Agoracom, it would be appreciated if you could please pass this message on to the attention of Mr. Nemis.

I feel that it would be an injustice to most shareholders if Mr. Nemis is not privy to some of the information contained in this article.

On behalf of all "Long" Noront Shareholders, thank you in advance.

The Crime of the Century

JOHN: Financial Sense Newshour continues the BIG Picture here. We're actually in hour three of the BIG Picture at www.financialsense.com.

In March of this year, Jim, you interviewed the CEO of www.overstock.com. That was Patrick Byrne, regarding naked short selling. And also at that time, Bloomberg television did a half-hour special. They still have it posted by the way. You can get it on naked short selling. Let's review with a clip from Bloomberg on what some people are beginning to call the “crime of the century.”

[`Phantom Shares,' Failed Trades and Naked Shorts Transcript]

HATCH: Well how can we allow $6 billion a day not to be reported? It ought to be stopped.

COX: And intentionally failing to deliver that stock within the standard three-day settlement period can be market manipulation that is clearly violative of the Federal Securities laws.

O'QUINN: Which is just stealing is all it is. This is all an example of stealing.

CHANOS: It sounds ominous. It sounds nefarious. And by and large it's a non-issue in the marketplace.

ANGEL: Is somebody manipulating the shares? What is going on here? It certainly smells bad.

SCHNEIDER: Welcome to this Bloomberg News Special Report. I'm Mike Schneider.

Stock manipulation. It's a problem that dates back to a time when Wall Street was just a wall. Built by the Dutch back in 1653, it stood 12 feet high, and ran pretty much beneath where I'm standing right now.

Over the centuries, investors have learned many tricks to drive stocks both up and down. One of the newest ways to drive them down – and you can make lots of money doing that – is with an obscure Wall Street trading tactic called naked short selling.

In a normal short sale, an investor borrows shares and sells them. If the price falls, he profits by replacing those borrowed shares with cheaper ones. But in a naked short sale, an investor fails to deliver the shares because he doesn't borrow them.

In extreme cases, he even sells phantom shares – shares that don't even exist.

While naked short selling is legal, manipulating markets is not, and regardless of intent, the effect of naked short selling can be the same – driving share prices lower.

Our story now begins with a man who has done more to call attention to this problem than anyone else.

BYRNE: There is in place a system. There is an Al-Qaeda, so to speak, a loosely organized group of people who are destroying small companies and looting the savings of America.

Gather round. We're doing our morning meeting this afternoon. Come on in.

SCHNEIDER: Meet Patrick Byrne, the outspoken CEO of Overstock.com, an Internet retailer based in Salt Lake City that went public in May 2002.

For the past two years, Byrne has been complaining that naked shorting has driven down share prices in thousands of small public companies, including his own, by permitting the sale of stock that, in some cases, doesn't exist.

From January 2005 to January 2007, Overstock share prices dropped nearly 70 percent.

BYRNE: It's a really simple concept, and when you get to it, you think, what's all the hullabaloo about? It's really basic. There are people selling things and not delivering.

SCHNEIDER: The 43-year-old Byrne, who counts Warren Buffett among his friends, says his troubles began after Overstock reported a profit for the second time in its history, in the fourth quarter of 2004.

UNIDENTIFIED: It is my privilege to welcome Overstock.com to NASDAQ this morning as we honor their accomplishment as one of the most innovative and successful Internet companies in recent history.

SCHNEIDER: In 2004, Overstock's sales had more than doubled, to nearly $500 million. Its stock had tripled.

But the high fives and champagne soon gave way to disbelief. From a high of $77.18 in December 2004, Overstock shares began tumbling. By December 2005, they collapsed to a low of $28.02.

Byrne become convinced his shares were being manipulated, a conclusion also reached by Tom Ronk, the President of Buyins.net. Ronk sells data on short sales to companies and investors.

RONK: Overstock is a - is the poster boy of naked short selling. What's interesting is that, from January 1st, 2005, Overstock.com has been on the naked short list for 91 percent of the trading days. In that exact same period of time, over 86 million shares have been shorted in Overstock.

How is that possible? It shouldn't be.

SCHNEIDER: Ronk says naked short selling explains the huge decline in Overstock shares that January, when the stock fell 20 percent in just one month.

RONK: We have found very large drops in U.S. stocks in one- month trading periods. So, we're seeing that, when they first come in and attack, they hit it hard. They really hit it hard, because they can get away with it. And they cause the largest damage to the stock usually in the first wave of selling.

SCHNEIDER: Overstock is just one of hundreds of companies considered at risk for manipulation by naked short sellers. They appear on stock exchange lists mandated by the Securities and Exchange Commission's Regulation Short Sales, or Reg SHO. These threshold lists consist of companies with too many trades that can't be settled because stock is not delivered to the buyer, so- called failures to deliver.

ANGEL: I mean, some people use the phrase counterfeit stock to describe the phenomenon, that if you can sell stock and you never have to deliver, it's going to have the same impact as selling, selling and selling. It's going to push the price down.

What is naked short selling?

SCHNEIDER: Angel says not all failures are the result of traders trying to manipulate stock prices. Some may be caused by clerical errors.

Overstock was on the list of failed deliveries that U.S. Exchanges released in January 2005. Along with Overstock were more than 240 other companies on NASDAQ's list, among them some familiar names - Trump Hotels and Casino Resorts, Global Crossing, Netflix, TASER and, U.S. Airways.

The New York Stock Exchange had nearly 60 companies on its list, including Delta Airlines, Martha Stewart Living Omnimedia, Krispy Kreme Doughnuts, and Winn-Dixie Stores.

And the problem is not going away. Since Reg SHO took effect, more than 4,500 companies have been affected by stock delivery failures severe enough to qualify them as threshold securities. That's roughly one in three companies traded on U.S. exchanges, the majority of them with small or very small market caps. [7:36]

JOHN: That was from a Bloomberg program, which is actually still available on the internet that came out much earlier in the year. Just how big is the issue of naked short selling, Jim?

JIM: Well, you know, as you heard at the beginning of that Bloomberg report, this thing, John, is huge. And when I say huge, I really mean that. This is so much bigger than the insider trading that the politicians are focusing on now. And what this boils down to is counterfeiting. Now, think about this for a moment, John. Let's say you and I decided we wanted to make some extra money. Let's say in your basement we set up a printing press and we started to counterfeit and print US dollars. How long do you think it would be before the Fed showed up on our door step? [8:17]

JOHN: Well, given some of their response in previous issues, not too long at all.

JIM: Absolutely. But here's the thing. When it comes to counterfeiting shares, regulators in the US and Canada, and especially Canada, are asleep at the wheel.

JOHN: How does this take place? I mean basically, these are supposed to be the watchers on the wall and the watchers don't seem to be watching.

JIM: In the US and Canada, we've seen a process that was developed in the securities sector where investors are basically separated from their shares in a process called dematerialization. And as a result when investors buy or sell stock, they are basically really trading security entitlements not actual stock certificates. And according to the SEC director Erik Sirri, the beneficial ownership, John, cannot be tracked to a specific share. In other words, you can't say, “oh, I bought my shares from Mr. Smith at ABC brokerage.” What you really do is you own a bundle of rights defined by federal and state law and by their contract with a broker, which I'm sure is news to probably most people. Brokers in the US and Canada receive commissions when buyers pay for shares, not when sellers deliver those shares. Thus, you have incentives for brokers and their large institutional customers, mainly hedge funds, who regularly use these loop holes to avoid delivering shares at all. The result is something what we call an FTD or a failure to deliver, or in this case, a naked short sale. [10:06]

JOHN: Well, there is something radically wrong here when regulators allow this to happen. I mean it would seem to me that there are other issues here besides cheating and stealing from shareholders.

JIM: Well, this goes beyond cheating share holders. Bob Drummond, an investigative reporter for Bloomberg, wrote a piece in a recent study about these phantom shares that are created through naked short selling and he said it's basically even moved into the area of corporate governance. In an analysis, according to Drummond, of 341 companies taking a look at corporate votes in 2005 by the Security Transfer Association, John, there was evidence of over voting in all 341 cases. In other words, 100 percent in the sample showed over voting, and that was the result basically of naked short selling. [10:55]

JOHN: Well, what other risks are created through naked short selling? This is not just one or two cases. This is almost endemic.

JIM: Oh, it's endemic throughout the whole system. Naked short selling distorts, John, share prices by flooding the markets with excess supply. This was something that security chairman of the SEC [Christopher] Cox said: It harms share prices for investors and has now become a common means of manipulating share prices in the US and the Canadian equity markets. It creates also, and here is something that goes well beyond this, it creates systemic risk. According to the DTCC, on any given day, these Failure To Delivers account for almost 6 billion more and people that have looked into this actually think that that's understated. In the words of a gentleman by the name of Bradley Abelow, a former DTC director, he calls FTDs “endemic” –the word you just used – and what has happened is the stock market has turned into a game of music call chairs where the claims of ownership exceed shares issues. What happens when the music stops? Think what happens, John, if there is a large naked short position and a company decides to, let's say, declare a dividend. And the company looks at it's books and says, oh, we have 50 million shareholders and we're going to declare a dollar dividend, so we're going to declare, let's say, 50 million in dividends. What happens if brokerage firms are showing that there are sixty million shareholders? Or even worse, what happens, if for example, let's say you're a junior mining company and you have, I don't know, 50 million shares, and let's say someone makes a take over and they are going to offer, I don't know, 3, 4 dollars a share and then when they add up all of the shares, you find out instead of 50 million shares, you have 60 million shares. So you've got corporate governance issues.

And it's like anything else, John: It's supply and demand. And with naked short selling, you're bringing more supply in the market and it's a way in which the short sellers, unable get enough shares to short into the market bring in and create, artificially, just like the Fed creates money shares out of thin air, to artificially suppress the price of the stock. [13:22]

JOHN: Yeah. All permitted because nobody really has possession for the actual shares themselves, so we create this artificial thing out there. But at some point or another, the music is going to quit; right?

JIM: Well, at some point, whether it's a crisis, whether it's a takeover and there are too many shares that have been lifted or printed, or a company declares a dividend or you have a scandal with corporate governance. What if there is a major, let's say, take over and it's put up to the shareholders to vote and then all of a sudden, when they count the votes there are more shares coming in than there are shares issued. How do you tabulate something like that? I mean there is all kinds of ethical issues here besides stealing from investors. [14:03]

JOHN: Yeah. You count chads. That's what you do. It worked back in 2000; right?

JIM: Have a recount. No. It's not working.

JOHN: I want to pick up here again, Jim, another segment out of the Bloomberg reports, just about a minute length here.

SCHNEIDER: Reg SHO is supposed to restrict short selling in threshold securities. Once a company is on an exchange's threshold list, Reg SHO requires prime brokers to settle any new trade failures after 13 consecutive trading days.

But Byrne and other CEOs say the SEC's own data prove that Reg SHO is failing to stop naked short selling. Companies including Overstock, Krispy Kreme, and Martha Stewart each have been on threshold lists for more than 400 trading days.

ANGEL: I can see no reason why sellers should be able to fail to deliver shares for years in name-brand companies. It just doesn't make sense. It raises the question, what is going on here? [15:19]

JOHN: In this report, there is a clearing agency owned by the prime brokers and it seems like if we look at it here, when we look at Reg SHO, the foxes have been put in charge of the help house. All right. Let's go back to the Bloomberg report and pick out one more thing before we talk about this.

SCHNEIDER: Byrne's battle against naked short sellers led him to one of Wall Street's best-kept secrets, the Depository Trust and Clearing Corporation or DTCC. It's just a few blocks from here.

On average, the DTCC says it processes more than $1.4 quadrillion worth of trades a year. That's more than 20 times the economic output of the entire planet. The DTCC also keeps track of the trades that can fail due to naked shorting.

Speaking at a conference just a few blocks from DTCC headquarters, Suzanne Trimbath, who worked for a subsidiary of the DTCC, explained the corporation's role in U.S. capital markets by comparing Wall Street to Broadway.

TRIMBATH: Imagine that all of Wall Street is a stage. The DTCC is like backstage. These are the guys that run the lights and the cameras, the grips and the gaffers, the people that moviegoers really don't need to know what they do, and you don't need to care about it. But we all do need to care about what's happening backstage at the capital markets.

SCHNEIDER: Meantime, Patrick Byrne says he received data from the DTCC that stunned him.

On January 12th, 2006, Byrne says the DTCC data indicated that there were seven million more Overstock shares in circulation than there should have been, a discrepancy coinciding with the steep decline in the company's share price.

BYRNE: If it's only seven million shares, it's 35 percent of our company has been counterfeited. I think I have a fiduciary duty to the shareholders, or the people who think they are shareholders, to clean this up.

SCHNEIDER: DTCC data obtained from the SEC through the Freedom of Information Act also revealed the scope of the failed trade problem. On an average day last March, failed trades amounted to more than 750 million shares in almost 2,700 stocks, exchange traded funds, and other securities.

In all, the DTCC says about $6 billion in trades can't be cleared every day, 1.5 percent of the total dollar value.

In this letter to the SEC, Wall Street's Trade Association, the Securities Industry and Financial Markets Associations, or SIFMA, says trade settlement failures are only a problem for an extremely small universe of securities.

Peter Chepucavage is a former SEC attorney who helped write Reg SHO.

CHEPUCAVAGE: To say it's trivial in the context of the entire universe is a meaningless statement. We all want to know more about how many fails there are with respect to short sales and who exactly is failing.

SCHNEIDER: Because trades can fail for innocent reasons, like clerical errors, the DTCC says it doesn't know how many failed trades can be blamed on abusive naked short selling. A statement on its Web site reads, “While we have data on the volume of fails, we have no information on the underlying causes of those fails.”

DTCC officials declined our request for interviews. DTCC members include the prime brokerage firms that control the $10 billion annual stock lending market and are responsible for many of the failed trades. Officials at SIFMA declined to be interviewed too.

Up next, is the SEC doing enough to crack down on abusive naked short sellers? [19:05]

JOHN: Okay. We have to look at this. This is a serious situation just like Enron. Remember after Enron and it became apparent and everybody wailing and gnashing of teeth, “it's people's savings,” yada yada yada. It's true. It truly is. So how are you going to fix something like this that is so endemic and not just pervasive, but how would I say, invasive to people's investments that they rely on?

JIM: The problem that you have here, John, when you have a corrupt system and you have regulators doing nothing, the only recourse is to take legal means. And that's basically what Patrick Byrne did. He hired a major law firm, the guy that runs this law firm is known as a giant killer because he's taken down major corporations.

But more importantly, there is a real key link here. Is you have to go after the gate keepers and that's the prime brokers and investment dealers in their clients in crime the hedge funds. Because that's what burn did to protect his shareholders. And John, play the clip of his lawyers as they talk about this situation.

SCHNEIDER: The same conviction motivated Patrick Byrne to hire six-foot six-inch John O'Quinn, one of the few attorneys in the country tall enough to look him in the eye, and by reputation, a giant killer.

In Texas, they call O'Quinn the billion-dollar man because he won billion dollar judgments against makers of silicone breast implants and Fen-Phen, and against big tobacco.

O'QUINN: The deal is rigged so bad, I can make this statement safely - you have more chance to be treated fairly in a casino in Vegas than you do in the stock market. The Securities industry has things rigged where they can deal from the bottom of the deck regarding your stock and your money.

SCHNEIDER: O'Quinn's co-council is another Houston-based attorney, Wes Christian. Together they represent some 20 U.S. companies that all claim damage from naked short selling, including Overstock, Sedona Corporation, and TASER. They represent Overstock in a lawsuit seeking $3.5 billion in damages from Wall Street's biggest prime brokers, accusing them of executing short sales with no intention of delivering stock, causing Overstock's share price to drop.

All the accused have declined comment on pending litigation.

BYRNE: If you're a short seller and you abide by all the rules governing short sales, then fine. It's legitimate, it's legal, it's proper. That's not what is going on on Wall Street. What's going on on Wall Street in our cases, and we're now seeing in many other companies is a rigged system. [21:54]

JOHN: I know you and Dave Morgan began, Jim, have talked about the whole issue of naked shorts in the junior sector. Jim Sinclair has written extensively about this. How does this work in the mining sector as well? Because it's obviously everywhere.

JIM: Well, usually, the naked short selling, John, takes place in the junior mining sector is usually associated with the financing; and what happens in a case like this is a mining company goes to an investment bank or brokerage firm and says, “look, we need to raise $10 million to finance next year's operation and drilling program.”

What happens then is the investment bank will contact its institutional clients, usually hedge funds and they'll tell them and say, “we're thinking of doing a finance thing with ABC company and we're going to do 10 million, how many shares do you want.”

And the hedge fund will usually say “okay, we're good for a million, half million, whatever the thing is.”

And what happens then is let's say the price of your shares are selling around a dollar. Then what they do is they go in and start shorting your stock. And then what they do is they drive the price down, to let's say, sixty cents. And so if by doing that they've driven down the price of the shares by 40%. Now, if they had to go into the open market and cover their short position, well, John, they are going to drive the price of those shares back up. But if they can participate in a financing, then what they do is they don't have to go into the open market as a regular investor would have to do to cover the short sale. What they usually do is they cover it through a financing, so basically what they are doing is illegal.

And so in this case, let's say there is warrants associated with the financing. If they can drive the price of the stock down 30, 40%, John, they've got a locked in profit in a four-month period of 40% because they get in on the financing and they get shares that completely cover their short position and they hold the warrants, which they get for free. So usually you will see this associated with the financing. [24:07]

JOHN: I would assume that that's illegal. I mean it's obviously to start with not ethical, but what about the legality of it?

JIM: No. It's illegal because there is nothing wrong with short selling. I mean you can short sell a stock. The thing about short selling, John, is you always know that the shorts are going to have to cover because at some point either the stock starts to rally back, they cover, they lock into their profits and they cover and they bring liquidity back into the market. But with the junior financing arena, it's a little bit different because what they are doing is they are not going back into the market. They are covering their position with the financing shares. [24:50]

JOHN: Okay. I'm getting a little bit confused here. Short selling is straight forward. How does the naked short selling figure into this anyway?

JIM: Usually, this might be because they are trying, they are having difficulty holding the price of the stock down and it may be that it's a company where the shares are tightly held. So basically, they can't get shares or find shares to short to keep suppressing the price of the stock, so what they then do is they go into a naked short position and that's actually what happens. The naked short position comes in normally when they've shorted a lot of shares and they simply can't find other shares to short. So that's when they start naked short selling. So you really have double illegalities here, you've got the naked short selling ahead of a financing and then you have the naked short selling. But generally there is a short supply of the stock and they are having difficulty, because remember if a lot of shares come into the market, you suppress the price. But if they can't find any shares, in other words people are holding onto their stock, they are not selling then they’ve go a problem and that's when they resort to crime and they go into naked short selling. [26:00]

JOHN: But theoretically, you mention crime in there, but nobody is tracking all of this? I mean we don't see all of these active prosecutions going on because of this or fines.

JIM: You know, every once in a while one of these firms will get caught, but I mean, John, at least on the Canadian side the fines are so low that basically crime pays. I mean it's just negligible. You know, it's imbedded. It's almost become institutionalized in the process.

JOHN: All right. So say that we know this is going on and say we know that it is going to go on because people aren't putting a stop to it. You as a person in the market, how are you going to spot this so you realize what's happening.

JIM: With the juniors it's pretty obvious. You know, the juniors have to go out, they have to get financing, they have to raise capital. What usually takes place and the way they do this is they start out with what we call a carpet bomb. [26:54]

JOHN: And you know I'm going to ask you to explain that.

JIM: What will happen is the stock’s trading along and let's say the average trading volume of the stock is between 50,000 to 100,000 shares a day. All of a sudden out of the blue with no news or anything, one day you will see all of a sudden volume spike ten-fold in the stock. You know, maybe the volume goes from let's say 100,000 to a million shares and two or three of these hedge funds will come in and they will just start just slamming the stock and you will see a sharp spike down. If you're a shareholder, you're looking at this stuff and you go, what the hell just happened because you're looking at trading volume goes up ten fold. There is no news on the company. There is nothing happening and you think what just happened here. And then what will happen is then they will use chat rooms, for example, or try to spread distance information out there and what they are trying to do is scare people.

And what they will do after the carpet bomb, then they'll just keep feeding into the shorts. The stock will start to lose its value, it will start dropping, you know, usually the carpet bomb can drop the stock down 20% or close to a 20% over a couple of day period. And then they keep shorting the stock and all of a sudden investors who know nothing about, they can't find any news, they are puzzled and they are trying to figure out what's happening and all of a sudden the price starts dropping as the hedge funds build their short position. Then what happens is it starts scaring investors so investors say: “Look what's happening to the stock. I'd better bail out.” And that's what they want. They want to fleece investors, scare the investors out of their position because remember, John, at some point they want the stock price to go lower, the lower they can drive the price down, the greater their profit they can lock in if they can get in on the financing. [28:48]

JOHN: Obviously, the companies are affected by this so if they know that brokers or bankers or whatever are doing this, with why do they permit it to be done to themselves?

JIM: In many cases, John, it's ignorance that exists in the mining industry. Remember a lot of these companies are dependent on bankers for capital to support their operations; and some people just kind of turn the way and say well, this is just the way the game is played. But the regulators don't do anything about it, the fines, at least in Canada are a joke. I mean one company got fined, I think, 75, 85,000 and they probably made twice that on just the commissions on doing the deal. So it's a situation where crime clearly pays. [29:29]

JOHN: Yeah. In other words, it's just the cost of doing business. If you're not going to spend any real hard time or any real sacrifice of assets for doing it, you know, pay the man and that's it. Now, let's take a theoretical case. A company does find out that's what's going on, are there some actions a company can take?

JIM: Well, sure. Well, number one, they can fire their investment banker or cancel the deal; or they can bring it up as a legal issue and just make sure that whoever is doing the shorting doesn't get in on the deal. So in other words, you ask whoever participates in the financing to sign a disclosure that, no, you are not short. But then you're liable and you're committing basically perjury in that sense. But you know, you have to be aware of it and then you have to take action. And unfortunately, a lot of companies just aren't aware of it. [30:19]

JOHN: So basically you're getting your investment banker to commit to the fact that he's not going to be shorting on this on you and that's an agreement or a statement. And like you say, if it’s done on a perjury basis. Then you have some legal recourse just on that basis.

JIM: Absolutely.

JOHN: Okay, now. You've got all of these short sellers. They are taking a risk here. There is still a risk because they have to get financing in order to make this whole naked short thing work. What happens to them if they can't get that financing and they've got a large short position.

JIM: They are up a creek.

JOHN: With or without a paddle?

JIM: You know, it depends on how liquid the stock is. If the stock is pretty liquid traded stock, then they are going to be forced to go in and cover. If the stock isn't as liquid, in other words it doesn't trade and their short position is huge, then, John, they really are up a creek. If the company becomes aware of, they can face very stiff legal issues in on the US side, John. It's a criminal offense. I mean you can actually go to prison over this. [31:26]

JOHN: Yeah. But how often does that now happen?

JIM: You know, it's starting to happen a lot more. You'll see when you get into this Bloomberg clip here of one fund institution that got caught and basically the guy is behind bars.

JOHN: Well, it always helps in these situations, Jim, is when something pops up right before you that you're talking about. In other words, when somebody tells you something is going on over here but all of a sudden, wham, there is a real world example, and that's exactly what happened today as we were getting ready to do this radio program. So let's talk about this issue.

JIM: Yeah. There is an up-and-coming exploration company that we're getting involved in in financing. And what they wanted to do is have two people come in, somebody like ourselves, and one other player, and who are long term investors which is why they approached us. So here is an up-and-coming exploration play. It's going to be a great company. The people behind it are super. But once again, John, that naivete in terms of what actually happens. And it was amazing because the person from this company called me up and said, “Look, we were going to do this financing, the beginning of the year wanted to talk to you now because we're getting a lot of pressure.” And what had happened and in the last couple of weeks the CEO had got contacted by this investment bankers saying “hey, we love your company, we want to get behind you. We want to do a bigger financing and we think we want to give you more money.” So as he told me that they've got these big investment banks coming in, so they are thinking of doing a bigger offering and this guy is saying, “you know, you need to get in.”

And I said I thought you were only going to do a non-brokered private placement.

He said, “well, we've been getting a lot of calls, the CEO...” And you know what it's like if you're in the mining business, all of a sudden you have the bankers all calling out giving you calls and trying to give you money. And I said when did you guys start talking to these guys. “We got calls about two weeks ago.” I said it's amazing because are you aware that the short position in your stock just tripled?

And he goes, “what?”

And I said, “Yeah. The short interest in your stock just tripled in the last week and a half.”

He said, “you're kidding.”

I said no, and I told him, you know what, if you're bringing these guys in, I said I'm not going to commit right now because what's going to happen is they are going to hammer your stock and then they are going to cover it with the shares that they are going to get in the offering. That's why they want you to do a bigger offering. You know, the day you and I are talking and here it happens right before. So what I'm going to do is I'm going to end up talking to the president and just make him aware, “hey, this is going on in your stock and if you're going to go in this direction, then we're going to bow out. We're not going to finance you because I know what's going to happen to your stock. It's going to crater.” [34:03]

JOHN: What happens if you, say for example, you tell the president and the president goes, “we don't want any part of this deal?” Now, obviously, at least somebody out there is shorting something and they are exposed, so what happens if is this company walk away from the table?

JIM: The short interest isn't big enough yet, and it probably won't get big until the company commits to the bankers. Once the bankers know they've got you locked in, then they just come in and their clients just, the hedge fund buddies just come in and just clobber your stock. So that's why I told this guy, I said, “you know what, the minute you sign some papers with these guys, you know what, we're out of here because they are going to clobber your stock and that's exactly what's going to happen.”

I said, “you think the short interest is big now, just wait until you sign papers and they've got you locked in for a six-month period. They are going to hammer the hell out of your stock.” [34:49]

JOHN: Well, when you cut through all of the nonsense and the verbiage, it really comes back at the heart of this is the investment bank hedge funds, clients. And frankly the whole deal stinks. It smells illegal.

JIM: It is. But that's how basically the junior mining finance system works. And as I mentioned earlier, it's just become institutionalized. And even when they are caught and, you know, basically all they do is they get their hands slapped. The fines are nothing. Nobody goes to prison. And quite honestly they've made more money in commissions on the deal, so in essence, you know, and especially as it relates to Canada, in Canada, it's basically, the message is crime pays. [35:33]

JOHN: That always reminds me of the line from National Treasure: Somebody has got to go to jail here.

You know, how is this going to get fixed? Usually when it blows open in some big scandal, then there's this horror of horrors reaction: “How could this have gone on.” And then something tend to get fixed hopefully. So how would you do it?

JIM: You know, unfortunately, to get the regulators attention, it's probably going to take a major scandal, much like in the mining industry, the Bre-X scandal came up with the 43-101 regulations. You know, with Bre-X here was a company that was overstating what it was that they had. They were falsifying their assays and unfortunately it takes a major scandal like this for the regulators to wake up. There is an outcry by investors because they realize they've been taken to the cleaners. And usually when something big like that happens, then the regulators finally take action. [36:24]

JOHN: Okay. But before the scandal breaks out, is there anything that would accelerate this whole process or can anything be fixed?

JIM: Well, you know the one thing as we can point out, you can be aware of this with companies, you can follow like if you're in a junior mining stock out of t he blue, you see the stock just crater and there is no news and then all of a sudden you start following the short positions. That's a clue. You can also, for example, the AMEX has something called threshold securities where the Amex actually reports companies which are on the threshold list. You can do the same in Canada. So the one thing you can do is complain too regulators and you can actually write to them. They'll provide sources and places...we're going to include some links with this broadcast of how people can become educated on this and how they can complain.

The other thing is for investor to pull their accounts from the firms that engage in this practice. In fact, Harvey Pitt who was the former SEC chairman recently gave the speech a couple of weeks ago in Washington DC, and he outlined what he calls his top 10 recommendations to close short selling loop holes. Let's listen in to the former head of the SEC discuss how to clean up this major criminal activity:

Now, those who have heard me speak before know that I am fond of stating that I have a list of 10 suggestions to solve a specific problem. I do this all of the time but I have to offer a disclaimer, which I always do, although I say I have 10, I never have 10. But if I told you that I had 12 or 3, you'd tune out and who could blame you. Now, this did get me in trouble when I was chairman of the SEC in August of 2002. I gave the speech to the American Bar Association’s Business Law Committee and I decided as a service to my audience to share with them the top ten lessons I had learned from public service. I gave the exact same disclaimer and I wound up with 12 lessons learned. The next day the front page of the business section of the New York Times said “no wonder we have all of these accounting problems. This joker at the SEC can't add.” In any event, here are my so-called 10:

First, SROs and the SEC need actively to pursue ongoing chronic and serial short selling infractions.

Next, meaningful penalties have to be proposed for violations of existing Reg SHO requirements.

Third, the SEC should define and punish as fraud abusive naked short selling practices.

Next, the SEC should act quickly and forcefully. Otherwise, state regulation is more likely; and as I've already said, I don't think that's the best way to go. Our capital markets work because they are governed by uniform rules from Portland, Maine to Portland, Oregon. State regulation means fragmented requirements, practices and procedures and could cause loss of our competitive edge.

Next, the SEC should eliminate the option market maker exception. It isn't demonstrably of any value and it risks facilitating illegal activity.

Next, Reg Sho should impose firm locate-requirements as a condition precedent to all short sales.

Next, Reg Sho should cover securities that are also traded in the pink sheets. Naked shorts occur in the shares of small, thinly traded issuers and those are likely to trade in the pink sheets.

Next, chronic and unjustified violations of ‘T plus 3’ settlement rules should be punished.

Next, before brokers are allowed to borrow margin shares, they should make clear disclosure and give investors the opportunity to opt out.

Next, securities lending should occur openly and transparently at arm's length prices, enhancing returns, increasing efficiency and promoting valid short selling and curbing abuses.

Next, the NSCC should allow member to settle borrowing and lending activity through these facilities that I've just mentioned, so accurate accounting and data is available to market participants and regulators.

Next, shady activities thrive in shadowy market corners. Exchanges and other markets should be required to report the securities on daily threshold lists and aggregate daily volume of fails for each such security.

And finally, form 13-F Institutional Investor reports should disclose both short and long positions. That would provide issuers and investors with a better understanding of trading activity.

JOHN: Mr. Pitt said a few things I think that would help stop a few things anyway. First of all, stiffer fines. Prison terms would really get people's attentions. Fines can be chalked off as a cost of doing business. Prison pretty well interrupts your business unless you're in the Mafia or gangs; okay? It's hard to do trades from, you know. Well, I guess you could do it, you know, make a phone call.

JIM: You know, it really does need to be taken to that level, John. And you remember the accounting scandals that we had at the beginning of this decade and it was only after the head of a lot of these firms got prison terms of life sentences. Think of what the government would do to you if you were caught counterfeiting US dollar bills. I mean I don't think you would get just slap in the hand. You'd get a serious fine. You would probably spend at least a minimum of 10 to 20 years in prison and that's what needs to happen. There needs to be prison fines. These people need to have – maybe you used RICO and confiscated all of their wealth. You shut the firm down, you bar them from their business or you close them down. I mean they are definitely right now there is sort of an open book go ahead and commit a crime because nobody is watching and you can get away with it. And then if you do get caught as in the case of Canada, you know, it's a slap on the hand. I mean it really is a joke.

But I think requiring firms –one of the things that Pitt talked about – is requiring firms to disclose in their 13-F (if you're in the securities business and you manage over $100 million, you're required to file a 13-F which is your holdings every quarter; what you own, what did you buy, what did you sell); but also I think it would open the system to more disclosure if you would put in short positions. Right now, basically these criminals are being shielded by a curtain of secrecy.

And you can find out, John, through the Freedom Of Information Act, through the DTC the amount of shares that have been naked short sold. But the key is as Pitt is talking about that here is more disclosure so that the legal system can be brought to bear. In other words, if you know and can find out who these people are, you see, right now the SEC is so pervasive when they issued Regulation SHO is they grandfathered all of the FTDs that occurred prior to Regulation SHO because it was so pervasive. So these people basically whether it's the investment bank, broker-dealers or hedge fund clients are never made to feel the pain of their crimes. A lesson basically right now from the regulators is crime pays.

And we're going to be providing a number of links with this broadcast as to how investors can become more informed. I also hope to have Patrick Byrne back on the show. They've been very helpful to me in educating me in what I need to do. And so hopefully we can have Byrne and maybe his attorneys on at the beginning of the year sometime next year. But this is a problem. It's getting bigger. It's more pervasive. But, you know, whether it's small-cap mining stocks, bio tech stocks or technology stocks, it's become so pervasive that in the mining sector it's going to need something like this to blowup, and almost like another Bre-X before regulators come out with some kind of regulation regarding junior mining finance and straighten this whole thing out, John, because what's going on here is just absolutely criminal. [46:11]

JOHN: Well, that's the end of our program for this week. We have a two part year end wrap up series that we're doing. Next week will be part two of our year end wrap, the year in review. We'll be looking at the rise of gold and oil, monetary and fiscal stimulus; and also the rise of inflation, and someone there will try to get you to do some predictions. How’s that.

JIM: Not until next year.

JOHN: Not until next year? I can't drag it out of you. Darn.

JIM: No. No. No.

JOHN: Bummer, bummer, bummer. We're coming up on Christmas so we'd like to wish everyone a Merry Christmas for those people who celebrate it out there. Obviously, New Year is not here yet and we will wish you happy New Years coming up next week. What are we looking at into the New Year as a matter of fact on the program? Anything special.

JIM: Well, January, as we did this year, we're going to get into our annual forecast. One of my first guests will be noted economists Paul Kasriel from Northern Trust. We will also have by popular demand Dr. Marc Farber. We'll have also Dick Davis. He's written a new book called The Dick Davis Dividend.

Vitaly...I'm not even...I'm not even going to go near this.

JOHN: “Now that I've said your name, Sir, we have no time for the interview. Thank you very much for being on the show.”

JIM: Yeah. We can try to pronounce this guy's last name, [Vitaliy N. Katsenelson] but he's written a book called Active Value Investing. Steven McClellan Full of Bull, Mike Staphis Cashing In On The Real Estate Bubble. And Lila Rajiva authored with Bill Bonner a book called Mobs, Messiahs and Markets. And we also hope to have the guys from Bank Credit Analyst join us. A lot of great stuff. Look for a couple of changes on the program coming in the New Year.

In the meantime, on behalf of John Loeffler and myself, we'd like to wish you a happy holiday and a very, very Merry Christmas. Until we talk again, we hope you have a pleasant weekend.

© 2007 James J. Puplava, Financial Sense ® Newshour