I wrote this awhile ago, but with today's emphasis and talk of financial crimes and the SEC, I thought I'd repost it here.
While I'm at it, I'll link to a couple other bits of thinking and figuring about the Crime of Naked Short Selling, and the story of LDK Solar.
Here's the Letter:
To Whom it may Concern,
Recent experiences have demonstrated to me the realities of a crime.
The crime is that of the Naked Short Selling of Stocks for the purpose of Market Manipulation (yes, it is actually a crime).
Case in point: LDK Solar.
In brief, allegations were recently made against the company by a former Accounting Controller. In the first ten days of trading upon the release of this claim, approximately 152 Million shares changed hands. It should be noted that the company was still in IPO lock-in, and so the only shares on the market available for trade added up to around 17 Million shares. Now, perhaps in the chaos, shares were traded through an average of 9 times each in the first 10 days, but since the ticker appeared on the Naked Short Threshold list on October 16th, we do know that at least some of the shares were not being delivered due to Naked Short Selling. As of 12/21/07, LDK remains on the Naked Short Threshold List.
Now, Naked Shorting of stocks "by market makers engaged in bona fide market making" is not illegal or unethical. However, "Selling stock short and failing to deliver shares at the time of settlement with the purpose of driving down the security's price" is indeed, illegal and unethical. ( See http://www.sec.gov/... )
It should be noted that in the process of Naked Shorting a stock, dilution of the shorted stock occurs due to the introduction of virtual shares (fails) into the system by the Naked Short Seller. According to the SEC, "The value of a stock is determined by the basic relationship between supply and demand. If many people want a stock (demand is high), then the price will rise. If a few people want a stock (demand is low), then the price will fall." Well, this seems pretty obvious, but it should be reiterated. Public companies are required to follow guidelines when altering the number of shares available for trade (dilution), because to do so alters the "supply" side of the equation. It is in the Investor's critical interest to have access to information regarding the "supply" of a stock that they would like to purchase. However, Information on the level of dilution of a stock due to Naked Short Activity is not available to the public. Thus, in the case of the purchase of a stock that is listed on the Naked Threshold List, the investor has no way of knowing how many shares of stock are outstanding, and thus has fundamentally no way of making an informed decision on an appropriate value for the stock.
The case of LDK is a convoluted one, and has not yet entirely concluded. However, it is a demonstration of the issues surrounding the Naked Shorting process, and it should be investigated, both from a Law Enforcement perspective, but from an ongoing Market Regulation perspective. As an investor in this company, do I not have reason to expect information on the number of shares of stock available for trade? I believe that I and other investors should very much be able to expect that this information is made public on some basis by the DTCC.
Thank you for your support,
DP