I am a private investor/trader and I am writing in response to concerns that I have regarding short selling abuses I have witnessed in the OTCBB marketplace.
Introduction
It appears that the SEC has deliberately, either through inaction or clever manipulation of the SEC's rule structure as suggested over the years by Brokerage's attorneys, created a two tier system of stock market exchanges in the US. One system for the national market exchanges that has short selling protections for the investor with pockets deep enough to afford the several dollar and up prices for stock, and a second system of exchanges for the "poor" investor, those investors who have determined they can only afford stocks trading at less than 10 cents, and who has not been afforded the same short selling protections deemed necessary solutions to the stock market crash of 1929, namely the 1934 SEC act.
This has created a system whereby the "rich" investor is protected from short selling abuses, while the "poor" investor is cheated by short selling abuses (bear raids) that are allowed by self regulation of the Market Makers. Most poor investors have been drilled by educators on the stock market crash of 1929 in grade school, and truly believe that the protections enacted in 1934 exist for them too, when in reality a double or multiple standard has been deliberately contrived.
Is the SEC is implicated in a scheme to defraud OTCBB investors of their hard earned dollars?
The SEC has allowed the structure of securities laws to favor big money interests and "manipulation of the little guy" over and above the interests and concern of the vast majority of the investing American public. The current SEC rule structure has parallels similar to the character "The Sheriff Nottingham" where the poor are robbed to pay for the rich. America is not supposed to be this way!
Discussion
Bid and Ask Volume and how it relates to Technical Analysis of a Stock
It has become painfully obvious that big money Market Makers have a stranglehold on the little guy in the OTCBB stock market. I have personally observed many times more than a 1:2 (bid:ask) volume ratio of the trades executing at the bid versus the ask, only to be followed by the bid and ask ticking down in stocks that I own. A discussion of the technical mechanics of an OTCBB investor's reality is in order here.
A comprehensive study of OTCBB time and sales reports with actual buys and sells listed proves that certain market participants sell at the ask, and buy at the bid. These reports were for about a year available to anyone requesting them free of charge from https://www.otcbb.com/secure_asp/tradeact_report_request.asp?type=tands, however, recently a pricing structure was devised that makes these reports much too expensive for many investors. Nevertheless, these reports, when combined with other data that report the time and price level of the inside bid and ask, do establish that some market participants are able to buy at bid and sell at ask.
Why is this noteworthy?
Because a common technical method of measuring accumulation/distribution of a stock is to measure the volume of trades at the bid (selling), and compare it to the volume of trades at the ask (buying), and to note the ratio of the two. Theoretically speaking a ratio of 1:1 should represent an equilibrium level where price neither goes up or down, since it shows that buying and selling activity are roughly equal. If there is more trading volume at the ask than at the bid, then price should go up, and conversely if there is more trading volume at the bid, then price should go down.
But in the OTCBB world, it's common knowledge that a ratio of about 1:2.5 or 1:3 (volume at bid to volume at ask) is required to move the price up, and this up move is often delayed by days and sometimes weeks. On the other hand, for prices to move down requires only fractionally less than 1:3. Prices commonly drop when the ratio is 1:2 or less.
Why is the ratio so much greater the theoretical 1:1?
In these instances which happen everyday in most OTCBB stocks there is more trading occurring at the ask than the bid, yet price falls! Why?
Certain market participants are allowed to routinely buy at the bid and sell at the ask, and these participants do much more selling at the ask than buying at the bid, in order too fool the general public that uses technical analysis in their trading arsenal into believing more buying is taking place than is actually occurring. Additionally the market participants doing the majority of the selling at the ask (the Market Makers) are not the same entities as the market participants doing the buying at the bid. It is my contention that this is allowed by the SEC to deliberately fool the "little guy" thereby allowing the Market Makers to conceal sells in the ticker tape while simultaneously making them appear to be buys because they occur at the ask. This should be considered Market Maker Manipulation, but unfortunately under the current rules it is allowed. Has the SEC been implicated in fraud by allowing this type of unusual buying and selling activity by certain market specialists while at the same time other market participants, namely the general public do not receive such favorable prices for similar trades?
Volume Manipulation and the "Market Maker orchestrated Pump and Dump"
Volume Manipulation is another area where Market Maker's collude to create the impression that there is more activity, accumulation or distribution, then there actually is. For example, Market Maker A buys 100K from Market Maker B, who then sells them to Market Maker C, then Market Maker D buys them, making it appear as if there is 300K worth of volume, when all that was happening was a "Churn" game that served to inflate volume for the day. For a more in depth discussion of how this works, please see The Forbes article titled "One Day Soon the Music's Going to Stop" http://www.forbes.com/forbes/072996/5803072a.htm
The core aspect of this manipulation is the structure of NASDAQ's ACT system itself, and which can be discerned by studying the buys and sells as they are reported in the OTCBB time and sales reports, and by studying the reporting as it occurs in the ACT system. The major distinguishing feature here is that Market Maker to Market Maker transactions are recorded on the sell side only (same as an investor buy), in contrast, the ACT system records both buys and sells by Market Makers when the trade is being made with the general public.
Lets look at a few examples, and please note that the side of the trade is inverted depending upon the market participants "point of view." When a Market Maker buys from the general public, it's the same as an investor sell, it is recorded as an ACT system buy or "B". When a Market Maker sells to the General public, which is the same as an investor buy, it is recorded as an ACT system sell or "S". So the Market Makers report both buys and sells to the general public. Unfortunately here is where the rules change to the detriment of the average investor: A Market Maker to Market Maker transaction is recorded solely on the sell side as an "S", not on the buy "B" side. If a Market Maker buys from another Market Maker, it is not recorded in the ACT system as a "B", it is only the selling Market Maker that reports it. This is the core reason that it appears in the real time price stream for OTCBB stocks that a bid:ask ratio of greater than 1:3 is often required in order for prices to move up, since a Market Maker to Market Maker transaction represents no change in the supply demand equilibrium of a stock. The excess over 1:1 is Market Makers trading with each other.
All sorts of technical accumulation/distribution models use volume in their calculations, and this churn game where Market Makers sell to each other can be used to manipulate the buying and selling of many who use such technical models in their trading. These types of churn trades are all but impossible to discern from retail trades and to my knowledge are currently completely impossible to discern in real-time. The Market Makers combine this "churn" trading with artificial price walk downs and naked shorting, and you have the potential of complete Market Maker Manipulation of the whole price and volume chart. This would be exceedingly profitable to conspirators at critical technical junctures such as the apex of triangles and quiet, pre-breakout trading ranges to make it appear that the order flow is going opposite to the "real" order flow.
Why are MarketMaker's are allowed to report these churn trades (Market Maker to Market Maker) as volume, since supposedly a Market Maker is only concerned with "making a market?" There is no legitimate need for volume figures reported in real time price streams as well as end of day price reports to include Market Maker to Market Maker transactions. After all, who is the market being made for? Another Market Maker?
Volume manipulation is a type of "pump and dump" scheme orchestrated by and for the benefit of the Market Makers themselves. It works like this: The Market Makers start selling to each other to artificially inflate the volume figure over a period of days to generate investor interest, but they do not yet start Naked Shorting. Now after some number of investors have laid down their hard earned money and there has been some price appreciation, Market Makers then start to Naked Short the position, effectively capturing the Investors Money, as price erodes due to the dilution that the creation of the short positions cause. This capture of investors money occurs in the event the investor has a stop loss figured into their trading strategy which mandates them to limit their losses, so they sell due to price erosion caused by Naked Shorting. Stop loss's are always recommended in beginner's guides to technical analysis and automated trading strategies.
I wonder why?
In any case these stop loss strategies combined with the flawed reporting structure of the real time price stream, line the Market Makers pockets with huge sums of money.
Naked Shorting, Sophisticated Hedging, and Price Manipulation
Thomas Jefferson once said something to the effect: "Any man has the right to swing his arm as far as the next mans nose, but no further." Allowing large and sophisticated portfolio holders to short against a stock I hold long as a hedging tactic when shares of another companys shares are the other leg of the said hedge, and further which has the effect of causing my stock holdings to tick downwards, is a violation of Thomas Jeffersons idea. In a similar fashion so does Naked Shorting. Namely, that sophisticated hedging and Naked Shorting tactics "extend their arms into and through my nose." These types of tactics should be stopped since they run counter to the ideals of the vast majority of Americans, and the spirit, if not the letter of the law, as envisioned by our Founding Fathers. No one should be able to sell what they don't own, only what they do own!
To sell something before it's purchased is not a stock sale, it's a hybrid stock/futures transaction, since the timeline is artificially reversed. It's nothing more than a promise to purchase at some time in the future, and in the OTCBB the suspicion is that it's often later, rather than sooner. This contrasts with what release No. 34-42037 suggests about short selling: The buy to cover is "usually the same day the purchase of the short sale is executed." On the other hand, an outright stock buy carries no implication to sell at any time in the future, and the same can be said of a normal sell when the buy occurred first...no further obligation to buy or sell further.
The current practice of Naked Shorting and also Hedging calls into question the entire ethics of our legal system as it relates to the purchase and sale of a company's stock.
Why do you allow the Market Makers, when acting in their roles as "bona-fide Market Makers," the right to short a stock without even an affirmative determination of the existence of shares to short against?
This activity of Market Makers essentially makes counterfeit shares of a company, then introduces them into the supply demand equilibrium of any particular stock in order to deflate or dilute the current value of each share held by shareholders. It's stated that this is done so that investors aren't forced to pay artificially high prices during short and temporary supply demand imbalances.
Why aren't Market Makers required to be responsible to the Company and it's shareholders with respect to an accounting of the Short Interest in real time held by Market Makers?
There is no oversight currently that insures that Market Makers are covering their short sales when the temporary order imbalance is corrected. It appears to many OTCBB traders that the Market Makers are keeping their short sales many days before covering. A similar suggestion was made as documented in the SEC Release No. 34-42037, File No. S7-24-99 in the sections C, Previous Reviews of Short Selling, item 3, 1991 Congressional Report on Short Selling, specifically numbered items (7) and (8). This lack of action from the SEC has let the Market Makers dictate the supply and demand for any given stock they make a market in and thereby they also control or "manipulate" the pricing of each and every share, for extended periods of time.
"Section 10(a) of the Exchange Act gives the Commission plenary authority to regulate short sales of securities registered on a national securities exchange, as necessary to protect investors"
If this is so, why aren't the short sales of OTCBB stocks regulated by the SEC?
The SEC has allowed the OTCBB market to be self regulated by the NASDAQ, who in turn allow Brokers for OTCBB stocks to have "run away" naked shorting. I presume it has been convenient for the Market Makers that the SEC has not determined that the OTCBB is a "national securities exchange." The inmates are running the asylum, and the SEC needs to wake up.
Conclusions
Current Securities Law need to be amended with respect to the OTCBB market so that:
a.. The Brokerage practice of Naked Shorting in the OTCBB market is stopped immediately. The number of outstanding shares of any stock should be fixed at whatever number the issuing company has determined. Trading entities must be prevented from "adding to the trading supply of stock available to purchasers," and by so doing diluting the price value of current shareholders.
a.. Market Makers are disallowed the right to Short Sell OTCBB shares when the Market Makers are trading for their own accounts unless the seller personally owns the shares being sold. They should never have the right to borrow any other entities shares for this purpose under any circumstance whatsoever, due to their information advantage and greater flexibility granted to them through NASDAQ self regulation over other market participants such as the general public.
a.. When the Market Maker is acting it it's role as a "bona fide Market Maker" the Market Makers must be forced to report the real time current total short sales accumulation numbers in aggregate form in the real-time price stream, available to all through many market data vendors at reasonable cost. Computer Technology now allows this with the simple addition of a few lines of code in publicly available price feeds. The OTCBB already has a portion of this capability in it's ACT system, but it's not available to the public at a reasonable cost, nor is it available in real-time to the general public, only to other Market Makers. Market Makers must be held responsible to companies and the shareholders for failing to report this critical market data freely to the trading public, as a check and balance on their own corrupt trading practices.
a.. Churn trades between Market Makers should never be reported in the volume figure at all. This would halt Market Maker orchestrated and price stream centered "pump and dump" schemes.
a.. Violations of these suggested changes to existing law should be enforced with mandatory jail time, not merely monetary punishments, which serve as little deterrent when contrasted with the huge sums of money they are culling from investors day in and day out. The current monetary fines imposed by the SEC for violations of SEC rules are relatively speaking "pocket change" to the corporate firms involved. They are nothing more than a token "slap on the wrist."
Where is Robin Hood when you need him?
Kenneth Klaser, Private Investor/Trader United States of America
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