Berlin Market's Conjuring Act

Hundreds of North American stocks materialize on the German exchange.
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Over the past few months, a large German brokerage has managed to get the shares of at least 800 tiny North American companies listed on the obscure Berlin Stock Exchange -- without asking for anyone's permission.

The listings, which took place just prior to the enactment of a new U.S. securities regulation that restricts a particularly brazen form of short-selling, have sparked an intercontinental shouting match that does little to repair the microcap world's reputation for shadiness.

Berliner Freiverkehr

, the brokerage that applied to list would-be corporate titans such as

Pickups Plus




Warp Technology



in Berlin, claims it was simply pursuing an initiative to drum up business for its market-making operation, the second-largest in Germany. The firm took advantage of a Berlin exchange rule that permits brokers to list stocks without a company's permission. Most of the stocks continue to trade freely there.

"We need huge trading volumes because we have very small fees here," says Holger Timm, chief executive of the Berliner firm. "We sent letters on just an informal basis to these companies and explained that their stock was being traded in Germany, and that they have no obligations and so on."

Rather than welcome the overseas exposure, however, dozens of the oft-ignored companies listed in Berlin are now crying foul, demanding that trading in their shares be halted on the exchange. The companies believe the dual listings are part of a sinister plot by market manipulators to drive down their stock price through techniques that would be much harder to pursue under stateside regulatory strictures.

"By listing the company's common stock on the Berlin Stock Exchange, market manipulators sought to benefit from an arbitrage loophole," read a Pickups Plus press release, one of dozens issued by U.S. companies that employed nearly identical diction. "We were both incensed and appalled to learn that our stock could be listed on a foreign exchange without our knowledge or consent."

The complaints about Berlin have gotten so loud that U.S. securities regulators are looking into the matter, even though the

Securities and Exchange Commission

and the NASD have limited jurisdiction over overseas markets. Sources say a meeting between German and U.S. regulators to discuss the controversy is scheduled for Friday.

"The commission is aware of the reports and looking into them," says SEC spokesman John Nestor.

Telling fact from fiction in this story of international intrigue is difficult, particularly in the murky world of short-sellers and speculative stocks. Paranoia about short-sellers runs rampant among companies listed on the U.S. Bulletin Board, an over-the-counter market that often is a stomping ground for stock scammers and pump-and-dump schemers. The executives who run these tiny companies, many of which are nothing more than an idea on a piece of paper, have a habit of blaming anyone but themselves for the low prices at which their stocks trade.

For example,

KleenAir Systems

, the latest company to raise a stink about a short-seller conspiracy, issued a press release on June 3 blaming the "unauthorized" listing of its shares on the Berlin exchange for a recent 50% decline in its stock price. The Irvine, Calif., company, which claims to be developing a "cutting edge" technology for reducing auto emissions, trades at around 20 cents a share. The company's auditors recently appended a going-concern clause to its financials.

Officials at the Berlin exchange deny any ill intent and say it's their policy to permit brokers to list stocks without a company's permission. Andreas Weihmueller, an attorney for the Berlin exchange, said the exchange's strict regulations make it all but impossible to short shares of Bulletin Board stocks.

Berliner Freiverkehr's Timm is similarly reassuring. "We haven't done anything wrong, and nothing has happened," he notes.

That's not how the companies see it, even if their executives have little concrete evidence to back up their allegations of an international short-selling conspiracy.

"Have we been able to prove it? No. But we suspect it," says Sean Hayes, director of investor relations for Pickups Plus.

Similarly, Gus Bottazzi, president and chief executive officer of WARP Technology, says he has a "strong suspicion" about the Berlin listing but no proof of any wrongdoing.

Hayes, Bottazzi and other executives say the timing of the listing of their stocks on the Berlin exchange is more than curious. They point out that Berliner Freiverkehr applied to list most of the Bulletin Board stocks in March, just weeks before a new NASD regulation on "naked short-selling" took effect on April 1.

Naked shorting is an unsavory practice in which traders place short bets without actually borrowing shares from a broker or even determining that there any shares available to borrow. Traders who engage in naked shorting take advantage of a regulatory loophole that was mainly intended to enable big trading firms to keep an orderly market in a stock.

Critics say naked shorting lends itself to potential abuse, because it enables the dishonest trader to short a stock more heavily than would be permitted if the trader had to actually borrow the shares. The new NASD rule seeks to close the loophole for would-be manipulators by requiring a broker to make sure a short-seller can borrow those shares within a specified time period. The SEC, meanwhile, is considering an even tougher naked shorting prohibition.

While it's by no means certain the Berlin exchange had provide a new loophole for manipulators to get around this new regulation, there's no doubt that naked shorting has been a big problem. Regulators contend that the practice, unchecked, can lead to an anomalous situation in which the total number of shares sold short on a stock can exceed its float, or the number of shares available for trading. Naked shorting permits traders to make bigger downside, and that can, in some scenarios, artificially lower the price of a stock.

The SEC, for instance, is stepping up an inquiry into the impact manipulative short-sellers may have on the market for public investment in private equity, an area of finance known on Wall Street by the acronym PIPEs. Regulators are trying to determine whether some of the hedge funds that invest in PIPEs are conspiring to drive down the stocks of companies that take part in these financing deals in order to maximize their return.

PIPEs are popular with hedge funds, because buyers can get preferred stock or bonds that convert into shares at a discount to market prices. The deals often include sweeteners, such as warrants, that permit the private investors to buy additional shares at prices well below what ordinary investors would pay.

The hedge funds that invest in PIPEs often have an incentive to go short, since the discounted shares they receive make it less costly to pay back borrowed stock. One thing regulators are looking for is any evidence of naked shorting by PIPE investors.

A review of the list of Bulletin Board companies added to the Berlin exchange finds that at least 72 of them have been involved in a PIPE transaction this year, according to PlacementTracker, a PIPEs market research firm.

Timm, Berliner Freiverkehr's chief executive, says the firm wasn't aware of the new rules against naked shorting when it applied to list the hundreds of stock on the Berlin exchange. That may be, but Timm and his firm aren't novices to the U.S. markets. Berliner's parent company, as of the beginning of April, owned a 10% equity stake in

Ladenburg Thalmann

(LTS) - Get Report

, a small New York investment firm that has been an active arranger of PIPE deals for small companies.

Charles Johnston, Ladenburg's president and chief executive, says he knows nothing about the controversy over the Berlin market.

Ladenburg, meanwhile, is the lead defendant in civil lawsuit filed by


, a tiny software company that the SEC alleges was the victim of a massive naked shorting conspiracy involving a $3 million PIPE deal.

Last year, the SEC imposed a $1 million fine on

Rhino Advisors

, an investment advisory firm, for its role in orchestrating the Sedona shorting scheme on the behalf of an overseas hedge fund. Federal prosecutors in New York subsequently charged the principals of Rhino, Thomas Badian and Andreas Badian, with conspiracy to commit securities fraud. Ladenburg wasn't charged with any wrongdoing in either action, but he was the placement agent on that PIPE deal. The firm insists it did nothing wrong and is seeking to dismiss the civil suit.

For now, there's more smoke than fire in this controversy over the Berlin exchange. But the episode is another illustration why prudent investors would do best to avoid betting on speculative Bulletin Board stocks altogether.