San Diego’s best-known short seller, Barry Minkow

Short sellers are getting short shrift at a time they should be getting tall praise. They borrow a stock, sell it, and hope to replace the borrowed shares later at a lower price. They make money when a stock goes down, thus frequently incurring the wrath of executives and investors who only want stocks to go up.

But in most cases, shorts are doing what they are supposed to do: discovering stocks that are overpriced, often because of fraud. A classic example is in the news now: in 2008, Wall Street’s Lehman Brothers collapsed in bankruptcy. The chief executive heaped blame on short sellers. Now, a new study has shown that Lehman had blatantly manipulated its books — just as one short seller had pointed out at the time it was happening.

Short sellers must have courage. They may identify a doggy stock, but if the longs (those betting the stock will go up) keep buying, the shorts lose. Also, the shorts are often sued by corporations whose hanky-panky is exposed.

Some San Diegans have been involved in some of the highest-profile short-selling donnybrooks. Carlsbad’s Donn Vickrey has a Ph.D. in accounting, is a former professor at the University of San Diego, and is cofounder and editor in chief of a Scottsdale, Arizona–based research company, Gradient Analytics, that often uncovers overpriced stocks. Gradient found itself in court over two of its exposés.

One exposé involved Biovail, a Canadian pharmaceutical company. In 2002 and 2003, Vickrey pointed out that in many respects, the company’s accounting was dubious. Biovail sued Gradient and a hedge fund, saying they had conspired to bring down the stock. In March 2006, the CBS TV program 60 Minutes took Biovail’s side. The Securities and Exchange Commission investigated both Biovail and Gradient and dropped the Gradient probe. In 2008, the securities agency charged that Biovail “repeatedly overstated earnings and hid losses” and “actively misled investors.” Last year, a judge dismissed Biovail’s suit against Gradient and a hedge fund.

Vickrey also smelled mice in the basement of Overstock.com, an online retailer. It sued too, charging that Gradient and a hedge fund worked together to knock down the stock. Patrick Byrne, Overstock’s chief executive, made it into a holy war. At every opportunity, he lashed out at short sellers, their Wall Street associates, regulators, and journalists who got information from the short sellers. He also sued a group of the largest Wall Street firms for “naked shorting,” or shorting without initially borrowing or locating shares. That case is still pending.

On December 8 of last year, Byrne boasted in a note to shareholders, “The good guys won.” Although still denying Overstock’s charges, the hedge fund paid Overstock $5 million. Gradient reached a supposedly confidential agreement with Overstock. But Byrne, in his statement, alluded to “any money Gradient paid which I cannot disclose.” Hmm. Gradient said it would improve internal policies.

Overstock was founded in 1997 and launched its first website in 1999. It has never had a profitable year. Its cumulative deficit is a whopping $268 million. It fired its accounting firm in November. It has delayed coming out with its 2009 annual report to the Securities and Exchange Commission. But Overstock claims that 2009 will prove to have been its first profitable year, although it was reporting losses under the now-dismissed accountant. The new report is to come out April 1.

Summed up Larry Witt, an analyst for research firm Morningstar, in a report a year ago, “We are…troubled by Patrick Byrne’s obsession with battling analysts, reporters, and hedge funds that may be shorting his company’s stock.”

In the message to shareholders declaring his purported victory, Byrne once again dragged in Herb Greenberg, a resident of North County. Greenberg was a columnist for the Wall Street Journal and a commentator for CNBC. Throughout the Overstock imbroglio, Byrne denigrated Greenberg for supposedly taking negative information about his company’s stock from Gradient. What’s wrong with that? Journalists regularly interview analysts who are touting a stock. Why not talk to one that is short? In his exultant message, Byrne stated, “Herb Greenberg and others of the journalists I have named have crawled under rocks.” Greenberg had left his media positions to start a research firm, GreenbergMeritz Research & Analytics.

Says Greenberg, who doesn’t short stocks, “I haven’t crawled under any rock. I broke a contract with CNBC and quit a job at Dow Jones because I decided to start a business with a friend. I am very much alive and well and enjoying life and business in San Diego. He [Byrne] is full of his typical, senseless, factless lack of intellectual honesty.” Byrne is “trying to divert attention away from the ongoing problems at his business by attacking anybody who dares to criticize his company.”

Byrne tries to blur the line between legal and illegal short sellers, says Greenberg. And that brings us to another San Diegan, flamboyant, volatile Amr (Anthony) Elgindy of Encinitas, once known as “the Internet’s most theatrical short-seller,” according to Wikipedia, but now in prison until November 2013. He clearly used illegal methods to short stocks. At the start of his career, Elgindy worked with one of San Diego’s most notorious stock manipulators, Melvin Lloyd Richards, who went to the slammer at least three times. Then Elgindy proclaimed that he had reformed. He began providing information on overpriced stocks and shorting them. Some government operations, such as the U.S. Attorney’s office in San Diego, relied on Elgindy’s word to nail stock market wrongdoers. On one 20/20 program, Barbara Walters sang his praises effusively. But Elgindy crossed the line between legal and illegal shorting. He got information illicitly. The federal government charged that he had misappropriated confidential corporate information from the Federal Bureau of Investigation, employing retired FBI agents, who also got nailed.

San Diego’s best-known short seller is Barry Minkow, who achieved notoriety in the 1980s when he was in his teens; he inflated the stock of his carpet-cleaning company by 90 percent, using every ruse in the book. In 1987 he was sentenced to 25 years in prison. He got religion there, was sprung after 7 years, and became senior pastor for Community Bible Church in Mira Mesa, as well as a fraud expert who is quoted frequently in national media and puts on seminars for government agencies. He splits his time between preaching the gospel and chasing crooks through Fraud Discovery Institute. He and a journalist have set up a second outfit, iBusiness Reporting. For several years, the Fraud Discovery Institute has helped fund itself by shorting the stocks of companies whose ledger-demain it uncovers. The new operation will do the same. Minkow regularly works with government agencies.

The institute has had to wiggle out of legal tussles, as short sellers often must. In September 2007, the Reader publicized Minkow’s 500-page, footnoted report on Usana Health Sciences, a multilevel marketing organization. Among many things, Minkow learned that two of the company’s key officials, Denis Waitley and Ladd McNamara, both of San Diego County, did not have the credentials they claimed to have. Both resigned. Minkow had shorted the stock and had fully revealed his position. Usana sued. A federal judge decided most of the counts in Minkow’s favor. Later, Usana and the institute made a confidential settlement of remaining issues.

In 2008, Minkow’s institute revealed that the president of Herbalife, another multilevel marketing operation, did not have the MBA degree he claimed to have. He admitted his deception and resigned. The stock plunged immediately, and Minkow made $50,000 on his short position. But after Herbalife sued, Minkow retracted statements by the institute about the company’s products and business plan. He cannot discuss either case. Now, another company he attacked, Medifast, is suing. Minkow has reacted by stepping up his attacks.

Right now, he is shorting stocks of some of the companies he is exposing, such as InterOil and Pre-Paid Legal. But he didn’t short shares of the big builder Lennar, whose stock plunged after the institute’s exposé of alleged accounting tricks. “I didn’t want to distract from the seriousness of the charges,” he says. Lennar, too, has sued. All told, “Counting expenses, we do a little better than break even shorting,” says Minkow.