Post by imSINGLEruRICH on Apr 15, 2007 9:56:38 GMT -5
oldepro says ... POST EVERYWHERE !!
ragingbull.quote.com/mboard/boards.cgi?board=ADZR&read=63386
By: makeuwonder
15 Apr 2007, 09:05 AM EDT
Msg. 63386 of 63386
Jump to msg. #
Here's how the game is being played.
Not sure if this has been posted here yet.
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. Let’s 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. Let’s 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 firm’s “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 firm’s “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 naiveté 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 doesn’t 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 corporation’s 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. We’ve 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 firm’s “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 don’t 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 wouldn’t 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 aren’t 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 buyer’s money?” The buyer’s 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 don’t 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 buyer’s 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 can’t hardly tell him that he can’t 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.
CONT'd
ragingbull.quote.com/mboard/boards.cgi?board=ADZR&read=63386
By: makeuwonder
15 Apr 2007, 09:05 AM EDT
Msg. 63386 of 63386
Jump to msg. #
Here's how the game is being played.
Not sure if this has been posted here yet.
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. Let’s 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. Let’s 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 firm’s “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 firm’s “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 naiveté 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 doesn’t 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 corporation’s 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. We’ve 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 firm’s “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 don’t 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 wouldn’t 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 aren’t 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 buyer’s money?” The buyer’s 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 don’t 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 buyer’s 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 can’t hardly tell him that he can’t 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.
CONT'd