Masterminding a firm's demise?

SEC wants to know if backers made money by trying to kill it.

The Philadelphia Inquirer
By Todd Mason
April 23, 2006

Marco Emrich relished the job he took on seven years ago as Sedona Corp.'s chief executive officer and architect of its new incarnation as a software firm.

"I told my wife, 'We don't have the product, the people or the money, but this is going to be fun,' " he said.

Emrich, 53, embarked instead on a bitter and - at first - baffling struggle to survive. Sedona stock fell in price after the company secured financing in 2000, and it kept sinking despite what company officials presented as encouraging developments.

Sedona says it was forced to lay off 62 of its 77 employees, as clients, partners and investors pulled back, questioning the company's ability to survive. To save money, it moved from an office park in King of Prussia to an industrial park nearby.

Sedona's board began an investigation that plumbed the dark side of Wall Street. Mastering an arcane language of PIPEs, death-spiral convertibles, and naked shorts, directors came to believe their financial backers were betting on Sedona's demise.

Sedona is now making its name in securities litigation, if not software, as Exhibit A for critics who say that manipulators are attacking small companies' stocks in ways that kill entrepreneurship.

"We never dreamed we would become the victim of an elaborate stock fraud," said former Sedona director Michael Mulshine, of Brielle, N.J. "You should say alleged," he added.

Sedona's case has been strengthened by Securities and Exchange Commission lawsuits against the backers' agents and brokers, and a federal arrest warrant issued for one, who fled to his native Austria.

In a civil lawsuit filed this month, the SEC alleged that three brokers at Refco Inc., the New York brokerage, had aided the fugitive, Thomas Badian of Rhino Advisors, in manipulating Sedona shares.

Refco filed for bankruptcy in November amid allegations that former chief executive Phillip Bennett hid $430 million in losses.

The investigation that began in King of Prussia is spreading now in a shadowy web of offshore funds acting for anonymous investors.

Sedona's principal backer, Amro International S.A., is an investment fund registered in Panama and managed in Switzerland. Of 82 companies financed by Amro, 55, or two-thirds, had lost half of their stock-market value a year later, according to Wes Christian, a Houston lawyer who represents Sedona and 19 other companies in civil lawsuits alleging stock fraud.

"They make money off of killing companies," he said.

The SEC, in its initial lawsuit - against Badian and Rhino in February 2003 - helped some of these companies figure out what was happening.

One was Pet Quarters, a now-moribund Arkansas pet-foods retailer. "If you pulled out the name Sedona and put in Pet Quarters, it would be our story," said Steve Dempsey, the company's chief executive.

Sedona was formulating strategy in 1999, when the story begins. Founded in 1987 as Scan Graphics Inc., it had made money in only one year as a maker of table-size image scanners. Worse, the market was looking like a technological dead end.

But Sedona had acquired promising software from Lockheed Martin Corp. in 1996. Programmers there were working to integrate data from dissimilar databases, with an initial goal of pulling together highly detailed military maps.

An executive-search firm recommended Emrich as an accomplished manager, overseeing software development at the former Digital Equipment Corp. and pulling together two Boston spin-offs as one company.

Emrich suggested a promising market: Small banks would pay for software that could pull together details of savings, lending and banking relationships into a complete picture of their customers.

Financing fell into place quickly, too. Ladenburg Thalmann & Co. Inc., of New York, offered to find wealthy individuals to capitalize Sedona directly in what are called private investments in public entities, or PIPE deals, Emrich said.

Amro and other investors furnished a $3 million loan convertible under favorable terms into common shares of Sedona, Emrich said. These securities are known today as death-spiral convertibles and are spurned by the investment community as desperate acts committed by desperate companies.

But Brett Goetschius, who edits a newsletter on PIPE deals, said they were considered innovative in the bull market of the 1990s. Convertible deals could result in fewer shares being issued than selling stock outright, if stock prices kept going up.

Sedona stipulated in the financing agreement that backers could not sell the stock short, or bet on a price decline. In a short sale, investors borrow shares and sell them, hoping to replace them later at a bargain price.

In early 2000, for no apparent reason, Sedona's shares soared as high as $10.25. Then the stock swooned, shrugging off news of promising alliances. Worried, Sedona's board sought assurances from Ladenburg that the company's backers were legitimate. The board decided to complete a second PIPE deal to pay off the first and avoid a damaging flood of new shares.

Emrich defends the decision. "We didn't suspect anyone in particular," he said, and least of all Ladenburg. "They have been in business 130 years."

Ladenburg did not respond to telephone calls and an e-mail requesting an interview. Sedona's lawsuit names Ladenburg as a defendant; the SEC lawsuits do not name Ladenburg.

Sedona's shares continued to languish, spelling doom by indifference for a company that needed recognition in the stock market to get financing.

The firm began to document the flood of "sell" orders that would greet favorable news, such as a decision by International Business Machines Corp. to sell Sedona's software in December 2000, or Sedona's designation in April 2001 as an Advanced IBM Partner.

Then in September 2001, Emrich received a package mailed to him anonymously. Inside was a thick book detailing suspicious trading patterns at Sedona and 60 other companies.

"We're not crazy," Emrich recalled saying. "Someone else is watching and sees this, too."

Sedona's board had influence beyond the company's modest circumstances. Director James Sargent, now 90 and retired from Sedona's board, served as an SEC commissioner between 1956 and 1960. He joined a Sedona delegation in Washington to brief SEC investigators. SEC commissioners ordered an investigation in June 2002 that led its lawyers to Refco, before the firm's spectacular collapse last year.

Emrich was facing tougher problems. Fiserv Inc., another giant in bank data processing, demanded concessions from the company to remain a partner. IBM drifted away, Emrich said, wary of Sedona's troubles.

Broke by the end of 2002, Sedona could not meet its payroll for nine weeks. "I met with employees' wives, husbands," Emrich said. "I told them I know that there is way out of this. I don't know what it is yet, but I'll find it." None of the 15 employees left, said Anita Primo, Sedona's chief financial officer. "If someone had issues, we all chipped in and helped."

Tim Rimlinger, Sedona's top engineer, said he and his wife agreed to press on, even though it was clear then that "he who has the best technology doesn't always win."

In 2002, Emrich met with Sedona's major investors to ask for help. One of them, Louisiana developer David Vey, ultimately stepped up. Vey said he hired a consultant to appraise Sedona's software offerings and described his support as a bet "on the quality of the product."

Sedona faced disappointed shareholders as well, said Mulshine, the former director, who had raised money for Sedona in its Scan Graphics days. "What do you tell them?" he asked.

The latest SEC complaint spells out many of the details, quoting from Refco tape recordings. Andreas Badian, a Rhino principal and Thomas' brother, directed Refco broker Jeffrey Graham to "clobber" Sedona stock in March 2001 as a second set of conversion rights were coming due, the SEC alleges.

Graham and two other Refco brokers, Jacob Spinner and Mottes Drillman, accounted for 40 percent of Sedona's trading volume that month, according to the SEC, selling 843,000 shares short despite Rhino's pledge to the contrary.

A man who answered the phone at Pond Securities Corp., of New York, where Spinner and Drillman now work, said they would not comment. Andreas Badian would not comment; Graham could not be reached.

Sedona's price had fallen that month to 75 cents from $1.43 when Badian told Graham on March 23 in a recorded call: "Keep waling away; this is very good," according to the SEC.

The latest SEC lawsuit alleges that Refco and Pond helped Rhino engage in illegal naked short sales - selling shares they have not borrowed.

The brokers then closed out the bogus positions with shares obtained at the conversion formula of 85 percent of prevailing market price in transactions meant to disguise them as regular sales, according to the SEC.

Spinner boasted to a colleague, according to the lawsuit: "Want to short something illegally for 12 months? You got my number."

Sedona added speculation to the SEC's allegations in its lawsuit. It contends that the company was targeted in a sophisticated variation of the pump-and-dump scheme - driving up a stock to generate interest, selling shares to unsuspecting buyers, and using naked short positions and conversion shares to avoid detection.

Sedona lost $3.2 million, or 4 cents a share, last year on revenue of $723,000, compared with a similar loss in 2004 on revenue of $1.1 million. Sedona's shares closed Friday at 28 cents. Relentlessly upbeat, Emrich said he believed that Sedona could grow again.

Sedona's woes are drawing an audience for critics of naked short selling, who have been dismissed as unsuccessful promoters and investors, and sore losers.

Owen Lamont, a Yale University professor of finance, dismisses the critics. They "don't like anyone selling, period," he said. He argues that investors would benefit if there were more "honest pessimists" to rein in overpriced shares.

But abuses exist, said Ralph Lambiase, director of the Connecticut Division of Securities. "Do I think American companies are being destroyed" by stock manipulators? he asked. "Yes."

Sedona's Baffling Slide

Jan. 24, 2000:Ladenburg Thalmann & Co. Inc. agrees to provide up to $17.5 million in financing.

March 6, 2000: Sedona shares hit $10.25 during the day and close at $9.375. There is no news to explain the jump.

Nov. 22, 2000: Rhino Investors, representing Amro International S.A. and other investors, provides $2.5 million in financing to Sedona, which issues a bond convertible to common stock at 85 percent of the prevailing price.

Dec. 7, 2000: Sedona announces that International Business Machines Corp. will begin selling its software to banks that own or lease its computers. Sedona stock climbs to $1.34 on heavy volume, but closes at $1.15, up just 3 cents from its opening price.

March 20, 2001:Rhino principal Andreas Badian urges Refco broker Jeffrey Graham to "clobber" Sedona, to sell shares with "unbridled levels of aggression," according to Refco tapes obtained by the Securities and Exchange Commission.

March and April 2001: Rhino exercises conversion rights, claiming 1.6 million shares at 64 to 77 cents a share.

March and April 2001: Rhino sells 1.2 million Sedona shares, but the stock is not delivered for settlement, according to the SEC.

April 19, 2001: IBM designates Sedona as an Advanced IBM Partner, signaling closer ties. The stock falls 2 cents to 96 cents.

September 2001: Sedona CEO Marco Emrich receives an anonymous briefing book outlining suspicious trading in Sedona's shares.

Oct. 24, 2001: Amro sues Sedona after the company refuses to honor a conversion request.

Oct. 25, 2001: Andreas Badian writes to his brother Thomas, "There is no way we can have this go into court," according to the U.S. Attorney's Office. Amro quickly settles its suit.

November 2001: A Sedona delegation meets with the SEC in Washington to present evidence of stock manipulation.

June 5, 2002: The SEC issues an order beginning an investigation, looking specifically at events of March and April 2001.

December 2002: Sedona employees go nine weeks without pay as Emrich seeks financial backing.

Feb. 27, 2003: The SEC sues Rhino and Thomas Badian, who settles the civil lawsuit for $1 million without admitting or denying guilt.

May 5, 2003: Sedona sues Ladenburg Thalmann, Rhino, Amro and others in federal court in New York, alleging fraud.

Dec. 3, 2003: The U.S. Attorney's Office in New York obtains arrest warrants for Thomas and Andreas Badian, alleging conspiracy to commit securities fraud. Thomas Badian later flees to Austria. Prosecutors later withdraw the warrant against Andreas Badian. The SEC later files a civil suit against Andreas Badian.

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