Bankrupting The Victim Company is not necessarily the end of the play. This case is an illustration of how Wall Street can effectuate the takeover of a victim company for nothing. Pending or contemplated litigation prohibits identifying the victim company or the broker dealers, but this occurred earlier this decade.
According to Jim Cramer, the perception of unfavorable industry conditions gave license to the shorts to attack the industry. The events, trading patterns and the precipitous drop in our examples stock price is indicative of a massive short attack, however the definitive information is locked within the DTC.
Our example had about 40 million shares issued and outstanding and with a large debt load and good, but declining earnings, they were a prime short target. Naked shorting was rampant and largely invisible then, consequently the environment was conducive for wholesale counterfeiting of the stock. It is not known what the exact extent of the shorting was, but assume it was 50 million shares for the sake of this illustration. The stock price dropped from over $25 to under $2 just prior to the bankruptcy filing. Assuming it was shorted all the way down at an average price of $15, the potential profit by the shorts would be $.75 billion.
According to court documents, concurrent with the decline in the stock price a group of investment bankers who had shorted the stock began buying participations in the victim's senior credit debt. Typically the investment bankers were purchasing portions of the original bank debt at a deep discount. Large credit facilities are typically spread among a consortium of participating lenders. The investment bankers, by controlling the senior debt were in a position to monitor and facilitate, if necessary, the filing of bankruptcy. A high degree of confidence by the investment bankers that bankruptcy was likely, would give their prop desks a high degree of comfort that the counterfeited shares would never have to be covered or be taxed. The potential profit from the short sales would be enough to purchase the discounted senior debt and still have a sizeable sum left over.
The investment bankers controlled the financial fate of the company by virtue of being the senior creditors. They forced a Chapter 11 filing, then manipulated the asset valuation by the bankruptcy court, insuring that they would own virtually all of the stock in the reorganized, debt free company. The shorting and the bankruptcy manipulation wiped out the original shareholders, the junior creditors and caused substantial losses for the banks who originally made the loans.
The reorganized company was split up by the new owners — the vast majority of whom were the investment bankers who purchased the discounted senior debt participations — and one division was sold to a competitor and one to a private equity firm, for about $4 billion. The investment bankers made billions of profits on little or no net investment, as a result of allegedly manipulating, the stock price and the valuation of the bankrupt estate. Manipulative naked shorting and bankruptcy fraud are alleged and both are illegal.