NEW YORK (TheStreet) -- I don't know the reason -- the full moon, the tsunami? -- but this has been a pretty lousy couple of weeks for the cause of skeptical research into small-cap companies.
This is an area that has been almost totally neglected by the Securities and Exchange Commission, which has taken the position, by doing nothing, that it doesn't matter if companies threaten, bully and sue their critics. So investors need to sit up straight and pay attention.
This week, a Chinese small-appliance manufacturer called
Deer Consumer Products
filed suit against one of its most vociferous critics, a blogger by the name of Alfred Little. Meanwhile, in a totally unrelated incident, an ex-con by the name of Barry Minkow, who masterminded the ZZZ Best securities fraud scheme years ago, was charged with market manipulation and his lawyer has said he will plead guilty.
Minkow, who allegedly got religion while serving time for the ZZZ Best fraud, admitted that he conspired to manipulate the share price of
He ran the Fraud Discovery Institute, which produced negative research on a host of companies, large and small.
It's hard to decide which of these -- Minkow's criminality or the Deer lawsuit -- is a worse blow to the cause of exposing fraud. I'd say it's a tie.
Now, I'm not familiar with the Deer lawsuit or Little's research, but I do know that suing critics is an effective way of sticking a gag in the throats of critics, whether they be operators of independent research firms, bloggers like Little or small investors mouthing off on Internet message boards. But whatever the target, the affect of such suits is to stifle the free flow of information. And a free flow of information is crucial for Chinese stocks such as
China Education Alliance
Such suits have been around since before there even was an Internet. In 1994, a brokerage executive named Daniel M. Porush of Stratton Oakmont, a Long Island firm, sued the Prodigy online service after an anonymous person said nasty stuff about Porush and Stratton on a Prodigy message board. Porush was called a "soon to be proven criminal" and Stratton "a cult of brokers who either lie for a living or get fired." These were accurate descriptions, but that only emerged five years later, when Porush went to the slammer and Stratton was shut down as the notorious boiler room that it was. But while they still had a scintilla of credibility, they used it to force an apology out of Prodigy. I call this the Porush Syndrome: It doesn't matter if you're guilty as hell. Sue!
The water was good, so other shady public companies dived in. Perhaps best known was the pharmaceutical company
( BVF), which sued SAC Capital, a big hedge fund, and Gradient Analytics, an independent research firm, for supposedly conspiring to drive down the price of Biovail shares. The lawsuit received sympathetic publicity, including an atrocious
This is a perfect example of the Porush Syndrome. Biovail pleaded guilty to federal kickback charges, and the suit was thrown out of court. SAC and Gradient countersued the successor firm,
, for malicious prosecution, and received apologies and, in SAC's case, $10 million.
It's too early to say whether Deer's suit is an example of the Porush Syndrome or a meritorious complaint, and that's the problem -- and not just for the su-ees, but the su-er. Even though Deer's shares rose on word of the lawsuit, the fact remains that suing critics is ordinarily a sign of a company that is more interested in suppressing dissent than in producing a fine product for customers or earning bucks for their shareholders. Besides, there is such a thing as the Streisand Effect. I wouldn't be writing about Little's blog posts if the man wasn't being sued. I'd never even heard of the guy, or Deer.
The Minkow unraveling hurts small-cap research because the old maxim "it takes one to know one" applies. I love it when crooked CEOs turn honest. So few do. Most sail away on golden parachutes. So it was a pleasure to see Barry Minkow turn into an apparently honest Joe, and put his talents to work in fighting corporate crime. The problem is that he didn't fight crime; in at least one case he was up to his old tricks. Minkow has admitted that he was hired by someone with an ax to grind against Lennar, and spread false reports about the company, abusing his position as a confidential FBI informant. (Minkow was also a defendant in an unrelated suit by a company called
, which, just by coincidence, was tossed out of court the other day.)
As soon as the ink was dry on the bad news about Minkow, I and several dozen other recipients were instantly bombarded with emails from Patrick Byrne, CEO of
. Byrne, best known for blaming his company's endless problems on the "Sith Lord," was exultant about Minkow's woes. Minkow had never written about Byrne, but he was close to another convicted felon named Sam Antar, who masterminded the Crazy Eddie fraud and now exposes the kind of creeps that he used to be. The problem, for Byrne, is that Overstock is no Lennar, and Antar's posts on Overstock's accounting irregularities have been proven correct by Overstock's multiple restatements. Byrne, undeterred, had an Overstock employee post a blog item comparing his boss to that poor lady in Libya who came to the foreign media with rape allegations. Yep, you read that correctly.
Companies can get away with stuff like that -- phony blogs, mendacious lawsuits or just acting like creeps -- because we live in a society where CEOs can get away with murder and which relies on private research firms, short sellers and ex-cons to blow the whistle on them. Minkow, who once gave every sign of turning over a new leaf, has given a new lease on life to corporate charlatans everywhere. I hope he rots in jail.
Gary Weiss has covered Wall Street wrongdoing for almost a quarter century. His coverage of stock fraud at BusinessWeek won many awards, and included a cover story, �The Mob on Wall Street,� which exposed mob infiltration of brokerages. He uncovered the Salomon Brothers bond-trading scandal, and wrote extensively on the dangers posed by hedge funds, Internet fraud and out-of-control leverage. He was a contributing editor at Conde Nast Porfolio, writing about the people most intimately involved in the financial crisis, from Timothy Geithner to Bernard Madoff. His book "Born to Steal" (Warner Books: 2003), described the Mafia's takeover of brokerage houses in the 1990s. "Wall Street Versus America" (Portfolio: 2006) was an account of investor rip-offs. He blogs at garyweiss.blogspot.com.