Two San Antonio firms claim fraud stinging stock

'Naked selling' scam shorts share value, they allege

By Mike W. Thomas
February 2, 2004

Just six months ago, Tidelands Oil & Gas (OTCBB: TIDE.OB) saw its stock fall to 12 cents a share from a high of $4. For the next three months, the company's stock price slowly began to climb back up until it went above $2 per share. Then suddenly in November, the stock began to dive once again, dropping nearly $1 in one afternoon.

Company founder and CEO Michael Ward issued a statement at the time stating that there had been no change in the company's business developments that would support such a decline in the stock price.

"In fact, we recently announced our first pipeline crossing into Mexico at Piedras Negras and Eagle Pass on Nov. 10, 2003, which marked a milestone in the history of our company," Ward said.

So how could good news for the company, which had recently moved to San Antonio, result in a sudden decline in its stock price? According to Ward, the culprit was stock market manipulation.

"There is a large short position in our stock and we have good reason to believe that for a considerable amount of time our company's shares have been manipulated by these short-sellers," he says.

Short selling is a common practice on Wall Street where investors can borrow stock from a broker to sell with the hope that the stock price will decline before they have to return the shares back or cover their position.

But there is a seamier side to the practice of short-selling called "naked shorting" -- whereby groups of people can manipulate the market by selling fictitious shares of stock in an effort to force a company's share prices to go down.

These naked short sellers tend to prey on small companies whose shares trade on the over-the-counter bulletin boards. Ward says he believes his company became a target of the naked short sellers about two years ago.

"We have a huge short position on our stock," Ward says. "The people who are shorting our stock have deep pockets and they really had us on the pavement at one time. The only way we have been able to weather the storm is because we have a good, large shareholder base."

In certain cases involving legitimate market makers, naked short selling is a legal practice. However, Ward claims more and more small companies are being victimized by illegal naked-shorting schemes carried out by unscrupulous players.

Perseverance

Gene Kazlow, a New York-based investor who controls about a million shares of Tidelands stock, says the naked short sellers may have finally met their match in Tidelands' case, though.

"Tidelands is about 40 or 50 million shares short, so this stock is going to explode when they get some really great news, which I think is imminent," Kazlow says. "I think some shorts are starting to cover now because this stock could go to 20, 30, 40, 50 dollars."

An investor holding a legitimate short position on a stock has borrowed and sold stock on the bet that the stock price will decline, at which point the investor can buy back shares at the lower price to cover his position. If, however, the share price increases, the investor has to purchase the stock at the higher price to replace the borrowed shares and is out the difference.

In an illegal naked short-selling scheme, the "investor" doesn't bother borrowing the stock and churns the same shadow shares in multiple short sales. That fraud is at risk of being compromised if the stock price increases.

"These people (naked short sellers) have tens of millions of dollars at stake and they have an investment in being right," Kazlow continues. "There are many different groups, some of whom work in concert with each other, and they don't trade under their own names. They trade under the cover of offshore corporations and they live in a gray area. They probably don't pay taxes and they are criminals.

"You can't prove it and you're not going to catch them, but we are going to punish them on this stock."

Ward says he believes Tidelands' perseverance may have finally allowed it to escape the short sellers' grasp. The company's stock is now past $3 per share and climbing. If that is the case, they would be one of the few to survive the ordeal, according to James Christian, a Houston-based attorney who along with John O'Quinn has represented hundreds of companies in lawsuits alleging naked short selling. O'Quinn is renowned for having won billions in settlements and verdicts against companies that make cigarettes, breast implants and other products.

Fighting back

One of Christian's and O'Quinn's clients is San Antonio-based ATSI Communications Inc. (OTCBB: ATSC.PK), which filed a lawsuit a year ago alleging that two groups of investors engaged in naked short selling of its stocks. The ATSI case is still pending before the U.S. District Court in the Southern District of New York.

"We think this entire matter has impacted thousands of public companies," Christian says. "Our economist says the market-cap loss to those companies just based on the fraud (illegal naked shorting) is about $700 billion to $1 trillion."

Christian says the average decline in value for companies that have been victimized by naked shorting is 94 percent. Most of those companies have been forced out of business, he adds.

ATSI's board of directors addressed their situation in their most recent Schedule 14A filing with the Securities and Exchange Commission (SEC):

"We believe that the price of our common stock may be artificially depressed due to abnormally high short-selling by speculators who are not stockholders. We believe that these sales are conducted through a practice commonly known as a 'naked short' sale. Certain brokers may have permitted their customers to sell shares that are neither owned by such customers nor borrowed from another stockholder. As a result, the broker has not delivered the shares sold to the purchasers.

"If this practice is widespread, it creates severe pressure on the price of our stock since there is no limit on the number of shares that are traded."

ATSI CEO Art Smith says the company is currently undergoing a re-incorporation in Nevada in an effort to shine a light on some of the people who have been driving the company's stock price down.

"An important reason why we are going through this reincorporation in Nevada is to squeeze out some of these guys that have been naked short selling," Smith says. "The re-incorporation in Nevada will permit us to require the delivery of certificates representing our shares for exchange in connection with the re-incorporation or subsequent changes in our capital structure. We believe that the practice of naked short sales, and the depression or our stock price which it has caused, will be discouraged as a result of the merger."

Criminal elements

Getting a bead on who is manipulating the market through naked short selling is difficult at best. Most of the illicit trades are carried out using shell companies based overseas, Christian says. But recent sting operations carried out by federal authorities have revealed the involvement of all five major crime families, he adds.

"This is one of the largest commercial frauds in U.S. history," Christian says. "It is financial terrorism on America."

Christian says that any small company sucked into a naked-shorting scheme faces an uphill climb in preventing their stock from going into a death spiral.

"We have companies that have traded more shares in one day than they have issued and outstanding," Christian says. "We have several companies who in 90-day periods have traded 170 million shares while only 50 million of those shares have cleared. The difference is naked shorts."

The gatekeepers

Christian says the practice of naked short selling is supported by an intricate web of broker dealers, clearing firms and offshore companies. He even puts part of the blame for the continuing problem on structural issues within the Depository Trust Co. (DTC), which oversees the electronic exchange of stocks.

The DTC, a subsidiary of the Depository Trust & Clearing Corp., is a member of the U.S. Federal Reserve System. DTC operates as a limited-purpose trust company under New York State banking law and is a registered clearing agency with the SEC.

The depository was established to bring efficiency to the securities industry by retaining custody of some 2 million securities issues, effectively "dematerializing" most of them so that they exist only as electronic files rather than as countless pieces of paper.

Tidelands CEO Michael Ward, who is considering taking legal action against naked short sellers similar to that taken by ATSI, says the weak link in the current DTC electronic trading system is the lag time involved in delivering the stock certificates that people are purporting to sell.

"Because it is all done electronically, the actual stock certificates don't trade hands until days later, if at all," Ward says.

In a statement last year, the DTC denied that it facilitates naked shorting in any way:

"DTC rules do not allow its participants to be short in deliveries to other participant firms. While a brokerage firm can lend shares to an investor, the brokerage firm cannot be short in delivering shares to another brokerage firm through DTC. If necessary, a firm can and must borrow shares from one or more brokerage firms that currently have enough shares in inventory to lend. Brokers who fail to deliver shares owed at DTC are subject to penalties."

But Ward says such penalties are rarely handed out. Such lax enforcement is one of the reasons Tidelands attempted to exit the DTC's electronic trading system last year before the SEC stopped them. The SEC began in 1999 looking at making changes to its short-selling rules to address some of the concerns raised by companies like Tidelands, but it has yet to take action.

"The SEC says they will do something," Ward says. "I think that they will spank a few hands, but it will take years to reform the system."

San Antonio Business Journal - February 2, 2004
http://sanantonio.bizjournals.com/sanantonio/stories/2004/02/02/story1.html

 

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