Some gambling on stock in bankrupt firms

Even though the companies are in bankruptcy and mere shells of their former selves, shares of Circuit City Stores Inc., Chesapeake Corp. and LandAmerica Financial Group Inc. are still trading.

Shares of these firms are no longer listed on the New York Stock Exchange. Instead, the stocks trade over the counter and for pennies per share.

Yesterday, for instance, more than 550,000 shares of Circuit City traded, even though the company is liquidating and closed its last stores in March. The stock price closed at 0.0191 cents, up 6.1 percent from 0.018 cents.

The Securities and Exchange Commission cautions against buying stock in companies that are in bankruptcy.

The reason is that common shareholders typically are at the bottom of the list when it comes to paying back debt. And often plans of reorganization cancel the value of shares that existed before the bankruptcy filing.

"It is extremely risky and is likely to lead to financial loss," the federal agency wrote in a primer about bankruptcies.

But still it happens.

So why trade?

"Usually it's hedge funds and day traders who will pick up shares and try to flip them for a couple of pennies," said James A. Cox III, managing partner of Harris Financial Group in Colonial Heights. "It's always your very speculative player."

Money can be made; for instance, if someone buys shares at 2 cents and sells them for 3 cents, he or she has made 50 percent on the deal, he said.

Smaller trading volumes of companies in bankruptcy could be attributed to people unloading shares to take the tax loss, Cox said.

Another reason could be short selling.

Short-sellers essentially borrow shares from brokerage accounts and then sell them at a high price with the hope that they can buy them back at a lower price. When the shares are returned to the original account, the short-seller pockets the difference.

Consider it essentially a short-term bet that a company will lose value.

Most financial advisers wouldn't recommend that individuals buy shares of companies in bankruptcy.

"It's not very prudent investing," said William T. Saunders, director of wealth management services at the Henrico County firm Equity Concepts LLC.

The danger comes when the stock price rises and the short-seller has to pay back the shares, he said.

If the short-seller borrowed shares at $30 per share and it goes up to $50 per share, that adds an additional $20 loss.

"It's very complicated," Saunders said. "We don't have any clients that we're shorting stocks for."

More than 342 million shares of General Motors Corp. were traded Monday, the day the company filed for bankruptcy and its shares were delisted from the New York Stock Exchange. Part of the reason for the high volume of shares traded could be a result of short selling, Saunders said.

Contact Emily C. Dooley at (804) 649-6016 or .