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  • peristentone peristentone Aug 6, 2011 3:49 PM Flag

    Redemption Terms for Preferred Shares

    I could not disagree more. If you loan me money, it is in bad faith for me to ask for a provision in the loan document that says if I get in financial trouble then the loan is reduced to 1/8th its original value. The fact that your lawyers were better than mine and I had a chance to read the fine print, doesn't make the provision good faith.

    You say it was very obvious, but in one month of discussions here I never heard this dilution clause mentioned a single time, and many thread recommended buying Preferred A and B shares. It was obvious to a lawyer, or to any smaller investor like me motivated enough to read the original prospectus. But obviously there was a very wide audience of retail investors who would and will invest in these financial death traps and think they are something they are not.

    The fact is preferred shares are more like *debt* than like common shares. Most retail investors in preferreds work under a set of assumptions that they will be paid in full before common shares get anything, and they treat preferreds as lowest ranked debt in the credit hierarchy. And 99% of the time that is exactly what it is.

    You are right without the $2 trick the preferreds would massively dilute the common shares. SO WHAT? Common shareholders always understand that if the company collapses and debt converts to common that they will be effectively wiped out. It has been so in 99.99% of all bankruptcies for the last 100 years. GM is a very notable exception. I have been an investor in at least four preferreds in which the company collapsed the preferreds were converted to common as part of a workout. And the common were diluted to almost nothing as a result. That's just the way it is supposed to work.