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Oil Seismology Firm Sues Funds in 'Death Spiral' Stock Case

An oil and gas exploration firm has alleged in federal court that a Connecticut hedge fund and related offshore investment funds unlawfully coordinated short-selling of the firm's stock in a "death spiral" scheme designed to enrich the funds while causing the company's market value to plummet.

In a complaint filed in the U.S. District Court for the Southern District of Texas, Houston-based Hyperdynamics Corp. claims it is one of "dozens" of thinly capitalized startup companies victimized by convertible preferred-stock financing arranged by Southridge Capital Management LLC, a hedge fund headquartered in Ridgefield, Conn.

The suit says Southridge, in a conspiracy with offshore funds it secretly controlled, used "short sales" on a massive scale to drive the price of Hyperdynamics stock downward in a "death spiral" in which the shares fell from $6 to 50 cents from April 2000 to March 2001.

Although the complaint does not specify the damages caused by the alleged scheme, an examination of court filings and Securities and Exchange Commission reports indicates that Hyperdynamics lost about $67 million in market value during the "death spiral" period.

Short sales are a bet that the price of targeted common stock will decline in value. A short-seller borrows a specific number of shares of a targeted company from a broker and sells them for cash. When the price of the target stock declines, the short-seller uses the cash to buy more shares at the lower price. After paying the broker the exact number of shares borrowed, the short-seller pockets the extra shares as profit.

The defendants allegedly reaped "immense profits" at the expense of Hyperdynamics by using discounted conversion shares to cover their short sales.

"With each conversion, the market was saturated with more and more shares of common stock which were rapidly offered for sale, thus creating a constant overhanging selling pressure on the market and driving the price even lower," the complaint says.