Investing 101 - Mar 19, 2004 - Printable Version
- Financial Terrorism in America
by Mark Faulk Editor's note: "The Faulking Truth" was showcased on IBC radio on Monday, March 29, 2004, concerning our articles on naked short selling. Also, this article was quoted and linked by financialwire.net and reprinted by investrend.com and wallstreetcity.com, and we have been given our own section in the investigatethesec medialinks: http://www.investigatethesec.com/MediaLinks.php
Part one: The Sucker
Picture this: You are a small-time investor who stumbles onto a start-up company that has just developed an innovative new product, a cutting edge technology, or maybe a medical breakthrough that could very well be "the next big thing". In the back of your mind, you can't help but think, "This could be the next Microsoft", and you have a chance to get in on the ground floor of a hidden gem that the big investors and analysts haven't even heard of yet. You do your homework, research the outstanding shares, study the recent press releases and filings, and read about the company on the stock message boards. Finally, you take the plunge, and decide to buy 500,000 shares at a nickle a share. That's right, you now own 1% of (there's that thought again) the next Microsoft, for a paltry $25,000. Sure it's a bit of a risk, but you know the saying, "no risk, no reward". You hit the buy button, turn off your computer, and wait for the money to roll in. A couple of weeks later, the company announces that they have secured a major financing deal, and now have the money to take their product to market, and you know you made the right decision. The volume picks up, the message boards are buzzing, and all is right with the world.
But then, something goes terribly wrong. For no apparent reason at all, the stock price begins to tank, and before you even have time to react, your 500,000 shares are down 80%, and you're just lost $20,000 of your hard-earned money. What the hell happened?
The Set-up
This same scenario is being played out time and again in every corner of America, and although there are many reasons for the failure of small, struggling, publically-traded businesses, including mismanagement and outright corporate fraud, another, more sinister, plot is carried out every day, robbing investors of their money, businesses of their chance to achieve the American Dream of success, and hard working, dedicated employees of their dreams and even their livelihood. And worst of all, up to now, this fraud has been ignored (and in many cases even condoned) by the SEC and our very own government.
This is how it works. Remember that great news that the company just released about securing financing to allow them to take their product to market? It's nothing more than an elaborate scheme perpetuated on the company, it's employees, and the shareholders by a network of skilled con artists. It begins with the financial institution (usually an offshore "lending institution" based somewhere like Bermuda or the Cayman Islands), who approaches the company with promises of funding to "help" the company get their product off the drawing board and into the market. The company, who is usually strapped for cash and desperate for some financial support, considers the terms of the offer. The lender promises them say, five million dollars in exchange for company stock at a 20% discount to the market price at the time they are converted into shares (although some deals are much worse, and the lender gets their shares at as much as a half price discount from the current market price). The company does the math: five million dollars converted to shares at 80% of the current price of around a nickle a share, not too bad a deal. Plus, once the news of the financing is released, investors will swoop down in a stock-buying frenzy, the trading volume will go through the roof, and the share price will soar, meaning the company will give up even fewer shares for the money they receive. The lender makes a nice profit, the company gets their product to market, their employees are finally rewarded for their years of dedication, and the loyal shareholders hit the jackpot. Everyone is happy.
Except that none of that actually happens. Before the ink on the contracts has even had time to dry, the lender is on the phone, calling his co-conspirators.
The Con:
What happens next is complex, and involves the offshore lender, US Brokerage firms, and Canadian Brokers. The lender calls his broker, who is instructed to short sell the company's stock into the the ground. Short selling involves the selling of imaginary shares into the market in the hope that the price will drop, and the short seller can then "buy back" the shares (that they never actually owned in the first place) at a cheaper price, and pocket the difference. Once a stock is sold short, a seller (or their broker) must cover their position by "borrowing" shares from other stockholders (usually those shares that are held in a brokerage house, such as ETrade, Ameritrade, etc.), and sell them into the market. Sound unethical, and bit confusing as well? Maybe, but it is a legal practice that has flourished unchecked for years. The real problem arises when the short sellers dump so many "imaginary" shares into the market that the selling overwhelms any buying pressure, and artificially causes the stock price to crash. And this is exactly what the lender and their cohorts do.
Canada: Co-Conspirators From The North
In order to sell short enough shares to truly cause the stock to tank in price, the broker often has to sell more shares than they can "borrow" from legitimate stockholders. This practice is known as naked short-selling (meaning the short sellers never intended to cover their position by borrowing real shares from legitimate stockholders). There is only one problem. Short selling is illegal in over-the-counter stocks (known as OTC, or penny stocks), and naked short selling any stock is illegal. That's where the Canadian connection comes in. While American brokers have to follow the National Association of Securities Dealers (NASD) rules, Canadian brokers don't. Canadian investors and brokers are allowed to sell short as many shares as they want, and never have to borrow the shares from legitimate stockholders, effectively flooding the market with counterfeit shares. In fact, they can legally sell more shares into the market than even exist in the entire float. So, to circumvent the rules, the American brokers funnel their short selling activities through their Canadian connections. If there are buyers for a million shares, they short sell three million into the market, and on and on, until the stock price eventually collapses under the weight of millions and millions (or billions and billions, if necessary) of fake shares flooding the market.
The Payoff:
So, in simple terms, our lender loans the company a small part of the money they promised them and then immediately calls their co-conspirators in America and Canada, who then flood the market with hundreds of millions of counterfeit shares, causing the share price to collapse. Often, as an insurance policy, bashers are hired to discredit the company on stock message boards such as RagingBull, in effect creating an even darker picture of the company. Then, the lender converts the loaned money into shares of company stock, not at 80% of the nickle stock price that the company envisioned, but at 80% of the market price after they've effectively manipulated the stock price down to almost zero. Instead of the few million shares that the company expected to give the lender, they are forced to give them hundreds of millions (and sometimes even billions) of shares. The lender turns around and dumps those shares into the market, and the price is driven even lower, and they collect their next payment in shares at an even cheaper price. This type of arrangement has become known as "death-spiral financing", because the company is often driven into bankruptcy by the lenders, their American brokers, and their Canadian cohorts.
The Damage:
In the end, this practice amounts to financial terrorism against the United States. Legitimate companies are forced out of business, dedicated employees (who often received stock as part of their compensation) lose their jobs and their stock investments, communities lose out on the opportunity to earn substantial revenues and the employee base that a successful growing business can provide, and the stockholders lose their hard-earned money. Even more, they lose their faith in the stock market as a whole, and vow to never take a risk on a small, unproven, start-up company again. Legitimate lenders stop loaning money to small businesses (which appear to be a much higher risk), and eventually, the entire enterprenarial spirit of America is put at risk. Make no mistake, lives are literally destroyed by this insidious practice.
What Can Be Done About It?
Both the SEC and the NASD have known about this practice for years, yet have stood idly by while Canadian brokers, offshore financial institutions, and their American co-conspirators have systematically financially raped and pillaged our small businesses, their employees, and small investors. Recently, numerous lawsuits have been filed by victim companies naming dozens of brokerage firms as defendants. Individuals and small independent organizations such as www.investigatethesec.com have attempted to draw attention to the problems, and finally, a few small publications such as www.faulkingtruth.com have begun to provide some coverage of the situation.
Proposed NASD and SEC rules don't go far enough to prevent this practice. Until Congress steps in and forces everyone to play by the same rules, and makes those rules tougher in regards to short selling in general (and naked short selling in particular), the OTC market will continue to be a rigged game, and the well being of America will continue to be threatened by unscrupulous foreign (and yes, domestic) interests.
Editor's note: To read the commentary that accompanies this article, click here: www.faulkingtruth.com/Articles/Commentary/1001.html
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Investing 101 Archives:
Financial Terrorism in America (Mark Faulk, Mar 19, 2004)
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