Investors Burned in Plunder of Crystallex Consider Action

On July 28 retail investors in one particular mining company took a behind-the-woodshed lesson in predatory stock activity.

 

Dealings are generally attributed by casual investors to a somewhat nebulous band of unscrupulous “shorters” (usually blamed are hedge funds), who aren’t just relying on their unique research, but instead take a more direct approach to milk the market. Whether or not the apparent July 28 “bear raid” against Crystallex [AMEX:KRY; TSX:KRY] was through hedge funds or more sinister entities, some shareholders in the company have banded together to consider retaliation.

 

By way of disclosure, I happen to be a long shareholder in Crystallex, and I’m incensed about the manipulation of its stock. Through my long familiarity with the company, my twenty-plus years of securities and metals trading, as well as access to a real time Level II trading platform, I was allowed a front-row seat to witness the effects of the manipulators. This article uses that lens to examine the barefaced actions of short-selling stock manipulators.

 

Anecdotal gripes about “evil short interests” manipulating stock prices of the companies they target, sending them into bone-shattering plunges by various sinister means, are common. Until very recently, I generally viewed such stories as excuses for other issues that the short-selling interests just happened to have done their research on and gotten right. However, that was before witnessing just such an attack on the company I happen to follow very closely and before witnessing the deliberate “breaking” of a publicly traded security, “in broad daylight.” I no longer view short-selling raid rants as mere sour grapes.

 

This is not to gloss over the fact that until a final permit is handed down, KRY is a target rich environment for people trying to manipulate the already undervalued share price, which just might be opportunity knocking for those who can handle the volatility. The company has in a sense invited some of the unwelcome attention by the information vacuum that it cannot fill, but rumour mongerers can.

 

Whilst the risk was clear, I had little inkling that the massive sell-stop triggering raid to come on July 28 would be as violent as it was. It was a lightening-fast sell-stop driven meltdown - one where the sell-stops did not function as they were originally intended to by the owners, who ultimately became suckers for an orchestrated stock manipulation.

 

Meltdowns are the opposite of short squeezes, and just like short squeezes, they rarely occur due to one single event. Indeed, it is my experience that they usually occur due to a cascade of issues, followed by a final news triggerm, which causes a reaction and a vacuum on one side of the market.

 

The July 28 meltdown of Crystallex stock is no exception and as we will see, it was the culmination of a cascade of events, some legitimate, but also some that were sinister. The one thing missing, however, was any legitimate news trigger for the meltdown.

 

For those who watched the trading unfold in real time on Wednesday, July 27 and Thursday, the 28th, there can be little doubt that the trading on the 28th was a manufactured and artificial panic intentionally created, most likely by a few large interests who held very large short positions in KRY stock.

 

A short sale is where a seller borrows stock and sells it in the market today with the hope that the share price goes down. The seller then repurchases the stock at the lower price and pockets the difference, less the costs to borrow the stock.

 

Yes, there were legitimate reasons for Crystallex stock to be under pressure (discussed below) but the coup de grace on the 28th was almost definitely an illegal and intentional “breaking” of a stock. The action being contemplated by the group of Crystallex investors is intended to determine who those interests were and whether they violated securities laws.

 

Stock Manipulation by Masters

As of July 15, the open short interest for KRY on the AMEX was in excess of 7 million shares with an additional unknown number in Canada. The reported Canadian short interest can be misleading due to the way short sales are reported there, but it is likely the combined short position was in excess of 9 or 10 million shares. Crystallex had by far the highest reported short interest among metals miners on the American Stock Exchange for the month of July, which indicates it was a target of the larger short players (see table).

 

It’s a Raid!

The 7-plus million shares sold short on Crystallex in July was apparently not enough for rapacious shorters. All through the day on Wednesday, July 27, a large (over 50K) short sell order was kept at or just above the offer. Reliable sources confirm that particular order came through a U.S. full service brokerage located in the U.S. heartland. Then, in the morning of the 28, an enormous market sell order was dumped into the already weakened bid, shattering all support. That immediately triggered a chain-reaction waterfall of sell stops all the way from around $3 to $2 in the span of a few minutes.

 

By the end of the day KRY had recovered much of the price damage, but not before the volume had reached a staggering 5.4 million shares on the AMEX. (The average volume is closer to 900,000 shares daily.) At the peak of the plunge, one trade crossed the tape, which truly stands out, 366,000 shares at $2.00, after opening at $3.08. Battered Crystallex shareholders probably hope that the AMEX specialist held the majority of the initial large “back-breaker” market order and filled it there, giving the manipulator a taste of his own medicine. But more likely, that was a sell-stopped victim of the raid taken out at $2 when 15 minutes before the price was 50% higher!

 

Commenting on the raid, a 30-year veteran trader and former market maker based in Chicago said, “No way [that] anyone would throw two or three or five hundred thousand shares at market. No way. That’s suicide for a legit seller. … Not unless it was intentional to try to break it. They [the short interests] loaded up their boat and then lowered the boom. No doubt about it.”

 

Another 25-year securities broker located in the Denver area who is very familiar with Crystallex commented: “I watched the raid. That’s exactly what it was. … If I had a large block of stock to sell for a client, I might put as much as 30K out at a time and then wait for the market to recover before sending out the next block, but no one would just throw a huge order like that out there.”

 

Other long-time traders and investors had similar comments. The consensus seems to be that not only was it a short-raid, it was an obvious short raid.

 

A "Short History"

In his excellent paper on short selling, first published in March, Fordham University Professor of Finance John D. Finnerty asserts: “The manipulators found that they could defeat any opposition by employing “tricks that only sly and astute speculators invent and introduce,” such as planting false rumors about the target firm’s precarious condition in the press. Finnerty cites ancestral work on the subject by Bernstein and Schneider (1935), which chronicled the so-called “bear pools” on the Amsterdam Stock Exchange in the late 1700’s, and later on the New York Stock Exchange in the 1920’s and 30’s. Back then shorters used largely legal but terribly unethical methods to manipulate their chosen targets.

 

Part of the strategy was to pool resources to sell short and then at a particular time to ferociously sell into the market an overwhelming number of shares all at once to literally break all support and create a panic. The goal of that panic was to frighten others to sell from the terror caused by a rapidly falling share price, driving the price even lower where the manipulators could then cover their short bets at a manufactured profit.

 

So that the market would be softened in advance of the bear raids, the ring leaders of the short pools would weave false and very damaging fiction with kernels of truth into a cloth of rumors and, through a network of contacts in the press and in the market, leak those rumors just ahead of the raid. A game plan, which was fine-tuned to perfection in the late 1800’s by “The Great Bear of Wall Street,” Jacob Little.

 

Since that time, there have been attempts to place restrictions on the means that short sellers can use to fraudulently scare other investors as well as mechanical trading regulations, such as the “zero-plus tic, or up tic rule,” (the “short sale rule”) designed to prevent short sellers from using short sales themselves to artificially drive down market prices. Other U.S. regulations are intended to prevent the short-selling of a security within fives days of the pricing of a variably priced equity offering with the intention of covering those short sales with shares obtained through that financing.

 

More recently, in July of 2004, the United State Securities and Exchange Commission (SEC) adopted Regulation SHO, which targeted abusive naked short sales, or short sales where the seller does not actually borrow the securities being sold short. Finally, other regulations are intended to prevent “trading for effect,” spoofing and creating a false impression of market activity.

 

Despite these attempts to reign in fraudulent manipulation of stock prices by short sellers, the recent explosion of largely unregulated hedge funds has led to a large increase in the opportunity and means for that manipulation to occur.

 

No one knows how many unregistered (and unregulated) hedge funds are currently operating, both offshore and in the U.S. Estimates are that there were at least 9,000 such funds as of the end of 2004. Not all of these funds are engaged in short selling and certainly not all are engaged in stock manipulation. But regulated funds and regulators say a disturbing trend of trading abuses has been developing due to the fact that so many of these funds do not report to anyone other than their investors. That doesn’t mean unregulated hedge funds and bear pools are immune to securities laws, but it does make them less visible to regulators.

 

In testimony before Congress in May of 2003, SEC Chairman William H. Donaldson commented, “… the Commission has seen an increase in the number of hedge fund frauds that we have investigated and that have resulted in enforcement action.” Some of the hedge fund frauds the SEC regulators have been investigating include what Donaldson called, “market manipulation in a variety of guises.”

 

In addition to the proliferation of unregulated hedge funds, over the past half decade there has also been an explosion in direct-to-market electronic trading through sophisticated electronic trading platforms. These powerful order execution and delivery systems allow real-time trading by individual traders that was once reserved to trade desks and floor specialists. Electronic trading of securities has added to the liquidity of the markets tremendously, allowing real-time trading from virtually any computer terminal. But along with the increase in liquidity and volume also comes an increase for the potential for abuse, something even the proponents of those trading platforms worried about as they were coming into use.

 

In U.S. Government hearings regarding the future of electronic trading in September 1999, David G. Downey, executive vice president of Interactive Brokers, now one of the larger electronic online broker/dealers, commented on what the future of online trading held for the markets. Downey said, “It is clear to us that while technology is going to bring tremendous change to our industry it will not by itself eliminate instances of fraud and deceptive practices. Regulation must remain true to the public policy objective of protecting the customer from abuse.” (Somewhat ironically, just three months later, on December 29, 1999, David M. Battan, vice president and general counsel for Timber Hill Group LLC, the parent company of Interactive Brokers, argued in a letter to the SEC that the short sale rule be eliminated entirely.)

 

While some may think that it is the 1920’s all over again and today’s short-raiders are the modern equivalents of Jacob Little, there are regulations in place today designed to prevent that kind of abuse. The SEC also has some sophisticated tools at their disposal to go in and reconstruct exactly what happened and by whom once something has been brought to their attention.

 

Reconstructing what happened is only part of what the Commission does. It also looks into the other means that manipulators use, such as spreading false rumors.

 

A Cascade of Events: Some Legitimate, Some Sinister

The July 28 short raid on Crystallex followed at least one (and probably more) suspicious press releases issued by a recently formed Latin media relations firm, which sports little more than a threadbare Web site.

 

Its specious press release made out to look like an “article” was widely distributed to online press outlets, but it only induced a couple of online Spanish-speaking news and information websites to pick up the story and post portions of it on their online publications.

 

Once published on these news sites, even baseless and inaccurate misinformation gains a kind of credibility. So-called “bashers,” were quick to pick up those obscure press clippings and repeat them multiple times daily. Bashers are the anonymous posters often allied with short sellers on internet stock message bulletin boards such as Yahoo! Finance or Silicon Investor. Bashers can dominate those bulletin boards with an overbearing and repetitively negative point of view. Eventually that negative repetition finds its way into the rumor mill, then the reactive broker community and from there to investors large and small.

 

Commenting on the effect of the relentless bashing of companies on those cyber bulletin boards, the Denver-area broker said, “I get calls from clients all the time who say, ‘Have you heard this? Have you heard that? I saw it on Yahoo or on Stockwatch.’ And a lot of it is just basically crap.”  He conceded though, that over time the incessant bashing and misinformation takes a toll and continued, “It’s really sad that these bashers play on the fears of people looking for useful information on those websites. Lately I have been telling my clients not to even visit those sites.”

 

One of the suspicious “articles” was even picked up by a reporter - who does double duty writing for U.S. major media outlets - on July 5. That reporter purported to quote an un-named Venezuela National Assembly member as saying that the Crystallex mining contract would be “reviewed” and potentially that the 12.8 million ounce gold mine called Las Cristinas would be taken from Crystallex and turned over to the government-aligned mining and holding company, CVG-Minerven.

 

Obviously, if true, such an event would be the nuclear event that vaporizes Crystallex.

 

An amazingly similar “article” (actually a press release by the Latin media relations firm) was repeated a bit later on July 22, dressed up with more Minca-inspired comments and picked up by other publications, but the second time the comments were attributed to Adel El Zabayar, a member of the Permanent Commission of Energy and Mines of the Venezuelan National Assembly.

 

Minca is aligned with Crystallex adversary Vannessa Ventures, Ltd. [TSXV:VVV], a Calgary based company, which has been claiming rights to Crystallex’ Las Cristinas project since 2001 when Vannessa bought for a reported $50 part of a Placer Dome [NYSE:PDG; TSX:PDG] subsidiary which formally held the Las Cristinas mining contract. Vannessa made that partial purchase hours before the dying contract was to expire and after the Venezuelan government had made it known that the previous Placer Dome contract would not be renewed.

 

From that tenuous toehold Vannessa went on to file a bevy of lawsuits in the Venezuelan courts and wage a public war of words in the press largely ignored by Crystallex. Despite the obvious, that the Placer contract was being terminated in 2001, through Minca, Vannessa sought to become a party to the now cancelled Placer contract and to gain rights to mine the Las Cristinas. However, the Venezuelan government never recognized that claim.

 

Last year Vannessa withdrew its lawsuits and decided to try its luck with arbitration at the International Centre for Settlement of Investment Disputes (ICSID) at the World Bank in Washington D.C. While few take the Vannessa challenge to Crystallex’ rights seriously, the conflict could be a useful tool for stock manipulators as long as it lasts.

 

Vannessa lawyer Mariana Almeida was also quoted in the July 5 article, so its genesis might have been with Vannessa, or interests that support Vannessa, but evidence is mounting that the article may have been connected to the shorters.

 

 

The Articles Are Frauds

The “articles” mentioned above are likely fictional. Maybe not in the sense that at some point in time El Zabayar may have said something to the effect of what was attributed in the July 21 press release, but they are fraudulent because it is certain that if El Zabayar made those comments (yet to be confirmed) he must have been doing so as a personal opinion and certainly not in the context of an official action on the part of the ministry. Yet the title to the suspicious press release made it sound as though an official action was underway by the Venezuela National Assembly Commission for Energy and Mines. Multiple sources confirm that no such action is contemplated by that body.

 

It is also possible that the Zabayar comments were from a much earlier time, perhaps from a period not long after the Las Cristinas mining contract was awarded to Crystallex in 2002, an event that was somewhat controversial at the time. If so, then those comments were repackaged by the manipulators and released as “new.”

 

Since 2002, Crystallex has gained considerable support throughout the Venezuelan government and only lacks one more permit before it begins construction of the mega-mine.

 

The incendiary July 21 press release was released at a critical time for Crystallex investor confidence due to delays in receiving the final construction permit. A search is underway for the original sources of those comments and for a possible tipster who may have sent the comments to the mainstream reporter before the very similar July 5 piece on it appeared in BNAmericas.com. Repeated emails to that mainstream reporter were ignored and he refused to return phone calls for this article, which is an odd way for a reporter to conduct himself.

 

Another earlier “article” made the bizarre claim that Crystallex was being investigated for failure to pay Venezuela value-added taxes (VAT) relating to payments to its Venezuela lawyers. Crystallex spokesman Richard Marshall says this is a ridiculous charge first trotted out in 2002 by supporters of Minca/Vannessa. “They have repeatedly made that claim but nothing ever came of it nor could it have,” said Marshall.  He adds that the responsibility for payment of VAT rests with the recipient, not the payer. Nevertheless that same charge was also tagged onto the end of the July 21 Zabayar press release by the Latin media relations firm.

 

Those counterfeit “articles” are partly what fueled the rumor mill over the past six weeks with what are proving to be completely baseless fears that Crystallex might lose the contract to mine the Las Cristinas. Part of the “softening” process by the manipulators. Given public comments from the president of the Corporacion Venezolana de Guayana (CVG) Victor Alvarez, those fears are unfounded. CVG is the government-aligned holding company that is Crystallex’ partner in the Las Cristinas mine. Alvarez is also the Ministry of Basic Industries and Mining (MBIM) Minister. (Similar to a cabinet level official in the U.S.).

 

In early June Mr. Alvarez was quoted widely as saying that the final permit for Crystallex was "well on track," that the approval of it was "a bureaucratic formality" and said in response to a reporter's question, "For our part we are going ahead with the Crystallex project."

 

Nevertheless, those counterfeit article rumors were out there waiting for a spark to gain traction because of the pseudo-credibility afforded them on the Spanish-speaking news publications. They also gained momentum via the consistent daily hammering of them on today’s cyber water-cooler gathering place, the stock message bulletin boards.

 

The effect those fake “articles” had on Crystallex investors is indisputable.

 

“I knew the articles were fishy,” says one long-time Crystallex shareholder who asked that her name not be used, “but until you mentioned the dates I couldn’t put my finger on what it was. But since the permit didn’t come in June I figured there must be something wrong and there it was in those articles.”Meaning, of course, that even long-time Crystallex investors were shaken by the suspicious articles, just when there were 9 plus million shares sold short. A tactic Jacob Little would have been proud of.

 

The cumulative effect of the rumor storm and the fallacious articles cause the company to issue two separate press releases in an effort to quell the escalating market damage. In the first, on July 22, Crystallex President Todd Bruce was compelled to say, “We wish to assure the market that the Company and the relevant government agencies are actively engaged in moving the permitting process to its conclusion. The best description of the status of the process is that provided in a recent public statement by Victor Alvarez, Venezuela’s Minister of Basic Industries and Mines and President of the CVG, in which he stated that the permit is in the final stages of a normal administrative process. We are not aware of any technical impediment to the granting of the permit and we have, earlier in the week, completed further successful meetings with Ministry staff.”

 

Taking Advantage

Manipulation is not the only reason that the big short raid succeeded so well. There were legitimate reasons for Crystallex shares to be under pressure.

 

One prime ingredient of the success of the raid was what turned out, in retrospect, to be a failure of a much reported company reliance on Venezuela public officials’ estimates on the timing of the final permit, the Permit to Impact Natural Resources.

 

Sifontes mayor Marlene Vargas (Sifontes is the community in Bolivar State that the Las Cristinas mine is closest to) said publicly after meetings with Ministry of the Atmosphere and Natural Resources (MARN) officials in March that the process for the long-awaited final permit for Crystallex would be completed within ninety days. Crystallex president Todd Bruce (and others) embraced this timetable publicly. So when the ninety days came and went, and even a kind of collective unofficial grace period of a few weeks also passed without the all-important go-ahead from the MARN, that disappointment became a door through which the other, false rumors could gain entry into the minds of Crystallex investors who had thought that the final permit might be in hand as soon as the end of last year.

 

While the delay in the final permit was a legitimate issue and a reason for the stock to be under selling pressure, it almost certainly was not enough of an issue by itself to cause the kind of reaction seen by Crystallex stock on July 28. What it was though, was a golden opportunity for short interests in the mining stock with the largest short position of any mining stock on the AMEX. But the short interests evidently didn’t want to leave anything to chance.

 

Timing is Everything

The perpetrators of the short raid chose the timing for their “back-breaker” well.

 

Investors and brokers who follow Crystallex closely and keep up with the company though cyber-communities and company press releases knew that Crystallex Chairman Robert Fung and President Todd Bruce had traveled to Venezuela for meetings about the final permit. Shareholders were waiting for news of those meetings on the 28.

 

The raid also came one day before a much ballyhooed internet message board discussion about the first meeting of the ICSID on the Vannessa arbitration matter. Message board posters heralded that first meeting repeatedly in the days prior.

 

Someone had managed to get into the online press the troubling “articles” and the broker-assisted rumor storm had become the equivalent of a cyclone.

 

With all that and more on the minds of Crystallex investors, someone threw the equivalent of a two-ton round bale of straw on the proverbial camel’s back in the form of a market sell order for hundreds of thousands of shares on the morning of the 28.

 

In other words, that it came at what would be a crescendo of shareholder apprehension, fear and fatigue, just speaks to the manipulators efficient use of timing. Tim Wood, chief editor of Resource Investor, called it “a finely run operation.”

 

Indeed it was a finely run operation, but probably not entirely legal, ethical or moral.

 

In this case there are several smoking guns, which the over-worked regulators can readily identify.

 

The first smoking gun is in the fraudulent “articles” mentioned above. The second, and perhaps the one that is most damning, is clear evidence that the short selling individuals or hedge funds used information about an upcoming financing to induce some large holders to sell and to sell short Crystallex shares in the approximately three week to five week period prior to the raid.

 

Importantly, the raid occurred on the very day that Crystallex was to file its preliminary shelf prospectus, but very damning for the short interests, the raid was that morning in advance of the filing, not in reaction to it.

 

The third hot pistol for the regulators was the back-breaker sell order fired into the marketplace on the morning of July the 28, and that is one clue that will likely lead to fast answers. As one regulator at the SEC put it, “We usually just follow the money.”

 

Finally, there has even been evidence turned over to regulators of message board bashers front-running the issuance of the fraudulent articles and in one instance, claiming to be the source of them.

 

“Financing Sickness”

A financing offering or prospectus like the one that Crystallex just filed on July 28, has to go through a process and get looked at by quite a few people before it is finally filed. In addition to upper management of the company, two separate outside legal firms, an accounting firm, the company’s financing consultant bankers and perhaps some regulators in Canada and/or the U.S. are consulted and the process can take up to a couple months to complete. That’s a lot of eyes, mouths with a multiplier effect on the ears.

 

It is not that uncommon for advance word of a financing to leak to the financial community precisely because of the number of people who necessarily must see and review the documentation prior to that filing. Short interests and some financing broker dealers seeking that very valuable information have found ways over the years to gain that information sometimes without the people responsible for keeping it confidential even knowing it. For example they might seek low-level informants at printers or in legal offices, who don’t have to know the subject; just get their hands on documents.

 

It should be noted that it is illegal to trade on that kind of non-public information until it is released, but regulators have noticed a pattern of stocks declining prior to equity offerings. Something called “financing sickness.”  It has become the rule rather than the exception.

 

June AMEX short-sale records indicate massive shorting of Crystallex stock on June 15 and 16 to the tune of over a million shares on those two days alone, very likely related to advance word of an upcoming financing by the company. As of this writing July short-sale records are not yet available to the public, but of course they are available to exchange officials and regulators. Those short sale records may end up being like elephant tracks in this particular case.

 

In the United States, using non-public inside information to gain an advantage in trade is a crime. Just ask Martha Stewart. It is also a crime to intentionally trade for effect, or to manipulate the price of a listed security. Although direct evidence of this happening will be tedious to reconstruct, with today’s technology it is very possible.

 

There is nothing at all illegal about selling a stock short. Short selling forms a legitimate free-market function and is generally accepted in all open markets in the U.S. However, it is one thing to create a very large short position based on sound technical or fundamental reasons in the normal course of business. It is quite another to do so and then through fraudulent articles, influencing others to sell and sell short using advance non-public information, and then intentionally crashing the share price with market sell orders, to initiate an artificial panic in the same stock.

 

That amounts to racketeering and it is blatant stock manipulation at the direct expense of a company, and the good people who own the publicly traded shares of that company. But that is apparently what happened to Crystallex stock and its shareholders in July of 2005.

 

Shareholders May Strike Back

Jason Gibson, a partner with the Houston firm of Smith-Gibson, thinks Crystallex investors, some of whom suffered horrendous losses through the raid, deserve a full investigation of the events and actions by the perpetrators of the July raid. “The integrity of the markets has to be protected,” says Gibson, “from those who profit illegally at the expense of the innocent.”

 

Gibson says his firm is looking into the short raid on behalf of Crystallex shareholders and if the evidence proves what he suspects, his firm will very likely be filing a legal action against the manipulators.

 

The good news for Crystallex shareholders who survived the raid is that most likely the interests who engineered this assault have more than likely now covered many of those millions of shares they borrowed and perhaps have even now reversed course and taken long positions.

 

They know that the “reasons” for the raid were mostly of their own making.

 

The above contains opinion and commentary of the author. Each person should study the issues carefully and make their own informed decisions. Disclosure: the author currently holds a long position in Crystallex, but not in any other company mentioned in this article.