Sam’s correspondence is filled with the the brio and charming repartee one normally associates with the letters of Voltaire (for more examples, see my recent piece, “Sam Antar: PS And Is That Mr. Goniff?“) So it seems a shame not to share today’s treasury of Sam’s wit with a wider audience.

From: Sam E. Antar [mailto:sam@whitecollarfraud.com]
Sent: Wednesday, November 18, 2009 11:24 AM
Subject: Overstock.com Conference Call Scheduled Today at 5 PM
Importance: High

Hi Patrick Byrne:

I received read receipts from you and other persons at Overstock.com regarding my previous email requesting to participate in the live conference call so I can ask questions about Overstock.com’s accounting practices and financial disclosures. However, I received no response from you or your employees. Since my blog posts about Overstock.com’s improper establishment of “cookie jar” reserves to cook its books is the main issue here, in the interest of transparency you should let me participate in the call to discuss those issues with management. By shutting me out of the call, you will be viewed as stonewalling those issues and afraid to address them.

Regards,

Sam E. Antar

__________________________________________________________________________________________________

From: Patrick Byrne <PByrne@overstock.com>

Date: Wed, 18 Nov 2009 12:48:08 -0700

Hi Sam:

Please:

1) Admit you paid fellow conman Barry Minkow $300,000 in cash (as he testified in deposition: see pages 8-10) to write hatchet jobs on USANA;

2) Disclose where you got the $300,000;

3) Explain why it was necessary to pay someone else to shill for you when you are an expert in the business of exposing frauds.

I’m looking forward to your answers.

Warm regards,

Patrick

__________________________________________________________________________________________________________

From: sam@whitecollarfraud.com [mailto:sam@whitecollarfraud.com]
Sent: Wednesday, November 18, 2009 2:01 PM
Subject: Re: Overstock.com Conference Call Scheduled Today at 5 PM

Hi Patrick;

I am asking the questions and not you. I will call in. It will be your choice whether to allow me to ask questions about your improper use of cookie jar reserves to manipulate earnings.

Sam

__________________________________________________________________________________________________________

From: Patrick Byrne [mailto:PByrne@overstock.com]
Sent: Wednesday, November 18, 2009 11:38 PM
Subject: RE: Overstock.com Conference Call Scheduled Today at 5 PM

” I am asking the questions and not you.”

Well evidently not.

__________________________________________________________________________________________________________

From: Sam E. Antar [mailto:sam@whitecollarfraud.com]
Sent: Wednesday, November 18, 2009 9:57 PM
Subject: RE: Overstock.com Conference Call Scheduled Today at 5 PM

Hi Patrick Byrne:

Why did you lie when you said there were no further questions? Are you afraid of taking questions from somebody who is aware of what you are doing and why it violates the securities laws?

Sam E. Antar

__________________________________________________________________________________________________________

Sam,

I just think that before you are allowed on a conference call with grown-ups you should make clear who you and what your motivations really are, and answering these questions would be a good start in that direction:

1) Admit you paid fellow conman Barry Minkow $300,000 in cash (as he testified in deposition: see pages 8-10) to write hatchet jobs on USANA;

2) Disclose where you got the $300,000;

3) Explain why it was necessary to pay someone else to shill for you when you are an expert in the business of exposing frauds.

Remember, well-started is half-finished.

Patrick

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 financial journalists, relationships which I depicted as intersecting through Jim Cramer (who later was caught on tape bragging about precisely the activities I had described), 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 David Einhorn has since confirmed) to build networks of corporate insiders (which may ring a bell with readers 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.  Their method was simply to cover the Miscreant’s Ball as though it was only about Overstock (though less than 1/4 of it concerned Overstock). The journalists who wrote of it 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 supporting affidavits: 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 replayed with 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: people who pretend not to understand metaphors dumb down the discourse).  Admittedly, salting the presentation with this and other colorful shibboleths proved insufficiently granular (i.e., all the journos turned out to be Ephraimites).

In subsequent interviews I refined the metaphor to be “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  (see, for example, see my correspondence with BusinessWeek’s Tim Mullaney, among others) 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 could have made it more obvious.

(Note: this is a work in progress. More will be added this weekend.)

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.

Sam

Sam E. Antar

Website: www.whitecollarfraud.com

Blog: www.whitecollarfraud.blogspot.com

My dear Sam,

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,

Yours always,

Patrick

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.

Regards to all,

Patrick M. Byrne

“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.

———————————————————————————————-

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.

Thank you for your interest in SABEW.

Sincerely,

Donna Dare

SABEW Membership Coordinator

Ph:  573-882-7862

Email: dared@missouri.edu

www.sabew.org

———————————————————————————————-

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

Donna Dare

SABEW Membership Coordinator

Dear Ms. Dare (& SABEW Membership Appellate Court),

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

———————————————————————————————-

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

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

———————————————————————————————-

Then, as no answer was forthcoming (or ever came), I then sent this:

———————————————————————————————-

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.

Strange Occurrences, and a Story about Naked Short Selling

Regards,

Patrick

———————————————————————————————-

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…”

On that same day The Colorado Independent (”A Center for Independent Media”) wrote, “Business Reporters Confess News Sins While the US Economy Collapsed“.

“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);

3) go here for additional suggestions: “So You Say You Want a Revolution?“

(draft only)

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.

Click image to enlarge

Of late, this story has taken a happy turn. On April 14 Dendreon released prelimary results of their prostate cancer vaccine trials (details of which will be disclosed at this coming week’s American Urological Association’s (AUA) Annual Meeting in Chicago) showing that Provenge works. It prolongs the lives of men with advanced stage prostate cancer.  Its stock promptly quadrupled, which will make getting financing easy (Investors Business Daily, “Prostate Cancer Drugs Get Street’s Attention“).

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:

1) email it to a dozen friends;

2) email The Story of Deep Capture to a dozen friends;

3) go here for additional suggestions: “So You Say You Want a Revolution?“

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 Dave Kansas, 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 Herb Greenberg (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 Loren Steffy 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”.

But it is nice she landed on her feet.

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.

Notwithstanding such general warm sentiments Deep Capture feels towards the GAO, a recent GAO publication (”Securities and Exchange Commission: Oversight of U.S. Equities Market Clearing Agencies“) disappointed my Deep Capture colleague, Mark Mitchell, enough for him to write a fairly scathing analysis of it (”Our Watchdogs and the Financial Scandal of the Century“).

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.

And to Ms. Williams I say: Much respect indeed.

=========================================================
(Click graph to enlarge)

- 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

a) July 12, 2006 Speech by SEC Chairman: Opening Statements at the Commission Open Meeting by Chairman Christopher Cox

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…

*****

b) March 4, 2008 – Reuters: “SEC proposes tougher “naked” short selling rules“

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.

*****

c) March 5, 2008 – Wall Street Journal: “SEC Proposes Teeth for Short-Selling Rules“  by Judy Burns

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.

*****

d) July 15, 2008 – Bloomberg: “SEC to Limit Short Sales of Fannie, Freddie, Brokers” By Jesse Westbrook and David Scheer

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.

*****

e) July 18, 2008 – Op-ed for the Investor’s Business Daily: “Public Statement by SEC Chairman Christopher Cox ‘Naked Short Selling Is One Problem a Slumping Market Shouldn’t Have‘”

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.

*****

f) July 29 – Bloomberg: “SEC Extends Naked Short-Sale Order on Fannie, Freddie” David Scheer and Edgar Ortega

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.

*****

g) August 2, 2008 – The Salt Lake Tribune: “Naked shorting’s early critic starts to see some vindication: Byrne’s Battle Helps Bring Curbs on Naked Short-Selling Practices“. By Steven Oberbeck

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.’

*****

h) August 13, 2008 USA Today: “Financial stocks suffer after protection ends” By Matt Krant

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.

*****

i) August 17, 2008 The Economist: “Searching for the naked truth“

The real problem with abusive short-selling

“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…”

*****

j) September 16, 2008 Associated Press: “Naked short-selling blamed in Wall St crisis“

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….

*****

k) September 21, 2008 Associated Press: “Dutch ban ‘naked’ short selling for 3 months“

The Dutch Finance Minister is banning “naked” short selling of financial stocks for the next three months to increase the stability of financial markets….

*****

l) October 28, 2008 Wall Street Journal: “Japan Cracks Down on Naked Short Selling” By Takashi Nakamichi and Ayai Tomisawa

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.”

*****

m) November 14, 2008 “Australia bans naked short-selling“

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.

*****

n) November 20, 2008 – CNBC: Interview with Former SEC Chairman Harvey Pitt:

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.

*****

o) November 21, 2008 – The Financial Times: “Regulators to discuss short selling rules” By Joanna Chung in New York

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.

*****

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.””

*****

q) December 1, 2008 – EuroMoney: “US equity market – Fails to deliver: The naked truth“

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.

*****

r) December 9 – Reuters: “SEC urged to do more to curb naked short selling” By Rachelle Younglai

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.

*****

s) December 9, 2008 – Wall Street Journal: “SEC Urged To Step Up Attack On Short-Sale Abuses” By Judith Burns

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.

*****

t) December 9, 2008 - MarketWatch: “Obama adviser: Short selling must be disclosed” By Ronald D. Oral

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.

*****

u) March 19, 2009 (Bloomberg): Naked Short Sales Hint Fraud in Bringing Down Lehman” By Gary Matsumoto

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 (1 2), the US Chamber of Commerce (1 2 3 ), 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.

*****

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);
• Go to the article on Naked Short Selling;
• 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.

Postscript: If you want to know how this is being done, watch Judd’s magisterial “Lecture on abuse of social media by stock manipulators“.  And if you want the back-story on that, read TheRegister’s article, “Emails show journalist rigged Wikipedia’s naked shorts – Overstock’s Byrne vindicated amidst economic meltdown” by Cade Metz.

What should we learn from the fact that “The Daily Show’s” Jon Stewart has in four evenings (1 2 3 and 4) exposed Jim Cramer in a way that, in any sane world, he would have been exposed a decade ago? To answer that, consider these associated facts: while the Jim Cramer constellation of journalists (Mitchell’s Media Mob) backed each other up while covering-up the subject of criminally abusive short selling by hedge funds to whom they were close, four channels of the media broke rank:

1. Two years ago Bloomberg’s Emmy Award-winning investigative journalist Gary Matsumoto did a half-hour documentary that broke away from the Party Line;
2. Liz Moyer at Forbes has covered the real issues fairly and diligently, and another Forbes reporter named Nathan Vardi took a good swipe at the story (”Sewer Pipes“);
3. Rolling Out Magazine (”an UrbanStyle Weekly serving the African American community”) called me up a couple years ago and did precisely the fair, non-disorted interview of which the remainder of the New York financial media was entirely incapable;
4. Now, “The Daily Show” has broken ranks by stating the obvious: there are journalists shilling for favored hedge funds.

Could the lesson be that the first news organizations that can break ranks with the Party Line are either fringe (”Rolling Out Magazine” and “The Daily Show”) or the properties of billionaires (Bloomberg and Forbes) who cannot be intimidated?

Perhaps someday, a journalist will look into the pressures that were brought on news organizations (e.g., on Bloomberg leading up to their running “Phantom Shares“). Just a few weeks ago I got the  story, again, from a journalist: “I was working on a story about naked short selling and Deep Capture. Then, suddenly I was stopped. It’s weird because I have been a journalist here for 9 years. I have built a great reputation with my editor, and have never had a story interfered with. But I got a couple months into this story, and suddenly I was stopped from above. I’ve never seen that happen before.” I replied, If you only knew how many times a journalist has said that to me in the last couple years….

If this essay concerns you, and you wish to help, then:

1) email it to some friends;

2) go here for additional suggestions: “So You Say You Want a Revolution?“

So here’s the preface: In the 1950’s there was a school of psychology called “Behaviorism”. Behaviorists turned away from the “internal states” that had been the concern of psychology since its inception, regarding them as mental constructs whose explanation invoked unscientific mysticism. Behaviorists instead proposed a new “scientific” paradigm and mission: to describe “the organism” in terms of inputs to and outputs from a Black Box whose inner workings need not be explained. If you have seen 1950’s grainy black-and-white films of BF Skinner teaching pigeons to spin around and peck buttons, and chickens learning to perform simple tasks, you have seen Behaviorism in action.

So here’s the joke: Two professors of behaviorist psychology have sex. When they’re finished they light up cigarettes. One says to the other, “So…. That was good for you. How was it for me?”

It’s a great joke. For those who still missed it, the point is that the professors were so wrapped up in their theory (in this case, the denial of internal states), that they could not experience what was right in front of them. They had to filter their data through the theory to which they were committed before they could experience it.

Sometimes such commitments bind their holders so strongly they forget that what they are committed to are just paradigms. For example, Richard Feynman told a story about how, in 1895, the chairman of the Harvard Physics Department discouraged new graduate students from starting PhD’s on the grounds that all the questions of physics had been answered, with the exception of two problems. Those two problems were the photoelectric effect and the problem of black-body radiation. Their subsequent investigation spawned relativity and quantum mechanics, shattering the classical Newtonian paradigm to which the Harvard department chair had been committed.

Modern finance theory is dominated by two pillars: the “Capital Asset Pricing Model” (or “CAPM”) and “Efficient Market Theory” (or “EMT”). CAPM is a model that says, Market participants will bid the price of a financial asset up and down until its return and its volatility satisfy a certain equilibrium equation. Efficient Market Theory evolves alongside of CAPM to say, Prices have already been so bid to reflect all publicly available information.

An implication of Efficient Market Theory is that, since securities are already priced to reflect all publicly available information, it is impossible to beat the market without having inside information. While for some years the leading edge of finance theory has been nibbling away at EMT, it is no exaggeration to say that it is still the dominant paradigm of modern finance, and that every MBA program in American universities teaches EMT as the core of finance theory.

By happy accident I was exposed to EMT by its greatest counterexample, Warren Buffett. I was 14 when he impressed upon me the ridiculousness of EMT. He loved the fact that it was taught in business schools, he said, for it made his job “like playing bridge with people who have been told it doesn’t help to look at the cards.” Later, I was fortunate also to know Dr. Kenneth Arrow (one of the founders of general equilibrium theory, and the originator of Arrow’s Impossibility Theorem, a tidy social choice proof he did over a weekend when he was 26 for which he later won the Nobel Prize). Dr. Arrow also ridiculed Efficient Market Theory, saying, “Believing in EMT is like believing you can’t find a $20 bill in the street because if it were there someone else would have picked it up already.”

Mr. Buffett and Dr. Arrow warned me about the intense dogmatic belief in Efficient Market Theory among finance professors. Mr. Buffett compared their profession to a Mayan priesthood whose practitioners had invested years in learning the arcane language of their priest craft (or as he put it with regard to finance professors, “had gotten their Ph.D.’s learning how to talk to each other in Greek letters”). He pointed out how natural it was for priests to defend the hard-won skills which set them apart from ordinary mortals.

Mr. Buffett has beat the market so handily, for so many years, that his success is an affront to Efficient Market Theory. Naive EMT proponents at first discounted Buffett’s success: give enough chimpanzees coins to flip, and one of them is going to get 10 heads in a row, they said. This led to Buffett’s famed response, “The Superinvestors of Graham-and-Doddsville“, first delivered in a talk at Columbia University, and then reprinted as an Appendix to The Intelligent Investor.

Buffett’s partner, Charles Munger, has had this to say on the subject:

“Now let’s talk about efficient market theory, a wonderful economic doctrine that had a long vogue in spite of the experience of Berkshire Hathaway. In fact one of the economists who won — he shared a Nobel Prize — and as he looked at Berkshire Hathaway year after year, which people would throw in his face as saying maybe the market isn’t quite as efficient as you think, he said, ‘Well, it’s a two-sigma event.’ And then he said we were a three-sigma event. And then he said we were a four-sigma event. And he finally got up to six sigmas — better to add a sigma than change a theory, just because the evidence comes in differently. [Laughter] ….

“…what made these economists love the efficient market theory is the math was so elegant. And after all, math was what they’d learned to do. To the man with a hammer, every problem tends to look pretty much like a nail…”

Finance professors and economists have missed the boat on stock manipulation schemes such as naked short selling because they are confined by the straight-jacket of their theory to the point that they cannot experience what is right in front of them. When confronted with data showing the existence of naked short selling, they answer that any manipulative effects are impossible. Their addiction to EMT locks them into a worldview that maintains, There is an ocean of capital out there ready to pour in and correct any mispricing, so mispricing cannot exist. This worldview prevents them from understanding the effects of stock manipulation schemes such as naked short selling.

I will give some recent examples of this (because I do not care to embarrass any individuals I will not identify anyone by name):

• Not long ago a sitting commissioner of the SEC made precisely this argument in private: CAPM tells us it should not matter how many shares are trading in the market, phantom or otherwise, as long as the market knows how many have been issued;

• Along the same lines, the current internal party line of the SEC’s Office of Economic Analysis someone objecting to naked short selling must object to short selling, because within legal short selling shares could theoretically be sold-lent-sold-lent, thus creating an infinite number of shares. This objection misses the boat on two counts: the practical constraints of the settlement system would prevent such an infinite chain from developing (and if it did, we might in fact have to reconsider our commitment to the benefits of short selling); besides which, the short seller pays for his position, and by paying that price he injects valuable information into the marketplace, whereas the naked short selling skips paying that price and hence the information he injects into the marketplace is value-less;

• As recently as last June, a high official within the SEC’s OEA was arguing internally that there is no difference between naked shorting and writing a futures contract. He was correct in that a naked short position is akin to a derivative called a “Contract For Difference”. He was wrong in that a naked short position creates a futures contract that is in some sense involuntary, cheats the buyer of rights he thinks he is acquiring (such as the right to vote shares), and has the unusual feature of being able to affect the underlying value of which its value is putatively derivative (write derivative contracts on how much the sun will shine in Florida all you want, and it will not affect the underlying event, but if I sop up all demand for a thinly-traded small cap company by diverting it into what are in effect CFD’s, the underlying event, that is, the stock price, will be affected).

My point is not to descend too far into the arcana of such debates. Instead, it is to suggest that modern finance theoreticians have become misguided because they reason from a foundation of Efficient Market Theory.

A couple of years ago I visited a United States Senator who walked me through arguments the hedge fund’s lobbyists had recently rehearsed to him, arguments holding that, in effect, everything I claimed was going on in the market was theoretically impossible. I said to him, “Sir, they can line up finance professors from here to MIT who say this is impossible. I can line up tough Italian guys from here to Staten Island that say they do it every day.”

Like Newtonian physics, which gives good results on much scale of interest to humans, EMT is useful. It may even be directionally correct, expressing a powerful marketplace dynamic. However, there are corner cases it gets hopelessly wrong. Sadly, over time those corner cases have become a non-negligible corner of the market. And as this has happened the finance professoriate, unable to see what was right in front of its eyes, has stayed busily asking itself, “That was good for you, how was it for me?”

If this essay concerns you, and you wish to help, then:

1) email it to a dozen friends;

2) go here for additional suggestions: “So You Say You Want a Revolution?“

Last Tuesday, February 24, 2009, the Congressional Research Service published a 40 page report, “Who Regulates Whom? An Overview of U.S. Financial Supervision” (Mark Jickling, Edward Murphy, CRS, February 24, 2009)  As the title suggests, the report is a primer on the parts of the US financial system, and who regulates which part.  As the Summary section puts it:

“This report provides an overview of current U.S. financial regulation: which agencies are responsible for which institutions and markets, and what kinds of authority they have….This report does not attempt to analyze the strengths and weaknesses of the U.S. regulatory system. Rather, it provides a description of the current system, to aid in the evaluation of reform proposals.” (Page 2)

And in the Introduction:

“A number of studies and reports have already proposed broad changes to the division of supervisory authority among the various federal agencies and in the tools and authorities available to individual regulators. This report provides a basis for evaluating and comparing such proposals by setting out the basic structure of federal financial regulation as it stood at the beginning of the 111th Congress.” (Page 5)

And describe the basic structure of the the financial system, its regulators, and their regulatory principles, it does, thoroughly, in 35 more pages of clear and informative, if not exactly gripping, prose. It covers US banking regulation and federal securities regulation, the regulation of derivative trading and of GSE’s such as Freddie Mac and Fannie Mae, and the non-regulation of foreign exchange and US Treasuries, nonbank lenders, hedge funds and venture capitalists. I confess it answered every question I could think to ask regarding the parts of the US financial system and which office of government regulates each part. I commend Messiers Jickling and Murphy for so thorough and well-organized a review of that subject.

There’s just one thing: it does not mention the Depository Trust and Clearing Corporation. In fact, it does not mention securities settlement.

Does that seem strange?

Consider this: The regulatory structure of the US capital market was set in the Secuties Exchange Act of 1934. It devoted a section (immediately after the section on Directors, Officers, and Principle Shareholders, and the section establishing the need to keep records), to describing the need for a “National System for Clearance and Settlement of Securities Transactions” (Section 17a). Its opening is instructive:

“a. Congressional findings; facilitating establishment of system

“1. The Congress finds that–

“A. The prompt and accurate clearance and settlement of securities transactions, including the transfer of record ownership and the safeguarding of securities and funds related thereto, are necessary for the protection of investors and persons facilitating transactions by and acting on behalf of investors.

“B. Inefficient procedures for clearance and settlement impose unnecessary costs on investors and persons facilitating transactions by and acting on behalf of investors.

“C. New data processing and communications techniques create the opportunity for more efficient, effective, and safe procedures for clearance and settlement.

“D. The linking of all clearance and settlement facilities and the development of uniform standards and procedures for clearance and settlement will reduce unnecessary costs and increase the protection of investors and persons facilitating transactions by and acting on behalf of investors.”

It seems that in 1934 Congress thought having securities transactions clear and settle promptly was pretty important.

Which makes it especially odd that in 2009, in the Congressional Research Service’s admirably thorough report on the parts of the US financial system and the regulators who oversee them, no mention is made of that “”National System for Clearance and Settlement of Securities Transactions”  whose establishment Congress in 1934 found “necessary for the protection of investors.”

I am reminded of an event from early 2005. It was the early days of the Mitzvah. I was having trouble synthesizing the data. It would be more honest of me to say: the data suggested that our settlement system was Swiss Cheese, an enormous derivative risk was building up that no one understood, the same SEC to which I had spent a lifetime looking up in awe and fear was actually lapdog to a tight circle of Wall Street crooks, the savings of America were being looted, and it was all going to end in systemic collapse.  But clearly, I thought, that’s crazy. So I was having trouble forming a hypothesis to fit the data, other than a crazy one.

I decided to find out who regulated the DTCC. Listen to what they had to say. No doubt I’d learn some piece of the puzzle that I was missing, something that would cause the light bulb to go on and me to say, “Oh, that’s where this is coming from. Oh, I see, there’s nothing to worry about after all.”

The problem was, I could not find out who regulated the DTCC. It was not on their website. I couldn’t find any government agency that claimed to regulate the DTCC, or any news story that mentioned the subject of DTCC regulation. A core finding of Congress in 1934, in the foundational document of modern regulation, established that something had to be done, but 71 years later I could find no evidence that it was the job of anyone in the federal government to do it. And that’s odd because usually government agencies fight turf wars over who gets to regulate this or that. But here was a great vital section of the Securities Exchange Act of 1934, authorizing the establishment of a crucial component of the system, yet no one seemed to be doing it.

That can’t be right, I thought. Clearly just another moment of bad craziness.

So I went to see two securities lawyers whom I knew socially. I asked them if they would research something for me, that I would be willing to pay them for their time, and that they did not have to worry about writing anything formal. I just needed from them one simple sentence of the form, “The DTCC is regulated by _____ .” They agreed to produce it.

A week later I went to visit them. For some time they sat hemming and hawing and scratching their heads, until finally they told me: “We can’t seem to find anything that establishes who regulates the DTCC, or even if it is regulated. We found one mention of the subject, in a footnote in a GAO report from a couple years ago. They say they think the SEC regulates the DTCC, but they don’t sound very sure.”

From the looks of it, neither is the Congressional Research Service.

If this article concerns you, and you wish to help, then:

1) email it to a dozen friends;

2) go here for additional suggestions: “So You Say You Want a Revolution?“

Not that anyone’s wrong to suspect it might crack: I’m the last guy on the planet that can be accused of being Dr. Pangloss. Not that they are wrong to decry the regulatory and political oversight of our finance system in general and the shenanigans of Wall Street in particular: the name of this blog is, after all, “DeepCapture.com”.

But for four years I’ve been eagerly flushing the handle while watching these guys circle the bowl. In that time I’ve developed a sense of how they move. I’m pretty sure now that their orders are, quite simply, to crack the system.

We have Joe Nocera’s Sunday New York Times piece, “Propping Up a House of Cards“, that basically says AIG has the financial world by the throat and that as they die they’ll take the rest of the world with them. Maybe so. But one would think Nocera would be able to draw on better sources than Donn Vickrey. From what is publicly known about Donn Vickrey, from what has been publicly alleged (in these three affidavits) then publicly admitted, Nocera’s continued use of him as a source (and the New York Times‘ tolerance thereof) is a disgrace. That Nocera quotes shamelessly from him signals that the gang is back in town.

But more interesting to me are recent pieces on Warren Buffett. The hit parade has been led by Doug Kass, a kind of half-bright Jim Cramer-wannabee, but Jim himself has added his own special brand of empty insinuation. From the last four weeks alone:

January 27, 2009 “Kass: Is This the End of Warren Buffett?” This article reads (no kidding), “Reflecting some of the above concerns and since late September 2008, Berkshire’s shares have fallen from $145,000 a share to $85,000 a share. There is no apparent end to the decline in sight. All good things, it seems, in markets and life, must come to an end.” That is to say, the analysis that Doug Kass has to offer is that something has gone lower therefore there is no end in sight to its going lower. (Isn’t that the quintessential panic argument?)

February 18 “Cramer on BloggingStocks: Buffett sells America“.

February 18 “Kass – Buffett Watch: Questions for the Oracle of Omaha – Doug Kass says Warren Buffett’s changes to the Berkshire portfolio raise more questions than answers.”

February 20 “Kass – Buffett Watch: Holdings Getting Hammered – The Berkshire Hathaway investment debacle continues apace.”

February 23 “Cramer: Buffett Watch – Jim Cramer advises investors to look at Warren Buffet’s inconsistencies before following his investment strategy”. Interestingly, in this video Jim Cramer correctly predicts precisely what Kass is going to say on television later that night (not that there is coordination between them).

February 24, 2009 Kass – “What’s Hot and What’s Not in 2009?” (Berkshire is listed as a “Not” with a link to another Cramer hit piece)

February 24 Kass “Buffett Watch: Bad News for HOG – Despite the assist from Buffett, there is some bad stuff in Harley-Davidson’s 10-K.”

Then February 28, the New York Times published a lie. In his annual shareholders’ letter released that morning Buffett had written:

“We’re certain, for example, that the economy will be in shambles throughout 2009 – and, for that matter, probably well beyond – but that conclusion does not tell us whether the stock market will rise or fall” (page 3).

That evening, New York Times journalist David Segal published an article which states in the third paragraph:

“But he [Buffett] also needled regulators and an assortment of unnamed chief executives as he predicted that fallout from the credit crisis would leave the stock market a shambles through 2009.”

Regarding a figure whose every utterance is scrutinized for meaning that can rock markets, such sloppiness is at best careless editing. Going on my one experience with New York Times Business Editor Lawrence Ingrassia (cf. “Anti-Investigative Reporter Joe Nocera and The Newspaper of Non-Record“) careless editing of a crucial point is not something I would put past him. Nor would I, for that matter, ask the fellow to whip up a batch of jet fuel. But the consistent direction of such little liberties with the truth must give one  pause.

As some readers may be aware, I have known Mr. Buffett since I was a lad, and after my parents, he has been perhaps my greatest teacher in life (which is certainly not to imply any endorsement from him on this Mitzvah of mine). However, I am not writing this article because of that connection, nor have I spoken to him of this, and I am sure he could give two hoots what these clowns write and say about him.  Seeing a self-confessed criminal like Jim Cramer (”Jim Cramer is a Complicated Man“) attack Warren Buffett’s ethics is like seeing Ratso Rizzo (the Dustin Hoffman character in Midnight Cowboy) giving grooming lessons to Mr. Rogers, while seeing the New York Times using discredited sources and fabricating positions for Warren Buffett is nothing too unusual, as far as that goes.

Instead, I am writing this because there is a pattern to which we of the Market Reform Movement began calling attention in the last few years, a pattern that is amply described in Chapter 2 of my work here (”Journalists Tried to Be Players But Became Pawns“) and in Mark Mitchell’s many Deep Capture pieces (e.g., “Email Exposes Short Seller Plot to Destroy a Public Company“). These hedge fund squeegee boys got caught in a spotlight (and while mentioning DeepCapture is something they avoid like the plague, from reviewing the IP logs I know that every major news organization in America visits this site regularly and extensively, so I can promise you it is indeed in their spotlight). For a year or more, that pattern submerged itself. Tiny stabs were occasionally taken (see Bethany’s piece on me on her way out the door of Fortune and my response: “David Einhorn, Cheryl Strauss, and the ‘Unavailable’ Bethany McLean“). But by and large, these stumblebums have been on their heels.

Yet suddenly they return, quoting hedge fund choagies to support doomsday predictions while firing up an attack machine on Buffett, up to and including having the New York Times publish a fabrication regarding the single line in Buffett’s letter that will get more attention than any other. So in sum, it appears to me that certain folks have piled up a lot of favors in a favor bank, are short the market, and are using these HandiWipe journalists to crack it for them.

As I said, no one can claim that I am being Panglossian: few have been out there arguing as loud and long as I that the sky might fall.

But right at this moment, I smell skunk.

Errata: DeepCapture has been relocating its servers and this has created numerous issues. A draft of this essay that was inadvertently set live last night at midnight had several errors which have been corrected: a number of flagrant typos were still present (corrected); I misidentified a law professor with a good history with one of San Diego hedge fund choagies (corrected & apologies); and the comments were accidentally turned off (corrected). In addition, you will continue to notice various other glitches occuring in the site: most text is in italics, buttons are appearing where they should not be, and the new navigation format is somewhat stillborn. When the move is completed this week thes problems should get cleared up as well.

In response, I posted this on InvestorVillage:

Mother Jones Defends Establishment

Well I thought I had seen it all. But I had not. Mother Jones has sided against us.

For years I listened to Lefties in academia. They could not say anything without working in the word “corporation”… They decry markets without knowing, in general, what they are talking about. They complain about unseemly relationships among corporations, government officials, and the corporate press.

But now they are faced with an actual series of events, entirely documented, whereby the public has been ripped off by the corporations that dominate our capital market while the government issued hall passes and the captured press obediently refused to report even when their faces were shoved into the data. In short, they have been handed precisely the situation that they have been fantasizing about for years. And what do they do? They say it is all far too improbable, and defend the Establishment.

Here is the Mother Jones article I’m talking about. If you feel like doing so, leave a comment.

Patrick

Over the following days a number of folks showed up at Mother Jones and wrote comments that were critical of MotherJones, but not overly aggressive or inappropriate. Yesterday those comments disappeared. Maybe they’ll reappear, but for now, the position of Mother Jones is: Something is true simply because they say so, thus their journalism need include neither facts nor argument, and dissenting opinion should be expunged.

Why am I not surprised?

Please follow the links in the preceding post, and if you share my astonishment that Mother Jones would publish a piece of such low intellectual caliber, free to leave you opinion on the article itself, and on Mother Jones’ backtalk page. Maybe if you are lucky the censors will permit your voice to be heard.

I now turn to Gary Weiss. Last year one of the most prominent journalists on Wall Street warned me, “I’ve known Weiss for years. Be careful. He’s a psychopath.” As you will see, he was neither joking nor exaggerating. I think, however, that Gary is better described as a “Scaramouch.”

In a series of brilliant investigations, Judd Bagley, a reporter-investigator-technologist friend of mine (and more recently, I am proud to say, a colleague) studied the IP footprints Gary’s computers have left scattered across the Internet for over a decade, and posted his extraordinary analyses of them on his cleverly-titled site, “Antisocialmedia.net”. Judd’s posts are as disturbing with regard to what they reveal about our society’s discourse, as they are regarding the activities of Gary himself.

It is a complex story that I recount below in as clear and straightforward a manner as I can muster. The best way for me to do that is to break it into 7 short stories. Embedded within each are links to carefully documented research . I respectfully suggest the reader try to understand these as individual stories, before synthesizing them into one complete picture.

#1) Gary’s start in social media

Gary started with simple Usenet group posting in the mid 1990’s, often making productive contributions to newsgroups devoted to matters Judaic. However, as this analysis shows, by the late 1990’s Gary had become a chronic “sock-puppeter,” that is, he maintained a stable of identities and personalities under which he could post in order to steer conversations to his ends (Gary even posted anti-Semitic statements that he could then respond to under other names). Another user caught Gary red-handed and confronted him. Establishing a pattern that would become Gary’s hallmark, when he was caught red-handed Gary Weiss practiced the “deny-deny-deny-then-disappear” school of personal responsibility.

Another pattern of Gary’s emerged as well: that of accusing anyone who disagrees with him about anything as being anti-Semitic. One person whom he has accused of hundreds of times of anti-Semitism complained to the Anti-Defamation League. Showing immense class, the ADL looked into it all and dismissed Gary out-of-hand. Notwithstanding this, Gary continues to level this allegation against that same man (under the assumption, presumably, that he understands anti-Semitism better than the ADL).

#2) Gary’s manipulation of Amazon reviews

For years Gary posted numerous reviews on Amazon praising his own books and trashing the work of other business journalists, as this analysis shows. While Gary’s sock-puppets trash other journalists (e.g., Charles Gasparino), there is one journalist whom he never bashes, but whom he uses his sock-puppets to promote: Jim Cramer. Hilariously, though they were supposed to be the work of various disinterested strangers, Gary’s sock-puppets’ glowing Amazon reviews of his own work began disappearing the moment Judd began exposing Gary’s methods.

#3) Gary goes beserk against another journalist and that journalist’ wife at the United Nations

The following remarkable history is recounted, with thorough documentation, on these two posts.

a) Ian Williams, a British journalist, was president of the United Nations Correspondents Association (UNCA) and UN correspondent for The Nation. Mr. Williams’ wife, a BBC World Service journalist (and native of Uzbekistan), also held a position within the UNCA.

b) Gary’s wife (an Indian national holding herself out as a correspondent for the Indian newspaper The Pioneer of India) applied to work within the United Nations Correspondents Association. To be admitted to the UNCA she had to demonstrate that she was in fact a journalist who covered the UN. Towards that end she submitted copies of her stories from the front page of The Pioneer of India, along with a letter from The Pioneer’s editor, Chandan Mitra, attesting to her employment there. On that basis she was admitted to the UNCA and began working in the UN offices in Manhattan.

c) Gary’s wife coveted the UNCA position above her that was then held by Ian Williams’ wife. Gary attempted to dislodge Ian Williams’ wife from that position by claiming that Mrs. Williams had lied in order to get her visa to enter the US, so as to create an opening which his own (Gary’s) wife could take. Gary’s allegations proved false.

d) Journalists at the UNCA noticed that the stories which Gary’s wife was regularly submitting from The Pioneer to document her ongoing UN coverage were of identical size and location on the front page of The Pioneer. A bit of investigation proved that they were all forged, and had been photo-shopped on a computer. The Pioneer was contacted, and its Editor Chandan Mitra stated that Mrs. Weiss had “never been engaged by The Pioneer for any purpose,” his signature on her documentation was “an outright forgery,” as was the letterhead upon which it had been generated. Simply put, Gary’s wife was a fake : she never was a reporter for The Pioneer of India. Gary’s wife’s UN credentials were revoked and she was escorted from UN premises under armed guard.

e) Within days of the exposure of Gary’s wife and her being escorted out of the UN, Gary was on Amazon writing reviews under the name “Ted Dichtler” trashing Ian Williams’ work, and within 30 days, had founded “Mediacrity,” a blog putatively devoted to media criticism, but actually largely engaged in (anonymously) hammering away at journalist Ian Williams for being “a fourth rate hack” and continuing the demonstrably false smears against Ian Williams’ wife.

f) It should also be noted that when confronting a man on a Usenet group, Gary posted that man’s wife’s name and home address. Pretty sleazy (although the man in question was a bigot, I think good manners demand that one not get even with a guy by revealing his wife’s name and address). In contradistinction to Gary, however, Judd, ever the gentleman, wrote:

“AntiSocialMedia.net has issues with Gary Weiss, not his wife. As it happens, one of the more startling examples of abuse of social media we’ve discovered anywhere and the central theme of this, the third part of this series on Gary Weiss – cannot be told without making reference to that relationship. However, because her identity is ultimately not material to this situation, we shall only refer to her as ‘Mrs. Weiss’ (though Weiss is not her real last name) and have set this site’s comment filter to immediately reject any comments that contain either her first or last name. Comments containing any other personally identifying information belonging to Mrs. Weiss will be immediately deleted and the commenter barred from further use of this site.”

I will follow the same principle here on DeepCapture.

g) Aside from the general zaniness of the story, there are at least two take-aways from this:

i) Gary had accused Mrs. Williams of lying to get her visa, but those accusations were false. Gary did this while Gary’s own wife was forging her credentials, which credentials were the basis of her own employment at the UN. Thus, Gary and his own wife were engaged in the act of which they were falsely accusing another journalist’s wife. That act takes a sociopath (e.g., the kind who could post anti-Semitic comments while continuously accusing others of anti-Semitism).

ii) What was Mrs. Weiss doing for those years when she was given access to the UN, under the guise of being a correspondent for The Pioneer of India?

#4) Gary manipulates stock message boards

Gary also stays busy posting thousands of times per year on stock message boards, as this remarkable piece by Judd exposes. Gary’s stock message board sock-puppeting and “bashing” sometimes involves switching among 6 sock-puppets while going at it for over 24 hours at a stretch, in a remarkable display of intensity and duration. What an odd “hobby.” Curiously, the stocks with which he concerns himself generally mirror the positions of Jim Cramer, Roddy Boyd, Bethany McLean, Herb Greenberg, Carol Remond, etc.

If only there were a pattern…

#5) Gary Weiss, Pyschopath: The Prequel

At this point you are probably wondering, “Who in the hell is Gary Weiss?” Allow me to give you seven pieces of background, a-g.

a) In the 1990’s, Gary made a name for himself with a BusinessWeek series exposing the Italian Mob (in particular, the Gambino Crime Family) and its infiltration of Wall Street. Bravo. But he relied heavily on two sources. One journalist who interviewed them told me that after debriefing them, and examining materials they supplied, “I can safely say that Gary Weiss built his career in the 1990’s just typing up whatever two sources gave him.”

b) In the mid-1990’s a Forbes reporter based in Russia named “Paul Klebnikov” wrote an expose called, “The Godfather of the Kremlin?” about an alleged Russian Mafia figure named Boris Berezovsky.

c) In 1999 Al Chalem and Laier Lehmann, two New Jersey stockbrokers operating a New Jersey securities firm called “Harbor Securities,” were executed in a New Jersey mansion. The same two sources who had supplied Gary so much other material presented him with evidence that this time it was not the Italian Mafia, but the Russian Mafia, and in particular, Boris Berezovsky. Gary then ran a story that (they maintained) fabricated everything they had told him in an attempt to divert attention from Russian involvement and focus it on (in this case non-existent) Italian Mob involvement. One of Gary’s sources actually sued Gary in an attempt to get public that which he felt Gary was suppressing.

d) In 2000, Forbes’ Paul Klebnikov completed a book, The Godfather of the Kremlin. It reiterated his earlier allegations about Mr. Berezovsky, but without the question mark. Quickly there appeared a series of anonymous Amazon reviews trashing Mr. Klebnikov’s book and discounting its conclusions. On the same days these reviews appeared on Amazon, Gary had a rash of positive reviews of his work. This and the language of the reviews trashing Mr. Klebnikov’s work raise an obvious question: if these startling coincidences of timing were not in fact coincidences, why was Gary adding to his normal routine (that is, going on Amazon with sock-puppets to promote his own work) the additional labor of trying to discredit the work of a Forbes journalist (Paul Klebnikov) who was trying to expose the Russian Mob? And is this related to the claim of his own two sources that his coverage of the execution of the two stockbrokers was designed to move attention away from the Russians and onto the Italian Mob?

e) On July 9, 2004, Paul Klebnikov was assassinated leaving the Moscow offices of Forbes.

f) Days later in July, 2004, Gary left BusinessWeek. If you ever want to shut a BusinessWeek reporter up, ask, “What were the circumstances surrounding the departure of Gary Weiss from BusinessWeek?” In a notoriously gossipy crowd, it is a closely guarded secret.

g) One of the first things Gary seems to have done after departing BusinessWeek was to join Project Klebnikov, “The global media alliance investigating the July 9th, 2004 murder of Paul Klebnikov, the editor-in-chief of the Russian edition of Forbes magazine.” I’ll bet O.J. Simpson finds his wife’s real killer before Gary solves that investigation.

#6) Gary covers-up for the DTCC from within DTCC offices:

Speaking of strange places from which to post: at the heart of our nation’s stock settlement system, and hence, at the heart of the issues of concern to DeepCapture, is a nearly unknown corporation called “The DTCC.” The company provides settlement for the nation’s capital market: $1.5 quadrillion in trades are settled there every year (that is, about 30X the economic output of the entire planet). For most of its history it has largely escaped regulation: state regulators are admonished that they cannot peer inside because the DTCC is federally regulated, and the DTCC has told federal regulators it escapes their regulation due to its strange ownership structure (one former federal regulator, and one former employee of the DTCC, have both told me the feds would not know where to begin if they tried to regulate it).

In short, at the heart of the world’s economy is an enourmous black box that is regulated except on the days it’s not, and through which 30X the economic output of the world flows. It is my contention that much of Wall Street’s illegal activity is funneled through this strange entity.

The huge, nondescript building in downtown Manhattan that houses the DTCC is something of a Fort Knox. Long-gun toting guards watch the entrances, and journalists who have been inside tell me that entering it is tougher than getting into the Federal Reserve or any comparable institution.

Gary recently made a slip that revealed he was inside the offices of the DTCC, using one of their computers to post on Wikipedia about the DTCC. Given that it’s like getting into Fort Knox, I’m pretty sure that’s odd. However, it casts some light on why Gary has been stridently denying that the DTCC is dirty and that none of the issues I have been raising regarding stock market manipulation are legitimate, and why he has (according to a colleague of his in the financial press sympathetic to me) devoted 93% of his blogs to criticizing my efforts to expose the illegal Wall Street activity which, I claim, intersects within the DTCC. Just as interestingly, when given opportunity to comment, the DTCC went into cover-up mode straight out of Bizarro World.

#7) The Finale

The following heavily-documented story qualifies as “mind-blowing.” It is so extraordinary, in fact, many people find it almost impossible to synthesize. Therefore I am going to tell it by first giving a three paragraph synopsis, then by recounting the story in 14 steps, a-n, with documentation for each.

The synopsis:

The intellectual battle over the existence of criminal naked short-selling has been won. As is demonstrated throughout DeepCapture, what was dismissed three years ago as a fringe theory is now no longer in serious dispute. There is an ongoing criminal prosecution and regulators and SRO’s have recently imposed multimillion fines over it. Papers by academic and government economists have confirmed it and reputable journalists have broken news stories concerning its effects. A Bloomberg documentary concerning naked short selling was nominated for an Emmy for long-form investigative journalism. Last summer SEC Chairman Christopher Cox aknowledged that it is real and illegal. Just last week, SEC Chairman Cox again publicly and matter-of-factly discussed the reality of this crime in a hearing at the United States Senate, in answer to sharp questioning from US Senator Bob Bennett. Earlier this week, Dr. Robert Shapiro, a Fellow of the National Bureau of Economic Research, Brookings, Harvard, and a former US Undersecretary of Commerce for Economics, explained the reality and implications of this crime on Canada’s Business News Network (start at minute 17).

Yet throughout the evolution of this awareness, the Wikipedia page on naked shorting has fought a steadfast rearguard action. It will be a matter for a future historian to reconstruct in detail, but at all times the thrust of that page has been to deny and deride the emerging understanding of the issue. Since the time when complete denial became impossible, it has labored mightily to minimize the problem of naked short-selling and all the attendant issues discussed in Deep Capture, citing every critic (Gary Weiss, Floyd Norris, Joe Nocera, and Holman Jenkins of the WSJ) while allowing only barest mention of the positive attention it has received from investigative journalists and economists.

I believe that the chief reason this happened was because Gary Weiss used the name “Mantanmoreland” (and later, “Samiharris”) to hijack the Wikipedia articles on naked short selling, Patrick Byrne, and Overstock.com (as well as the page on Gary Weiss himself). In addition, all the mechanisms within Wikipedia which are supposed to prevent such an act were subverted by Wikipedia’s elites on Gary’s behalf. Judd exposed Gary within Wikipedia, but Wikipedelites suppressed Judd’s evidence. When he began posting it off-Wikipedia on AntisocialMedia.net, Wikipedelites fought to make mention of “Antisocialmedia.net” or “Judd Bagley” a thought-crime within Wikipedia (under the spurious reasoning that someone mentioning either of them had to be a sock-puppet of Judd). Hence, no evidence contrary to official doctrine was permitted at “the free encyclopedia that anyone can edit.” However, evidence slowly circulated within the Wikipedia-in-Exile-community until the conventional Wikipedians began looking into Gary. Wikipedia ’s founder Jimbo Wales did everything possible to stop their investigation, although it turns out he knew all along that Judd was right. It has turned into a civil war within the Wikipedia community.

I turn take the paragraph immediately preceding this one, and serve its full story, cut into 14 bite-sized pieces, a-n.

The evidence:

a) Judd posted evidence that Gary was manipulating Wikipedia under the name “Mantanmoreland” (and later, “Samiharris”).

b) When confronted, Gary denied it, saying, “Similarly [Judd Bagley] continues to publish the lie that I am this ‘Mantanmoreland’ long after it was, again, denied by both myself and Jimbo Wales of Wikipedia.”

c) Judd sent evidence to a Wikipedia uber-administrator named “SlimVirgin,” who was posing as a neutral arbiter. However, as this demonstrates, when SlimVirgin received Judd’s evidence she immediately forwarded it to Gary (without even opening it herself).

d) A community debate ensued over whether Mantanmoreland was guilty of a Conflict Of Interest violation when he created and dominated the “Gary Weiss” page (i.e., whether or not he was in fact Gary Weiss). A highly regarded Wikipedia figure named “Cla68″ (apparently a former military officer living in Asia with encyclopedic knowledge of so many subjects that he is revered within Wikipedia) got close to taking sides against Gary. In a step that was extremely unusual given Wikipedia’s philosophies of transparency and strict retention of all sides of a debate, Wikipedia-founder Jimbo Wales personally intervened to delete the record of the debate. As Jimbo Wales wrote:

“The page contained wildly inappropriate speculation that a notable author was sock-puppeting. As I am sure you are aware, many authors have had their careers badly damaged by being caught sockpuppeting at Amazon, etc., and it is deeply wrong for people to ask me to restore a page with such speculations in Wikipedia after the claims have already been investigated and dismissed. If there are further problems in the future, there will be no problem restoring the article at that time. In the meantime, it is my position that MOST AfD pages for living persons or active companies should be courtesy blanked (at a minimum) as a standard process, and deleted in all cases where there was inappropriate commentary. This is not the current policy, but current policy does allow for deletions of material which is potentially hurtful to people.–Jimbo Wales 01:42, 13 November 2006 (UTC)”

e) Taking things to an Orwellian extreme the “ArbCom” (”Arbitration Committee”) attempted to pass a “BADSITES” policy prohibiting mention of “Judd Bagley” and “antisocialmedia.net,” the site Judd had started to post evidence as he gathered it (all evidence having been prohibited within Wikipedia itself). The debate ran for many weeks, but throughout it, it was prohibited even to name “Judd Bagley” or “antisocialmedia.net.” That is, for many weeks a debate raged in which the accused (Judd Bagley and his site antisocialmedia.net) could not be named, nor was the accused allowed to have a voice, nor were dissenting opinions permitted (on the grounds that anyone who wrote one must be a sock-puppet of the accused). All this happened on Wikipedia, “the free encyclopedia that anyone can edit.”

f) Throughout that process, anyone trying to mention Judd or Antisocialmedia.net, or positions supported by either, was banned as a Wordbomb sock-puppet (note the circularity of this position: WikiTruth demands that Goldstein be banned, and anyone sounding like he might agree with Goldstein will be banned, because clearly, he must be a sock-puppet of Goldstein. Hey, it worked in 1984, right?)

“Any user who creates links to the attack site or references it (other than in the context of this Arbitration) may be banned.”

g) Eventually, this was actually proposed as a matter of official policy for Wikipedia (”the free encyclopedia that anyone can edit.”)

“After warning, or without warning in the case of users familiar with the issue, users who link to the attack site or reference it may be blocked for an appropriate period of time.” (emphasis added)

h) As if that were not enough, in an attempt to prevent Judd Bagely from pointing out to observers the manifest circularities, fabrications, and sheer Orwellianism of the BADSITES debate, Wikipedia blocked Overstock and 1,000 homes around Judd Bagley’s neighborhood, as was exposed in this article that appeared in the well-regarded online British tech journal, The Register.

i) That effort collapsed of its own foul weight. However,  as this other investigative piece in The Register exposed, it did spawn the creation of a secret email list for Wikipedia elites wherein they plotted how to shape the discourse within Wikipedia.

j) Just when you thought this story could not be any weirder, an email has surfaced that was written by Jimbo Wales in September, 2007 at the start of this conflagration, where he admitted already believing that Mantanmoreland was Gary Weiss (this exchange occurred on another of those secret elite-only email lists):

Mantanmoreland@gmail.com: “…I am not going to reveal my real identity to prove that just because Judd Bagley is making a fuss. Rest assured that after all that has happened I am more determined than ever to not reveal my real identity to any person associated with Wikipedia.”

jwales@wikia.com(Jimbo Wales): “I just want to go on record as saying that I believe the reason for this is that Mantanmoreland is in fact Gary Weiss.”

k) Despite this private admission, Jimbo spent the next four months publicly defaming Judd and intimidating anyone who explored Gary Weiss’s activities on Wikipedia. For example, he wrote to the renowned Wikipedian Cla68:

“I fear that you have been manipulated by lying stalkers and trolls, and I am happy to talk to you about it privately, but I am sick of the drama around this issue on this page, and it absolutely has to come to an end…– Jimbo Wales 01:32, 21 October 2007 (UTC)”

l) Despite Jimbo’s opposition (and in the face of his attempts to derail it), over the last two weeks the Wikipedia community has to its credit performed exhaustive analysis of the Mantanmoreland account (as well as “Samiharris”, an additional Gary Weiss sock-puppet) and come down overwhelmingly in favor of Judd’s original thesis.

m) Even in that setting, Wales again attempted to derail the process and deny his earlier recognition of a link between Gary Weiss and Mantanmoreland. Here Jimbo dances on an arcane postmodern distinction between “knowing” and “believing it is a fact that” (in this context it’s a distinction without a difference, Jimbo). Jimbo’s statement is a compendium of fallacies from Logic 101 (e.g., argument from authority, ignoring contravening evidence, ad hominem attacks, non sequiturs, and straw-man rebuttals).

“Because there has been unseemly and false speculation in some quarters that I know this (or related claims) to be true, and that I have admitted as such in private forums, it is important for me to state what I know and what I don’t know.

“Claims about Mantanmoreland being author Gary Weiss have been floating around for a long time. Various claims of ‘proof’ have been made, none of which I have found convincing. At times I have believed one way, at times I have believed another way. I have investigated the claims to the best of my ability and I have been unable to find proof one way or the other.

“An email I sent to Mantanmoreland and others has been widely quoted as evidence that I supposedly ‘know’ this claim to be true. Such interpretations are malarky, and most of the people making the claims appear to me to be acting in bad faith. What I said, at a point in time, was that I believed it to be true that Mantanmoreland == Gary Weiss. This was specifically in the context of a conversation in which I was trying to get more evidence… a proof, one way or the other. Me believing at a point in time in an investigation that something was true, is not the same thing as an assertion that it is true, nor of an “admission” or anything else.

“Mantanmoreland steadfastly denies being Gary Weiss. Ask him yourself if you want to know.

“Related allegations that I am protecting a ‘friend’ are nonsense. Mantanmoreland and I do not get along well at all.

“Related allegations that I have some vested interest in the underlying content dispute are even worse nonsense. I have no opinion about ‘naked short selling’. I have never sold a stock short in my life. I have no financial interests of any kind in this case. If you read anything otherwise, or hints to that effect, on the overstock.com blog or elsewhere, well, I don’t know was else to say but: nonsense. I think such allegations tell more about the people who are making them than anything else.

“Regarding the specific claim at issue here, whether Samiharris and Mantanmoreland are the same user, I can say quite firmly that I do not believe it to be true. I have interacted (argued!) with both users over an extended period of time by private email, and I have not seen any reason to think it true. The offsite ‘evidence’ relating to this comes from a highly questionable source, and furthermore strikes me as completely unpersuasive. For all we know, these are faked screenshots from someone who has engaged in a campaign of harassment and bad behavior (on-wiki and off-wiki) that has been really astounding to witness.

“I have reviewed my email archives to look for similarities between the users. I have examined email headers. I have looked for textual similarities, time patterns, etc. I see nothing to lead me to a conclusion that Sami Harris and Mantanmoreland are the same user.

“For these reasons, I do not believe it to be true that Mantanmoreland == Samiharris. –Jimbo Wales (talk) 02:19, 15 February 2008 (UTC)”

n) All but Weiss’s most dogmatic defenders were silenced, however, when a law student from Chicago published a graph showing the dates and times of all Mantanmoreland’s Wikipedia edits. In it, one can clearly note two things: the rich posting patterns of Mantanmoreland and Samiharris never overlap (statistically, highly improbable); and more importantly, a perfect “phase shift” of precisely the right duration corresponding to a period in which Gary’s own Forbes work revealed him to be in India.

Conclusion

Gary Weiss is a psychopath and a Scaramouch, but this is incidental. Here is the moral of the tale: the great dilemma that journalists face is that they want to be first with a story, but most do not have the nerve to publish a story that is too far ahead of the pack. I believe Gary Weiss went to such effort to hijack these Wikipedia articles because somewhere, someone understands that professional journalists, much as they deride Wikipedia, will never depart more than a few degrees from a Wikipedia consensus. Thus if one can hijack a page so that it simply repeats the accusations of a few co-opted journalists, then rare is the new journalist who will come along and escape that equilibrium. Thus, by hijacking the Wikipedia consensus one can corral much of the industry of modern journalism (this is all the more reason why those few journalists who departed from that consensus over the last year, however meekly or bravely, deserve admiration).

The deeper question, then, is this: how many social institutions have failed when a “journalist” is manipulating the discourse within both the news and social media, and all the mechanisms that should curtail him are short-circuited? Or, more to the point of DeepCapture, trying to drown out a scandal while simultaneously manipulating social media from within the corporation that is at the heart of that scandal?

Postscript: There is a side matter that, in all fairness to Gary, I should mention to condition your reading of what I wrote about him. It is this: I have a lady friend who for 13 years has managed and been part-owner of a superb Italian restaurant in Manhattan. Her restaurant generally receives a Zagat’s rating of 23 or 24 (with a 24-rating being the threshold for the serous foodies). In fact, the restaurant is regularly one of the lowest-priced Zagat-24’s in Manhattan. Its reviews generally range from good to stellar. Weeks after Gary joined Forbes, a harsh, puerile review of her 10-employee restaurant appeared in Forbes magazine. I’m pretty sure that’s odd, too. Because the writing was florid and made no sense it is natural to suspect Gary of having written it (note to Gary: how does a pasta dish like orecchiette taste like it is from Bombay? And “branzino” is Mediterranean sea-bass, which explains why it tastes like fish.) Of course, it could have been just a coincidence that, weeks after Gary began his relationship with Forbes, the magazine suddenly felt the need to review a small Italian restaurant managed by the woman then displaying the unfortunate judgment of dating me (full disclosure: since then she has decided to display better judgment). I don’t really know if Gary was behind it, pursuing a personal vendetta by misusing his position as a journalist to hurt my magnificent lady friend.

But it sure is his style.

If this article concerns you, and you wish to help, then:

1) Let Forbes know how you feel about their columnist by writing Forbes Managing Editor Carl Lavin at clavin@forbes.net (post a copy in the comment section here!);

2) email it to a dozen friends;

2) go here for additional suggestions: “So You Say You Want a Revolution?“

Managing Editor: Andrew Serwer – aserwer@fortunemail.com

Time, Inc. Communications Director Katy Reitz – Katy_Reitz@timeinc.com

Dear Reader,

When Fortune Magazine contacts me I always respond (excluding unnoticed emails they send at day’s end hours before press-time). Yet Fortune Magazine has refused to comment on  DeepCapture’s documentation of the perfidious behavior of Fortune Magazine Reporter Bethany McLean. Two DeepCapture posts (”Bethany McLean: Your Benefit of the Doubt is Hereby Revoked” and “Rocker Partners and Bethany McLean: the Smarmiest Guys in the Room“) reconstruct how Rocker Partners sought out Bethany McLean to target a firm, took out a large short position 10 days after her cooperation was secured, then doubled down two months later, just three days before Bethany published her hatchet job (a time-line that suggests, of course, that they were privy to the content and timing of Bethany’s article). In addition, Bethany’s  reporting relied heavily upon Spyro Contogouris, a conman, now imprisoned, about whom she spun apologetics while regurgitating his criticisms (criticisms that with the passage of time proved baseless). When the share price of the target company rose, Bethany commiserated with the short-selling hedge fund that had assigned her the story, sending this email:

From: Bethany McLean
Sent: Thursday, March 22, 2007 6:12:48 PM
To: Marc Cohodes
Subject: Re: ffh

Sorry to be a little bad-tempered. This FFH story almost killed me, so I hate hearing that it was pointless. Maybe it’ll be a long, slow thing..

Thinking that Fortune Magazine might be troubled to learn that one of its journalists had provided such white glove service to a hedge fund, I sent Fortune two emails (below) giving opportunity to comment. They have refused. Please read the correspondence below and, if you agree that Fortune Magazine should address these concerns publicly, please let  Fortune know it (following the instructions at the top of this essay).

I thank you in advance for considering this request.

Respectfully,

Patrick M. Byrne

========================================
On Mon, Dec 22, 2008 at 7:03 PM, Patrick Byrne wrote:

Dear Ms. Reitz,

Happiest of holidays.

Last week I sent you a link to an exposé on erstwhile Fortune journalist Bethany McLean. http://www.deepcapture.com/bethany-mclean/

Today DeepCapture posted the sequel: analysis of the trading records of Rocker Partners (a.k.a. Copper River) confirms that Rocker did front-run Bethany’s story, both shortly after she met with Rocker Partners’ representative Richard Sauer (a.k.a. “Lavaman”, himself a former SEC attorney whose federal career seems to mirror Bethany’s approach to journalism), and then again immediately before Bethany published. http://www.deepcapture.com/rocker-partners-and-bethany-mclean-the-smarmiest-guys-in-the-room/

Note the data in that exposé regarding failures to deliver, and the likely provenance of those failures, in my recent critique of a DowJones reporter (”Carol Remond Tells a Joke She Doesn’t Get“).

I am preparing this as a story to be included in an Overstock email that gets sent to 17 million of my closest friends. It would explain that a crooked hedge fund (since imploded) cooperated with a bent reporter to break the law, the reporter used her offices at Fortune to indulge their illegal acts, that Fortune had been warned of this possibility and engaged in a cover-up, and that Fortune practices shill journalism for favored Wall Street elite, many of whom are crooks (a message that will, I expect, resonate). In short, Bethany’s emails and Rocker’s trading records will be used to demonstrate how the standards of journalism evinced by Fortune are more bent than a streetwalker’s stumble.

I understand the legal ramifications of suggesting to 17 million Americans that Fortune has taken part in a criminal conspiracy, of course, and will happily provide our lawyers’ address for receipt of service, upon request.

On the other hand, an abundance of journalistic caution leads me to contact Fortune once again to offer opportunity for comment, and in particular, to correct me if I am in error. In fact, I would like to offer you the opportunity to respond in up to 50 words that I will commit not to edit or abridge, an offer that is surely more generous than those your publication generally makes (setting aside whatever unknown arrangements it or its journalists make with hedge funds such as Mr. Rocker’s, of course). Please feel free to respond to the allegations above, or the questions below, or simply respond more generally, as you prefer.

I look forward to hearing from you. Until then, I remain,

Your humble servant,

Patrick Byrne

Journalist, DeepCapture.com

PS Please tell [a long-time acquaintance at Fortune] that I return her regards…

========================================

From: Patrick Byrne
Sent: Wednesday, December 17, 2008 2:22 AM
To: Katy_Reitz@timeinc.com
Subject: Respectfully request on-the-record response

Dear Ms. Reitz,

Please find a blog that DeepCapture posted today regarding 2006-2007 communications between a hedge fund manager and erstwhile Fortune reporter Bethany McLean concerning Canadian financial company Fairfax. I have obtained these communications pursuant to the decision of a New Jersey State court.

As is evident from the emails, the hedge fund manager put Ms. McLean up to the story hoping that a report in Fortune magazine would move the stock down. When the stock instead went up it rendered Ms. McLean’s story “pointless” in her eyes (which makes [sense] only in a world where her “point” was to move the stock down). After commiserating with the hedge fund Ms. McLean expressed her wish that the targeted company’s demise would be “a long, slow thing.”

Questions:

1) What is Fortune’s policy regarding journalists working with short selling hedge funds to drive down stock prices?

2) Has Fortune conducted an internal investigation into the relationship between Ms. McLean and hedge funds, including the one mentioned in the blog?

a) What were the results of that investigation?

b) Did this investigation have anything to do with Ms. McLean’s departure from Fortune?

3) Has Fortune conducted an internal investigation to determine the accuracy of Ms. McLean’s reporting on Fairfax and on other companies?

a) What was the result of that investigation?

b) Did this investigation have anything to do with Ms. McLean’s departure from Fortune?

4) Is Fortune aware that nearly every story written by Ms. McLean since 2001 was sourced from the same group of hedge funds, and that she never once contradicted their analysis? By Fortune’s standards, does this constitute “balanced” reporting?

5) In one email, Ms. McLean mentions Spyro Contogouris, who was employed by a group of hedge funds to harass and threaten Fairfax executives. After Mr. Contogouris was arrested by the FBI, Ms. McLean continued to characterize him as a credible financial researcher who worked independently of hedge funds. Does Fortune stand by that characterization?

I do not know when I am going to publish, but would expect it would be next week. However, I sincerely wish to represent fairly the point of view of Fortune.

Most respectfully,

Patrick Byrne

Reporter, DeepCapture.com

If this article concerns you, and you wish to help, then:

1) Let Fortune know how you feel about Bethany McLean’s work by writing Managing Editor Andrew Serwer (aserwer@fortunemail.com) and TimeLife’s spokesperson Katy Reitz (Katy_Reitz@timeinc.com) (post copies in the comment section below!);

2) email it to a dozen friends;

3) go here for additional suggestions: “So You Say You Want a Revolution?“

Before publishing the following critique of Carol Remond’s recent article on Copper River, I contacted Carol for comment. Unlike Joe Nocera and Floyd Norris (both of the New York Times), who have at least had the integrity to defend their work, however haplessly, Carol refused any on-the-record comment on this subject. Thus she joins that tradition of journalistic worthies which includes Bethany McLean, Herb Greenberg, and Roddy Boyd, who refuse to defend their work. They can critique, but not engage, opine, but not defend: the sophomores of intellectual discourse.

Last week DowJones reporter and shill extraordinaire Carol Remond wrote a story, “Hedge Fund Copper River to Liquidate“, about the implosion of her hedge fund patron, Copper River (née Rocker Partners). Following a course charted by no lesser luminary than Roddy Boyd (cf. “Roddy Boyd Works It Likes He’s Paying the Rent“), Carol devotes the article to shameless apologetics that would make a congressman blush. Quelle surprise, Carol.

I am not a bayonette-the-wounded kind of guy (indeed, to investors in Copper River I send my condolences). But buried within Carol’s  article is a critical admission that will be of interest both to readers of DeepCapture.com, and to those investors ill-starred enough to have stayed with Copper River/Rocker Partners through to its ugly and ignominious end. Carol states:

“Copper River held large short positions in some illiquid stocks when the Securities and Exchange Commission tightened the rules governing short selling…. By doing away with an exemption that was the backbone of a trading strategy that allowed funds to short stocks through the options market, the SEC effectively restricted their ability to maintain these positions.”

The “trading strategy” that was curtailed by the SEC “doing away with an exemption” that existed in the options market  was the illegal strategy of naked shorting via rolling failed  positions through the options market maker exception to Regulation SHO.  Ms. Remond appears not to understand the SEC’s view of this illegal strategy. A fine paper by noted young economist John Welborn fleshed this out over a year ago (”Married Puts, Reverse Conversions and Abuse of the Options Market Maker Exception on the Chicago Stock Exchange”) . In it, he explained the requirement to locate stock, the exception to that requirement which Reg SHO makes for market makers, and the SEC’s view of the misuse of that exception. I will quote from John’s paper at length:

“THE OPTIONS MARKET MAKER EXCEPTION

“An FTD is commonly the result of a naked short sale (or a naked long sale) that does not settle, i.e. the shares sold short (or long) are never delivered to the buyer. In general, naked shorting is illegal. As the SEC’s Chairman Chris Cox said on July 12, 2006, “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.”1 There are, however, a few of mechanisms through which naked short sales can be legally executed. One such mechanism is the “options market maker exception.”

“Current SEC rules state that a short seller, acting via a broker-dealer, need only ‘locate’ (as opposed to borrow) the stock prior to a short sale. Regulation SHO requires:

‘…A broker-dealer, prior to effecting a short sale in any equity security, to “locate” securities available for borrowing… Specifically, the rule prohibits a broker-dealer from accepting a short sale order in any equity security from another person, or effecting a short sale order for the broker-dealer’s own account unless the broker-dealer has (1) borrowed the security, or entered into an arrangement to borrow the security, or (2) has reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due. The locate must be made and documented prior to effecting a short sale, regardless of whether the seller’s short position may be closed out by purchasing securities the same day.’2 (Emphasis added.)

“In theory, stock markets are made more efficient by intermediaries who ‘make markets’ in order to smooth price and volume fluctuations.3 A market maker acts as a temporary counterparty that poses as buyer or seller in order to facilitate market liquidity. Ideally, market makers’ positions last minutes or hours; generally, positions are closed out at the end of each day. Large prime brokers make markets in both equities and options. Some broker-dealers, like Goldman Sachs and Merrill Lynch, clear and execute trades for options market makers…

“In the process of making markets, which requires hedging positions, market makers theoretically may need to sell stock they temporarily do not have. For this reason, Regulation SHO allowed market makers, ‘…[an] exception from the uniform “locate” requirement, as Rule 203(b)(2)(iii), for short sales executed by market makers, as defined in Section 3(a)(38) of the Exchange Act, including specialists and options market makers, but only in connection with bonafide market making activities (emphasis added).’4 Note that:

‘Bona-fide market making does not include activity that is related to speculative selling strategies or investment purposes of the broker-dealer and is disproportionate to the usual market making patterns or practices of the broker-dealer in that security. In addition, where a market maker posts continually at or near the best offer, but does not also post at or near the best bid, the market maker’s activities would not generally qualify as bona-fide market making for purposes of the exception. Further, bona-fide market making does not include transactions whereby a market maker enters into an arrangement with another broker-dealer or customer in an attempt to use the market maker’s exception for the purpose of avoiding compliance with Rule 203(b)(1) by the other broker-dealer or customer. 5 (Emphasis added.)’

“1 Christopher Cox, Chairman, SEC, “Opening Statements at the Commission Open Meeting,” July 12, 2006.

“2 SEC, Final Rule: Short Sales, Release No. 34-50103, Rule 203 – “Locate and Delivery Requirements for Short Sales,” July 28, 2004.

“3 Some view the market maker as an anachronism left over from the days when stock traded in 1/8th increments and paper certificates actually changed hands. Now, in the electronic age, stock trades in decimals and paper stock has been separated from the electronic claims of ownership on that stock (a process known as “dematerialization”).

“4 SEC Rule 203.

“5 Ibid, Section 1b, “Exceptions from the Locate Requirement: Bona-fide Market Making.”

Thus, Carol is explicitly stating, no doubt unwittingly, that the “backbone of a trading strategy” employed by David Rocker and Rocker Partners/Copper River was, in fact, abuse of an exception which the SEC had specifically deemed out-of-bounds.

Sloppy work, Carol: recommend you send for new instructions.

If this article concerns you, and you wish to help, then:

1) email it to a dozen friends;

2) go here for additional suggestions: “So You Say You Want a Revolution?“

But it’s a start. Given that the CNS system is the one place the SEC can look, and might be able to do something about, it is instructive to see how well they are cleaning up unsettled trades there.  Towards that end, DeepCapture has analyzed the data that the SEC released last week. These graphs show their fine progress in that regard.

============================================================================
Any questions?

If this article concerns you, and you wish to help, then:

1) email it to a dozen friends;

2) go here for additional suggestions: “So You Say You Want a Revolution?“

Take a Mercedes, stir in a couple hundred thousand dollars, and you get a car called a Maybach. Hedge fund guys in New York and Connecticut buy them.

===========================================================================================================

This is a Humvee. US military personnel drive them around war zones.

===========================================================================================================

This is an Improvised Explosive Device. Extremists set them up on roadsides in Iraq and Afghanistan.

===========================================================================================================

When a Humvee meets and IED, this is the result:

===========================================================================================================

Fortunately, there is a company in South Carolina called “Force Protection, Inc.” They manufacture “Mine Resistant Ambush Protected” vehicles (”MRAP”).

===========================================================================================================

Under their skin, MRAPs have V-shaped hulls that deflect bomb blasts, making them nearly impervious to IED’s. The last time I checked (June, 2008), there had been 300 IED attacks in Iraq against MRAP’s, and only one death (that, when the explosion caused a roll-over which killed the soldier in the gun turret).

===========================================================================================================

The Department of Defense has placed huge orders for MRAP’s. Force Protection revenue has soared, and they are nicely profitable.

===========================================================================================================

The stock price of Force Protection was holding its own….

===========================================================================================================

A natural move at this point might have been to do a secondary, that is, to sell some more of their stock into the public market, raising capital with which they could expand their production to keep up with DOD demand.  However, someone started naked short selling them:

===========================================================================================================

Force Protection is thus not able to complete a secondary, and remains unable to meet DOD’s demand.

Thus, this month more of these will be sent home from Iraq……..

===========================================================================================================

….. so that soft hedge fund guys can have more of these:

.

===========================================================================================================

If this article concerns you, and you wish to help, then:

1) email it to a dozen friends;

2) go here for additional suggestions: “So You Say You Want a Revolution?“

InterMune, Inc., is a California firm that focuses on the research, development, and commercialization of therapies in pulmonology and hepatology. It generates over $50 million/year in revenue, primarily from Actimmune, for patients with osteopetrosis and chronic granulomatous disease. It’s candidate drug Pirfenidone is in phase III clinical trials for the treatment of idiopathic pulmonary fibrosis. Its candidate drug ITMN-191, a hepatitis C virus protease inhibitor, is is in Phase Ib clinical trials to treat patients with HCV infections. It has license and collaboration agreements with some of the most prestigious names in biotech: Hoffmann-LaRoche, Inc. and F. Hoffmann-LaRoche, Ltd.; Genentech, Inc.; Connetics Corporation; Boehringer Ingelheim International GmbH; Novartis Corporation; Array BioPharma, Inc.; Eli Lilly & Company; and ALZA Corporation.

Stock manipulators think people with such medical problems can die, as they express by manipulating the price of InterMune stock so that InterMune cannot fund its research by accessing the capital market at the true market-clearing price of its stock.

==========================================================

In the interests of journalistic integrity, I should disclose that I don’t much like the people doing this.

If this article concerns you, and you wish to help, then:

1) email it to a dozen friends;

2) go here for additional suggestions: “So You Say You Want a Revolution?“

Click to see full chart

Dendreon Corp. is a Seattle, Washington-based biotech company that researches treatments for cancer. Their approach is novel in its dirty work is done by reprogramming the body’s monoclonal antibodies (I happen to have heard of these because my scrawny tomboy high school chum grew up to be a ridiculously attractive Ph.D. at NCI researching non-idiotypic monoclonal antibodies, at which point she gave me the brush-off: such is life).I have no idea if their approach works or not, but Dendreon has created a drug, Provenge, to  treat asymptomatic, metastatic, and androgen-independent prostate cancer. Provenge has completed two Phase III clinical trials, so someone thinks it works.

In any case, the decision as to the correct price of Dendreon’s equity (and hence, the terms on which it can raise capital to fund its research) is supposed to be made by the collective wisdom of investors expressed through a marketplace operating under the rule of law. In fact, however, for some length of time and to some significant degree, the pricing of its equity has instead been determined by some hedge fund guys who think cancer patients should die so they can take ski trips to Gstaad.

Note that this firm, which in most weeks sees 2 million shares trade, accumulated at one point 18 million failures.

Once again, the following are just the failures in the CNS system, which is some unknown (but small, I believe) fraction of the total:

I guess these car guys don’t have “the juice” with the SEC that their Wall Street counterparties have. Perhaps that is because fewer staff within the SEC dream of getting jobs in Detroit than in Manhattan.

If this article concerns you, and you wish to help, then:

1) email it to a dozen friends;

2) go here for additional suggestions: “So You Say You Want a Revolution?“

The answer is: I don’t know, and I think no one knows. I suspect no one agent has the full picture of what is going on across all of these cracks. In fact, I suspect some of these cracks are so obscure no one has a clear picture of what is going on in them individually, let alone collectively.

To some degree this is knowable a priori. We have a system that is shielded from scrutiny of every type. State regulators cannot successfully subpoena it (as various state regulators have told me) because the DTCC argues it is shielded by federal regulation. Yet when Feds try to look inside it they are simply rebuffed, and are helpless to assert themselves (as a high-level SEC official told some colleagues of mine). The Feds do not understand it (as a former DTCC employee and various Feds have told me). On those occasions that the Feds do get to look inside the system,  they get shined-on (as a former DTCC official tells me and a former SEC official confirms).  In fact, four years ago when I began this quest, the first thing I tried to do was to find out who regulated the DTCC, and quickly discovered that, other than a brief mention in an obscure GAO report, even the Feds are not sure if they regulate it.  And yet, through this opaque system the treasure of the ages passes every week. Such system-design is a recipe for disaster.

To a lesser degree this is knowable a posteriori, though getting data about the system from the system is an exercise in Kafkaesque futility. There are endless anecdotes of trades that won’t settle, of course. There is also the partial information expressed by the Reg SHO list.  There are various FOIA responses which have been pried from the SEC. And for the true aficionados, there are, lately, data files that the SEC periodically releases to the public regarding failures in one of the cracks mentioned, the CNS. Making use of these files is impractical for any members of the general public who do not employ an economist, statistician, and database expert to work the data.

Fortunately, DeepCapture employs an economist, a statistician, and a database expert to work the data. In the following series of posts I am going to reveal their output, stressing again that the failures I will be disclosing are not the totality of failures, but simply a fraction of the total, residing in just one of the cracks (the CNS) into which our federal regulator is permitted to peer.

Here is a chart showing the CNS failures from 2004, the year Reg SHO was adopted, through Q1, 2008:

Here is the same data with some key Reg SHO dates noted:

If this article concerns you, and you wish to help, then:

1) email it to a dozen friends;

2) go here for additional suggestions: “So You Say You Want a Revolution?“

A price is a combination of of information about value and scarcity, and because some folks likely manipulated the scarcity in VeraSun, they likely manipulated the price. Thus VeraSun was likely deprived the ability to access the capital markets at the true market-clearing price for any securities offering for at least the last year, and maybe for longer. Say what some will about its business model, its adventures in corn futures, the virtues of corn-derived ethanol (not a big fan myself), etc., the point is that those capital allocation decisions are something the market should figure out, not “something the market should figure out but one side gets to sell and fail to deliver over and over and over.”

Interestingly, we don’t even know what happened with the fails during the third quarter because, as the SEC explains right now, tonight, on their website, in this choice little nugget:

“V.1.11. Can I obtain fails information?

“Currently, threshold lists include the name and ticker symbol of securities that meet the threshold level on a particular settlement date. Some investors have requested that the SROs provide more detailed information for each threshold security, including the total number of fails, the total short interest position, the name of the broker-dealer firm responsible for the fails, and the names of the customers of responsible brokers and dealers responsible for the short sales. The fails statistics of individual firms and customers is proprietary information and may reflect firms’ trading strategies. The release of this information could be used to engage in unlawful upward manipulation of the price of the securities in order to “squeeze” the firms improperly. “

This graph registers the daily total of companies appearing on the Reg SHO list.

=================================================================

I have maintained all along that naked short selling was not a hard problem to solve: it was just a hard problem to solve without seeing about 20 rich guys get their asses handed to them. And because they were rich and well-connected, efforts to persuade the federal government to enforce the law were stopped dead in their tracks.

Somewhere in the middle of 2008, after the horses bolted from the barn, the barn collapsed, the barn burned, and the barn’s ashes scattered to the four winds, the federal government decided to close the barn door. They enacted a subset of the reforms which Deep Capture and a handful of other activists had been suggesting for a few years. The data suggests those reforms are working. I would not stake money on the likelihood that this means much, but hope springs eternal….

Admittance into Roddy’s New York financial journalism spooge-bucket-brigade is conditional upon acceptance of The Fundamental Principle and First Corollary of that august fraternity:

The Fundamental Principle – Hedge funds can do no wrong, particularly if they belong to a small constellation whose brightest lights are Stevie Cohen, Dan Loeb, David Einhorn, Jim Chanos, David Rocker & Marc Cohodes.

The First Corollary -  If any corporation or individual appears to have been wronged by activities of any of these hedge funds, using methods up to and including stock counterfeiting and manipulation, blackmail, harassment, and intimidation, use of private eyes and internal moles, inciting endless and expensive investigations that go nowhere, and so on and so forth, it must only be because they deserved it (for proof, see The Fundamental Principle).

Today Fortune Magazine’s Roddy Boyd gives fine illustration of these rules in an article on  Copper River Partners (née Rocker Partners). This is the same Copper River/Rocker Partners whose exploits are chronicled throughout DeepCapture, and who have been frequent beneficiaries of reportorial lotion-jobs from Roddy, Karen Richardson (WSJ), Herb Greenberg (CBSMarketWatch), Joe Nocera (New York Times), and Jim Cramer (CNBC & TheStreet.com), and have been long-time recipients of  Bethany McLean’s highly-regarded regulars-only service. (Full disclosure: Copper River is also on the business end of a Marin County lawsuit filed by Overstock.com, in which I played modest role.)

In today’s think-piece, Roddy treats us to such insights as:

• “But for noted short-sellers Copper River Management, a $1 billion hedge fund based in Larkspur, Cal., the month turned into a perfect storm. A devastating combination of counter-party failure, sudden regulatory edicts and margin calls conspired to turn the fund’s performance on its ear, leading to a 55% loss in just two weeks.” Translation: In the last two weeks Copper River lost over half of its billion dollars, though not through any fault of its own. Instead, counter-party failure, regulators, and those pesky margin calls “conspired” to create “a perfect storm” that lost the half-billion dollars.

• In case the point was lost that none of this had to do with the quality of Copper River’s investments, Roddy Boyd writes it out. He really does, in those words: “What’s worse for Copper River is that the battering had nothing to do with the quality of its investments.”

• We are treated to a bit of financial arcana: “On top of that, as Lehman unwound its own internal hedges to the Copper River trades, its trading desks bought shares of these companies, driving up their prices and leading to losses for Copper River.” Translation: Lehman sold puts to Copper River that Lehman then hedged by shorting stock (most likely in abuse of the option market-maker exception), and when Lehman covered those shorts it hurt Copper River, whose investment strategy assumed an environment where shorts rarely need cover (and understandably so). As far as Roddy Boyd is concerned, the possibility that a short might “cover” (that is, “at some point obtain and deliver that which they have sold”) and thereby cause loss to a favored hedge fund has “nothing to do with the quality of its investments.”

• As though that litany of impositions were not harrowing enough, Roddy chronicles further injustices suffered by Copper River: “That was bad enough, but on September 19, the bottom fell out for the fund. That was when the Securities and Exchange Commission ordered unprecedented restrictions in short sales” (as our nation’s financial system was imploding). And further, “As prices in those stocks shot upwards, Copper River was forced to cover – or buy back – some of its positions at steep losses. “ This is intolerable: how could a hedge fund such as Copper River make money if it has to deliver what it sells?

• And lastly, this chestnut: “The rising stock prices also led to a series of margin calls (demands for additional cash collateral to be deposited in a margin account) from Goldman Sachs, Copper River’s prime broker.” I’m with Roddy on this one: it’s damn inconsiderate of Goldman Sachs to insist that Copper River have funds to back its play.

But perhaps I am too hard on Roddy. “Out of the crooked timber of humanity no straight thing will ever be made,” said Kant. A gal moves to the big city, gets behind, does things of which she is not proud. Molded are we all of imperfect clay.

But normally, she doesn’t write home about it.

It’s just Roddy’s ill fortune to have to perform these acts in national print.

Thus I was a bit surprised at the turn taken by the following correspondence:

From: Patrick Byrne
Sent: Thursday, February 28, 2008 10:46 PM
To: Bethany Mclean
Subject: comment sought

Dear Bethany,

For the record, do you have any comment on either of these stories?

http://community.overstock.com/deepcaptureblog/why-is-sam-antar-the-crook-being-pimped-by-fortune-magazine-and-the-rest-of-the-new-york-financial-media/

http://community.overstock.com/deepcaptureblog/gary-weiss-scaramouch-psychopath/

Respectfully, Patrick

From: Patrick Byrne
Sent: Friday, March 14, 2008 12:37 PM
To: Bethany Mclean
Subject: Three requests

Dear Bethany,

1) I understand Roddy has become a co-worker at your fine magazine. I am not confident I have his correct email. Would you mind sending it to me (or ask him to do the same)?

2) I have posted a new piece about Michael Steinhardt (if I do say so myself, it’s frightfully good). Would you please provide comment it?

http://community.overstock.com/deepcaptureblog/category/9-the-players/

3) If you do not intend to provide comment on this or any of my stories, would you please let me know that? Any further explanation you would be willing to share in that regard would be much appreciated.

Your friend,

Patrick

From: Patrick Byrne
Sent: Thursday, March 27, 2008 12:49 PM
To: ‘bmclean@fortunemail.com’
Subject: Hello

Dear Bethany,

Hello. I hope you are well. As you are perhaps aware, I am working on an article in which you will figure. I want to treat you justly and have your point of view represented fairly. Unfortunately, you have not called or written me back (though I have always been prompt in my responses to your inquiries, I believe). I do not wish to publish and have you feel slighted. Therefore, on the off-chance that the reticence of your reply stems from a fear that I will not quote you accurately, may I propose a solution? I would like to ask you two questions. If you will answer these questions, I will commit to using your answers in full, unedited (I propose an upper limit on the length of each reply: 50 words). Since this is far more generous a deal than I generally extract from the New York financial journalists of my acquaintance, surely it should ease any discomfit you may have in being the recipient, rather than the purveyor, of questions.

Very respectfully,

Patrick

—–Original Message—–
From: bethany_mclean@fortunemail.com
[mailto:bethany_mclean@fortunemail.com]
Sent: Thursday, March 27, 2008 1:57 PM
To: Patrick Byrne
Subject: your email

Hey, Patrick. The only communication I’ve received from you (apart from today’s email) was another email in which you asked me to comment on a piece you’d written on Michael Steinhardt. (I think.) You’re correct that I didn’t respond to that. My editor has asked that you speak to our PR people. You can contact Katy Reitz at katy_reitz@timeinc.com.
Thanks.

—–Original Message—–
From: Patrick Byrne [mailto:PByrne@overstock.com]
Sent: Friday, April 04, 2008 3:07 AM
To: Reitz, Katharine – Fortune/Money
Cc: McLean, Bethany – Fortune
Subject: RE: your email

Dear Ms. Reitz,

As you can see below, I am writing at the suggestion of Ms. Mclean regarding the possibility of her answering several on-the-record questions for a story I am writing. Is this something you would be willing to facilitate?

Respectfully,
Patrick M. Byrne

—–Original Message—–
From: katy_reitz@timeinc.com [mailto:katy_reitz@timeinc.com]
Sent: Friday, April 04, 2008 8:12 AM
To: Patrick Byrne
Subject: RE: your emailPatrick,

Can you please email me the questions and I will see if Bethany is
available to answer. Also, please let me know what your deadline is and
what publication this interview will appear in. Thanks.

Katharine S. Reitz
Director of Communications
Fortune|Money Group
o. 212.522.6724
m. 917.543.9176
katy_reitz@timeinc.com

—–Original Message—–
From: Patrick Byrne
Sent: Friday, April 04, 2008 1:11 PM
To: ‘katy_reitz@timeinc.com’
Subject: RE: your email

Katy,

My questions for Bethany concern her state of knowledge at the time she wrote SGR regarding the investment track record of Jim Chanos prior to Enron (attached please find discussion of Jim Chanos in Bethany’s book on Enron; I can also provide Mr. Chanos partners’ letter if she needs).

What was Bethany’s understanding of that track record? Did she know what it was when she wrote SGR?

If she did not know, why not? Did she ask?
If she did know, does she believe her account on page 319 adequately summarizes it?

An answer within the next week would be deeply appreciated. You may assume that the first place her answer would be published would be within Overstock.com, or at DeepCapture.com.

Most respectfully,
Patrick

—–Original Message—–
From: katy_reitz@timeinc.com [mailto:katy_reitz@timeinc.com]
Sent: Tuesday, April 08, 2008 10:42 AM
To: Patrick Byrne
Subject: RE: your email

Patrick,

Bethany is unavailable to comment.

Thanks,

Katy

—–Original Message—–
From: Patrick Byrne
Sent: Tuesday, April 08, 2008 11:50 AM
To: katy_reitz@timeinc.com
Subject: RE: your email

Dear Katy,

Thank you for your kind response. I can wait, as it turns out, given the collapse of Bear and some subsequent comments made last week in the Senate, my publication schedule has changed. When would she be available for comment?

Very respectfully,

Patrick

============================================================================

I received no further reply, no elucidation of when Bethany would no longer be “unavailable for comment.”

However, this evening, just as I was preparing to leave work, I checked my email, and found this. Since it was sent at a quarter to 1 PM East Coast time, and Bethany gave me to “the end of the day” (which came four hours later for her), the time to respond has elapsed, obviously. And since Bethany neglected to call my office, cell, or assistant, though these are all numbers she has and has called in the past, I was not aware of her email until this evening.

—–Original Message—–
From: Bethany McLean [mailto:bethany_mclean@fortunemail.com]
Sent: Tuesday, April 22, 2008 10:43 AM
To: Patrick Byrne
Subject: Fact checking question

Hi, Patrick -

I’m doing a short book review of a new book by a hedge fund manager named
David Einhorn. The book isn’t about you, and nor is the review. But
Einhorn does write about your August 2005 conference call because you
mentioned both him and his wife on it. You also made some statements about
his business. Einhorn says you were factually inaccurate about both his
business and his relationships. You also made some unsubstantiated and very
negative allegations about his wife. Do you want to comment on this at all?

The column is shipping off at the end of the day, so please let me know.

Thanks,

Bethany

==============================================

I’m new to this reporting gig, so I have to ask: Is that odd? Is it odd that for weeks Bethany would not be “available” to answer two simple questions such as the ones I posed her (even given the generous terms I offered regarding the timing of her reply and the use of her quote), but then would be available to describe vaguely some criticisms David Einhorn has made about me, and ask for my comment by end-of-day? Is this asymmetry of responsiveness, time, and use of quotes, odd?

What makes these people feel so threatened by a level playing field?

Given that I just sat down at my email I have evidently missed Ms. McLean’s timetable: besides, given the vagueness of her description, it is hard to know what a reasonable reply would look like (beyond noting that it is not clear if David Einhorn is saying my allegations about his wife were false, or rather, simply that he felt they were unsubstantiated and negative). But Bethany does raise interesting points with which the reader should become familiar.

David Einhorn’s wife is Cheryl Strauss-Einhorn, who is, or was, an editor at Barron’s. It’s fair to say that Cheryl Strauss Einhorn’s favored sources over the years have been the short-selling friends of her boyfriend/husband. As a couple, they illustrate the intersection of money management and compliant journalism whose description is Deep Capture’s mission.

By way of example, here is Cheryl writing on Jim Chanos (yes, this is the same Jim Chanos mention above, the one about whom Bethany wrote a book-length lotion-job, about which she is now refusing to answer two simple questions). Note also Cheryl’s mention of David Rocker. Importantly, Cheryl notes (as if it’s all kosher) that most “bear” short interest (as opposed to arbitrage) is actually naked shorting (by the way, that is the same “naked short selling” which the New York financial press has spent the last three years denying exists).

Anyway, here are excerpts from this fine example of Cheryl’s work:

Short Fuses: Romping Dow leaves professional bears Bloodied; is this the sign of a market top?

By Cheryl Strauss Einhorn
1113 words
17 July 1995
Barron’s
15
English
(Copyright (c) 1995, Dow Jones & Company, Inc.) ….

….

“As the stock market charges ever higher, pros are increasingly asked if short selling continues to make sense as an investment discipline,” laments Jim Chanos, head of Kynikos Associates in New York and a dean of the short-selling community. “The frustrating thing has been trying to nail down just what has changed in the market such that it hasn’t had a 10% correction since 1990. Is it a new era? We are questioning the discipline as a whole, wondering if the short side of the market will ever work again.”

Well, it worked last year — for Chanos, at least. Even as other shortsellers were having problems, Chanos’s flagship Ursus Partners reaped a hefty 46.2% return, while the S&P 500 Index was up 1.3%. So far this year, though, Chanos has lost more than 20%, bringing his assets under management to $200 million, down from $250 million on Jan. 1. In recent weeks there have been rumors swirling that Chanos was giving up the shorting game, rumors that he denies vigorously. “It just isn’t true,” he says.

Chanos recently received another large chunk of money to manage on behalf of a wealthy New York family, and as he puts it, “It is our intention to remain fully invested.”

“Besides this one client, though, no one else is stepping up and saying, `Now is the time to give money to a short fund,’” Chanos concedes. “But if not now, when? Valuations are crazy and the public is in the market with both feet.”

Between now and the stock market’s eventual downfall, Chanos expects to see “a lot of shorts throw in the towel.” And a lot already have. By one calculation, assets in funds dedicated to shorting stocks have shrunk to somewhere between $600 million and $800 million in total, down from a peak of $3.5 billion in 1990. Put another way, it’s less than 1% of the $6 trillion that comprises today’s equity market capitalization.

….

There was also talk in the market last week that David Rocker, head of the hedge fund Rocker Partners LP, was thinking about giving up his penchant for going short. Rocker conceded that it’s been a tough year, but he says he remains net short because he believes the market is highly overvalued. With folks like Chanos and Rocker so demoralized, it’s easy to understand why short interest has slipped in such highflying stocks as Boston Chicken and Electronic Arts. Despite all the shorting in months past, these stocks just keep climbing. In fact, Boston Chicken’s short interest fell 17% between May 15 and June 15, and Electronic Arts’ fell 10% during the same period.

Nonetheless, overall short open interest on the New York Stock Exchange rose 3% in the month ended June 15, while short interest in the Nasdaq National Market was about flat. It’s important to note, though, that these numbers do not discriminate between naked short positions, taken by outright bears, and short positions that are part of arbitrage activity, such as a fund buying S&P futures while shorting the underlying stocks.

Short-sellers have been further hurt by a Nasdaq rule put into effect in September 1994 that prohibits shorting a stock on a downtick. “The brutal reality of the short-selling business is that one has to be there before the bad news hits,” says Chanos.

Still, Chanos continues to be drawn like a magnet to segments of the market he sees as most overvalued. Technology stocks, he wrote in a recent letter to investors, “increasingly look like a bubble, with many questionable companies receiving ludicrous valuations. Institutional investors are now horribly overweighted in this sector and most have the view that nothing can go wrong.”

….— Still Flying High

==========================================================================

A more remarkable example of Cheryl’s work can be found in her October, 2000 article regarding the “uptick rule”. As I discussed in my essay “Jim Cramer is a Complicated Man“, this is a rule that were implemented in the 1930’s to curtail the ability of stock manipulators to destroy companies. According to someone who worked for him, Jim Cramer flouted this while managing money at Cramer Berkowitz. The rule was repealed in the summer of 2007. Recently Cramer has been on TV explaining (correctly if insincerely) how the repeal of this rule is a disaster for our markets, allowed hedge funds to steal from hard-working Americans, and perhaps contributed to the implosion of Bear Stearns.

So it is instructive to see in retrospect how Cheryl analyzes this rule.

Cheryl’s article begins with the nice neutral title, “SEC may drop biased trading restrictions”, then goes downhill from there. I will make bold those sentences that represent the point of view of those who think that hedge funds should not be encumbered by the uptick rule. I will italicize those that represent the point of view who think the uptick rule a necessary check on the powers of stock manipulators. I will leave untouched any sentences that are simply factual, about which neither side would disagree.

=================================================================================

Clock Ticks For Short-Sale Rule- SEC may drop biased trading restrictions

By CHERYL STRAUSS EINHORN (Barrons, 10/2/00)

The SEC is considering dropping its restrictions on short sales of securities. The rules were implemented in 1938 to prevent stock manipulators from driving down share prices through short-selling. Proponents of the so-called short-sale rules have long maintained they are needed to help promote stock-market stability. But detractors consider the regulations outmoded in today’s increasingly transparent market. Besides, they point out, no precautions have ever been legislated to rein in manipulators seeking to drive up prices through similar means.

Although the SEC has put out a concept release seeking comment on the restrictions from securities-industry participants, Annette Nazareth, head of the market regulation division, acknowledges the whole subject is up for grabs. “Personally, I can find no economic basis for the short-sale rule,” she says.

Short-sellers hope to profit by selling borrowed shares that they can buy back later at lower prices. Under current restrictions, stocks can be shorted only on an uptick — that is, at a price above the preceding trade.

While the short-sale rule has remained fundamentally unchanged for the past 62 years, financial markets have changed radically since the 1930s. For openers, there has been substantial improvement in market surveillance. And as the volume, velocity and complexity of trading escalate, restrictions on short-selling “may inject unnecessary inefficiencies” into the market, Nazareth says.

John Damgard, president of the Futures Industry Association, agrees. “It makes no sense to prejudice a sale up or down,” he says.

The uptick requirement, he adds, just serves “to make people feel warm and fuzzy, because they like things to go up.”

Short-sellers, on the other hand, make other investors feel neither warm nor fuzzy. Through the years they have often been tarred as naysayers, doomsdayers and all-around troublemakers who love to gloat when the market tumbles. Yet there is little data linking their activities to price movements in the securities markets.

Dan Loeb, a New York hedge-fund manager, would like to see the uptick restriction abolished because it increases the difficulty of implementing short sales. Besides, he notes, “Shortsellers provide a service to the market by increasing liquidity and providing a cap on speculative stocks.” While the evidence in recent years suggests the last is merely wishful thinking, in fact short-sellers’ skepticism sometimes does inject a sorely lacking dose of reality into phantasmic situations.

Many institutions use short selling as a hedging tool, to protect their stock and bond portfolios from market declines. Gains in such short positions theoretically will offset any declines in the value of the firm’s portfolio.

Not all market participants want to do away with the short-sale rule, however. Major brokerages such as Merrill Lynch are conflicted about the shortsale regulations. While trading desks consider the rules excessively cumbersome, investment bankers and brokers believe the restrictions will protect their clients’ shares from potential “death spirals,” in which stocks are hammered by repeated waves of selling.

The SEC, according to its concept release, is considering eight different measures regarding short-sale regulations. In addition to outright elimination, these include suspending the short-sale rule when a stock or the market rises above a certain price threshold; providing exceptions for actively traded securities; focusing shortsale restrictions on certain corporate events, such as mergers, or trading strategies, such as options expirations; exempting hedging transactions and revising the definition of “short sale.”

The commission, which has received many complaints about short-sale abuses in the over-the-counter market, also is exploring whether to extend the rule to non-exchange-listed securities.

The short-sale issue is timely in part because Congress this week is expected to pass legislation lifting the 1982 ban on trading stock (as opposed to stockindex) futures. With trading volume in bond and currency futures down 10% this year, the futures business would welcome the opportunity to move into the equity market. Global competition, too, is propelling the issue forward. Beginning in January, the London International Financial Futures and Options Exchange plans to begin trading futures on a handful of U.S. stocks, including AT&T, Cisco Systems, Citigroup, Exxon Mobil and Merck.

Ironically, if the ban on stock futures is lifted, the short-sale rule could become moot. Not only are there no ticks in futures, but also short-sellers would not have to borrow shares to short them. Thus, they wouldn’t face having their shares “bought in,” which is what happens in a short squeeze, a form of market manipulation. Investors then would be able to sell futures on stocks without cumbersome restrictions or regulatory bias.

=========================================================================================================

That sure looks like thoughtful, unbiased analysis to me. Please keep in mind that the elimination of this “regulatory bias (sic)” in 2007 is now being brought up in US Senate hearings (as well as by Jim Cramer) as contributing to the take-down of Bear Stearns and the current market crisis in general. Also, note that Annette “Personally, I can find no economic basis for the short-sale rule” Nazareth is a lawyer, not an economist, and is one of the two SEC commissioners who stepped down within days of the publication of the Senate investigation into the whistle-blowing claims of SEC Senior Investigator Gary Aguirre, as is described by my piece on the regulatory capture of the SEC. She is also the person to whom I was referring when I wrote, “who, as we shall see later, is via marriage directly linked to the issue whose exposure is the ultimate purpose of this blog: unsettled trades in our settlement system.” But these are stories for another day.

These two articles demonstrate my point, I believe: writing articles favorable to one’s husband and his friends is a pretty clear conflict of interest. Call me madcap.

In August 2005 I mentioned Cheryl’s work in the Miscreants Ball conference call. The only objections I ever received were claims that she was no longer, in fact, employed at Barron’s. To these objections I simply sent people a link to the Barron’s masthead, which on that day did (and for all I know, still does) list her as an editor. No other inaccuracies were ever reported to me.

About six months later, Mark Mitchell from the Columbia Journalism Review began asking questions about Cheryl Strauss. According to him, her stories literally began disappearing from the Barron’s database within days. That is a good indication of how proud they were of the work of Cheryl Einhorn, née Cheryl Strauss.

In late 2005 I had lunch with Bethany. I mentioned that I had recently been shown the trading records of David Einhorn, and while Overstock was not among his positions, there were other statistical anomalies of note. It was the only time I saw her flinch.

In the summer of 2006 I had lunch with Whitney Tilson, a paymeister of convicted felon Barry Minkow (according to a deposition Barry gave). Whitney invited me to address a group of hedge funds at that year’s Value Investor Congress, which he organized. Whitney’s friend David Einhorn protested my appearance to Whitney, whereupon Whitney rescinded his invitation to me. (One year later a different conference organizer, Brett Goetschius of “The Pipes Report” gave me a similar invitation to address 800 hedge funds. I told him I could accept his invitation, but that he would just have to rescind his invitation later. He replied, “No no, in the last year the whole community has changed: at least 50-60% of hedge funds are now on your side.” I went and gave the talk and received a nice ovation: the recording of this became the body of Deep Capture: The Movie.)

Last year Bethany devoted some serious effort to trying to prove that I was collaborating in a vast secret scheme with someone. Unfortunately for her case, I had never met my supposed collaborator.

But Bethany is nothing if not persistent. Some weeks ago Bethany visited a hedge fund for an interview. According to them, she regurgitated the criticisms of one obscure analyst who was trashing a firm in which they had invested, criticisms they were immediately able to dispel, with documentation (including a recent FDA approval about which she was unaware). She got visibly irritated, then brought up my name. When they told her that they thought I was right about compliant journalists being spoon-fed stories by select hedge funds, she got very irritated, and left somewhat abruptly, they say.

If only there were a pattern….

Your humble servant,

Patrick

PS Bethany, if you know any of the specifics of David Einhorn’s allegations of error on my part, please let me know. Deep Capture is in the final stages of preparing a major piece, and would not want to repeat being “factually inaccurate about both [Einhorn's] business and his relationships.” Since you are writing a column about his book, you probably are familiar with the substance of his claims (of course, most reporters would have actually given some clearer indication of his claims when asking for my comment on them, beyond saying he thought I was “factually inaccurate”). In any case, out of an abundance of caution, please let me know of any specifics about which you or David Einhorn believe I was in error, so that such error would not be replicated in the coming piece. We journalists have our standards, of course.

PPS To the casual reader: have any of you noticed that, for all that these journalists like to write about me and how improbable are my claims, none of them mentions DeepCapture.com? The Wall Street Journal once practiced a remarkable circumlocution in order to avoid mentioning where to find my blogs. It is almost as if…. they fear their own writing will not stand up on its own. What do you bet Bethany’s upcoming column avoids mentioning it as well?