- Dividend Record Date Just Days Away: October 12, 2018
- Possible Short Squeeze Imminent
- AtoZpay Distribution Date:November 30, 2018
- Stay UPDATED: Weyland Tech Twitter Feed (https://twitter.com/weylandtechinc)
All seasoned smallcap investors eventually point the finger at naked shorts when good news fails to rally a stock. They are an easy target to explain the unexplainable. Naked shorts are these mythical creatures like Bigfoot that leave footprints behind but has never been caged. It’s hard to believe in their existence because typically investors don’t have these superhuman type powers of invisibility to endlessly short a stock without having to put up any collateral or every have to do a buy-in. Naked shorts are rarely captured or prosecuted. They operate with impunity in dark investor pools. They even write blogs about how it doesn’t exist.
Elon Musk one of the most powerful and influential billionaires has been unable to rid Tesla (TSLA) of their naked short problem. CEO of Overstock (OSTK) Patrick Byrne, developed a blockchain solution called TZero to combat the abusive shorting, but has little to show for it as his solution needs regulatory support. In the next 3 to 5 days a small company called Weyland (WEYL) with about an $88 million market capitalization is using a loophole to expose the shorts. Will they succeed where so many have failed will be determined within the next 5 days. Given the large naked short position and small investor float of 4.9 million shares any sort of buy-in by the brokerages to square positions ahead of settlement would propel price very quickly.
History behind DTCC
First some background is necessary on the formation of the Depository Trust & Clearing Corporation (DTCC). It was formed to provide clearance, settlement and information services for equities, bonds, unit investment trusts, mortgage backed securities, money markets, and over the counter derivatives. The genesis of DTCC can be traced back to the 60’s when volume of trading swelled so much that the exchanged needed to shut down mid-week to deliver stock certificates and mail them out to the appropriate owners. The concept of a central depository for physical certificates was born. This lasted about 5 years and then DTC was born in 1973. The idea was a “certificateless society” that was only supposed to be a “temporary measure.” This evolved into multilateral netting which is a legal term that allows a net position of the broker to be the legal reconciliation of the position. DTCC essentially holds all the deposited securities and keeps track of its owners via book entry form. They clear $1.7 quadrillion worth of securities annually. Keep in mind that DTCC is owned by its users which are the major banks like Chase and Bank of America as well as major brokers like Goldman Sachs, Charles Schwab, and UBS.
There is no need for an issuer to interact with DTCC EXCEPT in special instances when mergers, splits, or dividends are issued. In order to assure the fair distribution an accounting must be taken to ensure the proper ownership is effected on the record date. Almost all securities are held at DTC which is titled as Cede and Company. Most of the exceptions are small OTC stock. Over 600 broker-dealers and banks keep their ownership in stocks in the form of a net debit or credit to their account daily. The actual certificates stay in the vault. Shareholders need to realize that what they own is an IOU. For example, a client of TD Ameritrade would own a contractual right for those shares from TD Ameritrade and in turn TD Ameritrade would have a claim on their balance of shares held at DTCC. This would be a very efficient system if not for Fail to Delivers.
High Fail to Delivers Signals Naked Short Sales
A Fail to Deliver happens when one party cannot deliver the security. There are 3 primary reasons, they either didn’t have the money to pay for it, they couldn’t locate the certificate, or they sold something they didn’t own and collected the money. The third reason is called a naked short seller and it is illegal to naked short sell stock but it happens every day and the SEC had done next to nothing to curb its growth. The real question is what happens when your stock broker gets a fail to deliver on a security you just purchased. Do they call you up and say “Mr. Client I just want to let you know but that stock that we bought for you, well the trade didn’t clear and your money is gone and we don’t even have an IOU with your name on it.” No they don’t do that because it would be bad for business, but their strategy is nothing other than HOPE. They HOPE the stock eventually settles and if not they transfer this to their trading department to clear up. Then the trading department can sell it to another broker dealer and then buy it back in seconds later and the clock is reset for the market maker on Regulation SHO. Hope isn’t the best investment strategy nor is it the best way to settle accounts.
Regulation SHO was implemented in 2005 and was designed to create a mechanism to force the locate and clearing of shorted stocks to prevent the unethical naked short selling practices. There were so many loopholes in Regulation SHO that it has been amended subsequently many times in an attempt to curb the abusive naked short selling practices. The underlying weakness remains in the market maker exemption which allows them to naked short a stock under the guise of maintaining a fair and orderly market. Investors need only imagine how this could multiply if this same security was traded multiple times during the day. Market participants can essentially pass a fail to deliver from one party to the next and never be forced to deliver. Regulation SHO has good intent but fails because there are too many loopholes allowing the fail to deliver to kick the can down the road.
Ideal Breeding Ground for Naked Shorts
After Regulation SHO was implemented hedge funds flocked into the market making business because then they could be exempt from reconciling the fail to deliver. Market makers could act as proxy for the naked short sellers and get big payoffs for the service. When the SEC placed onerous reporting requirements on small companies they were forced into toxic financings that hedge funds would short in advance of getting the stock certificates cleared from the transfer agent and not only benefit from the discount in the security but also from the short sales. Investors know these as deal spiral financings. Every now and then one of these type of financings would go wrong and the certificate would get cancelled for lack of performance but the hedge fund already sold the shares and was planning on covering with the certificate. Instead of executing a buy-in they would sell more stock in the hopes of creating more panic.
Weyland Case Study
The Weyland story started a number of years ago when they were initially slated to buy a company subject to certain due diligence provisions. Claw back provisions in the contract that were subject to due diligence allowed WEYL to unwind the deal and required the surrender of the stock. The seller and the finder of the company had 3.5 million and 1.5 million respectively. The finder refused to give the stock back because he already sold it to the hedge fund and now it was the responsibility of the hedge fund. The hedge fund has already presold the stock without clearing it. Once the hedge fund found out that the stock certificate was never going to clear they were confronted with a choice to cover the security or double down and short the company more. WEYL is still in litigation with the individuals detailed in the company filings. The hedge fund will be unable to cover the naked short and with the dividend looming a forced buy-in is likely to happen.
The company knew that the stock was being manipulated by the Naked short trying to cause panic with a low closing print. Since FINRA, the SEC, and OTC Markets would do nothing with the naked short information, they crafted a bullet proof plan to trap the short via this loophole in DTCC. All the market participants were expecting to be able to give an IOU for a dividend which typically comes electronically. The issue is that dividends are supposed to have an audit date whereby the DTCC cross references with the broker. WEYL has a keen understanding of the problem and understood that a spin off needs to be constructed in a way where the naked short cannot exploit a journal entry and just make another IOU. This special dividend is outside of DTCC which means the company has explicit instructions that they want all the brokerage firms to give them a true owner as of October 12, 2018. This forces the brokerages to square their positions with DTCC. That means in order to get a dividend the book of DTCC and the brokerages need to match and verify. Normally this is never done, there is rarely a need except in this special circumstance. This the LOOPHOLE. Right now, the brokerages are trying to track down the certificates and make sure they have a bonafide list to deliver to the transfer agent on the record date. Remember there is T+2 settlement so any shortfall could be covered in that 2-day window with a guaranteed settlement trade. When this buy in happens nothing can stop it. Any discrepancies will force the broker to buyin the security and locate guaranteed shares.
Dividend Strategy – Gross Undervaluation
Here is a quote from the 10-Q, “In order to maximize the independent growth os AtoZpay and consequently shareholder value, management has begun the process to spin-off the e-wallet business via a special dividend.” This needs to be be translated into investor language. In other words management is saying in the public markets PaaS companies are getting valuation 6 times sales. With expected sales of $25 million this year the company should have a market capitalization of $150 million on just this portion of the company, not factoring the CreateApp business unit. Under the current share structure the price should be valued between $5.15 (2018 revenues) to $20.50 (2019 revenues). In the private market the valuations are much richer which means at 15.9X assuming the $25 million 2018 target is %13.70 target price. This is why investors must have this dividend of shares. This graphic encompasses their strategy. Warren Buffet has been a very big consolidator of private companies in this space and AtoZpay might be on its radar.
Valuation Gap Driven by Naked Short
All one has to do is look at the trading behavior of the stock for about 15-20 minutes and then it is readily apparent that ALL buying will be followed by a low offer giving the appearance of a big seller because there is actually a big seller. The seller is a naked short seller thay got into a lot of trouble selling stock off of a hypothetical certificate that no longer exists. This issue was litigated. It started off a 1.5 million share cert and has grown to 5 million shares. According to OTCMarkets there is 4.8 million shares in the float. This represents an epic short squeeze opportunity when 100% of the float is short. The question is what will be the catalyst? The catalyst is in 3 trading days, but come as early as Monday when FINRA announces to the broker dealers how this special dividend is to be paid. It will be paid via Stock certificate.
The brokerages are going to do the buy-in or they risk the liability of the foreign hedge fund that is naked shorting the stock. The company they are spinning out is worth multiples of the current stock price. There is a real business here and that is an excellent reason to own and keep the stock. There is very little risk in this transaction except there could be sellers on 10/11/18 who played the stock just to get the dividend and don’t care to see how big the naked short position is. The unwinding of this position can happen at anytime because brokerages do have the ability to do same day settlement. All it takes is one discrepancy at a brokerage firm and this stock could soar. All investor should set a volume alert for over 100,000 shares. If it triggers in the AM then the mystery is over and this stock will serve as a template for others to follow. Happy hunting!
Disclosure: The author of this article has NOT been compensated by the company or any third party, but does have a LONG position in the company and may add more, hold or sell in the near future.