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To get a handle on the concept of naked short selling, one has to
know a little about the steps and players involved in the processing
of a buy order on the OTCBB and Pink Sheets.
Step 1: The purchaser either calls his broker on the phone or reaches
his brokerage firm on the Internet. Let's assume he decides to buy a
1% interest in a penny stock that has 100 million shares issued and
outstanding. The buy order is thus for 1 million shares. Let's assume
the buy order is "at market".
Step 2: The broker on the receiving end of the order then writes up
the buy order and places the order on his firm's "Trading desk".
Step 3: Assuming that the firm does not make a market in this
security, they will hand the order on to a market maker that does.
Step 4: This buying market maker will then either go to the selling
market maker showing the lowest offer or to a favorite market maker
of his and ask him to match the lowest offer. The trade is executed
between the buying and selling market makers at the agreed upon
lowest offering price.
Step 5: Assuming the buying and selling brokerage firms are small and
do not have the facilities to "clear" the trade, they then send the
details of the trade to their respective clearing firms.
Step 6: Since both clearing firms have both "cash" and "shares"
accounts at the DTCC, the buying clearing firm wires the purchase
price from their "cash" account to that of the selling clearing firm
in exchange for the selling clearing firm wiring the 1 million share
block from their "shares" account to the buying clearing firm's
"shares" account. This is called "Delivery versus payment". The
buying brokerage firm then sends out both a trade confirmation and a
monthly statement to their client, the buyer of the 1 million shares,
indicating that he does indeed "own" the 1 million shares, what he
thinks to be 1%, of that company. Thus the transaction is complete. A
"real" buyer paid "real" cash to a "real" seller for "real" shares.
An intermediary known as a market maker provided a mechanism to bring
the buyer and seller together. This basically is an over-simplified
explanation of the system used on these trading venues, the OTCBB and
the Pink Sheets. Selling market makers do not really have to have a
sell order in hand to sell securities. Their job is to provide
liquidity and to buffer the market from sharp peaks and deep troughs
when an imbalance of buy or sell orders appears.
The phenomenon of illegal naked short selling (INSS) is a form of
market manipulation/securities fraud that can be perpetrated at any
step in the process. A legitimate short sale involves the seller
following the letter and spirit of Rule 10(a)1, "The short sale
rule". It involves the selling firm making "affirmative determination
in writing" that the shares being sold are indeed "borrowable". It
also prohibits short sales on a downtick. The borrowed shares are
later returned. In illegal naked short selling, the shares were not
only not borrowed, but they never did exist in the first place. They
were created out of thin air. The legal term that describes this
fraud is that the perpetrators created an "Artifice to defraud" the
purchasers of the shares. Rule 10(b)-5 of the 1934 "Exchange Act"
addresses this behavior.
PREEXISTING CONDITIONS AMENABLE TO NAKED SHORT SELLING
In order for this fraud to be perpetrated on unsuspecting investors,
two main prerequisites exist. The first is the fact that purchasers
of shares on these trading venues do not request the registration and
home delivery of their shares. They see an entry on their monthly
brokerage statement and have no reason to question its validity.
The second prerequisite is the fact that brokerage firms do not
monitor for the "good delivery" of shares purchased by their clients
as mandated by "The Customer Protection Rule" or Rule 15 (c) 3-3.
With the presence of these two prerequisites as being the "norm" on
these trading venues, clever opportunists have realized that they can
sell nonexistent shares through Canadian margin accounts, in an
undetected fashion, and thereby assume a "naked" short position.
This followed by the subsequent selling of yet more nonexistent
shares tends to result in a precipitous drop in the share price, a
share rollback of the victim corporation and its disastrous loss of
market cap, or the outright bankruptcy of the victim corporation
which circumvents the need for the naked short position to be closed,
as it no longer trades. This lack of closure of the "sell then buy"
circuit allows the massive proceeds of this fraud to bypass the
taxman.
The typical naked short selling campaign or "bear raid" results in
the death of the victim company within a 6 to 9 month period. The
management teams and investors are often left scratching their heads
wondering what hit them.
A variety of other preexisting conditions are present on these
trading venues that allow this fraud to be perpetrated with little
chance of detection. One of these is the inherent inability of a
public corporation to communicate with its shareholders holding
shares in "Street Form".
The advent of the Internet has helped somewhat though. Statistics
show that 8 of 10 companies trading on these 2 trading venues, the
OTCBB and Pink Sheets, will die within their first three years of
existence. These thinly traded and under-capitalized companies are
often no more than "shell" companies whose existence was designed to
line the pockets of their creators. The level of chicanery on these
trading venues is distinct and the investment community knows about
it. When the Vancouver Stock Exchange drastically buckled down on
fraudulent behavior several years ago, the scamsters headed south of
the border to the OTCBB and Pink Sheets.
The above statistic of 8 of 10 failures combined with the knowledge
of the massive amounts of "pump and dump" programs in effect has
caused the investment community to collectively look upon these
companies as "future bankruptcies". This mindset leads to certain
behaviors among those opportunists that have visibility of buy orders
for these "future bankruptcies".
When a buy order for one of these presupposed "scams" lands then the
entire investment community has their antennae up and a certain
"feeding frenzy" occurs wherein the investment "professionals" fight
amongst themselves to be the one to naked short sell into this buy
order. Also these trading venues have very little supervision by the
regulators who are strapped for cash as well as manpower. There
really are no "cops on the beat".
The Pink Sheets, for example, are a privately run trading venue,
owned and operated by the National Quotation Bureau. Who needs
regulators though when you have naked short sellers determining which
corporations are "scams" and systematically annihilating them? The
markets themselves have no visibility whatsoever to investors, even
those with "Level 2" machines, and market makers pretty much can do
what they please. If a market-making firm is selling 50 million
shares per month of a certain victim company and buying only 2
million shares per month and has been doing this for several years,
then this would surely be nice to know.
The tremendous amount of money involved here attracts these
opportunists by the boatload. Investor naiveté is also a cornerstone.
Very few people, with the exception of the perpetrators of this
fraud, know how this game is played. The inherent confusion involved
with millions of trades settling at any given time creates a certain
cloud of dust that can obscure the perpetration of this fraud. There
is no "Day of reckoning" for these trades. The IOUs just fly around
in Cyberspace and never seem to land. It becomes incumbent on the
victim corporations to call a "Legal time out" to get a peak at these
IOUs. There is a certain psychology involved also that is inherent to
some naked short sellers. They think of themselves as self-appointed
sheriffs trying to rid the wild west of companies they diagnose as
scams.
If their diagnosis is incorrect then it usually doesn't make much of
a difference anyway because they will bankrupt both legitimate and
scam corporations. Bankrupting legitimate corporations is seen as
"collateral damage" which occurs in any war. Brokerage firms hosting
the accounts of "Offshore Corporations", especially those located in
the tax havens, do not follow the "Know Your Customer" rules. A
commission is a commission.
The "Patriot Act" is buckling down in this regard and brokerage firms
are to be on high alert for suspicious money flow activity. For those
in need of laundering the proceeds of illicit activity, naked short
selling provides a handy way to launder that 200% margin maintenance
requirement attached to naked short sale orders for especially penny
stocks.
Actually the crimes of naked short selling, wire fraud, money
laundering, and tax evasion go hand in hand on these venues. Another
key preexisting condition is that market makers are not forced to
make public their naked short positions on a monthly basis as they
must on the more senior exchanges. This is yet another example of the
lack of transparency on these trading venues. As far as the Pink
Sheets go, there are basically no demanding standards to match or
surpass in order to be granted membership.
Another contributing factor has to do with the fact that input into
the DTCC comes solely from the broker/dealers. Any picture that the
brokerage firms want to paint regarding the disposition of a
corporation's shares can be painted at will. The fox is guarding the
henhouse.
All of these factors combined form an environment within which this
fraud can be perpetrated with very little risk of detection. If the
laws were to drastically change tomorrow then these same fraudsters
would just tweak their modus operandi accordingly and not even miss a
beat.
THE MECHANICS OF NAKED SHORT SELLING
Referring back to the 6 steps involved in a "model buy order", one
can see the myriad of ways available to naked short sell into this
purchase order. The first individual with a shot at this opportunity
is the broker who gets the phone call from his client, the purchaser.
There are two main modalities used to naked short sell at this level.
We've seen where the broker himself can naked short sell into the buy
order by picking up the phone and placing a matching sell order,
usually through his own non-U.S. margin account, into the market at
an opportune time.
The more common technique used at this level is the broker picking up
the phone and telling an associate of his about the "opportunity"
that has just landed on his desktop. The broker is used as a "scout"
and is usually paid back for these favors by the brokerage business
coming his way from those he is scouting for. Manipulations at this
"Step 1" level are relatively rare but do occur especially when the
broker receiving the call works in a Canadian Brokerage Firm where
the naked short selling rules are more lax.
Step 2 level manipulations are fairly common and they involve the
broker receiving the phone call writing up this buy order and setting
it on his firm's "trading desk". The trader processing this buy order
has 3 main mechanisms to utilize in order to avail either himself or
a colleague of his to this wonderful opportunity to naked short sell
into this buy order for shares of this "future bankruptcy".
The first modality involves the trader picking up the phone to his
personal broker at a Canadian firm and having him feed in a naked
short sell order for a matching amount of shares at an opportune
time. He can also naked short sell into the order right at his
trading desk, a process called "desking", which places the naked
short position into a "proprietary account" of his own firm. This
practice is almost universally done to all international buy orders.
"Desking" is very commonplace. A third option would be to act as a
"scout" for colleagues that would like to avail themselves of this
wonderful opportunity and give them a "heads up" to the fact that a
buy order is about to enter the system.
Step 3 involves a heretofore unmanipulated buy order being sent to a
buying market maker from the trading desk of the firm receiving the
buy order. There is an intrinsic reality in this relationship between
the market maker and its client, the buying brokerage firm, that is
critical to understand. The buying market makers need the order flow
from the buying brokerage firms. It is their lifeblood.
When presented with a buy order, the buying market maker often has to
naked short sell into the order just to keep his client brokerage
firm happy with his services. The buying brokerage firm wants rapid
execution of the buy order in order to get their hands on the
commission. Since the stock of these companies is usually very thinly
traded, oftentimes there are no sellers around to satisfy the demand
for shares. The market maker is expected by his client to "perform",
which means to continuously naked short sell into buy orders
presented by that client.
It is incredibly common for even the most ethical of market makers,
due to this pressure to keep their clients happy, to run up immense
naked short positions just in the course of their business. Their job
is to provide liquidity to these illiquid markets. Where the crimes
are often committed at this Step 3 level is in how the market maker
handles this predicament he has gotten himself into. On the other
hand, there are certain market makers that blindly naked short sell
into each buy order on these trading venues that crosses their desk.
Market makers have literally dozens of ways to cause harm to these
corporations that they "accidentally" ran up an immense naked short
position against. These vary from continuing to naked short sell into
every buy order that appears, effectively neutralizing these buy
orders, to contacting naked short selling consortia to lend them a
hand in killing the company. There is an endless list of market
manipulative techniques to employ.
These Step 3 manipulations are the single biggest component of the
overall naked short selling campaigns. Market makers are incredibly
powerful in these campaigns in that they are legally allowed to naked
short sell "while acting in the capacity of a bona fide market
maker". Not only this but they don't have to reveal the size of their
naked short positions to anybody. The "Short Sale Rule", Rule 10 (a)-
1, does not apply to the OTCBB and Pink Sheets. Step 3 manipulations
involving these buying market makers are collectively known as "The
Wall". Very few buy orders make it over this wall and find a "real"
seller.
Step 4 manipulations presuppose that the buying market maker behaved
himself and went into the market and filled that buy order by
approaching the market maker with the lowest offer price or a
different market maker that was willing to match that lowest offer.
The "Semi-ethical" buying market makers are in need of a quick
"print". They want to run the order and grab a quick "markup". They
know only too well which brokerage firms and other market makers to
approach in order to get the buy order quickly naked shorted to them.
Many of these public corporations' shares are "Piggy-back Qualified",
this allows any firm to put on a "Market maker hat" and legally naked
short sell without having to file a Form 15(c)2-11.
The same games are played with these selling market makers, but the
height of the wall is a little less. Ethical selling market makers
may or may not have a "real" sell order in hand. Oftentimes they will
naked short sell into a buy order and then go on the bid to attempt
to level out this now naked short position. If they accidentally dug
themselves into a hole while servicing clients then they may sit on
the offer all day and naked short sell into every buy order that
appears. The lack of visibility that these markets provide to
investors allows extremely manipulative techniques to go undetected.
Step 5 presupposes that both the buying and selling broker/dealers
are not self-clearing. The clearing firms are in a unique position to
orchestrate these manipulations behind the backs of
their client brokerage firms.
Step 6 manipulations occur in and around the DTCC. The back office
policies at the DTCC have long been ascribed the role as the problem
here. Activities at the "Lending Pool", both of the Canadian
Depositary Service and the DTCC also provide opportunities to both
add yet another layer of manipulations as well as cover up earlier
manipulations. All of the input into the DTCC is, of course, from the
brokerage community. When attempting to drain this "lending pool" of
its contents, careful attention must be paid to those shares held in
Canadian Brokerage Firms because the level of chicanery here is
alleged to be extremely high.
One can now get an appreciation for the nearly limitless
opportunities available to attack one of these corporations during a
"bear raid". A very small percentage of buy orders actually meet up
with a "real" seller selling "real" shares. There is just too much
money to be made taking on naked short positions and then killing
companies. From a risk/reward point of view the chance of detection
is infinitesimally low and the rewards are abundant.
The ability to sell nonexistent shares in an undetected manner
provides for a self-fulfilling prophecy of sorts. The victim
companies find it necessary to finance their "burn rate" at
artificially low levels, which leads to massive dilution. If the
company were fortunate enough to actually have earnings at some
point, they would be diluted so badly that it wouldn't even matter.
Of all of the varieties of securities fraud in existence, and there
are many, naked short selling campaigns are usually thought of as the
"manipulation of choice" providing the most favorable risk/reward
ratio.
Since the "model buy order" that executed all 6 steps results in an
exchange at the DTCC of cash for shares between the buying and
selling firms, any "short circuiting" at any step would prevent this
exchange from happening. In order to exchange cash for shares you
need shares! There aren't any when it comes to naked short selling.
There never were any. The purchaser paid hard-earned cash for "air".
That monthly statement is a lie. His brokerage firm never did receive
"good delivery" of a share certificate, there never was one. In fact,
in the case of a Step 1 or 2 manipulation, the broker/dealer first
damaged the company by artificially diluting it, and then he sold
this damaged bill of goods to his client.
One might ask, "Well then where is the buyer's money?" The buyer's
money is in the hands of his own brokerage firm. The same people he
just paid a commission to and that have a fiduciary responsibility to
him. Since there was no "good delivery" of shares made to the buying
brokerage firm in exchange for payment, ("Delivery versus payment"),
the check never left the coffers of the buying brokerage firm. There
never was a "real" seller into whose pocket the cash should have
gone. In Wall Street parlance, the buying brokerage firm has a
"Failure to receive" on their books. All of the intermediate
brokerage firms have both a "failure to deliver" and a "failure to
receive" on their books except for the manipulating party itself, he
would just have a "Failure to Deliver" on his books. The IOUs just
travel through cyberspace and never get addressed.
Everybody owes everybody else and as long as nobody puts their foot
down and demands delivery then this will be the status quo. So why
don't all of those firms with all of these "Failures" on their books
rectify matters and level up their positions. "The Customer
Protection Rule" (Rule 15 © 3-3), clearly states that the buying
brokerage firm is mandated by law to go into the open market and buy-
in that "Failure to deliver" within 10 business days of settlement.
But in the case of a Step 1 or 2 manipulation, it is the buying
brokerage firm itself that is the crook. How can you buy yourself in?
The sobering reality is that all of the brokerage firms in their
various roles in this buy transaction will make a ton of money if
NOBODY forces anybody to deliver. That would wreck this whole
wonderful low risk/high reward game, and nobody wants to do that.
The question now becomes, "What is that entry in my monthly statement
all about if there never were any shares purchased?" We refer to
these entries as "BEEs" or "Bogus Electronic Entries". Their purpose
is to give the buyer a certain comfort level so that he never
suspects any fraud. It also serves to cover up the fact that the
buyer's money is actually in the coffers of his own brokerage firm,
and being lent out or invested by them. The investor who bought
nonexistent shares from his brokerage firm or whomever, was the
victim of a "Double Whammy". Not only did he not get the 1% ownership
that he thought he was buying, he actually got a much lesser
percentage of a company that he might not even recognize, one that
perhaps he would have never bought the shares of if he had known the
truth.
This company might have 100 million "real" shares issued and
outstanding according to its Transfer Agent, but it may also have 500
million bogus electronic entries in existence. The bad news here is
that all 600 million "shares" of this company can be sold tomorrow.
An interesting phenomenon occurs when this investor holding the bogus
electronic entry decides to sell his shares. After all his broker
can't hardly tell him that he can't sell his "Bogus Electronic Entry"
because we failed to get "Good Delivery" as mandated by law. When you
want to sell, your broker is going to sell this "Bogus Electronic
Entry" or "air" to some unsuspecting investor, who in no way shape or
form can ever get "Good Delivery".
The seller had no idea that he bought and sold nonexistent shares,
and this process will go on and on and on. As long as nobody suspects
anything and those monthly statements keep coming, then this little
secret will never be revealed. The stock itself will trade like a big
overweight whale, and buy orders of a significant size will not nudge
the price one iota because of all of those "extra" shares that can be
sold at any time. Should bad news be released a market massacre might
ensue.
Typically the financiers of the company will fatigue and stop cutting
checks, deeming that any more checks cut may be good money after bad.
They will assume that all of that selling must be coming from
somewhere and the only people that own that much stock is management,
so this whole thing must have been some kind of a "Pump and dump"
from the get go. Then it will be time to turn out the lights and
nobody will ever know the reality of what was going on.
The transaction that this investor took part in actually created out
of thin air a new million shares of stock. These shares can be bought
and sold at will. They will never be detected by anybody as being
fake, because of the lack of a "Day of reckoning". The company in
question will show 100 million shares being owned at the DTCC by
various firms if everybody leaves them in "Street Form".
If you, however, stack up all of the monthly statements of all of the
shareholders for a given date, and add them up, you will come to the
total of 600 million "shares" being "owned", not 100 million. The
absolute size of naked short positions actually have a tendency to
increase in an almost geometric fashion because the larger the naked
short position, the larger the potential losses to the naked short
sellers should something go awry. This increases the incentive level
to kill this corporation. Long-lived "Bear raids" are very scary to
naked short sellers and demand special "weapons and tactics".
The brokerage firms that perpetrate this fraud cover it up by
breaking yet more laws. By law the purchase confirmation mailed to
the buyer of the "shares" was to indicate to the buyer the capacity
within which his broker acted. Typically the brokerage firm will act
as an "agent/broker" and charge a commission.
In Step 1 and 2 naked short selling, however, the brokerage firm
actually acted as a "principal/dealer" and actually charged what is
known as a "markup". If the brokerage firm were to indicate this
capacity under which it actually acted, then the investor might
question what this "principal/dealer" business is all about. Since
the brokerage firm does not want the investor to know that they naked
short sold him this "air" and that they were sitting on his money,
they will just lie on the confirmation slip as to the capacity in
which they acted.
The question is often asked as to when the "day of reckoning" occurs
wherein these bogus entries must be made good upon. The law lists
three different "days of reckoning". The "Customer Protection Rule",
Rule 15(c)3-3, mandates that the "Failure to receive" certificated
shares that were purchased in a transaction, are to be "bought in" by
the purchasing brokerage firm on the 10th business day past the
settlement date (T plus 3). The law also states that the selling firm
in this transaction is to buy-in their client doing the selling if he
hasn't produced the certificate within 30 days of settlement.
The law further mandates that brokerage firms buy-in failures to
receive and deliver within 45 days of filing quarterly reports that
noted these "Fails". With the absence of Rule 10 (a)-1, "The Short
Sale Rule", having any application to the OTCBB and Pink Sheets, the
Customer Protection Rule is the only line of defense left against
this fraud but it is ignored almost 100% of the time. There is just
too much money to be made while ignoring it to turn down.
Investors becoming educated as to the nature of naked short selling
and demanding the registration and home delivery of their shares has
to be the cornerstone of the effort to end the perpetration of this
fraud.
Since all 6 steps need to be completed in the "Model buy order" in
order to match up a "real" buyer with a "real" seller, all of these
manipulations at the various steps along the way result in the
creation of new shares which exist in the form of a "bogus electronic
entry". These cause massive dilution of a corporation's share
capital, which has a depressant effect on the share price.
Since all financings of these corporations are tied to these
artificially depressed prices, the dilution problem is further
exacerbated. All corporations have to cover their monthly "burn rate"
just to keep the lights on. This accelerated dilution rate is a
constant source of discontent with shareholders. They not only see
the price per share evaporating, but their percentage ownership of
the corporation is also dwindling due to the artificially high
dilution levels.
The resultant loss in shareholder morale throws yet more fuel on the
fire of this company's problems. Again there is a bit of a geometric
progression in the company's problems as opposed to a more linear
arithmetic progression. Due to the inherent nature of this animal
called naked short selling, the playing field becomes so tipped in
favor of the racketeers that one wonders how any corporation could
survive.
SELL SIDE NAKED SHORT SELLING
The same games can be played in the absence of a buy order from the
sell side of the equation. Sophisticated naked short sellers
typically work out of offshore corporations located in tax havens
around the world. Banking secrecy laws in these havens help to
prevent detection of the identity of the actual perpetrator of the
fraud. If one is going to break 20 or 30 securities laws then one
might as well do it in an anonymous fashion.
The modus operandi usually has an offshore corporation "A" setting up
a margin account in a non-U.S.brokerage firm. This corporation "A"
will have one shareholder and one director namely Corporation "B"
from a different tax haven with different banking secrecy laws.
Corporation "B" in turn will have one director and one shareholder
being Corporation "C" in yet another tax haven.
For the victim company to attempt to identify Corporation "C"'s owner
would now cost a fortune and take a great deal of time. These victim
companies have neither. During this past February, non-U.S.regulators
discovered the existence of 13,00 of these offshore corporate
accounts amongst non-U.S.broker/dealers. Corporation "A" will now
start selling massive amounts of the victim company's stock.
Corporation "A" will often be set up as a "Hedge Fund".
The non-U.S.Brokerage Firm taking the sell order knows darn well that
this offshore corporation doesn't own any shares, but they can always
play dumb later on should something go awry. Besides there's some big
commission money to be made. The non-U.S.Brokerage Firm will
typically insist on a 150% to 200% margin maintenance requirement.
The naked short selling of penny stocks is inherently dangerous and
the broker/dealer needs to be protected. It is extremely easy to
"Scuttle" an offshore corporation should the plan backfire and the
non-U.S.firm knows this.
As far as the role of the non-U.S.Broker/dealer utilizing the lax non-
U.S. laws regarding naked short selling, they have three main
incentives to break the law and take the order. The first is the
commissions generated. The second is the use of all of that money
placed for margin maintenance requirements, and the third is the
visibility of large sell orders providing opportunities for "front
running".
One technique the non-U.S.Brokerage Firms utilize is known as the
"Hot Potato" technique. Firms are often allowed to keep a naked short
position on the books for only a 10-day period after which fines may
be levied. After 9 days a firm carrying a large naked short position
can hand that position off to a "Buddy" brokerage firm like a hot
potato. After another 9 days it may go to a 3rd firm or back to the
original firm. If it gets too burdensome then it's off to a friendly
hedge fund for long term "storage".
Non-U.S.OFFSHORE ACCOUNTS
Who are the typical holders of these non-U.S.margin accounts used for
perpetrating this fraud? Offshore hedge funds are the most powerful
of these groups. Hedge funds with less than 100 participants do not
need to follow the rules and regulations dictated by The Investment
Company Act of 1940. This provides both anonymity and lack of
liability for the participants. Hedge funds typically contain the
money of deep-pocketed players not averse to risk. Large market
making firms as well as other Wall Street entities own significant
positions in these hedge funds and can count on them when caught in a
pinch. Hedge funds account for a very large percent of this naked
short selling activity. The Senate Finance Committee is currently
investigating the relationship between hedge funds and naked short
selling.
Various naked short selling consortia are in existence around the
world. They pride themselves on their due diligence capacities and
they really are very impressive in that regard, but not infallible,
which leads to significant opportunities when they do make errors.
Some of these groups have their own websites and aid their disciples
on the choice of non-U.S. Brokerage Firm to set up a relationship
with. Usually a firm with a Head Compliance Officer that is willing
to turn his head the other way a lot. These groups will typically
have their head "guru" with good investigative connections as well as
"street smarts".
Recently we've seen a lot of activity out of Europe. Shares of OTCBB
and Pink Sheet stocks actually "trade" on subdivisions of various
markets over there, totally unbeknownst to management. Not
unexpectedly 99% of the trades are "sells".
One aspect of this business that has recently been revealed is how
these various naked short selling groups communicate and collude with
each other. If one group is having a tough time killing a company and
their intent is becoming very obvious, then they will hand the baton
on to their co-conspirators to help polish off the corporation. This
is a very scary thought. These people are incredibly deep-pocketed in
the first place.
"PILING ON/FRONT RUNNING/TRADE PADDING"
An interesting phenomenon often occurs when the non-U.S.broker/dealer
first gets visibility of a large sell order. Let's assume that it is
a 20-million share sell order of nonexistent stock "at market" to be
executed in two weeks time. The typical source of a sell order like
this might be a market maker with a hedge fund connection that
"accidentally" got into a large naked short position while servicing
a valued client.
Knowing that this sell order is going to severely depress the victim
company's share price, the non-U.S.broker/dealer will often put in
their own sell order of maybe 10 million shares and process it before
processing the 20 million share sell order. The offshore corporation
can't exactly point an accusing finger should they detect the front
running since they are breaking the law themselves. Now the non-
U.S.broker will hand a 30-million share sell order to a market maker.
When the market maker sees this now gigantic sell order they will
often front run this 30 million share sell order with a 10 million
share sell order of their own making. They know all too well what a
30 million share sell order will do to one of these thinly traded
securities. Thus a sell order of 20 million nonexistent shares has
now grown to 40 million nonexistent shares.
This elucidates the "Self fulfilling prophecy" aspect of naked short
selling. Unsuspecting shareholders will pay "real" money for all 40
million of those shares and not suspect any hanky-panky at all. How
could a monthly statement from one of these prestigious Wall Street
firms be telling a lie?
Thus naked short selling can work from left to right through the
various steps involved in the processing of a buy order, in essence
"neutralizing" the up ticking effect on share prices caused by buy
orders, or from right to left with the introduction of massive sell
orders of nonexistent shares.
DEATH SPIRAL FINANCINGS/TOXIC FINANCINGS/FLOORLESS CONVERTIBLES
A close cousin of naked short selling involves a form of predatory
financing called "Death Spirals". Companies in dire need of
financings are often forced, by necessity, to trust that financiers
will not pre-sell their equity financings in an effort to clobber the
market and then convert for a very large number of shares at
artificially low prices. These financings are based on fixed dollar
amounts of conversions and not a fixed number of shares. A riskier
form of death spirals involves potential financiers dumping tons of
shares before even cutting a deal for a financing. Conventional death
spirals are actually a form of "temporarily naked short selling"
because the shares are forthcoming but usually restricted by Rule
144.
RECENT DEVELOPMENTS WITHIN THIS "INDUSTRY WITHIN AN INDUSTRY"
Within the past two years the world of naked short selling has been
changed forever. Four separate events have rocked the world of the
naked short sellers. Since the secrecy of the modus operandi is so
important to these people, the headlines caused by these Four events
is not welcome at all by the perpetrators.
The first event was the arrest of Anthony Elgindy and the exposure of
his methodologies of naked short selling utilizing the services of
two allegedly corrupt FBI agents. Elgindy and his huge following have
allegedly been one of the pillars in the naked short selling
community.
The second event was the sudden bankruptcy of the non-U.S. Brokerage
Firm which has been the alleged "headquarters" for naked short
selling worldwide.
The third event was the arrest of the CEO of this firm for attempting
to naked short sell $30 million worth of three companies' shares to
an undercover FBI agent. The fourth event was Operation Uptick,
revealing the incestuous linages between organized crime and
reputable brokerages in the U.S. The "Winds of Change" do seem to be
blowing a bit, and it wouldn't take much of a breeze to knock down
this "House of cards" the naked short sellers have built.
The significance of these events is not just getting these
individuals and institutions out of commission. The real importance
is the education that the public needs to receive in regards to naked
short selling as these trials and bankruptcies go forward. Again the
secrecy factor is the key to naked short selling. If the investing
public knew what was going on behind the scenes on the OTCBB and Pink
Sheets, then the uproar caused could mushroom into a total lack of
confidence in this system, which is already on its knees after the
Enron and Anderson debacles. If this knowledge did become
commonplace, then at least one of the main two prerequisites, that of
not registering and demanding delivery of shares, might be
eradicated.
Several non-U.S.Brokerage Firms were recently sued by clients for not
delivering the share certificates that he had demanded the delivery
of. He had obviously been naked shorted the shares by both firms. In
their statement of defense, the attorneys for the firms claimed that
it was the actual client of theirs doing the naked short selling that
owed the share certificate to the client/buyer and not the firm. The
Customer Protection Rule would obviously beg to differ. This is a
typical example of the mentality of the non-U.S.Brokerage Firms.
The non-U.S.Regulators have "lowered the boom" on the behemoth BMO
Nesbitt in regards to "Serious Know your client deficiencies" and
"Failure to supervise brokers". Many of those 13,000 "offshore
corporate" accounts have tens or even hundreds of millions of dollars
playing the naked short side of the market. A broker managing these
accounts is supposed to look into the sources of these funds to rule
out any illicit activity like money laundering.
In the U.S. the Patriot Act demands that brokers scrutinize these
funds and file "SAR"s (Suspicious Activity Reports") when illicit
behavior is suggested. This was implemented mainly as an anti-
terrorist funding measure, but hopefully will spill over into keeping
in check naked short selling. The dynamics of bringing to the
public's attention this insidious disease of naked short selling, has
never been more exciting than at the present. The public is being
immersed in learning the mechanisms of action of the Elgindys, the
Valentines, the Thomson Kernaghans, these 13,000 offshore corporate
accounts, money laundering, tax evasion aspects, etc.
LONG TERM SURVIVORS
An important aspect of these naked short selling wars is the length
of time that the victim company has been under attack. When these
naked short selling "gurus that can smell a scam from 40 miles away"
guess right and beat up a scam company, the company doesn't have a
chance because of the vicious nature of naked short selling. The lack
of assets of the company will be exposed and announced from the
mountaintops.
What are interesting are the battles that ensue when these "gurus"
misdiagnose a "real" company with "real" assets as a scam. The naked
short sellers will still be able to knock the market cap down by 99%,
but often it becomes tough to "Kill" the company. Investors that know
that the company has the goods can sit back and buy shares at a tiny
fraction of book value and thereby average down their previous
purchases. Since the size of the naked short position is of a
cumulative nature, increasing with the age of the battle, a point is
reached wherein the naked short sellers cannot afford to cover this
massive naked short position without driving the share price to the
moon. This is when the games get really dirty because hundreds of
millions of dollars are now up for grabs, winner take all.
THE DAMAGES
One has to wonder how many young micro cap corporations with great
promise have been snuffed out while in this incubator of the OTCBB
and Pink Sheets. Have we missed out on any potential cures for cancer
or high tech breakthroughs? What happened to the dreams of all of
those entrepreneurs who put every penny they had into their private
companies in preparation for going public, and then getting massacred
once public?
RECORD KEEPING AT THE DTCC
For an annual fee of $1,850, a corporation can receive from the DTCC
a weekly update as to the number of shares that each of the brokerage
firms on Wall Street have for a given corporation in their "Shares"
account. Keep in mind they all have "cash" accounts also. The problem
with these lists are two-fold. They only reflect the number of shares
for which "Good Delivery" was attained. They also don't address
whether or not that brokerage firm owes any shares to a common "pool"
of shares there available to any broker/dealer in need of quick
shares. If for example the weekly DTCC Summary states that a broker/
dealer has 1 million shares of a given corporation's stock in their
account, this must be compared to the sum of all shares being
reflected as owned in the monthly statements of that firm as mailed
out to their client/shareholders. Let's assume this total is 4
million shares. The difference between these two figures can be
characterized in several ways. The difference represents: 1) The
naked short position of that firm, 2) The number of shares bought by
that firm for which "Good delivery" did not occur, 3) The number of
"Bogus electronic entries" that firm has on its books and that gets
mailed out every month.
Wall Street can camouflage very well the number of shares represented
by the sum of all shares being reflected as owned in monthly
statements. An indication of this number can be attained by a
corporation receiving its "NOBO" list or list of non-objecting
beneficial owners. To this number must be added the number of shares
owned by "OBO"s or objecting beneficial owners. When a person signs
up for a brokerage account he is asked to check a box denoting
whether or not the company in which he owns shares of has the right
to know of his shareholdings. If he does not object to this, then he
is a "NOBO". The "NOBO" lists are available from ADP Brokerage
Services Group at 1-888-237-1900.
When a person adds the total shares held of a given corporation at
the DTCC to the number of shares held by "Registered" shareholders in
safe deposit boxes, the sum will equal the issued and outstanding
number of shares of that corporation exactly. So at first glance, all
seems to be in order until you realize that the DTCC list only
represents "Good deliveries" which on these trading venues is the
exception and not the rule. And so the fraud is perpetrated on and on
and on.
In regards to the "Pool" of shares held at the DTCC that is available
in the case of an emergency, this was allowed by Addendum C- (1) of
the NSCC's (National Securities Clearing Corp.) rules and regs. They
were taken over by the DTC several years ago, the amalgamation of
which formed the DTCC. The Lending Departments of a firm monitor
things here and are one of the biggest profit centers in any firm.
From a practical point of view, until this pool is 100% empty of
shares, don't expect any upward pressure on share prices due to the
borrowing ability provided by the pool. Once it is empty, however,
each further demand for the registration and delivery of shares
should theoretically cause a forced buy-in of shares under a
"Guaranteed Delivery" basis.
It is relatively easy to empty out the "pool" at the DTCC. If a
company has 70 million shares at the DTCC and a naked short position
of 500 million shares, then all the company has to do is create a
situation that withdraws 70 of 570 million shares available to be
withdrawn. As was stated earlier, all of the brokerage firms
represented along the chain of events of one buy order are HIGHLY
incentivised not to demand the correction of those "Failures to
receive and deliver". In order for this to occur, the shareholder and
the issuer must be educated as to how this game is played
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