SEC action clips high-flying stock

Smart Online stock trading suspended

Smart Online, a small-business software company in Durham, is burning through cash. It expects to run out of money in April unless it raises new funding.

But that hasn't stopped the company's stock from soaring. At least, the stock was riding high until regulators stepped in.

Last week the Securities and Exchange Commission took the highly unusual step of suspending trading in the over-the-counter stock through Monday. The reason: The agency is investigating the possibility of stock manipulation.

The SEC won't say whether its probe is targeting manipulation by insiders or other investors with no ties to the company. But stock manipulation usually is the work of "scurrilous individuals" outside the company, said James Cox, a Duke University professor of securities law. One way of illegally manipulating a stock is known as "pump and dump." Schemers buy shares in a thinly traded stock to pump up the price, then sell at a profit, Cox said.

Nor is the SEC saying what time period it is investigating. Smart Online's shares have risen more than six-fold since its stock first began trading in April -- from $1.50 to $10 on Jan. 13, the last day shares were bought and sold before trading was halted.

At $10 per share, Smart Online's market value, or the total value of its outstanding stock, was $136.7 million.

Gerald Gross, assistant regional director in the SEC's Northeast regional office, declined to comment.

Smart Online officials didn't return calls seeking comment.

In a prepared statement, the company said it doesn't know "when the SEC will complete its investigation, the result of the investigation or its effect on the company. The company intends to fully cooperate with the SEC during its investigation so that the trading suspension is lifted as soon as possible."

Suspending a stock for 10 trading days, as the SEC has done with Smart Online, is "a remedy of almost last resort," Cox said.

In such cases, the SEC has concluded that information about a company circulating in the marketplace is so untrustworthy that it's unfair to allow investors to continue to buy and sell the stock.

Market manipulation usually involves over-the-counter stocks that are thinly traded, because relatively small stock purchases can have a major effect on supply and demand, Cox said. Last year, Smart Online's daily trading volume averaged about 15,000 shares.

Smart Online's Web-based software helps entrepreneurs start and expand small businesses. The latest version of its OneBiz bundles of software applications was launched in November. The 13-year-old company has more than 70 employees.

The SEC action has cast a shadow that will make it extremely difficult for Smart Online to raise the financing it needs until the issue is resolved, experts say.

"The risk would be through the roof," said Robert Bushman, an accounting professor at UNC-Chapel Hill's Kenan-Flagler Business School.

Smart Online projected in SEC filings that its working capital, which totaled $3.5 million as of Sept. 30, will only last through April. The company noted that "if substantial additional funding is not acquired or alternative sources developed, management will be required to curtail its operations.

"Management has plans which it believes will enable Smart Online to raise capital and generate greater cash flow from operations," the SEC filing states. "However, there can be no assurance that these efforts will be successful."

The company has racked up about $40 million in losses since it was founded in 1993.

Smart Online lost $3.3 million during the first nine months of last year, and generated $1 million in sales. By comparison, in the first nine months of 2004, the company lost $2.4 million on revenue of $723,118.