SEC may be failing to protect investors
By Wayne Jett
The Securities & Exchange Commission, created in 1934 as federal watchdog of investor interests, is under fire from critics charging the agency is a captive of Wall Street interests. Evidence is mounting that the SEC is failing to enforce federal laws against securities trading fraud.
On Aug. 9, the SEC disclosed data showing that Wall Street firms allowed clients to sell more than 10million shares of a small company, Global Links, in April 2005 without owning or delivering the stock. Normally, a seller must own or borrow stock and deliver it to the buyer within three days after a sale.
In early 2005, Global Links' stock was at such a low price the company initiated a 1:350 reverse stock split. By sharply reducing the number of its shares from 350 million to about 1 million, the firm hoped to raise the price per share. A higher share price often assists listing on stock exchanges, enabling a company to raise additional working capital by selling more shares to the public.
As GLKC's reverse split took effect in mid-February 2005, however, the price per share did not increase proportionally as ordinarily occurs. Also, trading volume remained high.
When the new (post-split) GLKC shares began trading officially on April 15, 2005, the reason for the trading abnormalities became apparent (at least to the SEC). The SEC data just released show that as of that date, 10,088,023 GLKC shares had been sold but not delivered, called "fails-to-deliver" (FTDs). At the time, GLKC had only about 4 million shares outstanding.
Between February and April 2005, the firm's shares traded with the designation GLKCE. Ordinarily, SEC monitors trading during such transition periods, and likely had current data showing high rates of FTDs.
On April 15, the SEC definitely had the data. Yet the agency took no action to halt trading in GLKC or to require traders to deliver shares to investors who bought between February and April.
With the SEC remaining silent, GLKC's stock price continued to languish. Small investors who bought between February and April 2005 thinking the new shares would be worth 350 times as much as the old shares, lost confidence. GLKC tried to raise working capital by selling more shares, but the low price caused high dilution, seeming to confirm the low share value.
Traders who sold phantom shares at high prices in February-April began covering their short sales at very low share prices during 2005. By year-end, FTDs in GLKC were reduced by about 4.5million shares, as remaining FTDs fell below 6 million.
While these events seem convoluted to casual observers, they mean financial losses to small investors involved. The GLKC data (obtained in a FOIA request by David E. Patch, a prominent muckraker of securities fraud) indicate SEC is not serving as "cop on the beat" protecting individual investors.
Other recent events raise similar concerns. On June28, former SEC senior counsel Gary J. Aguirre testified to the Senate Judiciary Committee that he was fired by the agency when an investigation of insider trading he was leading implicated a prominent Wall Street executive as the primary target.
On Aug. 15, the New York Times reported a letter to SEC chairman Christopher Cox from two Senate chairmen, Arlen Specter of Judiciary and Charles E. Grassley of Finance, asking for more evidence about Aguirre's allegations. The letter told Cox evidence about Aguirre presented to the Senate by SEC and its inspector general was "inconsistent, incomplete and contradicted by documentary evidence."
The senators asked chairman Cox to furnish copies of all documents in the SEC relating to the investigation of Pequot Fund LLC, the subject of Aguirre's inquiry. This would include records of the agency's recent questioning of John J. Mack, presently the CEO of Morgan Stanley. Mack was the person Aguirre sought permission to question in August 2005 when Aguirre was blocked and fired shortly after receiving a double-step pay increase.
Not joining in the letter to SEC from Specter and Grassley was Sen. John Shelby R-Ala., chairman of the Banking Committee. Shelby's committee claims exclusive jurisdiction of SEC, but showed no interest when Aguirre filed his evidence of SEC wrong-doing with Shelby.
Also, two class-action lawsuits filed in federal court in April 2006 against 11 of Wall Street's largest "prime brokers," including Goldman Sachs, Merrill Lynch, Bear Stearns, Lehman Brothers and others, reveal shocking insights into dealings among such firms. The suits filed in Manhattan by Electronic Trading Group LLC and Quark Fund LLC say the prime brokers collect high fees for lending shares to short-selling hedge funds, but never actually furnish the shares for delivery to buyers.
If true, this means millions of shares purchased (and paid for) by buyers in the investing public have not been delivered. So far as can be determined, SEC has taken no action in response to the suits filed by ETG and Quark. The agency customarily does not announce investigations, but public companies subject to inquiries do so in order to inform investors.
The abnormal GLKC trading data just disclosed has drawn public attention partly because Senator Robert F. Bennett R-Utah, specifically asked SEC's then-chairman William Donaldson about alleged manipulation of GLKC shares during a Senate hearing in March 2005. Bennett told Donaldson public reports on GLKC made it appear the agency's Regulation SHO was not working.
Bennett asked Donaldson to provide the Banking Committee an "in-depth briefing" on Reg. SHO and Global Links. Donaldson resigned months later without having done so, and was replaced by Cox in August 2005.
Several companies traded in U.S. markets have complained in recent years that manipulative trading practices were damaging their firms and shareholders. In some instances, lawsuits are pending that seek remedies for the companies or for shareholders. These include Novastar Financial Inc., Biovai, a Canadian pharmaceutical firm, and Fairfax Financial Holdings Ltd., another Canadian firm. All three firms are traded on the NYSE. Another firm prominent in opposing stock manipulation is Overstock.com, which trades on Nasdaq.
On August 14, another Nasdaq-traded company, Private Media Group Inc., based in Spain announced its intention to explore moving to a European exchange, stating it is "extremely unhappy" about "selling pressure on our stock (in U.S. markets) as a result of naked short selling."
sgvtribune.com
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