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DIANA DAY AFTERNOON

October 15, 1996, was a make-or-break day for Asensio & Company. We were a tiny brokerage firm, less than three years old. Even though we had thus far achieved solid results for our investors, we were just another struggling, small business. Few, if any, had ever heard of us. Earlier in the year we had struck off into uncharted territory—short selling high flyers in the hottest sectors of a bubbling market. Our new direction was to discover hyperpromoted, grossly overvalued companies, research them seven ways to Sunday, and take a trading position.

But that's not all. Although promotions that rise on hot air will eventually fall to earth, many short sellers have gone broke waiting for the laws of gravity to take effect. In fact, the object of our disaffection had already cost the shorts a bundle. Many had begun to short this puppy at $10 only to see it rise to $120, despite a flurry of major negative news stories. Instead of just sitting back and waiting, our plan was to escalate the fight, to get all the facts, and then to publish the straight, fully documented story and our opinions directly on the Internet, with no wishy-washy middleman.

Ready or not, here come the New Wave shorts.

We first issued a sell advisory on the Diana Corporation on May 29, 1996, when its stock was trading over $100, giving the company a market capitalization of more than $500 million. The overall stock market had since inflated so much that this may seem like peanuts, but back in 1996 this was the big enchilada of stock promotions. This meat distributor turned sizzling tech avatar had risen in only nine months from $5 a share to an intraday high of $120 on May 24. It was one of the sexiest playthings on Wall Street: volatile, high volume, high short interest, and price action like a late '90s dot-com initial public offering (IPO). The company was promoting an Internet access switch that would allegedly provide huge savings and productivity gains for Internet Service Providers (ISPs). But of all the investors and prominent analysts pumping up the stock, apparently not one had done the research to learn that it was all just an elaborate scam.

In the months following my first report, the stock sank like a bag of Sakrete, dropping to as low as $20 per share. Investors who followed Asensio & Company's advice to short Diana collectively made millions. But the institutional wise guys promoting the stock, whether aware of its true nature or not, just didn't quit. Five months after our initial report, the promote became reinvigorated, and the stock charged back up as high as $50 again.

The stakes in Diana had grown massive and the climate nasty. On October 15, 1996, it all came to a head: apparent stock manipulation by front-running, fat-cat investment bankers; high-level corporate skullduggery; choruses of traders from both the short and the long side beseeching me for information; and the complete inability of the world's most respected stock market, the New York Stock Exchange, to maintain a fair and orderly market.

Diana's resurgence had kicked off what some call a short squeeze on Wall Street. This happens when a large number of investors have sold the stock short—that is, borrowed the stock from their brokers to sell with the intention of buying the shares back on the market at a future date. The short sellers are betting the stock price will fall and that they will be able to buy it back at a lower price than what they sold it for, pocketing the difference.

When the Diana battle was raging, the regulatory climate allowed for liberal interpretation of the short selling rules. As a result, the company's efforts to keep the shorts out of its stock had failed and Diana became one of the most heavily shorted companies on Wall Street.

Investors, whether they are professional money managers or individuals overseeing their personal investments, tend to think of the stock market in terms of buying stock—and generally holding it. Short selling, on the other hand, is about selling—without first buying—to make a profit. When a lot of traders have gone short and the stock price begins to rise, a certain number will panic, leaping to buy the stock and cut their losses. This can send the stock price even higher.

There were more than 3 million shares short in Diana and only 5 million total shares outstanding—a huge short interest. This means that an inordinate number of traders had chosen to short Diana, expecting its price to fall. A large short interest in a stock usually indicates negative investor sentiment and should be a blinking caution light to anybody thinking of buying the stock. Sure, all those short sellers might be wrong, but as a group short sellers have always been accorded a grudging respect on Wall Street for the quality of their research. In this case, the large short interest also meant that there might be more "weak hands" out there holding short positions who could be induced to panic and buy if the stock price were to rise suddenly and steeply.

Amid this "squeeze," we hired a software expert and a hardware expert—unfortunately, both must remain anonymous—with intimate knowledge of Diana's switch and other switches that actually worked. With their input I began preparing an extensive plain-language 16-page engineering report detailing the flaws in its technology and proving beyond doubt that it was, in fact, a worthless, obsolete device. During the three weeks it took to prepare this report, Diana kept rising and rising. Shorts were feeling the pain. Finally, on October 15, we were ready to release the report.

Up until this day, we had released all our reports via the PR Newswire. PR Newswire publishes releases about stock opinions from firms in good standing with the National Association of Securities Dealers (NASD). These releases can then be picked up by the other wire services. This report needed to be handled differently, however. For one thing, it isn't practical to issue a 16-page press release, especially not one of such a technical nature. For another, our report had been leaked. Before it was published, we were getting calls about it from retail and institutional investors and brokers, and we knew this would continue.

We needed to release the report simultaneously and democratically. I didn't want to give it to one person and then have that person characterize it to others rather than passing on the actual document. If we were to fax the document separately to individuals, our fax machine and personnel would be tied up; it would be time-consuming and expensive.

We wanted no one to control the report. It is what it is. Come and get it, draw your own conclusions, form your own opinion. Thus, we decided to publish the report on the Internet after putting out a brief release announcing its existence and Web location. That was the genesis of our policy of free and open dissemination of our information. No fee, no commitment, no need to open an account. Get it and read it anonymously.

We announced the location of our report over the PR Newswire at 7: 01 A. M. and again at 9: 10 A. M. Both releases were picked up by the major wire services. On the first day, the report was downloaded over 300 times.

I had barely been home the night before our release. I hadn't slept much that entire week—because of work, not because of tension. For me, researching and preparing a report is relaxing. We were discovering information that added to our conviction about Diana's stock and business at deep levels. We were talking to people who were involved in the design of products competitive to Diana's. They knew this design, and they knew how it compared to others. We could describe not just the functionality of Diana's equipment but also the genesis of its design, how it was designed, and its flaws. We were confident of the accuracy, completeness, and fairness of our report. From that does not come anxiety or nervousness. From that comes peace, satisfaction, conviction. Regardless of the price action. Regardless of the "squeeze."

The tension would come later, when Diana's insiders successfully manipulated the stock, and New York Stock Exchange officials failed to stop them. Not that anyone should ever count on any official—Exchange or otherwise—to stop stock promoters from going about their business.

Diana had recently trumpeted a "deal" it had made with a company called Concentric Network Corporation that we discovered to be a sham. Concentric was a real company, but this turned out to be a false deal. Diana had simply enlisted a legitimate but needy third party to help simulate "sales." I thought our report would undermine any credibility Diana would receive from this announcement.

On the other hand, several major institutions were still issuing buy recommendations on Diana and holding its stock. All I had was faith in the efficient pricing mechanism, despite what I knew these institutions could do to Diana's stock price in the short term.

I got to work early that day, concerned about our first foray onto the Internet. My office, which was at 555 Madison Avenue at the time, was a 12-by-12-foot room with force-fed air. We had to put in a big fan that sounded like an airplane engine. It was hot and noisy all year round. Coming out of that room was like stepping out of a steam cooker. We had three work areas in that tiny room, with a fax machine, a printer, four computers, and six phones with seven lines. It was like being in the cockpit of a 747. When a phone rang, you had to pick it up quickly, because it hurt if you didn't.

The morning of October 15, 1996, Asensio & Company's tiny broker-dealer trading fund was short 43,000 shares at an average price of $38, a $1.6 million position. Diana had closed the previous day at $30.95, down $0.47, which made our unrealized profit before the opening 43,000 shares × ($38 - $30.95) = $303,150.That's small potatoes to a Wall Street hot shot. To us it represented a big chunk of our trading capital.

The stock opened at $32, but there was palpable tension in the trading. Few buyers. No sellers. Traders were standing to the side and observing. The stock slowly sank over the first hour of trading. It hit $28.63 at 10: 26 A. M. We were comfortable, looking forward to further trading. We had a high degree of certainty that this stock promotion was finished. People had to realize, we reasoned, that there was no realistic possibility of Diana ever creating value, of having sales or gross profit margins with this product. This stock had a long way to fall.

And then came the halt.

I gazed incredulously at my ADP quote machine. Trading in Diana had been halted by the New York Stock Exchange. What?! Why? How was the order flow going right before the halt? Who halted it? When was it going to open again? I phoned our superb floor brokers, the twins Larry and Howard Helfant. Throughout the morning they had been giving me "looks": how many buyers were in the crowd, how many sellers. What the specialist had on the books: how much was on the bid, how much was on the offer. Who was on the bid, who was on the offer, who was in the crowd. This is the type of information that can be obtained only from Johnny-on-the-spot traders in a listed market.

Meanwhile, it seemed like every short seller in the game was calling me. Even diehard longs were phoning. This was only our second hostile, adversarial short sell, but the first had been nothing like this.

I had too many calls to return. People with connections to the promote were trying to get through to tell me what the company was up to. But I didn't speak to them, either. I was focused on what was happening at the New York Stock Exchange. When I tried to reach Richard A. Grasso, its chairman, I was shunted down the chain of command to the general counsel, who referred me even further down the chain. I finally got a callback from Tom Viet, the Exchange's vice president of client services—the man in charge of keeping Diana, the NYSE's paying customer, happy. I asked him about the Exchange's halt policies, who had requested Diana's halt, and the reasons the Exchange had allowed it.

Trading halts arise from significant order imbalances or when a company has news to release that is expected to impact its stock price. In theory this allows investors to digest the news and make informed trading decisions. Under the listing agreement, companies listed on the NYSE are asked to call the Exchange 10 minutes before making a material statement. Client Services then calls the trading floor to recommend that trading on the security be halted. A floor governor makes the ultimate decision whether to halt the stock. It takes the say-so of two floor officials to override this recommendation.

Legitimate trading halts occur often; they're a useful way to maintain a fair and orderly market. But what was up with Diana? What did the company all of a sudden claim was so important? What possibly could have occurred? If it had something to announce, one would think it should have been announced before the stock opened. Suddenly at ten o'clock, on the morning we release our report, the company makes representations to the New York Stock Exchange that something has occurred. My initial impression was that there had been no legitimate reason for Diana's request to halt trading.

Nevertheless, the stock continued to be held. It was now past noon. This was no ordinary halt. Where was Diana's immediately pending, big market-moving news? If the halt was a reaction to our report, then it had nothing to do with any internal Diana news. If the company wanted to comment on our report, it could, but that was no reason to halt the stock. I already knew of the scarcely concealed contempt the Street has for short sellers, but now I sensed a palpable and dangerous prejudice that favored paying customers of the New York Stock Exchange over the public. Along with other short sellers and the integrity of the markets in general, I was a victim of that prejudice.

At 2:34 P. M., almost four hours after the trading halt, Diana issued a press release. The "news," which supposedly refuted my report, cited nothing specific. It referred to me as "a short seller posing as a securities analyst of Diana's stock." In fact, I was an analyst—the only securities analyst doing independent, objective, and, most important, uncompromised work on Diana.

James Fiedler was the head of a small company called Sattel Communications Corp., a division of Diana that had supposedly created the would-be wonder switch. Fiedler claimed to possess a letter from an engineering analyst alleging that I solicited a negatively biased technical report from him in exchange for $5,000 plus a percentage of my short-selling profits. In fact, I had never solicited from anyone anything but unbiased, truthful information on Sattel's products. Within 24 hours I served a demand on Diana to produce this letter, but to this day it has never surfaced.

The only other piece of "news" in this release was an incredibly premature, ridiculously trivial, and ultimately untrue announcement. Only 15 days into the new fiscal quarter, Sattel was supposedly expecting to report a modest profit in the quarter as opposed to a forecasted loss. (We already knew that the only deal it had going was with Concentric. There would be no additional income from any other source.) Sattel also announced it had added new personnel in sales and research and development, and a new chief financial officer. Good reason for a trading halt—not.

Well, that was the big news. No transaction had occurred, let alone one that would be expected to have a significant impact on the stock price. Furthermore, nothing in this release was of such an abstruse or confusing nature that it would necessitate the continued halt of trading in the stock.

All that had happened was that James Fiedler, a man who seemed more and more to be the architect of an overblown stock promotion, had been involved in a fabricated attack on my integrity. But I can absorb a personal attack. What made me truly livid was the way that Fiedler abused the procedures of New York Stock Exchange in order to halt trading in Diana.

Americans have a collective sense of entitlement that extends to justice. When fairness is denied, when those in power change the rules without explanation simply because they can, we react with frustration and anger. I know that I certainly do. But there was no time for that now. There was work to be done, facts to uncover. I had to decide: What if the stock reopens higher? Do I stay in if it's going back to $50? It had been at $29—that's $21 of losses times tens of thousands of shares. And if the market could so easily shrug off the cold truths in our report, will it continue on back to $100? Why not? Crazier things happen all the time. I had to deliberate these questions seriously.

At any rate, the Diana release had no substance. A securities analyst would not be able to look at it and say "Yes, here's something to buy on." So why did the company issue it? It needed to show that the game was still on. In effect, they were signaling the promoters that Diana was ready, willing, and able to take the scam to the next higher level of deception: "Yes, people, the cat's out of the bag. But we're in it together, and for the long run. If you liked our stock when you didn't know the truth about it, you gotta love it now."

And then there are those investors who perceive a company's statements as authoritative because they want to. They're hopeful; they refuse to take their losses. They blame the stock's decline on a short seller. They may think, "Okay, he's taken his shot, the worst is over . . . it's going back to $120!"

The so-called news was out. There was nothing that required thoughtful assimilation. So the next question was: Why isn't the stock trading now? There was a good answer to this from a stock manipulator's point of view, which I would soon learn, but I never learned the NYSE-sanctioned answer—the possible justification for continuing to halt the stock for yet another hour after the Diana press release. Only a few minutes were left in the trading day.

Okay, I thought, the stock will stay closed until tomorrow. Let investors read our report and Diana's vapid press release tonight. It's good to allow everyone to think things through overnight. But that didn't happen. Instead, trading resumed at 3:51:56, more than five hours after the halt. Again, there was no expressed reason why the NYSE reopened the stock a mere eight minutes before the close. Why not wait till the next morning? We quickly learned the sinister strategy behind allowing only eight minutes of trading.

When trading resumed, a 32,100-share block immediately crossed the tape at $33.50, almost $4 above where the stock had last traded before the halt. The run-up ravaged our tiny trading account. In the few remaining minutes before 4 P. M., 188,200 shares traded, closing at the high of the day, $35.75. Incredibly, the Dianites had tacked 5 points onto the price since the stock was halted, costing the tiny Asensio trading fund $244,750.This represented a disastrous 50 percent of the net regulatory capital of our brokerage operation. More significantly, on a day when the most lethal possible news had been released—a report that definitively refuted any possibility that this company's product possessed the virtues it had been claiming—the stock actually closed more than 2 points above the previous day's close.

It appeared that the promoters' spin had carried the day. We had taken our best shot and the market shrugged it off. According to the script Diana's promoters concocted that day, the pall cast upon the company would now lift, and the stock could rise back where it belonged, over $100. I didn't know specifically who had been buying the stock in those eight minutes, but I did know that someone had done a helluva job rallying the troops. I figured that during the five-hour halt, some or all of the major institutions supporting the stock had scrounged up buyers to pile into Diana.

Things looked grim. And we had no way of knowing what was actually going on.

It wasn't until a Securities and Exchange Commission (SEC) filing a few weeks later that the story became clear. What happened was, that morning the followers of Diana's institutional backers who were already stuck bought even more shares while the broader Diana market sold off. The tide had turned before the halt. Those who could get out had started doing just that. It appeared that major holders, unable to unwind their large, concentrated positions, had tried to create market action to keep the followers in. But the followers elected to take the opportunity created by the institutions buying more of what they already owned and sold to them. The institutions couldn't prop up the stock if their own followers were selling to them. Despite what had looked early on to be a rout for the manipulators, the credibility of the facts had overpowered them, foiling their strategy and necessitating more drastic action. We'll probably never know exactly what went on behind the scenes. We can, however, indulge in some informed speculation.

In those five hours, Team Diana strategized its defense. Calls would have to have been made from the real inside promoters to the people they had put into the stock. The call was simple. Here's what might have been said: "We have looked at Asensio's report. We view this as a buying opportunity and are going to do just that—buy." Those people would have to have made determinations, in the face of my report, whether to buy along with the orders from the big perma-bull holders or to abandon the promote.

This is what I believed happened during the unjustified five-hour trading halt. Of course, these calls should have occurred while the market in Diana was open and flowing, but they didn't. That's a very important distinction. In a football game, if a running back has broken into the clear and is charging toward the goal line, the defense isn't allowed to suddenly call a time out in the middle of the play to foil the touchdown. All they can do is chase after him.

Companies have many weapons to counteract the market effect of short sellers. Their corporate communications departments can publicly refute any reports or rumors that they feel are damaging their share price. They can make new announcements that might appear to have the potential to increase shareholder value. If they feel their share price has been battered unfairly, they can use cash reserves to repurchase their own stock—or at least announce plans to do so—shoring up the price as well as banking this "bargain" stock. And they can attempt to attract new buyers through vigorous promotion and solicitation by complicit financial institutions. All of this is standard corporate procedure—these are perfectly legitimate attempts to support the price of a stock. I say, let them support their stock, but don't let them manipulate it.

If Diana supporters could concentrate their buying at the end of the day and cause the stock to close up, they could score a significant propaganda victory. Many people might not even realize it had been halted a large part of the day. The promoters could never sustain this kind of manipulation over five hours—there was too great a risk of rebellion in the ranks, as had happened that morning; in a mere eight minutes, however, a bogus buying frenzy could be better simulated.

During the five-hour trading halt, Diana surely disclosed its "news" to individuals who then helped arrange large and aggressive stock purchases immediately upon the resumption of trading. This buying volume was intended to make it appear that Diana's press release had generated interest in the stock and had successfully discredited our report—to create the illusion that Asensio & Company had artificially depressed its stock and that it would now recover and rise. It was also to serve as a cover story that gave institutional buyers an excuse for their buying.

For whatever reason, Dawson Samberg Capital Management, Inc., a large, well-known, and highly respected institutional investor specializing in technology stocks, owned a shameful 7.8 percent of Diana. What was happening here? Based on the per-share price disclosed in the SEC filing, during the last eight minutes of that day, Dawson Samberg apparently purchased for its clients 35,000 shares of Diana at an average cost of $34.31.

Consider what this means. Dawson Samberg probably spent as much as $1.2 million of its investors' money in order to support a company whose lead product had that morning been debunked in exacting detail. Representatives of Dawson Samberg would have been seriously malfeasant to further invest substantial sums in the company without having read the report. If they saw the report and believed it, they should have sold the stock, or at least stopped to think a little: "Hmm, maybe we should wait a quarter or two. Why rush out and buy a stock on the very day that serious questions are being raised about it? If we really believe in this company, and we already own almost 8 percent, why rush in now?" Instead, knowing that Diana had neither denied the report nor offered any specific rebuttal for any single point made in it, Dawson Samberg bought more.

In this case, we thought Dawson Samberg's action went beyond simply being irresponsible. Arthur Samberg, the president of Dawson Samberg, had in fact purchased 20,000 Diana shares for his own private account months earlier in a negotiated transaction at a per share price of $20.50. Now, this is a supposedly shrewd guy. Why would a shrewd guy buy this stock?

Samberg held those shares on October 15. Although there are no laws or Exchange rules against such dealings, he faced an awkward conflict of interest, or at least the appearance of such a conflict. He had to decide whether to use investors' funds to buy and therefore help prop up the stock price or to exit before it collapsed completely. Who goes first?

Such maneuvers aren't just harmless little zero-sum games that cigar-chomping tycoons play to one-up other tycoons. These machinations have real victims. Small investors were drawn into the Diana promote as cannon fodder. To many of them and their brokers, Dawson Samberg's purchases were an endorsement of Diana. To them, Dawson Samberg's actions meant a hell of a lot more than the advice of some Cuban from a firm they'd never heard of. Followers left in this stock until the bitter end saw their investment shrink 99 percent. There are other victims, too: legitimate companies that honestly state their risks and potential. They shouldn't lose out on funding to the Dianas of their industries.

The Asensio & Company trading account held only $500,000 in net equity in October 1996. I didn't know about the heavy Dawson Samberg purchasing at the time. What I did know was that we were facing a potential killer: The short interest was so gargantuan that it was like rocket fuel. Short sellers forced to cover might end up tussling over shares like bargain shoppers elbowing each other over discounted Versace. In the short run, this could juice up the stock price into the stratosphere. And last time Diana ran up it had gone all the way to $120.

Although I had taken some profits that morning, I was still short a lot of shares.

We have to manage our risk. Back then, unbelievably, we paid our monthly operating expenses with our monthly trading profits.

We are also technically sensitive to price action and volume. Wall Street is not a place for martyrs. We don't sit on a stock and take losses. We believe the only right thing to do is to manage the risk, preserve our capital, continue the work, and come back again with a more profitable position. Winning the war doesn't require winning every battle.

I know this is not at all the way that short sellers are perceived. Because of the theoretically unlimited downside risk we take, we are considered buccaneers. And because of the aggressive, public brand of short selling we do at Asensio & Company, I know that we in particular are perceived as stubborn and combative.

I have seen too many short sellers, especially in the bull market of the late 1990s, stand firm in the face of mounting losses. We did not want to become another bull market casualty. Even if a company is ultimately doomed, a great promote and a tight rig can temporarily shoot its stock into the stratosphere. Short sellers who, like us, have limited amounts of capital and who refuse to cut their losses are often not there at the end for the collapse.

I stayed in the office very late on the night of October fifteenth wondering whom I had spoken to who had spoken to Diana. I tried to discover who had provided Diana with the letters that said I had solicited a negative report. That's not as hopeless as it sounds. Whenever you break an industry down to its lowest common denominator, you will always find a small group of people who know each other. That's an important concept when you're dealing with the sort of esoteric products we usually find at the center of a stock promote. Only so many people are truly informed on any abstruse technology, even fewer on the specific application being touted. If you dig deep enough, usually you will find someone knowledgeable who is willing to discuss it. That said, I wasn't able to trace the alleged letter, and to this day a copy has never surfaced. Either Fiedler fabricated the letter's very existence, or whoever had been coerced into concocting such a letter managed to save his or her own reputation in the end by suppressing its release.

The uncertainty that night was beyond frustrating. After all the work that went into Diana, after all the millions of dollars I had generated for our clients, our little trading fund faced a potentially crippling depletion of capital. Future campaigns—research and reporting on the many, many other frauds that were thriving in a raging, ravenous market—might have to be sidetracked by the more immediate need to generate operating capital.

What's worse, a terrible injustice would have been perpetrated. The bad guys were standing on the other side of the river, laughing, with their saddlebags full of loot. And as the stock rose higher and higher, the short sellers, despite being on the correct side of the Diana fraud, would have been squeezed out of the market, sending the stock ever higher and "justifying" the institutional support for this no-product company. October 16 would truly be a day of reckoning.

A little of my own background and the firm's early short-selling history might be helpful before I write about how things turned out for the mighty Diana team and its hagridden short sellers.