OT: Maybe their job is done
or they have positioned for the next leg up.
Special report
Dirty tricks in U.S. otcbb stocks
SEC Regulation S allows US public companies to sell
shares of their stock very
quickly. The rule was originally intended to help
growing companies to raise money
without time consuming and costly regulatory
interference. Unfortunately, Reg S has
instead been used as one of the most common conduits
for securities fraud. Reg S
shares are typically sold at a significant discount to
the current market price because
they can only be sold overseas to non-US individuals
and investment entities. The
other major catch is that they can not be resold into
the US market for a specified
period, usually 45 days from the date of closing. The
idea is that the company can raise
money quickly with a minimum of regulatory
requirements and the newly issued stock
does not flood the market. Unfortunately in practice,
this has often not been the case.
Some of the buyers of Reg S shares have actually been
Americans hiding behind
ownership in offshore investment companies. The
biggest problem with Reg S shares,
however, have been violations of the required hold
period. Because the Reg S shares
are sold at a discount to the current market price,
there is a huge temptation for the
buyer to quickly resell the stock into the open market
to capture and pocket the
difference. This is difficult to do since the
certificates are restricted. What is often done
instead is the stock certificate is deposited in a
foreign brokerage account (often
Canadian) and then a like amount of shares are sold
short. This immediately "locks in"
the full amount of the difference between the discount
sale and the current market
price, minus commissions and margin interest. When the
required hold period is up, the
now unrestricted certificate is turned over to the
transfer agent and the short position is
eliminated. Technically, this is not "naked shorting"
but "covered shorting" because the
seller owns the same amount of shares it has sold
short. It has the same overall effect
on the stock, though, especially since the stock is
sold so quickly and without the
requirement of public filings current shareholders
usually know nothing about it. The
SEC recognizes that Reg S abuse has been a huge
problem. They have begun to take
steps to clean up the Reg S market.
The convertible securities that are such a problem for
OTCBB companies are often
called "death ride" or "death spiral" convertibles.
Normal convertibles give the holder
the right to convert the first security (either a
stock or a bond) into another type of
security (usually common stock) at a given price
(i.e., since the price is fixed, the total
number of shares underlying the convertible instrument
is a known quantity. Death
Ride's, however, are not convertible at a given price
per share but instead at the
number of shares required to meet the face value of
the convertible instrument. For
instance, if the convertible is preferred stock worth
$1000 and the common stock is
worth $1, then the convertible is worth 1000 common
shares. However, if the common
stock subsequently declines to 50 cents, then the
preferred is now convertible into
2000 shares. What some buyers of the death rides do is
to play them like they do Reg
S shares. They deposit the convertible shares into a
brokerage account and then short
sell a like amount of the common stock. The short
selling activity helps drive the
common share price lower, which means the convertible
is worth a higher amount of
common shares. The additional common share equivalent
is then sold short, driving the
share price even lower. This almost never-ending cycle
is why these instruments are
called "death spirals". Since the short sellers own
the convertibles, this is also
considered by many to be covered shorting and not
naked. If the issuer of the
convertibles is on the Federal Reserve list of
marginable securities, then the owner can
conduct their shorting with a U.S. brokerage. If the
issuer is traded on the OTCBB, then
they will often use a Canadian brokerage because, in
certain situations, they do allow
shorting OTCBB securities.
Most individual investors cannot -legally- short
bulletin board stocks in the US.
There are several reasons why, but for this discussion
I think it is enough to say it
really is not done. If anyone doesn't know why, ask
your broker or drop me a line and I
will explain it further. Although individual investors
cannot short these stocks, market
makers can. Market makers can go short on any stock as
long as it is related to ""bona
fide market making activity" (Rule 3350). Naturally,
the key is the term "bona fide". The
NASD manual clearly states that market makers should
not go short a security simply
for speculative purposes. However, there are several
market makers widely known to
do almost nothing but short stocks for their own
account. NASD rules make it extremely
easy for a market maker to begin making a market in
any stock very quickly, so these
particular MM's often show up suddenly in many hot,
high-flying OTC stocks. When
they do, it is a pretty good indication that they
stock price will soon be under pressure
and it is a good time to take a hike. Besides the fact
that market makers are
professionals and some do a efficient job identifying
overpriced stocks, they also have
very deep pockets. Considering the average OTCBB stock
has a tiny market
capitalization, it doesn't take much to help nudge a
stock one way or the other.
Finally, we come to the last form of shorting, the
so-called "naked" shorting. Yes, it
does occur in OTCBB stocks. Yes, Canadian exchanges do
allow for shorting of
OTCBB shares. However, the actual amount of shorting
in these shares by individuals
is probably a lot less than most people think. For
some reason, every time an OTCBB
stock goes down it seems someone starts screaming
"naked shorts". The facts are that
although Canadian securities regulations do allow
OTCBB and other low priced shares
to be both marginable and shortable, the amount of
collateral required is large. For
instance, to short an OTCBB stock selling for under 50
cents per share, Vancouver
Stock Exchange rules require the account must have
credit equal to the market value of
the shorted stock plus 50 cents per share. Can an
American short OTC BB shares this
way? This is where it gets sticky - US regulations say
no. This is almost certainly one
of several areas in which the ongoing SEC
investigation of Canadian brokerage firms is
focusing upon. More on this later.
Just about every stock promoter likes to trot out the
"naked shorting" excuse when
the stock they are hyping is falling. With 20/20
hindsight (and some help from
regulators' legal briefs) we can often see that these
same stock were declining not
because of "naked shorting" but because insiders,
control persons as well as the
promoters themselves were dumping huge blocks of stock
into the open market. Thus,
they were using the "naked shorting" excuse to cover
their tracks and perhaps entice
gullible investors into buying more of the stock,
which is likely the promoter's own
shares. Often, this selling and shorting is being done
through Canadian brokerages.
AI
