already lasted for more than a year and a half.
However, Jon Dalberg, an attorney with Landau Gottfried & Berger LLP who is representing FirstFed in its bankruptcy, said that “at this time there is nothing” to suggest that the case will be particularly complex or long lasting.
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