Replies to post #160674 on CMKM Diamonds Inc. (fka CMKX)

[hundred to one]

Ignutz check out the bold text in this article...

PAINTING THE TAPE
http://www.rgm.com/articles/pipe3.html
Draining the Naked Shorting Swamp

The PIPEs Report
Part Three of a Three-Part Series
by Brett Goetschius
August 1, 2003

Market manipulators are bursting through loopholes littering the regulations and processes put in place to ensure the integrity of the securities markets: This is the charge that lies at the core of allegations made over the last year by PIPE issuers Sedona, Internet Law Library, JAGNotes, NanoPierce Technologies, Hyperdynamics and more than 80 other small-cap firms. They assert that, through the practice of naked shorting - selling shares of a stock without first determining that an equal number of shares is actually available to complete the trade - rogue short sellers are, in effect, counterfeiting shares of stock and selling them on the market. This scheme, its opponents charge, unfairly decimates the share value of targeted companies and threatens the integrity of the market as a whole.

As the plaintiffs in these shorting abuse suits have alleged in case after case, it is not only the short sellers that are the problem: NASD-regulated market players and the regulators them-selves facilitate these frauds by providing waivers, exemptions, and loans to short sellers. Such assistance provides perpetrators the time and leverage they need to execute their schemes, plaintiffs say. The issuers assert that damage done through shorting abuse is downplayed or denied by the clearing firms, broker-dealers, and regulators because each is complicit in supporting a trading system that accords extraordinary flexibility and discretion to brokers holding large undelivered short positions in small-cap stocks. Indeed, the toughest challenge for the prosecution in these cases typically is proving not that orchestrated naked shorting occurred, but that such schemes are specifically prohibited by law.

The trading records of the parties involved present clear pictures of the ability of short sellers to commandeer a small-cap company’s trading activity and drive down the stock price. In the Sedona case, the SEC found - and defendant Rhino Advisors did not contest - that accounts controlled by Rhino accumulated an undelivered short position in excess of 1.19 million shares in 31 trading days. That amount accounted for more than 25% of Sedona’s trading volume during the five-day pricing period prior to Rhino exercising its conversion rights on its Sedona convertibles.

In the NanoPierce case, shuttered Toronto broker Thomson Kernaghan accounted for an average 40% of NanoPierce’s daily trading volume from late October 2000 through early May 2001. Kernaghan client Harvest Court, a PIPE fund advised by Steve Hicks of Southridge Capital Management, held warrants with reset rights in the company during that time. Every trade executed by Thomson Kernaghan for that period was a sale. Total trading activity exceeded 4.5 million shares. NanoPierce’s share price fell during the seven-month period from $2.63 to $0.51.

Examination of trading records of Internet Law Library, another Southridge investment, by John Pinto, a former senior executive of the SEC’s examination and enforcement division, led him to conclude that Thomson Kernaghan’s “aggregate volume of heavy concentrated selling... is indicative of market manipulation.” In testimony as an expert witness for Internet Law, Pinto, a 29-year SEC veteran, described the one-way trading in Internet Law stock by Kernaghan as “indicative of a systematic and calculated initiative by [the] defendants to artificially depress the price of INL shares.”

The Tunnel Under the Border

Regulatory deficiencies in the Canadian securities regime, Pinto testified in the Internet Law case, is a key enabling factor in the alleged manipulation schemes. Canadian broker-dealers trading in Nasdaq stocks are exempt from NASD and SEC regulation, despite their open access to the U.S. markets. “In my opinion,” Pinto asserted, “ this fact was a key ingredient of the manipulative activity, as it facilitated the scheme that most likely could not have been effected if executed through a U.S.-based member of NASD...”

Canadian short sellers play the U.S. markets using a rulebook that differs from those of their domestic counterparts in two key respects. First and foremost, Canada’s system of provincial securities regulations lacks any rule equivalent to NASD’s “affirmative determination” rule. Known as Conduct Rule 3370, the rule requires a U.S. broker-dealer to affirm in writing that it has pre-determined each short trade it accepts can be matched with a similar amount of shares available for purchase or loan. Reinforcing it is SEC Rule 15c3-3, which requires broker-dealers to force “buy-ins” of undelivered short positions in their clients’ accounts after 10 business days. Affirmative determination, backed by forced buy-ins, is aimed at preventing shorting abuse by limiting shorting activity to only that trading volume which can be supported by the amount of registered securities issued and outstanding.

Canadian short positions, on the other hand, legally can extend well beyond the investor’s ability to cover or even complete the trades at a company’s current float and volume. Not only is naked shorting legal in Canada; the country’s regulators aren’t convinced enacting affirmative determination and buy-in rules would prevent it. “An affirmative determination rule would be nice to have,” a regulatory affairs official at the Ontario Securities Commission told TPR last week. “But if bad actors want to do bad things, they are going to do it regardless.”

PIPE Securities as Short Collateral

While not all of them involve variable-priced convertible securities, a majority of naked shorting schemes do. Ostensibly, a forced direct issuance of stock from the naked shorting target is usually the only way to deliver enough securities to cover the undelivered short positions built up over the course of a naked short raid. For schemes involving variable-priced convertibles, Canada offers short sellers a second shorting tool unavailable to their U.S. counterparts: the ability use unregistered convertible securities to collateralize undelivered short positions in the underlying common stock almost indefinitely.

Known as Rule 100 in the Canadian Investment Dealers Association rulebook, it states:

“A Member may hedge: ...Any long convertible security, including warrants, rights, shares, instalment (sic) receipts or other securities pursuant to the terms of which the holder is entitled to currently acquire underlying securities, held in the account of a guarantor that guarantees a customer account against any short positions in the underlying securities held in that customer account; provided that the convertible securities held in the guarantor’s account are readily convertible into the related underlying securities held in that customer’s account and the number of underlying securities available on conversion shall be equal to or greater than the number of securities sold short;”

Critics of Canada’s lax shorting regulations, including NASD enforcement officials familiar with the Sedona and Internet Law cases who spoke to TPR last week, condemn Rule 100 as the “tunnel under the border” that allows privately placed, unregistered securities held in Canadian accounts to finance the short sale of registered public stocks in the United States.

U.S. Protections Weak; Violations Frequent

Loopholes in the U.S. regulatory regime, meanwhile, remain legion. It routinely permits extended undelivered short positions to be held by domestic investors at U.S.-based broker-dealers; the lack of meaningful penalties and enforcement, even in instances of flagrant violations, invites even more abuse. Citing the U.S.-based NASD member firms in the Internet Law case that are accused of aiding and abetting Southridge’s alleged manipulation scheme, Pinto testified that “it is my opinion that many of the U.S.-based NASD member firms may have violated most if not all of [the] NASD and SEC rules [governing short sales].”

Though every U.S. broker/dealer is required to make an affirmative determination before executing a short trade, what should constitute a legitimate determination has been the subject of dispute between the NASD and the SEC. Current rules only require a broker to use its best knowledge and judgment to determine the availability of shares for purchase or loan, and to annotate each trade ticket that such a determination has been made. No actual seller or borrower of the securities in question need be contracted with, or even located. Nor does the information used to make the determination need to be authoritative.

In practice, affirmative determination compliance boils down to a reliance on “hard-to-borrow” lists distributed daily by large clearing firms and wire house stock loan departments. These lists are not routinely audited or reviewed by any regulator. Typically they contain no information regarding the actual liquidity; they simply are ticker lists. Criteria for inclusion in the lists vary with the list distributor, and often reflect only those companies the clearing firm or loan department regularly clears or trades - not the availability of every issue in the market. This reality makes a stock’s absence on a “hard-to-borrow” list affirmative of nothing other than the prima facie that it is absent from the list - not that it has been declared available for shorting in unrestricted amounts.

While drafting the affirmative determination rule in 1994, NASD pushed for a much more stringent determination standard. Proposed in its Notice to Members 94-80, it would have prohibited the use of such lists by requiring traders “to annotate, on the trade ticket or on some other record... the identity of the individual and firm contacted who offered assurance that the shares would be delivered or were available for borrowing by settlement date...” The NASD argued that “a ‘blanket’ or standing assurance that securities are available for borrowing is not acceptable to satisfy the affirmative determination requirement.” In particular, the NASD said brokers “cannot rely on daily fax sheets of ‘borrowable stocks’ to satisfy their affirmative determination requirements...”

Under pressure from the SEC, NASD deferred implementation of the rule for a year; then, it backed down to the agency and amended it. In a Special Notice on January 6, 1995, NASD stated that it would allow trading firms to “rely on daily fax sheets from their clearing firms as a basis for making their affirmative determinations made in connection with short sales.” Four days later, the SEC, which had never approved the more stringent rule, published a release confirming the NASD’s Special Notice. The SEC stated that one reason for the delay in confirming the affirmative determination rule was “the NASD’s concern that the prohibition against the use of daily fax sheets and other ‘blanket’ or standing assurances may have created an unnecessarily burdensome regulatory requirement on NASD members...”

Affirmative determination requirements on the books poorly protect small-cap issuers due to two major exemptions: (1) Nasdaq market makers engaged in “bona fide market making activities” and (2) short trades involving OTC stocks. NASD has defined bona fide activities to “exclude activity that is related to speculative selling strategies... and is disproportionate to the usual market making patterns or practices of the member in that security.” Decisions regarding which activities constitute speculation and which constitute market making are made by the NASD on a case-by-case basis.

Even when affirmative determination violations are discovered, which is routine according to NASD enforcement reports (the association says it keeps no data on the number of such actions), penalties typically add up to a charge of a few thousand dollars coupled with a letter of censure. A random review of the 112 NASD disciplinary actions reported for July and August 2001 reveals six actions involving affirmative determination violations and nine involving short selling violations. Penalties typically included a letter of censure and a fine of less than $20,000. NASD enforcement officials refer to such censures as “parking tickets” and admit that their resources do not allow them to “catch all the speeders.”

To date, the NASD has only successfully prosecuted one case against a naked shorting scheme brought under Rule 3370. In that case, NASD vs. Steve Carlson et. al and John Fiero, defendant Fiero was found to have committed extortion and fraud in a naked shorting scheme involving a group of OTC penny stocks. Like drivers who see parking and speeding tickets simply as costs of riding the roads, Fiero told the court that he viewed the penalties and buy-ins for failing to deliver securities sold short as “an ordinary course of business” and “pretty much a bookkeeping function.”

NASD officials admit that more naked shorting abuse cases have not been prosecuted because the likelihood of conviction is low, unless as in the Fiero case, insiders can be convinced to testify against their fellow conspirators.

For unlike a typical penny stock “pump and dump” scheme that involves managing a substantial sales staff, creating call scripts, making high volumes of out-bound calls to retail investors, and other evidence-generating activities, naked short schemes typically involve only a small, tightly-knit group with no paper trail to document trading strategies or intent. And until stricter shorting rules are established for affirmative determination and collateralization of short trades in the U.S. and Canada, they say few other short manipulation cases are likely to be brought.



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...kaos

[janice shell]

According to whom? Sheesh. He's a DENTIST, for God's sake.

Dr. Jim DeCosta is the worlds' leading expert on naked short selling and the disaster it is creating for investors.

[Sec 10]

Ignutz-then why are virtually all of the companies making naked short claims absent from the SHO threshold list?

BTW, the good Dr. starts with an error. "Naked shorting" is specifically allowed in Canada, although the margin requirements make it an uneconomical strategy for penny scams, and there is a ten day limit before a borrow must be effected.