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Naked Short Selling
While NASD Rule 3350, “The Short Rule”, protects stock issues by prohibiting short sales on a down bid and the practices of "Bear Raiding" and "Piling On", NASD Rule 3370 (b)(2)(B) creates a loophole allowing primary market makers in OTCBB traded securities to make naked short sales without having to make a “positive determination” that securities are available to borrow for delivery by settlement date. Also, holders of convertible debentures can technically short sell securities that are technically “covered” via the convertibles. Short Selling and Convertible Debentures on the OTCBB While NASD Rule 3350, “The Short Rule”, protects stock issues by prohibiting short sales on a down bid and the practices of "Bear Raiding" and "Piling On", NASD Rule 3370 (b)(2)(B) creates a loophole allowing primary market makers in OTCBB traded securities to make naked short sales without having to make a “positive determination” that securities are available to borrow for delivery by settlement date. Also, holders of convertible debentures can technically short sell securities that are technically “covered” via the convertibles. A typical issuer of convertible debentures has a dire need for financing, and the insolvency of the company makes a stock issue an unpractical tool to raise capital. These companies alternatively turn to issuing convertible debentures. Buyers of the convertibles understand the precarious situation of the company, and hedges against their investment in the company by short selling shares against their convertible position. In the case that stock prices fall, the convertible owner further shorts additional shares equivalent to their convertible position. While the owners of convertible securities have an interest in higher share prices of the issuer, the securities owners must continue to protect their interest in the subject company by adjusting their hedge position. The Convertible Debenture “Death Spiral” In many ways, the issuance of toxic convertibles are a legal method to transfer assets from the existing common shareholders into the pockets of the toxic convertibles and, to a smaller degree, the management. The toxic convertible holders get the bulk of the benefit, but don't be fooled - the issuing company's management is also a beneficiary. Let's face it, most of the companies that stoop low enough to issue these death ride convertibles do it because without the quick cash they bring in the Company would be forced to go out of business. In almost every case, the small amount of cash they receive is not enough to rescue the business which is almost always a casualty of bad business decisions our faulty business plan capped off by the terminal decision to issue the death ride convertibles. The small amount of cash and brief window of time afforded by the convertible's issuance is almost never enough to rescue a company which by all rights is already on life support. In the meantime, management gets to draw what is usually generous salary and benefits for awhile longer and may even bail out of their own share positions before the ship sinks entirely. While the only winners in the issuance of death rides is the convertible holders and the management, there are lots of losers on the deals. The biggest losers are usually the company's original creditors. If we assume that most of the issuing companies are destined for business oblivion anyway, then certainly the company should end its life while there are still assets left to pay off existing debts. After the death ride is over, there is usually nothing left and the creditors are left with nothing. That money is almost always siphoned off into the pockets of the toxic convertible holders who almost always short the issuing company right into the ground. The common shareholders are also losers. Like the creditor scenario, any possible assets that might be available to the common shareholders end up in the pockets... [continued...] Want to know more? Download the White Paper "Naked Short Selling" for just $19.95. People who ordered this paper also ordered: |
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