David Dayen, a persistent chronicler of how oligarchs exploit the financial system to enrich themselves at the expense of others, writes about Chris DiIorio, a stock analyst who for 10 years has obsessively investigated how exactly he came to lose $1 million on one penny stock. A remarkable story ensues.

Illustration: Erik Carter for The Intercept.

The Money Is Gone

Illustration: Erik Carter for The Intercept.

Part 1

David Dayen, a persistent chronicler of how oligarchs exploit the financial system to enrich themselves at the expense of others, writes about Chris DiIorio, a stock analyst who for 10 years has obsessively investigated how exactly he came to lose $1 million on one penny stock. A remarkable story ensues.

Chris DiIorio had just lost a million dollars.

This was back in 2006. DiIorio, who was 39 at the time, had recently moved with his new wife from Boston to Castle Pines, Colorado, a leafy suburb of Denver, and was toiling in finance as a market researcher, analyzing the financial statements of public companies and giving recommendations to portfolio managers.

He had previously worked on Wall Street as an institutional equity trader and research analyst for a subsidiary of the now-defunct investment bank Donaldson, Lufkin, and Jenrette. He had 13 years experience executing massive trades for large mutual fund clients like Fidelity and Putnam.

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Chris DiIorio

Photo: Matt Slaby for The Intercept

But in his new life, DiIorio happened upon a technology company called E Mobile (symbol: EMTK), a small computer chipmaker that claimed to hold patents on an antenna-type Wi-Fi router and other products. He reviewed company press releases, as well as investor chatter online claiming that E Mobile’s chips were provoking interest from Chinese content companies.

E Mobile didn’t trade on the New York Stock Exchange or Nasdaq, however. It was an over-the-counter stock, traded on an electronic exchange called the Pink Sheets that is home to what are commonly called “penny stocks.”

A penny stock is actually any equity that trades for $5 a share or less. But many shares can be had for a literal penny, or even a fraction of one. They are purchased on the Pink Sheets and the over-the-counter Bulletin Board market, through your regular brokerage account.

Not every penny stock is suspect; some are simply startup companies working their way to larger exchanges. But they do lurk on the dark edges of the financial markets, with sudden volumes and massive volatility. Regulation and reporting vary from light to nonexistent.

“They don’t have the same standards,” said Joseph Borg, director of the Alabama Securities Commission, who achieved fame by investigating Jordan “The Wolf of Wall Street” Belfort’s company Stratton Oakmont for penny stock fraud in the 1990s. “Willie Sutton said he robbed banks because that’s where the money is. This is the easiest place to manipulate something.”

The Pink Sheets’ own website warns that it “offers trading in a wide spectrum of securities” and that “With no minimum financial standards, this market includes foreign companies that limit their disclosure, penny stocks and shells, as well as distressed, delinquent, and dark companies not willing or able to provide adequate information to investors. As Pink requires the least in terms of company disclosure, investors are strongly advised to proceed with caution and thoroughly research companies before making any investment decisions.”

But DiIorio didn’t know that at the time.

On Wall Street, he had executed multimillion share trades, usually of blue chip companies that make up the Dow Jones Industrial Average, like IBM or General Electric.

“I had never invested in a penny stock before,” DiIorio said. “I was not super sophisticated in this world.” But he decided to take a flyer on E Mobile, based on its promising news. “I bought this company on hype.”

Between February and May 2005, DiIorio bought over 3.7 million shares of E Mobile, mostly through his rollover IRA account with TD Ameritrade. The total cost: $100,000, or a little over 3 cents a share. It was a big position, but this was retirement money he was trying to grow, and if it paid off, the payday would be tremendous.

E Mobile bounced around for a year, not doing much. The CEO, Nan Hu, personally called DiIorio, asking him to invest more through a “private placement”: an off-market offering of stock to select investors.

DiIorio declined. “I was already up to my eyeballs. I said, ‘I’m good with my position.’” Attempts to reach Hu for comment were unsuccessful.

Then, in March 2006, E Mobile announced a “reverse merger” with Best Rate Travel, a private company specializing in online vacation booking. Adrian Stone replaced Hu as CEO. To DiIorio, it was a puzzling maneuver for a chipmaker. “They announced a merger with a travel company?” he said. “What the fuck?”

As part of the merger, E Mobile changed its name to Best Rate Travel, altered its stock ticker symbol to BTVL, and did a 1-1,000 “reverse stock split.”

You’ve probably heard of a stock split; it can happen when a company’s share price gets unmanageably high. So when a stock hits, say, $200, investors who owned one share receive two, each priced at $100.

Well, the opposite can happen, too. Best Rate Travel’s reverse split gave existing investors like DiIorio way fewer shares — at a way higher price.

As a major shareholder, DiIorio was offered a slightly better deal: a conversion to preferred shares of E Mobile at a lower reverse split rate of 1-to-30, and then a conversion at 3-to-1 to Best Rate Travel. After all that, he was left with 373,599 BTVL shares.

The merger hype, repeated in a feedback loop of positive press releases, moved the stock. DiIorio recalls it peaking at $3.50 by September 2006, giving his holdings a value of around $1.3 million.

“I thought this was the exception to everything I knew about the markets,” DiIorio said. “Cheap stocks are cheap for a reason.” But the success fed DiIorio’s ego. He felt like he beat the odds, vindicating his stock-picking acumen.

There was a problem, however. Best Rate Travel structured the conversion with a “lock-up” agreement, restricting shareholders like DiIorio from selling the stock for a year. This is common for newly public companies.

But it left DiIorio helpless when the stock plummeted from $3.50 to $0.06 a share within two months.

DiIorio initially saw it as a classic “pump-and-dump” scheme, where major investors in a company lure in other investors with overhyped claims, raising the stock price, and then sell their shares, leading to a drop. Pump-and-dumps have proliferated with the rise of internet message boards. “It’s not just promoters calling you on the phone anymore,” said Laura Posner, bureau chief of the New Jersey Bureau of Securities. “People pretend to be other people, pretend to have inside information.”

But to DiIorio, BTVL’s drop didn’t make sense, because prior shareholders were prohibited from trading the stock. “I called the CEO regularly and said: ‘Who’s selling the stock? How is this happening? The stock is not for sale.’ He told me that he was locked up too.” Phone numbers and email addresses listed for CEO Adrian Stone no longer function, so he could not be reached for comment.

By the end, DiIorio took a loss from the peak stock value of well over $1 million. “I never saw such devastation in a stock before,” he said.

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In a pump-and-dump scheme, investors buy a stock, hype it to pump up its value, then dump it before it crashes back down.

Graphic: The Intercept

A Real Head-Scratcher

DiIorio prided himself on being a savvy trader.

And the implosion of Best Rate Travel, given the lock-up period, shouldn’t have occurred. DiIorio wanted to understand what really happened to crush his investment so completely. And he had the background in financial market analysis to see it through.

So DiIorio started learning what firms traded Best Rate Travel. The biggest two by far were the giant Swiss bank UBS and a massive New Jersey-based company named Knight Capital.

He thought these were very big names to be involved in such an obscure penny stock.

Something fishy was going on, but DiIorio had no idea what. “I just thought, what the hell, I’m going to figure this out.”

Part 2

Big Players, Little Stocks, and Naked Shorts

David Dayen, a persistent chronicler of how oligarchs exploit the financial system to enrich themselves at the expense of others, writes about Chris DiIorio, a stock analyst who for 10 years has obsessively investigated how exactly he came to lose $1 million on one penny stock. A remarkable story ensues.

Contact the author:

David Dayendavid.dayen@​gmail.com@ddayen

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˅
Illustration: Erik Carter for The Intercept.

Big Players, Little Stocks, and Naked Shorts

Illustration: Erik Carter for The Intercept.

Part 2

David Dayen, a persistent chronicler of how oligarchs exploit the financial system to enrich themselves at the expense of others, writes about Chris DiIorio, a stock analyst who for 10 years has obsessively investigated how exactly he came to lose $1 million on one penny stock. A remarkable story ensues.

Chris DiIorio had lost a million dollars when the penny stock he was betting on shed 98 percent of its value in a matter of weeks. But when he looked deeper, he found this wasn’t a typical penny stock pump-and-dump scheme. He was determined to get to the bottom of it.

For one thing, there were two huge companies involved.

UBS, one of the world’s largest private banks, seemed to have no business trading in penny stocks. “This was a $50 billion-plus bank, it didn’t seem like penny stocks would move the needle,” DiIorio said. But just in December 2011, UBS’s trades in 32 penny stocks represented over half of the firm’s total share volume, according to his calculations.

In a one-line response to a series of detailed questions from The Intercept, UBS media relations director Peter Stack wrote in an email: “UBS applies strict due diligence and anti-money-laundering standards to all its business.”

After some research, DiIorio became even more disturbed by the presence of the other company, Knight Capital, which has traded an average of more than 2 billion shares of penny stocks daily for the past three years.

Based in Jersey City, N.J., Knight is what is called a “market maker,” a dealer that facilitates trading by actually holding shares itself, if ever so briefly, so investors can buy and sell without any delay. “They’re selling the service of convenience to investors, like a car dealer makes it easier to buy or sell a car quickly,” said Jim Angel, an associate professor specializing in market structure at Georgetown University.

Knight Capital is a giant in the field; it alone was responsible for 11 percent of all trading in U.S. stocks by volume as of 2012. It’s known in particular for speed. The ability to jump in and out of stocks quickly through electronic markets is attractive to customers and enables Knight to trade nearly $30 billion every single day. “Market making is a business where the spreads are small but the volumes are large,” Angel said. The spread is the difference between the buy price and the sell price, and it’s how Knight makes money.

DiIorio looked closely at how Knight operated. He determined that between 80 and 90 percent of its share volumes came from penny and fractional penny stocks. According to DiIorio’s calculations, Knight traded over 10 trillion shares of OTC and Pink Sheets securities from 2004 to 2012.

This level of volume persists — the most recent statistics show that 73 percent of the company’s equity share volumes in August 2016 came from penny stocks, and 81 percent as recently as May.

A share in a penny stock is worth magnitudes less than a share in Google or Apple. But the spreads — where the market makers cash in — are proportionately bigger on a penny stock. For example, if the market maker earns a penny per share of a $50 stock, that’s only a spread of .02 percent. But a stock worth 25 cents where a market maker sees even a tenth of a penny in profit represents a spread of 2 percent — a 100-fold increase.

Still, DiIorio wondered how much volume a broker would need to make any money through penny stock trading. “You would have to move hundreds of millions of shares per trade,” he said.

And, because his personal investigation had started after his shares in a company called Best Rate Travel tanked precipitously, he also wondered: Why was Knight so involved with them in particular?

While DiIorio was mulling that, he started talking to his fellow traders and reading rumors online from owners of dozens of small companies who blamed the rapid destruction of their penny stocks on a practice known as naked short selling.

Let’s take that step by step. A short sale, generally speaking, is a bet that a stock price will drop over time. Typically, short sellers borrow shares of a stock from a broker and sell them on the open market, hoping to buy them back at a cheaper price in the future and make money on the exchange. This can become a self-fulfilling prophecy, if done right. Short selling can cause a market panic, and the prices drop in the frenzy.

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How to short a stock.

Graphic: The Intercept.

But in naked short selling, you don’t even borrow the stock. You sell additional, phantom shares. This is even more likely to drive down the price than regular shorting, because suddenly the supply is larger but the demand is the same. “I can think of a number of stocks where the shares on the short exceeded the shares ever issued by the company,” said Alabama Securities Commission Director Joseph Borg. “You can’t do that unless it’s naked.”

Naked short selling is, not surprisingly, illegal in most circumstances.

But market makers like Knight have an exemption from naked short selling restrictions, on the grounds that they use the practice to maintain liquidity in markets. For example, if there’s high demand for a stock, the market maker can fill orders even if it doesn’t have the shares available.

As the Securities and Exchange Commission explains, “A market maker engaged in bona fide market making, particularly in a fast-moving market, may need to sell the security short without having arranged to borrow shares.” This often occurs in thinly traded stocks, like penny stocks.

DiIorio reasoned that naked short selling would explain where all the trades were coming from on Best Rate Travel; while he and his counterparts were locked into their investments for a year after the company’s merger, maybe someone was flooding the market with shares and battering the stock with ease.

At this point, DiIorio had no evidence that Knight did anything but facilitate trades. But he began to suspect that Knight somehow used naked short selling for its own devices. DiIorio’s attempts to get some explanations from Knight were brushed off — as were The Intercept’s during the reporting of this series.

Did Knight manipulate the stock price of Best Rate Travel, costing DiIorio and other investors millions? If so, why? Who benefited? Who needed this obscure, tiny penny stock to tank?

Part 3

Naked Shorts Can’t Stay Naked Forever

David Dayen, a persistent chronicler of how oligarchs exploit the financial system to enrich themselves at the expense of others, writes about Chris DiIorio, a stock analyst who for 10 years has obsessively investigated how exactly he came to lose $1 million on one penny stock. A remarkable story ensues.

Contact the author:

David Dayendavid.dayen@​gmail.com@ddayen

˅ 51 Comments (closed)
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˅
Illustration: Erik Carter for The Intercept.

Naked Shorts Can’t Stay Naked Forever

Illustration: Erik Carter for The Intercept.

Part 3

David Dayen, a persistent chronicler of how oligarchs exploit the financial system to enrich themselves at the expense of others, writes about Chris DiIorio, a stock analyst who for 10 years has obsessively investigated how exactly he came to lose $1 million on one penny stock. A remarkable story ensues.

A few years into his personal quest to understand how he had lost a million dollars on a penny stock, Chris DiIorio developed a sweeping hypothesis involving Knight Capital, the mammoth brokerage company that frequently traded in them.

Knight earned $333 million in pre-tax profits in 2008, and another $232 million in 2009. But DiIorio didn’t think Knight was making that kind of money simply from executing transactions for clients.

As a market maker, Knight was in the rare position of being able to legally sell a stock it didn’t have (the principle being that it will get that stock soon, so no worries). That’s called naked shorting. It’s illegal when regular people do it.

DiIorio suspected that Knight, either on its own behalf or on behalf of clients, made a practice of artificially increasing the number of shares available in a stock through naked shorting, thereby depressing the price.

His suspicion grew when he noticed that Knight often traded in securities that were red-flagged on the Depository Trust Company’s “chill list.”

The DTC is an obscure financial industry-owned company that manages the custody of more than $1 quadrillion in securities annually, recording the transfers with journal entries and guaranteeing the trade. The company makes it easy for people to buy and sell securities without needing to exchange paper stock.

But when the DTC senses trouble, it will stop clearing trades on a stock temporarily.

A chilled stock can still trade — as long as the market participants handle the physical certificates themselves. But it can be a sign that something is gravely wrong. The DTC states on its website that it chills stocks “when there are questions about an issuer’s compliance with applicable law.”

That doesn’t stop Knight from buying and selling them, though. Its chief legal officer, Thomas Merritt, acknowledged at a 2011 Securities and Exchange Commission roundtable that the company actively traded chilled stocks, saying that as long as the security still trades, “we are going to be involved in that business.” And DiIorio found numerous examples of Knight trading chilled penny stocks.

“I didn’t know they did that,” said Jim Angel, a Georgetown University business school professor. “I’m kind of shocked to think that Knight would be working with paper stock certificates.”

He suggested that Knight might simply want to accommodate customers trying to get out of chilled stocks. “Or maybe they feel there’s enough interest in a security that they can trade profitably, even if they have to shuffle the certificates.”

Because most other market makers flee chilled stocks, however, this means Knight can assume even more control over the stock price.

Naked Manipulation

The thing about naked short sales is they can’t stay naked forever.

Even if you don’t have the stock when you sell it, at some point it is expected that you hand it over.

And even with its market-maker exemption, Knight is required by SEC rules to eventually deliver the shares in a naked short transaction to the buyer and close out the trade.

Not doing so results in a “fail to deliver,” which DiIorio describes as the securities version of an IOU. And that IOU comes with rules: Under the SEC’s  Regulation SHO, short sellers have to cough up the stock within one day of incurring the fail. Routine failures to deliver can lead to fines by the SEC, or even a ban from the securities markets.

Instead of complying with the rule, however, DiIorio alleges that Knight circumvented it by manipulating an obscure process within the machinery of the nation’s clearing system known as the “Obligation Warehouse.”

This service facilitates the matching of self-cleared trades (often known as “ex-clearing”) that don’t go through the DTC —  for instance if the stock was chilled.

The Obligation Warehouse instead simply asks the buyer and seller of these ex-cleared trades if they “know” the transaction. If they both agree, the trade gets confirmed with a journal entry — and the buyer receives their stock purchase. It actually shows up in the buyer’s brokerage account.

The trades still have active IOUs, but according to DiIorio’s theory, buyers wouldn’t clamor for the trades to be closed because they would’ve already received their purchase.

If true, this would allow Knight to bury its naked short trades.

“They set up a shadow clearing system,” DiIorio said.

Furthermore, DiIorio recognized what he considered a persistent cycle in the stocks Knight traded. After being beaten down through what he suspected was naked shorting, they would often engage in a reverse stock split or reverse merger, like E Mobile did with Best Rate Travel in the trade that ended up losing DiIorio over $1 million.

This, he observed, could enable Knight to rerun the scheme over and over again, pummeling the stock price and then letting it move back up like a yo-yo.

Laura Posner of the New Jersey Securities Commission said constant reverse splits would require a coordinated relationship between the penny stock issuer and the broker-dealer. “I know that there are situations in which fraudsters will take advantage of a stock split to commit fraud,” Posner said. “But it’s different than a typical pump-and-dump, where you don’t have to have a personal relationship.”

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Photo: Louisa Gouliamaki/AFP/Getty Images

Alternately, the cycle could be a cat-and-mouse game playing out between the short sellers and the stock issuers. Hawk Associates, a consulting firm to small companies, recommends that penny stock issuers victimized by naked shorting engage in reverse mergers and/or reverse splits to stop the rapid degradation of their stock price. “It may be useful as part of a larger strategy to deter naked shorting,” the firm writes on its website. “This may be more trouble than it’s worth, however. Once the new shares are in circulation, there’s nothing to stop a new round of naked shorting by determined parties.”

Knight’s involvement with suspicious stocks following this same pattern kept cropping up.

For example, NewLead Holdings (NEWL) — a shipping company with a mining concern on the side that was accused in federal court of having “no coal mines, no coal, and no ability whatsoever to engage in the coal business” — engaged in 1-1,125,000 worth of reverse splits over nine months in 2013 and 2014, meaning that 1,000 shares prior to the splits were equivalent to 0.0008 shares afterward. NewLead did another 1-300 stock split just this spring; it now trades as NEWLF, at 0.00030 as of August 23. Its 2015 annual report admits, “There is substantial doubt about our ability to continue as a going concern.”

FreeSeas (FREE), another penny stock, did a 1-60 reverse split on January 15 of this year, and then another 1-200 split on April 13, changing its stock symbol to FREEF. The company has engaged in seven reverse splits in the last five years; someone with 900 million shares five years ago would have one share today, trading at less than a penny. The company’s annual report says it currently has no employees. Private equity firm Havensight Capital made an alleged bid to purchase FreeSeas in June at $0.43 a share, about 80 times its price at the time of this writing, which FreeSeas called “false and misleading.”

While one might think this cycle of splits and price declines would trigger red flags with federal regulators, Joseph Borg of the Alabama Securities Commission doubted they would pay attention. “It’s like asking the SEC, of all the 35,000 private placements issued, you look at how many? And if they were telling the truth they would say we’re putting them in a drawer,” Borg said. “Anything like that on miniscule levels, they just get filed away.”

Furthermore, while there are “circuit breaker” rules preventing short sales when a stock loses more than 10 percent of its value in a day, these swings were more gradual. Knight made a lot of money on these plays, not just from the spread in trading profits, but because it often traded on its own account rather than on behalf of customers, DiIorio concluded. When the stock dropped, Knight got rich from the short. And it could rerun this repeatedly

“He’s got a theory that, without studying it, I see theoretically where he’s going with it,” concluded Borg. “It’s an interesting idea.”

Knight is now known as KCG. Its spokesperson Sophie Sohn declined to comment when asked about this and other matters.

Attempts to reach spokespeople at FreeSeas have proven unsuccessful. Elisa Gerouki, corporate communications manager at NewLead, asked me to prove I wrote for The Intercept; after I did so, Gerouki failed to respond to questions.

Where Naked Shorts Go to Die

DiIorio also spotted a significant, seemingly toxic byproduct of this sort of activity.

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Graphic: The Intercept.

Reverse mergers and reverse splits typically result in a change in the CUSIP, the nine-digit identification symbol assigned to a public stock.

Once that CUSIP changes, the naked shorter has no apparent way to close out the naked short position. No stock under the old CUSIP number exists anymore; it all automatically converts to the new CUSIP.

Those trades can sit in the Obligation Warehouse forever, in theory. But the “aged fails” — essentially orphaned naked short transactions — remain on the naked shorter’s balance sheet as a liability to be paid later.

By DiIorio’s reckoning, then, the cycle of naked shorting and reverse splits would inevitably result in an ever-increasing number of aged fails. And if that was happening, and those liabilities grew bigger and bigger, then federal regulators could see the outlines of the scheme on any financial statement.

DiIorio believed Knight accounted for its aged fails in the “sold not yet purchased” liability on its balance sheet. That’s supposed to be an inventory of stocks for use in future market making, which goes up and down as orders are filled. But DiIorio says it was a hiding place for a billowing structural liability.

And consider this: According to its own financial reports, Knight’s “sold not yet purchased” liability jumped from $385 million at the beginning of 2008 to $1.9 billion by mid-2011.

Jim Angel, the business professor, said there could be other explanations — such as Knight’s growth as a company during that period — for why the “sold not yet purchased” liability ballooned. But, he said, market makers are typically “in the moving, not storing, business, and like to keep their inventories as small as possible.”

DiIorio had no such doubts. He saw the fact that Knight was blowing a hole in its own balance sheet as undeniable evidence of the naked shorting play.

KCG spokesperson Sophie Sohn was asked specifically about that claim and declined to comment.

If DiIorio was correct, Knight was driving penny stocks down over and over again with naked shorting, then not actually closing the trades, and racking up enormous paper liabilities.

This was even more complicated than he thought. It was time to call the cops.

Part 4

Calling the SEC

David Dayen, a persistent chronicler of how oligarchs exploit the financial system to enrich themselves at the expense of others, writes about Chris DiIorio, a stock analyst who for 10 years has obsessively investigated how exactly he came to lose $1 million on one penny stock. A remarkable story ensues.

Contact the author:

David Dayendavid.dayen@​gmail.com@ddayen

˅ 27 Comments (closed)
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Illustration: Erik Carter for The Intercept.

Calling the SEC

Illustration: Erik Carter for The Intercept.

Part 4

David Dayen, a persistent chronicler of how oligarchs exploit the financial system to enrich themselves at the expense of others, writes about Chris DiIorio, a stock analyst who for 10 years has obsessively investigated how exactly he came to lose $1 million on one penny stock. A remarkable story ensues.

Chris DiIorio suspected major broker-dealer Knight Capital of tanking penny stocks on purpose and racking up massive, unsustainable balance-sheet liabilities based on all the stocks it “sold” that it never really had.

It had taken him five years to reach these conclusions — five years of digging through reams of financial data in search of answers to how and why his particular penny stock investment was so brutally crushed. Knight never answered DiIorio’s questions, nor, during the reporting of this story, any of The Intercept’s.

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Graphic: U.S. Securities and Exchange Commission

In April 2011, DiIorio decided he had to alert the Securities and Exchange Commission. He reached out to the SEC through its Office of the Whistleblower.

“The core business at Knight has always been naked shorting penny stocks,” DiIorio asserted.

Shorting a stock is betting it will drop in price: You borrow a share, sell it, hope the stock price drops, then buy another share to pay back your loan, hopefully for less than you borrowed it for.

In naked shorting, you sell a share that doesn’t exist and cash the proceeds. Do that enough and you bet the price will drop. Set it up so that it looks like you really sold the share to everyone except an obscure middleman, and the only toxic byproduct is a liability on your balance sheet representing shares you have sold but not yet purchased.

DiIorio believed this represented the secret of Knight’s success. “I told the SEC, ‘If you don’t believe me, ask Knight!’ If their penny stock volumes went to zero, what would happen to their trading profits?”

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Photo: Richard Drew/AP


DiIorio filed a TCR (tip, complaint, or referral) form. Under Section 922 of the Dodd-Frank Act, the SEC has the authority to provide substantial monetary awards to eligible whistleblowers who inform the agency of securities law violations, if the subsequent enforcement actions exceed $1 million. But DiIorio says he wasn’t trying to win back his losses by filing a whistleblower complaint; he just wanted to see the ongoing fraud of investors like him put to a stop.

He also pointed to the threat to the markets from Knight’s thinning capital compared to the billion-dollar-plus “sold not yet purchased” liability. “I said, ‘Knight is insolvent, and this is how I know.’”

Indeed, the firm’s own second-quarter 2011 report to the SEC clearly showed $1.9 billion in “sold, not yet purchased” liabilities — up from $1.3 billion just six months earlier. By contrast, it reported “net current assets, which consist of net assets readily convertible into cash less current liabilities, of $105.1 million.”

Other than a perfunctory acknowledgement of receipt, the SEC did not respond to the TCR. DiIorio sent personal emails to top officials at the agency. One still exists on the SEC’s website, an October 2011 letter to Robert Khuzami, then the SEC’s head of enforcement. “Why won’t [then-Knight CEO Thomas] Joyce disclose to the investing public the nearly [$2 billion] sold not yet purchased liability is where he moves aged fails,” DiIorio wrote. “It is a structural liability and does not in fact ‘fluctuate with volumes’ as [Joyce] has said in several public filings.”

In this case, aged fails are the obligation left over when the stock whose shares the seller was supposed to actually hand over no longer exists because of a merger or split.

SEC spokesperson Ryan White declined to comment on the matter. As a matter of policy, the SEC never confirms nor denies the existence of an investigation until it reaches the public record in a court action or administrative proceeding, and it usually doesn’t inform whistleblowers about the status of their cases unless it grants them an enforcement award.

But DiIorio grew frustrated with the lack of response. “I was baffled why the SEC was not acting on what appeared to be blatant securities violations,” he said.

What About UBS?

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Photo: Jin Lee/Bloomberg/Getty Images


He used the delay, however, to clear up another nagging question: What about the other major trader in these penny stocks, the Swiss bank UBS, one of the largest private banks in the world?

Time after time, DiIorio would isolate individual penny stocks and find UBS and Knight as major traders in them. While it wasn’t possible to know for sure, the correlation suggested that UBS was repeatedly on the other side of Knight’s trades; its clients would go long while Knight’s would go short. If true, that meant UBS, or its clients, were taking on multitudes of losses by design.

Why was UBS so involved with penny stocks, which had little upside potential for a global megabank? Why was it so intertwined with Knight? Who was it purchasing these penny stocks for?

And why didn’t the bank seem to care that its clients were being sold stock that kept going down in value?

Part 5

Turning Up Like a Bad Penny

David Dayen, a persistent chronicler of how oligarchs exploit the financial system to enrich themselves at the expense of others, writes about Chris DiIorio, a stock analyst who for 10 years has obsessively investigated how exactly he came to lose $1 million on one penny stock. A remarkable story ensues.

Contact the author:

David Dayendavid.dayen@​gmail.com@ddayen

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Illustration: Erik Carter for The Intercept.

Turning Up Like a Bad Penny

Illustration: Erik Carter for The Intercept.

Part 5

David Dayen, a persistent chronicler of how oligarchs exploit the financial system to enrich themselves at the expense of others, writes about Chris DiIorio, a stock analyst who for 10 years has obsessively investigated how exactly he came to lose $1 million on one penny stock. A remarkable story ensues.

One summer day in 2012, Chris DiIorio pulled up outside a home that Colorado Goldfields Inc., a mining company in Littleton, Colorado, listed as the home address of its chief financial officer, Stephen Guyer.

DiIorio — whose investigations into the penny stock market dated back six years, to when his own investment swelled up before losing $1 million in value in two months — had already determined through property records that Guyer didn’t own it.

As he approached the front door, he found the shades drawn and no sign of life in the house. “It looked like the only thing active was the mailbox,” DiIorio said.

Colorado Goldfields, originally listed on the over-the-counter market as CGFIA, has traded at or below $0.01 since September 2013, making it a quintessential penny stock, one of the many DiIorio researched for years before making a formal Securities and Exchange Commission complaint about a potential wide-ranging fraud scheme.

(In an interview with The Intercept this month, Guyer said that he rented the property DiIorio visited because his association with the company wiped him out financially. “The company is in a total neutral situation,” Guyer said, citing active litigation with the former leadership.)

Like many of the penny stocks DiIorio had determined that the giant New Jersey-based financial firm Knight Capital actively traded, Colorado Goldfields stock had been placed on the Depository Trust Company’s “chill list.” Public records indicate that Knight traded 8.5 billion shares of CGFIA stock in 2012 — 31 percent of the total share volume — after the stock was placed on the list in May 2011.

The chill is given to stocks for various reasons, including displaying suspicious activity.

Guyer criticized the DTC for “acting arbitrarily” in chilling Colorado Goldfields. But the chill may have been issued because the company appears never to have mined any gold or other precious metal. Indeed, its most recent annual SEC filing, in 2013, states, “We have not generated revenue from mining operations.”

Guyer acknowledged that the company was always pre-revenue, claiming that project-level funding that would allow mining to commence would always fall through right before the transactions completed.

Along with this run of bad luck, Colorado Goldfields’s main activity seems to be generating press releases, announcing the acquisition of mines or approval to begin work at an existing mine. DiIorio found several of these press releases, which the company began issuing in 2007; in at least one instance, the company announced the same acquisition in separate press releases more than a year apart. (Guyer explained that “in those cases, we were announcing contracts that were entered into and weren’t closed.”) Yet the press releases would lure investors into the stock and the stock price would fall, to the benefit of the stock’s manipulators — and Knight Capital, according to DiIorio.

It’s not uncommon for new companies, even ones publicly traded over the counter, to show no revenue for several years. After all, the majority of startup businesses fail. But not all of them embark on a frenzy of stock issuance.

Between 2008 and 2012, Colorado Goldfields authorized the issuance of an amazing 35 billion shares of stock, while the stock price moved from $3 a share on June 15, 2007, to $0.01 on April 2, 2009, staying at or below a penny for three years, despite enormous trading volumes (over 1.4 billion shares moved in just four days of trading in August 2012).

Colorado Goldfields stock price chart.

24hgold.com

Asked about the massive stock issuance, Guyer said, “There was significant trading. A lot of that came from conversion of debt.” In other words, Colorado Goldfields would pay off creditors with IOUs that they could convert into stock — and Guyer claimed a lot of the stock issued came from them. “Once put in place, those conversions go out of the company’s control. As it converts, it does put downward pressure on [the stock] price.”

That’s exactly the kind of behavior DiIorio suspected was taking place with Best Rate Travel, the stock whose collapse launched his personal investigation.

In August 2012, Colorado Goldfields announced a reverse split of its common shares at 1-to-5,000, just the sort of activity DiIorio had noticed in other stocks. After the reverse split, the company was issued a new nine-digit identification code, or CUSIP, and began trading as CGFI.

That aligned with another of DiIorio’s claims: He suspected that Knight was “naked shorting” — or selling shares of stock it didn’t have — and then once the stocks changed ID codes, Knight had no way of actually completing the transaction. As a result of the new CUSIP, Knight would as a result accumulate what are known as “aged fails” on its balance sheet.

Colorado Goldfields had a particular distinction, which is what aroused DiIorio’s interest in the first place: Two of its top traders were Knight Capital and UBS, the massive Swiss bank. Knight traded 31 percent of its shares in 2012; UBS traded around 5 percent. (Guyer said he didn’t recall the trading volumes of Knight or UBS.)

This correlation between Knight and UBS was not an anomaly. According to DiIorio’s research, Knight and UBS were also the top two traders in 2012 in Universal Detection Technology (UNDT) (totaling 69 percent of all shares), and the top two traders in Sungro Minerals (SUGO) (totaling 51 percent). Like Colorado Goldfields, both of these companies appeared on the DTC chill list, and admitted in SEC filings that they’ve never generated significant revenue — but they’ve issued billions of shares of stock.

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Photo: Paul Falardeau/Getty Images

The Canadian B.C. Securities Commission began investigating Sungro for a suspected stock scam in 2009. Canadian authorities fined three of the men involved and banned them from future trading, and the company is now defunct. The phone number listed on UNDT’s annual report is no longer in service.

Knight and UBS even traded a stock called Videolocity (VCTY), though the Pink Sheets website refuses to list information about it, showing only a skull and crossbones. Videolocity, a consulting firm whose website is in Japanese (and mostly discusses cat food) despite being incorporated in Nevada, did not return a request for comment.

“It strains credulity for these two large market players [Knight and UBS] to coincidentally find themselves in bed together this many times,” DiIorio wrote to the SEC in 2013.

Knight declined to comment on its penny stock share volume. UBS spokesperson Peter Stack would only say, “UBS applies strict due diligence and anti-money-laundering standards to all its business.”

Several penny stocks Knight and UBS traded shared similar fates: rapid drops in value, followed by reverse splits that brought the stock price back up, and then more drops in value. The only thing left was to figure out how both Knight and UBS could prosper while seemingly being on opposite sides of the same trade. How could this possibly be in both of their interests?

This yo-yo would crush the investment of whichever company was on the side of the trade betting the price would go up.

DiIorio came up with a hypothesis after he read the text of an enforcement action against UBS in October 2011 taken by the Financial Industry Regulatory Authority, or Finra, which is the security industry’s self-regulatory organization. Finra had fined UBS $12 million for violations of regulations prohibiting abusive naked shorting and “failing to properly supervise short sales of securities.”

This was precisely what DiIorio had accused Knight Capital of doing. Finra discovered that UBS placed “millions” of short sale orders without locating the securities.

The SEC, in a separate action, merely called it “faulty record-keeping” and fined UBS just $8 million in a civil settlement without going to court. “They basically punted,” DiIorio said.

But finding out that UBS had been accused of the same issues with short sales that he saw in Knight gave DiIorio an idea for a theory that could explain everything.

Part 6

Were Paper Losses the Goal All Along?

David Dayen, a persistent chronicler of how oligarchs exploit the financial system to enrich themselves at the expense of others, writes about Chris DiIorio, a stock analyst who for 10 years has obsessively investigated how exactly he came to lose $1 million on one penny stock. A remarkable story ensues.

Contact the author:

David Dayendavid.dayen@​gmail.com@ddayen

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Illustration: Erik Carter for The Intercept.

Were Paper Losses the Goal All Along?

Illustration: Erik Carter for The Intercept.

Part 6

David Dayen, a persistent chronicler of how oligarchs exploit the financial system to enrich themselves at the expense of others, writes about Chris DiIorio, a stock analyst who for 10 years has obsessively investigated how exactly he came to lose $1 million on one penny stock. A remarkable story ensues.

Say you’re a Swiss bank and you want to launder some money for high-net-worth clients.

Here’s one way: Start by placing large quantities of the funds into a brokerage account at the bank under the name of a shell corporation.

Then, conduct multiple financial transactions with the funds, confusing the true source of the money. Once the transactions “wash” the money, it can be spent out of the brokerage account as simply as writing a check or using a credit card.

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Photo: Serdar Yagci/Getty Images

Wealthy clients will pay handsomely for this activity. Not only do they get access to funds laundered through the banking system, but by placing the money offshore in a shell corporation, they can avoid taxation in their host country. “Money laundering is tax evasion in process,” said John Cassara, a 26-year intelligence and law enforcement official and former special agent for the Treasury Department. “Shell companies make it more complicated to figure out who that money belongs to and where it’s going.”

UBS, the giant Swiss bank that self-appointed investigator Chris DiIorio suspected was part of the kind of penny-stock manipulation that wiped out his penny-stock investment in 2006, has a checkered history with these types of activities.

The bank entered into a deferred prosecution agreement with the Justice Department over cross-border activities for its clients in February 2009, paying a $780 million fine. UBS admitted that it established secret accounts for roughly 17,000 wealthy American clients “in the name of offshore companies, allowing United States taxpayers to evade reporting requirements and trade in securities as well as other financial transactions (including … using credit or debit cards linked to the offshore company accounts).”

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Department of Justice press release.

Source: U.S. Department of Justice.

The government dismissed criminal charges against UBS in 2010, claiming the bank had fully dismantled its cross-border tax evasion activity.

DiIorio believes UBS never stopped. Years of digging through public records and connecting dots led him to that conclusion.

But this is also where DiIorio’s accusations get considerably harder to substantiate, and his theories start to multiply, sometimes even contradicting one another.

His suppositions up to this point come with swaths of data that bolster them. From this point onward, DiIorio’s main argument is the absence of alternate explanations.

Here, however, is the way DiIorio thinks it worked — and continues to work: UBS clients use their brokerage accounts to invest in penny stocks issued by companies that appear to conduct no business activity and have no revenue potential — all they do is issue billions of shares of stock. These stocks, he figures, are the same ones Knight Capital is naked shorting: selling shares it doesn’t really have.

UBS’s clients, according to DiIorio, purchase the penny stocks because they know they will drop in price. That way, they can use capital losses to offset any capital gains in the brokerage account, “resulting in a reduction in their reported income-tax liability and the underpayment of millions in taxes,” according to DiIorio’s 2013 complaint to the SEC.

That happens at the same time that the money placed in the brokerage account is being commingled with the various trades, he argues — effectively laundering it.

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Photo: Artiom Muhaciov/Getty Images

The IRS rarely suspects trading in equity markets is a vehicle for money laundering or tax evasion, because it assumes stock investors are trying to make money. “It’s a lot more efficient than stuffing diamonds into toothpaste,” DiIorio says.

In fact, illicit financial flows through brokerage accounts are rarely scrutinized at all. “In federal law enforcement, we have skilled people, but we have a whole lot of people in there, they don’t get the securities markets,” said Cassara, the former Treasury agent. “They don’t get trade-based money laundering. The bad guys know this so they pile on the layering.”

He cited statistics from Raymond Baker, president of the research group Global Financial Integrity, that indicate money-laundering enforcement fails 99.9 percent of the time. “I use his line, total failure is only a [decimal] point away.”

DiIorio argues that client losses from the drops in value of the penny stocks are a small price to pay for the layering activity and tax avoidance. That’s if they’re even losses at all. Because if the stock shares never really existed, maybe the payments never happened either.

In fact, DiIorio also alleges that many of the transactions go through outside hedge funds, which convert promissory notes from the penny stock companies into equity, in private stock offerings. (The CEO of E Mobile tried to sell DiIorio a private placement back in 2006, you may recall.)

Normally, a company issues a promissory note in return for cash — the note representing a promise to pay it back later, plus interest. But some notes, called convertible promissory notes, are also convertible to stock.

DiIorio claims that in some cases, penny stock issuing companies were simply creating convertible promissory notes as a way of issuing more stock. The funds from these investments never appeared on the balance sheet of the companies — suggesting that no money changed hands for the purchase of the note, which was then converted to stock. That would make the losses merely on-paper losses: a classic tax evasion play.

One example DiIorio provides comes from FreeSeas, the shipping company referenced earlier (see The Penny Stock Chronicles, Part 3). It engaged in four convertible promissory note sales with stated values of between $500,000 and $600,000 in five months in 2015, with Alderbrook Ship Finance Ltd. (April), Casern Holdings Ltd. (June), the AMVS Value Fund (July), and Casern again (September). Alderbrook Ship Finance didn’t exist until two days before the sale; AMVS had a lifespan of four days before it purchased FreeSeas’s promissory note. The two companies share the same Toronto address and the same director, Justine Kerrivan of Ber Tov Capital. And despite all the cash flow, FreeSeas only had $20,000 cash on hand at the end of 2015, per its annual SEC filing.

“FreeSeas is a structured tax evasion/money laundering scam being perpetrated on the investing public as we speak,” DiIorio wrote in an email to SEC officials last September.

A contact for Casern, a company incorporated in the British Virgin Islands (a location notorious for shell corporations), did not respond to a request for comment. Ber Tov Capital, the company that apparently set up Alderbrook and AMVS, also declined to comment.

DiIorio jumps back and forth in his claims. Sometimes he says there’s no money changing hands, just a bunch of paper losses. Sometimes he says there are some losses, but less than the tax liability avoided. And sometimes he says the losses are real, but worth the cost in exchange for laundering large sums of money. To DiIorio, it’s all variations on the same basic scheme: using sham companies and stock manipulation to generate losses on purpose, tailored to clients’ individual needs.

The Intercept asked UBS about all of these allegations. The only response, from Director of Media Relations Peter Stack, came in a single line: “UBS applies strict due diligence and anti-money-laundering standards to all its business.”

Collateral Damage

DiIorio’s initial investment in 2006 — where the on-paper value dropped from $1.3 million to next to nothing in a matter of months — was a fluke, he now believes. Sure, naked shorting rips off investors, but that’s not the true aim. In his view, penny stocks like FreeSeas or NewLead or Colorado Goldfields were structured tax evasion vehicles for the benefit of unknown people with money looking to hide their activities.

He was unlucky enough to be collateral damage.

The theory has an internal logic to it but is based on a fair bit of speculation. While trading activity can be used to launder money, some experts argue there are far simpler ways to do so instead of actually losing a share of the money to throw regulators off the trail.

For example, Jack Blum, a former U.S. Senate investigator and white-collar crime expert, suggests that launderers can more easily wire money through international markets, use bogus tax shelters, or even lend themselves money to buy property while falsifying the records of the transfer. (“Each case requires a small book to explain,” he said.)

And none of those tactics involves actually losing money intentionally. Even in his complaint to the SEC, DiIorio acknowledged that he was “alleging a massive and nefarious conspiracy based, at least in part, on circumstantial evidence.” And in a separate complaint, he admitted that he does not have the taxpayer records that would be critical to pinpointing the scheme.

But John Cassara found the theory relatively plausible. “People do what they know,” he said. “If you’re talking about financiers that work in a world I can’t relate to, for them it may be, let’s construct this financial instrument, this trade, I’ll work with my guy, a wink and a nod and it’s done.”

Furthermore, many of the facts DiIorio based the alleged conspiracy on checked out. There was an array of penny stocks that kept undergoing reverse splits. Knight and UBS did trade in them. Knight’s balance sheet appeared to expand strangely, including an increase in the “sold not yet purchased” liability. And UBS had a history of helping its clients evade taxes, often through shell corporations.

UBS’s admission and fine in 2009 came only after whistleblower Bradley Birkenfeld, a former UBS banker, divulged the schemes that the bank used to encourage American citizens to dodge their taxes. But Birkenfeld’s information exposed the undeclared bank accounts. “How did the cash get there, and how do they get the cash back?” DiIorio said. “I explained how.”

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Bradley Birkenfeld.

Photo: Bloomberg/Getty Images

DiIorio added UBS to his list of claims with the SEC. The list would grow over the years to take in several of the microcap stocks the bank traded, such as FreeSeas and NewLead. DiIorio amended his initial complaint in November 2011 and continued to send dozens of emails directly to SEC officials, including Chief of the Office of the Whistleblower Sean McKessy and even Chair Mary Schapiro. But the SEC remained mute.

The SEC wouldn’t answer our questions, either. And through spokesperson Sophie Sohn, Knight also declined to comment for this story.

And then something happened that changed DiIorio’s entire perception of how the securities regulators were dealing with his claims. He went from thinking that the SEC and its counterparts just didn’t understand the sophisticated scheme — to believing they were waving it through.

Part 7

The Half Billion Dollar Glitch

David Dayen, a persistent chronicler of how oligarchs exploit the financial system to enrich themselves at the expense of others, writes about Chris DiIorio, a stock analyst who for 10 years has obsessively investigated how exactly he came to lose $1 million on one penny stock. A remarkable story ensues.

Contact the author:

David Dayendavid.dayen@​gmail.com@ddayen

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Illustration: Erik Carter for The Intercept.

The Half Billion Dollar Glitch

Illustration: Erik Carter for The Intercept.

Part 7

David Dayen, a persistent chronicler of how oligarchs exploit the financial system to enrich themselves at the expense of others, writes about Chris DiIorio, a stock analyst who for 10 years has obsessively investigated how exactly he came to lose $1 million on one penny stock. A remarkable story ensues.

On August 1, 2012, the Dow Jones Industrial Average opened the day at 13,007.47.

Business headlines that morning included conservative opponents of gay marriage celebrating “Chick-fil-A Appreciation Day,” the continued reluctance of Fannie Mae and Freddie Mac to offer debt relief to their borrowers, and profit declines at the video game company Electronic Arts.

And then the Glitch happened.

Knight Capital, the company Chris DiIorio had insisted to the SEC for a year was engaged in a monumental fraud, opened the day by inadvertently buying millions of shares in 154 different stocks. The company blamed an untested software installation that triggered the rapid-fire trades.

In an environment where milliseconds can mean millions, it took Knight Capital 45 minutes to turn the software off.

Stock values surged from the high demand, and when Knight sold back the shares it had bought by mistake, it was left with a net loss of around $468 million. The New York Stock Exchange canceled trades in six of the 154 stocks involved but deemed itself “hamstrung” by SEC rules that prevented it from breaking all of them.

Knight could have used the assets on its balance sheet to absorb the loss, but DiIorio had maintained for years that many of those assets were inflated or even fictional — ghost receivables intended to balance out the massive liabilities Knight had accrued by selling stocks it didn’t really have.

And DiIorio alleged that Knight’s immediate efforts to raise the full amount of its Glitch losses, instead of offsetting them with existing assets, proved that something was amiss on its balance sheet.

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Jason Blatt of Knight Capital Americas reacts to down market on the floor of the New York Stock Exchange, Aug. 8, 2011.

Photo: Stan Honda/Getty Images

In one of those attempts, Knight sent 7,000 securities to JPMorgan Chase as collateral for a tri-party loan, but the Wall Street Journal reported that JPMorgan deemed 4,000 of them “unreadable through databases used to reach valuations,” and refused to accept them.

DiIorio saw this as consistent with shares in companies whose CUSIP, or unique identifying symbol, had changed after a reverse merger or split — just what he had been warning about for years. Such stocks would be unredeemable for any real value.

“Those were the stocks that no longer traded!” DiIorio says. “They were pledging worthless collateral.”

The proposed loan collapsed.

The funding Knight did receive, from a consortium of investors that took 73 percent of the company without a shareholder proxy vote, was not collateral-based. In late 2012, Knight announced a merger with rival market maker Getco.

DiIorio filed a new “tip, complaint or referral” form to the SEC — this one vetted by the law firm Berger & Montague — highlighting Knight’s post-Glitch funding issues and how they pointed to evidence of a naked short selling scheme. DiIorio’s “findings — the product of thousands of hours of careful study — can protect others from falling victim to these same frauds,” the TCR concluded.

Berger & Montague eventually parted ways with DiIorio. The lead attorney on the complaint, Daniel Miller, did not respond to requests for comment.

The SEC did not respond to the new TCR, nor did it prevent the Knight/Getco merger. It did fine Knight Capital $12 million related to violations of the market access rule when it committed the Glitch. But compared to DiIorio’s claims, that was miniscule.

DiIorio even tried to collect a whistleblower award for a 2011 enforcement against UBS for violations of Regulation SHO. He wanted to force the SEC to look at his claims again, and hopefully open a new investigation. The SEC denied DiIorio’s application to collect the award. While he is not privy to undisclosed SEC investigations, DiIorio does not believe the agency has investigated Knight’s or UBS’s involvement in penny stocks.

DiIorio thinks the agency could audit Knight’s profit and loss statements to understand its concentration in penny stocks. Or officials could deny the numerous penny stock reverse mergers and reverse splits that DiIorio says drive the scheme. Or they could investigate why the splits proliferate.

SEC spokesperson Ryan White declined to comment. SEC Chief of the Office of the Whistleblower Sean McKessy and Chief of Enforcement Andrew Ceresney did not respond to requests for comment. The agency did recently tout its whistleblower program as “a gamechanger … in its short time in existence.”

In July, McKessy announced his exit from the agency after five years running the Office of the Whistleblower. In September, he became a partner at the law firm Phillips & Cohen, which has won for clients one-third of the total whistleblower awards granted by the SEC.

Meanwhile, the Justice Department is reportedly investigating Knight, now known after the merger as KCG, over allegedly executing stock trades to shortchange its clients. KCG’s most recent quarterly report acknowledges that “the Company is currently the subject of various regulatory reviews and investigations,” including by the SEC and the Justice Department.

But there’s been no public acknowledgment of any investigation into penny stock activity.

KCG declined to comment, through its spokesperson Sophie Sohn. UBS only responded to multiple requests by saying, “UBS applies strict due diligence and anti-money-laundering standards to all its business.”

Knight’s own trading data confirms that it never stopped selling penny stocks. It boasted in its 2013 annual report of being “the clear market leader in over-the-counter (OTC) traded stocks.” And it increased its volume  in 2014, trading 19.1 billion shares of OTC and Pink Sheet stocks per day in February of that year, up from a little over 4 billion a day in the previous quarter. While those volumes have lessened somewhat, to this day between 73 and 80 percent of Knight’s share volumes are in OTC and Pink Sheet stocks.

“The activity continues today and the investing public remains at risk,” DiIorio says.

DiIorio is highly skeptical of the SEC’s intentions at this point. He believes the agency has all the information it needs to move on the scheme. But prosecuting Knight and UBS would raise questions about the SEC’s silence before and during the Glitch, and its decision to dismiss criminal charges against UBS in 2010 on the grounds that UBS had changed its ways.

“How are they going to say that [UBS] did penny stock money laundering?” DiIorio asks.

The charge is explosive. It’s hard for a member of the public, lacking access to the SEC’s data and analytics, to fully vet DiIorio’s claims. This rankles even securities regulators. “I have no authority to look at a reverse split unless someone alleges fraud on the markets,” said Joseph Borg, director of the Alabama Securities Commission. “Enforcement is after you burn down the forest. I can’t blow out the match because I can’t even ask what you’re doing in the forest to begin with!”

Since the Bernie Madoff scandal, the SEC’s Office of the Whistleblower has professed a greater desire to fully investigate cases. Part of the post-Madoff recommendations mandated that the SEC’s Office of Compliance Inspections and Examinations vet all whistleblower information. But last year, when DiIorio contacted Kevin Goodman, director of OCIE for broker-dealers, Goodman responded, “Thank you for your recent emails. I wanted to acknowledge them and let you know I have received and will consider the information you have provided.” To DiIorio, that suggested Goodman had not seen the claims before. The SEC would not make Goodman available for comment.

Frustrated with the SEC, DiIorio reached out to the Financial Industry Regulatory Agency, the security industry’s self-regulatory organization. DiIorio had a two-hour conference call in August 2012 with a team leader at Finra’s whistleblower office shortly after the Glitch. He had another meeting later with FBI agents. And this April, he met with IRS officials.

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Chris DiIorio.

Photo: Matt Slaby for The Intercept

Since he first contacted Finra, the agency has issued several complaints against brokers other than Knight over failing to comply with anti-money laundering regulations. Some of them cited penny stocks DiIorio highlighted in his claims.

In particular, Finra fined Brown Brothers Harriman $8 million for violating money-laundering rules by turning a blind eye to “suspicious penny stock transactions,” executed “on behalf of undisclosed customers of foreign banks in known bank secrecy havens.” But none of those foreign banks or their customers were named.

“Who does that protect?” DiIorio asked.

Richard Best, the lead enforcement official at Finra on the Brown Brothers Harriman case, now runs the Salt Lake City regional office for the SEC. The agency declined to make him available for comment.

Five years after alerting the SEC to his allegations, DiIorio has never been brought in for a meeting. He’s going public now because he’s fed up with the inaction. “I’ve always said to the SEC, ‘I’ll be there tomorrow, I’ll come without an attorney,’” DiIorio says. “They won’t even pick up the phone.”

DiIorio doesn’t do much investing anymore. But he never sold off his original investment in Best Rate Travel, now known as Yora International, which has traded at a fraction of a penny for several years. It’s still sitting in his IRA account, the shares having been reduced through more reverse splits to 3,299.

Under market value, it just says, “$NP,” or “no price.”

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Chris DiIorio’s IRA statement.

Source: Chris DiIorio

This is the last installment of The Penny Stock Chronicles for now, although the series will resume if and when new information comes to light.

David Dayen, a persistent chronicler of how oligarchs exploit the financial system to enrich themselves at the expense of others, writes about Chris DiIorio, a stock analyst who for 10 years has obsessively investigated how exactly he came to lose $1 million on one penny stock. A remarkable story ensues.

Contact the author:

David Dayendavid.dayen@​gmail.com@ddayen

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