Wall Street's Next Nightmare?
Rob Wherry, 10.06.03

Flamboyant litigator John O'Quinn is gunning for another bonanza: the entire trading system in penny stocks
From his 23rd-floor suite of offices in Houston's Lyric Centre, John M. O'Quinn is plotting what he hopes will be his next multibillion-dollar jackpot. Not that the 62-year-old senior partner of O'Quinn, Laminack & Pirtle needs the dough; FORBES estimates his law firm has won $1.5 billion in fees from the makers of silicon breast implants and cigarettes. This time he's aiming at Wall Street. O'Quinn has a hand in 15 lawsuits alleging that various brokerages (including Ameritrade and E-Trade) and marketmakers like Knight have destroyed his clients by helping to sell the companies' shares short in a scheme to run the stock prices into the ground. The damage is daunting: O'Quinn says 1,000 companies have lost at least $100 billion in market capitalization. "If you short a stock for the sole purpose of killing the value," he says, "that's a threat to the view that we have an honest market."

The fuss is over naked shorting, a practice that's been around for decades and that is sometimes legal. Normal short-selling involves borrowing real certificates for stock, selling the stock, buying new shares at a later date, and using the new certificates to replace the ones borrowed. Naked short-selling differs in that no real certificates change hands. Instead, the short-seller creates a paper entry showing that it owes shares to the stock buyer and will get around to delivering them later.

Naked short-selling is legal if done by a marketmaker in a temporary arrangement; it's normal for a marketmaker to be net short for a day or two and then close out the position by buying real shares later. Naked shorting can be illegal if done with the conscious intention of leaving the short position as a paper entry indefinitely.

It's often hard to tell the legal variety of shorting from the illegal. Nowadays most stock available for trading is held in book-entry form, and thus takes the form of electronic blips on the books of a stock-clearing company. Depository Trust &Clearing Corp.'s subsidiary is one of the leaders in the clearing business. In the normal course of business DTCC tolerates so-called failed-to-deliver entries of shares offered for sale by, say, brokers. This means the seller doesn't have the certificates on hand but promises to be good for them eventually. Is the clearing firm too tolerant of failed-to-delivers, thereby facilitating illegal naked shorting by brokers (or their customers)? That's the allegation in the lawsuits.

O'Quinn and his top lawyer on these cases, James W. Christian, senior partner with Houston-based Christian, Smith & Jewell, claim that over the last three years billions of uncovered naked shares were sold; that marketmakers (and/or their clients) took profits after waiting for share prices to fall before buying in--if at all; and that brokerages allowed fictitious shares to be traded two, three and four times over, in possible violation of Securities & Exchange Commission rules. Defendants deny the charges and have tried to dismiss some of the cases.

"It's the perfect murder," says O'Quinn, who is quick to smell collusion. "We've got a situation where the cop can't arrest the suspect because it causes too many problems for the police department."

But in this case the police seem to be getting involved. Last February the SEC levied a $1 million civil penalty against Rhino Advisors, a small New York City investment house, and its president, Thomas Badian, for using offshore accounts to short the stock of Sedona Corp., a King of Prussia, Pa. software maker and an O'Quinn client. (Rhino and Badian didn't admit or deny any wrongdoing.) Just last month Louisiana's attorney general issued a subpoena on behalf of that state's Sedona shareholders against UBS PaineWebber. (He's seeking information on failed stock deliveries, among other things.) In a separate civil suit Sedona wants a hefty $2 billion in damages against 17 defendants, including Credit Suisse FirstBoston's Pershing clearing unit and Westminster Securities, alleging their naked shorting knocked Sedona's share price so low that several big vendors shied away from doing business with it. New York's Attorney General, Eliot Spitzer, is interested in the case.

Still, a tobacco-size payoff for O'Quinn is not in the bank. The case of Universal Express, a Manhattan-based logistics firm (and not an O'Quinn client), illustrates one reason it's hard to collect. In 2001 it received a $389 million award levied against three Florida defendants found liable for fraud and stock manipulation, including naked short-selling. But Universal is having a tough time seeing a penny: It says the assets are in offshore accounts.

Before anyone can collect, plaintiffs have to prove fraud or manipulation--and that's tough. It's not enough to show a sliding stock price, wild discrepancies in daily volume or even a disparity between a company's authorized number of outstanding common and the number of shares traded. The key lies in demonstrating manipulation of the entire trading system.

"These claims divert attention away from the real problems: failed business plans, poor management, little revenue and no prospects," says Michael S. Rosenblum, a Los Angeles lawyer who has represented some of the defendants in these cases.

As I have said many times, in many ways,
the SEC is absolutely corrupt.

The SEC and Wall Street working together,
this is a RICO violation deserving of
federal prosecution.

Won't happen. Wall Street has so much
money, the SEC big wigs have so much
money, both have so much political
clout, they can and do buy off anyone
and everyone, including the Whitehouse.

Neither will ever be prosecuted.

Innocent investors will continue
to be victimized.

Some of you should consider joining
our war against the SEC and Market
Makers per my article on this, posted
about a month back.