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Zombie Stocks Can Lure Casual Investors Into Danger

By Michael S. Rosenwald
Washington Post Staff Writer
Sunday, September 27, 2009

To prove how astonishingly easy it is to make a dimwitted investing move, I logged into my online brokerage account the other day and bought stock. I have made dumb buys before -- who hasn't? -- but this time I was practically betting on a horse that could no longer gallop.

It's not like I didn't know a lot about this company, a common investing sin. Actually, I do. I have been reading about this company for months. I studied its history in college. Like millions of other Americans, I once even owned one of its products.

I invested in General Motors. Well, not the new General Motors I keep hearing about in TV commercials -- rather, what's left of the bankrupt GM, now known as Motors Liquidation Company. Ticker: MTLQQ. Buying a share in Motors Liquidation took fewer steps than ordering a book from Amazon.com. I paid 75 cents.

A few clicks and my experiment made me the rather unproud owner of a zombie stock -- so known because its shares are almost certainly headed to zero due to bankruptcy proceedings or insolvency. Once bankruptcy is complete, zombie shares almost always vanish, meaning the right price on them is zero. Any bet on them at a higher price would be better spent searching for ghosts.

"What people really need to understand with these stocks is that they are speculating, they are not investing," said John Gannon, senior vice president for investor education at the Financial Industry Regulatory Authority, also known as FINRA. "They are simply taking a bet." Asked which was a bigger bet -- a zombie stock or the lottery -- Gannon said, "With the lottery you know the odds."

Last year's death knell for Wall Street and the ensuing deep recession have left a dangerous pack of zombies lurking on Wall Street. Motors Liquidation shares have traded as high as $1.15 since July. Lehman Brothers, whose bankruptcy a year ago helped throw the economy into a tailspin, has traded between 3 and 33 cents. Washington Mutual, the largest bank failure in U.S. history, is trading for 26 cents. Speculation in troubled insurer AIG, not bankrupt but largely owned by the government, has sent its shares over $40. Yes, $40. Fannie Mae shares are also still popular.

Who is trading them? It is hard to tell, but experts say a lot of the movement is probably from day traders or hedge funds hoping to make money on small, quick swings in a stock, often with the unwitting help of everyday investors who either don't realize what they are doing or are making bets that they are smarter than the market pros (or bankruptcy law).

An investor like me who buys shares of Motors Liquidation for 75 cents can actually help set a price that professional traders use to make a lot of money -- not to mention online brokers raking in steep commissions. But the reality is "these stocks are dead or almost dead," said Ravi Shukla, a professor of finance in the Whitman School of Management at Syracuse University.

Securities and Exchange Commission officials have become increasingly concerned about trading in bankrupt stocks, saying it is "a very dangerous game for retail investors to get into." Currently, the agency can only stop shares from trading if the company violates securities laws. But SEC officials said last week they are looking at ways to end such haunting trading altogether, examining whether they have the authority to halt or ban trading in bankrupt firms. If they don't, they could ask Congress for help.

The officials acknowledge such moves are extraordinary but say they could be necessary.

"The chairman has questioned whether there is any benefit to trading in zombie stocks and has directed the staff to conduct a thorough review of existing rules to determine whether added investor-protection measures are needed," SEC spokesman John Nester said.

Meanwhile, agency officials said they are stepping up monitoring of brokers to make sure proper information on these bankrupt firms is being communicated to investors. My broker, Charles Schwab, has a link on its Web site to an SEC alert about Motors Liquidation and other bankrupt companies. The alert "reminds investors that holding shares of any company involved in bankruptcy, or buying shares in a bankrupt company in the hope that those shares will surge in value down the road, are highly risky courses of action."

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