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How CEO Margin Calls Squeeze Shareholders

When executives at cash-poor tech upstarts see their holdings depreciate, the result can be forced selling.

Last Wednesday, in what has become something of a trend lately, the phone and Internet service provider



said that its vice chairman, Alfred West, had been forced to sell 1.2 million shares to satisfy a margin call.

West suffered the same fate that many individual investors have suffered since the market went south last spring: He'd borrowed money using his stock as collateral, and when the bank saw that collateral depreciate (Viatel is at the lowest levels it's seen in over two years), it started worrying about its principal. Since West apparently had no other collateral to put up for the loan, the bank asked for that principal back. Viatel was already under heavy pressure after


downgraded its debt outlook to negative from stable. Putting 1.2 million shares -- 2.4% of Viatel's total outstanding shares -- on the market made a bad thing worse. In the week preceding the announcement of West's sale, Viatel shares shed 32%.

The Low Road
Viatel's sinking fortunes

At another company, West might not have needed to sell. The board could have, as companies sometimes do, extended their man a loan.



, for instance, said in its latest quarterly filing that it has guaranteed up $100 million in debt owed by CEO Bernie Ebbers to an institutional lender, along with lending Ebbers $50 million. This helps keep Mr. Ebbers happy -- there's no margin call for him -- and it also keeps WorldCom from seeing a big block of its shares hitting the market, bringing its stock price lower still.

Cash: It's King

The difference between WorldCom and Viatel is money. Though its shares have been suffering, WorldCom is still a profitable company with a fat reserve of accessible cash. Viatel, on the other hand, has never turned a profit and risks running out of cash before it ever does. It is in a capital-hungry industry in an era when raising capital suddenly became very hard. Every penny counts, and that means that handing cash over to an officer with margin trouble just isn't going to happen. Stock price be damned.

It's not just Viatel.



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CEO William Schrader had to sell 11.4 million shares of his company due to a margin call. Jaap van der Meer, the CEO of a company called



, was forced to sell 150,000 shares of his company's stock.


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COO Naeem Ghauri had to sell 72,900 shares in September.

And how many other companies might see top management forced into selling by the margin clerk? There is absolutely no way to tell. If you are an officer at a company, most of your wealth is probably tied up in the company's stock. Using that stock as collateral is not an uncommon practice. Nor is a company required to disclose whether its officers have used its stock as collateral for a loan.

"There's nothing they have to report prior to the margin call, and even then they don't have to report it unless it has some implication," says

Harvard Business School

professor David Hawkins.

Good Old Days

In the past, margin calls haven't really mattered -- most public companies were profitable and had decent cash positions. If the stock went down and one of the officers ran into a margin call, a loan could be extended, a la Bernie Ebbers. Nor would the company even have to specify why it had extended the loan, only that it had extended the loan -- something companies are always doing for their top dogs.

But this is a much different market. Nearly a quarter of all

Nasdaq Composite Index's

stocks are 80% or more below their 52-week highs. Many of those companies risk running out of cash before they turn profitable.

All of which leads to a pretty unsatisfactory situation for the company whose CEO has gotten a margin call. It can let the forced selling happen, diluting its public float and pushing its stock even lower (remember that part of the magic-making a lot of these stocks fly before the crash was that the floats were so small). Or it can lend some of its dwindling cash to cover the loan, hoping that it will get to profitability anyway ... hoping that the check it has just written wouldn't have made the difference between having and not having a business.