Here is an article explaining how OTC-BB stocks are shorted:
============================================================
Special report
Dirty tricks in us otcbb stocks
Continued…...
SEC Regulation S allows US public companies to sell shares of their stock very quickly. The rule
was originally intended to help growing companies to raise money without time consuming and costly
regulatory interference. Unfortunately, Reg S has instead been used as one of the most common
conduits for securities fraud. Reg S shares are typically sold at a significant discount to the current
market price because they can only be sold overseas to non-US individuals and investment entities.
The other major catch is that they can not be resold into the US market for a specified period, usually
45 days from the date of closing. The idea is that the company can raise money quickly with a
minimum of regulatory requirements and the newly issued stock does not flood the market.
Unfortunately in practice, this has often not been the case. Some of the buyers of Reg S shares have
actually been Americans hiding behind ownership in offshore investment companies. The biggest
problem with Reg S shares, however, have been violations of the required hold period. Because the
Reg S shares are sold at a discount to the current market price, there is a huge temptation for the
buyer to quickly resell the stock into the open market to capture and pocket the difference. This is
difficult to do since the certificates are restricted. What is often done instead is the stock certificate is
deposited in a foreign brokerage account (often Canadian) and then a like amount of shares are sold
short. This immediately "locks in" the full amount of the difference between the discount sale and the
current market price, minus commissions and margin interest. When the required hold period is up,
the now unrestricted certificate is turned over to the transfer agent and the short position is
eliminated. Technically, this is not "naked shorting" but "covered shorting" because the seller owns
the same amount of shares it has sold short. It has the same overall effect on the stock, though,
especially since the stock is sold so quickly and without the requirement of public filings current
shareholders usually know nothing about it. The SEC recognizes that Reg S abuse has been a huge
problem. They have begun to take steps to clean up the Reg S market.
The convertible securities that are such a problem for OTCBB companies are often called "death
ride" or "death spiral" convertibles. Normal convertibles give the holder the right to convert the first
security (either a stock or a bond) into another type of security (usually common stock) at a given
price (i.e., since the price is fixed, the total number of shares underlying the convertible instrument is
a known quantity. Death Ride's, however, are not convertible at a given price per share but instead at
the number of shares required to meet the face value of the convertible instrument. For instance, if the
convertible is preferred stock worth $1000 and the common stock is worth $1, then the convertible is
worth 1000 common shares. However, if the common stock subsequently declines to 50 cents, then
the preferred is now convertible into 2000 shares. What some buyers of the death rides do is to play
them like they do Reg S shares. They deposit the convertible shares into a brokerage account and
then short sell a like amount of the common stock. The short selling activity helps drive the common
share price lower, which means the convertible is worth a higher amount of common shares. The
additional common share equivalent is then sold short, driving the share price even lower. This
almost never-ending cycle is why these instruments are called "death spirals". Since the short sellers
own the convertibles, this is also considered by many to be covered shorting and not naked. If the
issuer of the convertibles is on the Federal Reserve list of marginable securities, then the owner can
conduct their shorting with a U.S. brokerage. If the issuer is traded on the OTCBB, then they will often
use a Canadian brokerage because, in certain situations, they do allow shorting OTCBB securities.
Most individual investors cannot -legally- short bulletin board stocks in the US. There are several
reasons why, but for this discussion I think it is enough to say it really is not done. If anyone doesn't
know why, ask your broker or drop me a line and I will explain it further. Although individual investors
cannot short these stocks, market makers can. Market makers can go short on any stock as long as it
is related to ""bona fide market making activity" (Rule 3350). Naturally, the key is the term "bona
fide". The NASD manual clearly states that market makers should not go short a security simply for
speculative purposes. However, there are several market makers widely known to do almost nothing
but short stocks for their own account. NASD rules make it extremely easy for a market maker to
begin making a market in any stock very quickly, so these particular MM's often show up suddenly in
many hot, high-flying OTC stocks. When they do, it is a pretty good indication that they stock price will
soon be under pressure and it is a good time to take a hike. Besides the fact that market makers are
professionals and some do a efficient job identifying overpriced stocks, they also have very deep
pockets. Considering the average OTCBB stock has a tiny market capitalization, it doesn't take
much to help nudge a stock one way or the other.
Finally, we come to the last form of shorting, the so-called "naked" shorting. Yes, it does occur in
OTCBB stocks. Yes, Canadian exchanges do allow for shorting of OTCBB shares. However, the
actual amount of shorting in these shares by individuals is probably a lot less than most people think.
For some reason, every time an OTCBB stock goes down it seems someone starts screaming
"naked shorts". The facts are that although Canadian securities regulations do allow OTCBB and
other low priced shares to be both marginable and shortable, the amount of collateral required is
large. For instance, to short an OTCBB stock selling for under 50 cents per share, Vancouver Stock
Exchange rules require the account must have credit equal to the market value of the shorted stock
plus 50 cents per share. Can an American short OTC BB shares this way? This is where it gets
sticky - US regulations say no. This is almost certainly one of several areas in which the ongoing SEC
investigation of Canadian brokerage firms is focusing upon. More on this later.
Just about every stock promoter likes to trot out the "naked shorting" excuse when the stock they
are hyping is falling. With 20/20 hindsight (and some help from regulators' legal briefs) we can often
see that these same stock were declining not because of "naked shorting" but because insiders,
control persons as well as the promoters themselves were dumping huge blocks of stock into the
open market. Thus, they were using the "naked shorting" excuse to cover their tracks and perhaps
entice gullible investors into buying more of the stock, which is likely the promoter's own shares.
Often, this selling and shorting is being done through Canadian brokerages.
============================================================
taylorstock.com
============================================================
ADOT shareholders should check the next quarterly filing very carefully to see if this alleged financing is Reg. S.
Of course it may be too late by then. Geez I wonder if that is why ADOT did not release the terms?????
Tom B. |
