Stockgate - Naked Shorting Scandal

» Kirk - Dateline to Air Stockgate Segment April 10th

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Mar 28, 2005
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FINALLY!
Dateline to Air Stockgate Segment April 10th

by Mark Faulk
http://www.faulkingtruth.com/Articles/In...

After over a year of promises, postponements, and delays, Dateline finally confirmed today that they will air their report on the stock market scandal on Sunday, April 10th, at 7 pm ET. The segment, dealing with the scandal dubbed "Stockgate", has long been anticipated by advocates pushing for reform in the stock market, and was first confirmed by The Faulking Truth last June. This is an excerpt from that article:

"It's been called the biggest financial scandal in the history of the world, with incurred losses estimated by some experts at well over $1 trillion dollars. It's a scandal that involves over 1,200 offshore hedge funds, over 150 US brokers, and has already bankrupted over 7,000 US companies in the past six years. According to many of the lawsuits filed to date, the crooks include terrorist groups and organized crime syndicates. Sources say that this scandal, which involves an intricate system of selling electronic counterfeit shares of stock in an effort to destroy the market value of small publically traded companies by utilizing a method known as "naked short selling", will eventually implicate almost every major broker in America, all of the governing bodies that oversee trading, and will extend into Canada and Europe."

Sources at the time told us that the Dateline story contained information that would "blow the roof off of this scandal", and that Dateline had already filmed over 100 hours of explosive footage, with interviews from class action attorneys John O'Quinn (of the Houston law firm of O’Quinn, Laminack and Pirtle), and Wes Christian (of Christian, Smith, Wukoson and Jewell), who along with the law firm of Heard, Robins, Cloud, Lubel & Greenwood, who are representing clients in dozens of lawsuits filed against the SEC, the DTCC, and several of the country's largest brokerage firms.

"What's Up With The SEC?"

Since that time, we have learned that officials from both the SEC and DTCC have been interviewed by Dateline, and numerous other recent developments have (at long last) triggered a frenzy of media coverage over the past few weeks. In addition to that, ads have been taken out in several major newspapers, and the roles of hedge funds, who specialize in shorting stocks, have been brought into question in other fraudulent schemes as well. In fact, in an ad in today's op-ed section of the New York Times (March 28, 2005), in an editorial entitled "What's Up With The SEC?" the conservative Washington Legal Foundation ( http://www.wlf.org/ ), blasts the SEC for "sitting on several complaints of misconduct filed by the Washington Legal Foundation, and supported by the U.S. Chamber of Commerce, detailing examples of questionable stock manipulation by short sellers and class action attorneys". According to WLF Chairman Daniel J. Popeo, in one case, information about a class action lawsuit was leaked to short sellers who, in turn, made a huge profit by shorting the stock before the information was made public. Popeo also claims that "in other cases, short sellers and trial lawyers dish dirt about a targeted company to financial reporters, analysts, and regulators, and the damaging news sends the stock price plummeting, thereby forcing the company to settle. Short sellers then reap the profit when the stock drops."

"If I Only Had a Hedge Fund"

In a related development today, the New York Times online edition ran an article about the incredible proliferation of hedge funds today entitled "If I Only Had a Hedge Fund", in which they said that the number of hedge funds created since 1999 has increased by 209%, with 1,406 new hedge funds introduced in 2004 alone. A recent study released by Credit Suisse Boston said that hedge funds now account for half of all stock market activity, and that they now manage a staggering $1 trillion in funds. Why are managers tripping over each other to start new hedge funds? Because instead of the small fixed percentage that they get by managing traditional funds (sometimes as low as 1%), they instead 1% plus 20% of any profit the hedge fund generates, which has made many of the hedge fund managers instant multi-millionaires. In fact, according to a survey in Institutional Investor magazine, the 25 highest paid hedge fund managers earned an average of $250 million in 2003. To read the New York Times article, go to: http://www.nytimes.com/2005/03/27/busine...

With those kinds of profits to be made, it is any wonder that the SEC, the DTCC, brokers, and hedge fund managers have begun to circle the wagons? Every time a share trades hands, every one of them gets a piece of the action. Even legitimate hedge funds, those who don't engage in naked short selling, profit when their corrupt counterparts drive down the price of stocks through illegal naked short selling. And the SEC, NASD, and DTCC take their cut for every share that is bought and sold, whether that share is real or counterfeit.

If the SEC needs a smoking gun, they need only to take a close look at Global Links Corp (OTCBB: GLKCE), where one investor recently bought 100% of the issued stock AND another investor bought 15% of the same stock, only to watch hundreds of millions of phantom shares continue to be bought and sold. While the SEC has ignored this curious case, Congress hasn't. Senator Robert Bennett cited the Global Links story (as first reported by Financial Wire) on March 9th when he grilled SEC Chairman William Donaldson about the naked short selling scandal, "this article just last Friday in a national publication indicates that people are still selling short shares that they don't have and clearly are never gonna acquire." This stock is merely a microcosm of the larger problem that pervades the stock market system, and serves to illustrate how pervasive the fraud really is.

It is vitally important that the Dateline story gets the attention it deserves. We can only hope that their report tells the real story of this scandal, and that Congress and the major media will join us in our mission to, at long last, restore trust and credibility to our stock markets, so that honest investors can once again invest their hard-earned money and have a chance to achieve the American Dream.

To contact members of the US Senate Committee on Banking, Housing, and Urban Affairs, go here and click on the members' names:
http://banking.senate.gov/index.cfm?Fuse...

To contact members of the Senate Finance Committee, go here and click on the members' names:
http://finance.senate.gov/sitepages/comm...

Sign the petition at www.investigatethesec.com

-- posted by Kirk

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» arommel88 - Re: Dateline to Air Stockgate Segment April 10th

In response to Dateline to Air Stockgate Segment April 10th posted by Kirk:

"Become a lawyer. One man with a briefcase can steal more than a hundred men with guns."
-- Don Vito Corleone, The Godfather

-- posted by arommel88

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» Kirk - Who's Behind Naked Shorting?

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Who's Behind Naked Shorting?

http://www.fool.com/Server/FoolPrint.asp...

By Karl Thiel
March 30, 2005

Last week, when I wrote about naked short sellers and Regulation SHO, I suggested none too subtly that the new rules seem to deal pretty lightly with any bad guys operating outside the law. If the Securities and Exchange Commission is acknowledging a problem, as it seems to be, then Reg SHO seems like a pretty weak tool for controlling it.

But that was last week's subject. Having gotten to that point, I was left wondering how extensive the problem really is. As I said then, I'm deeply skeptical of some conspiracy theories that suggest that short selling is not only rampant, but also a part of a coordinated scheme involving brokers, media, and regulators trying to bring down targeted companies. In fact, let me say at the outset that after spending many hours looking at this issue, I remain unconvinced of the larger conspiracy theories and agnostic on how extensive naked short selling is or how exactly it happens. There is no shortage of theories -- some of which I'll discuss here -- but little in the way of concrete answers. So the first and most obvious question is, how much of this is going on?

Rare or everywhere?

Unfortunately, nobody seems to know. The Depository Trust & Clearing Corporation (DTCC), a holding company that clears and guarantees almost all trades in the U.S., very recently posted an interesting Q&A on naked short selling, an article well worth reading if you're at all interested in the subject. "While naked short selling occurs," says DTCC First Deputy General Counsel Larry Thompson in the document, "the extent to which it occurs is in dispute." Ain't that the truth.

Nevertheless, the DTCC has a good reason to say something public about the issue. The subject of naked short selling has gained some momentum with the introduction of Reg SHO early this year and a rising tide of complaint from companies like Overstock.com (Nasdaq: OSTK) and others. But in addition to this general attention, 12 separate lawsuits have accused the DTCC itself of engineering naked short-selling schemes. Nine of these, according to Thompson, have been dismissed or withdrawn, while three are still pending.

The basic accusation is that the DTCC itself counterfeits shares through its stock borrow program. This program has been around for more than 20 years and helps guarantee transactions when one party fails to produce promised shares. While the DTCC itself doesn't own shares, a network of participating broker-dealers lists shares available for borrowing with the program, and these are called on to complete failed transactions.

Lawsuits have claimed that the DTCC loans out shares it never collects from participants. These, in turn, presumably show up as new "fails to settle" transactions, but from the point of view of the market, they appear to be new shares floating around -- in electronic form, that is, without stock certificates to back them up. These can then be relisted, the theory goes, as available for borrowing, and the process repeats itself, allowing the folks manipulating the system to essentially manufacture any number of phantom shares.

Thompson calls these accusations "either an intentional misrepresentation of the SEC-approved system, or a profoundly ignorant characterization of this component of the process of clearing and settling transactions." I want to stress that I'm not supporting these accusations -- I mention them because they describe one popular theory of how naked short sellers operate.

Something's going on here

But if we rule this out, how does one explain the suspicious volumes and consistent, ongoing settlement failures experienced by companies like BioLase Technology (Nasdaq: BLTI), Netflix, or Rule Breakers pick Taser (Nasdaq: TASR) on the Threshold Security lists? Thompson, while acknowledging that naked shorting does happen, suggests that many settlement failures are innocent. "An investor can get a physical certificate to his broker too late for settlement," he suggests. "An investor might not have signed the certificate, or signed in the wrong place. There may have been human error, in that the wrong stock (or CUSIP) was sold, so the delivery can't be made. Last year, 1.7 million physical certificates were lost," he continues, "and sometimes that isn't discovered until after an investor puts in an order to sell the security. There are literally dozens of reasons for a 'fail to deliver,' and most of them are legal. Reg SHO also allows market makers to legally 'naked short' shares in the course of their market making responsibilities, and those obviously result in fails."

But can unsigned or lost certificates really explain why some companies have lingered on the list for weeks, meaning that more than 10,000 shares per day or over 0.5% of the company's entire float is subject to failed settlement on a daily basis? If that's the root cause, it would certainly seem to point to some pretty shoddy settlement practices among broker-dealers. If that's really all there is to this, then maybe Reg SHO will serve its greatest purpose in embarrassing some brokers into improving their settlement procedures.

Who's making the market?

Yet, as I noted last week, it is the market-making exemption that still seems to me like a source of potential trouble. Market makers don't have to locate shares before executing short sales in most circumstances. Their role is to keep an inventory of readily available stock, to smooth volatility, and to manage their own risk, and this sometimes requires them to short shares. A prime example of why this is sometimes a valuable function and even protects investors can occasionally be seen with companies emerging from bankruptcy.

When US Airways (OTC BB: UAIRQ.OB) was planning to re-emerge from bankruptcy in 2003, for instance, its old common stock, trading on the OTC BB, rallied -- apparently because some investors mistakenly thought the news was somehow good for shareholders in the old common stock. But the plan called for the issuance of new stock, and the old shares were to become worthless. Market makers, by shorting the old common shares, could burst a speculative mini-bubble in the making and stop more ill-informed investors from losing their shirts. (Of course, one wonders why stocks are allowed to trade at all in these situations, but that's another matter). In any case, this is an extreme example of one function legitimate market makers serve by shorting stock and why they are given an exemption to the rules.

The potential problem is that unscrupulous folks could potentially register as market makers to take advantage of the exemptions. (Do you want to be a market maker? Go here for an application! It's not a rubber-stamp process, but it's not as hard as you might think.) Right now, "bona fide" market making is judged by the individual transaction rather than by the individual market maker, so no market maker gets a blanket exemption, but any market maker -- even the ones posting $0.001 bid/$10,000 ask spreads -- get a pass in the right circumstances. It's a situation that seems to hold potential for mischief.

Overseas intrigue?

And here is a final source of potential trouble I'll suggest. Say the broker placing the order to short a stock is in an offshore location where naked short selling is legal. This would seem to open up the same opportunities purportedly exploited to naked short the stock of companies that have issued floorless convertible debt.

A floorless convertible bond (a vehicle of what is sometimes called the "convertible death spiral") is a debt instrument issued by desperate or dishonest companies to raise cash; the bondholder can convert the debt into stock at variable, below-market prices.

It's not a deal a responsible company should enter into. When a company does a floorless convertible, its stock, not surprisingly, drops. The new bondholders have every reason to short the stock unmercifully, and as the price drops further, they get more shares upon conversion because the conversion rate changes. Thus, the original shareholders lose virtually all their stake in the company. Meanwhile, the bondholders simply short all the shares they can, take their profit, and then hope the stock price continues to drop until they get more than enough shares upon conversion to cover the original short.

As long as the bondholders are using legitimately borrowed shares and not engaging in unscrupulous tactics to manipulate share price lower, this is a legal strategy -- although it is hard to see why such floorless converts, devastating for existing shareholders, are in fact legal. But if the bondholders are in an offshore location where they can legally naked short, they might theoretically short more shares than they can get their hands on. After all, the shares they have coming back to them are multiplying as the price drops, so why not?

At the root of the conspiracy theory?

There are folks out there who believe this is the main source of naked short selling in the market. Certainly, in this scenario the bondholder has an incentive to naked short the stock, and one could expect to see massive issuance of new shares as the debt is converted to stock at a rock-bottom price. Failed settlement and suspicious volume in one neat package, right?

Maybe. But since most of the companies on the Threshold Security List haven't issued toxic convertibles, of what relevance is this? Only this: If an offshore concern can naked short the shares of a company to which they've issued a convertible loan, why can't a foreign broker naked short a company for which there is simply high demand for borrowed shares?

When I look at the Threshold Security List, even ignoring the penny stocks, I see companies that a lot of investors want to short (OK, that's pretty much true by definition). The very appearance of these companies means that not everyone is getting to borrow the shares they want -- you won't see Microsoft (Nasdaq: MSFT) or General Electric (NYSE: GE) on the list. Couldn't an enterprising broker in some foreign location be executing naked short sales to satisfy some of this demand? Wouldn't this cause persistent settlement failure?

I have no way of proving this -- it is just surmise. But notice that this scenario does not suggest that the naked shorts are successfully pushing down the price of the threshold stocks to any significant degree. It only suggests that the real demand for shares to short is being satisfied by extra-legal means -- brokers who have set up shop to transact shares of a popular short target. Investors who see value and want to take a long position in these same stocks should naturally balance out the shorts, absent some highly organized conspiracy to spook the market. Thus, I don't think investors in threshold companies should necessarily believe that their stock is artificially depressed to any substantial degree.

More unanswered questions

This may only go part of the way toward explaining unusual volume, however. Last week, I mentioned Global Links (OTC BB: GLKCE.OB), a penny stock that has a listed float of a little over 1 million shares but traded many times that volume in a single day despite there being one shareholder who claimed to own the entire float. I mentioned that particular company because it came up by name at the March 9 Senate Banking Committee hearing, and the story makes a good illustration of the kinds of absurdities showing up on the Threshold Security List.

But in fairness, I should point out that in this particular case, there are other factors that might explain the volume. Among other things, the company has a huge overhang of preferred shares convertible to common stock. It's impossible to tell from the SEC filings alone exactly what's going on here, and while it's an interesting story, a smoking gun it ain't. This is part of what makes penny stocks really bad investment ideas for nearly everyone.

But while Global Links is a strange and perhaps poor example of suspicious trading volume, there are other examples out there. Overstock CEO Patrick Byrne has noted seeing four or five times his company's float trade hands in a day. The same thing has happened to other threshold companies. What explains this?

I'm afraid I still don't know. Is it day traders on steroids, frantically trading back and forth? Perhaps. Could it be a few hedge funds painting the tape, hoping to make it look like the sky is falling? Maybe. Could it be huge numbers of phantom shares out there, making the reported float inaccurate? I guess it's possible.

Unfortunately, Reg SHO appears to raise more questions than it answers. As the DTCC is quick to point out, its job is simply to report the failed settlements. It is up to the SEC to actually do something about it.

By the way, I'll look at some more of the specifics of naked shorting and what they mean to investors in the next issue of the Rule Breakers newsletter.

Karl Thiel is a member of the Rule Breakers newsletter team. Click here for a free trial. He does not own stock in any companies mentioned in this article. The Motley Fool has a disclosure policy.

-- posted by Kirk

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» setyoustraight - This is incredible.

I can't believe you haven't figured out the punch line to Global Links.

It was all a joke.

-- posted by setyoustraight

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» setyoustraight - How the Global Links story really worked

On January 3rd, 2005, just before they reverse split their common stock, Global Links made a post-effective amendment to a previous S-8 securities offering. The S-8 was for 600 million shares.

The key text in their S-8 POS appears below:

4.1 Adjustments Upon Change in Capitalization.
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4.1.1 The number and class of shares subject to each outstanding Stock Option, the Exercise Price thereof (and the total price), the maximum number of Stock Options that may be granted under this Amended Plan, the minimum number of shares as to which a Stock Option may be exercised at any one time, and the number and class of shares subject to each outstanding Award, shall not be proportionately adjusted in the event of any increase or decrease in the number of the issued shares of the Common Stock which results from a split-up or consolidation of shares, payment of a stock dividend or dividends exceeding a total of five percent for which the record dates occur in any one fiscal recapitalizationlization (other than the conversion of convertible securities according to their terms), a combination of shares or other like capital adjustment, so that (a) upon exercise of the Stock Option, the Employee shall receive the number and class of shares the Employee would have received prior to any such capital adjustment becoming effective, and (b) upon the lapse of restrictions of the Award Shares, the Employee shall receive the number and class of shares the Employee would have received prior to any such capital adjustment becoming effective.

-- posted by setyoustraight

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» setyoustraight - Mark Cuban figured it out

http://www.blogmaverick.com/entry/123400...

-- posted by setyoustraight

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» Kirk - Dateline Stockgate Update: POSTPONED YET AGAIN!

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Apr 6, 2005
- Dateline Stockgate Update: POSTPONED YET AGAIN!
by Mark Faulk

It's official: Representatives at Dateline have confirmed that the Stockgate segment originally scheduled for Sunday, April 10th, at 7 pm ET, HAS BEEN POSTPONED. According to Dateline, the segment will definitely still air, but that because of scheduling conflicts that have arisen due to the death of the Pope, the Stockgate segment schedule has been pushed back. A Dateline official confirmed that special segments that aired at the time of the Pope's death has caused a "major reshuffling of the entire Dateline schedule". Dateline producer Sharon Hoffman said that, "It has been a very busy news cycle, and Dateline is always subject to change." They have not yet announced a new air date for the show.

Instead, according to the Dateline website, they will air a segment in which "NBC's Al Roker sits down with 'American Idol' star Ruben Studdard to discuss his latest gospel album and how his life has changed since beating Clay Aiken on the second season of 'American Idol.'" Wow! An interview with last year's American Idol winner. It HAS been a busy news cycle!

Once again, this raises the usual questions about how committed Dateline is to this story, and after postponements and cancellations that have kept this off the air for over a year, those concerns are valid. While Dateline officials assured us that they "will air the segment", the major media has been stepping up the pressure over the past few weeks, releasing a flurry of articles on the naked short selling scandal that has plagued the stock market for years.

As for the Dateline segment, according to representatives with Koerner Kronenfeld Partners, who are the communications directors for attorneys O’Quinn, Laminack & Pirtle, Christian, Smith, Wukoson and Jewell, and Heard, Robins, Cloud, Lubel & Greenwood, the law firms representing clients in dozens of lawsuits filed against the SEC, the DTCC, and several of the country's largest brokerage firms, Dateline producer Sharon Hoffman has spent the week fact-checking and editing the story. We have also heard several unsubstantiated rumors that the DTCC has been pressuring Dateline to change or not air the story at all, and that Dateline is doing additional fact-checking as a result. We'll update that information as the story continues to develop.

So there you have it: one more delay on the story that has been called "been called the biggest financial scandal in the history of the world, with incurred losses estimated by some experts at well over $1 trillion dollars." Instead, it's beginning to look like everyone will be treated to a hard-hitting interview with American Idol teddy bear Ruben Studdard. Enjoy. We'll keep you posted, and that's the Faulking Truth.

-- posted by Kirk

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» setyoustraight - Re: Dateline Stockgate Update: POSTPONED YET AGAIN!

Someone at NBC must have taken the time and trouble to do a little bit of research on these dirtwad companies. Too bad Felicia Taylor and Bob Bennett didn't.

-- posted by setyoustraight

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» Kirk - Re: Re: Dateline Stockgate Update: POSTPONED YET AGAIN!

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In response to Re: Dateline Stockgate Update: POSTPONED YET AGAIN! posted by setyoustraight:

I hope you are not suggesting that it is OK to attack a company with a lousy business model using illegal tactics because the ends justify the means.

What I am suspicious of is why don’t the companies who are being naked shorted call those who own large blocks of shares and ask them to take them out of margin accounts so the shares can’t be lent? Or even ask the large shareholders to demand paper certificates? If a large percentage of the float is naked short, then this SHOULD cause a squeeze that would end the practice.

It would not be hard for a clever hedge fund manager to do this to a couple of companies and make a killing if the manager had regulators looking over his shoulder who were ready to enforce the rules. Since this has NOT happened, I remain a skeptic to the claims but I’d sure like to see trading in counterfeit shares stopped.

-- posted by Kirk

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» Kirk - Overstock underwhelms

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Overstock underwhelms
Also, Netflix and market mania
By Herb Greenberg, MarketWatch
Last Update: 2:38 PM ET April 22, 2005

Editor's note: This is a free version of Herb Greenberg's column. To receive all of Herb's insights and market tips from his RealityCheck newsletter and updates on his RealityCheck Watch List, click here. http://www.marketwatch.com/news/story.as...

SAN DIEGO (MarketWatch) -- One rule of thumb on Wall Street is that the more a company goes after critics, including short-sellers and the press, the more likely that something isn't quite right -- and that its stock is likely to implode.

It's a lesson you would've thought Overstock (OSTK: news, chart, profile) CEO Patrick Byrne would've learned after his January 28 fourth-quarter conference call. It was on that call that he let someone go off on a rant about naked short-selling; Byrne himself then lashed out at yours truly and a few others with a few choice words.

His stock at the time was around $72; it was around $55 on February 18 when it officially went on the Watch List of my subscription newsletter, Herb Greenberg's RealityCheck. Now it's $36.

<img align=left src=http://www.marketwatch.com/charts/gifquo...>But Byrne just can't help himself. Just before Friday's call ended he brought up my name again, this time commenting that Cramer (of Jim and CNBC's Mad Money) and me (on Cramer's show) were saying he managed his stock. "I don't manage my stock at all," he said. "I think I'm the least managing CEO in America."

Given the stock's performance, a better way to put it would be that he's the least effective stock-managing CEO in America. The announcement of a stock repurchase program coupled with his personal purchases of shares in the high $40s and low $50s while at the same time continuing all efforts to discredit the critics are usually signs of stock management.

However, in the end, stock-managing is irrelevant if the numbers are bad, which they were at Overstock. Its loss in the first quarter was nearly double what analysts were expecting. April isn't starting any better. On the company's conference call Byrne said he wasn't sure if the April slowdown was the result of "tax day" or "the Pope." Tax day or the Pope? I rest my case, your honor. (As for the stock's 8% slide Friday: must be those darned naked short-sellers again.)

-- posted by Kirk

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