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AIM chief exec Lofgran breaks ranks to challenge market makers over naked shorts (NTOG)

Matt Lofgran, CEO of Nostra Terra Oil & Gas (LSE:NTOG) has broken ranks to become one of the first AIM bosses to call out market makers for naked short selling- one of the junior market’s worst-kept secrets. Speaking to Total Market Solutions, Lofgran said he is not willing to co-operate with certain market makers who take short positions in target companies and then seek to close these out through discounted placings.

Lofgran said: ‘If someone wants to base their business model around building up a short position in a company and then closing it out with the company to make a profit then they are free to try that, but I am not interested.’

Naked shorting, which is rumoured to be rife on AIM, sees a market maker sell stock that does not exist in a target firm to retail investors at a higher price until they have built up a large short position. The market maker’s goal is then to close the short by participating in a discounted placing of the target firm and then using the placing stock it receives to settle its open trades, pocketing the difference in the two prices. Such shorts can typically be anywhere between £300,000 and £500,000 in size, although there have been notable occasions when the naked shorts have run into millions.

By targeting firms that are likely to raise money, such trades can be incredibly profitable for the market maker, while the retail investor invariably ends up on the losing side.

Unlike traditional shorting, which relies on borrowing stock that actually exists, naked shorting can have dire consequences. Despite often being touted as a way of increasing liquidity, if the market maker cannot deliver the stock it borrowed it creates ‘phantom shares’ that can dilute the price of the underlying stock. Some even blame the process for the collapse of Bear Stearns and Lehman Brothers in 2008, and as such, the procedure was banned in the US in the wake of the financial crisis.

This failure to deliver can also result in a so-called ‘short squeeze’. This is when naked short sellers rush to cover their positions on a stock, attracting other short sellers to cover, and ultimately creating a buying volume that artificially drives the company’s price up.

In his interview with Total Market Solutions, Lofgran reiterated that this style of shorting can be harmful to shareholders: ‘It does not help our shareholders, and fortunately we are in a position that we do not need to accept the money. Some of them have got a track record of being able to do this because they know a lot of companies are out there passing around and looking to raise money. That’s not us. We are in a position where we do not need to raise money. We will raise money when we want to. We will do it when it is the right opportunity to have a big impact of the company and only if and when the time is right.’

We at find it very interesting that, following the interview, Lofgran went on to say he was approached by a market maker earlier this month, which offered Nostra Terra funds.

In a Tweet, Lofgran wrote ‘We were approached by an MM with an offer this month. We’re not letting market shorts close out! Not in shareholders interest.’

Nostra Terra’s “strange” share price movement in June and early July does suggest that perhaps the company’s stock was the focus of a targeted short. While the West Texas Intermediate (WTI) oil benchmark rallied, Nostra Terra’s stock was pushed lower.

This divergence was especially surprising given that the company sells its oil using WTI as its benchmark, has been consistently increasing production over 2018 and in February this year announced it was cash flow positive at the Plc level. Admittedly Nostra had experienced something of a quiet news period, but careful watching of the daily trades revealed the share price was dropping on little volume. This suggested that perhaps the decline was not down to long-term holders selling out.

Under the Short Selling Regulation, market makers are afforded an exemption from disclosing shorts so long as their total position is less than 10% of the issued share capital of the company they are shorting, the short is part of their regular market making activity (i.e. is not a proprietary trade) and (crucially) they’ve applied for the exemption in advance of using it. If the trade is a proprietary trade (i.e. the market maker has targeted a stock because it believes it is going down) then the standard 0.5% threshold applies, which requires that shorts above this level of a company’s issued share capital are reported to the FCA for disclosure in the weekly shorted shares report.

Interestingly no short position in Nostra Terra was reported in the FCA’s recent weekly updates.

Make of that what you will.

Author: Stuart Langelaan

Disclosure: The Author owns shares in the company mentioned above.


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