Thursday, May 28, 2009

SEC Complaint Confirms Gulling of Media on Pegasus Wireless

Yesterday I wrote about the sad but familiar tale of Pegasus Wireless, which was busted by the SEC in a fraud scheme. One of the more interesting aspects of the Pegasus tale is how the financial media gave p.r. support to the scam artists, by uncritically repeating the claims of CEO Jay Knabb--despite a Barron's article which totally discredited that same person.

This is an interesting example of how competitive pressures resulted in some truly awful journalism.

The SEC complaint is out today, and it shows the media's negligence in this area even more clearly than yesterday's press reports. Let's contrast the SEC complaint with the adoring press coverage by Liz Moyer in Forbes.com and the critical coverage in Barron's.

The SEC complaint:

Pegasus shares reached a high of$18.69 per share in May 2006, briefly giving Pegasus a market capitalization of approximately $1.42 billion. Knabb promoted Pegasus through word of mouth, as well as unique promotional events such as an appearance at a major sporting event and a concert by a world-renowned musician.

The stock, however, began a steady decline after that, in apparent response to press articles questioning Pegasus' valuation and reports that Knabb and [ex-CFO Stephen] Durland had headed other microcap companies whose stock rose and crashed in short periods of time.
The "press articles" is mainly a reference to this piece in Barron's, The Medusa Effect, by Leslie Norton. Norton's piece turned out to be prophetic:

In the past, shares of two Knabb companies — BIFS Technologies, formerly Biofiltration Systems, and Wireless Frontier — ballooned, then collapsed. Asked about last week's decline in Pegasus, Knabb shakes his head. "It's really a shame the true story of the stock is not being told," he says. "This is a real company with real technology, and real people. We will show the world the new video-streaming. I'm not looking to the Street for money. This is only hurting shareholders. We're growing at 40% organic growth a year. Why is it the business is doing $100 million with net profits and no [cash] burn?"

After his brush with Knabb, Babak Dowlatshahi borrowed money to start a new firm, Creative Computers, in Fayetteville. Last month, he made his final payment to the bank. "I bounced back," he says.

Others may have to face the music.

Shortly thereafter came this in Forbes.com, which described how Pegasus shares were under "constant attack" from, among other things, negative press coverage. That was followed by this even more disgraceful article that famously began that there's a "hit out on Pegasus Wireless." Knabb's outlandish claims were uncritically reported.

Seth Jayson was moved to observe at the time:

. . . in this day and age, even a CEO and CFO with an amazing record of microcap tomfoolery can find a sympathetic ear out there -- at least if they've got a market story with sufficient nudity.

Enter Forbes' Liz Moyer, who seems to have swallowed the Pegasus peanut gallery's short story hook, line, and sinker. Worse yet, she believes the Pegasus corporate party line -- that an unproven outfit like Pegasus is going to outmaneuver Apple (Nasdaq: AAPL), Hewlett-Packard (NYSE: HPQ), Cisco (Nasdaq: CSCO), and everyone else playing in the hotly contested PC-to-TV video-streaming market. I'm not kidding. She opens her Monday night article with this line, "Jasper Knabb and his streaming video technology is [sic] about to beat Steve Jobs to the punch."

As for that "hit out on Pegasus Wireless"--sure was. The hit men were the top execs of the company, who were touted in the Forbes.com piece. The SEC complaint said that just while this jousting in the media was underway, Pegasus was flooding the market with unregistered shares:

29. In August 2006, Pegasus began issuing massive amounts of supposedly unrestricted shares to Jones, Speer, Wilson, Aero-Marine, and others connected to Knabb and/or Durland. To convince Pegasus' transfer agent to issue the shares without restrictions on their immediate resale, Pegasus claimed it was issuing the shares to satisfy promissory not~s purportedly issued by a Blue Industries, Inc. subsidiary in 2003 and 2004.

30. To support Pegasus' claim to the transfer agent, Durland presented at least 33
supposed promissory notes to the transfer agent between August 2006 and February 2008. By February 2008, Pegasus had issued nearly 479,150,000 shares -75% of its outstanding shares - in this manner.
In one of her stories, Moyer said as follows: "Records held by Pegasus' transfer agent indicated there may be as many as 30 million more shares out there than it has on record. That suggests that short-sellers have been selling shares without actually borrowing them--a controversial practice known as naked short-selling."

In fact, it wasn't naked shorting at all. It was the people whose cause she was advocating selling unregistered shares.

As for why the shares declined so badly, the SEC complaint doesn't blame "short sellers"--including the "naked shorts" rapped by Moyer-- or "the media." It blames the management of Pegassus Wireless:

. . . Having received millions of Pegasus shares directly from Pegasus or indirectly through conduits, Speer, Wilson, Jones, and Aero-Marine proceeded to dump the shares and remit the bulk ofthe proceeds to Knabb. During the Commission's investigation, Speer, Wilson, Jones, and Aero-Marine's supposed manager declined to testify about the transactions or activities relating to Pegasus, asserting their Fifth Amendment privilege against self-incrimination.

Between June 2005 and September 2006, Jones sold at least 978,235 shares to
individual investors, including unaccredited investors, in the Myrtle Beach, South Carolina area, often through face-to-face meetings. Knabb often participated in the selling efforts, accompanying Jones in the face-to.:.face meetings and touting Pegasus' prospects. From the proceeds of these directly to investors, Jones wired to Knabb at least $2.2 million between January 2005 and September 2006. Investors who acquired Jones' shares sometimes wrote checks directly to Knabb.
I don't blame them, if they had read the two Forbes.com articles that talked up Pegasus Wireless and its CEO, thereby attempting to discredit the Barron's piece. It was a superb job of media manipulation, I must admit.

The SEC goes on to say that "Between approximately November 2006 and December 2007, relief defendant Aero-Marine sold approximately 125 million shares of Pegasus stock to the public, receiving proceeds of about $12.8 million." Note that the share sales commenced right after the two Forbes.com articles, which have never been retracted or followed-up.

Hey, we all get suckered sometimes. In Wall Street Versus America I described how Business Week was similarly gulled by a sob story by penny stock hustlers (and got called on it by Barron's).

I'm sure it will happen again. Con men are like that. But what makes this tale different is that a con man gulled a reporter after a story in Barron's indicated that Knabb, had a questionable track record. Instead of telling Knabb to take a hike, what happened here was an example of the age-old pastime of knocking down the competition's story. Sometimes that works. But sometimes it fails spectacularly, as it did with Pegasus Wireless.

The public is fed up with the financial press being manipulated by corporations. They're tired of stock market cheerleading. Hopefully the next reporter who is at the receiving end of a CEO's "the shorts are attacking me" sob story will remember Pegasus Wireless.

UPDATE: This evening Moyer produced this anemic, belated follow-up, mentioning one of her previous puff pieces without retracting or expressing regret for it. She then says as follows:
Pegasus investors, meanwhile, grew repeatedly frustrated by the late summer and fall of 2006 because of Knabb's growing elusiveness. He would eventually move the company's operations from Northern California to the Bahamas, but even there he, and Pegasus, appeared to drop off the map.
Funny, her stories never said anything about shareholder frustration. She totally swallowed the management line back then. She should acknowledge that and apologize.

But worst of all was her failure to acknowledge that the SEC found that all those unregistered shares she had talked about were not from naked shorting.

Putting that issue aside for a moment, one question that I have, after reading the serious allegations in the SEC complaint, is this: why haven't criminal charges been filed?

© 2009 Gary Weiss. All rights reserved.

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