Tuesday 1st June 2004

Naked shorting is the sale of fictitious shares – i.e. the seller either is NOT required to make an undertaking that he can or will deliver the stock he has sold, or simply fails to deliver. This practice – thought by many to be immoral - is quite capable of bringing a blameless small company to its knees through no fault of its own, although it is fair to say that some weak organisations do cite it as an excuse for their own poor share price performance. On 1st April 2004, new regulations in the US made the practice of naked shorting just about impossible, by requiring that sellers of any stock must be able to deliver the sold shares within 2 days of settlement.  

Between January and April, hundreds of US companies found themselves listed in Berlin, on the Berlin Stock Exchange, without their knowledge or consent. Why might this be?

 An overview of what is being called “Stockgate” appears here:

http://www.friedlandfinancingnews.com/052204%20Friedland%20Corporate%20Finance%20News.htm

The Financial Times had this to say:

http://www.rgm.com/articles/ft7.html

Another of the many commentaries from the US is here:

http://tfc-charts2.w2d.com/forum/index.cgi?noframes%3bread=294241

All of these cite the “arbitrage exception” to the naked shorting rules as being a loophole which can be used now that these companies are listed on a foreign exchange. The wording of this exception – Rule 10a-1 (e)(8) is as follows: (NB – “paragraphs (a) and (b) of this section” refers to the short selling rules)

(e) The provisions of paragraphs (a) and (b) of this section (and of any exchange rule adopted in accordance with paragraph (a) of this section) shall not apply to:

(8) Any sale of a security registered on, or admitted to unlisted trading privileges on, a national securities exchange effected for a special international arbitrage account for the bona fide purpose of profiting from a current difference between the price of such security on a securities market not within or subject to the jurisdiction of the United States and on a securities market subject to the jurisdiction of the United States; provided the seller at the time of such sale knows or, by virtue of information currently received, has reasonable grounds to believe that an offer enabling him to cover such sale is then available to him in such foreign securities market and intends to accept such offer immediately;

Nowhere is the actual use of this loophole spelled out – but the implication appears to be that the stock is SOLD in the domestic market, in anticipation of immediately BUYING at a lower price in the overseas market to cover the sale and make a profit from the difference in price. However, for this to be a “loophole”, there must be an advantage to the US seller – thus one can speculate that if the seller then fails to purchase in the foreign market, the wording of “reasonable grounds to believe” appears to permit any number of excuses for such failure to cover the short. In the meantime, the now-naked short remains open….or is eventually settled via the stock borrow program of the US Depositary Trust and Clearing Corporation (DTC). 

So what has this to do with UK listed companies?

Go first to http://www.berlinerboerse.de/?LANG=en

Choose About Us

Choose New Companies

Choose Listings

Then browse through the pages to understand the sheer scope and scale of what was done in just a few weeks during March and April 2004. Allegedly, the bulk listings began earlier than this, but I cannot find evidence of dates on the BSE’s website prior to 1st March.

145 UK listed companies – largely small caps and speculative stocks – have been listed on the Berlin Exchange since 1st March. At the same time, hundreds more companies from all over the world, but mainly from the US and Canada, were also listed, largely by the same brokers - 1170 and 1172. It is notable that the majority of companies listed are small cap and/or speculative stocks, particularly the huge number of mining and exploration vehicles.

A Google search turns up very many US companies complaining bitterly that within only weeks of the effective outlawing of naked shorting in the US on 1st April, they have discovered that they are now exposed WITHOUT THEIR KNOWLEDGE OR CONSENT to the same activity via – apparently - the arbitrage loophole.  The Berlin Stock Exchange deny that the exchange is being used for naked shorting, but it is a remarkable coincidence that highly speculative US short targets, many of them already in severe trouble, suddenly end up - in their hundreds - listed on a foreign exchange within a very "short" period indeed of the ending of the practice in the US. It is a fact that one of the complainants, Goldspring, which now appears to have been removed from trading, had been listed in Berlin in late November 2003. Its price experienced a fairly volatile rollercoaster ride, from 0.45 Euros in November to approximately 0.8 Euros by mid-Feb. On 1st April the price in Berlin was 0.7 Euros, but immediately began to fall sharply, and by early May, when Goldspring requested the removal of their listing, the price was down to 0.4 Euros. Interestingly, no volume AT ALL was recorded for the stock during the entire period of its listing – a common feature of the recently listed US and UK stocks. There is virtually NO trading going on in Berlin in the shares of these companies. Which once again raises the question: why were they listed?

Are UK companies also being targeted via a similar route?

Of small cap UK companies that have suffered recently, Bioprogress and Proteome Sciences spring to mind. Both have halved from recent highs, partly due, it has been thought, to organised shorting by hedge funds intent on destabilising a substantial margin trade position to bring the stocks ever lower

Proteome Sciences (PRM.BE) has been listed on the Berlin Stock Exchange since Autumn 2000. Bioprogress – as discovered by a sharpeyed ADFVN bulletin board poster known as “Scram” - was listed on 21 April 2004 (BPRG.BE).  Both companies are known in the US through an earlier listing on the OTCBB in the case of BPRG, and commercial relationships in the case of PRM.  On 1st April – the day from which the focus of US naked shorters was switched to stocks listed in Berlin - Proteome was standing at £1.90 per share, having reached £2.30 on an earlier high, and had been trading steadily for the previous month in the £2.10 - £1.90 range. Bioprogress had come off an earlier unsustainable high at £1.60 to a 6-week trading range of £1.00 - £1.20.

On 1st April, Proteome Sciences’ share price began to fall sharply and by 28th April had reached 90p.

On 29th April, just 8 days after listing in Berlin, Bioprogress began a rapid descent to 75p by 14th May .

Neither have recovered more than a fraction of their earlier highs.

Coincidence?

Perhaps – but perhaps not.

Many companies have had a hard time of it during April and May, which has been put down to poor market conditions, macroeconomic effects throughout the world, and general underperformance. In the particular cases of Bioprogress and Proteome, traders were becoming increasingly nervous as expected commercial deals failed to materialise.

However, six other UK companies were listed in Berlin on the same day as Bioprogress – 21st April. Their short term charts make interesting reading:

Regal Petroleum – share price declined from 10 May

Pipex Comms – share price began a decline at the end of March, which has steepened since 29 April.

RAB Capital – share price commenced a decline on 20 April, corrected a little on 26 April, but resumed an overall downtrend on 28th

African Gold – share price decline commenced 22 April, flattened off from 26 April – 6 May, and then resumed the downtrend.

Oystertec – follows a similar pattern to Pipex, though the price has since recovered

ASK Central – the company was under offer, which became conditional in early May – hence there was no share price effect.

Several more UK companies were listed on 28 April. Of these:

Supercart’s price – already in decline from 54p to 36p – fell to 23p between 29 April and 20 May.

Visonic, after two weeks of trading sideways, commenced falling sharply on 30 April

Omega Int began to fall from £1.23 on 4 May to £1.04 by 20 May

The charts of two more companies listed on that day, Dignity and Polaron, show them to have been good short candidates. Dignity had experienced a sharp rise – and Polaron appeared to be rapidly declining. However, neither appeared to have suffered ill-effects after their Berlin listing.

Another group of UK companies were listed in Berlin on 1 March 2004. A review of their charts is even more interesting! The companies involved are Golden Prospect, Gold Mines of Sardinia, Glencar Mining, Eurasia Mining, Avocet Mining, Randgold, African Eagle, Oxus Gold, Griffin Mining and Tertiary Minerals. It is worth noting that most of the UK companies listed since 1 March are highly speculative, many illiquid, and several were already excellent short candidates. In fact, one has to wonder why this relative handful of 145 companies have been added at all, if it were not for the fact that most of them, at some point, will be or have been first rate shorts.

All the above looks at only a few of the UK companies listed in Berlin during the last 3 months, and any evidence that they are being targeted by naked shorters is purely circumstantial. However, the charts and the general absence of any trading in these stocks on the Berlin Exchange do appear to be telling a story.

It is clear that there are many more UK companies enjoying a Berlin listing, in addition to the 145 that have been listed since 1st March this year. A random input of various UK tickers, particularly those of speculative stocks, into the Berlin Exchange’s search facility turns up a result in many cases. Some will no doubt have chosen to be listed there – others may as yet be unaware. How many more of these older listings are now increasingly vulnerable to a shorting community focused on the Berlin exchange?  Proteome Sciences might be a salutary example.

Finally - could it be that the “generally poor market conditions” which have been given as a reason for sliding prices in many UK listed smallcap and speculative stocks have been a symptom rather than a cause?  

Wendy Durham 1st June 2004
 

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