What Most Penny Stock Investors Don't Know

From: Sepod writes: [spodlofs@optonline.net]
Sent: Wednesday, November 19, 2003 1:31 PM
To: rule-comments@sec.gov
Subject: Short Sales... File No. S7-23-03Short Sales File No. S7-23-03To Whom it may Concern at the SEC,There's a rule that the market makers use ... a rule that only has less
than two hundred words in it ... and that rule allows them to naked short
an OTCBB or Pink Sheet stock into oblivion.It allows them to literally create, out of thin air, as many shares as
they need to maintain an orderly market."(B) Proprietary short salesNo member shall effect a “short” sale for its own account in any security
unless the member or person associated with a member makes an affirmative
determination that the member can borrow the securities or otherwise provide
for delivery of the securities by the settlement date.
This requirement will not apply to transactions in corporate
debt securities, to bona fide market making transactions by a member in
securities in which it is registered as a Nasdaq market maker, to bona fide
market maker transactions in non-Nasdaq securities in which the market maker
publishes a two-sided quotation in an independent quotation medium, or to
transactions which result in fully hedged or arbitraged positions."This rule allows a market maker to create a share in a company by simply
taking the money from the buyer and making an electronic entry into their
brokers' account, and the broker then electronically credits the buyer with
one share of that company.But several things that no one is aware of take place in this transaction.
1. The buyer thinks that his share actually exists, but unless he or she
has read his account agreement very carefully, he won't understand that
all he did is give money to someone other than the company and never got
any actual proof of ownership. His certificate, presumably, is sitting at
the DTCC. 2. The market maker filling the order for one share has the
buyer's
money, and gave nothing except electronic acknowledgement of receipt
of it ... the electronic entry in the buyer's account.One very important thing to understand here, is that at no point in
this process, did the company in which the buyer 'invested' ever get
one single dime of the money paid by the buyer for that share.
There is a tremendous misconception out there that causes many to
assume that when they buy a share of a company's stock, the company gets
the money.This is only true if the buyer is buying an IPO, or a private
placement of shares from the company. In any other sale or purchase
of a stock by an investor, the company does not even see the money.This is particularly vexing when one begins to understand what
happens in naked shorting situations. Situations where the provision
that allows for naked shorting to maintain an orderly market is abused.Understand that whoever is doing the naked shorting is the one receiving
the money. They keep it. For as long as it is convenient to do so. That
is where the abuse of the rule comes in.That rule was created to allow for market makers, who by becoming market
makers, agree to 'make a market' in certain stocks. That means that they
will sell you a share, or buy a share from you,
even if there isn't any available, or there are no other buyers for it.
The Market makers'
job is at least partly, to provide liquidity to the market. In thinly
traded securities, or securities where
there is a small public float, the market makers' ability to naked
short is crucial to the liquidity of the market in that security.The abuse takes place when the market maker for whatever reason
determines that the market for a particular security has become
"disorderly". Too much buying pressure, for instance, can cause a
price spike in that security that would have no relationship to the
true book value of the security. The market maker then determines
that he will naked short to fill orders, knowing that by doing so,
the price will not explode on unusually high demand because he can
literally issue new shares under this rule. The market maker then
waits, with an open naked short position in that stock,
until the buying pressure subsides, and he can buy enough shares back
at lower prices to cover his naked short position.The rule does not have any time requirements and that allows for the
market maker to keep a naked short position open for potentially years.
In reality, until the buying pressure subsides enough for him to buy
back at lower prices however many shares he needs to fill previously
filled orders that make up his naked short position, it simply stays
open, and the money sits in his account.Someone is going to ask the question, "So, how big are all those naked
short positions, anyhow?"There is another provision that says that the market makers do not
have to publish their open naked short positions. Never. At all. All
OTCBB and Pink Sheet securities can be naked shorted - indefinitely -
by market makers under this rule, and there is no way that an investor
can discover if there is an open naked short position in a stock he may
be interested in, or even how big that short position is.So far, the SEC does not see a strong need to correct this situation,
either.Think about it. There are unlimited amounts of shares that were never
authorized or issued by a company made available to the unsuspecting
investor. They are authorized and issued by the
market makers under this rule, and the company never gets any money
from the sale of shares created under this rule.The temptation to abuse this rule is irresistable. Just do the math.
A million naked shorted shares sold by a market maker at 0.01 (one cent)
is $10,000 that the market maker keeps in
his account, and that the company does not get. At 0.10 (ten cents)
the market maker gets to keep $100,000. Now, that is for each million
shares that the market maker creates.Under this rule, if a company and/or a group of shareholders begin to
suspect a short position exists in their security, they can not
discover this from any published source. The price
of the stock remains constant, or goes down, even though there is
unusually heavy buying ... buying that goes on for years in some cases.The company thinks that there is someone illegally shorting their
stock in an attempt to ruin the company. The shareholders think that
the company is illegally printing shares behind
their backs and is scaming them. Eventually, this distrust between
the company and it's shareholders becomes so great that investors
start selling, or the company, already damaged
by a supressed share price, is forced to issue additional shares into
the market because other collateral-backed loans can not be made with
share prices so suppressed.This is what the market maker is waiting for ... sometimes for as
long as years. In both cases, the market maker eventually gets his
naked short position covered, and all it cost was
the company's reputation, the shareholders' money, and the SEC's
full cooperation by allowing this abuse of the rule.There is a third situation that the market makers naked short
into ... a stock that is a likely prospect for failure. In that
case, they just continue naked shorting no matter what,
keeping the price suppressed, and eventually the company files
for bankruptcy, and ... the company goes out of business, the
shareholders
lose their investment ... and the market maker keeps the
proceeds of his continued naked shorting.A good question for the SEC would be, "Seeing as how the
companies that failed never got the proceeds of the sale of
stock over and above their issued and outstanding, but the market
makers did, isn't the SEC allowing actual fraud to take place,
and condoning it by the creation and continued existance of this
rule?"Like it or not, the SEC has allowed securities fraud to run
rampant in the OTCBB and Pink sheet stock markets by simply
looking the other way and allowing the market makers to target
the OTCBB and Pink sheet markets as a source of huge amounts of
cash, literally stolen from investors by the third party creation
of shares by an entity other than the the issure - the company.This rule is nothing less than blanket permission by the SEC for
market makers to become the issuers of company stock, no matter
what the company's official authorized and issued amounts are.Sincerely,Stanley Podlofsky
80 Sycamore Street,
Massapequa, NY 11758
516-799-5121