Short-selling penny stocks can prove a far from simple move.
By FLOYD NORRIS
Published: March 23, 1995
WHEN most people describe short-selling, they usually refer to shares that are borrowed and then sold. If the life and death of Hanover Sterling, a penny stock firm, proves anything, it is that things are not that simple.
Hanover's collapse last month, after it tried and failed to support the price of shares it had underwritten, has shed light on some of today's more extreme Wild West tactics of stock trading. And it raises questions about whether market rules of the National Association of Securities Dealers are simply ignored by many traders.
The penny stock battlefield is far removed from the more genteel world of established stocks and companies. Want to buy Ford or I.B.M.? Fine. Want to bet against them, by borrowing shares to sell short? That is also fine. No one will stop you from doing either, and eventually the market will determine which strategy was better.
But in penny stocks, promoters often go to great lengths to prevent short-selling. Shares of companies are kept within the network of the underwriters' customers. If they are made available for borrowing at all, the loan can be quickly canceled, leading to what is called a "buy-in," in which the short-seller is ordered to come up with stock immediately. If he can't get the stock, the buyer in the original trade buys it from someone else -- or from himself -- and forces the short-seller to pay the price.
If shares are impossible to borrow, one might think that would mean short-sellers would just look elsewhere rather than "go naked," or short without borrowing. It is not so simple. Some traders simply lie and say they are selling stock they own. Some use foreign accounts, asserting such accounts are not covered by some American rules. And there are brokerage firms that take advantage of a Nasdaq regulation that allows a market-maker -- a broker who makes a market in the stock -- to short without actually borrowing shares.
That exemption was supposed to cover a market-maker who, responding to customer demand, buys or sells shares in response to customer orders. But some of the more aggressive firms go far beyond that. Most firms that do so won't talk about it for attribution. An exception is Steve Carlson of Denver's Aspen Capital Group, who freely admits to having sold large quantities of shares he did not own to Hanover. He also contends he deserves praise. "Our activities in the stocks prevented them from ripping off the public even more," he said, arguing that the securities were overvalued.
That is not the way that Edwin Mishkin sees it. Mr. Mishkin, a partner in the New York law firm of Cleary, Gottleib, Steen & Hamilton, is the trustee appointed by the Securities Industry Protection Corporation to clean up the mess left when Hanover went under and took with it the firm that cleared its trades, Adler Coleman. Mr. Mishkin conducted a buy-in of short-sellers on Monday and brought in about $15 million, making the shorts pay the prices that prevailed before Hanover failed.
Mr. Mishkin said he was "hopeful that the hundreds of Adler Coleman employees who had lost their jobs as a result of what appeared to be naked short-selling by others, and the many creditors of the Adler Coleman estate, would now have a meaningful opportunity to recover at least some of their losses."
In the final weeks of Hanover's existence, the firm bought wave after wave of shorted stocks. It bitterly complained to regulators, futilely seeking a trading halt. Meanwhile, shorts complained that Hanover must have used up its capital to buy all those shares, and asked regulators to investigate. That investigation closed down the firm.
Now, in the wake of the collapse, all the shares available for public trading in several companies appear to be held by the trustee and by Hanover customers. The trustee is not selling, and the Hanover customer accounts are frozen, with the customers unable to buy or sell securities. Yet hundreds of thousands of shares are reported to have traded every day.
It appears that few, if any, of those shares can be delivered to settle the trades. But no one seems to be concerned about that. Nasdaq officials have declined repeated requests for interviews regarding the Hanover situation, both before and after the firm collapsed. But they don't appear to have done much.
