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Zombie stocks: Speculators gamble on firms whose shares may be worthless

The prices of so-called blue-penny stocks rarely rise above a buck. That, plus the lure of familiar failures such as Washington Mutual and Lehman Bros., make for a lively, if extremely risky, market.

September 24, 2009|Ken Bensinger

A year ago, Washington Mutual Inc. collapsed into bankruptcy and disappeared. But its stock is still trading -- in fact, its shares posted a 64% gain Monday.

The thrift is among a slew of dead and damaged companies, casualties of the financial crisis, that have seen spectacular stock run-ups amid Wall Street's latest rally.

Although their prices rarely crack $1, appetite for these zombie stocks has soared in the last six weeks. And precisely because they are both cheap and very well known, the stocks draw speculators hoping to turn price swings of a few cents into big profits through rapid-fire, high-volume trades.

Federal regulators say they have gone to great lengths to warn investors of the risks involved in buying these stocks, many of which don't trade on major exchanges.

But for those bold or reckless enough to accept the risk of trading in troubled companies, Wall Street's graveyard can be a gold mine:

* Lehman Bros. Holdings Inc., the bankrupt investment bank whose collapse set off the financial crisis a year ago, has nearly quintupled in value in the last four weeks, rising to its highest levels in 11 months. It fell 1 cent on Wednesday to close at 22 cents.

* Motors Liquidation Co., which holds all the assets General Motors dumped in U.S. Bankruptcy Court, saw its shares more than double last month. Trading remains active despite repeated warnings from regulators and company officials that the stock has "no value." Motors Liquidation closed down a penny Wednesday at 74 cents.

* Mortgage giant Fannie Mae, which was taken over by the government last year, enjoyed two monster trading days in August. With volumes topping 500 million shares, its share price more than tripled and, some say, stoked the surge in activity that boosted the Dow Jones industrial average by 1,600 points in the last two months. It closed at $1.69 on Wednesday, up 1 cent.

Experts said the trading boom in stocks of dead or troubled companies has been fueled almost exclusively by speculation at the hands of aggressive day traders operating alone or on specialized high-frequency desks at trading firms and hedge funds.

Although the dollar values are low, traders buy up huge quantities of shares; a 1-cent hike on 1 million shares yields a $10,000 profit.

"You look at this using conventional valuation metrics and it makes no sense," said Steve Sosnick, equity risk manager at Interactive Brokers Group's Timber Hill, who calls the trend a "flight to garbage."

"There's suddenly a huge potential for profit in these essentially worthless companies," he said.

In most cases, shares in bankrupt or government-controlled firms can be bought and sold until a judge orders that trading cease. Stocks of Enron and Bethlehem Steel continued trading long after going belly up, although at very low volumes.

The Securities and Exchange Commission and the Financial Industry Regulatory Authority say they can do little to restrict such trading.

Yet because the companies are well-known (some call them blue-penny stocks, a combination of blue-chip and penny stocks), there is concern that small investors could be lured into the investments.

Online brokerages and investor information websites aren't helping. At least two sites describe Lehman as a 28,500-employee investment bank, for example, when in fact it is no longer a going concern and has no employees.

Bankrupt companies are denoted by a ticker symbol ending in Q, but that's something novice investors might overlook.

The New York Stock Exchange changed rules last year to temporarily allow shares of companies that slipped under $1, including Fannie Mae, to stay listed, and altered rules to keep options of American International Group Inc. trading despite their low price.

In response to inquiries from The Times, the SEC said it was contacting several firms that post stock information to ask that errors on their websites be corrected.

Critics argue that brokerages and exchanges have little interest in discouraging such activity because of trading commissions.

"It's all about . . . brokerage commissions and luring in suckers," said Timothy Sykes, a New York day trader who calls these risky stocks "carcasses."

The trend underscores how Wall Street is changing and how easily valuations can be manipulated. Thanks to new technologies, millions of shares can now trade in a fraction of the time it takes to blink.

Some players "short" the stocks, betting the price will drop. Others focus on options, while still others aim for tiny gains on the margins of huge trades. Traders talk to one another in chat rooms and build excitement off news on CNBC and the Internet.

Lehman's recent run-up, for example, was driven in part by rumors that shareholders might recover assets from Barclay's, the bank that bought much of the legendary Wall Street firm's assets. In just two trading days last month, Lehman's shares leaped 300% amid a fiftyfold jump in volume.

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