Interesting article on Canadian short selling. It is a little old, but the principals are still the same.
Investor Perils from Canadian Short Sales & Media Disinformation
According to one unsubstantiated rumor, the short sale position for Naxos, prior to the stock being halted from trading, was
between 5 million and 7 million shares. But according to the Alberta Stock Exchange there were only around 80,000 shares of
Naxos sold short. Discrepancies between the "official" short sales and rumored shorts sales is nothing new in the Canadian
equities markets. Since I began publishing this newsletter fifteen years ago this month, I have learned that most smaller public
companies in Canada that have some success in Canadian equities markets, believe that actual short sales almost always
exceed "officially acknowledged" short sales by a very large margin.
For many years I naively shrugged my shoulders at these constant concerns. I reasoned that the intrinsic value of a company
vis-a-vis its share price is what really mattered. If the price of the stock is considerably below its value, then I want to own it. If
it is overpriced, I want to sell. I always believed that it did not matter why the stock was undervalued. While my thinking may
have been correct in a text book sense, the fact of the matter is that extensive short selling can and has often ruined good,
legitimate Canadian companies by depriving them of the ability to raise funds to see the light of the next day. The recent unfair
treatment of Naxos Resources in the press (and also I believe by the Alberta Exchange) was one reason that I recently began
to get very interested in apparent unethical if not illicit behavior on the part of the Canadian securities establishment.
Over the past several months, I have spoken to a number of Canadians with respect to how the Canadian short selling system
works. What I found absolutely shocking was the unanimous belief that in Canada, a very large number of short sales (perhaps
most of them) are never reported. The only kinds of short sales that are reported in Canada are what the Canadians call
"uncovered" shorts. All other shorts sales (most likely the vast majority of them) are simply not reported in Canada.
Since most of us do not participate in the mysterious world of short selling, some definitions may be in order. Short Sales are
sales of stock that are borrowed, not owned. The short seller receives the proceeds of the short sales just like he does when he
sells stock he owns. However, at some time in the future (i.e., when the rightful owner of the shares wishes to sell them) the
short seller is forced to return those shares to the owner. When the short seller originally sells the stock, he believes the price of
the stock will decline.
If he is right, he can buy the stock back on the market at a lower price than he received when he sold the shares short. Then he
returns those shares to the person from which he borrowed them. In Canada, "Covered" Short Sales are simply short sales in
which the brokerage firm doing the short selling continues to hold at least twice as many shares as it sells short.
Thus, if Canacord held 5 million shares of Naxos on its books in the names of your account and mine, it could sell 2.5 million
shares of stock short and never report a single share of short sold stock! And you will never know that these shares were sold
short because Canacord is not required to report it nor are they about to volunteer that information to anyone! According to the
rules of the various exchanges, the only way that Canacord would be required to report any short sales would be if it sold more
shares short than it held on its books for its clients. This is what the Canadians refer to as "Uncovered Short Sales".
Thus, if under these circumstances, Canacord sold 2,580,000 shares short while only holding 5,000,000 shares on its books
for its clients accounts, under Canadian regulation the broker would be required to report only 80,000 shares of short sales
because the 80,000 shares the broker could not replace from his own books, when the rightful owner of those shares wishes to
sell. If I am correct in my understanding of all this, it is clear that Canadian regulation of short selling is enormously misleading to
investors and these reports are worse than useless because they create the false appearance of honesty when in fact very
sinister behavior may be taking place.
After several Canadians confirmed that my understanding of how short selling is reported in Canada is correct, I received still
additional confirmation from VSE Short Position Reports as they appear on the Bloomberg system. I looked up every stock
listed on the back page of this newsletter that is traded on the Vancouver Stock Exchange.
Exactly ten stocks (Columbia Gold, Crystallex International, GMD Resources, International Freegold, Jersey Goldfields,
Navarre Resource, Northern Crown, Paramount Ventures, Stellar Gold, and Silver Eagle) had VSE Short Position reports.
The form of the report is typified by the example of GMD Resources shown to the right. The important thing to note is that
under the "covered" column, not a single value appears for GMD, nor are there any values placed in the covered column for
any of the ten above named stocks for any three month period we reviewed.
The reason, I fear, is very simple. In Canada, so called covered shorts are simply not reported! I believe this explains why a
very large level of Naxos short sales may be a reality even though the Alberta Exchange acknowledges only approximately
80,000 shorted shares and why over the years persistent claims of foul play from the "Vancouver" establishment has been
heard from many Canadian listed companies and U.S. brokers.
So What?
Why are covered shorts not reported in Canada? Why should you care? My close tracking of Naxos may provide a clue to the
answers to both questions. I have followed the unfolding story of Naxos during the past 6 years and I have learned to know the
management fairly well. Therefore, when certain things were published about this company I knew they were phoney. I believe
that it was no co-incidence that a barrage of unflattering articles about Naxos were published as the price of Naxos peaked at
around Can$10 this year.
In fact I believe the evidence points toward an unholy alliance between a major Vancouver based investment bank and its use
of major Canadian media to create false stories and impressions to drive the price of Naxos lower so that these unsavory
characters could cover their short positions at the expense of the investors. The motives of those writing the unflattering articles
about Naxos were called into question by yours truly not only because one after another they false, but also because the writers
never bothered to spend any time trying to understand anything about Naxos, or the validity (or lack thereof) of its process.
They automatically tabbed it a fraud!
Enormous pressures were placed on the Alberta Stock Exchange (ASE) as a result of the regular pattern of untruthful and
reckless reporting by the establishment press in Canada. That pressure led to the shares of Naxos being halted since mid May.
If I am correct about how professional short sellers work in Canada and about how they use the establishment press to pocket
enormous amounts of money, I believe the rotten reputation the Canadian equities markets have among U.S. investors and
investment professionals can be explained and is largely justified. The victims of this Canadian scam are not only companies that
have legitimate businesses that could enrich society, but also investors who have worked hard to understand the fundamentals
of the companies they invest in. The following two fictitious short selling scenarios involving XYZ Exploration Co. and
Dishonest Brokers Ltd. illustrates some of the underlying dynamics that I believe may be to blame for the grief suffered by
Naxos Resources and its shareholders over the past several months.
SCENARIO I - "IF XYZ TRIES TO GET UP, HIT HIM AGAIN AND AGAIN AND AGAIN !"
XYZ Exploration Co. (XYZ Corp.) a junior mining company with several good gold exploration targets in Africa, approaches
a Canadian investment bank named Dishonest Brokers Ltd in quest of venture capital. Dishonest Brokers responds to the
company's needs by taking the company public by way of an IPO of 5 million shares at $0.50. XYZ Co. nets $2.25 million
(Dishonest Brokers pockets $250,000 in underwriting fees) and uses most of the net proceeds of its IPO to explore for gold.
XYZ's efforts are successful so its shares rise to $5.00.
Investors, especially those in the U.S. who may have bought the stock near its IPO low, are very happy about this turn of
events so they vow to hold the stock for "the long haul". Many investors believe XYZ has a chance to be the next BRE-X.
With the stock now priced at $5.00, the mining company is able to raise equity via private placements, or list on NASDAQ or
elsewhere to raise its money, so Dishonest Brokers becomes of less value to XYZ Co.
However, Dishonest Brokers Ltd. does not like the idea of XYZ Co. gaining its independence because that would mean that it
would no longer be able to make future profits off of this good mining prospect. So Dishonest Brokers proceeds to force XYZ
to once again depend on it by selling say, 2,020,000 shares of XYZ short. Dishonest Brokers holds a total of only 4 million
shares of the company's stock on its books for its clients, so therefore, reports only 20,000 uncovered shorts sales even though
the actual number of short sales was 101 times more! The enormous and sudden supply of XYZ stock hitting the market in a
short period of time overwhelmed the market for XYZ stock, so its price plunges back to $0.50. With XYZ's shares now "in
the basement where they belong" the company is forced to return to Dishonest Brokers with hat in hand, begging for them to do
another public offering. Again Dishonest Brokers issues another 2 million shares and nets themselves a cool $250,000 plus
some well priced warrants which it also pockets a windfall from when the next Phase of the company's exploration project is
reported to be favorable which again leads to a rise in the shares to over $5.00. That sets the table for yet another round of foul
play and dilution of shareholders' interests. A series of unproven adverse articles in the press appears to make XYZ's price
drop seem very reasonable and everyone except the company itself reasons that if its printed, it must be true.
SCENARIO II - A Short Sale "Killing" Gone Terribly Wrong!
What do you suppose happens if Dishonest Brokers' short sales of XYZ does not bring about the destructive results it hopes
for. Suppose that despite massive short sales, the stock refuses to fall, but instead rises because optimistic investors have solid
reasons to believe XYZ holds the promise to become the next BRE-X or Diamond Fields? Let's say that Dishonest Brokers
Ltd. sells 2 million shares of XYZ short when the stock is at $5.00. It borrows these shares from yours and my account held on
its books and sells them short at the market price of $5.00. Dishonest Brokers pockets $10 million dollars from this sale. Now
lets suppose XYZ, like BRE-X, discovers a gold ore body of upward to 75 million to 150 million ounces of gold and the price
of XYZ rises to $250. Dishonest Brokers is now in Big trouble as investors call the firm to sell say 500,000 shares of the total
2 million shares Dishonest is supposed to hold for them. Dishonest Brokers is now forced to go into the market and buy those
500,000 shares at a cost of $125 million! Having received only $2.5 million ($5 x 500,000 shares) for the short sale of these
shares, Dishonest Brokers would be left with a staggering loss of $122.5 million which represents a sizeable portion of its total
net worth. And guess what! At some time in the future, Dishonest still has to buy an additional 1.5 million shares. At the current
price of $250, XYZ's success may wipe out all Dishonest Brokers equity!
Finding itself deep in the hole, Dishonest Brokers would have yet another alternative to buying these shares on the market. It
could borrow the 500,000 shares of XYZ that exists on its books. But if it did that, it would now need to report an uncovered
short position of 500,000 shares. That could backfire even more because the market would now know that eventually
Dishonest Brokers would have to buy 500,000 shares which would cause the shares to rise even more. No matter what it
does, Dishonest Brokers is in deep do do... unless it can get some help. |
