Foul Play Among the UAL Shorts?


By Gene Marcial The shorts have crowded in on UAL in a big way, helping to push the parent of financially troubled United Airlines much closer to bankruptcy. The stock has nosedived from $20 a year ago to $2 on Oct. 8. Right after US Airways filed for bankruptcy protection on Aug. 11, UAL (UAL) announced that it, too, might have to resort to Chapter 11 bankruptcy protection. UAL shares were then trading at $4.

Not all that long ago, UAL was one of the high-fliers on the New York Stock Exchange, trading in mid-1999 as high as $80 a share.

But the Big Board is now said to be looking at the surge in the shorts' activity. And if the NYSE finds something amiss -- such as complicity among the clearinghouses and some hedge funds in allowing the shorts to unreasonably delay delivery of the shares they have sold within the required three-day period -- it might launch a full-scale investigation.

SWEET PAYBACK. With bankruptcy in the air, the number of investors shorting the stock has swelled. Some 24 million of UAL's 56.9 million outstanding shares, are now in the hands of the shorts -- plus many more unreported that have been shorted through the ECNs (for Electronic Communications Networks, which are computer-based trading systems), such as Instinet, or through the options exchanges.

The shorts sell shares borrowed from brokers in the hope of buying them back (to replace the borrowed shares) when the price comes down sharply, thereby pocketing the difference between the sale price and buyback price.

But here's the rub: In this case, they often don't have possession of the UAL shares they've shorted. One of the ways they can delay delivery of the shares is to sell short through the ECNs, because computer-generated stock trades are difficult to track or police. Also, since ECNs aren't members of the NYSE, they don't necessarily have to enforce its rules.

According to the NYSE regulations, a person short-selling shares has to "deliver" the shares to the buyer three days after the trade date. Extensions are usually allowed by the clearinghouses. But investors who are long on UAL say in this case, the many of the shorts haven't been able to deliver.

UNWATCHFUL EYE? Investors who are buying are demanding that they get delivery of the actual shares. So the shorts' brokers start pressing the shorts to return the stocks they have borrowed. The clearinghouses at the big investment banks are supposed to have control over such activity -- and make sure that the shorts turn in their borrowed shares on time.

"But these clearing firms usually look the other way and give the shorts more time," says one investment manager, who owns a big chunk of UAL shares. This is a violation of the Big Board's rules, he argues. And in the current environment of investigations into corporate shenanigans, the exchange is being pressured by institutional investors and by UAL itself to launch an investigation.

A UAL spokesperson, Jeff Green, declined to comment. A spokeswoman at the Big Board also declined to comment on whether a probe is under way. Among the three big clearinghouses -- Goldman Sachs, Bear Stearns, and Bank of America -- Goldman and Bear Stearns, as well as ECN Instinet, say they're looking into the situation. Bank of America hadn't returned calls seeking comment as of publication.

DOWNWARD SPIRAL. The amount involved runs up to hundreds of millions of dollars, says one trader, who also claims that the clearinghouses tend to help the hedge funds that short stocks and don't always follow up on rule violations because these funds provide a rich source of business.

In the meantime, the shorts are putting more pressure on UAL to file for bankruptcy by driving the stock down -- mainly by shorting its shares unrelentingly in big numbers. Should bankruptcy occur, UAL's stock will continue to drop, and the shorts will then scoop them up at probably only several cents a share -- pocketing huge gains.

UAL shares are a perfect target for the shorts: "Like other major airlines, UAL is posting heavy losses, stemming from excess industry capacity, heavy pricing competition, and excess costs," notes Damon Churchwell, a Value Line analyst. UAL has been in the red in the past eight quarters.

If this case isn't quickly resolved, it could balloon into another major scandal on Wall Street, considering that several big clearing firms are owned by some of the Street's largest investment banks. Marcial is BusinessWeek's Inside Wall Street columnist


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