CMKM Diamonds Inc. (fka CMKX)

[jetfish]

Outcry grows over naked short sales
STARTUPS' POTENTIAL STIFLED, CRITICS SAY
By Will Shanley
Denver Post Staff Writer
Article Last Updated:10/14/2006 02:52:59 PM MDT

http://www.denverpost.com/business/ci_4494028

Traders work on the floor of the New York Stock Exchange on May 17, 2006 in New York City. (Getty / Spencer Platt)Acting on a stock tip three years ago, Carol Pederson made what turned out to be one of the costliest investments of her life.

It began as Pederson watched words appear on her computer screen at her Arvada home office. Investors, writing via an Internet chat room, were touting a mining company called CMKM Diamonds Inc.

The Las Vegas-based company, the investors claimed, owned mineral rights to more than a million acres of diamond-rich land in Saskatchewan, Canada. Intrigued, Pederson bought shares worth $15,000.

The decision began Pederson's involvement in a saga that includes lawsuits, huge financial losses and allegations of fraud on Wall Street and inaction by federal regulators.

CMKM, Pederson said, became the target of naked short sellers, who bet that a company's stock price will fall. The traders pledge to borrow shares, then sell them and later buy them back at a lower price, pocketing the difference.

Unlike traditional short sellers, such "naked" traders don't actually borrow the shares or deliver them to buyers, and the unfulfilled orders can hang over a company for months, dragging down the stock price.

Naked short selling, say a growing number of companies nationwide, including some in Colorado, is a scourge that snuffs out startup companies before they can fulfill their promise.

Securities and Exchange Commission Chairman Christopher Cox, during a July speech, called naked short selling a "serious problem" that can "drive down a company's stock price to the detriment of all of its investors."

Added Pederson of her soured investment in CMKM: "We believe it is the biggest naked short sell in history. There were so many bashers, the company never had a chance," Pederson said.

But others question whether some companies, including CMKM, use naked short selling as an excuse for mismanagement or even fraud.

Targeted firms lose value

Two Denver-based companies, Vyta Corp. and Metretek Technologies, have complained about naked short selling. Vyta, in particular, says its stock price declined after it was targeted by such traders.

Meanwhile, dozens of public companies, investors and financial experts are pushing the SEC to tighten loopholes that they say allow hedge funds and stock brokers to profit from naked short selling at the expense of American companies and investors.

The practice is not illegal as long as it is not part of a concerted effort to manipulate share prices. It is regulated by the SEC, which is considering enacting additional regulations, such as requiring shorter settlement deadlines on these kinds of transactions and mandating greater transparency for hedge funds.

Some Wall Street investment banks, which are lobbying against the proposed changes, say additional regulations would disrupt the market and make short sells more difficult to execute. They also argue that naked short selling affects only a small swath of companies.

Critics of the tactic, however, contend the problem is widespread and threatens the integrity of the U.S. financial markets.

"The system is rigged," said Patrick Byrne, chairman and chief executive of Over stock.com, the Salt Lake City-based online retailer. "I've gone from golden boy to public enemy No. 1 for trying to expose this."

Far-reaching effects

Byrne's company, with $827 million in annual revenue, has since January 2005 been on a stock exchange-generated list that identifies companies possibly targeted by naked short sellers. Since then, the company's share price has dropped from above $55 to about $18.

Byrne, 43, one of the most high-profile critics of naked short selling, said brokerage firms sometimes short-sell more shares than have even been issued. He said if the SEC changed its policy and required investors to suddenly cover their short positions - meaning investors had to purchase the shares to replace the ones that they had shorted - it could possibly cause "hedge funds to blow up and banks to blow up."

While Byrne acknowledges that is the worst possible outcome, other financial experts are concerned.

Naked short selling affects "significant numbers of stocks and, in many cases, harm(s) their markets," wrote Robert Shapiro, an economist and former economic adviser to Bill Clinton, in a Sept. 14 letter to the SEC.

Shapiro added that the current setup "provides a means for stock manipulation and other criminal activities."

Yet some companies claiming to be hurt by naked short sellers have other problems and are perhaps using short sellers as an excuse to cloak their own mismanagement or fraud, experts say. Some company executives even naked short-sell shares of their own firms as new investors buy in, a twist on the classic pump-and-dump scheme, they say.

"You have two separate types of companies" that talk about naked short selling, said Mark Faulk, an Oklahoma City-based author preparing to release a book later this year about CMKM. "This company, by my estimation, is not a good poster child for the problems associated with naked short selling."

CMKM Diamonds, which legally issued 700 billion shares when it held its initial public offering in 2003, had its shares revoked in 2005 after it failed to file financial reports with the SEC.

The company, Faulk said, used unusual promotional tactics to create an "obsessed" legion of investors. The company plastered its stock ticker on billboards and on the side of a race car and even handed out free shares.

Faulk estimates that investors lost $250 million or more and that at least three government agencies are investigating it. He said it's unclear whether CMKM knowingly defrauded investors; the company owned mineral rights to some land in Canada that initial tests showed could contain diamonds, he said. Attempts to contact CMKM officials were unsuccessful.

Pederson, the Arvada investor, said she has become spooked by the effect naked short selling can have on publicly traded companies.

"I wouldn't put my money in Wall Street until there are changes," said Pederson, a small-business owner who provides cost estimates for floor coverings at commercial buildings. "This is bigger than anyone realizes."

Staff writer Will Shanley can be reached at 303-954-1260 or [e-mail]