You can hardly blame Fat Squirrel Trading Group (FSTG) and Rhino Trading, LLC.

After all, it was 2007, and illegal short selling was almost the norm. The SEC, in passing a toothless Regulation SHO, had demonstrated that it didn’t care much. With just a few exceptions, America’s financial press had made it clear that the shorts were to be believed and their targets attacked or ignored.

And, in the midst of what history would eventually show to be the high-water mark of the greatest bull market of all time, how could a self-respecting short seller possibly be expected to do business in any other way?

What FSTG and Rhino couldn’t have known is that four factors were working against them:

1- In December of 2007, the SEC would appoint a true inspector general, in the form of David Kotz, and that Kotz would hear the cries of untold thousands of shareholders certain that the SEC had ignored their untold thousands of complaints of illegal naked shorting of companies in which they had invested untold millions of dollars, and that before too long, Kotz would issue a scathing report confirming as much, and…

2- In September of 2008, naked short selling would provide the spark that lit the fuse that ignited the greatest financial collapse of all time, and…

3-  In January of 2009, Joe Biden would leave the Senate for the Vice President’s mansion and Ted Kaufman, Biden’s successor, would make a major issue out of demanding the SEC start enforcing long-ignored prohibitions on illegal naked short selling, and, perhaps most unjustly…

4- By November of 2009, FSTG and Rhino would remain small and inconsequential firms (FSTG is headquartered at the end of a dirt road 90 miles from NYC), not at all the kinds of major players with deep payrolls into which SEC staffers hope the revolving door will eventually thrust them.

Rhino Trading Founder Damon Rein (on right)

Except for the “small and inconsequential” part, how could FSTG and Rhino Trading have possibly known that these factors would conspire to hold them to account in 2009 for their participation in an illegal and manipulative trading strategy that was de rigueur in 2007?

But it happened.

In fact, it happened yesterday.

Yes, the SEC has opened the second (or possibly third, depending on how you count an abortive 2005 case against the unrelated hedge fund Rhino Advisors) administrative proceeding alleging illegal naked short selling in its storied history. And we should be very happy about that. I know I am!

But I’m also bothered by the above alluded-to fact that Rhino Trading and FSTG are really just insignificant patsies, cast, like a pair of white-robed virgins, into a fiery volcano to appease the angry gods in Congress intent on forcing the SEC to do what it would really rather not (it’s job).

In the complaint, FSTG and Rhino are accused of illegally shorting such long-time threshold listees as USANA, iMergent, Medis Technologies, and NovaStar: all companies that experienced extreme levels of naked shorting for much longer periods of time than those described in the SEC’s action, and on a level unattainable by a firm headquartered at the end of a dirt road 90 miles from NYC.

In fact, certain very reliable sources confirm that a major hedge fund – one which has received much more than its fair share of coverage on this site – was coordinating media and message board attacks on one of these targeted companies during precisely the same period.

And yet the wrist slap (in the form of a $45,000 fine and firm instructions not to naked short any more) goes to the guys set up in a converted barn with dial-up internet access.

Brilliant.

The SEC was a bit tougher on Rhino Traders. The company and principals Damon Rein and Steven Peter will pay several hundred thousand dollars between them, in addition to promising to mend their naked short ways. They will also consider themselves officially censured.

Take that!