Brace yourself, this one will be a shock. Ever notice how certain things always have innocuous names that disguise what is really going on? This is just one of those things, PIPES, a type of hedge fund where millionaires or billionaires use the exclusive unregulated domain of private equity investment funds to manipulate the markets of thousands of small companies. Now, I will go slow, because I want to make this very clear and easy to understand. You remember Joe Paycheck. He has been wondering how he will retire on his present savings rate, so he begins looking for an investment he could buy that will present a better-than-average return on investment.
His friend John Doe tells him he was reading an article that recommended looking at small cap, micro-cap or penny stocks as potential opportunities. These are stocks just like the NYSE stocks but the share prices are much lower per share, and the SEC regulates these companies just like the big ones.
Joe never really knew much about the stock market and so had always played it safe with mutual funds,. Those, however didn’t make much. When he asked about buying stock he was told he needed to buy a round lot (100 shares), or he would pay a premium. One-hundred shares made the cost too high. With companies like IBM selling at $58 per share (or $5,800) or, say, Microsoft at $24 per share (or $2,400) that represented more money than Joe had at the time, and he had always heard it was best to diversify by owning at least a half a dozen companies or so to spread the risk around in case one company went south. It was impossible to do this when he had to buy 100 shares of each.
But Joe is worried about that retirement and so he decided to look around. After a few weeks of looking, Joe decides he will start watching the subscription services like PR Newswire, Business Wire, and Reuters. One day he reads a press release about a small startup company that has gotten a patent on the next big thing, and, low and behold, they just received $100 million dollars in equity funding from a venture capital fund that struck a private equity deal with the company and its principals. But they are only going to take a draw against it right now of $100,000. And can you believe it, those guys at the venture firm are even willing to take stock in return for the money they loaned! This has got to be a winner! More importantly, they are willing to wait on registering the stock they are getting until the company does its next stock offering! Joe assumes that these venture guys must have done their homework or they would never have agreed to loan $100,000,000 dollars to a small startup company.
Going back a bit, a few weeks earlier, Joe had received a gift from his mom and dad for $11,000 and he had gone to DATEK and opened a self-directed investment account in anticipation of doing something.
So with all this new found courage Joe logs onto DATEK and places an order for 100,000 shares of this stock in Big Thing Enterprises trading at .011 cents per share or $1,100 total. Wow that’s just over a penny a share! A penny is nothing! I will own 100,000 shares of the Next Big Thing! I’m rich... and, low and behold, the next day the stock is trading at 3 cents and Joe has tripled his money.
So he decides he has to have more of this before it gets away from him and everybody else finds out about the next big thing! He decides he will buy another 100,000 shares at .03 and spends another $3,000 of his parents’ gift.
The next day he gets home from work and checks the market, and the damn thing is 8 cents per share. He has nearly a 400% total investment return and there are still three trading days left in the week.
So he says, well I am way "in the money,"so he decides what the hell, he takes the entire remaining $6,900 in his account and buys 90,000 more shares at 8 cents a share, and for the next few weeks the company issues even more press releases and the stock goes as high as 18 cents a share on low volume but rather thin trading (more buyers than sellers). Then the company announces that they have spent all the money on research and development and needs to take another advance against the equity line of credit for another $100,000. The venture firm says okay and another big spurt in the stock occurs with heavier volume (more sellers than buyers). All the company had to give up for the $200,000 it borrowed was 30 million shares of stock (or .007 cents a share) and they still have 40 million shares in treasury and the principals have the rest (20 million). The company had a float of 10 million shares before this all started. That makes a 100,000 million share capitalization.
Then, all of a sudden, news stops coming out, and the company freezes its borrowing from the venture firm, and things go very quiet. The stock continues to fall in price all the way down to3 cents a share. Then it hits 2 cents a share and them 1 cent a share the next week. Joe decides he’s just going to hold onto his stock and wait for it to come back. Then the company decides it isn’t going to borrow any more of the $99,800,000 left on its equity line of credit with the venture firm, because the cost of capital is just too high and the they would have to give up the company and still never have borrowed all the money on the equity line. Joe and the company have both received the same news, the light bulb has gone on.
Through manipulation of the rules, Chris Cox and his predecessors have made it possible for the most potentially lucrative investments to be driven, like cattle through holding pens, into the slaughter yards we learned about above called, "Hedge Funds."
Imagine for a moment you are an eager, intelligent, hardworking young American who has come up with a Great Idea. You patent that idea at not inconsiderable cost to yourself. You even do market analysis that proves that this idea is gold plated. Eyes shining with belief in the American dream you start looking around for capital. You are surprised to find that none of your local banks will back you. Doing an Initial Public Offering costs more than you can afford and still bring your product to market. What good would that do, you’d be forced to do business like all other small public companies and sacrifice the company to the vultures because you can’t sell to small investors; the brokerage forms won’t back you because they have all been scared off by the ugly, nasty SEC after the 9/11 debacle. You are puzzled and surprised.
The banks and others you contact, for instance the Small Business Administration, your local bank, say they can’t deal with you and that you need sophisticated financing and point you to places like the Venture Capital Vultures and hedge funds. There, you learn that to get the capital to take your invention into the market you will need to "cut an inside deal" that they tell you is this standard practice. That, at least, is true. But "the deal" makes it possible for the Vulture Capitalist to end up owning your business.
At first you will probably be excited. The deal means you can get all you need to secure your success — $20,000,000 is no problem. But then you learn that you never GET all that money at one time. You have to get it in smaller increments that always leave you underfunded and returning for more – and on increasingly bad terms. Because the Vultures now have reduced price stock available to them, they can "short" the stock, because the company is actually giving them shares for cash, which they get as part of the loan the company signed, meaning they can sell it (even if it is restricted or unregistered) thus making the stock sooner or later worthless. And so it goes.
This is one of the reasons so many companies fail. It seems like this would be bad for the Vultures, but surprise, the SEC and the wealthy owners in those Hedge Funds can even write off their profits as ‘losses.’ Most of them pay no taxes of any kind. And when they ultimately end up with the company, the loss carry-forwards allow them to reap all those profits and reduce their taxable income by applying the loss carry-forwards.
Like I said, these things can make really big money. They make even more money if you have a powerful friend who muscles people around like the SEC, leaving them few other options. This is how the wealthy turn ‘the market’ into their own personal playground and sock billions away in the piggy bank.
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