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Naked Truth Dressed to Baffle

Determining the cause -- and prevalence -- of naked short-selling is no small task.

Updated from 9:07 a.m. EDT

In early February 2005, something truly bizarre happened to the shares of

Global Links


that thrust an unknown, pink-sheet stock into the center of a heated debate over naked short-selling.

It all started when the company completed a 350-to-1 reverse stock split -- an unusual step in itself, but one that paled alongside what came next. With 5.43 million shares outstanding and a float of 1.15 million shares, Global Links saw trading volume of 143.5 million shares in the first four sessions of February, driving the stock as low as 8/100ths of a penny.

"What happened the first week of February 2005 really took us by surprise," Frank Dobrucki, Global Links' CEO, wrote in a letter to shareholders. "It became very clear that we had no control of the volume or price of our stock in any way. Outside forces were now manipulating our stock." (Dobrucki didn't respond to requests for an interview.)

Later that month, a Michigan investor named Robert Simpson paid a cool $5,205 for 1.15 million shares of Global Links -- equal to 100% of the float. Yet, strangely, shares were still available for trading. Two weeks later, an Oregon investor bought another 180,000 shares, not in hopes of making a profit, but simply to make a point: "It would appear that my securities purchases prove that

Regulation SHO has been systematically violated by market-making brokers and securities-clearing firms," Paul Floto, the investor, declared in his unorthodox filing with the

Securities and Exchange Commission


"I had a number of other stockholders call me and tell me they owned lots of shares as well," Floto said in an interview.

In March, Global Links became the poster child for those asserting that naked short-selling is out of control. During a Senate Banking Committee meeting, Utah Sen. Robert Bennett used the company's extraordinary trading data to browbeat SEC Chairman William Donaldson.

"Thirty-three million shares traded in a single day when there are only 1 million shares outstanding and one investor has filed a statement with you saying that he has all of them," Bennett chided. "That's clearly something that needs work."

"Yes, well, Sen. Bennett," replied Donaldson. "Thank you for that observation."

Donaldson was right. Global Links may be tiny -- in 2004, it had in $113,000 in revenue and $104 in interest income -- but it deserves observation. It represents clearly both sides of the growing and complex debate over why shares fail to deliver and how prevalent naked short-selling is.

On the one hand, Las Vegas-based Global Links (or, in its former incarnations, United, United Casino Corp. and Blue Jacket Mining Co.) has raised the kinds of red flags that draw the attention of short-sellers.

According to the company's SEC filings, before a series of 350-to-1 reverse splits, it had increased its number of common shares to 1.9 billion; it let go of its Encino-based accountant following a violation of the Sarbanes-Oxley Act; and it invested $125,000 last year into R&D of a Web site,, whose home page still says it's "currently under construction."

On the other hand, it's hard to explain the stock's February trading, if you reject the notion that naked short-selling wasn't a factor. Since early February, Global Links has spent 89 days on the NASD's threshold list of companies that have delivery failures of 13 days or more.

Because regulators are prevented from disclosing or talking about any abusive trading they may observe, it's hard to find clear-cut examples in the public record. So instances of extreme trading like Global Links has seen are, for now, as clear cut as it gets.

But what if the aggressive trading seen in Global Links has spread beyond the pink sheets and into brand-name stocks like




Shanda Interactive




, which are more commonly held by average investors?

Brent Baker, who went into private practice at Woodbury and Kesler this spring after 14 years at the SEC, says naked short-selling "is a very large problem."

Baker is representing Overstock in a lawsuit alleging hedge fund Rocker Partners and research firm Gradient Analysis engaged in unfair business practices designed to "denigrate" Overstock. Rocker has countersued, alleging Overstock launched a "smear campaign."

Baker says many regulators regard short-selling as a useful tool that brings suspicious business and accounting practices to the light of day. "They see short-selling as a beneficial market force -- and it is. It's when it becomes a procedure to game the system that it becomes illegal."

"Everyone at the SEC has good intentions," he adds. "The problem is they don't realize short-selling has grown up. You now have sophisticated hedge funds that have short-selling as part of their business model."

Letting hedge funds weed out the weaker companies is kind of like hiring the Hell's Angels to handle security at your free rock concert -- you may solve lots of little problems, but you also run the risk of creating a few, much bigger ones.

The only clear-cut information on naked short-selling as an abusive practice has come from trials where such evidence was made public -- but often years after the fact. Ken Breen, an attorney in the Justice Department during the

Anthony Elgindy case, says the prosecution presented evidence that naked short-selling was active in stocks between late 2000 and early 2002.

"There was a significant amount of naked short-selling in the Elgindy case," says Breen, now a partner at Fulbright and Jaworsky. "We presented evidence on nearly 40 stocks where there was manipulative short-selling, and in nearly all of those cases, there was naked short-selling."

But in the era of Regulation SHO, which took effect last January in an effort to curtail naked short-selling, it's harder to show such activity. So, while some investors describe an elaborate method of listing stocks on foreign exchanges so that short-sellers can claim to U.S. brokers that they have shares available to borrow, others are more skeptical.

"If you deal with a major brokerage firm, they won't tolerate this," says David Rocker, who heads hedge fund Rocker Partners (which owns about 8% of


.) "This business that it's this fantasy world of dealing in Europe and German listings, it's all horses---."

"From a functional matter, it is almost impossible to do a naked short. We don't do any -- first of all, if you dealt with

Goldman Sachs

, you would know they are not about to risk their charter for David Rocker -- or for any other client for that matter," Rocker says.

So what's causing the failed deliveries? Rocker has his own theory: "What you need to make clear is that 'fails-to-deliver' are fails for longs as well as shorts, and that it can be done for manipulative purposes to create the impression that the stock is a tight borrow," Rocker says. "In this instance, it's not the failure of shorts to deliver but a failure of a long to deliver."

Right now, who knows for sure what caused the surge in Global Links' trading. Even after the good intentions of Regulation SHO,

so scant is the disclosure on failed deliveries that getting everyone to agree on what's happening is like getting conspiracy buffs to agree on who shot JFK. Only with naked-shorting, the problem isn't what anybody saw, it's what nobody is allowed to see.

Put people in a dark room and they tend to either do nothing, or they do something that they don't want to be seen doing. Reports in the

New York Post

and elsewhere suggest that regulators are finally looking into the failed deliveries on threshold lists. If so, any light shed on naked-shorting may show once and for all whether all of this controversy is about nothing, or about something unseemly in the dark.