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Some Kmart Investors Burned

As the retailer exits from bankruptcy, it issues new stock that makes the old shares worthless.

May 12, 2003|Robert Schmidt | Bloomberg News

WASHINGTON — Kmart Corp.'s exit from bankruptcy Tuesday didn't turn out to be the blue light special that some investors had hoped.

The Securities and Exchange Commission has received complaints from investors who snapped up the retailer's shares last month after a federal judge approved the company's plan to wipe out $7.8 billion in debt.

The investors didn't realize that Kmart was issuing new stock that would make the old shares worthless, the SEC said.

"This is an issue that we tend to see when large companies emerge from bankruptcy," said Susan Wyderko, head of the SEC's investor protection office. "People are watching the newspapers and looking to buy something that will rise in value relatively quickly."

The problem is growing, the SEC said, because online discount brokerages, which are popular with many small investors, don't intervene with advice the way a broker might.

The SEC is boosting its education efforts to warn investors about the dangers of buying shares of bankrupt companies.

"I've been in the business for almost 30 years and this just happens time after time after time," said William Rochelle III, a bankruptcy partner at the law firm Fulbright & Jaworski in New York. "It is just a lack of proper knowledge or information and it is very sad."

Trading in the shares of bankrupt companies is legal although it is "a very perilous proposition," Rochelle said. Under bankruptcy law, common stockholders are the last creditors of a company to get paid back.

Troy, Mich.-based Kmart, known for its in-store bargains called blue light specials, filed for bankruptcy in January 2001 amid competition from Wal-Mart Stores Inc. and other larger rivals. Kmart stock, which traded at $17 a share less than two years earlier, fell to about 6 cents during bankruptcy.

Kmart disclosed to investors that its plan for emerging from bankruptcy would make its old stock worthless. In a list of questions and answers about the reorganization on its Web site, the company said, "holders of Kmart Corp.'s former common stock are not going to receive any distributions following emergence and their equity interests have been canceled."

The company also warned investors in SEC filings and news releases. On April 14, announcing that its creditors had accepted the bankruptcy plan, Kmart said it "considers the value of the common stock to be highly speculative and cautions equity holders that the stock may ultimately be determined to have no value."

When a federal judge in Chicago approved Kmart's reorganization April 22, the news led to a jump in volume of shares traded the next day to 133 million shares from 21 million the day before. About 25% of Kmart's outstanding shares changed hands as the stock price rose to 14 cents from 8 cents.

Some investors knew what they were doing, bankruptcy specialists said. Investors who made bets that Kmart stock would decline, so-called short sellers, needed to buy shares to cover their bets. Other trades probably were made by speculative investors who understood the risks, the specialists said.

SEC officials said they were concerned about investors who saw the news of the plan and thought they would buy Kmart stock while the price was under $1, expecting that it would rise as the company exited bankruptcy.

The agency has received a handful of complaints from confused Kmart investors, Wyderko said. The SEC withheld the names of the investors.

The SEC last month revised its investor education publication on corporate bankruptcy "to make more plain and more clear the fact that reorganization will often cancel existing equity shares," Wyderko said.

Still, the SEC can't help the investors who bought Kmart stock before it emerged from bankruptcy, she said.

"Our system of securities regulation is premised on disclosure and that people have access to the information they need," Wyderko said. "We can't forbid people trading stocks."

Kmart's new shares rose 15 cents to $13 on Friday in over-the-counter trading.

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