Thursday, October 11, 2007

Owner Mark Cuban Trades Stocks on Sharesleuth's Findings Before They're Published

Owner Mark Cuban Trades Stocks on Sharesleuth's Findings Before They're Published
By Patricia B. Gray 09.25.07 | 2:00 AM

"Newspapers have abandoned their mission," Carey says. "We've taken it on at Sharesleuth."
Photo: Michael Lewis It shouldn't have fallen to Chris Carey to notice that there was something suspicious about Xethanol. The company, which claimed it had a process to convert garbage into vast quantities of energy-rich ethanol, could have raised the eyebrows of any newspaper reporter. The company's original name — — didn't exactly augur a long-term commitment to energy. Xethanol's SEC filings showed that several of its major investors had previously been disciplined for fraudulent activities. The company's balance sheet was another red flag. In two years, Xethanol had spent just $239,651 on research and development, while its competitors were investing tens of millions annually.

But scan Xethanol's press coverage during the first half of 2006 and you'll find mostly glowing reports. Local newspapers and trade magazines repeated the company's claims that it would triple capacity at its plant in Blairstown, Iowa. The Atlanta Journal-Constitution plugged Xethanol's stated ability to wring ethanol from stale butterscotch candy. The Associated Press put a story out on the wires saying Xethanol planned to convert homeowners' grass clippings into auto fuel. All that press helped send Xethanol's shares soaring; its stock price grew almost fivefold in six months, despite the fact that its research scientist had never made more than a couple of liters of ethanol in the lab.

The Sharesleuth Effect
In its first year, the site posted investigations of two public companies. Four weeks after publication, Xethanol's stock had dropped 39 percent, and Utek's fell 36 percent.
Source: Yahoo Finance"The company was not on our radar because they were such a small producer," says Lynn Hicks, business editor of the Des Moines Register, the closest major newspaper to the Xethanol plant. "It's a New York company that happened to have a small plant in Iowa, which we didn't think was worth digging into based on our readers' interests."

So Carey did it for them. A former business reporter for the St. Louis Post-Dispatch, he spent months probing deep into the archives of federal and state agencies. He traveled to Hopkinton, Iowa, to take snapshots of one of Xethanol's plants, and to Delaware and Washington, DC, where he pored over corporate filings and regulatory documents.

On August 7, 2006, Carey posted his findings on his Web site, Frankly, his report does not make for scintillating reading. The writing is cornhusk-dry. (Sample: "He said in an SEC filing that the shares were contributed through a settlement among the shareholders of Xeminex.") The design is rudimentary, a long strip of black text against a stark white background, broken up only by the occasional photo. And at 6,000 words (more than twice the length of this article), the piece could tax the attention span of even the most dedicated stock watcher.

But the exposé torpedoed Xethanol. On the day Carey posted it, online financial message boards lit up with links to the story, and by the next day the company's stock had dropped 14 percent. Three months later, share prices had fallen from $6.91 to $2.90, erasing some $100 million in shareholder value. Lawyers pounced, filing no less than eight class-action shareholder lawsuits in federal courts against the company. Louis Bernstein, Xethanol's CEO during those turbulent months in the fall of 2006, says he spent most of his time managing the fallout from Sharesleuth. "I was constantly defending the company to shareholders, brokers, and analysts," he says. "For three months, it took up most of my day." (Bernstein resigned in November 2006, and current executives at the company declined to be interviewed.)

Since the Xethanol takedown, Sharesleuth has become required reading for a small but influential cadre of securities analysts, stockbrokers, money managers, and journalists. In the week after posting a scoop, Carey says, the site typically draws upwards of 40,000 unique viewers a day. "Sharesleuth provides some of the checks and balances that are missing in the market these days," explains Yolanda Holtzee, a money manager in Seattle who says she follows the site. "Companies can — and do — hire promoters to boost their stocks all the time, but there are fewer and fewer journalists and regulators who dig deep to find out if these companies are delivering on all their promises."

Sharesleuth is still more of a hobby than a profit center for Cuban. But future plans include hiring additional researchers and a videographer.
Photo: Michael Lewis"That's the power of investigative journalism on the Internet," Carey says. "Newspapers have abandoned their mission, and we've taken it on at Sharesleuth."

But don't expect reporters to thank Carey. In old media circles, Sharesleuth is considered just as compromised as the companies it covers. The beef: Sharesleuth is funded by Mark Cuban, the infamous founder and Dallas Mavericks owner. Cuban finances the site by shorting the stocks of the companies Carey investigates in his stories. And Cuban trades before Carey publishes. (Short sellers are betting a stock will fall; they borrow the stock from a broker and sell it, with the promise to buy the stock later — hopefully, at a lower price — and return it to the broker.) Carey and Cuban disclose the financing technique on the site, but that hasn't stemmed the criticism. On his blog, The New York Times' Andrew Ross Sorkin dubbed the strategy "about as basic an ethical violation as there can be, whether that stake is disclosed or not." Blogger Gary Weiss, a former BusinessWeek reporter, accuses Cuban of "soiling investigative journalism to line his pockets." Fred Brown, vice chair of the ethics committee of the Society of Professional Journalists, a trade group, warns that "Mr. Cuban is eating the fruit of the poison tree."

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