security positions sold but not borrowed. In addition, short sellers are able to nullify buy-ins which are issued by re-shorting prior to or soon after a buy-in notice is received, in effect indefinately postponing delivery. The CNS clearing system and its lax rules and controls invite short selling abuses. Unde: CNS, a short seller is not being forced to make delivery of stock sold on a timely basis. Neither are fails at settlement date being pursued adequately by CNS. CNS acts as a middleman, clearing trades for each broke and on a daily basis takes in securities and delivers them out. The problem originates because CNS is continuously in a short position whereby timely deliveries cannot be made because timely receipts are not made. In effect someone in the system is continuously being delayed in receiving stock until some new trades (hopefully long sales) hit the CNS which will enable the system to deliver out. CNS were to operate on a flat, daily position, there would be no indefinite shortage of securities, deliveries would be forced daily and any naked short positions would be revealed. The reason the shortage is never a problem is because of the fact that trades are continuously done, and there is the hope that eventually the system will balance out via some long sales. This might occur over time; however, in the short run, naked short sales cause massive delays in stock deliveries. The naked short sellers keep hoping that the system doesn't catch up with deliveries before the target stock price collapses from the artificially excess supply. The same firms violating NASD laws with regard to the initial short selling are the same firms who are continuously on the fail to deliver list at settlement dates. Another violation occurs when a buy-in is issued against a short seller on behalf of a long. Actual buy-ins are rarely done because under the current rules the party doing the buy-in has to notify the party being bought in in advance and give that party time to respond. Usually a two day automatic extension is issued, which more often than not gives the short enough time to borrow the shares from someone else and supply them under the buy-in. However, this delivery is in actuality someone else's shares, so the buy-in threat is passed on to the next long buyer who did not get his shares at settlement. In other instances, a short seller who is confronted with a buy-in notice will start laying out new short positions in anticipation of being bought in. At the time the actual buy-in takes place, the short has a new position out and will allow his old short position to net out in the CNS. This has the effect of rolling over the short position and continuing the vicious cycle again until the next buy-in. Another serious violation of securities laws by short sellers. All of the above practices attack the credibility and controls cf the The NASD has fallen far behind the exchanges in monitoring these abuses which in many ways presents a mirror image of the listed markets of the pre-September 1929 period. These predatory practices violate the intent of the 1983-34 Securities Acts which forbade this type of manipu lation in the listed markets. If the action is not taken to preve large clients from controlling NASD firms by a new form of greenmailgigantic commission and stock loan income for those willing to viclaze the rules that we have created for our community to live under consequences could be severe. More and more companies will depart the NASD system and leave law suits behind. Eventually, if history is a lesson, the SEC and Congress will determine that we have compromised the principles of self regulation for the benefit of a group of unprincipled fimms who miçn= best be eliminated from our community. There is little doubt that if a long buyer failed to pay for stock, was sold out to himself to prevent a large loss only to fail to pay once again, and then repeated the procedure again and again, that buyer would no longer be able to trade and most probably would be accused of manipulating markets. The converse is being carried out ca the short side with failure to deliver stock and capping the buy-ins, the equivalent of failing to pay and rebuying the shares. The soluzion should be either compulsory delivery on settlement date by the entire community or delayed delivery by mutual consent. Anything less will encourage continued viciations of NASD with the attendant unwarranted destruction of companies and severe losses to unsuspecting investors. Illegal bear raids have been dealt with harshly by the exchanges and they should have no place in our community. Sincerely yours, RAS:20 Robert A. Spira Mr. BARNARD. Thank you very much, Mr. Spira. We will now hear from Mr. Robert J. Flaherty, who is the editor of the OTC Review. Mr. Flaherty. STATEMENT OF ROBERT J. FLAHERTY, EDITOR AND PRESIDENT, OTC REVIEW, INC. Mr. FLAHERTY. Thank you. My name is Robert Flaherty, and I'm editor of the OTC Review. I have written or edited scores of stories concerning short selling, including some award-winning ones, and our magazine cosponsored the Short Symposium some years ago where hundreds of executives, regulators, analysts, and journalists discussed the subject of abusive short selling. Let us agree at the beginning, legitimate short selling is beneficial, legal, adds stability. Publications which assist shorts in exposing fraud perform a public service. In theory-and I say "in theory" because for a select network of secret short sellers the system doesn't work this way-ordinary investors first borrow stock from their brokers then sell it, and their brokers deliver the borrowed stock to the buyer. In theory, a short sale will not be executed if the stock cannot be borrowed. Therefore, in theory, a short-selling position cannot exceed a company's available float or the even smaller normal amount of shares available to borrow. Profits from successful short selling can be fantastic, but so can losses, since there is no limit to how high a stock can rise. Unfortunately, the possibility of such large gains, combined with unlimited risks which can terrify people, attract aggressive speculators who will bend or find a way around existing rules if they can. The sooner they can make a stock go down, the sooner the pressure on them will ease. As editor of OTC Review, I have observed many bear raids where a network of secret short sellers, working together, attacked the stock of emerging companies. I, by the way, am not the first person to use the word "network," it was used in an award-winning story in the Wall Street Journal. Often backed by wealthy interests such as the Bass Brothers, the raiders' market power can swamp small market makers. The raiders' combined activities appear to go far beyond mere selling shares short and hopefully waiting until fundamentals deteriorate and targeted shares fall sharply and can be bought cheaply to cover the short positions. If that was all they did, I would have no complaint with them. Leaders of this network have been given well-deserved nicknames by security traders, like "the Mortician" for Edward Washington Rose III, and "the Stockbusters" for the three Feshbach brothers. Members of this network act as financial euthanasiasts by killing or hurting the underlying company so its stock will drop. They have engaged in naked shorting, where they do not borrow the shares when they short, so they can overshort and exert extra downside pressure. They have learned how to manufacture shares to borrow artificially so again they can overshort. I have listened to short sellers explain how their shorting can create shares so it does happen. They have developed symbiotic relationships with regulatory agencies, such as the SEC, so they can provide information which can trigger investigations. Sometimes shorts spread rumors of future investigations which never occur but frighten outsiders and hurt shares. They speed dissemination of bad news to the press and also often to the target company's current and prospective customers, suppliers, financial backers, and friendly market makers and institutional shareholders. They do heavy prepublication trading even up to hours before the appearance of the first negative article which follows their story line and usually was initiated anonymously by one of the short selling network. Frequently, the integrity of the company attacked is questioned and also the integrity of the company's management, earnings, accounting, or products or services, but the shorts are not mentioned at all. Their role in causing or worsening a company's problems often goes unreported. Usually, the heavy prepublication trading isn't mentioned either. Over the years, when people have interviewed me, this is the one area that is usually left out of stories when other journalists write about it. Shorts like Rusty Rose, who initiate many of these negative stories and then short heavily, manage money for very wealthy people like Texas' Bass family. Here is another case where the rich get to invest before the stock moving story appears while the ignorant average reader is the last to know as usual. If the prepublication trading that has been going on for decades is legal, it is certainly not ethical, and I should make the point here that this is nothing new, this prepublication trading has been going on all the way back to the twenties. It is the one area, it is the most unchanged area, since the 1920's, at least as far as financial journalism goes. Short selling abuses contributed to the great stock market crash in 1929. We all know about these short pools rigging prices, acting on inside information, numerous sham transactions, spreading rumors and lies to move stocks. Like today's network, they sold stocks in groups where the wave of selling hammers down prices and destabilizes the market. At least in terms of this last mentioned activity, selling in groups, I fail to see how today's short-selling network is different from a Roaring Twenties pool. Most of the old abuses went on with exchange listed stocks, as Mr. Spira noted. The OTC was too tiny and insignificant for such actions. In the thirties, the exchanges initiated this retail uptick rule which, by the way, many today argue is easily gotten around. In 1938, the SEC adopted the uptick rule. Since my written testimony covers it, I won't go into exactly what the uptick rule does. The OTC really emerged with the creation of NASDAQ over the last two decades and has no similar rule. Because I can see the committee is more interested in the effect of shorting on emerging companies, I will skip the next section, other than to say that I feel that the uptick rule should also be applied to program trading, because the whole idea of the uptick rule was to prevent short sellers from hammering stocks down in a falling market, and it seems to me that when you exempt program trading from the uptick rule you are letting a mindless computer do what you would stop individuals from doing, and the reason this rule was put in is, the public was frightened by the volatility of the market, so I would like to see the uptick rule also go into program trading if you want to bring the public back. They are not going to go back if computers or individuals can hammer shares down. I first became aware of this network in July 1984 when we did an award-winning story called the Secret Short Sellers. I mentioned names of them, and it was interesting, we scooped some very famous publications. Some of these short sellers had never been mentioned in print before because they always got anonymity before they acted, and I didn't grant anonymity to anyone. It wasn't necessary; all you have to do was call a market maker, and they will tell you who is shorting. I am now going to go to this set of possible abuses that I have seen that affected specific emerging companies. As editor of OTC Review since 1981, I have watched well-organized groups of secret short sellers go after promising OTC companies and try to destroy or cripple them. The stocks of some target companies were hyped too high, and the companies deserved to be destroyed. There, the shorts did a public service. But some legitimate entrepreneurial efforts suffering the normal growing pains of emerging companies were subjected to such abuse that they never were the same again. Some lost their public credibility and their ability to raise more money. Blocked, their management permitted their company to be acquired to survive or to finance growth. Recently, Lyphomed and Vipont are two examples where shorts had really destroyed their ability to raise money. They had to go to outsiders to buy them out. The businesses are perfectly all right and will be OK. The most frequent abuse is flattening a stock by spreading rumors which contain errors or untruths or give a misleading image of the company. False material to move stock prices down is just as wrong as when false materials levitate a stock. Samples of rumors that smeared a company's image or undermined management's credibility are-and I have picked all these up not only from companies but I have confirmed them with market makers who said they did hear of them-the abstemious ex-chairman of Keystone Medical was rumored to be a drunk; a perfectly healthy one-man-band head of AT&E was said to have terminal cancer; that dropped his stock from 20 to 8; the board of directors of Occupational Urgent Care Health Systems were said to be crooks; its president was falsely accused of running a Ponzi scheme; its earnings were branded fake; receivables of International Telecredit were said to be no good; a bank run was supposed to be occurring at Florida's Sunrise Savings on a July day when the branch was empty; proposed joint ventures with larger companies, Bechtel, for instance, at American Surgery Centers, were labeled fictional. I talked to Bechtel, and they showed us a report they spent $15,000 to create. At AT&E, a deal they had with Seiko was said to be collapsing, and it wasn't. Interestingly enough, in most cases people believe the short sellers and not the companies. Lloyd Cherne of Cherne Industries is trying to replace the step test with his passive measurements in his Cherne Chair. Now here is a brave entrepreneur, and he is selling his existing business to |