Followers of the twisted tale of DeepCapture may remember that on August 12, 2005, I gave a webcast of which I will always remain proud. It was titled, “The Miscreant’s Ball” (see slidedeck and accompanying transcript). Contrary to popular “journalism” (if mindless back-and-forth parroting by hedge fund choagies Bethany McLean, Roddy Boyd, Herb Greenberg, Ron Insana, Joe Nocera, Carol Remond, Jessie Eisenger etc. of research so shoddy it would make sophomore poetry students blush can be called “journalism”), that talk did not primarily concern Overstock. In fact, only 9 of the 40 slides (2 at the opening, 7 at the end) concerned Overstock.
The bulk of the Miscreant’s Ball presentation discussed the modern bear raid in the context of a web of relationships among a number of Wall Street players, including certain prominent hedge funds and journalists (relationships which I depicted as intersecting through Jim Cramer), a law firm named Milberg Weiss (which since imploded under a DOJ indictment), the SEC (which I claimed had stopped protecting the USA due to its having become hopelessly captured by Wall Street), Eliot Spitzer, and Kroll, a corporate intelligence service which was, I said, employed by hedge funds (which Einhorn has since confirmed) to build networks of corporate insiders (which may ring a bell if you are following the news now emerging regarding the recently indicted Raj Rajaratnam).
The original Miscreants Ball relationship web. Click to see full version.
The Machine went apoplectic in an attempt to spin, deride, downplay and obfuscate those claims, sacrificing with wild abandon all vestiges of journalistic ethics. Their method of argument was simply to cover the Miscreant’s Ball as though it had only concerned Overstock (though less than 1/4 of it even mentioned Overstock). To a journalist, they utterly refused to cover, describe, or even mention the claims concerning this web of relationships, claims which formed 3/4 of the Miscreant’s Ball presentation. CNBC’s Ron Insana went so far as to trade taping an interview with me regarding these claims in return for access to affidavits supporting some of their aspects: once Ron Insana had the affidavits, CNBC refused to air the interview, and days later, the affidavits turned up in the hands of Roddy Boyd. How odd.
Their stylistic technique, mindlessly rehearsed with all the creativity and originality of a Lawrence Welk repeat, was to ridicule my use of the term “Sith Lord” (note to Hedge Fund Choagies Local 107: only stupid people pretend not to understand metaphors). Doubtless, salting shibboleths into the presentation such as this and a few other moments of color was not as productive as I had hoped, for they proved insufficiently granular (i.e., they all tested out to be Ephraimites).
As a result, publicly I soon refined the metaphor to “Al Queda” (a network of people sharing operating methods and goals, but not necessarily communicating extensively). Yet when interviewers asked about the Sith Lord comment (for example, see my correspondence with BusinessWeek’s Tim Mullaney, and numerous other interviews as well) I made a rule of including something along the lines of:
“I really think in terms of a composite of two people. Some day I might sack up and let the world know who the master minds are, but not now.”
I suppose I should have made it more obvious. Because as far as I can tell, only the Bunny ever got the joke.
(Note: this is a work in progress. More will be added this weekend.)
For those new to the story: besides my gig as a journalist at the award-winning Website DeepCapture.com, I also have a day job as CEO of Overstock.com. In that context I received tonight an email from Sam Antar, of whom I have written fondly: see for example my “Why are Fortune Magazine and the New York Financial Media Suddenly Pimping Sam Antar the Crook?” (N.B. this statement from the Utah Attorney General warning the public that Sam is a con man). It is, of course, the contention of DeepCapture that Sam Antar is deeply affiliated with the world of criminal stock manipulating hedge funds whose mission it is DeepCapture’s work to expose.
In any case, here is Sam’s letter, and my reply.
From: Sam E. Antar [mailto:sam@whitecollarfraud.com] Sent: Friday, October 30, 2009 10:52 PM To: Patrick Byrne Cc: Joseph Tabacco Subject: Overstock.com Conference Call
Patrick:
I recently learned that Overstock.com scheduled its Q3 2009 conference call for November 3, 2009. If you agree, I would like to participate in that call like other analysts and ask questions about Overstock.com’s financial disclosures. Please let me know by Monday if you will let me participate in the conference call.
Sam
Sam E. Antar
My dear Sam,
Of course, you are always welcome to participate. As always, simply send your questions to us via email: limit of 25 words per question, and no more than 4 questions. We will respond to any questions that are not of the “Do you pick your toes in Poughkeepsie?” variety.
Regarding my introduction to your questions… How do you like to be introduced? “Felon”? “Crook”? Or “Goniff”? Are you sensitive about having threatened little girls on the Internet, or having pled to a felony while ratting out your own family so as to reduce your sentence? How do you feel about jokes concerning tossed salad? Please let me know.
I look forward to your “participation” in our call, and until then, I remain,
Sincerely yours,
Patrick
Sam E. Antar [mailto:sam@whitecollarfraud.com] Sent: Friday, October 30, 2009 10:52 PM To: Patrick Byrne Cc: Joseph Tabacco Subject: Overstock.com Conference Call
Patrick:
I recently learned that Overstock.com scheduled its Q3 2009 conference call for November 3, 2009. If you agree, I would like to participate in that call like other analysts and ask questions about Overstock.com’s financial disclosures. Please let me know by Monday if you will let me participate in the conference call.
Of course, you are welcome to participate, as always. Simply send your questions to us via email: limit of 30 words per question, and no more than 3 questions. We will read them and respond to any questions that are not of the “Do you pick your toes in Poughkeepsie?” variety.
Regarding the introduction of your questions… Which moniker do you prefer? “Felon”? “Crook”? Or “Goniff”?
I look forward to your participation in our call, and until then, I remain,
For some months Mark Mitchell has been working on his next piece. It has grown into something massive, about the length of The Story of Deep Capture. It concerns Dendreon. I read it for the first time a few days ago. It is semi-infuriating. Deep Capture is going to serialize it. The first piece will be going up within hours.
Normally we encourage people to quote any DeepCapture piece in full anywhere on the Internet. This time, however, I would appreciate it if people would show Mark Mitchell a little courtesy by not quoting his piece in full. Fair Use, and all that. If you like what you read, try to drive others to DeepCapture to read it. Mark has gone way down the rabbit hole, and I think it only fair to thank him by showing him this respect.
Incidentally, I feel it only prudent to mention that, on the remote chance that anything happened to interrupt the serialization of this piece on DeepCapture (say, for example, a power failure), then arrangements have been made for it to receive immediate publication, in full, in a way that would reach 20 million people, instantly. In addition, the whole package is already in the hands of some politicians who care. Lastly, over the last couple of years I constructed a Doomsday Machine (and of course, there’s no point in having a Doomsday Machine if you keep it a secret). The reader who gets but a few pages into it will understand why I make this cautionary mention.
And lastly, to the supporters of Dendreon, including the Care to Live organization, I say: Much honor to you. This piece is much like The Story of Deep Capture, only even better, as it concerns not the travails of some guy in Utah who sells toasters, but those of people trying to cure cancer. It is, you will see, uber-complicated: I hope you print it out, take your time, and enjoy it (if that is possible with so infuriating a tale). It is, I think, the investigative journalism for which you have been waiting, of which our MSM is, by all appearances, no longer capable.
The Society of American Business Editors and Writers (SABEW) met in Denver this week. Some months ago I had applied for membership on the grounds that the “Join SABEW” page on their website encourages application from those “writing, reporting, editing or overseeing business, financial or economic news for … online publications”. Given that DeepCapture had won the 2008 Weblogs Award for Best Business Blog, and that I have spent considerable time “writing, reporting, editing [and] overseeing business, financial, and economic news” on this website, I was curious to see if I would qualify within this rubric. Of course my application was denied, and while I considered crashing the party in Denver anyway, I decided against it, already confident that my experience would match George Orwell’s in a conference of British writers, described in his fine 1946 essay, “The Prevention of Literature”:
“About a year ago I attended a meeting of the P.E.N. Club, the occasion being the tercentenary of Milton’s Aeropagitica — a pamphlet, it may be remembered, in defense of freedom of the press. Milton’s famous phrase about the sin of ‘killing’ a book was printed on the leaflets advertising the meeting which had been circulated beforehand.
“There were four speakers on the platform. One of them delivered a speech which did deal with the freedom of the press, but only in relation to India; another said, hesitantly, and in very general terms, that liberty was a good thing; a third delivered an attack on the laws relating to obscenity in literature. The fourth devoted most of his speech to a defense of the Russian purges. Of the speeches from the body of the hall, some reverted to the question of obscenity and the laws that deal with it, others were simply eulogies of Soviet Russia… political liberty was not mentioned… Significantly, no speaker quoted from the pamphlet which was ostensibly being commemorated…
“There was nothing particularly surprising in this. In our age, the idea of intellectual liberty is under attack from two directions. On the one side are its theoretical enemies, the apologists of totalitarianism, and on the other its immediate, practical enemies, monopoly and bureaucracy. Any writer or journalist who wants to retain his integrity finds himself thwarted by the general drift of society rather than by active persecution. The sort of things that are working against him are the concentration of the press in the hands of a few rich men, the grip of monopoly on radio and the films…Everything in our age conspires to turn the writer, and every other kind of artist as well, into a minor official, working on themes handed down from above and never telling what seems to him the whole of the truth… In the past, at any rate throughout the Protestant centuries, the idea of rebellion and the idea of intellectual integrity were mixed up. A heretic — political, moral, religious, or aesthetic — was one who refused to outrage his own conscience. His outlook was summed up in the words of the Revivalist hymn:
Dare to be a Daniel
Dare to stand alone
Dare to have a purpose firm
Dare to make it known
“To bring this hymn up to date one would have to add a “Don’t” at the beginning of each line.”
Orwell’s disappointment in the meek conformity of the writers of his day mirrors DeepCapture’s in the business journalists of our own. A close reading of much of what has passed for business journalism in recent years reminds one of nothing so much as Soviet-era artists dutifully churning out dozens of murals of square-jawed workers striding boldly into the future, or hack reporters extolling the virtues of this or that ball-bearing plant, perhaps criticizing the occasional apparatchik who has fallen from favor with the masters, but entirely incapable of independent thought which questions the system itself, a system in whose benefits those reporters derive modest share.
As will be remembered by anyone who experienced that totalitarian era first-hand (as I did, living in mainland China for 12 months in 1983-1984), this ideological correctness generally expresses itself in a eagerness to confront with pronouncements, coupled with an incapacity to engage in even the mildest form of real debate. I will illustrate this point by publishing an exchange I had some months back with the SABEW Pooh-Bahs, after I had submitted my application to SABEW wearing my DeepCapture.com (”2008 Weblogs Award for Best Business Blog”) journalist’s hat.
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From: Dare, Donna D. [mailto:DareD@missouri.edu] Sent: Saturday, January 24, 2009 11:49 AM To: Patrick Byrne Subject: Regarding Your Application for SABEW Membership
January 24, 2009
Patrick Byrne, Journalist
Deepcapture, LLC
I regret to inform you that your application for membership in the Society of American Business Editors and Writers Inc. has been denied.
The Membership Committee could not ascertain that your primary career responsibilities fit the criteria for membership. You may submit evidence to support your application, such as story clippings or audio- or videotape.
Criteria for membership in SABEW (as stated in the organization’s bylaws) is as follows:
Membership in the Society shall be restricted to persons for whom a significant part of their occupation involves writing, reporting, editing or overseeing business, financial or economic news for newspapers, magazines, newsletters, journals, books, press or syndicate services, radio or television, online publications, or other media approved by the board and to teachers and students of business journalism or business media subjects at recognized colleges or universities or other organizations approved by the Society’s Board of Governors. Members may retain full membership status, after being assigned to another news position at news organizations, even if the new position is not directly involved in business news.
If, in the future, you meet the criteria, we would be happy to reconsider your application for membership in SABEW.
If you wish to appeal this decision, please contact the SABEW office at sabew@missouri.edu.
SABEW did not process (and has destroyed) your credit card information submitted with the membership application on 1-18-09.
From: Patrick Byrne [mailto:PByrne@overstock.com] Sent: Saturday, January 24, 2009 8:00 PM To: SABEW; Dare, Donna D. Subject: RE: Regarding Your Application for SABEW Membership
I thank you for the courtesy of your response denying my application for membership in SABEW. Respectfully, however, and per your letter, I am writing to appeal this decision on the grounds that the reason you gave in your letter is not, in fact, supported by the bylaws from which you have quoted. The inconsistency can be seen in these two points:
* In denying my application you wrote, “The Membership Committee could not ascertain that your primary career responsibilities fit the criteria for membership.”
* The paragraph from your organization’s bylaws you have cited in support of this position reads: “Membership in the Society shall be restricted to persons for whom a significant part of their occupation involves writing, reporting, editing or overseeing business, financial or economic news for newspapers, magazines, newsletters, journals, books, press or syndicate services, radio or television, online publications, or other media approved by the board and to teachers and students of business journalism or business media subjects at recognized colleges or universities or other organizations approved by the Society’s Board of Governors. Members may retain full membership status, after being assigned to another news position at news organizations, even if the new position is not directly involved in business news.”
As one can plainly see, in denying my application your membership committee has referred to “primary career responsibilities” as the standard. This position is not supported by the bylaws you have cited, which instead state that membership will be restricted “to persons for whom a significant part of their occupation involves…” These are clearly two quite different standards.
You have also written, “You may submit evidence to support your application, such as story clippings or audio- or videotape.” Towards that end, I submit the following:
1. “The Darkside of the Looking Glass” – This online lecture and PowerPoint explanation of settlement failures in our equity system has been downloaded well over 1 million times, including over ten thousand times from IP’s associated with news organizations, and over 30,000 times from IP’s associated with the federal government.
2. “Deep Capture: The Movie” – This presentation, performed in October, 2007 in front of 800 hedge funds and members of the press, has been viewed over 50,000 times.
3. The website I founded, DeepCapture.com , has recently received the 2008 Weblog Award for the #1 Business Blog on the Internet (this is, in fact, the largest blog poll in existence).
4. My individual writings are organized there as, “Deep Capture: The Explanation”, to which your committee may refer.
5. Here you will find a selection of over two dozen appearances I have made on CNBC, Bloomberg, and Fox Business. Some of these relate to my corporate duties, but many of these appearances make little to no reference to those duties, and instead seek my opinions on matters of business and economics.
6. As you are perhaps not aware, my investigation and exposure of deep systemic problems in our nation’s stock settlement system became the subject of a Bloomberg Special Report that was itself nominated for an Emmy, Long Form Investigative Journalism.
In sum, it is clearly correct to say that “a significant part of [my] occupation involves writing, reporting, editing or overseeing business, financial or economic news for … newsletters, … radio or television, online publications…” For this reason, I respectfully challenge the membership committee’s decision and reasoning, as elaborated upon above.
Of course, I am not blind to the possibility that the content of my reporting (much of which is critical of other members of SABEW) is what discomfits the members of the Membership Committee. However, I have reviewed the bylaws of your organization and find no evidence of an ideological standard which applicants must meet. Please inform me if I am in error on this point.
Until then, I remain,
Your humble servant,
Patrick M. Byrne, PhD
Journalist, DeepCapture.com
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From: Kevin Noblet [mailto:kevin_noblet@hotmail.com] Sent: Monday, January 26, 2009 9:01 AM To: Patrick Byrne Cc: Donna Dare Subject: RE: Regarding Your Application for SABEW Membership
Patrick:
Donna forwarded your message to me. In SABEW’s view, not all business blogs qualify as news publications just as all writing and editing doesn’t qualify as journalism. From its standpoint your activities and those of DeepCapture seem closer to corporate public relations, and SABEW isn’t open to PR professionals _ or of course to retail business executives.
I hope this makes the decision clearer.
Donna also had forwarded me Judson Bagley’s message and I responded to him along similar lines.
Regards,
Kevin Noblet
Secretary and Membership Committee Deputy Chair
SABEW
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From: Patrick Byrne Sent: Monday, January 26, 2009 4:36 PM To: knoblet@pobox.com Cc: Donna Dare Subject: RE: Regarding Your Application for SABEW Membership
Kevin,
Respectfully, could you explain how DeepCapture is “corporate public relations”? We are performing analyses on data that no one else has obtained; these analyses are requested by national news organizations and numerous congressional reps, senators, and various other federal bodies; our analyses of flaws in the nation’s settlement system have become fodder for numerous congressional demands of the SEC; our publication of secretly-recorded tapes of journalists planning a cover-up, and our unearthing of emails documenting the relationships among hedge funds and journalists, are apparently of strong interest to many others in this profession (judging from the volume of traffic we get from news organizations). Clearly, the vast majority of DeepCapture’s activities have precisely 0 to do with my corporate day job as a “retail business executive.”
Is this truly the fig leaf behind which your organization is going to hide? Why not write into the bylaws a rule which demands ideological purity? It would save all this back-and-forth at least.
Regards,
Patrick
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Then, as no answer was forthcoming (or ever came), I then sent this:
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From: Patrick Byrne Sent: Wednesday, January 28, 2009 1:23 PM To: ‘knoblet@pobox.com’ Cc: ‘Donna Dare’ Subject: RE: Regarding Your Application for SABEW Membership
Dear Kevin,
Here is some more of that “corporate public relations” you don’t want to miss. This one is from Mark Mitchell.
Now the truth is, I did not really have a burning desire to join SABEW. To steal a page from Groucho Marx, I wouldn’t want to join any club that would have SABEW members as members. That said, I thought it would be interesting to find out if a profession which professes a commitment to toleration and pluralism would display the same commitment it asks of society, or would it respond, as SABEW ultimately did, like apparatchiks threatened by the possibility of criticism? I confess that my interest was pretty negligible, so confident was I in the likely result, but I did think it a box worth checking off.
As I mentioned, this past week the SABEW conference in Denver went on without me. Something occurred there, apparently unscripted, which reminds me of the aftermath of Jim Cramer’s appearance on Jon Stewart’s The Daily Show. In any earlier age Cramer’s exposure there would have meant his disappearance from public life and, possibly, the tarnishing of his network beyond recovery, but ours is an age in which shame and accountability are wholly absent (as P. J. O’Rourke wrote, “If you say a modern celebrity is an adulterer, a pervert and a drug addict, all it means is that you’ve read his autobiography.”) Since that night, Cramer has publicly spun his appearance along the lines of, They say we could have done more to see this coming, and in the future we’ll try harder, apparently banking on the fact that many people did not see, or will not remember, what really happened: Jon Stewart dismembered Cramer not for “not trying hard enough”, but instead, for taking part in crimes such as stock manipulation, and for relying upon shill journalists in his schemes to cheat the public. Those are two quite different things, and in any sane world, Cramer would not be permitted to rewrite history so effortlessly.
By press accounts, this past week’s SABEW Denver conference saw the apparatchiks employing the same kabuki dance, the same confessions and self-criticisms directed to the wrong issues. On April 27, this Reuters story appeared (”Did the Watchdog Forget to Bark?” ) describing the scene:
“The opening panel at the Society of American Business Editors and Writers annual meet in Denver addressed an interesting question: Did 9,000 business journalists blow it when it came to ringing the alarm bells on the financial meltdown?
The five SABEW panelists — The New York Times’ business editor Larry Ingrassia, Columbia Journalism Review critic and former Wall Street Journal reporter Dean Starkman, personal finance columnist Jane Bryant Quinn, Emmy-winning former ABC News investigative reporter Allan Dodds Frank and Greg Miller, a professor at the University of Michigan — agreed that the financial press could have done more. Newspapers, wire services, magazines and television stations could have been more aggressive…”
“In a windowless room at the Westin Hotel in downtown Denver, leading business journalists and editors explained how the media “blew it” in covering the economic meltdown. They admitted, on one hand, to falling under the sway of free-market ideology and celebrating risk-taking financial leaders and, on the other, to missing the complex story of the rupturing system by only reporting it in parts and to almost no effect for the past decade.
Although not planned as confession, the discussion, which kicked off the annual conference of the Society of American Business Editors and Writers (SABEW), quickly descended into an unburdening, with the panelists taking turns voicing their own explanations and excuses for the failure. Former Wall Street Journal managing editor and current ProPublica.org chief Paul Steiger moderated the impromptu journalistic penitence.
‘We drank the Kool-Aid,’ said Jane Bryant Quinn, personal finance columnist for Bloomberg and Newsweek. ‘We believed that free markets were the best kind [of markets].’ She said it had become ‘unfashionable’ over the last three decades to write about regulation, so they didn’t.”
Apparently, as far as SABEW’s membership is concerned, the events of recent months reflect only a lack of being suitably “aggressive”, of not “hav[ing] done more”, and, as always, of having been taken in by “free-market ideology.” Those are the issues over which SABEW members now wring their hands, it being apparently unthinkable (just as it is with Jim Cramer) that some of their membership deeply transgressed all notions of journalistic ethics by growing so close to favored hedge fund sources that they became shills (e.g., Bethany McLean), and when their sources committed crimes, those journalists threw the credibility of their publications into denying, downplaying, masking, and apologizing for that crime (and now, on the basis of little evidence and no investigation, prematurely declare it resolved, as Floyd Norris did yesterday).
In Capitalism, Socialism, and Democracy, Joseph Schumpeter wrote, “Capitalism stands its trial before judges who have the sentence of death in their pockets. They are going to pass it, whatever defense they may hear.” Schumpeter neglected to mention that to this same jury, the possibility that the enforcement of regulation has been compromised due to the subversion of the mechanisms of enforcement, from the exchanges to the regulators to the politicians to, most disturbingly, the intellectual class itself (in particular, those who count themselves members of SABEW), is a possibility which that jury finds unthinkable, quite literally, and in the purest Orwellian sense.
If this article concerns you, and you wish to help, then:
1) email it to a dozen friends;
2) write SABEW’s Donna Dare and Kevin Noblet (DareD@missouri.edu and knoblet@pobox.com) asking them to make explicit the ideological policies to which SABEW demands its members conform (and please post as a copy of your email to them in the comment section below);
One of the arguments made with metronomic regularity by those defending stock manipulation, and unthinkingly regurgitated by their lapdog financial reporters, is this: Demonstrate the harm caused by naked short selling (the fact of its illegality being too conceptually difficult for them to grok). Well, here is a good example.
Dendreon (DNDN) is “a biotechnology company, engages in the discovery, development, and commercialization of therapeutics to enhance cancer treatment options for patients. The company’s product portfolio includes active cellular immunotherapy, monoclonal antibody, and small molecule product candidates to treat various cancers.” For the last few years its operations have burned through $66 million to $80 million per year (a not-unusual pattern for pharmaceutical firms researching and developing cures for diseases like cancer). As it stands, its balance sheet looks like it could support perhaps one more such year without additional capital raising. However, given the $5 share price at which Dendreon has been hovering, such additional capital raising would dilute the owners about 20%, assuming that it is possible in the current environment.
It turns out that the collapse of DNDN from over $20 to that $5 price was accompanied by massive levels of naked shorting. At one point, 18 million shares were unsettled (about 20% of the ownership of the company). It cannot be repeated too often: That is just the data coming from one crack in the system, the CNS bucket at the DTCC, and does not include any fails accumulating at the brokerages, or diverted by pre-netting, or masked by the Stock Borrow Program, or swept into the ex-clearing system, or stemming from offshore failures. So it is the tip of the iceberg (and perhaps, the tip of the tip of the iceberg).
As is so often the case, manipulations in Dendreon stock coincided with all that we have come to expect: surprise rejection of its drug Provenge by the FDA, endless bashing from the likes of the Media Mob and Jim Cramer the Self-Confessed Crook, and other strange incidents soon to be explored by my Deep Capture colleague, journalist Mark Mitchell.
I will assume that most readers agree that it is a good thing that Dendreon managed to survive long enough to see this day, and that it would have been a bad thing if illegal stock manipulation had suppressed Dendreon’s stock until they ran out of cash and could raise no more (as they say in intro logic classes: “If not, work the proof out on your own”). Which makes this serve, of course, as answer to the challenge that opened this essay.
Given that, one may then ask of those journalists who defend the right of hedge funds to destroy firms they wish to destroy, that is to say, of DowJones’ Carol Remond and Karen Richardson, of Fortune Magazine’s Roddy Boyd and Bethany McLean (now at Vanity Fair), of New York Times’ Floyd Norris and Joe Nocera, of Herb Greenberg hiding behind vapid emails and Dave Kansas hiding under his desk, of NY Post/Portfolio Magazine’s Dan “Crusher” Colarusso and CNBC’s Jim Cramer the Crook: Do you get it now? Do you understand why illegal stock manipulation is wrong, and can impose costs on society it was your duty as journalists to explore? You purveyors of reportorial Velveeta, you lazy and captured, half-educated and dim-witted, snarky, insufferable, conformist and indolent pseudo-intellectual lickspittles, do you get it now? You are sell-out journalists who grovelled to your sources, missed the story of your careers, and in the eyes of an increasing fraction of the public, rank just below pedophile priests.
If this essay concerns you, and you wish to help, then:
As a rule, I avoid criticizing individual public servants. Elected officials are fair game, in my view, but not public servants. They do not wake up and go into work wanting to do a bad job, I know, and I have had too many tailwinds in life to criticize wantonly people who devote themselves to public service of any kind, simply as a matter of principle.
For recently retired SEC Enforcement Director Linda Thomsen, however, I’ll make an exception. (As Mr. Buffett says, “There are times when a man has to rise above his principles.”)
The first story I would like to tell about this Enforcement Director concerns an investigation that the SEC’s San Francisco office was conducting a few years into collusion among short-sellers and crooked journalists who shilled for them using ammunition provided by “research shops” which were fed their material by those same hedge funds, in a kind of “serpent-eating-its-tail” of financial hooliganism. It was a hard scheme to miss: any company shorted by Stevie Cohen (SAC), David Einhorn (Greenlight), Dan Loeb (Third Point), David Rocker, or a handful of others, could count on coming under the “where-there’s-smoke-there’s-fire” journalistic scrutiny of such worthies as Jim Cramer and DaveKansas, Gary “Scaramouche” Weiss, Bethany “Long, Slow Thing” McLean and Roddy Boyd (both of Fortune Magazine), Carol Remond and Karen Richardson (both of DowJones), Floyd Norris and Joe Nocera, (both of the New York Times), and HerbGreenberg (MarketWatch), that “smoke” often being supplied by research shops of which those same hedge funds were clients. Invariably they’d be naked shorted as well, and show up on the Reg SHO Threshold List, and anyone noticing this constellation of facts occurring over and over with complete regularity could be counted on to be declared “wacky” by these same journalists.
I learned about this investigation because I was invited to a meeting by the SEC investigators conducting it. I’m pretty sure that “invitation” came in the form of a federal subpoena, but I am not completely clear on that, having over the last few years received enough such paperwork to wallpaper my bedroom. In any case, I arrived at the appointed hour, and was sworn in. My deposition was conducted by a man named “Mark” and overseen by his boss, Tracy, both of whose last names I see no reason to reveal. They both were the kind of federal employees that make one swell with pride: They displayed neither favor nor enmity, but simply, white collar professionalism such as has largely been lost in Corporate America. They were prompt, prepared, and business-like, and, without being rude, challenged me fairly aggressively while revealing to me as little as they could.
That said, try as they did, it was impossible for them to be as blank to me as they wished. After all, if someone asks, “What do you know about the possibility that Colonel Mustard killed his victim in the library with a rope?”, then it is resonable to infor that the utterer suspects that Colonel Mustard may have indeed killed someone in the library with a rope. In this fashion, I became reasonably confident that while the New York financial press was bleating about how wacky I must be to notice patterns that many sane observers had noticed, those same patterns had been noticed by others better placed to do something about them than I. (Incidentally, normally I would be loathe to reveal the contents of such a deposition, but given that this is all moot now, yet tied to today’s news, and the bad guys are using FOIA requests to get this stuff anyway, it seems like the right thing to do.)
Somewhere around this time, Jim Cramer and others of the journalists mentioned above received their own subpoenas. All hell broke loose, because they made it break loose (see for example “Herb Greenberg, The Worst Business Journalist in America, on the Conspiracy“). Of course, in a world where editors still had integrity, it would have been considered somewhat unseamly to have journalists reporting on an investigation of which they, themselves, had become the targets (I’m not sure why I mention that: I suppose it seems like it should be germane or something). But as a result, that investigation was promptly shit-canned. There’s no other way to describe it: the investigators were summoned to Washington, publicly crapped upon from a great height by SEC Chairman Chris Cox, the Enforcement Director who signed those subpoenas stood by idly while this happened to her staff, and we returned to our regularly scheduled programming of Muzak and bromide business reporting interrupted occasionally by B-list actors pitching Grandmother-Safe financial products and narcissistic hustlers promising that this time they really wanted to make you money, Mad Money!
Interestingly, not all the press backed up their brethren: editorials by LorenSteffy of the Houston Chronicle spring to mind in this regard. But by and large, the profession of business journalism stood mute while the reporting on a federal investigation was dominated by folks who were themselves the targets of that investigation.
The second story I would like to tell about this SEC Enforcement Director concerns some comments she made in 2008 in a keynote address before the United States Chamber of Commerce. In a pattern that observers of this issue have seen before, when asked about naked short selling, the Enforcement Director avoided the question by simply talking about the virtues of short selling, an issue which is not in contention. This pattern of avoiding the subject of naked short selling has been used time and time again by apologists for the practice (imagine someone being asked about sexual harassment, and answering with a response about the virtues of sex). Unfortunately for the Enforcement Director, her interlocutor, who was standing in the front row, directly in front of her podium, using a microphone that broadcast his voice loudly to the whole room (and you will see in a moment why that is relevant) pressed her on the distinction in a way that we would never see happen in any of the captured business media such as CNBC, New York Times, or Fortune. The Enforcement Director’s subsequent answer (she blamed the victim companies and excused the crime) is instructive because it confirmed, as though further confirmation were necessary, that there are in fact two and only two plays in the apologists’ playbook: first, conflate naked short selling with short selling and discuss the benefits of short selling; second, blame the victim companies and excuse the crime.
3:00 p.m. – 3:30 p.m. Regulatory Keynote Address: A View from the Division of Enforcement: Perspectives and Priorities
Linda C. Thomsen, Director of the Division of Enforcement, U.S. Securities and Exchange Commission
Introduced and moderated by: Michael J. Ryan, Senior Vice President and Executive Director, Center for Capital Markets Competitiveness
AUDIENCE MEMBER: “You spent a lot of time talking about insider trading and penny stock fraud, but you failed to mention an issue that’s of great concern to the Chamber, and that is naked short selling and the unsettled trades that can result from that. How can the Commission claim that it is serious about enforcement when millions of trades fail to settle every day and companies remain on Reg SHO Threshold Lists for years and years? And, second part of the question, why is the new rule 10b-21 necessary when, as Commissioner Casey pointed out, it makes illegal activity that is already illegal?;
SEC ENFORCEMENT DIRECTOR: “Um… I didn’t hear all of it, unfortunately, but as to the issue of short selling, we recognize that short selling is -”
AUDIENCE MEMBER: “My question was not about short selling. We all know that short selling is legal, and a necessary and efficient part of the market process. I’m talking about naked short selling-the selling of shares one does not have in inventory and probably has no intention of locating or borrowing.”
SEC ENFORCEMENT DIRECTOR: “As to naked short selling, and more generally market manipulation generally (sic), it is an area we are focused on. We have seen fewer cases in that arena because, often times, this is not necessarily with respect to naked shorts, but shorting or market manipulation more generally, because often the components of something that might look to be manipulative are all legal trades as you point out. So it’s a hard case to bring, which is not to say that it isn’t something that we don’t investigate, because we do. So I .. hear and understand the frustration of many on the subject of short selling generally. When we hear complaints about short selling-and, frankly, it is both short and naked short, it is a combination of both-we routinely hear from companies who’ve come in, who worry that they’re being shorted in an illegal way. We routinely take all that information in and look into it. And often times, as I think many defense counsel would be happy to tell you, when we dig in, what we find is that some of the information that has caused people to be shorting is actually true as to the company, and we may very well be confronted with two issues, one on the company and its disclosure side as well as on the trading side. But they’re very difficult cases, which is not to say that we aren’t focused on them and interested in them and indeed this new focus that we have on some smaller companies and smaller issuers will wrap some of those concerns into their focus as well.”
As you may have gathered, that SEC Enforcement Director was Linda Thomsen.
That would be the same Linda Thomsen who, for the entire 14 year duration of her service in the Enforcement Division of the SEC (the last four as Director), missed the $67-billion-and-counting walking Ponzi scheme/human brown stain known as Bernie Madoff, though concerned citizen Harry Markopolis not only did the work for the Enforcement Division, he all but spray-painted his findings on the lovely Italian marble of the SEC’s posh new DC headquarters.
That would also be the Linda Thomsen who, regarding Mr. Markopolis, acquitted herself so handily in this now-famous exchange with New York Democratic Congressman Gary Ackerman.
That would be the same Linda Thomsen against whom the SEC’s Office of the Inspector General recommended disciplanary action for her role in hanging out to dry SEC Senior Investigator Gary Aguirre, due to his impertinence in trying to subpoena Morgan Stanley CEO John Mack simply because a trail of clues in “the most important insider trading case in 30 years” led directly to him. Aguirre had failed to regonize that the law of the land does not apply to Mr. Mack because he has too much “juice“, as Aguirre’s boss Robert Hanson put it while shutting down the investigation. According to a subsequent report of the United State Senate Judiciary Comittee, by “juice” Hanson meant, “meaning they could directly contact the Director or an Associate Director of Enforcement. That Director was, again, Linda Thomsen, and the Associate Director was Paul Berger, who was, at the time of these events, negotiating for a job with Mr. Mack’s law firm, Debevoise Plimpton, a job which Mr. Berger ultimately took. That report by the US Senate Judiciary Committee summarized the culture of Enforcement Division under Director Linda Thomsen:
“Staff Attorney Gary Aguirre said that his supervisor warned him that it would be difficult to obtain approval for a subpoena of John Mack due to his ‘very powerful political connections.’ Aguirre’s claim is corroborated by internal SEC emails, including one from his supervisor, Robert Hanson. Hanson also told Aguirre that Mack’s counsel would have ‘juice,’ meaning they could directly contact the Director or an Associate Director of Enforcement.
“SEC management delayed Mack’s testimony for over a year, until days after the statute of limitations expired. After Aguirre complained about his supervisor’s reference to Mack’s ‘political clout,’ SEC management offered conflicting and shifting explanations.
“The SEC fired Gary Aguirre after he reported his supervisor’s comments about Mack’s ‘political connections,’ despite positive performance reviews and a merit pay raise.
“After being contacted by a friend in early September 2005, Associate Director Paul Berger authorized the friend to mention his interest in a job with Debevoise & Plimpton. Although that was the same firm that contacted the SEC for information about John Mack’s exposure in the Pequot investigation, Berger did not immediately recuse himself from the Pequot probe. Berger ultimately left the SEC to join Debevoise & Plimpton. When initially questioned, Berger’s answers concerning his employment search were less than forthcoming.
“The SEC’s Office of Inspector General failed to conduct a serious, credible investigation of Aguirre’s claims.”
That would be the same Enforcement Director to whom the SEC’s new Inspector General was obliquely referring, in page after page, for 55 pages, in a report explaining how three well-organized 6th graders could have handled the nation’s naked shorting complaints better than did the SEC Director Linda Thomsen’s Enforcement Division.
That Linda Thomsen is the same one whose resumption of employment with white-shoe law firm Davis Polk & Wardwell (I say “resumption” because Ms. Thomsen worked at Davis Polk until she joined the SEC in 1995) was announced today in this gem (”SEC Enforcement Chief Joins Davis Polk“) from the Blog of Legal Times (”Law and Lobbying in the Nation’s Capital”).
The announcement reads, with no detectable irony:
Linda Thomsen, who headed the SEC’s enforcement division until February, is starting as a partner in the firm’s white-collar defense and government investigations and enforcement practices in June. She will be joining former SEC commissioner Annette Nazareth, who started at Davis Polk last year, and Robert Colby, who joined the D.C. office this year after serving as deputy director of the SEC’s trading and markets division…
Thomsen practiced in Davis Polk’s New York office before joining the SEC in 1995. She started at the commission as assistant chief litigation counsel and went on to become head of enforcement in 2005. After leaving the SEC earlier this year, Thomsen says, “I had no preconceived ideas about where I was going to go, or what I was going to do.” – Translation: “I swear, it never occurred to me to go work for the law firm defending wealthy clients against whom I was overseeing cases until weeks ago.”
At the firm, Thomsen will advise clients on internal investigations and defend them against SEC probes. – Comment: Probes such as those ones she was overseeing weeks ago.
After serving at the agency for 14 years, Thomsen says she understands the kind of questions clients should be asking themselves to stay out of trouble with the commission. “I think I know and can see the kind of issues that get people into trouble, and the kinds of processes that cause them to, perhaps, ignore warning signs,” says Thomsen. - Comment: Yes, I am sure Ms. Thomsen is one of the world’s most recognized experts on the subject of processes that cause people to ignore warning signs.
Thomsen headed the enforcement division as it came under fire for failing to catch Bernard Madoff’s Ponzi scheme, as well as problems that contributed to the meltdown on Wall Street. In response to critics, Thomsen vehemently defends her former division. “I think the professionalism in the division of enforcement is really unparalleled,” she says. ‘If you look at the totality of the enforcement efforts…it’s really a record that I know I’m proud of.”
Considering the world-historic implosion of the US capital market occurring to vamp-til-ready accompaniment of Ms. Thomsen’s blind-piano-player-in-the-cathouse Enforcement Division, I’m at something of a loss for words with which to comment upon Ms. Thomsen’s “pride”.
Lest someone claim that I am but a DC-hostile, fed-fighting small “l” libertarian, let me be the first to say: Much respect goes to the GAO for their response to a Deep Capture story.
Readers of Deep Capture may have noticed that, while I may not be on the best of terms with some federal institutions (e.g., the SEC), I have sought to be respectful to individuals serving the public in whatever capacity, and especially, to those institutions which appear to me to be part of the solution and not part of the problem. For example, recently I wrote of the Congressional Research Service, “The CRS is one of the most respected institutions in Washington, DC, and its output is universally considered non-partisan, objective, and thorough” (”It Only Hurts When I Laugh“). And in June of 2008, in an essay (”So You Say You Want a Revolution?“) now linked to dozens of times through this site, I wrote of the GAO:
Another place you can turn is the United States Government Accountability Office. The GAO is probably the most respectable group in DC (setting aside the military). When Congress needs a non-partisan, no-bullshit answer to any question, they turn to the GAO. Write Chuck Young at youngc1@gao.gov and let him know about your interest in naked short selling and the general issues raised in DeepCapture.com.
Today the GAO’s Orice Williams (”Director, Financial Markets and Community Investment, US GAO”) has responded to Mark Mitchell’s story, to the great credit of the GAO and Ms. Williams herself. Because one can fairly read her intent to be one of public response (Ms. Williams has, in fact, posted this in the comments on Mark’s story), out of courtesy to Ms. Williams and respect for her organization I am reproducing her response here, in full, so that it not be lost among the comments of others.
———- Forwarded message ———-
From: Orice M Williams
Date: Wed, Apr 8, 2009 at 4:12 PM
Subject: Mr. Mitchell,
To: mitch0033@gmail.com
Mr. Mitchell,
On March 26, 2009, GAO issued a correspondence entitled Securities and Exchange Commission: Oversight of U.S. Equities Market Clearing Agencies. It was an interim product of an ongoing study on Regulation SHO and not, as mistakenly stated in the article, a report on the findings of an “investigation.” The March 2009 correspondence was issued as an interim product to provide Congress and the public with a descriptive overview of how U.S. clearing agencies settle and clear equities securities trades and how SEC oversees the clearing and settlement systems of these agencies through its examination process. Therefore, the information provided was descriptive and not intended to evaluate SEC’s oversight of clearing agencies or to provide detailed information on examination findings. Further, as is the case with all GAO reports, the March 2009 correspondence provided an introduction that explained why GAO did this work. In this case, as noted in the letter, GAO did this work because of the importance of an effective clearance and settlement process. This is our standard reporting format and is neither strange nor uncommon. GAO’s final report on Regulation SHO and SEC’s efforts to address failures to deliver and naked short selling will be issued in May 2009.
I have posted this information as a response to your article. However, I also wanted to bring it to your attention.
Regards,
Orice
Orice M. Williams
Director
Financial Markets and Community Investment
US GAO
If I know Mark, he may have something to write in reply. In the meantime, however, the publication of this GAO letter is required, I believe, by those very principles of journalistic integrity which Deep Capture was established to illustrate and defend.
“The Matrix is the world that has been pulled over your eyes, to blind you from the truth.”
- Morpheus to Neo, The Matrix
It is the mission of DeepCapture to show you, dear reader, that the financial world you inhabit, a world vouched-for in dulcet Midwestern tones by actor-spokesmen you recognize and trust, a world inhabited by honest brokers looking after your money, brokers who interact through self-regulating exchanges overseen by diligent regulators, themselves overseen by elected politicians looking out for their constituents, themselves challenged by an adversarial free press maintaining a critical posture towards it all, is in fact a “world that has been pulled over your eyes, to blind you from the truth.” It doesn’t exist: it is a socially constructed reality designed to keep you complacent as you feed your savings to the machine.
And I can prove it. For that matter, so can you, right now, from your computer. To explain how, I must continue with reference to The Matrix.
There is a point in the movie where Neo and his comrades are walking up a staircase. Neo glimpses a black cat that disappears then reappears:
In this essay I will explain a glitch that is available for you to verify right now, from your computer. I do not know how long it will remain after I write this, but it has existed for many months, and cannot be fixed without causing other problems for those seeking to keep you deluded. I will take you through three steps, and then you will be able to test this theory from your computer, and see a glitch that should not exist.
*****
STEP #1 OF 3: UNDERSTAND WIKIPEDIA
Wikipedia is a social media encyclopedia. That is to say, it is the work of thousands of people collaborating across the Internet to write millions of articles on every subject one would expect to find in an encyclopedia, and many more. People are free to edit other peoples’ words, adding their own knowledge to the sum. The constitutional principles of Wikipedia demand that such edits and additions be written from a “Neutral Point of View”. Every article is backed up by a discussion page, where the people who are working on that article can meet and work out their differences in an atmosphere where good faith is assumed. Ultimately, differences which are not so resolved are put to community vote. In sum, Wikipedia is socially constructed reality.
Wikipedia has drawn its detractors (myself among them) across many fronts. One thing that both supporters and detractors agree on, however, is the remarkable speed with which Wikipedia is updated to reflect the world around us. When any significant event happens, the appropriate page is updated within minutes, or even within seconds, by someone. Be it a public statement of a treasury official, the passing of a celebrity, or a car bomb going off on a street in Beirut, the appropriate Wikipedia pages are updated before the story has finished scrolling across the wire.
*****
STEP #2 OF 3: SCROLL THOUGH THE HEADLINES OF (OR READ) THESE 21 ARTICLES (a-u) CONCERNING NAKED SHORT SELLING AND THE GLOBAL FINANCIAL IMPLOSION
Second Item – Proposed Amendments to Regulation SHO
The next item on our agenda is the serious problem of abusive naked short sales, which can be used as a tool to drive down a company’s stock price to the detriment of all of its investors. The Commission is particularly concerned about persistent failures to deliver in the market for some securities that may be due to loopholes in the Commission’s Regulation SHO, adopted just two years ago.
At the Commission’s request, the Division of Market Regulation has prepared proposed changes in Rule 203 under Regulation SHO to cut down on failures to deliver.
The need for Regulation SHO grew out of long-standing and growing problems with failures to deliver stock by the end of the standard three day settlement period for trades, some of which were symptoms of abusive “naked” short selling. Selling short without having stock available for delivery, and intentionally failing to deliver stock within the standard three-day settlement period, is market manipulation that is clearly violative of the federal securities laws…
A grandfather provision, however, gave an exception from Rule 203(b)’s mandatory close out provision for any fail to deliver positions established before a security became a threshold security. And another provision of Rule 203(b) – the options market maker provision – provides an exception for any fail to deliver positions in a threshold security if they result from short sales by an options market maker, for the purpose of establishing or maintaining a hedge on options positions created before the underlying security became a threshold security.
We are particularly concerned about the potential negative effect that substantial and persistent fails to deliver may be having on the market in some securities. Specifically, these fails to deliver can deprive shareholders of the benefits of ownership – voting, lending, and dividends from issuers. Moreover, they can be indicative of abusive naked short selling, which could be used as a tool to drive down a company’s stock price. They may also undermine the confidence of investors who may believe that the fails to deliver are evidence of manipulative naked short selling in the stock. In turn, issuers may be harmed, as investors may be reluctant to commit capital to a stock that they believe is subject to abusive naked short selling.
To address these concerns, the Division of Market Regulation is recommending proposals to amend Regulation SHO. The recommended proposals are based on examinations conducted by the Commission’s staff and the SROs since Regulation SHO became effective in January 2005. While preliminary data indicates that Regulation SHO appears to be significantly reducing fails to deliver without disruption to the markets, there continues to be a number of threshold securities with substantial and persistent fail-to-deliver positions that are not being closed-out under existing delivery and settlement guidelines. It appears these persistent fails are primarily attributable to the grandfather and options market maker exceptions to the delivery requirements of Regulation SHO.
The proposals being recommended today would eliminate the grandfather provision, and narrow the options market maker exception. The proposals would include a limited one-time phase-in period following the effective date of the amendment. The proposals also include a technical amendment that would update the market decline limitation referenced in the rule. In combination, these proposals are intended to eliminate the persistent fails to deliver that are attributable to loopholes in Regulation SHO as originally adopted…
WASHINGTON, March 4 (Reuters) – The U.S. Securities and Exchange Commission on Tuesday proposed tougher rules to curb so-called “naked” short-selling abuses and prevent market price manipulation.
SEC Chairman Christopher Cox said regulation SHO, an existing rule partly aimed at short selling abuses, “needs teeth.”
Short sellers borrow shares they consider overvalued and sell them. If the price drops, they repurchase the shares, return them and pocket the difference. In a naked short sale, the investor sells stock that has not yet been borrowed.
The three-member SEC voted unanimously to propose the rule, which targets sellers who intentionally deceive broker-dealers or purchasers about their ability to meet delivery deadlines.
Sellers sometimes deliberately fail to deliver securities as part of a scheme to manipulate the stock price.
WASHINGTON — Securities regulators voted 3-0 to propose a rule intended to crack down on lingering abuses involving so-called naked short sales and failures to deliver shares that have been used in such sales.
The proposal is part of a continuing attack by the Securities and Exchange Commission on short-sales abuses, an effort begun four years ago with the adoption of rules known as Regulation SHO.
Separately, the SEC voted to propose changes that could speed the introduction of exchange-traded funds, without review by federal regulators. (Please see related article.)
Short selling involves sales of borrowed shares, producing profits when prices decline, allowing the short seller to replace borrowed shares at a lower price.
In contrast, “naked” short sellers don’t borrow shares before engaging in short selling, and they may have no intention of borrowing them.
Regulation SHO sought to curb such practices by requiring short sellers to locate shares for borrowing before engaging in short sales, but it did not include any new mechanism to enforce the requirement.
Under the proposal, the SEC would create an antifraud rule targeting those who knowingly deceive brokers about having located securities before engaging in short sales, and who fail to deliver the securities by the delivery date.
SEC Chairman Christopher Cox said the proposal would bring needed teeth to Regulation SHO and address concerns about short-selling abuses, particularly in the market for small-cap stocks. “Reg SHO can’t be effective without enforcement,” Mr. Cox said.
Even with the regulation in place, the SEC received hundreds of complaints last year about alleged abuses involving short sales. While most trades settle within three days, as required, the SEC estimates about 1% of shares that change hands daily, or about $1 billion, are subject to delivery failures.
The SEC’s move last year to close off a “grandfather” exception to Regulation SHO, has done little to reduce longstanding delivery failures, according to preliminary data analyzed by SEC staff.
The SEC has yet to announce its plans for a separate pending proposal to scale back or eliminate an exemption for options market-makers.
Brokers who engage in short selling for customers would not face any new obligations under the proposed antifraud rule, and the SEC said it wouldn’t apply to market makers engaging in market-making activities.
Although the SEC already has authority to sue illegal short sellers, SEC officials said a new rule explicitly targeted to naked short sales might affect behavior. SEC Commissioners Paul Atkins and Kathleen Casey expressed support for the crackdown on abusive sales but said they want to be sure it doesn’t result in unintended consequences, such as driving legitimate short sales offshore.
The U.S. Securities and Exchange Commission will limit the ability of traders to bet on a drop in shares of brokerage firms, Freddie Mac and Fannie Mae as part of a crackdown on stock manipulation, the agency’s chairman said.
Christopher Cox told the Senate Banking Committee that the agency will require traders to hold shares of the two mortgage buyers and the brokerages before they execute a short sale. The emergency order, to be in effect for 30 days, will bar the practice called naked short selling, in which traders avoid the financial cost of borrowing shares when betting they’ll fall.
Cox said the SEC will draft rules “to address the same issues across the entire market.”
Hedge-fund manager William Ackman, who oversees $6 billion at Pershing Square Capital Management, is among those betting that shares of Fannie Mae and Freddie Mac will fall. There’s no indication he is engaging in naked short selling, in which traders never borrow shares from their broker or deliver the stock to buyers.
The SEC has been reluctant to curb short selling “because it would require a major retooling of the plumbing of Wall Street,” said James Angel, a finance professor at Georgetown University studying short sales. “It’s only when the big Wall Street firms are threatened that the SEC does something about it.”
Trading Abuses
The SEC is investigating whether trading abuses contributed to the collapse of Bear Stearns Cos. in March and the 78 percent drop in the market value of larger rival Lehman Brothers Holdings Inc. this year. Fannie Mae and Freddie Mac have each lost about 80 percent of their value amid speculation the mortgage-market crisis may push the firms into insolvency.
Short-sellers, who borrow shares betting that they’ll decline, are spreading rumors about Lehman in an organized attempt to depress the stock, according to Richard Bove, bank analyst at Ladenburg Thalmann & Co. in Lutz, Florida.
“As with Bear Stearns, Lehman has been targeted by the fear-trade,” said Fox-Pitt Kelton Cochran Caronia Waller analyst David Trone in a report yesterday. Lehman should go private so it can avoid the attacks by short-sellers, he said.
Freddie Mac, down as much as 34 percent today before Cox’s comments, erased some of the decline and fell $1.49, or 21 percent, to $5.62 at 2:34 p.m. in New York Stock Exchange composite trading. Fannie Mae shares rebounded from a 30 percent drop and were down 18 percent.
Opposition
“I don’t think the government should ban short-selling in anything as long as it’s fully disclosed, as long as there’s no manipulation,” MFS Investment Management Chairman Robert Pozen said in an interview with Bloomberg News yesterday. “Don’t we want the market to work here?”
John Nester, an SEC spokesman, said the emergency order will “require any person effecting a short sale in the listed securities to borrow the securities before the short sale is effected and deliver the securities on settlement date.”
In traditional short selling, traders borrow stock through a broker and hope to profit by selling shares high and later buying them back at lower prices to repay the loan.
Naked short selling isn’t necessarily illegal, unless authorities can prove fraud, such as a scheme to manipulate stock prices.
The demise of IndyMac, coming on the heels of Bear Stearns’ desperate sale to JPMorgan Chase, is a sure sign of the fragility of today’s markets. What’s needed now, more than ever, is reliable information for investors and confidence that trading can be conducted without the illegal influence of manipulation.
Because financial institutions depend on confidence, they are uniquely vulnerable in the current climate. A “run on the bank” can take hold quickly, and can be fatal. But stampedes are not always rational.
When an irrational panic is fueled by a sense of urgency, false rumors that must be acted on immediately and the fear that everyone else may get out first, market integrity is threatened. It is the job of market cops to provide a measure of confidence that financial information about public companies is accurate and reliable — and when it is not, to punish those responsible.
Who profits from intentionally false information in the marketplace? Those who are in on the scam and positioned to benefit from the predictable response of others who believe the fraudulent information to be true.
The classic “pump and dump” scheme, in which a stock is inflated through false information and then dumped on unsuspecting investors when the perpetrators flee, is one example of how this works. “Distort and short” is the same thing in reverse.
Naked short selling can turbocharge these “distort and short” schemes. In a naked short, the usual process of short selling is circumvented, because the seller doesn’t actually borrow the stock and simply fails to deliver it. For this reason, naked shorting can occur even when actual shares aren’t available in the market. It allows manipulators to force prices down without regard to supply and demand.
Next week, the SEC will implement an emergency order designed to prevent naked short selling in the financial firms that the Federal Reserve Board has designated as eligible for access to its liquidity facilities.
Because these are large firms with substantial public float, honest short sellers can readily locate shares to make good on their short positions. Continued legitimate short selling in these issues will act, as it is supposed to, as a way for market participants to invest in the downside and to hedge other positions.
At the same time, eliminating the prospect of naked short selling will help assure investors that it is safe for them to participate, and that the current declining market is not the product of unseen manipulators and “distort and short” artists.
Our emergency order is not a response to unbridled naked short selling in financial issues — so far, that has not occurred — but rather it is intended as a preventative step to help restore market confidence at a time when it is sorely needed.
Many people think naked short selling is already illegal, but that isn’t true. Shares are normally delivered to the buyers within three days of the trade. But in most stocks, including those covered by our emergency order, that three-day period can be extended indefinitely.
Even without these extensions, and even when a short seller locates shares that can be borrowed, there can be problems because the short seller is not currently required to actually borrow those shares until settlement.
As a result, securities lenders can tell multiple short sellers they can borrow the same shares of stock — a sure recipe for a failure to deliver. Once the commission’s order takes effect, this possibility will no longer exist.
The SEC is committed to maintaining orderly securities markets. The abusive practice of naked short selling is far different from ordinary short selling, which is a healthy and necessary part of a free market.
Our agency’s rules are highly supportive of short selling, which can help quickly transmit price signals in response to negative information or prospects for a company. Short selling helps prevent “irrational exuberance” and bubbles.
But when someone fails to borrow and deliver the securities needed to make good on a short position, after failing even to determine that they can be borrowed, that is not contributing to an orderly market — it is undermining it. And in the context of a potential “distort and short” campaign aimed at an otherwise sound financial institution, this kind of manipulative activity can have drastic consequences.
It was famously — perhaps too famously — said that “markets will fluctuate.” That is certainly true if they are well-functioning. As market referee, the SEC neither can nor should direct the market’s fluctuations. Instead, our most basic role is to ensure a continued flow of liquidity to the markets from participants who are confident the game isn’t rigged against them.
Naked short selling can undermine the market’s integrity. For the financial sector in this crisis, certainly, but as soon as possible for the entire market, this is one worry investors shouldn’t have.
The U.S. Securities and Exchange Commission extended an emergency limit on short sales in shares of Freddie Mac, Fannie Mae and 17 brokerages as it prepares broader rules to thwart stock manipulation.
The SEC pushed back expiration of its ban on so-called naked short sales of the firms’ stocks from today through Aug. 12, the Washington-based agency said in a statement. The order aims to keep traders from driving down financial stocks to boost profits after Bear Stearns Cos. and IndyMac Bancorp Inc. collapsed amid rumors they were faltering.
The emergency order, focused on companies whose collapse might expose the U.S. government to losses, gives regulators time to weigh wider restrictions. SEC Chairman Christopher Cox last week told lawmakers the agency is examining other proposals, such applying the ban on naked short sales to the broader market.
“It definitely appears that the SEC is interested in making adjustments to short-sale regulations,” said John Standerfer, vice president for financial services at S3 Matching Technologies, the Austin, Texas-based trade processor.
In traditional short selling, traders borrow shares and sell them. If the price drops, they profit by re-buying the stock, repaying the loan and pocketing the difference.
Naked short sellers don’t borrow shares before settling sales. The SEC is concerned manipulative investors may use the sales, legal under some conditions, to drive down prices by flooding the market with orders to sell shares they don’t have.
Arrange to Borrow
The temporary order, which took effect July 21, requires traders to at least arrange to borrow shares before selling short Freddie Mac and Fannie Mae, the government-sponsored mortgage buyers. The order covers brokerages with access to the Federal Reserve’s discount window, which was opened to investment banks after the March collapse of Bear Stearns.
Market makers have an exception under the SEC order that permits them to sell short to maintain liquidity. Investors, such as hedge funds, previously could start trades without an agreement to acquire shares.
Short sales, particularly among retail investors, plummeted after the SEC announced the ban, according to data from S3 Matching Technologies, which processes trades for three of the top five retail brokerages. The sales fell 78 percent on average among the companies named in the order, compared with trades on July 14, the day before the SEC announced the measure, S3 data shows. The company handles about 15 billion transactions daily.
`Pretty Restrictive’
“I see no reason that will turn around,” said Standerfer in an interview yesterday. “It seems like a pretty restrictive rule to put in place for the entire market.’
Cox last week told Congress the agency may also force investors to disclose “substantial” bets on falling stocks and or reinstate a version of the so-called uptick rule, which barred short sales of stocks when prices are falling.
The uptick rule, implemented after the Great Depression and scrapped last year, allowed short sales only if a preceding trade boosted the stock price. The SEC is studying whether increasing the uptick increment, such as to a nickel or dime, might be more effective, he said.
Over the past several years, Patrick Byrne’s campaign to clean up Wall Street and end a practice that has destroyed companies and cost unwary investors billions of dollars generated plenty of publicity for him, mostly the wrong kind. Critics labeled him nuts, a conspiracy theorist, a complete wack job. Byrne, the chief executive of the Utah-based discount online retailer Overstock.com, even found himself tagged a member of the “tin-foil hat” brigade, a reference to the flying saucer fanatics of the 1950s who adorned their heads with aluminium to ward off, or enhance, thoughts from aliens in outer space. These days, when people talk of Byrne, the word ‘vindication’ comes up a lot. ‘You can always tell who the pioneers are — they’re the ones with all the arrows sticking out of their backs,’ said James Angel, a finance professor at Georgetown University. ‘You really can’t understate what Byrne has accomplished.’
The SEC’s emergency curb on short selling of 19 major financial services firms stocks expired before Wednesday trading, leaving investors to wonder if the measure helped protect the strained system.
Since July 21, the SEC rule banned “naked” short sales on those 19 stocks. Short sellers hope to profit by selling borrowed shares and replacing them at lower prices. In naked short sales, traders don’t actually borrow the shares; that can intensify the downward pressure on a stock.
The rule’s expiration appeared to have some effect Wednesday as financial stocks suffered sizable losses. That could mean short sellers have been at least partly behind big drops in shares of some financial companies.
“There has to be some sort of correlation between the moratorium ending and these stocks being down,” says Eric Fitzwater, analyst at research firm SNL Financial.
Perhaps more telling: The day the Securities and Exchange Commission announced the rule, July 15, was the day financial stocks bottomed for 2008. “If (the SEC) wanted to protect these companies artificially, it served its purpose,” Fitzwater says.
“It is impossible to know how big this problem is, but regulators accept it exists. The American Stock Exchange fined two market-makers for precisely this violation in July 2007. A month later the SEC proposed limiting or eliminating the exemption, but momentum stalled in the face of opposition from banks and exchanges. The anti-short lobby, emboldened by the July ban, is again pushing for an end to the market-makers’ exemption. …. How much does all this matter? Deliberate naked shorting has no place in a well-run market…”
WASHINGTON – With Wall Street engulfed in crisis, the Securities and Exchange Commission is planning measures to rein in aggressive forms of short-selling that were blamed in part for the demise of Lehman Brothers and which some fear could be turned against other vulnerable companies. During emergency meetings between federal officials and investment bank executives over the weekend, SEC Chairman Christopher Cox indicated to the bankers that the agency plans in a few days to impose new permanent protections against abusive ‘naked’ short-selling, a person familiar with the matter said Monday….
The Dutch Finance Minister is banning “naked” short selling of financial stocks for the next three months to increase the stability of financial markets….
TOKYO — Japan moved Tuesday imposed new restrictions on so-called “naked” short selling of stocks, stepping up its efforts to arrest the tumble in domestic share prices.
The Tokyo Stock Exchange has asked member brokers to stop accepting naked short-sell orders, TSE President Atsushi Saito told a news conference.
The TSE’s move followed comments from Finance Minister Shoichi Nakagawa, who said that regulations on naked short selling would be tightened. Mr. Nakagawa didn’t say that the practice would be banned, but the TSE’s move and local media’s interpretation of his comments suggested that the new strictures, to be enforced from today, will be a ban in all but name.
Short-sellers typically borrow stocks and then sell them on, profiting from the fall in price when they buy back the securities. Naked shorting removes the need to first borrow the stock, which means that larger volumes of shares can be dumped on the market. Short-selling generally has drawn fire from regulators across the world, who say it has contributed to the sharp market declines of recent months.
The Japanese government had planned to ban naked short selling from Nov. 4, but the recent plunge in local share prices has caused the new rule to be introduced a week ahead of schedule. The Nikkei 225 Stock Average closed at a 26-year low on Monday, as investor sentiment was battered by the global financial crisis, the rising yen and concerns about an international economic slowdown.
Traders said the naked short-selling ban was one reason for a big recovery in Japanese shares Tuesday.
The ban “was one of the positive factors behind the Nikkei’s gains (in the afternoon), but I don’t think it’s the main catalyst,” said Yukio Takahashi, market analyst at Shinko Securities. The Nikkei ended 6.4% higher Tuesday, erasing most of Monday’s sharp slide, due mainly to the yen’s weakening and firmness in major Asian stock markets, traders said. (See related article.)
The naked shorting ban comes as the government mulls a series of measures to improve confidence in Japan’s financial sector. Among other steps, the government wants to raise the cap on possible injections of taxpayers’ money into domestic banks from ¥2 trillion ($21.37 billion), ease fair-value accounting rules, loosen capital adequacy requirements for banks and enlarge tax breaks for stock investors.
At Tuesday’s news conference, Mr. Nakagawa highlighted the urgency of the task at hand. “I’ve discussed with Prime Minister [Taro Aso] the fact that the coming few days will be very important and that we must take steps immediately,” he said. “Our assessment is that the coming several days will be very important — and therefore dangerous — for the Japanese stock markets.”
Mr. Nakagawa also said the government will immediately open investigations into possible illegal practices linked with naked short selling. The Financial Services Agency, the Securities and Exchange Surveillance Commission and the TSE will work together in looking into past records on such sales practices, he said. “If we find out any violation of the law,” Mr. Nakagawa said, “we will retroactively deal with it strictly.”
CANBERRA: Australia moved to slap a permanent ban on the most controversial form of short-selling yesterday amid an historic fall in share prices, part of a crackdown that is also targeting hedge funds and credit rating agencies.
Interviewer: Let’s talk shorts. Harvey Pitt is former SEC chairman and founder and CEO of Kalorama Partners. Harvey, great to have you with us….Chairman Pitt, do we need to bring back the Uptick Rule? Would that make a difference here at all?
Harvey Pitt: I don’t believe so. The Uptick Rule was almost non-existence in terms of its detrimental affects. There’s a very simple solution and the SEC has it and they know what is. It’s very simply this. If you want to sell a stock short you have to have a legally and forcible right to produce that stock on settlement day. That’s all it takes. If the SEC does that people will not be able to sell short unless they have actually first located and gotten their stock.
Interviewer2: In other words that would do away with naked shorting right?
Harvey Pitt: Absolutely, and naked shorting is what’s causing a lot of the problems in the market.
Interviewer2: Because nobody is forced to deliver. Nobody must deliver. Too much of that going on.
Harvey Pitt: That’s been the real problem. People in affect are just gambling. They’re assuming the stock price will go down. They then spread false rumors to help the stock go down, but they have no skin in the game because they haven’t committed to produce the shares that they purportedly are selling.
Global securities regulators will gather on Monday to discuss rules on short selling and disclosure of credit derivatives, the head of the US Securities and Exchange Commission said on Thursday.
Christopher Cox, SEC chairman, said the meeting, to be held via teleconference, would address “urgent regulatory issues in the ongoing credit crisis.”
The announcement came during yet another tumultuous day of trading in global stock markets.
“In addressing turbulent market conditions, it is essential not only that regulators act against securities law violations, including abusive short selling, but also that there be close coordination among international markets to avoid regulatory gaps and unintended consequences,” Mr Cox said in a statement on Thursday.
The International Organization of Securities Commissions, which includes securities regulators from around the globe, will consider the effectiveness of their recent actions to reduce abusive short selling, without hurting legitimate shorting…
Mr Cox said regulators will explore “possible coordination” on rules relating to naked short sales – when shares are sold without being borrowed first– in particular with regard to position reporting and delivery and pre-borrowing requirements.
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p) November 24, 2008 Reuters “Global regulators focus on abusive short selling”
WASHINGTON, Nov 24 (Reuters) – Global securities regulators launched three task forces to study abusive short selling, unregulated financial products and unregulated financial entities such as hedge funds, the U.S. Securities and Exchange Commission said on Monday.
“The working groups were established amid volatile market conditions and designed to support work of the world’s 20 largest economies, which have already agreed to step up oversight of the troubled financial system. “One group will focus on aligning global regulators’ approach to naked short selling, the SEC said.””
Fails to deliver in the US equity market have exacerbated the sharp declines in share prices of financials.
IT IS NO surprise that the stock of Bear Stearns was heavily shorted in the run-up to its government-supported rescue in March, given its high leverage, poor risk management and the fact that its sub-prime bets had gone awry. Short-selling of any financial company would have been understandable by March this year. But just why on March 12, two days before the rescue announcement, almost 1.25 million Bear Stearns shares were shorted is a question that is a little harder to answer.
Up to that point in 2008, cumulative fails to deliver of Bear Stearns’ stock were only between 10,000 and 200,000 on any given day. On March 14, more than 2 million Bear Stearns shares went undelivered, and from then until the end of March, failures increased, peaking one day at more than 13.78 million shares. At the same time, from March 12 to the announcement on Friday March 14, Bear Stearns’ share price crashed from $61.68 to $30, dropping to $4.81 the following Monday.
That the precipitous drop in Bear Stearns’ share price coincided with fails to deliver has forced the market to properly address a long-standing question: are fails to deliver responsible for rapid share price deterioration? Had those failures been averted through better regulation would Bear Stearns have had a slower downfall, or even avoided outright collapse? And what of Lehman Brothers, Fannie Mae and Freddie Mac? Indeed, would all financial companies have enjoyed more resilient share prices, instead of seeing sudden, sharp price declines that were the final nudge to creditors and counterparties abandoning firms and driving them into bankruptcy?
The SEC has since attempted to bring a halt to naked short-selling, which gives rise to fails to deliver, but are its efforts sufficient?
Formal investigations are taking place to look into abusive short-selling of the stocks of both Bear Stearns and Lehman Brothers.
Robert Shapiro, former economic adviser to Bill Clinton, chairman of Sonecon and an adviser to the presidential transition team of Barack Obama, believes there is sufficient evidence that naked shorting accelerated the collapse of Bear Stearns. He says: “Bear Stearns failed because it went bankrupt. However, the pace of the collapse of the stock price was clearly accelerated by the enormous naked short-sale activity. There perhaps could have been a more orderly bankruptcy which would have preserved more of the assets.”
John Welborn, an economist with investment firm the Haverford Group, agrees. “Fails to deliver added to the downfall of Lehman Brothers and Bear Stearns but were not, obviously, the whole story. Fails in Lehman Brothers were never significant enough to drastically alter the tradable float. In Bear Stearns, however, a torrent of fails began on March 12, before the public knew most of the bad news. The important thing to note here is that T+3 settlement essentially allows people to sell an infinite amount of any stock either to precipitate a bear raid or to capitalize on one already in progress.”
Welborn continues: “A bear raid encourages panic selling by long holders. Once enough long holders are induced to sell, then there are plenty of shares available to cover any naked positions ex post. When the long holders have sold their positions and the naked short sellers have covered at a lower price, then the issuer faces a dramatically depressed market. That may make it difficult (or impossible) to recapitalize, especially if that issuer is in the financial sector.”
Naked short-selling can be a confusing topic. A short-seller can only sell short if it can locate a source from which to borrow that security and therefore ensure delivery to the buyer – within the T+3 requirement. In most circumstances it is up to the prime broker to confirm whether it is possible to locate the stock and agree the transaction. If it is not possible to locate a stock, which can happen when certain stocks become illiquid, the trade is not allowed to take place. Market makers are an exception to this rule, and are able to lend stock without having located a source from which to borrow, in order to keep the markets liquid. This type of “naked shorting” is legal. If the source of stock is not a market maker, selling of a stock without having located a stock to deliver is illegal. Illegal, however, means very little when no enforcement penalties are in place.
Up until the end of this summer – not till September did the SEC enforce a crackdown – shorting without locating a source from which to borrow has suffered no penalty in the US, and brokers’ statements about efforts to locate them might be rather vague. “A broker can say he has located a stock, but that’s it,” says a hedge fund manager. “What if five other brokers are looking at that same stock and telling their clients they have located it. Who will get it?”
And if there is no penalty for failing to locate and failing to deliver, then why not just fail to deliver? In equity markets if a short-seller does not deliver, he can simply wait until the stock price deteriorates sufficiently so that he will never have to deliver, and therefore is able to keep the money from his sale. Do short sellers, be they hedge funds or proprietary trading desks, do this often? No. But can they do it? Yes. And were some doing this during the peak of the financial crisis? Absolutely.
One former employee of regulator NASD says he knows of a hedge fund that was shorting Freddie Mac and Fannie Mae on a “massive scale”, with no intention of ever locating stock. “His prime broker let the trade go through regardless as he was a large client of theirs,” he says.
Illegal naked shorting, at its worst, can be implemented to bring a company down. In the present crisis of confidence among financial institutions, it can also simply be a means of jumping on a losing target. If a financial institution’s stock looked as if it was falling, why not short-sell without promising a buy-in within three days and hope that the fall is sufficiently large beyond three days to make an even bigger profit?
A glance at the fails to deliver in the financials market indicates that some investors applied this strategy. A comparison of the average daily reported shares failing to deliver between the first quarter of 2007 and the first quarter of 2008 for the US’s top financial firms showed a clear increase over the period. The data, compiled by Washington publication IA Watch, showed a 335% increase for Freddie Mac, a 226% increase for Citigroup, a 133% increase for Goldman Sachs, a 632% increase for Morgan Stanley and a 1,123% increase for Bear Stearns. One source even suggests that some market participants never intended to buy-in and simply marked their tickets “long” selling shares that they did not even own as they knew they would never have to make delivery.
Fails to deliver: Unheard voices
Fails to deliver in the US stock markets are not a new phenomenon. In response to an increasing number of fails, the SEC introduced Regulation SHO in January 2004. This required that a daily list be compiled of all securities that had more than 10,000 fails to deliver, or more than 0.5% of issued shares failing to deliver for five consecutive days or more. No penalty was introduced to deter fails but it was believed that publication of the list would act as a deterrent. The majority of the stocks on the list were those of small firms on the Pink Sheets or Bulletin Boards and many were regarded as companies with weak business models that were likely to see fails to deliver, as levels of shorting in the stock would be high.
For years, small companies affected, and larger companies such as Overstock.com (which has market capitalization of $500 million) have appealed to the SEC to prevent fails to deliver, claiming that their stock prices have suffered as a result of the practice. In April 2004, in a series of articles, Euromoney warned about the implications for larger household names if fails to deliver were not properly addressed. Shapiro agrees that larger companies are now being targeted. He says: “Ordinarily this doesn’t happen to large institutions with large stock floats but in a panic situation they become vulnerable along with those companies that are always vulnerable – smaller companies that are without large public floats. In a time of panic, mechanisms that allow the markets to overshoot (naked shorts) mean you can drive a stock into the ground.”
Patrick Byrne, chief executive of Overstock.com, continues to lobby against fails but insists it is not a matter of self-interest. “The argument gets reduced to me being upset that stock in my firm might be being shorted. That was never the argument. Shorting has its place, I know. This has always been about why the government is ignoring the loopholes within the settlement system that are allowing for fails to deliver to occur.”
He is certain, as are several other long-standing lobbyists, that the recorded number of fails to deliver is only a fraction of the true amount. “If two broker/dealers clear through the DTCC, and one fails, then the two brokers can turn that failure into a private contract to be dealt with outside the DTCC and it becomes ‘ex-clearing’. After that there is no register of that fail,” says Byrne. If failures are as frequent as suggested, the idea of broker/dealers preferring to cancel out each other’s fails on a private basis is not beyond the realms of possibility.
Wes Christian is partner in a law firm representing 15 companies that allege that their stock price has been driven down by illegal naked shorting and fails to deliver. “We are aware of these deals being ex-cleared and of the failings of Reg SHO. Allowing failures to deliver creates artificial supply and that drives down prices,” he says. The defendants in Christian’s clients’ cases are the majority of broker/dealers on Wall Street.
Fails to deliver in the equity markets are seen to create artificial supply. If a stock can be sold without having to be borrowed, there is a strong possibility that stocks in excess of those issued are being sold. Indeed, several companies, Overstock.com included, have reported instances of more owners of stock than is possible. On March 14 128% of Bear Stearns stock outstanding was traded. These “phantom shares” can be on-lent without delivery again and again, further diluting the stock.
It’s a situation specific to the US markets, say participants. Patrick Georg at Clearstream Luxembourg says there has been no decline in settlement efficiency in Europe. Alan Cameron, head of clearing, settlement and custody client solutions at BNP Paribas Securities Services in London, says he has seen little to indicate similar instances of fails to deliver in Europe. “Some European countries like Spain impose strict fines on failures to deliver, as does Crest. It’s not an issue here in Europe.” Byrne adds that in Europe, the impact on reputation of failing to deliver is a deterrent. A head of a prime brokerage in the UK agrees: “It just does not happen in Europe. Securities get delivered in a timely fashion or business is lost.”
However, settlement is faster in Europe than in the US. It is surprising that the US still operates a T+3 system. Robert Greifeld, chef executive of Nasdaq, questioned the system in March this year at a conference when, in reference to fails to deliver, he said it was hard to believe that in 2008 the market still required three days to settle, and that a T+1 system should be part of a discussion about fails.
The SEC has pussyfooted around enforcing delivery in the US equity market over the past 10 years or so, but the collapse of financials stocks has pushed it to be stricter. On September 17, SEC chairman Christopher Cox announced several actions to “make it crystal clear that the SEC has zero tolerance for abusive naked short-selling.” From that date, fails to deliver beyond T+3 have been subject to a hard close-out. If stocks fail to deliver beyond T+3, the broker/dealers acting on the short-seller’s behalf are prohibited from further short sales in that security unless stocks are pre-borrowed.
This change of tack upsets those such as Byrne who have been fighting to have their voices heard for years. “When companies that had access to the Fed window became victims of fails to deliver, the SEC then had to sit up and take notice,” says Byrne.
Actions taken against naked shorting: Small steps
Since August, the number of companies with stock on the Reg SHO list has fallen from an all-time high of 650 to an all-time low of 90, although this does not take into account ex-clearing data. Shapiro says it is a step in the right direction. “The actions taken are an acknowledgement of the issues regarding naked shorting and fails to deliver at least. Progress is under way. Given there are many issues facing the SEC at the moment, this is encouraging.”
Others, however, are disappointed that more has not been done. Byrne says: “A hard close-out is not nearly enough. To truly stop failures to deliver, the SEC must enforce a pre-borrow where parties have to guarantee that a locate has been found through a contract.” At present, broker/dealers and short-sellers can say they have located a source of stock when several other parties might have also identified the same source. Peter Chepucavage of the International Association of Small Broker/Dealers and Advisers agrees that an initial pre-borrow rule is crucial in preventing fails to deliver. “The industry is resisting an initial pre-borrow rule but it is essential,” he says. “Without it the stock market is like the airline industry. You’re overselling the airplane seats knowing that someone will not be able to board even though they reserved/located, to avoid decrementing their inventory.”
The argument against pre-borrows is that liquidity will dry up, and that shorting will be deterred. However, Greg DePetris at Quadriserv believes the opposite would occur as lending would increase. “A more efficient settlement process should result from recent regulatory changes, and these tighter inventory controls might create new trading opportunities,” he says. “It’s important for anyone in possession of lendable supply to monetize its value, and traditionally that’s been done through the lending spread and reinvestment of cash. The notion of pre-borrows implies that there may be derivative value in the latent supply of securities, which lenders may be able to realize for their clients.”
Welborn says the SEC knows it has to introduce the pre-borrow rule if it wants to eliminate fails to deliver for good. “As long as there are companies on the Reg SHO list, then the problem has not been solved,” he says. “The only sustainable solution to naked short-selling is a rule requiring both a pre-borrow and a hard delivery. With only one of these pieces in place, the system is still open to abuse. For example, a hard-delivery requirement by itself would not have made an iota of difference for Bear Stearns; only a pre-borrow could have put a brake on the naked short-selling.”
Welborn points out that the SEC did precisely this in July when it ordered emergency pre-borrows for Fannie Mae, Freddie Mac and the 17 primary dealers. “The SEC knows what must be done to fix this problem once and for all,” he says.
WASHINGTON, Dec 9 (Reuters) – U.S. securities regulators need to do more to crack down on abusive naked short selling — a type of trading blamed for contributing to the free-fall in financial stocks — former and current regulators said on Tuesday. Amid volatile market conditions, the Securities and Exchange Commission adopted a number of rules to rein in those who profit illegally from stock declines. Making bearish bets on stocks is a legitimate investment strategy but the SEC’s rules are designed to weed out abusive practices, such as investors’ failure to deliver stock by settlement date. Short sellers arrange to borrow shares they consider overvalued in hopes of repaying the loan for less and profiting from the difference. A naked short sale occurs when an investor sells stock that has not yet been borrowed, which can distort markets.
Former SEC Chairman Harvey Pitt praised the SEC for taking constructive steps but said the agency has not done enough.
“Naked shorting is a situation in which someone is gambling but they have no skin in the game. They are not required to make any effort to deliver the shares,” said Pitt, one of the panelists speaking at a “Coalition Against Market Manipulation” event in Washington.
The SEC tightened up its rules this year and required short sellers to deliver securities three trading days after shorting the stock.
Rex Staples, general counsel for an association of state securities administrators, said the states are trying to eliminate the problem, but said “this seems to be a solution that the commission is best-equipped to solve.”
“States are ready to act, but we are throwing our support behind the federal regulator at this point,” said Staples, general counsel for the North American Securities Administrators Association.
Pitt and other panelists said the SEC needed to do more to eliminate ambiguity in its rules.
For example, investors are required to locate shares before shorting them. However, SEC rules require broker dealers to have “reasonable grounds” to believe that the security can be borrowed so that it can be delivered by settlement date. Critics say the language is vague.
“If you want to sell short any security, you should have a legally enforceable right to deliver stock on day of settlement. It’s unambiguous, it doesn’t leave any wiggle room,” said Pitt.
WASHINGTON — U.S. securities regulators need to do more to curb short-selling abuses, a group of academics, business executives and former top regulators said Tuesday.
The Securities and Exchange Commission should close loopholes and enforce current rules against “naked” short selling, said Harvey Pitt, former SEC chairman and now chief executive of Kalorama Partners, a Washington, D.C., consulting firm.
“The agency has to make it clear that naked short selling in any form is prohibited,” Mr. Pitt said at a midday press conference.
Short sellers aim to profit by borrowing shares for sale and replacing them later at a lower price. “Naked” short sellers don’t borrow shares they sell short, which can pummel stocks and facilitate market manipulation.
The SEC has sought to crack down on short-selling abuses in recent years, most recently with an interim rule requiring short sellers to deliver borrowed shares within three days of trade settlement. Mr. Pitt and others urged the SEC to make the requirement permanent and take other steps to stiffen pre-borrowing requirements, provide better tracking of stock-delivery failures, including those outside stock-clearing systems, and force buy-ins when delivery failures occur.
Ambiguous rules limiting naked short selling must be clarified, attorneys say
WASHINGTON (MarketWatch) — A top adviser to President-elect Barack Obama on securities regulation on Tuesday said he wants the Securities and Exchange Commission to require public disclosure of short selling.
“We’re looking for disclosure of positions, with a small delay, after a short sale is made,” said Roel Campos, a former Democratic SEC commissioner and member of Obama’s transition team.
After the precipitous drop in stocks of major investment and some commercial banks including Citigroup Inc. in September, the agency implemented a series of short sell rules, many of which were temporary in nature. Among these, the SEC temporarily banned short sales in roughly 800 financial institutions. That ban expired on October 8.
Regulators and others argued that many short sellers — who make bets that a stock price will decline — contributed heavily to the financial crisis and the collapse of many financial institutions.
The next agency chairman is expected to grapple with whether the agency is doing enough to chill manipulative short selling of shares, particularly when it comes to financial institutions.
Campos is seeking to have the next SEC chairman introduce new rules requiring short sellers to publicly disclose their positions in a manner that is similar to how equity investors are required to reveal their equity stakes.
For example, to comply with the SEC’s 13F rule, investors with $100 million in capital or more are required to publicly disclose their positions 45 days after every calendar quarter. Equity investors with 5% or greater stakes are also required to disclose that information to the agency in either an activist Schedule 13D or passive Schedule 13G filing.
But Campos argues that four-times-a-year public disclosure of short sell positions isn’t enough. He wants to see a requirement that hedge funds and other short sellers disclose their positions publicly more quickly after stakes are made, perhaps as fast as two weeks after each position is taken.
Among the temporary regulations put into place in the fall is a requirement for confidential weekly disclosure of short positions to the agency.
According to the rule, investors with $100 million or more in capital must disclose on a weekly basis to the agency their short positions. However, these investors only must provide that position information to the agency on a confidential basis. The expiration date for the provision was extended in October to Aug. 1 of 2009.
Short seller critics argue that public disclosure will mean their proprietary strategies will be disclosed, enabling rivals to copy their approach. Campos said the delay in public disclosure is intended to protect some proprietary strategies, but that there should be some parity with equity disclosure requirements.
Other ways to rein in short selling
In addition to disclosure, securities attorneys and academics discussed other mechanisms that the SEC could impose that could reign in short selling at an event hosted by the Coalition Against Market Manipulation in Washington.
Participants argued that the agency needs stronger rules limiting illegal naked short selling, the practice of selling shares without arranging to borrow the securities up-front.
The SEC in September adopted rules requiring short sellers and their broker dealers to deliver securities within three days of a trade. Participating investors who fail to arrange to borrow shares in advance are prohibited from making future short sales in the same securities.
But securities attorneys at the event argued that there are too many qualifiers on the naked short selling rule.
Rex Staples, general counsel for the North American Securities Administrator’s Association Inc., said there is a “reasonable” qualification on the delivery requirement. “To the extent you can qualify a word like reasonable, you are going to get that time after time,” said Rex Staples, general counsel for the North American Securities Administrator’s Association Inc.
Former SEC chairman Harvey Pitt, who participated in the discussion agreed that the SEC should eliminate ambiguity when it comes to the agency’s naked short selling provision. The agency should also take steps to enforce the rules.
“The agency must make it extremely clear that any naked short selling is illegal and it has to remove the ambiguities so the rules are very clear,” Pitt said.
Participants also debated bringing back the so-called up-tick rule, a regulation removed last year that allowed short sales only if a preceding trade boosted a company’s stock price.
Georgetown Finance professor James Angel said he wants to see an up-tick rule that would take effect when a stock has fallen 5%. He also sought additional prohibitions when a stock price falls 10% and 15%. Staples argued that the SEC should bring back the same up-tick rule it eliminated in 2007. “It is very helpful in times of financial turmoil,” Staples said.
The biggest bankruptcy in history might have been avoided if Wall Street had been prevented from practicing one of its darkest arts.
As Lehman Brothers Holdings Inc. struggled to survive last year, as many as 32.8 million shares in the company were sold and not delivered to buyers on time as of Sept. 11, according to data compiled by the Securities and Exchange Commission and Bloomberg. That was a more than 57-fold increase over the prior year’s peak of 567,518 failed trades on July 30.
The SEC has linked such so-called fails-to-deliver to naked short selling, a strategy that can be used to manipulate markets. A fail-to-deliver is a trade that doesn’t settle within three days.
“We had another word for this in Brooklyn,” said Harvey Pitt, a former SEC chairman. “The word was ‘fraud.’”
*****
In addition to these articles, please note that naked short selling has been implicated in the hobbling of the US financial system by The American Bankers’ Association (12), the US Chamber of Commerce (123 ), the CEOs of Goldman Sachs, Morgan Stanley, JP Morgan, and Lehman, politicians John McCain, Hillary Clinton, Barack Obama, Ron Paul and numerous other congressional representatives, the Chairman of the SEC, the Secretary of the Treasury, and so on and so forth.
*****
STEP #3 OF 3: THE CURRENT WIKIPEDIA PAGE ON NAKED SHORT SELLING OMITS EVERYTHING YOU JUST READ, AND YOU ARE FORBIDDEN FROM FIXING IT
At “the encyclopedia that anyone can edit” it is as forbidden to add information such as that contained in the preceding articles as it would be to sell Adam Smith’s works on the streets of Pyongyang. Instead, right at this second, the Wikipedia page on Naked Short Selling sticks to a thoroughly-discredited two-year out-of-date Party Line that holds that experts think naked short selling is not a problem (or even exists) and the mass media agrees with the experts. Much of the page is written in gibberish apparently intended to make it more difficult for a lay person to confront (which is unusual for Wikipedia). And unique among the millions of Wikipedia articles, it cannot be fixed or updated to reflect any of the information cited exhaustively above.
That’s right. Notwithstanding thousands of articles such as the ones cited above, the current Wikipedia article on naked short selling insists that experts believe that it is not a problem. No mention is made of hearings, statements by economists and SEC Chairmen, emergency federal actions and emergency meetings of regulators from the G-20 to stop the world financial system from implding, etc.
Instead, the tone is set by this quote:
“While concern expressed by the regulator has been echoed by journalists, some commentators contend that naked short selling is not harmful and that its prevalence has been exaggerated by corporate officials seeking to blame external forces for their own shortcomings. Others have discussed naked short selling as a confusing or bizarre form of trading.”
That is, in a 54-word statement about a “concern”, precisely 11 words vaguely describe the existence of the “concern” and 43 say that there is no concern. This, though space is allocated to describe results from two off-topic studies from 2007 (one on failures in the IPO market, the other on the Canadian market):
A study of trading in initial public offerings by two SEC staff economists, published in April 2007, found that excessive numbers of fails to deliver were not correlated with naked short selling. The authors of the study said that while the findings in the paper specifically concern IPO trading, “The results presented in this paper also inform a public debate surrounding the role of short selling and fails to deliver in price formation.”
An April 2007 study conducted for Canadian market regulators by Market Regulation Services Inc. found that fails to deliver securities were not a significant problem on the Canadian market, that “less than 6% of fails resulting from the sale of a security involved short sales” and that “fails involving short sales are projected to account for only 0.07% of total short sales.”
Again, notwithstanding the thousands of articles such as the ones I cited above, the current Wikipedia page maintains that the mass media agrees that naked short selling is not a problem:
Reviewing the SEC’s July 2008 emergency order, Barron’s said in an editorial: “Rather than fixing any of the real problems with the agency and its mission, Cox and his fellow commissioners waved a newspaper and swatted the imaginary fly of naked short-selling. It made a big noise, but there’s no dead bug.” Holman Jenkins of the Wall Street Journal said the order was “an exercise in symbolic confidence-building” and that naked shorting involved echnical concerns except for subscribers to a “devil theory”. The Economist said the SEC had “picked the wrong target”, mentioning a study by Arturo Bris of the Swiss International Institute for Management Development who found that trading in the 19 financial stocks became less efficient. The Washington Post expressed approval of the SEC’s decision to address a “frenetic shadow world of postponed promises, borrowed time, obscured paperwork and nail-biting price-watching, usually compressed into a few high-tension days swirling around the decline of a company.” The Los Angeles Times called the practice of naked short selling “hard to defend,” and stated that it was past time the SEC became active in addressing market manipulation.
The Wall Street Journal said in an editorial in July 2008 that “the Beltway is shooting the messenger by questioning the price-setting mechanisms for barrels of oil and shares of stock.” But it said the emergency order to bar naked short selling “won’t do much harm,” and said “Critics might say it’s a solution to a nonproblem, but the SEC doesn’t claim to be solving a problem. The Commission’s move is intended to prevent even the possibility that an unscrupulous short seller could drive down the shares of a financial firm with a flood of sell orders that aren’t backed by an actual ability to deliver the shares to buyers.”
The Wikipedia page engages in such pettifoggery as: “However, the SEC has disclaimed the existence of counterfeit shares and stated that naked short selling would not increase a company’s outstanding shares” (true only in the narrow technical sense that the SEC does not consider that which is increased by naked short selling to be “outstanding shares”: by the same token, the National Transportation Safety Board could claim that there are no plane crashes because the NTSB considers anything which crashes to no longer be a plane).
And so on and so forth. You will find such gibberish on the naked short selling article on Wikipedia, but what you will not find is any of the information presented in the articles cited in Step #2. It is forbidden to enter that information into Wikipedia.
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THE TEST: ARE YOU FORBIDDEN FROM UPDATING WIKIPEDIA WITH THIS INFORMATION?
I know that to many this can be a maddeningly complicated issue, and it may not be easy to know who or what to believe. So I propose that you, the reader, conduct an easy, simple test, using the articles cited above. You can do it in about 2 minutes:
Log on to Wikipedia (if you do not have an account you can create one in seconds);
Attempt to edit it with any information regarding events, data, or quotes from any of the articles cited above.
You will find that it is forbidden for you to add any information, data, or quotes from those numerous articles, or to correct any of the glaring omissions and laughable spin of the current article. If you try, your additions will be removed nearly instantaneously. In fact, you may find yourself banned from Wikipedia while all proof that you even made an edit disappears.
On “The encyclopedia that anyone can edit”, a resource that updates in seconds at the passing of a celebrity or the gaffe of a politician, you will find that you cannot insert quotes on this one topic, even when those quotes come from SEC Chairmen, economists, presidential candidates, Congressmen and Senators, G-20 regulators, and Wall Street leaders, even when those quotes appeared months or years ago in The Economist, Reuters, DowJones, Associated Press, or Bloomberg.
Two million English-language articles work by one set of rules, but this article on a grave financial crime turns out to run on a secret set of rules.
And that, dear reader, is the stutter-stepping black cat that should wake you to the synthetic reality you inhabit.
