4.1 Biomatrix case exercises - student module  (Page 4/21)

Short selling

• One of the motives behind the defamatory posting may have been short selling. The following is an explanation of how it works from Zlotnick v. Tie Communications, 86 F.2nd 818-820 (3rd Cir. 1988):
• Where the traditional investor seeks to profit by trading a stock the value of which he expects to rise, the short seller seeks to profit by trading stocks which he expects to decline in value….Short selling is accomplished by selling stock which the investor does not yet own; normally this is done by borrowing shares from a broker at an agreed upon fee or rate of interest. At this point, the investor’s commitment to the buyer of the stock is complete; the buyer has his shares and the short seller his purchase price. The short seller is obligated, however, to buy an equivalent number of shares in order to return the borrowed shares. In theory, the short seller makes this covering purchase using the funds he received from selling the borrowed stock. Herein lies the short seller’s potential for profit: if the price of the stock declines after the short sale, he does not need all the funds to make his covering purchase; the short seller then pockets the difference. On the other hand, there is no limit to the short seller’s potential loss: if the price of the stock rises, so too does the short seller’s loss, and since there is no cap to the stock’s price, there is no limitation on the short seller’s risk. There is no time limit on this obligation to cover.

Short selling: step by step

• Consider how investor Z can profit from 100 shares of stock X that he borrows from broker A:
• 1. Z borrows 100 shares of X from A at a certain time, T1 (say Monday, October 11, 2004). X is worth $10 a share at this time so 100 shares of X are worth $1000.
• 2. Z immediately sells these 100 borrowed shares of X at its market value of $10 per share or $1000. This still occurs within time frame, T1.
• 3. Z opens an account with Yahoo and starts spreading false rumors about the financial health of X on Yahoo’s financial bulletin board. He uses several usernames, copies the same message over and over, and creates the illusion that X is going down the tubes:
• By c_smear/c1_smear/c_smearrr/etc. All people who run corporation X are lying thieves OUT TO STEAL YOUR MONEY. They also DRESS FUNNY too. So SHUN THEM LIKE THE PLAGUE! SELL YOUR STOCK, even if you have to take a loss .
• 4. Through cyber smear, Z lowers the price of X to $9 a share.
• 5. Z then buys back 100 shares of X at T2 at its new value of $9 a share for a total of $900.
• 6. Z gives back the 100 shares of X that he borrowed to dealer A.
• 7. Z pockets the difference between the value of 100 shares of X at T1 ($1000) and its reduced value at T2 ($900). He has just made $100 by short selling stock.
• 8. But there are two small problems. First, the ISP (Yahoo) used by Z is required to reveal his IP address if it receives a subpoena from the court. Second, defamation, specifically libel, is illegal.

Slander = whistle blowing by meddra 2k

The following is a BXM posting on Yahoo's Finance Bulletin Board. It was posted 4/11/00 and accessed 8/10/2000.