A LEGENDary Ploy

edit: The Anderer injunction discussed in this post has been denied as of September 22, 2014, as suspected.

Over many years of observing the methods by which suspect companies artificially control their stock price, we’ve seen many tricks employed.   Today we will examine one of those timeless tactics and see how it might have been applied in the case of Sphere 3D. It goes like this:

(1) Target certain industry-related companies for acquisition – growing your Company and increasing the number of promotional press releases you can distribute.

(2) Pay for the acquisition using some cash and your own restricted shares.

(3) Fail to lift the restrictions on those shares on an as-promised and timely basis, preventing their owners from profiting from the sale while maintaining a tight grip on your share float.

We’ve seen this play out time and again. And now we may be seeing it with Sphere 3D (S3D). They sourced V3 Systems and paid for the acquisition in part using their own restricted shares (1,089,867 of them). They agreed that the shares would be free trading in four months. Then when the four months passed, S3D management refused to allow the restriction to be lifted.   And in a closely related strategy, S3D also failed to qualify the units issued in their June private placement, in spite of the “intends to file a short-form prospectus”, as declared in the press release. In essence, these tactics allowed the company to keep as many shares as possible out of the market, thereby making it easier to keep the shares floating at a lofty price for as long as possible.

Thanks to a series of recently filed court documents, we now know much more about the distressed V3 Systems that S3D purchased, and know that the liquidators of V3 are making every attempt to sell their S3D shares and distribute the proceeds to a long list of V3 debtors.   The company is essentially bankrupt with the only remaining asset being the S3D shares.   We believe they could have begun selling on September 23, being the expiry of the six month hold period as prescribed by US Rule 144, but it’s unclear if S3D has any further tricks up its sleeve to further delay the sale of those shares. Certainly time is running out. Read on for more details, as we piece together the story based on information gleaned from recently filed court documents.

When Sphere 3D bought the assets of V3 Systems on February 11th, the deal was heralded by the Company as a transformative acquisition adding “breadth to our (S3D’s) product portfolio, and fast tracks our transition to commercial operations with accretive revenue from day one.” Now we won’t argue with whether V3 Systems was all those things to S3D, but the fact is that V3 Systems at the time of its asset sale was a very troubled company.

As detailed in recent statements (Lindstrom StatementKesselring statement, Shields Statement), by the fall of 2013 V3 Systems was in desperate shape. It had unpaid bills and payroll stretching back over a year, raised preferred share (superior to any common shares) capital on two separate occasions worth more than $5mm, and as of September 2013 was on the verge of being forced into bankruptcy by its former CFO, Catherine Voutaz. She sought repayment of bridge loans in the amount of $1.9mm! (Lindstrom Statement, Page 5)

The president of V3, Eric Lindstrom, was in a quandary. How could he keep the Company from being forced into bankruptcy? The business had failed, revenues and profits were nowhere to be found and employees were leaving on account of not being paid. He and V3 found their savior in S3D. After a lengthy negotiation process, during which time S3D actually “began fulfilling orders for V3 products…as a result of V3’s…lack of funding” (ANY F4 July 23 2014, Page 51) S3D agreed to acquire all of V3 Systems assets for $4,000,000 cash, 1,089,867 shares, and an earn out provision based on revenue.

Following closing the $4mm in cash (actually only $3.2mm due to an $800k loan from Sphere 3D prior to closing) was immediately distributed to “as many creditors as possible.” The only assets owned by V3 Systems (since renamed to U.D. Dissolution Corp, but we will continue to refer to it as V3) were the 1.1mm shares of S3D received in partial consideration for its asset sale, and the possibility of earn-out payments.

Given V3 had nothing else in the Company and no operations, it began a dissolution process. William Kesselring, a consultant who had helped negotiate the sale of V3 to S3D, was appointed manager of the dissolution. On August 5, 2014 he transmitted a letter (Kesselring statement, Exhibit A) to the shareholders of V3 outlining his work and among other things, listing the current liabilities of the Company. A screenshot of this section of the letter is reproduced below:

Kesselring Letter excerpt

Kesselring’s plan, as outlined in the letter, was to begin liquidating its 1.1mm S3D shares, which he believed had become free trading on July 23, four months after the asset sale. V3 had already “…opened a securities account with a brokerage firm which is capable of selling the stock in a rational manner to maximize its value and to avoid depressing the price. Sales should be under way by the second week in August.”

But soon after this letter was sent, one of Sphere 3D’s directors and lawyer, Jason Meretsky (also a director of the ignominious Biosign Technologies), threw a wrench into V3’s best laid plans. According to a statement by one of V3 Systems’ lawyers, Jeffrey Shields (Shields Statement, Page 4), S3D refused to allow the legend on their share certificate to be lifted following expiration of the four month hold period. The objection “was made by Jason Meretsky, through an email to the transfer agent dated July 31, 2014.” This came as a shock to V3 Systems as they understood the selling restriction was to last only four months. We don’t think this was an unreasonable position given that S3D itself gave four months as the hold period in the press release announcing the acquisition.

Shields’ statement continued: “While V3 takes issue with S3D’s motives and good faith in making the objection, nevertheless the legend has not been lifted and V3 has not sold any of its shares and cannot do so until the legend is lifted, probably after the US restricted period.” Essentially, V3 was under the impression (based on their agreement) that S3D would allow V3 to take advantage of the Regulation S/Rule 904 exemption allowing them to sell restricted securities after four months as opposed to six months as prescribed by US Rule 144. But, knowing of V3 Systems’ dire financial situation, S3D knew that it was in no position to take legal action. As it were, S3D seems to have promised V3 liquidity by July 23 and taken that away at the last minute. Tough break guys.

Regardless, the six month hold period ended on September 23rd. One final roadblock was raised by Michael Anderer, a former business partner of the V3 Systems’ founders. He has been suing V3 and its directors for over a year claiming monies owed. The court filings (Anderer Ammended Complaint ) associated with this proceeding have provided much of the background for this post: all the gory details of V3’s failure as a business, its distressed sale to S3D and subsequent manoeuvrings have been found in its pages. Most recently, Anderer filed a request for a temporary restraining order against V3 Systems (TRO Request) – preventing its management from proceeding with the plan to sell V3’s remaining asset: S3D shares.  We don’t believe this injunction has been successful. But even if it is, it appears that this will only delay the inevitable (distressed) selling of S3D shares.

So here we are: V3 Systems, a company in liquidation, with millions of dollars in unpaid bills, is about to begin selling its only assets: S3D shares. S3D management has delayed this moment for as long as they could but their time appears to be up.

Along with the 1.2mm shares issued in S3D’s last bought deal that will become free-trading on October 6th (which should have been unrestricted several months ago had management filed their paperwork correctly) there may be a great deal of stock hitting the market. Current shareholders may want to take note of this dynamic, or at the very least peruse some of Anderer documents (a full listing is available here). A quick glance at Sphere’s website shows how important the V3 acquisition has been to their business – understanding its history is in our opinion, critical due diligence. And finally, shareholders should ask themselves: why did S3D management go to such lengths on two separate occasions to maintain selling restrictions on its own stock?