Short vs. spy: The case of 4C Controls
Tiny stocks often rise on hype and hope. But one skeptic can spoil the fun. Just ask shareholders in this 'leading international security' firm.
FORTUNE (New York) -- 4C Controls bills itself as a "leading international security and surveillance company," though at present it has no revenues, no products in the marketplace and a grand total of $229,000 in the bank.
What it did have, until recently, was a rising stock price.
On August 14, shares were fetching $9.35 on the over-the-counter market, where equities that don't meet listing requirements for the big exchanges are traded.
OTC stocks are typically lightly traded, which can make for volatile share prices. At $9-plus per share, the company had a nearly-$400 million market capitalization, representing a wonderful, non-economically driven increase in value from under $2 in February.
Then along came short-seller Andrew Left. He posted a withering, tabloid-like critique of 4C Controls on his Web site, Citron Research. The stock dropped to below $7 by the end of trading on August 14, and fell below $2 the next day. It closed at $3.96 on Aug. 26.
Shorts try to profit from a decline in a stock's price. They sell borrowed shares, which they hope to replace with cheaper stock at a later date. Typically they operate quietly, which makes them a convenient bogeyman for both company managements and shareholders, both of whom have a vested interest in seeing the stock's price increase. In the credit crisis, they've been attacked for spreading false rumors about troubled financial firms, and additional scrutiny has been given to their activities by the SEC.
Left is a short of a different stripe. He puts his beefs on the record, though only after he's taken a position in a stock. And unlike the few other shorts who go public - Greenlight Capital's David Einhorn or Kynikos Associates' James Chanos come to mind - Left could hardly be called "measured" in his attacks.
In the case of 4C, Left blasts the company's opaque ownership structure, the fact that one of its key investors is located in the Marshall Islands (he offers a link to a 2000 Treasury Department warning about the region's banking practices), and of course, its nearly non-existent financial profile.
"What's worse about this company," he asks, "the tale or the truth?"
Noting that Switzerland-based private equity shop Rudana Investment Group is 4C's majority owner, Left argued that chief executive Olivier De Vergnies, a former executive at a Swiss money manager, was hired because his "expertise in privacy laws was more crucial to [his] job than his expertise in security products."
A 4C spokesman, Robert Leahy, did portray Rudana as having "super-quiet, secretive European and Middle Eastern investors."
Left's attack on 4C isn't just a matter of applying a worst-case spin wherever possible. There are some truly baffling transactions in the company's recent past.
Take just one: the purchase of over 2.2 million shares, or 5.31% of 4C's float, by Marshall Islands-based investment firm Black Sea Trading last month. That's interesting enough. A closer reading of the disclosure form filed with the SEC shows that Black Sea paid 23 cents per share on July 2, when the stock was trading at $7.50. Also, the filing claims this trade was done on the open market, but the records for that day show only 66,500 shares trading.
Black Sea's general partner, Robert Jarva, has a long history of sitting on the boards of OTC Bulletin Board companies, according to SEC filings, and includes in his resume time spent as a marketing director for a restaurant in British Columbia. Jarva's involvement in the OTC stocks has not paid off, with eight of the nine stocks trading well under $1.
Jarva could not be reached for comment and the lawyer listed on his 13-D filings did not return repeated calls for comment.
For its part, 4C's chief financial officer, Gerry Sullivan, told Fortune that Black Sea's 4C stock was actually purchased last October, prior to Rudana getting involved in the company.
"I have no idea how this happened or who he bought it from," said Sullivan. "When I saw the filing [last month], I just noted the size of Black Sea's holding and didn't think about the price." He added that the company thinks Jarva is simply an investor and doesn't seek to change its business plan.
Here's another odd thing: According to SEC filings, Jarva's Black Sea Trading also owns 5.13% of another Rudana-controlled company, Prime Sun Power, whose temporary CFO is also 4C's Gerry Sullivan. Like 4C, Prime Sun is also seeking to implement a new operating plan, having just changed to solar energy from its previous life in the ATM cash-dispensing business.
Like many companies targeted by short-sellers, 4C has pushed back with equal parts furor and press release.
First were the releases announcing the hiring of a former FBI special agent to head up its "Security Assessment and Threat Analysis" effort, and what purports to be 4C's first revenue-generating contract - an agreement to provide security and surveillance at several Dubai real estate projects. The company said that deal should bring in $40 million over the next two years.
The company also put together a 19-point "refutation" of Left's article, a copy of which was provided to Fortune.
While 4C's tone can be as over-the-top as Left's - arguing that Left's concerns over the possible role of anonymous Middle Eastern financiers in 4C amounts to little more than racism - it correctly notes that Left is raising the specter of a web of international fraud when 4C has barely had time to launch a business. As of now, its headquarters is a mail drop in Rockefeller Center and its phone number goes to an answering service.
The company also sent a letter to the SEC, demanding an investigation into Left and his activities. Left has been the subject of many such demands from his targets. A spokesman for the SEC declined comment.
The 38-year old Florida native has not been subject to any enforcement action by the agency. He does, however, have an interesting past. He's been a short-seller for seven years, having previously run a now deceased dot.com business. In February 1998, Left was tagged by a National Futures Association disciplinary committee as having made "False and misleading statements" to a customer and barred from working as a futures broker for three years.
Left, by way of explanation, says he was 23 years old and operating off a sales script when the mistakes were made in 1993 and that he only held the job for five months.
His recent record of spotting inflated values is impressive. Two years ago, he raised questions about a Texas-based homebuilder called Home Solutions of America that had made some massive promises about its business prospects. Home Solutions' stock now trades at 66 cents, down from around $10 when he began writing about it. Several of his recent targets have been forced to seek bankruptcy protection or been ordered to restate their earnings. Dozens of others, with the hype removed from their stocks, have simply drifted into illiquidity and obscurity.
His best-known target may have been RTIN Holdings, an Internet prescription-fulfillment company. Despite the fact that legendary Fidelity Investments Magellan fund manager Peter Lynch owned a large stake in the company, Left argued that analysis of its financials and business operations revealed big problems.
"I used to get e-mails taunting me about my credibility in a 'Lynch vs. Left' scenario," Left says. But RTIN's CEO, Curtis Swanson, was sentenced to 10 years in prison in 2007 after pleading guilty to securities fraud and money-laundering charges.
As the 4C saga winds its way forward, perhaps the best sentiment to sum up the whole affair can be found at the bottom of Left's report: "Cautious investing to all." 
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