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OCZ shares trashed by short seller's research note

I did bad stuff, but I also built a company with no venture capital, says CEO...

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OCZ stock went into freefall last week after serious allegations were published about its technology and its chief executive.

According to a research note, the company was alleged to have hidden CEO Ryan Petersen's youthful misdeeds from investors during the recent secondary capital-raising. This was later discovered to be inaccurate. The note also alleged that the company had misrepresented its SSD growth.

The allegations are contained in a research note from Copperfield Research, parts of which were published on the SeekingAlpha investors' website on 20 April.

The note from Copperfield Research comes from a short seller – a person who believes a stock price is going to fall. The seller sells stock which he/she doesn't own at the price of the day for delivery in the future. Then he or she waits until the share price falls, and then buys the stock for a lower price than the price at which it was sold, and pockets the difference.

The seller's tactic appears to have worked. On 15 April, OCZ shares were trading at $9.97. The research note was published on 20 April and shares now trade at $7.49, a difference of $2.48. If the short seller had sold 100,000 shares on 15 April and bought 100,000 shares on 20 April, then the profit would have been $248,000 less dealing costs: a tidy sum.

Craig-Hallum [one of the underwriters] responded to the first part of the allegations:

"Material information withheld about CEO's past felonious activity.
Information regarding arrests was disclosed when the company was listed on the AIM because the charges occurred within the last 10 years. After 10 years this was no longer considered material when the company was listed on NASDAQ. The company chose to inform potential investors of 'youthful' indiscretions in the most recent follow-on offering to provide additional disclosure."

A stock trader writing under the pseudonym firstadopter, claims to throw more light on this, saying:

Copperfield Research's alleges that the company withheld information about the CEO's criminal background to investors during the recent equity secondary capital-raise. Here is Needham [one of the under-writers] analyst's response:

"Information Withheld On CEO's Past: FACTUALLY INACCURATE. The buyside was made known of the CEO's youthful indiscretions many years ago through the filings as well as throughout the roadshow, and our own conversations suggest that investors were not concerned with something so old and irrelevant to current product roadmaps and the future of the company."

Petersen himself chimed in, telling Bloomberg: "I believe my only felony conviction was for trafficking in stolen property in exchange for marijuana. He told Bloomberg that the stolen property had been a car stereo and that the phrase "youthful indiscretion" had been a term chosen by the underwriters. He added: "It's irrelevant information. I did a lot of stuff I'm not proud of, but I built a company out of the ground with no venture capital."

The 1934 US Securities Act requires a company must reveal information about any executive convicted of a criminal proceeding or is named subject to a pending criminal proceeding in the past 10 years. Petersen's conviction was in 1998 and this was altered to a misdemeanour in March, 2006. Since the second funding round offering was in April 2011, there was no requirement for OCZ to reveal the information and the Copperfield allegation does appears to be irrelevant.

The Copperfield short seller also alleged that OCZ has claimed to triple (manufacturing) capacity out of thin air, and that there have been accounting irregularities within the company concerning, among other things, prior losses.

Stifel Nicolaus analyst Aaron Rakers has spoken to OCZ's CEO and CFO about the SSD growth misrepresentations, and states:

The company’s 10-Q filing does have an incorrect table with regard to the company's SSD vs Memory breakdown – an error that was corrected in the text relative to the initial filing (ie, $41.5m in F3Q10 vs $21.3m in F3Q09 was wrong and then corrected to $41.5m vs $9.8m, or up 325 per cent; however, this was not corrected in the subsequent table in the filing). While clearly a mistake in the company's filing (a mistake that will certainly be corrected), we believe the company's SSD growth is not misrepresented.

Rakers says Stifel Nicolaus is "less concerned with the other claims with this report, specifically with regard to the CEO's past, competitive thoughts, the Indilinx acquisition, or references to competitive dynamics. With regard to the tripling of capacity, our conversations have highlighted that OCZ acquired used equipment. In reference to prior losses, we would highlight the change in OCZ's business focus on the SSD market relative to the company's initial focus on the high-speed memory business over the past few years."

Rakers states: "We continue to view the company as [being] well positioned to benefit from the strong secular growth trends in the enterprise adoption of SSDs over the coming quarters."

We have seen these two underwriters' client advisory notes. They make it clear that they see nothing of any substance in the Copperfield Research note.

Craig-Hallum goes further: "We believe the market's reaction to a negative article published on SeekingAlpha anonymously authored by Copperfield Research (who claimed to be short the stock) was grossly overstated and we would use recent weakness as a buying opportunity." Take that Copperfield.

The effect of the Copperfield note, by uncontactable authors operating under a pseudonym, has been to create a short seller's dream and enable a profitable pair of trades. It was clearly in the author's self-interest that OCZ's stock price should fall.

OCZ says its corporate policy "is not to respond to market rumours and speculation". In this particular case one feels that corporate policy should be set aside and an immediate and robust corporate response would have been justified.

OCZ's stock price is still depressed, trading at $7.61, from a high of $10.30 immediately before the Copperfield Research note appeared. ®

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