Naked shorting: Stung by the German connection By: Peter Koh Published on: Monday, March 28, 2005 Thousands of US stocks are being traded on a little-known Berlin exchange, without the knowledge of many of the companies involved. Have the naked short sellers exported their practice overseas? Order A YEAR AGO Ted Noble, chief financial officer at Advanced ID Corporation, a Calgary-based microchip-tracking company, received some surprising news. "We were congratulated by a third party who saw that our shares were trading on the Berlin Stock Exchange," he recalls. "That came as news to us because we'd not done anything to get listed in Germany. I talked to a few people and we couldn't figure out whether it was good or bad." Noble soon found out when his company's shares started behaving oddly on the US OTC bulletin board. "April 29 [2004] was a slow day, and only about 10,000 of our shares had traded. Then 370,000 shares traded in the last 20 minutes before the close. It knocked our stock price down from 58 cents to 41 cents, before closing nearly 20% down at 48 cents. That was very unusual for our stock. I'd never seen anything like it." Noble was not the only interested party shocked by what had happened. "We had a number of very angry shareholders calling us, wanting to know what was going on. But there hadn't been any negative news about the company, so we couldn't explain it." Noble went in search of more information. "I looked back at days with irregular trading activity and the pattern was always the same. Just before the end of the day, someone would come in and batter our stock down. There was a big short going on and we just suspected that Berlin might have something to do with it. We acted quickly to delist and the problem just went away after that." Advanced ID Corporation is hardly an isolated case. Over the past 10 months, over 250 US-listed micro-cap companies have stopped their shares from trading on the Berlin Stock Exchange's Freiverkehr (unofficial) market because they fear that trading overseas is being exploited to circumvent US naked shorting restrictions. Many more are scrambling to do the same but they might not be so lucky. On the threshold Wireless Age Communications, a Toronto-based high-tech telecommunications equipment manufacturer listed on the US OTC bulletin board, is the latest. On March 10 2005, the company announced that it had hired lawyers to try to halt trading of its shares on the Berlin Stock Exchange and to prevent the trading of its shares on any international exchange, after the company found itself on the Nasdaq Threshold Securities List, indicating that the company had been naked shorted. A month before, on February 16, Greg Manning Auctions, a New Jersey-based auction house, filed a complaint with the National Association of Securities Dealers (NASD) regarding possible manipulation of the company's share price through naked short selling. Greg Manning also announced that it was seeking to halt trading of its shares in Berlin. In its statement, CEO, president and first vice-chairman, Greg Manning said: "We believe this listing is part of an effort by certain individuals or firms to circumvent NASD and SEC restrictions against short selling." US companies fear that exemptions for international arbitrage trades in the SEC's Regulation SHO, which came into effect this January, and the fact that foreign brokers are not subject to US delivery requirements, makes it possible for traders to get away with naked short selling in the US. Hard evidence that this is happening is dificult to come by but anecdotal evidence abounds. Companies are astounded that their permission was never sought before their shares began trading in Berlin. But under German rules, their permission is not necessary. Any stock traded on any recognized exchange in the world can be traded in Germany, provided that certain minimum criteria are met. All that is needed for a company's shares to begin trading is for a broker to nominate it. The broker then buys the shares from the home market, quotes them in euros and trades them in Germany. Officially, the idea behind the system is to make it more affordable for German investors to trade foreign stocks, by avoiding the very high costs associated with cross-border clearing and settlement. In total 5,275 US securities trade on the Berlin Stock Exchange. Some market experts in Germany, however, see the Freiverkehr system as one primarily designed to prop up the regional exchanges by giving them something to trade. Although many companies have managed to stop their shares from trading on the Freiverkehr over the past year, this came down to the good will of the German brokers and the exchange. There is no legal argument available to these companies to order a cessation of trading. In fact it might not even be possible once shares in a company are owned by German investors. "There is really no way of 'delisting' from the Freiverkehr," says Oliver Kessler, a partner at international law firm Lovells in Frankfurt. "The only thing a company can do to try to achieve a 'delisting' is to fail to meet the preconditions for inclusion, which it may be able to do by failing to provide any information requested of them by the exchange." Suspicious nominations Many companies are suspicious about why about 1,000 OTC bulletin board companies were nominated for trading in Germany shortly after a long-running problem with Canadian brokers had been resolved and the NASD extended its Rule 3370 to include non-member broker dealers in April 2004. German brokers however, have legitimate reasons for applying to trade overseas stocks in large numbers. "We have a lot of competition here," says Holger Timm, CEO of Berliner Freiverkehr, one of the major brokers on the Berlin exchange. "The different stock exchanges are in competition with each other as are all the market-makers. Bulletin board companies are more interesting for us because we get better margins. We trade big caps too but don't make as much money on these." Timm thinks the US companies have been jumping to the wrong conclusions. "The whole story that trading in Germany is damaging the share prices of these companies is complete nonsense," he says. "We have been doing this for 20 years. It cannot hurt these companies if German investors want to buy their shares." However, Timm says that after news began to surface of US companies' concerns about being naked shorted through Freiverkehr trading, he received a telephone call from a man claiming to represent hedge funds interested in doing just that. "An individual claiming to be a consultant for some hedge funds asked me how to do it [naked short selling]. I said there was no way, but he insisted that there must be and that he wanted to know the secret." Freiverkehr brokers cannot lend stock but as market makers, can short sell, so long as their books are covered within two days. If there is not enough liquidity in Germany to complete a trade, the German market-maker would go to a market-maker in the US to get it done. According to brokers, naked short selling is not possible in Germany because of the strict settlement requirements. Although every trade is automatically reported directly to the federal regulator BaFin, experts on the German securities market describe regulation of the Freiverkehr as "insignificant". Many rules simply do not apply. While an ordinance was recently introduced to cover market manipulation, the rules are very broad and enforcement experience is lacking. Retail investors that buy on the Freiverkehr via their brokers tend to stick to foreign blue chips. The companies that have complained, however, are all micro-caps worth less than $50 million. They are predominantly early stage biotech, defence technology and internet companies. "What could be happening is that market manipulators in the US are so short on some of their positions that they are trying to cover some of their naked short positions overseas," says Rich Kaiser, CEO of Yes International, an investor relations consultancy that has helped 15 US companies to get their shares off the Freiverkehr. "The Berlin Stock Exchange is probably being used as a conduit but the scheme works by exploiting flaws in the US trading system, particularly at the DTCC [see main story]. If they trade on overseas exchanges through offshore accounts, the trades take longer to settle and become harder to trace." The SEC and the NASD visited Germany in June last year to meet with the Berlin Stock Exchange, the state regulator and BaFin. Though the SEC refuses to confirm the visit, the Berlin Stock Exchange confirmed the parties met to investigate the naked short selling claims. In a statement issued last year Jörg Walter, managing director of Berlin-Bremen Stock Exchange, said: "We checked all OTC bulletin board stocks and focused on stocks of companies which had complained about illegal short selling activities on Berlin-Bremen Stock Exchange. We came to the conclusion that in none of these cases was there an indication that short selling actually took place on our exchange. In some cases stock prices went up due to a majority of buy orders. In some other cases our investigations revealed that stocks were either not yet introduced to trading on our exchange or that there was no trading activity at all during the relevant period although the companies had explicitly blamed trading on the Berlin-Bremen Stock Exchange for falling stock prices." After returning from Germany in July 2004 however, the NASD took the unusual step of reminding its members of the extension to Rule 3370 and the guidelines governing the international arbitrage exemption, which came into effect just three months before. Complaints from US companies keep emerging. "It looks to me like it's a good way for lawyers in the US to make money," says Thomas Posovatz, speaker of the management board at MWB Wertpapierhandelshaus, a Freiverkehr broker. Department of Commerce and secret service representatives at the US embassy in Berlin are now also believed to be investigating the situation. The US embassy in Berlin declined to comment when contacted.
TOO MANY HERE are NOVICES and those that are ultra specialized bully pulpits, pied pipers have only obfuscations, excuses; deflections etc etc...... no atonement let alone social consciousness for their actions. let alone admit their limitations.
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