“In death spiral finance a lender typically agrees to loan a publicly-traded company some amount of cash. In exchange the lender takes a convertible debenture with typically a reasonable interest rate.” 

The money, however, “doesn’t come without a catch: the lender can convert his/her debenture at any time into shares of common stock. In typical fashion, such an offer will come without a predetermined number of shares but instead with a share conversion rate that is a moving target which is always less than the prevailing market rate. That way, when the investor  [unscrupulous lender] sells the shares –  will always profit, even on the downside.”

Whether or not the investor decides to short the stock has significant consequences on the company’s stock value.  From a legal point of view, short selling frequently leads to the  investors indirectly acquiring five percent or more of the target company. By short selling and causing the dilution of the company’s stock, the investors can gain control of the company, similarly to the control held by issuers or significant investors.

In a famous case in 2003, Thomas Newkirk, then the Associate Director of the SEC’s Division of Enforcement, stated the following in relation to toxicity of “death spiral” finance:

“Certain convertible securities, particularly those referred to as ‘toxic’ or ‘death spiral’ convertibles, present the temptation for persons holding the convertible securities to engage in manipulative short selling of the issuer’s stock in order to receive more shares at the time of conversion.”