On September 18, 2008, the SEC announced an emergency ban on short-selling. 797 tickers belonging to companies in the financial industry could not be shorted for the next three weeks. This was a drastic if temporary move, cutting off short activity cold-turkey to save the patient. Or, so it seemed at the time.
The rule went into effect the next day. Companies were added and dropped, exceptions were made — and then, exceptions to those exceptions — but the overall impression left with the investing public was one of a total ban, a wall of protection around the banned stocks.
SEC Chairman Cox commented recently that, “the actual effects of this temporary action will not be fully understood for many more months, if not years”. We here at Deep Capture just could not wait that long. So we looked at actual short sales effected on NYSE ARCA for the tickers in question, for the duration of the ban. The picture that emerged was less that of a total ban and more of a… well, let’s allow the numbers to speak for themselves.
We chose NYSE ARCA (Archipelago) for this experiment because it makes short sale data available. While it would be easy for all exchanges to release data on short sales, only two do so. This practice started as part of a pilot program to measure the effects of REG SHO and at one time, every exchange participated. By August 2007, the SEC had stopped requiring the release of short sale data because it was too burdensome for the exchanges. The two that went on publishing (Archipelago and Philadelphia), we might assume, forgot to turn off the database scripts that automatically generate these reports.
So what does the data say? To keep things simple at the outset, we only considered the original 797 tickers on the ban list. There were 940,000,000 shares worth of short sales executed on Archipelago for that subset of banned tickers. These 797 tickers were 80% of the 976 that eventually ended up on the list. Furthermore, only 705 (under 90%) had short trades executed on Archipelago. And for those tickers, Archipelago executed only 19% of the overall volume during the dates in question. Thus, to back into an estimate of the total shorting that took place in these tickers while there existed a ban against shorting them, one would calculate that 940,000,000 is 19% of 90% of 80% of all the shorting: this would imply that over 7 billion shares were shorted in these companies, while they enjoyed a ban against shorting their stock.
To be fair, a few tickers ended up being dropped from the list (and could be expected to exhibit regular shorting activity for part of the ban period). Excluding all trades in those tickers during the ban period (a generous assumption) would mean subtracting 1.4 million in volume. 938 million and change is the most conservative number that results from this calculation.
One question that naturally arises is this: what level of short sale activity should be considered normal on Archipelago? During the same period a year ago (a period that included the same number of trading days), these very same stocks racked up 332 million in total short volume on Archipelago. Granted, Sep/Oct 2008 was no ordinary time for market volume. Yet an almost threefold increase over the same period last year, coming at a time when there was ostensibly a total ban on shorting these stocks strains credulity. Below is a chart comparing the short sale volume for the same dates in 2007 and 2008:
Coverage of the ban in financial media has been almost uniform in emphasizing the ineffectiveness of the ban. Jubin Zelveh titles his Portfolio.com blog entry on Dec. 19, “S.E.C. Short-Sale Ban: Pretty Much Useless” and quotes from a new academic paper in the pipeline showing a steep drop in the prices of banned NYSE-listed stocks. William Ackman of Pershing Capital (a person-of-interest here at Deep Capture), quoted in a Reuters piece on Oct. 6, proclaims, “Short sellers have been blamed for bringing down the market, but since the ban, the markets have been falling even further, which means ‘the longs’ are selling now.” Menachem Brenner and Marti G. Subrahmanyam, in their commentary on Forbes.com from October 1st titled, “End The Ban On Short-Selling” speculate that the ban on short sales, “may have already contributed to a further decline in prices”.
The take-away from the coverage is that there was ostensibly a total ban on short selling and prices declined anyway – suggesting that short sales were not to blame for falling prices, after all. A stretch, even if one concedes the underlying assumption but a somewhat plausible argument. What it fails to consider is how imperfect a ban this turned out to be.
And finally, Chairman Cox himself declared just the other day, “The costs appear to outweigh the benefits” — professing regret over the short-selling ban. What costs/benefits went into that analysis, we do not yet know. What we do know is that the ban on short selling was far from total in practice. A barrier marked with 940 million holes is, in fact, a sieve… and any analysis that laments its meager virtues should recognize that fact.
This series will analyze the many ways in which the short-sale ban has indeed been a sieve.
If this article concerns you, and you wish to help, then:
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http://www.sec.gov/news/openmeetings/2007/openmtg_trans052407.pdf
This is a link to an SEC “Roundtable” addressing voting issues. Starting on the 11th page is a good summary of how the DTCC is “wired”. When you see “CDINCO” substitute “CEDE and Co.” the nominee of the DTC. The “Broadridge” citation refers to the old “ADP” due to a spin off.
There’s a lot of wiggle language in that transcript. I tend to believe Senator Metcalf’s findings from 1971 that Cede & Co. was another name for the Stock Clearing Corporation, which has been a private subsidiary of the private NYSE since the 1920’s, long before the DTCC existed.
Some of their wriggle language:
Transcript: “DTC is the record holder of all of those shares 12 through CDINCO”
Dave: In other words, the DTC keeps track of how to divvy Cede’s ownership among clearing house partcipants of the DTC (in most cases, not the actual broker or investor unless they use DRS)
Transcript: “All of that is in our nominee named CDINCO. The stock is not re-registered and all of the movements take place through a book-entry system at DTC.”
Dave: In other words, the DTC registers it in the name of the mysterious Cede, who they nominate to own it. It doesn’t tell you who owns Cede.
Transcript: “we issue a proxy card to all our registered proxy holders, including CDINCO, which then issues an omnibus proxy card to all the people that they held chairs for, including all the brokers, who then issue proxy cards for all their
voters. And the shares that are loaned out, then they get another proxy card.”
Dave: But you can’t vote proxy cards. At the end of the day, the proxy cards are only directions as to the wishes of all the various entities that have claims on IOU’s and they finally get reconciled into netted directions / wishes for Cede and as far as I can tell, Cede generally votes in accordance with those wishes.
But the reality is that as Senator Metcalf was told by the lawyers, Cede has the right to vote as it sees fit as it literally owns the shares and only has a trust agreement with the beneficial owners which is only governed by contract law.
The penalty for voting against instructions is just damages for civil breach of contract.
It just seems bizarre to me that the DTC wouldn’t more clearly disclose the relationship between themselves and the actual owner of the shares.
Cede must have a board of directors and domicile and corporate charter. What is it? Are the shares encumbered or subject to counterparty risk? Why does the DTC need Cede? Why not just register electronically each night in the clearing participant’s name at the company transfer agent? How would the computer horsepower required to move actual ownership be any different than moving beneficial ownership, which they do each night today?
Obama should withdraw Geithner and Mary Schapiro from his nominations. He has an excuse for both of them, using past unethical behavior. He can just convince them to withdraw for personal reasons or whatever. Quick and clean. Just like Richardson. Make the changes fast and move on.
Patrick, Judd, Mark….
I am expecting one hell of an article regarding the miscreants in celebration of the victory for Best Business Blog. May the ink flow in abundance for 2009.
R101
Dr. DeCosta..your thoughts on these comments please.
By: pleiadian
13 Jan 2009, 10:12 AM EST
Msg. 36826 of 36826
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What if the Fed Bank has been cornered and the treasury has taken it over. As far as I am concerned all the Naked SHorting of equities profits ultimately go back into the Fed bank coffers through their surrogate the DTCC..Is the Fed Bank being forced to use all the cash they have stolen and that is why all the infusion of cash that is keeping the market floating. Covering all the naked short shares. Just a thought…..
Sean, I don’t really think so. First of all, abusive naked short sellers never, never, never cover their naked short positions unless forced to by a management team that is well versed on how these frauds are perpetrated. There’s a phenomenon that takes place that often renders them unable to cover even if they wanted to.
Once a naked short position gets to a certain level the bad guys need to naked short sell all day long just to keep the collateralization requirements tolerable for an astronomic naked short position. If they merely stopped their daily naked short position then the share price will gap upwards. It’s tough to cover an astronomic naked short positon in a market that’s already gapping upwards. After covering 10% of your naked short position the price level might be at a level wherein the collateralization requirements for the other 90% might be financially prohibitive.
One has to appreciate how incredibly easy it is to “accidentally” run up an astronomically large naked short positions wherein the company under attack doesn’t go bankrupt on cue. Why not? Because maybe just maybe they weren’t the “scam” that the bad guys thought they were and there are tons of buyers more educated than the bad guys in the business that the company under attack is in.
Every single DTCC participating market intermediary is extremely financially incentivised to flood the share structures of pretty much all corporations with FTDs and the “securities entitlements” that they procreate. The coup for the bad guys ocurs when the NSCC predictably claims to be “powerless” to buy-in the delivery failures of its abusive “participants” that absolutely refuse to deliver that which they sold even though the NSCC is the “Central counterparty” to that trade that is now the creditor of that failed delivery obligation.
There could never be a systemic fraud as beautifully designed or as effectively covered up as abusive naked short selling is.
One caveat I would offer for those of you with successful corporations but the desire to go public in order for reasons involving “capital formation” wherein you need money to leverage your hard earned success via expansion. DO NOT DO IT UNTIL YOU ARE CASH-FLOW POSITIVE TO A DEGREE WHEREIN YOU CAN BUY BACK YOUR OWN SHARES SHOULD YOU GET ATTACKED BECAUSE YOU WILL GET ATTACKED.
I’m well aware of the “Catch 22″ here wherein a family run corporation may have already committed enough of their own funds and that you might not able to expand UNTIL you go public.
Yet to be cash flow positive development stage corporations are the prey of choice for abusive naked short selling criminals. Why? Because they can predictably put your share price into a “death spiral” which will FORCE you to sell shares into the market to fund your monthly “burn rate” at lower and lower share price levels throughout time. By the time you do become cash flow positive you are likely to have so many shares “outstanding” that any future earnings are going to be diluted by a gazillion shares and your all-important “earnings per share” (EPS) will still be negligible and your future share price will be predicated upon a multiple of EPS.
That’s why these criminals love to attack biomedical companies with new cancer cures because they know that they have huge monthly “burn rates” and that due to the nature of the FDA approval process there is no way that this company will be cash flow positive for a very long time. The decision making process for certain of these abusive naked short selling criminals becomes saving human lives versus purchasing a yacht longer than your neighbor’s yacht in the Hamptons.
Unregulated hedge funds spend $11.2 billion annually to the DTCC participating market intermediaries willing to be the most “accommodative” (break the greatest number of securities laws) to the needs of the hedge fund manager making “2 and 20″. In a “closed system” like Wall Street where do you think the billion dollar plus annual “earnings” of dozens of hedge fund managers come from?
Dr. DeCosta,you posted this two back
“Sean, I don’t really think so. First of all, abusive naked short sellers never, never, never cover their naked short positions unless forced to by a management team that is well versed on how these frauds are perpetrated. There’s a phenomenon that takes place that often renders them unable to cover even if they wanted to”, so does that mean there is hope for a company to fight back if they have developed cash flow and more important have gotten educated about how this fraud is done?
The reason I ask is I own one that you advised a few years ago which I believe is getting in that position. My worry is if the naked short against my company is too big won’t the naked short holding the short just vaporize leaving everyone empty?
Thank you and the others for all you do to help us in this struggle.
Dr. D thank you for so eloquently explaining how we have been robbed and the process. I think I understand fully and all to well how this game was played. Now here’s hoping someone figured this out a couple of years ago and set these guyS up for the shortsqueeze of a lifetime!!! Thanks again for your response.
For those here who have more knowledge about naked shorting, I have a question about how the term “ponzi scheme” might apply.
First here is the definition I found in the online Meriam Webster Dictionary:
>> Pon·zi scheme – an investment swindle in which some early investors are paid off with money put up by later ones in order to encourage more and bigger risks.
My first thoughts when the news about the Madoff “ponzi scheme” hit the news wires was that the term “ponzi scheme” did not apply to naked shorting. Now I am beginning to think that this first thought was NOT CORRECT.
When I consider that “naked shorting” is “illegal counterfeiting,” and that the counterfeiting hedge funds and their supporting cast members might very likely have to declare bankruptcy if they were FORCED to buy in the open market all the counterfeit share they created, then there seems to be some connection between the term “ponzi scheme” and “naked shorting/ counterfeiting”.
Consider this:
“…investors are paid off with money put up by later ones”
Counterfeiting hedge funds are making easy money through counterfeiting and they are NOT explaining to their “new investors” (nor old ones) that they keep a “second set of books” which show the continually rising debt they are daily accruing for converting the counterfeit shares into genuine shares through regulatory mandated “buy-ins”.
Since the counterfeiting hedge funds are hiding their second set of books, and not explaining to investors they are accuring a hiden debt, is not this a type of “ponzi scheme?”