Investor blamed for stock's losses

DURHAM - On Sept. 5, a small Durham lighting company with a handful of employees, annual revenue in the six figures and a share price that was less than a penny made an announcement: It was suing its major investor.

Just another day in the litigious world of penny stocks?

Not quite.

The suit by Cyberlux against the N.I.R. Group, which is affiliated with hedge funds on Long Island, is the latest in a string of legal salvos between microscopic, over-the-counter companies and the manager of N.I.R, a New York University MBA graduate in his mid-30s named Corey Ribotsky.

At issue is financing known as a "floating convertible" - or, in the vernacular of skeptics, a "death-spiral convertible." It's a specialized form of convertible bond in which holders are eligible to convert their bonds to more and more shares of discounted stock as a company's stock price drops further and further.

Cyberlux's suit accuses N.I.R. of converting shares that gave it far more than the 5 percent beneficial ownership limit set in an agreement between the two companies. It also says N.I.R. shorted Cyberlux stock in violation of that agreement.

Shares of Cyberlux dipped from 29 cents in November 2004, when N.I.R.'s transactions began, to three-tenths of a cent in mid-August 2007.

N.I.R., for its part, has filed a motion to dismiss Cyberlux's claim and a countersuit to recover notes that Cyberlux has refused to issue.

"For over 10 years, N.I.R. has made sound investments in quality, emerging companies and in the process delivered significant returns to our investors," Ribotsky said in a statement sent to Triangle Business Journal. "We are committed to defending our good name and that of our investors and are confident that the lawsuit we filed will vindicate our position."

Ribotsky did not respond to requests for further comment. Cyberlux officials and their lawyer, a former U.S. Securities and Exchange Commission attorney named Ernest Badway who has represented multiple companies in lawsuits against N.I.R., likewise declined to comment.

Top convertibles issuer

A public records search turns up more than a dozen cases against Ribotsky or affiliated firms. They include claims from the florist for Ribotsky's wedding as well as a former business partner who successfully sued after Ribotsky allegedly stole his marketing firm.

The bulk of the cases, however, involve micro-cap companies that say N.I.R. Group put them under.

Robert Kyle, vice president of San Diego firm Sagient Research, says Ribotsky's hedge fund is one of the top issuers of floating convertibles in the country, issuing more than 10 percent of the $377 million in such deals made last year nationwide. Sagient research reveals that an N.I.R. Group investment, on average, is followed by a 54 percent decline in stock value in the year after a deal.

But that's not necessarily because of anything a hedge fund does, Kyle says. Nearly all of the companies that issue floating convertibles do so out of desperation, meaning their underlying business usually isn't strong enough to boost a stock. The securities do dilute shareholders' earnings, he says, but getting shares of discounted stock is the only way hedge funds will agree to invest in micro-cap companies.

"It's tough for these small companies to find traditional financing, and there are just not investors who are willing to take a risk on a company with no product that's on the market," Kyle says.

Not that some executives haven't tried. Take David L. Smith, the former chief executive of a Rocky Mount company called Roanoke Technology that sued Ribotsky after N.I.R. invested. In 2006, Smith settled claims made by the SEC that he illegally issued stock to consultants who then kicked back $4 million to him. He's now barred from serving as a director or executive of a public company.

Better revenue forecast

Regulators have been doing their fair share of sniffing around both the hedge fund managers who invest in micro-caps and the people who run the companies. They've filed suit in more than a dozen cases in recent years, including a high-profile 2006 case in which New York hedge fund manager Jeffrey Thorp and three funds he managed settled and agreed to pay $15.8 million in fines.

As of March, according to hedge fund newsletter Absolute Return, N.I.R. Group had about $700 million under management in its micro-cap stock fund and another $3 billion under management in a new collateralized debt obligation fund. The company also has started a real estate fund and opened an office in Charlotte.

Cyberlux, meanwhile, had a market cap of $16.7 million as of Sept. 27. It posted second quarter revenue of $173,893, though the company says it expects revenue of $3.7 million for the fiscal year selling products such as its EverOn battery-operated light and its BrightEye "stadium lighting" system. Its stock is up 10-fold since its mid-August nadir.