Tuesday, May 01, 2007 9:44:31 AM
OK, heres another template to send your congressperson and Senators, be sure to replace the names i put in or they might put you on iggy ...LOL
Dear Senator Stuff T. Shirt,
I have recently been sued for securities fraud in the State of Oklahoma. I beleive that the only reason I am being sued is that the company I bought stock in has had a "global freeze" placed on it by the DTCC for over a year. The company name is Bancorp International, symbol BCIT. The court case is No CJ-2007-3818, and is posted on the internet here:
http://www.oscn.net/applications/oscn/getcaseinformation.asp?submitted=true&number=CJ-2007-3181+....
I am confident that I will be found not responsible for the actions outlined by the plaintiff. My letter to you is to point out to you the extraordinary lengths to which the "powers that be" within the markets are forcing companies to go to because of the common practice of selling shares and not delivering the shares to our brokerage accounts. The following is a long but apparently accurate representation of the problem in the marketplace.
Subject: File No. S7-12-06
From: Glen SmithApril 15, 2007
Christopher Cox and Annette Nazareth is this how the game is being played? Everybody knows now its only a matter of time Game Over
NAKED SHORT SELLING
(excerpted from Dateline Research)
To get a handle on the concept of naked short selling, one has to know a little about the steps and players involved in the processing of a buy order on the OTCBB and Pink Sheets.
Step 1: The purchaser either calls his broker on the phone or reaches his brokerage firm on the Internet. Lets assume he decides to buy a 1% interest in a penny stock that has 100 million shares issued and outstanding. The buy order is thus for 1 million shares. Lets assume the buy order is at market.
Step 2: The broker on the receiving end of the order then writes up the buy order and places the order on his firms Trading desk.
Step 3: Assuming that the firm does not make a market in this security, they will hand the order on to a market maker that does.
Step 4: This buying market maker will then either go to the selling market maker showing the lowest offer or to a favorite market maker of his and ask him to match the lowest offer. The trade is executed between the buying and selling market makers at the agreed upon lowest offering price.
Step 5: Assuming the buying and selling brokerage firms are small and do not have the facilities to clear the trade, they then send the details of the trade to their respective clearing firms.
Step 6: Since both clearing firms have both cash and shares accounts at the DTCC, the buying clearing firm wires the purchase price from their cash account to that of the selling clearing firm in exchange for the selling clearing firm wiring the 1 million share block from their shares account to the buying clearing firms shares account. This is called Delivery versus payment. The buying brokerage firm then sends out both a trade confirmation and a monthly statement to their client, the buyer of the 1 million shares, indicating that he does indeed own the 1 million shares, what he thinks to be 1%, of that company. Thus the transaction is complete. A real buyer paid real cash to a real seller for real shares. An intermediary known as a market maker provided a mechanism to bring the buyer and seller together. This basically is an over-simplified explanation of the system used on these trading venues, the OTCBB and the Pink Sheets. Selling market makers do not really have to have a sell order in hand to sell securities. Their job is to provide liquidity and to buffer the market from sharp peaks and deep troughs when an imbalance of buy or sell orders appears.
The phenomenon of illegal naked short selling (INSS) is a form of market manipulation/securities fraud that can be perpetrated at any step in the process. A legitimate short sale involves the seller following the letter and spirit of Rule 10(a)1, The short sale rule. It involves the selling firm making affirmative determination in writing that the shares being sold are indeed borrowable. It also prohibits short sales on a downtick. The borrowed shares are later returned. In illegal naked short selling, the shares were not only not borrowed, but they never did exist in the first place. They were created out of thin air. The legal term that describes this fraud is that the perpetrators created an Artifice to defraud the purchasers of the shares. Rule 10(b)-5 of the 1934 Exchange Act addresses this behavior.
PREEXISTING CONDITIONS AMENABLE TO NAKED SHORT SELLING
In order for this fraud to be perpetrated on unsuspecting investors, two main prerequisites exist. The first is the fact that purchasers of shares on these trading venues do not request the registration and home delivery of their shares. They see an entry on their monthly brokerage statement and have no reason to question its validity.
The second prerequisite is the fact that brokerage firms do not monitor for the good delivery of shares purchased by their clients as mandated by The Customer Protection Rule or Rule 15 (c) 3-3. With the presence of these two prerequisites as being the norm on these trading venues, clever opportunists have realized that they can sell nonexistent shares through Canadian margin accounts, in an undetected fashion, and thereby assume a naked short position.
This followed by the subsequent selling of yet more nonexistent shares tends to result in a precipitous drop in the share price, a share rollback of the victim corporation and its disastrous loss of market cap, or the outright bankruptcy of the victim corporation which circumvents the need for the naked short position to be closed, as it no longer trades. This lack of closure of the sell then buy circuit allows the massive proceeds of this fraud to bypass the taxman.
The typical naked short selling campaign or bear raid results in the death of the victim company within a 6 to 9 month period. The management teams and investors are often left scratching their heads wondering what hit them.
A variety of other preexisting conditions are present on these trading venues that allow this fraud to be perpetrated with little chance of detection. One of these is the inherent inability of a public corporation to communicate with its shareholders holding shares in Street Form.
The advent of the Internet has helped somewhat though. Statistics show that 8 of 10 companies trading on these 2 trading venues, the OTCBB and Pink Sheets, will die within their first three years of existence. These thinly traded and under-capitalized companies are often no more than shell companies whose existence was designed to line the pockets of their creators. The level of chicanery on these trading venues is distinct and the investment community knows about it. When the Vancouver Stock Exchange drastically buckled down on fraudulent behavior several years ago, the scamsters headed south of the border to the OTCBB and Pink Sheets.
The above statistic of 8 of 10 failures combined with the knowledge of the massive amounts of pump and dump programs in effect has caused the investment community to collectively look upon these companies as future bankruptcies. This mindset leads to certain behaviors among those opportunists that have visibility of buy orders for these future bankruptcies.
When a buy order for one of these presupposed scams lands then the entire investment community has their antennae up and a certain feeding frenzy occurs wherein the investment professionals fight amongst themselves to be the one to naked short sell into this buy order. Also these trading venues have very little supervision by the regulators who are strapped for cash as well as manpower. There really are no cops on the beat.
The Pink Sheets, for example, are a privately run trading venue, owned and operated by the National Quotation Bureau. Who needs regulators though when you have naked short sellers determining which corporations are scams and systematically annihilating them? The markets themselves have no visibility whatsoever to investors, even those with Level 2 machines, and market makers pretty much can do what they please. If a market-making firm is selling 50 million shares per month of a certain victim company and buying only 2 million shares per month and has been doing this for several years, then this would surely be nice to know.
The tremendous amount of money involved here attracts these opportunists by the boatload. Investor naivet is also a cornerstone. Very few people, with the exception of the perpetrators of this fraud, know how this game is played. The inherent confusion involved with millions of trades settling at any given time creates a certain cloud of dust that can obscure the perpetration of this fraud. There is no Day of reckoning for these trades. The IOUs just fly around in Cyberspace and never seem to land. It becomes incumbent on the victim corporations to call a Legal time out to get a peak at these IOUs. There is a certain psychology involved also that is inherent to some naked short sellers. They think of themselves as self-appointed sheriffs trying to rid the wild west of companies they diagnose as scams.
If their diagnosis is incorrect then it usually doesnt make much of a difference anyway because they will bankrupt both legitimate and scam corporations. Bankrupting legitimate corporations is seen as collateral damage which occurs in any war. Brokerage firms hosting the accounts of Offshore Corporations, especially those located in the tax havens, do not follow the Know Your Customer rules. A commission is a commission.
The Patriot Act is buckling down in this regard and brokerage firms are to be on high alert for suspicious money flow activity. For those in need of laundering the proceeds of illicit activity, naked short selling provides a handy way to launder that 200% margin maintenance requirement attached to naked short sale orders for especially penny stocks.
Actually the crimes of naked short selling, wire fraud, money laundering, and tax evasion go hand in hand on these venues. Another key preexisting condition is that market makers are not forced to make public their naked short positions on a monthly basis as they must on the more senior exchanges. This is yet another example of the lack of transparency on these trading venues. As far as the Pink Sheets go, there are basically no demanding standards to match or surpass in order to be granted membership.
Another contributing factor has to do with the fact that input into the DTCC comes solely from the broker/dealers. Any picture that the brokerage firms want to paint regarding the disposition of a corporations shares can be painted at will. The fox is guarding the henhouse.
All of these factors combined form an environment within which this fraud can be perpetrated with very little risk of detection. If the laws were to drastically change tomorrow then these same fraudsters would just tweak their modus operandi accordingly and not even miss a beat.
THE MECHANICS OF NAKED SHORT SELLING
Referring back to the 6 steps involved in a model buy order, one can see the myriad of ways available to naked short sell into this purchase order. The first individual with a shot at this opportunity is the broker who gets the phone call from his client, the purchaser. There are two main modalities used to naked short sell at this level. Weve seen where the broker himself can naked short sell into the buy order by picking up the phone and placing a matching sell order, usually through his own non-U.S. margin account, into the market at an opportune time.
The more common technique used at this level is the broker picking up the phone and telling an associate of his about the opportunity that has just landed on his desktop. The broker is used as a scout and is usually paid back for these favors by the brokerage business coming his way from those he is scouting for. Manipulations at this Step 1 level are relatively rare but do occur especially when the broker receiving the call works in a Canadian Brokerage Firm where the naked short selling rules are more lax.
Step 2 level manipulations are fairly common and they involve the broker receiving the phone call writing up this buy order and setting it on his firms trading desk. The trader processing this buy order has 3 main mechanisms to utilize in order to avail either himself or a colleague of his to this wonderful opportunity to naked short sell into this buy order for shares of this future bankruptcy.
The first modality involves the trader picking up the phone to his personal broker at a Canadian firm and having him feed in a naked short sell order for a matching amount of shares at an opportune time. He can also naked short sell into the order right at his trading desk, a process called desking, which places the naked short position into a proprietary account of his own firm. This practice is almost universally done to all international buy orders. Desking is very commonplace. A third option would be to act as a scout for colleagues that would like to avail themselves of this wonderful opportunity and give them a heads up to the fact that a buy order is about to enter the system.
Step 3 involves a heretofore unmanipulated buy order being sent to a buying market maker from the trading desk of the firm receiving the buy order. There is an intrinsic reality in this relationship between the market maker and its client, the buying brokerage firm, that is critical to understand. The buying market makers need the order flow from the buying brokerage firms. It is their lifeblood.
When presented with a buy order, the buying market maker often has to naked short sell into the order just to keep his client brokerage firm happy with his services. The buying brokerage firm wants rapid execution of the buy order in order to get their hands on the commission. Since the stock of these companies is usually very thinly traded, oftentimes there are no sellers around to satisfy the demand for shares. The market maker is expected by his client to perform, which means to continuously naked short sell into buy orders presented by that client.
It is incredibly common for even the most ethical of market makers, due to this pressure to keep their clients happy, to run up immense naked short positions just in the course of their business. Their job is to provide liquidity to these illiquid markets. Where the crimes are often committed at this Step 3 level is in how the market maker handles this predicament he has gotten himself into. On the other hand, there are certain market makers that blindly naked short sell into each buy order on these trading venues that crosses their desk.
Market makers have literally dozens of ways to cause harm to these corporations that they accidentally ran up an immense naked short position against. These vary from continuing to naked short sell into every buy order that appears, effectively neutralizing these buy orders, to contacting naked short selling consortia to lend them a hand in killing the company. There is an endless list of market manipulative techniques to employ.
These Step 3 manipulations are the single biggest component of the overall naked short selling campaigns. Market makers are incredibly powerful in these campaigns in that they are legally allowed to naked short sell while acting in the capacity of a bona fide market maker. Not only this but they dont have to reveal the size of their naked short positions to anybody. The Short Sale Rule, Rule 10 (a)-1, does not apply to the OTCBB and Pink Sheets. Step 3 manipulations involving these buying market makers are collectively known as The Wall. Very few buy orders make it over this wall and find a real seller.
Step 4 manipulations presuppose that the buying market maker behaved himself and went into the market and filled that buy order by approaching the market maker with the lowest offer price or a different market maker that was willing to match that lowest offer. The Semi-ethical buying market makers are in need of a quick print. They want to run the order and grab a quick markup. They know only too well which brokerage firms and other market makers to approach in order to get the buy order quickly naked shorted to them. Many of these public corporations shares are Piggy-back Qualified, this allows any firm to put on a Market maker hat and legally naked short sell without having to file a Form 15(c)2-11.
The same games are played with these selling market makers, but the height of the wall is a little less. Ethical selling market makers may or may not have a real sell order in hand. Oftentimes they will naked short sell into a buy order and then go on the bid to attempt to level out this now naked short position. If they accidentally dug themselves into a hole while servicing clients then they may sit on the offer all day and naked short sell into every buy order that appears. The lack of visibility that these markets provide to investors allows extremely manipulative techniques to go undetected.
Step 5 presupposes that both the buying and selling broker/dealers are not self-clearing. The clearing firms are in a unique position to orchestrate these manipulations behind the backs of
their client brokerage firms.
Step 6 manipulations occur in and around the DTCC. The back office policies at the DTCC have long been ascribed the role as the problem here. Activities at the Lending Pool, both of the Canadian Depositary Service and the DTCC also provide opportunities to both add yet another layer of manipulations as well as cover up earlier manipulations. All of the input into the DTCC is, of course, from the brokerage community. When attempting to drain this lending pool of its contents, careful attention must be paid to those shares held in Canadian Brokerage Firms because the level of chicanery here is alleged to be extremely high.
One can now get an appreciation for the nearly limitless opportunities available to attack one of these corporations during a bear raid. A very small percentage of buy orders actually meet up with a real seller selling real shares. There is just too much money to be made taking on naked short positions and then killing companies. From a risk/reward point of view the chance of detection is infinitesimally low and the rewards are abundant.
The ability to sell nonexistent shares in an undetected manner provides for a self-fulfilling prophecy of sorts. The victim companies find it necessary to finance their burn rate at artificially low levels, which leads to massive dilution. If the company were fortunate enough to actually have earnings at some point, they would be diluted so badly that it wouldnt even matter. Of all of the varieties of securities fraud in existence, and there are many, naked short selling campaigns are usually thought of as the manipulation of choice providing the most favorable risk/reward ratio.
Since the model buy order that executed all 6 steps results in an exchange at the DTCC of cash for shares between the buying and selling firms, any short circuiting at any step would prevent this exchange from happening. In order to exchange cash for shares you need shares There arent any when it comes to naked short selling. There never were any. The purchaser paid hard-earned cash for air. That monthly statement is a lie. His brokerage firm never did receive good delivery of a share certificate, there never was one. In fact, in the case of a Step 1 or 2 manipulation, the broker/dealer first damaged the company by artificially diluting it, and then he sold this damaged bill of goods to his client.
One might ask, Well then where is the buyers money? The buyers money is in the hands of his own brokerage firm. The same people he just paid a commission to and that have a fiduciary responsibility to him. Since there was no good delivery of shares made to the buying brokerage firm in exchange for payment, (Delivery versus payment), the check never left the coffers of the buying brokerage firm. There never was a real seller into whose pocket the cash should have gone. In Wall Street parlance, the buying brokerage firm has a Failure to receive on their books. All of the intermediate brokerage firms have both a failure to deliver and a failure to receive on their books except for the manipulating party itself, he would just have a Failure to Deliver on his books. The IOUs just travel through cyberspace and never get addressed.
Everybody owes everybody else and as long as nobody puts their foot down and demands delivery then this will be the status quo. So why dont all of those firms with all of these Failures on their books rectify matters and level up their positions. The Customer Protection Rule (Rule 15 3-3), clearly states that the buying brokerage firm is mandated by law to go into the open market and buy-in that Failure to deliver within 10 business days of settlement. But in the case of a Step 1 or 2 manipulation, it is the buying brokerage firm itself that is the crook. How can you buy yourself in? The sobering reality is that all of the brokerage firms in their various roles in this buy transaction will make a ton of money if NOBODY forces anybody to deliver. That would wreck this whole wonderful low risk/high reward game, and nobody wants to do that.
The question now becomes, What is that entry in my monthly statement all about if there never were any shares purchased? We refer to these entries as BEEs or Bogus Electronic Entries. Their purpose is to give the buyer a certain comfort level so that he never suspects any fraud. It also serves to cover up the fact that the buyers money is actually in the coffers of his own brokerage firm, and being lent out or invested by them. The investor who bought nonexistent shares from his brokerage firm or whomever, was the victim of a Double Whammy. Not only did he not get the 1% ownership that he thought he was buying, he actually got a much lesser percentage of a company that he might not even recognize, one that perhaps he would have never bought the shares of if he had known the truth.
This company might have 100 million real shares issued and outstanding according to its Transfer Agent, but it may also have 500 million bogus electronic entries in existence. The bad news here is that all 600 million shares of this company can be sold tomorrow. An interesting phenomenon occurs when this investor holding the bogus electronic entry decides to sell his shares. After all his broker cant hardly tell him that he cant sell his Bogus Electronic Entry because we failed to get Good Delivery as mandated by law. When you want to sell, your broker is going to sell this Bogus Electronic Entry or air to some unsuspecting investor, who in no way shape or form can ever get Good Delivery.
The seller had no idea that he bought and sold nonexistent shares, and this process will go on and on and on. As long as nobody suspects anything and those monthly statements keep coming, then this little secret will never be revealed. The stock itself will trade like a big overweight whale, and buy orders of a significant size will not nudge the price one iota because of all of those extra shares that can be sold at any time. Should bad news be released a market massacre might ensue.
Typically the financiers of the company will fatigue and stop cutting checks, deeming that any more checks cut may be good money after bad. They will assume that all of that selling must be coming from somewhere and the only people that own that much stock is management, so this whole thing must have been some kind of a Pump and dump from the get go. Then it will be time to turn out the lights and nobody will ever know the reality of what was going on.
The transaction that this investor took part in actually created out of thin air a new million shares of stock. These shares can be bought and sold at will. They will never be detected by anybody as being fake, because of the lack of a Day of reckoning. The company in question will show 100 million shares being owned at the DTCC by various firms if everybody leaves them in Street Form.
If you, however, stack up all of the monthly statements of all of the shareholders for a given date, and add them up, you will come to the total of 600 million shares being owned, not 100 million. The absolute size of naked short positions actually have a tendency to increase in an almost geometric fashion because the larger the naked short position, the larger the potential losses to the naked short sellers should something go awry. This increases the incentive level to kill this corporation. Long-lived Bear raids are very scary to naked short sellers and demand special weapons and tactics.
The brokerage firms that perpetrate this fraud cover it up by breaking yet more laws. By law the purchase confirmation mailed to the buyer of the shares was to indicate to the buyer the capacity within which his broker acted. Typically the brokerage firm will act as an agent/broker and charge a commission.
In Step 1 and 2 naked short selling, however, the brokerage firm actually acted as a principal/dealer and actually charged what is known as a markup. If the brokerage firm were to indicate this capacity under which it actually acted, then the investor might question what this principal/dealer business is all about. Since the brokerage firm does not want the investor to know that they naked short sold him this air and that they were sitting on his money, they will just lie on the confirmation slip as to the capacity in which they acted.
The question is often asked as to when the day of reckoning occurs wherein these bogus entries must be made good upon. The law lists three different days of reckoning. The Customer Protection Rule, Rule 15(c)3-3, mandates that the Failure to receive certificated shares that were purchased in a transaction, are to be bought in by the purchasing brokerage firm on the 10th business day past the settlement date (T plus 3). The law also states that the selling firm in this transaction is to buy-in their client doing the selling if he hasnt produced the certificate within 30 days of settlement.
The law further mandates that brokerage firms buy-in failures to receive and deliver within 45 days of filing quarterly reports that noted these Fails. With the absence of Rule 10 (a)-1, The Short Sale Rule, having any application to the OTCBB and Pink Sheets, the Customer Protection Rule is the only line of defense left against this fraud but it is ignored almost 100% of the time. There is just too much money to be made while ignoring it to turn down.
Investors becoming educated as to the nature of naked short selling and demanding the registration and home delivery of their shares has to be the cornerstone of the effort to end the perpetration of this fraud.
Since all 6 steps need to be completed in the Model buy order in order to match up a real buyer with a real seller, all of these manipulations at the various steps along the way result in the creation of new shares which exist in the form of a bogus electronic entry. These cause massive dilution of a corporations share capital, which has a depressant effect on the share price.
Since all financings of these corporations are tied to these artificially depressed prices, the dilution problem is further exacerbated. All corporations have to cover their monthly burn rate just to keep the lights on. This accelerated dilution rate is a constant source of discontent with shareholders. They not only see the price per share evaporating, but their percentage ownership of the corporation is also dwindling due to the artificially high dilution levels.
The resultant loss in shareholder morale throws yet more fuel on the fire of this companys problems. Again there is a bit of a geometric progression in the companys problems as opposed to a more linear arithmetic progression. Due to the inherent nature of this animal called naked short selling, the playing field becomes so tipped in favor of the racketeers that one wonders how any corporation could survive.
SELL SIDE NAKED SHORT SELLING
The same games can be played in the absence of a buy order from the sell side of the equation. Sophisticated naked short sellers typically work out of offshore corporations located in tax havens around the world. Banking secrecy laws in these havens help to prevent detection of the identity of the actual perpetrator of the fraud. If one is going to break 20 or 30 securities laws then one might as well do it in an anonymous fashion.
The modus operandi usually has an offshore corporation A setting up a margin account in a non-U.S.brokerage firm. This corporation A will have one shareholder and one director namely Corporation B from a different tax haven with different banking secrecy laws. Corporation B in turn will have one director and one shareholder being Corporation C in yet another tax haven.
For the victim company to attempt to identify Corporation Cs owner would now cost a fortune and take a great deal of time. These victim companies have neither. During this past February, non-U.S.regulators discovered the existence of 13,00 of these offshore corporate accounts amongst non-U.S.broker/dealers. Corporation A will now start selling massive amounts of the victim companys stock. Corporation A will often be set up as a Hedge Fund.
The non-U.S.Brokerage Firm taking the sell order knows darn well that this offshore corporation doesnt own any shares, but they can always play dumb later on should something go awry. Besides theres some big commission money to be made. The non-U.S.Brokerage Firm will typically insist on a 150% to 200% margin maintenance requirement. The naked short selling of penny stocks is inherently dangerous and the broker/dealer needs to be protected. It is extremely easy to Scuttle an offshore corporation should the plan backfire and the non-U.S.firm knows this.
As far as the role of the non-U.S.Broker/dealer utilizing the lax non-U.S. laws regarding naked short selling, they have three main incentives to break the law and take the order. The first is the commissions generated. The second is the use of all of that money placed for margin maintenance requirements, and the third is the visibility of large sell orders providing opportunities for front running.
One technique the non-U.S.Brokerage Firms utilize is known as the Hot Potato technique. Firms are often allowed to keep a naked short position on the books for only a 10-day period after which fines may be levied. After 9 days a firm carrying a large naked short position can hand that position off to a Buddy brokerage firm like a hot potato. After another 9 days it may go to a 3rd firm or back to the original firm. If it gets too burdensome then its off to a friendly hedge fund for long term storage.
Non-U.S.OFFSHORE ACCOUNTS
Who are the typical holders of these non-U.S.margin accounts used for perpetrating this fraud? Offshore hedge funds are the most powerful of these groups. Hedge funds with less than 100 participants do not need to follow the rules and regulations dictated by The Investment Company Act of 1940. This provides both anonymity and lack of liability for the participants. Hedge funds typically contain the money of deep-pocketed players not averse to risk. Large market making firms as well as other Wall Street entities own significant positions in these hedge funds and can count on them when caught in a pinch. Hedge funds account for a very large percent of this naked short selling activity. The Senate Finance Committee is currently investigating the relationship between hedge funds and naked short selling.
Various naked short selling consortia are in existence around the world. They pride themselves on their due diligence capacities and they really are very impressive in that regard, but not infallible, which leads to significant opportunities when they do make errors. Some of these groups have their own websites and aid their disciples on the choice of non-U.S. Brokerage Firm to set up a relationship with. Usually a firm with a Head Compliance Officer that is willing to turn his head the other way a lot. These groups will typically have their head guru with good investigative connections as well as street smarts.
Recently weve seen a lot of activity out of Europe. Shares of OTCBB and Pink Sheet stocks actually trade on subdivisions of various markets over there, totally unbeknownst to management. Not unexpectedly 99% of the trades are sells.
One aspect of this business that has recently been revealed is how these various naked short selling groups communicate and collude with each other. If one group is having a tough time killing a company and their intent is becoming very obvious, then they will hand the baton on to their co-conspirators to help polish off the corporation. This is a very scary thought. These people are incredibly deep-pocketed in the first place.
PILING ON/FRONT RUNNING/TRADE PADDING
An interesting phenomenon often occurs when the non-U.S.broker/dealer first gets visibility of a large sell order. Lets assume that it is a 20-million share sell order of nonexistent stock at market to be executed in two weeks time. The typical source of a sell order like this might be a market maker with a hedge fund connection that accidentally got into a large naked short position while servicing a valued client.
Knowing that this sell order is going to severely depress the victim companys share price, the non-U.S.broker/dealer will often put in their own sell order of maybe 10 million shares and process it before processing the 20 million share sell order. The offshore corporation cant exactly point an accusing finger should they detect the front running since they are breaking the law themselves. Now the non-U.S.broker will hand a 30-million share sell order to a market maker.
When the market maker sees this now gigantic sell order they will often front run this 30 million share sell order with a 10 million share sell order of their own making. They know all too well what a 30 million share sell order will do to one of these thinly traded securities. Thus a sell order of 20 million nonexistent shares has now grown to 40 million nonexistent shares.
This elucidates the Self fulfilling prophecy aspect of naked short selling. Unsuspecting shareholders will pay real money for all 40 million of those shares and not suspect any hanky-panky at all. How could a monthly statement from one of these prestigious Wall Street firms be telling a lie?
Thus naked short selling can work from left to right through the various steps involved in the processing of a buy order, in essence neutralizing the up ticking effect on share prices caused by buy orders, or from right to left with the introduction of massive sell orders of nonexistent shares.
DEATH SPIRAL FINANCINGS/TOXIC FINANCINGS/FLOORLESS CONVERTIBLES
A close cousin of naked short selling involves a form of predatory financing called Death Spirals. Companies in dire need of financings are often forced, by necessity, to trust that financiers will not pre-sell their equity financings in an effort to clobber the market and then convert for a very large number of shares at artificially low prices. These financings are based on fixed dollar amounts of conversions and not a fixed number of shares. A riskier form of death spirals involves potential financiers dumping tons of shares before even cutting a deal for a financing. Conventional death spirals are actually a form of temporarily naked short selling because the shares are forthcoming but usually restricted by Rule 144.
RECENT DEVELOPMENTS WITHIN THIS INDUSTRY WITHIN AN INDUSTRY
Within the past two years the world of naked short selling has been changed forever. Four separate events have rocked the world of the naked short sellers. Since the secrecy of the modus operandi is so important to these people, the headlines caused by these Four events is not welcome at all by the perpetrators.
The first event was the arrest of Anthony Elgindy and the exposure of his methodologies of naked short selling utilizing the services of two allegedly corrupt FBI agents. Elgindy and his huge following have allegedly been one of the pillars in the naked short selling community.
The second event was the sudden bankruptcy of the non-U.S. Brokerage Firm which has been the alleged headquarters for naked short selling worldwide.
The third event was the arrest of the CEO of this firm for attempting to naked short sell $30 million worth of three companies shares to an undercover FBI agent. The fourth event was Operation Uptick, revealing the incestuous linages between organized crime and reputable brokerages in the U.S. The Winds of Change do seem to be blowing a bit, and it wouldnt take much of a breeze to knock down this House of cards the naked short sellers have built.
The significance of these events is not just getting these individuals and institutions out of commission. The real importance is the education that the public needs to receive in regards to naked short selling as these trials and bankruptcies go forward. Again the secrecy factor is the key to naked short selling. If the investing public knew what was going on behind the scenes on the OTCBB and Pink Sheets, then the uproar caused could mushroom into a total lack of confidence in this system, which is already on its knees after the Enron and Anderson debacles. If this knowledge did become commonplace, then at least one of the main two prerequisites, that of not registering and demanding delivery of shares, might be eradicated.
Several non-U.S.Brokerage Firms were recently sued by clients for not delivering the share certificates that he had demanded the delivery of. He had obviously been naked shorted the shares by both firms. In their statement of defense, the attorneys for the firms claimed that it was the actual client of theirs doing the naked short selling that owed the share certificate to the client/buyer and not the firm. The Customer Protection Rule would obviously beg to differ. This is a typical example of the mentality of the non-U.S.Brokerage Firms.
The non-U.S.Regulators have lowered the boom on the behemoth BMO Nesbitt in regards to Serious Know your client deficiencies and Failure to supervise brokers. Many of those 13,000 offshore corporate accounts have tens or even hundreds of millions of dollars playing the naked short side of the market. A broker managing these accounts is supposed to look into the sources of these funds to rule out any illicit activity like money laundering.
In the U.S. the Patriot Act demands that brokers scrutinize these funds and file SARs (Suspicious Activity Reports) when illicit behavior is suggested. This was implemented mainly as an anti-terrorist funding measure, but hopefully will spill over into keeping in check naked short selling. The dynamics of bringing to the publics attention this insidious disease of naked short selling, has never been more exciting than at the present. The public is being immersed in learning the mechanisms of action of the Elgindys, the Valentines, the Thomson Kernaghans, these 13,000 offshore corporate accounts, money laundering, tax evasion aspects, etc.
LONG TERM SURVIVORS
An important aspect of these naked short selling wars is the length of time that the victim company has been under attack. When these naked short selling gurus that can smell a scam from 40 miles away guess right and beat up a scam company, the company doesnt have a chance because of the vicious nature of naked short selling. The lack of assets of the company will be exposed and announced from the mountaintops.
What are interesting are the battles that ensue when these gurus misdiagnose a real company with real assets as a scam. The naked short sellers will still be able to knock the market cap down by 99%, but often it becomes tough to Kill the company. Investors that know that the company has the goods can sit back and buy shares at a tiny fraction of book value and thereby average down their previous purchases. Since the size of the naked short position is of a cumulative nature, increasing with the age of the battle, a point is reached wherein the naked short sellers cannot afford to cover this massive naked short position without driving the share price to the moon. This is when the games get really dirty because hundreds of millions of dollars are now up for grabs, winner take all.
THE DAMAGES
One has to wonder how many young micro cap corporations with great promise have been snuffed out while in this incubator of the OTCBB and Pink Sheets. Have we missed out on any potential cures for cancer or high tech breakthroughs? What happened to the dreams of all of those entrepreneurs who put every penny they had into their private companies in preparation for going public, and then getting massacred once public?
RECORD KEEPING AT THE DTCC
For an annual fee of $1,850, a corporation can receive from the DTCC a weekly update as to the number of shares that each of the brokerage firms on Wall Street have for a given corporation in their Shares account. Keep in mind they all have cash accounts also. The problem with these lists are two-fold. They only reflect the number of shares for which Good Delivery was attained. They also dont address whether or not that brokerage firm owes any shares to a common pool of shares there available to any broker/dealer in need of quick shares. If for example the weekly DTCC Summary states that a broker/dealer has 1 million shares of a given corporations stock in their account, this must be compared to the sum of all shares being reflected as owned in the monthly statements of that firm as mailed out to their client/shareholders. Lets assume this total is 4 million shares. The difference between these two figures can be characterized in several ways. The difference represents: 1) The naked short position of that firm, 2) The number of shares bought by that firm for which Good delivery did not occur, 3) The number of Bogus electronic entries that firm has on its books and that gets mailed out every month.
Wall Street can camouflage very well the number of shares represented by the sum of all shares being reflected as owned in monthly statements. An indication of this number can be attained by a corporation receiving its NOBO list or list of non-objecting beneficial owners. To this number must be added the number of shares owned by OBOs or objecting beneficial owners. When a person signs up for a brokerage account he is asked to check a box denoting whether or not the company in which he owns shares of has the right to know of his shareholdings. If he does not object to this, then he is a NOBO. The NOBO lists are available from ADP Brokerage Services Group at 1-888-237-1900.
When a person adds the total shares held of a given corporation at the DTCC to the number of shares held by Registered shareholders in safe deposit boxes, the sum will equal the issued and outstanding number of shares of that corporation exactly. So at first glance, all seems to be in order until you realize that the DTCC list only represents Good deliveries which on these trading venues is the exception and not the rule. And so the fraud is perpetrated on and on and on.
In regards to the Pool of shares held at the DTCC that is available in the case of an emergency, this was allowed by Addendum C- (1) of the NSCCs (National Securities Clearing Corp.) rules and regs. They were taken over by the DTC several years ago, the amalgamation of which formed the DTCC. The Lending Departments of a firm monitor things here and are one of the biggest profit centers in any firm. From a practical point of view, until this pool is 100% empty of shares, dont expect any upward pressure on share prices due to the borrowing ability provided by the pool. Once it is empty, however, each further demand for the registration and delivery of shares should theoretically cause a forced buy-in of shares under a Guaranteed Delivery basis.
It is relatively easy to empty out the pool at the DTCC. If a company has 70 million shares at the DTCC and a naked short position of 500 million shares, then all the company has to do is create a situation that withdraws 70 of 570 million shares available to be withdrawn. As was stated earlier, all of the brokerage firms represented along the chain of events of one buy order are HIGHLY incentivised not to demand the correction of those Failures to receive and deliver. In order for this to occur, the shareholder and the issuer must be educated as to how this game is played.
I apologise for the length of this letter, but this is not a simple problem problem. I am not complaining about losing money on a "bad investment". I am complaining about a system that does not respect the law. The system appears to be similar to a "check kiting scheme". We have laws in place that are not being enforced. This lack of enforcement is forcing small publicly traded companies to take unusual and drastic measures to attempt to find Justice. In this case, the CEO is filing suit against the shareholders who obviously never had access to any of the aforementioned tools. It is a desperate ploy, but after more than a year of attempting to work with the system, one can hardly blame them. Those that do have access to the aforementioned tools act with impunity while the shareholders and the companies continue to suffer.
Sincerely,
Bozohead
Dear Senator Stuff T. Shirt,
I have recently been sued for securities fraud in the State of Oklahoma. I beleive that the only reason I am being sued is that the company I bought stock in has had a "global freeze" placed on it by the DTCC for over a year. The company name is Bancorp International, symbol BCIT. The court case is No CJ-2007-3818, and is posted on the internet here:
http://www.oscn.net/applications/oscn/getcaseinformation.asp?submitted=true&number=CJ-2007-3181+....
I am confident that I will be found not responsible for the actions outlined by the plaintiff. My letter to you is to point out to you the extraordinary lengths to which the "powers that be" within the markets are forcing companies to go to because of the common practice of selling shares and not delivering the shares to our brokerage accounts. The following is a long but apparently accurate representation of the problem in the marketplace.
Subject: File No. S7-12-06
From: Glen SmithApril 15, 2007
Christopher Cox and Annette Nazareth is this how the game is being played? Everybody knows now its only a matter of time Game Over
NAKED SHORT SELLING
(excerpted from Dateline Research)
To get a handle on the concept of naked short selling, one has to know a little about the steps and players involved in the processing of a buy order on the OTCBB and Pink Sheets.
Step 1: The purchaser either calls his broker on the phone or reaches his brokerage firm on the Internet. Lets assume he decides to buy a 1% interest in a penny stock that has 100 million shares issued and outstanding. The buy order is thus for 1 million shares. Lets assume the buy order is at market.
Step 2: The broker on the receiving end of the order then writes up the buy order and places the order on his firms Trading desk.
Step 3: Assuming that the firm does not make a market in this security, they will hand the order on to a market maker that does.
Step 4: This buying market maker will then either go to the selling market maker showing the lowest offer or to a favorite market maker of his and ask him to match the lowest offer. The trade is executed between the buying and selling market makers at the agreed upon lowest offering price.
Step 5: Assuming the buying and selling brokerage firms are small and do not have the facilities to clear the trade, they then send the details of the trade to their respective clearing firms.
Step 6: Since both clearing firms have both cash and shares accounts at the DTCC, the buying clearing firm wires the purchase price from their cash account to that of the selling clearing firm in exchange for the selling clearing firm wiring the 1 million share block from their shares account to the buying clearing firms shares account. This is called Delivery versus payment. The buying brokerage firm then sends out both a trade confirmation and a monthly statement to their client, the buyer of the 1 million shares, indicating that he does indeed own the 1 million shares, what he thinks to be 1%, of that company. Thus the transaction is complete. A real buyer paid real cash to a real seller for real shares. An intermediary known as a market maker provided a mechanism to bring the buyer and seller together. This basically is an over-simplified explanation of the system used on these trading venues, the OTCBB and the Pink Sheets. Selling market makers do not really have to have a sell order in hand to sell securities. Their job is to provide liquidity and to buffer the market from sharp peaks and deep troughs when an imbalance of buy or sell orders appears.
The phenomenon of illegal naked short selling (INSS) is a form of market manipulation/securities fraud that can be perpetrated at any step in the process. A legitimate short sale involves the seller following the letter and spirit of Rule 10(a)1, The short sale rule. It involves the selling firm making affirmative determination in writing that the shares being sold are indeed borrowable. It also prohibits short sales on a downtick. The borrowed shares are later returned. In illegal naked short selling, the shares were not only not borrowed, but they never did exist in the first place. They were created out of thin air. The legal term that describes this fraud is that the perpetrators created an Artifice to defraud the purchasers of the shares. Rule 10(b)-5 of the 1934 Exchange Act addresses this behavior.
PREEXISTING CONDITIONS AMENABLE TO NAKED SHORT SELLING
In order for this fraud to be perpetrated on unsuspecting investors, two main prerequisites exist. The first is the fact that purchasers of shares on these trading venues do not request the registration and home delivery of their shares. They see an entry on their monthly brokerage statement and have no reason to question its validity.
The second prerequisite is the fact that brokerage firms do not monitor for the good delivery of shares purchased by their clients as mandated by The Customer Protection Rule or Rule 15 (c) 3-3. With the presence of these two prerequisites as being the norm on these trading venues, clever opportunists have realized that they can sell nonexistent shares through Canadian margin accounts, in an undetected fashion, and thereby assume a naked short position.
This followed by the subsequent selling of yet more nonexistent shares tends to result in a precipitous drop in the share price, a share rollback of the victim corporation and its disastrous loss of market cap, or the outright bankruptcy of the victim corporation which circumvents the need for the naked short position to be closed, as it no longer trades. This lack of closure of the sell then buy circuit allows the massive proceeds of this fraud to bypass the taxman.
The typical naked short selling campaign or bear raid results in the death of the victim company within a 6 to 9 month period. The management teams and investors are often left scratching their heads wondering what hit them.
A variety of other preexisting conditions are present on these trading venues that allow this fraud to be perpetrated with little chance of detection. One of these is the inherent inability of a public corporation to communicate with its shareholders holding shares in Street Form.
The advent of the Internet has helped somewhat though. Statistics show that 8 of 10 companies trading on these 2 trading venues, the OTCBB and Pink Sheets, will die within their first three years of existence. These thinly traded and under-capitalized companies are often no more than shell companies whose existence was designed to line the pockets of their creators. The level of chicanery on these trading venues is distinct and the investment community knows about it. When the Vancouver Stock Exchange drastically buckled down on fraudulent behavior several years ago, the scamsters headed south of the border to the OTCBB and Pink Sheets.
The above statistic of 8 of 10 failures combined with the knowledge of the massive amounts of pump and dump programs in effect has caused the investment community to collectively look upon these companies as future bankruptcies. This mindset leads to certain behaviors among those opportunists that have visibility of buy orders for these future bankruptcies.
When a buy order for one of these presupposed scams lands then the entire investment community has their antennae up and a certain feeding frenzy occurs wherein the investment professionals fight amongst themselves to be the one to naked short sell into this buy order. Also these trading venues have very little supervision by the regulators who are strapped for cash as well as manpower. There really are no cops on the beat.
The Pink Sheets, for example, are a privately run trading venue, owned and operated by the National Quotation Bureau. Who needs regulators though when you have naked short sellers determining which corporations are scams and systematically annihilating them? The markets themselves have no visibility whatsoever to investors, even those with Level 2 machines, and market makers pretty much can do what they please. If a market-making firm is selling 50 million shares per month of a certain victim company and buying only 2 million shares per month and has been doing this for several years, then this would surely be nice to know.
The tremendous amount of money involved here attracts these opportunists by the boatload. Investor naivet is also a cornerstone. Very few people, with the exception of the perpetrators of this fraud, know how this game is played. The inherent confusion involved with millions of trades settling at any given time creates a certain cloud of dust that can obscure the perpetration of this fraud. There is no Day of reckoning for these trades. The IOUs just fly around in Cyberspace and never seem to land. It becomes incumbent on the victim corporations to call a Legal time out to get a peak at these IOUs. There is a certain psychology involved also that is inherent to some naked short sellers. They think of themselves as self-appointed sheriffs trying to rid the wild west of companies they diagnose as scams.
If their diagnosis is incorrect then it usually doesnt make much of a difference anyway because they will bankrupt both legitimate and scam corporations. Bankrupting legitimate corporations is seen as collateral damage which occurs in any war. Brokerage firms hosting the accounts of Offshore Corporations, especially those located in the tax havens, do not follow the Know Your Customer rules. A commission is a commission.
The Patriot Act is buckling down in this regard and brokerage firms are to be on high alert for suspicious money flow activity. For those in need of laundering the proceeds of illicit activity, naked short selling provides a handy way to launder that 200% margin maintenance requirement attached to naked short sale orders for especially penny stocks.
Actually the crimes of naked short selling, wire fraud, money laundering, and tax evasion go hand in hand on these venues. Another key preexisting condition is that market makers are not forced to make public their naked short positions on a monthly basis as they must on the more senior exchanges. This is yet another example of the lack of transparency on these trading venues. As far as the Pink Sheets go, there are basically no demanding standards to match or surpass in order to be granted membership.
Another contributing factor has to do with the fact that input into the DTCC comes solely from the broker/dealers. Any picture that the brokerage firms want to paint regarding the disposition of a corporations shares can be painted at will. The fox is guarding the henhouse.
All of these factors combined form an environment within which this fraud can be perpetrated with very little risk of detection. If the laws were to drastically change tomorrow then these same fraudsters would just tweak their modus operandi accordingly and not even miss a beat.
THE MECHANICS OF NAKED SHORT SELLING
Referring back to the 6 steps involved in a model buy order, one can see the myriad of ways available to naked short sell into this purchase order. The first individual with a shot at this opportunity is the broker who gets the phone call from his client, the purchaser. There are two main modalities used to naked short sell at this level. Weve seen where the broker himself can naked short sell into the buy order by picking up the phone and placing a matching sell order, usually through his own non-U.S. margin account, into the market at an opportune time.
The more common technique used at this level is the broker picking up the phone and telling an associate of his about the opportunity that has just landed on his desktop. The broker is used as a scout and is usually paid back for these favors by the brokerage business coming his way from those he is scouting for. Manipulations at this Step 1 level are relatively rare but do occur especially when the broker receiving the call works in a Canadian Brokerage Firm where the naked short selling rules are more lax.
Step 2 level manipulations are fairly common and they involve the broker receiving the phone call writing up this buy order and setting it on his firms trading desk. The trader processing this buy order has 3 main mechanisms to utilize in order to avail either himself or a colleague of his to this wonderful opportunity to naked short sell into this buy order for shares of this future bankruptcy.
The first modality involves the trader picking up the phone to his personal broker at a Canadian firm and having him feed in a naked short sell order for a matching amount of shares at an opportune time. He can also naked short sell into the order right at his trading desk, a process called desking, which places the naked short position into a proprietary account of his own firm. This practice is almost universally done to all international buy orders. Desking is very commonplace. A third option would be to act as a scout for colleagues that would like to avail themselves of this wonderful opportunity and give them a heads up to the fact that a buy order is about to enter the system.
Step 3 involves a heretofore unmanipulated buy order being sent to a buying market maker from the trading desk of the firm receiving the buy order. There is an intrinsic reality in this relationship between the market maker and its client, the buying brokerage firm, that is critical to understand. The buying market makers need the order flow from the buying brokerage firms. It is their lifeblood.
When presented with a buy order, the buying market maker often has to naked short sell into the order just to keep his client brokerage firm happy with his services. The buying brokerage firm wants rapid execution of the buy order in order to get their hands on the commission. Since the stock of these companies is usually very thinly traded, oftentimes there are no sellers around to satisfy the demand for shares. The market maker is expected by his client to perform, which means to continuously naked short sell into buy orders presented by that client.
It is incredibly common for even the most ethical of market makers, due to this pressure to keep their clients happy, to run up immense naked short positions just in the course of their business. Their job is to provide liquidity to these illiquid markets. Where the crimes are often committed at this Step 3 level is in how the market maker handles this predicament he has gotten himself into. On the other hand, there are certain market makers that blindly naked short sell into each buy order on these trading venues that crosses their desk.
Market makers have literally dozens of ways to cause harm to these corporations that they accidentally ran up an immense naked short position against. These vary from continuing to naked short sell into every buy order that appears, effectively neutralizing these buy orders, to contacting naked short selling consortia to lend them a hand in killing the company. There is an endless list of market manipulative techniques to employ.
These Step 3 manipulations are the single biggest component of the overall naked short selling campaigns. Market makers are incredibly powerful in these campaigns in that they are legally allowed to naked short sell while acting in the capacity of a bona fide market maker. Not only this but they dont have to reveal the size of their naked short positions to anybody. The Short Sale Rule, Rule 10 (a)-1, does not apply to the OTCBB and Pink Sheets. Step 3 manipulations involving these buying market makers are collectively known as The Wall. Very few buy orders make it over this wall and find a real seller.
Step 4 manipulations presuppose that the buying market maker behaved himself and went into the market and filled that buy order by approaching the market maker with the lowest offer price or a different market maker that was willing to match that lowest offer. The Semi-ethical buying market makers are in need of a quick print. They want to run the order and grab a quick markup. They know only too well which brokerage firms and other market makers to approach in order to get the buy order quickly naked shorted to them. Many of these public corporations shares are Piggy-back Qualified, this allows any firm to put on a Market maker hat and legally naked short sell without having to file a Form 15(c)2-11.
The same games are played with these selling market makers, but the height of the wall is a little less. Ethical selling market makers may or may not have a real sell order in hand. Oftentimes they will naked short sell into a buy order and then go on the bid to attempt to level out this now naked short position. If they accidentally dug themselves into a hole while servicing clients then they may sit on the offer all day and naked short sell into every buy order that appears. The lack of visibility that these markets provide to investors allows extremely manipulative techniques to go undetected.
Step 5 presupposes that both the buying and selling broker/dealers are not self-clearing. The clearing firms are in a unique position to orchestrate these manipulations behind the backs of
their client brokerage firms.
Step 6 manipulations occur in and around the DTCC. The back office policies at the DTCC have long been ascribed the role as the problem here. Activities at the Lending Pool, both of the Canadian Depositary Service and the DTCC also provide opportunities to both add yet another layer of manipulations as well as cover up earlier manipulations. All of the input into the DTCC is, of course, from the brokerage community. When attempting to drain this lending pool of its contents, careful attention must be paid to those shares held in Canadian Brokerage Firms because the level of chicanery here is alleged to be extremely high.
One can now get an appreciation for the nearly limitless opportunities available to attack one of these corporations during a bear raid. A very small percentage of buy orders actually meet up with a real seller selling real shares. There is just too much money to be made taking on naked short positions and then killing companies. From a risk/reward point of view the chance of detection is infinitesimally low and the rewards are abundant.
The ability to sell nonexistent shares in an undetected manner provides for a self-fulfilling prophecy of sorts. The victim companies find it necessary to finance their burn rate at artificially low levels, which leads to massive dilution. If the company were fortunate enough to actually have earnings at some point, they would be diluted so badly that it wouldnt even matter. Of all of the varieties of securities fraud in existence, and there are many, naked short selling campaigns are usually thought of as the manipulation of choice providing the most favorable risk/reward ratio.
Since the model buy order that executed all 6 steps results in an exchange at the DTCC of cash for shares between the buying and selling firms, any short circuiting at any step would prevent this exchange from happening. In order to exchange cash for shares you need shares There arent any when it comes to naked short selling. There never were any. The purchaser paid hard-earned cash for air. That monthly statement is a lie. His brokerage firm never did receive good delivery of a share certificate, there never was one. In fact, in the case of a Step 1 or 2 manipulation, the broker/dealer first damaged the company by artificially diluting it, and then he sold this damaged bill of goods to his client.
One might ask, Well then where is the buyers money? The buyers money is in the hands of his own brokerage firm. The same people he just paid a commission to and that have a fiduciary responsibility to him. Since there was no good delivery of shares made to the buying brokerage firm in exchange for payment, (Delivery versus payment), the check never left the coffers of the buying brokerage firm. There never was a real seller into whose pocket the cash should have gone. In Wall Street parlance, the buying brokerage firm has a Failure to receive on their books. All of the intermediate brokerage firms have both a failure to deliver and a failure to receive on their books except for the manipulating party itself, he would just have a Failure to Deliver on his books. The IOUs just travel through cyberspace and never get addressed.
Everybody owes everybody else and as long as nobody puts their foot down and demands delivery then this will be the status quo. So why dont all of those firms with all of these Failures on their books rectify matters and level up their positions. The Customer Protection Rule (Rule 15 3-3), clearly states that the buying brokerage firm is mandated by law to go into the open market and buy-in that Failure to deliver within 10 business days of settlement. But in the case of a Step 1 or 2 manipulation, it is the buying brokerage firm itself that is the crook. How can you buy yourself in? The sobering reality is that all of the brokerage firms in their various roles in this buy transaction will make a ton of money if NOBODY forces anybody to deliver. That would wreck this whole wonderful low risk/high reward game, and nobody wants to do that.
The question now becomes, What is that entry in my monthly statement all about if there never were any shares purchased? We refer to these entries as BEEs or Bogus Electronic Entries. Their purpose is to give the buyer a certain comfort level so that he never suspects any fraud. It also serves to cover up the fact that the buyers money is actually in the coffers of his own brokerage firm, and being lent out or invested by them. The investor who bought nonexistent shares from his brokerage firm or whomever, was the victim of a Double Whammy. Not only did he not get the 1% ownership that he thought he was buying, he actually got a much lesser percentage of a company that he might not even recognize, one that perhaps he would have never bought the shares of if he had known the truth.
This company might have 100 million real shares issued and outstanding according to its Transfer Agent, but it may also have 500 million bogus electronic entries in existence. The bad news here is that all 600 million shares of this company can be sold tomorrow. An interesting phenomenon occurs when this investor holding the bogus electronic entry decides to sell his shares. After all his broker cant hardly tell him that he cant sell his Bogus Electronic Entry because we failed to get Good Delivery as mandated by law. When you want to sell, your broker is going to sell this Bogus Electronic Entry or air to some unsuspecting investor, who in no way shape or form can ever get Good Delivery.
The seller had no idea that he bought and sold nonexistent shares, and this process will go on and on and on. As long as nobody suspects anything and those monthly statements keep coming, then this little secret will never be revealed. The stock itself will trade like a big overweight whale, and buy orders of a significant size will not nudge the price one iota because of all of those extra shares that can be sold at any time. Should bad news be released a market massacre might ensue.
Typically the financiers of the company will fatigue and stop cutting checks, deeming that any more checks cut may be good money after bad. They will assume that all of that selling must be coming from somewhere and the only people that own that much stock is management, so this whole thing must have been some kind of a Pump and dump from the get go. Then it will be time to turn out the lights and nobody will ever know the reality of what was going on.
The transaction that this investor took part in actually created out of thin air a new million shares of stock. These shares can be bought and sold at will. They will never be detected by anybody as being fake, because of the lack of a Day of reckoning. The company in question will show 100 million shares being owned at the DTCC by various firms if everybody leaves them in Street Form.
If you, however, stack up all of the monthly statements of all of the shareholders for a given date, and add them up, you will come to the total of 600 million shares being owned, not 100 million. The absolute size of naked short positions actually have a tendency to increase in an almost geometric fashion because the larger the naked short position, the larger the potential losses to the naked short sellers should something go awry. This increases the incentive level to kill this corporation. Long-lived Bear raids are very scary to naked short sellers and demand special weapons and tactics.
The brokerage firms that perpetrate this fraud cover it up by breaking yet more laws. By law the purchase confirmation mailed to the buyer of the shares was to indicate to the buyer the capacity within which his broker acted. Typically the brokerage firm will act as an agent/broker and charge a commission.
In Step 1 and 2 naked short selling, however, the brokerage firm actually acted as a principal/dealer and actually charged what is known as a markup. If the brokerage firm were to indicate this capacity under which it actually acted, then the investor might question what this principal/dealer business is all about. Since the brokerage firm does not want the investor to know that they naked short sold him this air and that they were sitting on his money, they will just lie on the confirmation slip as to the capacity in which they acted.
The question is often asked as to when the day of reckoning occurs wherein these bogus entries must be made good upon. The law lists three different days of reckoning. The Customer Protection Rule, Rule 15(c)3-3, mandates that the Failure to receive certificated shares that were purchased in a transaction, are to be bought in by the purchasing brokerage firm on the 10th business day past the settlement date (T plus 3). The law also states that the selling firm in this transaction is to buy-in their client doing the selling if he hasnt produced the certificate within 30 days of settlement.
The law further mandates that brokerage firms buy-in failures to receive and deliver within 45 days of filing quarterly reports that noted these Fails. With the absence of Rule 10 (a)-1, The Short Sale Rule, having any application to the OTCBB and Pink Sheets, the Customer Protection Rule is the only line of defense left against this fraud but it is ignored almost 100% of the time. There is just too much money to be made while ignoring it to turn down.
Investors becoming educated as to the nature of naked short selling and demanding the registration and home delivery of their shares has to be the cornerstone of the effort to end the perpetration of this fraud.
Since all 6 steps need to be completed in the Model buy order in order to match up a real buyer with a real seller, all of these manipulations at the various steps along the way result in the creation of new shares which exist in the form of a bogus electronic entry. These cause massive dilution of a corporations share capital, which has a depressant effect on the share price.
Since all financings of these corporations are tied to these artificially depressed prices, the dilution problem is further exacerbated. All corporations have to cover their monthly burn rate just to keep the lights on. This accelerated dilution rate is a constant source of discontent with shareholders. They not only see the price per share evaporating, but their percentage ownership of the corporation is also dwindling due to the artificially high dilution levels.
The resultant loss in shareholder morale throws yet more fuel on the fire of this companys problems. Again there is a bit of a geometric progression in the companys problems as opposed to a more linear arithmetic progression. Due to the inherent nature of this animal called naked short selling, the playing field becomes so tipped in favor of the racketeers that one wonders how any corporation could survive.
SELL SIDE NAKED SHORT SELLING
The same games can be played in the absence of a buy order from the sell side of the equation. Sophisticated naked short sellers typically work out of offshore corporations located in tax havens around the world. Banking secrecy laws in these havens help to prevent detection of the identity of the actual perpetrator of the fraud. If one is going to break 20 or 30 securities laws then one might as well do it in an anonymous fashion.
The modus operandi usually has an offshore corporation A setting up a margin account in a non-U.S.brokerage firm. This corporation A will have one shareholder and one director namely Corporation B from a different tax haven with different banking secrecy laws. Corporation B in turn will have one director and one shareholder being Corporation C in yet another tax haven.
For the victim company to attempt to identify Corporation Cs owner would now cost a fortune and take a great deal of time. These victim companies have neither. During this past February, non-U.S.regulators discovered the existence of 13,00 of these offshore corporate accounts amongst non-U.S.broker/dealers. Corporation A will now start selling massive amounts of the victim companys stock. Corporation A will often be set up as a Hedge Fund.
The non-U.S.Brokerage Firm taking the sell order knows darn well that this offshore corporation doesnt own any shares, but they can always play dumb later on should something go awry. Besides theres some big commission money to be made. The non-U.S.Brokerage Firm will typically insist on a 150% to 200% margin maintenance requirement. The naked short selling of penny stocks is inherently dangerous and the broker/dealer needs to be protected. It is extremely easy to Scuttle an offshore corporation should the plan backfire and the non-U.S.firm knows this.
As far as the role of the non-U.S.Broker/dealer utilizing the lax non-U.S. laws regarding naked short selling, they have three main incentives to break the law and take the order. The first is the commissions generated. The second is the use of all of that money placed for margin maintenance requirements, and the third is the visibility of large sell orders providing opportunities for front running.
One technique the non-U.S.Brokerage Firms utilize is known as the Hot Potato technique. Firms are often allowed to keep a naked short position on the books for only a 10-day period after which fines may be levied. After 9 days a firm carrying a large naked short position can hand that position off to a Buddy brokerage firm like a hot potato. After another 9 days it may go to a 3rd firm or back to the original firm. If it gets too burdensome then its off to a friendly hedge fund for long term storage.
Non-U.S.OFFSHORE ACCOUNTS
Who are the typical holders of these non-U.S.margin accounts used for perpetrating this fraud? Offshore hedge funds are the most powerful of these groups. Hedge funds with less than 100 participants do not need to follow the rules and regulations dictated by The Investment Company Act of 1940. This provides both anonymity and lack of liability for the participants. Hedge funds typically contain the money of deep-pocketed players not averse to risk. Large market making firms as well as other Wall Street entities own significant positions in these hedge funds and can count on them when caught in a pinch. Hedge funds account for a very large percent of this naked short selling activity. The Senate Finance Committee is currently investigating the relationship between hedge funds and naked short selling.
Various naked short selling consortia are in existence around the world. They pride themselves on their due diligence capacities and they really are very impressive in that regard, but not infallible, which leads to significant opportunities when they do make errors. Some of these groups have their own websites and aid their disciples on the choice of non-U.S. Brokerage Firm to set up a relationship with. Usually a firm with a Head Compliance Officer that is willing to turn his head the other way a lot. These groups will typically have their head guru with good investigative connections as well as street smarts.
Recently weve seen a lot of activity out of Europe. Shares of OTCBB and Pink Sheet stocks actually trade on subdivisions of various markets over there, totally unbeknownst to management. Not unexpectedly 99% of the trades are sells.
One aspect of this business that has recently been revealed is how these various naked short selling groups communicate and collude with each other. If one group is having a tough time killing a company and their intent is becoming very obvious, then they will hand the baton on to their co-conspirators to help polish off the corporation. This is a very scary thought. These people are incredibly deep-pocketed in the first place.
PILING ON/FRONT RUNNING/TRADE PADDING
An interesting phenomenon often occurs when the non-U.S.broker/dealer first gets visibility of a large sell order. Lets assume that it is a 20-million share sell order of nonexistent stock at market to be executed in two weeks time. The typical source of a sell order like this might be a market maker with a hedge fund connection that accidentally got into a large naked short position while servicing a valued client.
Knowing that this sell order is going to severely depress the victim companys share price, the non-U.S.broker/dealer will often put in their own sell order of maybe 10 million shares and process it before processing the 20 million share sell order. The offshore corporation cant exactly point an accusing finger should they detect the front running since they are breaking the law themselves. Now the non-U.S.broker will hand a 30-million share sell order to a market maker.
When the market maker sees this now gigantic sell order they will often front run this 30 million share sell order with a 10 million share sell order of their own making. They know all too well what a 30 million share sell order will do to one of these thinly traded securities. Thus a sell order of 20 million nonexistent shares has now grown to 40 million nonexistent shares.
This elucidates the Self fulfilling prophecy aspect of naked short selling. Unsuspecting shareholders will pay real money for all 40 million of those shares and not suspect any hanky-panky at all. How could a monthly statement from one of these prestigious Wall Street firms be telling a lie?
Thus naked short selling can work from left to right through the various steps involved in the processing of a buy order, in essence neutralizing the up ticking effect on share prices caused by buy orders, or from right to left with the introduction of massive sell orders of nonexistent shares.
DEATH SPIRAL FINANCINGS/TOXIC FINANCINGS/FLOORLESS CONVERTIBLES
A close cousin of naked short selling involves a form of predatory financing called Death Spirals. Companies in dire need of financings are often forced, by necessity, to trust that financiers will not pre-sell their equity financings in an effort to clobber the market and then convert for a very large number of shares at artificially low prices. These financings are based on fixed dollar amounts of conversions and not a fixed number of shares. A riskier form of death spirals involves potential financiers dumping tons of shares before even cutting a deal for a financing. Conventional death spirals are actually a form of temporarily naked short selling because the shares are forthcoming but usually restricted by Rule 144.
RECENT DEVELOPMENTS WITHIN THIS INDUSTRY WITHIN AN INDUSTRY
Within the past two years the world of naked short selling has been changed forever. Four separate events have rocked the world of the naked short sellers. Since the secrecy of the modus operandi is so important to these people, the headlines caused by these Four events is not welcome at all by the perpetrators.
The first event was the arrest of Anthony Elgindy and the exposure of his methodologies of naked short selling utilizing the services of two allegedly corrupt FBI agents. Elgindy and his huge following have allegedly been one of the pillars in the naked short selling community.
The second event was the sudden bankruptcy of the non-U.S. Brokerage Firm which has been the alleged headquarters for naked short selling worldwide.
The third event was the arrest of the CEO of this firm for attempting to naked short sell $30 million worth of three companies shares to an undercover FBI agent. The fourth event was Operation Uptick, revealing the incestuous linages between organized crime and reputable brokerages in the U.S. The Winds of Change do seem to be blowing a bit, and it wouldnt take much of a breeze to knock down this House of cards the naked short sellers have built.
The significance of these events is not just getting these individuals and institutions out of commission. The real importance is the education that the public needs to receive in regards to naked short selling as these trials and bankruptcies go forward. Again the secrecy factor is the key to naked short selling. If the investing public knew what was going on behind the scenes on the OTCBB and Pink Sheets, then the uproar caused could mushroom into a total lack of confidence in this system, which is already on its knees after the Enron and Anderson debacles. If this knowledge did become commonplace, then at least one of the main two prerequisites, that of not registering and demanding delivery of shares, might be eradicated.
Several non-U.S.Brokerage Firms were recently sued by clients for not delivering the share certificates that he had demanded the delivery of. He had obviously been naked shorted the shares by both firms. In their statement of defense, the attorneys for the firms claimed that it was the actual client of theirs doing the naked short selling that owed the share certificate to the client/buyer and not the firm. The Customer Protection Rule would obviously beg to differ. This is a typical example of the mentality of the non-U.S.Brokerage Firms.
The non-U.S.Regulators have lowered the boom on the behemoth BMO Nesbitt in regards to Serious Know your client deficiencies and Failure to supervise brokers. Many of those 13,000 offshore corporate accounts have tens or even hundreds of millions of dollars playing the naked short side of the market. A broker managing these accounts is supposed to look into the sources of these funds to rule out any illicit activity like money laundering.
In the U.S. the Patriot Act demands that brokers scrutinize these funds and file SARs (Suspicious Activity Reports) when illicit behavior is suggested. This was implemented mainly as an anti-terrorist funding measure, but hopefully will spill over into keeping in check naked short selling. The dynamics of bringing to the publics attention this insidious disease of naked short selling, has never been more exciting than at the present. The public is being immersed in learning the mechanisms of action of the Elgindys, the Valentines, the Thomson Kernaghans, these 13,000 offshore corporate accounts, money laundering, tax evasion aspects, etc.
LONG TERM SURVIVORS
An important aspect of these naked short selling wars is the length of time that the victim company has been under attack. When these naked short selling gurus that can smell a scam from 40 miles away guess right and beat up a scam company, the company doesnt have a chance because of the vicious nature of naked short selling. The lack of assets of the company will be exposed and announced from the mountaintops.
What are interesting are the battles that ensue when these gurus misdiagnose a real company with real assets as a scam. The naked short sellers will still be able to knock the market cap down by 99%, but often it becomes tough to Kill the company. Investors that know that the company has the goods can sit back and buy shares at a tiny fraction of book value and thereby average down their previous purchases. Since the size of the naked short position is of a cumulative nature, increasing with the age of the battle, a point is reached wherein the naked short sellers cannot afford to cover this massive naked short position without driving the share price to the moon. This is when the games get really dirty because hundreds of millions of dollars are now up for grabs, winner take all.
THE DAMAGES
One has to wonder how many young micro cap corporations with great promise have been snuffed out while in this incubator of the OTCBB and Pink Sheets. Have we missed out on any potential cures for cancer or high tech breakthroughs? What happened to the dreams of all of those entrepreneurs who put every penny they had into their private companies in preparation for going public, and then getting massacred once public?
RECORD KEEPING AT THE DTCC
For an annual fee of $1,850, a corporation can receive from the DTCC a weekly update as to the number of shares that each of the brokerage firms on Wall Street have for a given corporation in their Shares account. Keep in mind they all have cash accounts also. The problem with these lists are two-fold. They only reflect the number of shares for which Good Delivery was attained. They also dont address whether or not that brokerage firm owes any shares to a common pool of shares there available to any broker/dealer in need of quick shares. If for example the weekly DTCC Summary states that a broker/dealer has 1 million shares of a given corporations stock in their account, this must be compared to the sum of all shares being reflected as owned in the monthly statements of that firm as mailed out to their client/shareholders. Lets assume this total is 4 million shares. The difference between these two figures can be characterized in several ways. The difference represents: 1) The naked short position of that firm, 2) The number of shares bought by that firm for which Good delivery did not occur, 3) The number of Bogus electronic entries that firm has on its books and that gets mailed out every month.
Wall Street can camouflage very well the number of shares represented by the sum of all shares being reflected as owned in monthly statements. An indication of this number can be attained by a corporation receiving its NOBO list or list of non-objecting beneficial owners. To this number must be added the number of shares owned by OBOs or objecting beneficial owners. When a person signs up for a brokerage account he is asked to check a box denoting whether or not the company in which he owns shares of has the right to know of his shareholdings. If he does not object to this, then he is a NOBO. The NOBO lists are available from ADP Brokerage Services Group at 1-888-237-1900.
When a person adds the total shares held of a given corporation at the DTCC to the number of shares held by Registered shareholders in safe deposit boxes, the sum will equal the issued and outstanding number of shares of that corporation exactly. So at first glance, all seems to be in order until you realize that the DTCC list only represents Good deliveries which on these trading venues is the exception and not the rule. And so the fraud is perpetrated on and on and on.
In regards to the Pool of shares held at the DTCC that is available in the case of an emergency, this was allowed by Addendum C- (1) of the NSCCs (National Securities Clearing Corp.) rules and regs. They were taken over by the DTC several years ago, the amalgamation of which formed the DTCC. The Lending Departments of a firm monitor things here and are one of the biggest profit centers in any firm. From a practical point of view, until this pool is 100% empty of shares, dont expect any upward pressure on share prices due to the borrowing ability provided by the pool. Once it is empty, however, each further demand for the registration and delivery of shares should theoretically cause a forced buy-in of shares under a Guaranteed Delivery basis.
It is relatively easy to empty out the pool at the DTCC. If a company has 70 million shares at the DTCC and a naked short position of 500 million shares, then all the company has to do is create a situation that withdraws 70 of 570 million shares available to be withdrawn. As was stated earlier, all of the brokerage firms represented along the chain of events of one buy order are HIGHLY incentivised not to demand the correction of those Failures to receive and deliver. In order for this to occur, the shareholder and the issuer must be educated as to how this game is played.
I apologise for the length of this letter, but this is not a simple problem problem. I am not complaining about losing money on a "bad investment". I am complaining about a system that does not respect the law. The system appears to be similar to a "check kiting scheme". We have laws in place that are not being enforced. This lack of enforcement is forcing small publicly traded companies to take unusual and drastic measures to attempt to find Justice. In this case, the CEO is filing suit against the shareholders who obviously never had access to any of the aforementioned tools. It is a desperate ploy, but after more than a year of attempting to work with the system, one can hardly blame them. Those that do have access to the aforementioned tools act with impunity while the shareholders and the companies continue to suffer.
Sincerely,
Bozohead
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