Nearly one year after its original date of publication, my video, Hedge funds and the global economic meltdown has finally received its first bit of serious criticism, and I can’t express how pleased I am about it.

So far, at least as far as bloggers and YouTube commenters are concerned, response to the video has come in five flavors:

1. Approval
2. Nutty approval (“This makes me so angry I want to take to the streets in bloody revolution! It’s all [insert political party or current/past president]’s fault! ”).
3. Tentative approval (“You’ve got part of the story right, but the real problem is…”)
4. Random and unaware (“I’ve got a puppy named Patches. He has a wet nose.”)
5. Nutty disapproval (“[Insert anything Gary Weiss would say]”)

What’s been missing is educated criticism based on the hard facts presented in the video. And believe it or not, this has bothered me, because it suggests that not enough smart people are paying attention.

As I mentioned, that changed this week when Mike “Mish” Shedlock of SitkaPacific Capital Management analyzed the video on his blog and managed to make a compelling contrary case. Though compelling, Mike misses the mark on a few key points and his analysis requires a rebuttal, which I’ve decided to offer here as it would probably be of interest to DeepCapture.com readers.  I’ve also invited Mike to respond, and will print whatever he offers at the end of this post.

(If you’ve not seen the video yet, I encourage you to watch at least the first five minutes now, otherwise nothing that follows will make much sense.)

Shedlock frames his criticism of the video in terms of what he identifies as three assumptions (printed verbatim in black, with my response in blue italics).

1. That whoever bought way out of the money Bear Stearns PUTs “knew” something and illegally acted on it. I agree with this.

2. The same institution that bought the PUTs was illegally shorting shares. I think this is a safe assumption.

3. There is a conspiracy to protect those evil doers. I do not agree that there is a conspiracy to protect the short sellers who attacked Bear Stearns any more than there was a conspiracy to protect Bernard Madoff before his scheme blew up. What “protects” them is Wall Street culture, and it’s no conspiracy…it’s common knowledge.

Shedlock then attempts to explain how the market really works via four statements of fact which he expects will undo my arguments, but which in reality only support them.

Here again, I present Shedlock’s facts verbatim, followed by the information he apparently did not have when he originally wrote them, in blue italics.

Fact #1: When someone buys PUTs the market maker or counterparty who sold them is short those PUTs. This is a mathematical statement of fact. This is 100% truth.

Fact #2: The market maker who sold the PUTs, shorts stocks as a hedge against those short PUTs.
This is also 100% truth, and an indispensible component of illegal naked short selling, which requires the options market maker to sell the stock naked short to the fund buying the puts. This is part of the married put strategy we’ve claimed from early on facilitates illegal short selling. As far back as 2003, the SEC expressed concern about married put strategies as a means of circumventing multiple market regulations. In this 2007 paper, an economist explains how a combined strategy of married puts and reverse conversions provided the engine that powered the naked shorting epidemic that grew unabated until changes were finally made in the wake of Lehman’s demise.

Fact #3: The lower the share price, the more shares the market maker has to short to stay delta neutral. Also true.

Fact #4: Market Makers are not governed by naked shorting rules. Again, Shedlock steals my line. Prior to the repeal of the options market maker (OMM) exception of Regulation SHO, OMMs were not bound by the locate and delivery requirements of that rule. So, it’s entirely predictable that options trading would play a key role in any effort to circumvent Reg SHO.

The existence – and illegality – of these kinds of tactics are documented in this November 2009 administrative action brought by the SEC against Rhino Trading and Fat Squirrel Trading (one of only two enforcement actions specifically alleging naked short selling filed in the Commission’s history). In it, you’ll learn how reverse conversions and “resets” (the call-based alternative to the married put) were used to illegally manipulate other stocks down.

At this point, Shedlock has spelled out the entire philosophical foundation for his disagreement with me, and yet we’re apparently in the awkward position of not disagreeing about any of the parts that really matter. The actual disagreement seems to be based on our interpretations of the implications of these facts, in my case informed by a slightly more detailed (though not very broadly-applicable) knowledge of the tactics used by illegal stock manipulators. That Shedlock is not familiar with these tactics speaks very well of him as an investment manager, in my opinion.

So, while Shedlock claims, “the [options] market makers shorting Bear Stearns did so for purely mathematical reasons, to remain delta neutral” I assert that this necessity, combined with their exemption from Regulation SHO’s locate and delivery requirements in place at the time, made them the perfect counterparty to a short-selling hedge fund seeking to warp the market for Bear Stearns stock through the generation of artificial supply.

Shedlock further asserts that Bear’s demise was the inevitable product of its own greed and toxic balance sheet. I respond by agreeing that Bear probably was destined to go under, and in capitalism, that’s ok. However I further point out that Bear had $18-billion in cash on hand when the assault began, and so the process should not have taken just one week. In a civilized world, even when someone is on their deathbed, it’s not ok to hasten death through forceful application of the pillow; and particularly not when the incentive for doing so is pecuniary.

As promised, the space to follow is reserved for Mr. Shedlock to offer his rebuttal.

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

.

This short video clip was shot in a business class at CSU Fresno, where the basics of naked short selling were being taught. The explanation of the mechanics are just a little rough, but made up for by the introduction, wherein the instructor makes it very clear that on its most fundamental level, naked short selling is really about greed.

Naked Short Selling from nader assemi on Vimeo.

Last week I dared to predict the number of then unreleased delivery failures in shares of Sears Holdings (NASDAQ:SHLD). The figures I ultimately settled upon (after two minor tweaks in the days to follow) were:

1/29/2010 879,444
1/28/2010 873,222
1/27/2010 870,570
1/26/2010 851,904
1/25/2010 848,742
1/22/2010 865,266
1/21/2010 857,106
1/20/2010 1,535,508
1/19/2010 1,540,914

This morning, the SEC having yet to release the numbers, I explained the basis for my prediction, which is in simple terms, based on a pattern of apparently manipulative naked short “reset” transactions the Deep Capture team has observed in SHLD, and how those trades consistently predict how many shares of SHLD will fail to deliver after two days.

Well, literally moments after I published my explanation, the SEC released the numbers.

I asserted that my prediction would be accurate to within +/-2.5%. I’m embarrassed to reveal that in the end, my predictions were on average accurate to within 2.55%.

Sorry. I’ll try harder next time .

For the record, here’s a table comparing my predictions and the actual numbers.

At this point, the most relevant question is: will the SEC do anything about this obvious violation of the law?

Sadly, I predict that no, the SEC will not.

The next most relevant question is: will the manipulator continue manipulating, knowing he or she has been spotted?

Because I suspect the manipulator is operating without much concern over being held accountable, I must also predict that no, this pattern is unlikely to change.

However I can confidently predict that Deep Capture will continue identifying and reporting on these sorts of abuses, in the trading of SHLD and several other companies, in the very near future.

Mostly inconsequential postscript: Deep Capture team member Patrick Byrne points out to me that instead of average error, I should have used weighted error, in which case my prediction was off by just 2.51%.

Most of the examinations of stock manipulation published here on deepcapture.com take place after the fact, the damage being done. However, we’ve become aware of instances of apparently illegal, manipulative trading in several companies’ stocks, happening right now, which we have the ability to monitor and report on in nearly real time.

I’ll start with Sears Holdings Corporation (NASDAQ:SHLD).

A few months ago, an unusual trading pattern in shares of Sears emerged, in which large blocks of shares change hands within minutes of deep in-the-money call options equivalent to precisely the same numbers of shares in these blocks. This behavior is consistent with the illegal “reset” transaction described in the enforcement case brought by the SEC against naked short seller Steven M. Hazan:

“…a market participant who has a “fail-to-deliver” position in a threshold security buys shares of that security while simultaneously selling short-term, deep in-the-money call options to – or buying short-term, deep in-the-money put options from – the counterparty to the share purchase. The purchase of shares creates the illusion that the market participant has satisfied the close out obligation of Reg SHO. However, the shares that are apparently purchased in the reset transactions are never actually delivered to the purchaser because on the day after executing the reset, the option is either exercised (if a call) or assigned (if a put), transferring the shares back to the party that apparently sold them the previous day. This paired transaction allows the market participant with the fail-to-deliver position to effectively borrow the stock for a day, in order to appear to have satisfied the close out requirement of Rule 203(b)(3).”

If you want to see each of these reset transactions in detail, you can do so here. But if you’re content with the bottom lines, take a look at the following table, keeping in mind each call option contract gives the buyer the right to purchase 100 shares of the underlying stock (meaning, these trades were undeniably “matched” to one another).

Take a look at how these blocks trades appear when charted.

SHLD matched block trades: click to enlarge

Looking at the relationship between these matched blocks and the delivery failure data currently available suggests the blocks are a pretty reliable predictor of delivery failures reported two days later.

SHLD matched block trades and delivery failures: click to enlarge

Moving fails back two trading days we see just how reliable a predictor these matched block trades really are.

SHLD matched blocks and failed trades, offest -2 days: click to enlarge.

On average, SHLD fails are roughly 102% of these matched blocks. Given that relationship, I feel quite confident predicting how the as-yet-unreleased SHLD delivery failures will appear (note the dashed line).

SHLD matched block trades and offset delivery failures with prediction: click to enlarge

Now for the good and bad news inherent to this situation.

The good news is: this unusual market activity is fairly easy to spot.

The bad news is: despite being easy to spot, in recent months multiple companies have come under identical attack, suggesting whoever is responsible is not too concerned about the consequences of overtly violating the securities laws…a familiar situation for anybody who’s followed deepcapture.com for any length of time.

I’ll have more on this subject as soon as the SEC fails data are released, so stay tuned.

I’ve got everything ready to go for my next post, save one thing: the most current stock delivery failures data, corresponding to the second half of January, which the SEC was supposed to have made available yesterday.

I’m particularly eager to get that batch, because it has the capacity to confirm or rule-out my ability to predict the future.

See, I believe I know, to within a few percentage points, how some of that delivery failures data — up to this point supposedly known only to the DTCC and SEC — will read.

But instead of going mad waiting for it to be posted, I’m going to very publicly make my prediction here and now, and then follow up with the actual numbers once published. I shall then take my clairvoyant victory lap around the tiny office where I sit.

Therefore, I do predict the following:

With a margin of error of +/-2.5%, Shares of Sears Holdings Corporation (NASDAQ:SHLD) will be shown to have experienced CNS delivery failures of the following magnitudes on the indicated dates:

1/29/2010 879,444
1/28/2010 873,222
1/27/2010 870,570
1/26/2010 851,904
1/25/2010 848,742
1/22/2010 865,266
1/21/2010 857,106
1/20/2010 1,535,508
1/19/2010 1,540,914

Please check back often between today and tomorrow (or whenever the SEC gets around to posting the final numbers) to learn how accurate my predictions turned out to be, how I arrived at them, and why this is very bad news for our capital markets.

(note: on 2/22 at 8:27am MST I adjusted my prediction)

This is a transcript of the Deep Capture podcast episode published on February 10, 2010.

You may:

• Download the episode in mp3 format.
• Subscribe to the podcast’s RSS feed.
• Download in iTunes.
• listen to the episode right here in this handy audio player:
   Barry Ritholtz and a tale of two media. [12:35m]: Hide Player | Play in Popup

It’s no secret that the Deep Capture message is not a popular one in certain places. I’m thinking about Wall Street and environs, specifically. In fact last month I was the subject of a fairly lengthy profile in the New York Observer, Manhattan’s alternative weekly, examining the deepcapture phenomenon and the impact it’s had on Wall Street from precisely that perspective.

In my interview with the Observer’s Max Abelson, one theme that emerged was this idea that the market reform movement could only take root in fly-over country because the culture of the coasts — New York in particular — runs in direct opposition to everything we’re trying to accomplish. That’s not to say that there are no moral, law-abiding people in New York or San Francisco, only that the extreme unpopularity of our message would probably keep it from taking root there. It had to be somewhere else.

And even though we’re making headway, as the mere existence of the Observer story demonstrates, the New York press — yes, even the alternative press — generally does not do nearly enough to afflict the comfortable on Wall Street. Sure, they’ll pile on when there’s blood in the water, but dare ask hard questions of the Wall Street celebrity set otherwise? Not going to happen, because the culture doesn’t allow it.

How many business reporters did Harry Markopoulos brief on Bernard Madoff during the decade leading up to his downfall? How many sports writers apparently knew about Tiger Woods’ infidelities in the years leading up to his downfall? But in both cases, nothing happened because the boosterism mentality endemic to both Wall Street and sports journalism means there’s too much to lose by sticking one’s neck out and challenging a celebrity in either field.

Keep that in mind as you consider what follows. I want to preface by saying that this is a very personal situation which I’m certain is of much greater significance to me than most anybody else. I recognize this and I’m not whining. Instead, I’m telling this story because it illustrates a couple of important and broadly-applicable market reform lessons.

Here’s the background…

In early December, I published a video suggesting that — based on links revealed by their publicly-available Facebook friend lists — there is more than a little substance to the long-held suspicion that a group of well-known Wall Street reporters and bloggers have close interpersonal ties with some of the short-selling hedge fund managers they write about. I further posited that these apparent conflicts might explain some of the pro-short seller biases many (myself included) claim to have observed in their writing.

I knew that this social network was only significant to the extent that its own members regarded it as significant. In other words, if it was composed entirely of people who view Facebook as a proxy for a Rolodex, the network would be meaningless. If, on the other hand, this network had dynamics comparable to real world relationships — meaning, some degree of exclusivity based on common interests — then it would be very significant, indeed.

In order to find the answer, I created a fictitious Facebook account and sent friend requests to every member of this group. What I discovered was that I, as a stranger, only managed to replicate about 20% of the network. With that, I knew I was on to something, as the video explains.

And that was it. I didn’t need to be Facebook friends any of these people to see who their friends were.  I did it to determine whether being Facebook friends with them actually means anything.

Well, apparently it does mean something, because my video struck a nerve among these folks. The real journalists kept quiet…likely out of embarrassment, but the bloggers in that network went on the attack like never before. It started with Gary Weiss insisting that I’d gained this publicly-available friend data, by hacking into everybody’s accounts. Then he said that it was actually Overstock.com (NASDAQ:OSTK) CEO and frequent Deep Capture contributor Patrick Byrne himself who did the hacking. Bloggers Felix Salmon, John Carney and Joe Wiesenthal swallowed this easily-refutable line and regurgitated it whole on their own blogs. A few times.

After that silly angle ran its course, Weiss escalated things by announcing that I sent friend requests to many young children he claims are connected to the people in the network, in order to get their personal information so that I could harass and stalk them.

And that was repeated, unexamined, by the same chorus.

Then Weiss revised slightly by saying that it was actually Patrick Byrne who did the kid-stalking.

And that was repeated.

And just when I didn’t think things could get any more ridiculous, Barry Ritholtz showed up.

Ritholtz, a fairly well-known (in fact, the Observer’s Max Abelson called him “revered”) Wall Street blogger, trader and recently book author, has consistently parroted the position of the short selling mega hedge funds who oppose the reform movement for obvious reasons.

Well, out of nowhere, Ritholtz latched on to the demonstrably false notion of my having attempted to become Facebook friends with young children, and created an entirely new reality, going so far as to assert that I am a child molester. That is not an exaggeration. In fact, he said as much multiple times.

Ritholtz then demanded a boycott of Overstock.com, saying the company violates its customers’ personal information and hires deviants to stalk their kids.

Did I mention Ritholtz has a law degree? But you don’t need to go to law school to know what libel is. You barely even need to be human.

Though I’ve been wary of Ritholtz and his motives from the beginning, I contacted him, to set the record straight and respectfully ask that he stop with the poisonous pedophilia rhetoric. He received my messages, but ignored them and continued as before. He also announced on his blog that if I sued him for what he was saying, he would hire a private investigator to uncover all my sexual secrets and very publicly broadcast them.

Anybody else sense something dark going on? What could possibly be motivating this guy?

For authors, large market talk radio interviews are gold, as the host usually gives the author 15 minutes to show off talking about an area in which they’re particularly well-versed and promote the hell out of their book. Talk radio listeners are very loyal and engaged and they will buy books. For the author, it’s money in the bank.

Well, recently Barry was invited to promote his book on the finance-themed talk show “Wall Street Shuffle” airing on a CNN Radio affiliate in Dallas, Texas.

Along the way, Ritholtz told the radio show’s producer that he was hoping to use some of his air time to attack me and repeat his call for a boycott of Overstock. The producer did the responsible thing by giving me an opportunity to respond, if Barry’s attacks warranted a response.

And one more thing: they didn’t tell Barry about this arrangement beforehand.

And so I sat and listened on hold while Barry spent much of the time any normal author would have dedicated to selling books, attacking me and renewing his call for a boycott of Overstock instead.

It was brutal. But better than describe it, you need to hear it. Listen to this.

Finally, the host broke in to say that it was only fair to give me a chance to respond.

Before playing that tape, let’s consider what might happen.

Assume Barry truly believes that I’m the monster he claims and is justifiably outraged. In that case, considering how vocal he’s been in condemning me in my absence, you’d expect him to jump at the chance to give me the same treatment in person…really make an example out of me, and get it on tape, to boot. That would be gold for his boycott campaign and make him look like a hero in front of at least 20,000 engaged, drive-time listeners. Meanwhile you’d expect that I’d want to stay as far away from that setting as possible, right?

On the other hand, what if Barry were repeating a lie and knew it? What if he knew he could never back up what he was saying, and was afraid of looking foolish (at best) and on tape, to boot? In that case, you’d expect him to run while I would leap at a chance to set the record straight, right?

Well, keep those two scenarios in mind as you listen to what actually happened.

Just like that, Barry was gone. While I regret not having an opportunity to truly confront him, I am very pleased that I was able to spend the remainder of what was to be his segment discussing Deep Capture and the market reform movement, and that the host was kind enough to invite me back to continue the discussion.

As you’ll recall, I promised that this story had application to more than just me. So what is the moral of this story?

Remember, this took place on an investing-themed radio show based in Dallas, Texas, not New York. I’m not sure it could have happened in New York. That’s because I’m pretty sure that Wall Street-themed broadcasts originating on or near Wall Street are talking to Wall Street; while the people listening to this show and the hundreds like it across America are mostly retail investors…precisely the crowd most victimized by short-side stock manipulation and most apt to support our reform efforts.

Herein lies both a problem and an opportunity.

The problem, I just described: Wall Street media culture is getting better but has yet to break free of its celebrity-focused ethic and is probably not going to critically examine the words or actions of a Barry Ritholtz. They’re just going to hand him a microphone. Consequently, in that kind of setting, a blogger living in Utah is unlikely to get the opportunity to rebut something Barry says, no matter how extreme.

The opportunity should be implicit in the problem: there are plenty of Wall Street-focused talk shows broadcasting from middle America where people generally place a higher value on fairness than celebrity (as this recent example proves). Chances are, you…yes you, I’m talking to you…know these broadcasts well. If so, I’m hoping you’ll tell me about opportunities in your area. My email is jbagley@deepcapture.com. Send me a note and help us spread the word.

Click here to download the full Ritholtz/Bagley segment from Wall Street Shuffle.

Barry Ritholtz and a tale of two media. [ 12:35 ] Play Now | Play in Popup

Barry Ritholtz issues not-so-vague threat Play Now | Play in Popup

Barry Ritholtz hangs up and runs Play Now | Play in Popup

It’s difficult to overstate the influence of Wikipedia these days, particularly when it comes to informing media coverage. A recent experiment, carried out by a student in Ireland, makes this very clear. So it should come as no surprise that those who wish to minimize the perceived impact of illegal naked short selling on markets and the economy as a whole have made the online encyclopedia a major point of focus.

Recently, yet another effort to infiltrate and alter the content of Wikipedia by a proponent of illegal shorting came to light and was foiled. As before, the infiltrator was former Business Week reporter Gary Weiss (whom a senior contributor recently termed “one of [Wikipedia’s] most slippery sockpuppeteers”), operating for over a year in complete defiance of an edict specifically banning him from the site based on his very well-documented history of abusing Wikipedia for his own conflicted purposes.

In the past (as you can read about here), we know Weiss spread misinformation relating to stock fraud via Wikipedia on behalf of the Depository Trust and Clearing Corporation (DTCC), the Wall Street firm considered a key enabler of illegal short selling. Exactly who’s sponsoring Weiss these days is unclear; however, as the evidence that follows will demonstrate, his concerted effort to whitewash DTCC’s Wikipedia article makes that company the prime suspect.

Now that his ruse has been uncovered – yet again – the focus becomes one of identifying and repairing the damage done. A brief review of some of the thousands of changes made by Weiss will give you a sense of both the scope of the problem and the nature of his motives. I’m organizing the following tiny sampling of Weiss’s Wikipedia edits by topic, with the content as it originally appeared on the left, with Weiss’s changes on the right. Words added or removed appear in red.

As you read what follows, ask yourself two questions:

1. Which version, be it the left (before Weiss) or the right (after Weiss), better reflects reality and serves readers (particularly journalists) seeking to form an opinion?
2. What might be Weiss’s motive for obsessively making these changes (and literally hundreds more like them)?

If there is a silver lining to this cloud, it’s the following: Wikipedia’s current ruling Arbitration Committee, which has the unenviable task of, among other things, dealing with Weiss and his continued efforts to subvert their authority, is genuinely interested in doing the right thing in this situation. Though you might take that for granted, I can assure you that this has not always been the case. Indeed, at one time, Wikipedia’s ArbCom seemed to go out of its way to enable Weiss’s abuse of this most important social media platform, resulting in (if you can believe it) an even greater number of yet more dramatically skewed and self-serving changes to these articles by Weiss.

Wikipedia has come a long way since then.

Finally, it seems unlikely that Portfolio.com, where he authors a business column, is aware of Gary Weiss’s actions. They would probably appreciate knowing more. If you agree, consider sending a brief and informative note to Condé Nast Publications Group President David Carey: David_Carey@condenast.com.

Postscript: If you’re at all unclear on why you should be bothered that DTCC seems to have hired former journalist Gary Weiss to cover-up the crime of illegal of naked short selling, I strongly suggest you check out Lila Rajiva’s recent post on the composition of that company’s board of directors.

_____________________

And now, for what long-time readers of DeepCapture.com will recognize as my favorite part of writing about Gary Weiss: a little running up of the score (piling on with additional insights that don’t necessarily make the case on their own, but certainly make the case much more entertaining).

After discovering the Wikipedia edit placing Gary Weiss within the Fort Knox-like DTCC (see this for the explanation, if you didn’t already follow the link above), I sent DTCC spokesman Stuart Z. Goldstein the following email:

From: Judd Bagley
To: Stuart Goldstein
Sent: Wed, 31 Jan 2007 10:24 PM
Subject: media inquiry
Mr. Goldstein,
Yesterday I received some information suggesting Gary Weiss either is or has been hired or retained by the DTCC (or DTC or NSCC). Can you confirm the existence of a professional relationship between Gary Weiss and your organization?

More than two days passed with no response. Finally, I received the following:

From: Stuart Goldstein
To: Judd Bagley
Date: Fri, Feb 2, 2007 at 12:00 PM
Subject: your inquiry

*** Body Not Included ***

That’s right…the body of the email read only “*** Body Not Included ***”

With that, I responded:

From: Judd Bagley
To: Stuart Goldstein
Date: Fri, Feb 2, 2007 at 1:20 PM
Subject: Re: your inquiry

Mr. Goldstein,
Thanks for your reply, though the body appears to be missing…may I trouble
you to re-send your reply?

Goldstein’s record-breaking response (especially considering his earlier reply took two days to arrive) hit my inbox three minutes later:

From: Stuart Goldstein
To: Judd Bagley
Date: Fri, Feb 2, 2007 at 1:23 PM
Subject: Re: your inquiry

My response to your question is no.

On the surface, this would seem to be Goldstein denying a relationship between DTCC and Weiss. The problem is, I didn’t ask a yes or no question. I asked him to confirm something specific, to which he responded “no.” The answer didn’t fit.

I twice asked Goldstein to clarify his response, and was twice ignored.

That’s when I realized I’d been played.

Goldstein’s quick reply of “My response to your question is no” was probably calculated beforehand as his response to my inevitable request that he re-send the reply which read only “*** Body Not Included ***”.

He got me.

Here’s how this applies to Weiss.

Weiss’s most recently-banned Wikipedia sockpuppet, known as JohnnyB256, generally began to arouse suspicion in September, following a series of extremely slanted edits to the Wikipedia article on DTCC. At that time, multiple Wikipedia editors asked JohnnyB256 if he had a relationship with Gary Weiss. JohnnyB256 avoided answering the question (other than to dismiss it as “unmitigated gall”) until a senior Wikipedia administrator known as Lar inserted himself into the conversation to say he felt it was a “reasonable question.”

JohnnyB256 then responded, in a way that was unambiguously directed to Lar alone, saying, “The answer to your question is ‘no’.”

Only problem is, Lar was the one person who never asked him the question. Unfortunately, nobody picked up on this serpentine strategy at the time, allowing JohnnyB256 to claim he’d already answered the question of  a link to Weiss when it came up from time to time.

Anybody else suspect Weiss and the DTCC are using the same playbook?

My most recent post, showing emails suggesting an instance of insider trading on the parts of short-selling hedge funds SAC Capital, Kynikos Associates and Third Point Partners, included a brief appearance by a fellow named Jeff Perry.

As with all those included on these emails, I had to do some research to determine the role each played for their respective employers at the time the emails were sent. For most, this was easy. But for Jeff Perry, it was difficult. That’s because since 2002, when the emails were originally sent, Perry has worked for SAC, Third Point, and Kynikos.

So, not only do these supposedly fierce competitors share and profit from inside information, they also share employees.

The sender of possibly the most damning of the highlighted emails was, at the time, SAC portfolio manager Forrest Fontana, who, with the help of a SAC investment of $50-million, left to start his own hedge fund, Fontana Capital, in 2005. However, despite a very strong start, Cohen suddenly pulled his money out of Fontana Capital in 2007, leaving the firm far out of the money and, according to Reuters, hardly a hedge fund at all these days.

And this brings us to another interesting phenomenon, recently examined by financial blogger and author Lila Rajiva: the startlingly high mortality rate of SAC-sponsored spin-off hedge funds. As Lila notes, the consistently poor performance of Cohen’s anointed proteges — often a result of Cohen’s inconsistent support of them — contrasted with the strong showing of one fund launched by former SAC traders who left under a cloud, is a little suspicious…as though maybe these satellite SACs weren’t supposed to succeed.

Here are Lila’s observations on the matter:

1. The high number of SAC traders who seem to have gone off into their own businesses.

You’d think with all that money and the fund’s record as the most consistently successful in the business (only one bad year on record), their traders would stay forever. Quite the opposite.  People seem to have been leaving all the time to form their own businesses.

But SAC was also said to be a very tough environment. You produced, or you left.

So maybe that’s why Lee and Far, Grodin and Goodman, all left to found their own firms?
Could be. But I’m not convinced.

2. None of the spin-off firms seems to have been very successful.

Why not? Why couldn’t these hot-shot traders make money on their own?

The Reuters piece suggests that perhaps the SAC experience didn’t foster business ability. And that perhaps SAC traders flounder without SAC’s huge supporting cast.

But those things are likely to be true of other firms as well, not solely SAC.

Still not convinced.

Furthermore, consider this.

3. A spin-off fund that didn’t get money from Cohen ended up quite successful:

“Healthcor, a healthcare industry focused fund, had raised $3.2 billion by June 2009 since launching four years ago. The fund returned 25 percent in 2006, 18 percent in 2007, and was up 4 percent last year, when the average hedge fund lost 19 percent. In the first 10 months of 2009, Healthcor was up 7 percent.

Healthcor, founded by Arthur Cohen and Joseph Healey, opened without any financial support from SAC. In fact, soon after Cohen and Healey struck out on their own, SAC sued the pair, accusing them of breaching their employment contracts. The matter ultimately was settled. (Healthcor’s Cohen is not related to SAC’s Cohen).”

4. Even spin-offs that were doing well were shut down.

When Stratix started in 2004, it had $60 million given to it by SAC. When it shut down, in 2007, it was up 17% and had $530 million under management. Yet it shut down. Why did it shut down? Those numbers sound pretty good.

Another spin-off, Fontana Capital, started out in 2005 with $50 million of SAC money. It grew to $325 million by 2006.  But sometime in 2007, Cohen pulled out all his money. And in 2009, Fontana was down to $16.1 million, despite being down only 7.69%, compared to the average S&P Financial index loss of 57%. Again, that sounds like it wasn’t doing all that bad.

Reuters quotes someone familiar with the record of ex-SAC traders:

“So many of the ex-SAC people seem to have this model where they attract you with fantastic returns in the first year but in year two or three or four you get annihilated,” said a person who is familiar with several former SAC employees’ records.

Shades of Bernie Madoff….

Someone need to look closely at what happened to the money at these firms…

Investigative financial reporter Teri Buhl says hedge funds are scrambling to put as much distance as possible between themselves and the increasingly radioactive SAC Capital, which is rumored to be the next target of the FBI’s crackdown on insider trading. According to Buhl, this includes purging email exchanges with SAC.

Funds like Blue Ridge, Greenlight, Third Point, Glenview, and Maverick are cutting back on any contact with [SAC Capital's Steve Cohen]. When we asked major players such as [President of hedge fund Kynikos Associates] Jim Chanos and others if they’ve been pinging Stevie about a trade lately, you’ll get a very defensive ‘no.’

…Extra measures are being taken to hire data-miners to comb through any and all emails firms and their trading consultants ever sent to anyone at SAC in an attempt to erase them from internet memory.

If true, hedge funds Third Point and Kynikos will find it quite impossible to delete all their correspondence with SAC, given DeepCapture.com possesses several emails which, it just so happens, implicate all three funds in insider trading of a different sort; specifically, influencing and trading ahead of an analyst’s report.

DeepCapture.com first reported on this situation nearly one year ago, but I feel it’s worth revisiting and updating this topic, given recent developments.

Here’s the short version: in late 2002, a group of short-selling hedge funds, led by Kynikos Associates, learned from a Morgan Keegan analyst that he was preparing to initiate very pessimistic coverage of Canadian insurance company Fairfax Financial Holdings (NYSE:FFH). Kynikos promptly alerted SAC Capital and Third Point Partners about this prime shorting opportunity. In the days that followed, traders at Kynikos and SAC met with the analyst, reviewed and offered input on drafts of his forthcoming report, and, together with Third Point Partners, built up large short positions in Fairfax, which they very profitably covered following the report’s publication.

In one particularly telling email, a SAC trader sends an email to Steve Cohen himself, in which he explicitly states that SAC will cover their Fairfax short position following the Morgan Keegan report’s publication.

Here’s the long version: Fairfax Financial Holdings was first listed on the NYSE on December 20, 2002. During its first 15 trading days there, volume averaged well under 180,000 shares.

Then, on January 16, 2003 FFH volume exceeded 500,000 shares on an otherwise uneventful day in the life of a Canadian insurance company.

The next day, January 17, 2003 Morgan Keegan analyst John Gwynn initiated coverage of FFH with a scathing report and rating of “underperform”, making for one of the more eventful days in the lives of Fairfax shareholders, as their investments took heavy losses on extremely high volume.

Because information drives markets, one would expect to see extra activity in the wake of new information, such as that introduced by Gwynn on the 17th.

But what accounts for the unusually high volume observed the day before Gwynn’s report was published?

The answer to that question would come in October of 2008, when Morgan Keegan announced that Gwynn had been terminated for sharing his unpublished research on Fairfax with a small group of short-selling hedge funds.

Gwynn’s termination appears to be linked to the lawsuit Fairfax filed against several firms, including SAC, Third Point and Morgan Keegan alleging racketeering.

Email and trading data obtained through discovery in that suit conform that hedge funds Kynikos, Third Point, and SAC Capital all traded ahead of this material, non-public information.

It all started on December 11, 2002 when Kynikos employee Mark Heiman alerted Chanos that he had just learned from an analyst at Ziff Brothers Investments that a Morgan Keegan analyst was about to publish a negative report on Fairfax.

From: Mark Heiman (Kynikos Analyst)
Sent: December 11, 2002 11:06 PM
To: James Chanos (Kynikos President), Douglas Millett (Kynikos COO)
Subject: Fairfax
——————————————————————-
I just got off the phone with ZBI’s insurance analyst, Michael Ting. He just talked to a new insurance analyst at Morgan Keegan, and apparently that analyst is about to initiate FFRX at “Underperform,” with the thesis being that they are extremely under-reserved into the $3-$5 BN area. Also, there may be an article in Forbes or Fortune soon that will be similarly critical.
Ting said he thought that analyst was one of the best P&C analysts he has talked to, and wanted to give us the heads-up, as well as hear how we’re coming at it.

The next day, Kynikos employee Matt Cantrell apparently contacted Gwynn, as he sent Ting several documents relating to Fairfax subsidiaries, with the comment, “John Gwynn believes these might be of interest to you.”

Four days later, Heiman spoke to Gwynn personally, having a conversation which he summarized in the following report to Chanos:

From: Mark Heiman (Kynikos Analyst)
Sent: December 16, 2002 4:46 PM
To: James Chanos (Kynikos President), Douglas Millett (Kynikos COO), Charles Hobbs (Kynikos Managing Partner)
Subject: Fairfax
——————————————————————-
Just spoke to John Gwinn at Morgan Keegan, and he was more critical of FFRX than I’ve ever heard a sell side analyst. It looks like his criticisms of from the top to the bottom–everything from underwriting to accounting to dishonesty. He gave me his basics, as he is somewhat restricted because he hasn’t officially launched. It will be interesting to see how much of this the people who run the research department there will let him publish!

On December 18, 2002, Chanos forwarded Heiman’s email to Jeff Perry, then a senior portfolio manager at SAC Capital.

The day after Fairfax began trading on the NYSE, Gwynn’s revelations became much more explicit as he shared with Kynikos employee Heiman portions of his forthcoming report on Fairfax.

From: Mark Heiman (Kynikos Analyst)
Sent: December 21, 2002 6:03 PM
To: James Chanos (Kynikos President), Douglas Millett (Kynikos COO), Charles Hobbs (Kynikos Managing Partner)
Subject: Fairfax
——————————————————————-
Last night John Gwinn at Morgan Keegan faxed over to me an outline detailing the issues at FFH, basically those he will be publishing on. He has been a huge help and even offered to talk to me from his home today. We can look at these and talk to him next week–I just wanted to come in today and take a look at what he sent to get a head start on what he sent.

In the days to follow, Gwynn and SAC Capital Portfolio Manager Forrest Fontana held a face to face meeting where they discussed Fairfax.

Fontana followed up on that meeting via email to Gwynn:

From: Forrest Fontana (SAC Portfolio Manager)
Sent: January 06, 2003 8:57 AM
To: John Gwynn (Morgan Keegan Analyst)
Subject: RE: hope you had a nice holiday!
——————————————————————-
you available to touch-base on Fairfax sometime this week?

Followed by Gwynn’s prompt and eager reply:

From: John Gwynn (Morgan Keegan Analyst)
Sent: January 06, 2003 9:01 AM
To: Forrest Fontana (SAC Portfolio Manager)
Subject: RE: hope you had a nice holiday!
——————————————————————-
Name the time.

Fontana proposed a conversation the following day and requested a spreadsheet summarizing Gwynn’s analysis on Fairfax, which Gwynn promised to send.

On January 13, 2003 Fontana sent his boss, Steven A. Cohen himself, a summary of his planned activities for the week, which included:

Tuesday 1/14: Morgan Keegan expected to launch on Fairfax with sell rating – we will be covering into this.

As it turns out, Gwynn’s report was published on the 17th of January, not the 14th as Fontana expected. Still, it’s clear that SAC Capital was formally planning to trade ahead of the information received by Gwynn.

Trading records produced by Kynikos and Third Point all tell the same story: heavy short selling in anticipation of Gwynn’s report, and highly profitable short covering in the days that followed.

What did John Gwynn get out of all this? That’s unclear, though upon his firing, Morgan Keegan went to great lengths to say that Gwynn’s opinions were his own and not influenced by the hedge funds that profited from advance knowledge of them. We’ll likely never know more than that, as Gwynn reportedly passed away earlier this year.

The next question is: did Morgan Keegan get anything out of this arrangement?

The answer is yes: On December 21, 2002, the day after Kynikos received Gwynn’s unpublished analysis, Kynikos COO Douglas Millett declared his intention to begin sending business to Morgan Keegan.

Apparently, that’s how big hedge funds like Kynikos operate, which makes Chanos, who is also head of the Coalition of Private Investment Companies,  the logical person to lobby Congress as that body considers long-overdue reforms.

A few weeks after these emails were initially published here on DeepCapture.com, the Wall Street Journal reported “The Securities and Exchange Commission is investigating whether several hedge funds traded improperly after being given advance notice by a research analyst of his negative report on a prominent insurer.”

At the time, I made it clear that if anything became of that investigation, I would publicly eat my hat…not because of a lack of evidence of wrongdoing on the part of these hedge funds, but because — consistent with its captured state — it goes against the SEC’s culture to take action against big players.

Had these been small hedge funds acting illegally, the SEC’s version of civil justice would have most certainly been both swift and sternly-worded.

Wikipedia’s Jimbo Wales sees Gary Weiss sockpuppeting all over the internet

As is described at great length in these pages, Wikipedia has been one of the principal battlegrounds in the effort to cover-up the crime of illegal naked short selling.

For just over two key years, former journalist Gary Weiss dedicated an enormous amount of time and energy to the process of gaining control over and skewing the Wikipedia article on naked short selling. We know that given Wikipedia’s influence as a research tool – of journalists in particular – the heavily Weiss-influenced version of the article made it much more difficult than it should have been to get real reporting done on the issue.

Fortunately, as more and more Wikipedians came to see what Weiss was doing, an army of volunteers banded together to prove, beyond any doubt, the extent of Weiss’s deception. Their conclusion: Weiss created multiple Wikipedia identities (commonly known as “sockpuppets”) working in parallel to give the false impression of much more support for his position than actual existed.

This is a huge no-no on Wikipedia, and resulted in Weiss’s permanent expulsion from the project, and the liberation of the naked short selling article (though far too late to matter, as naked short sellers managed to destroy Bear Stearns exactly one month later).

If you’ve followed the Deep Capture saga for very long, that much you probably knew.

Now you’re going to hear the rest of the story.

For the purpose of what follows, you need to know that in 2007, Weiss’s two main Wikipedia sockpuppets were named Mantanmoreland and Samiharris.  In September of that year, a group of Weiss’s protectors decided to create a private mailing list in order to counter the efforts of the growing number of people already working together to expose Weiss, his lies and his enablers.

Included on that private list were Wikipedia’s founder Jimbo Wales and three or four dozen other members of the site’s inner circle. Just to complete the illusion, Gary Weiss also joined the list…twice, as both Mantanmoreland and Samiharris.

Some time ago, I was given many of the emails exchanged by what came to be known as the super-secret Wikipedia Cyberstalking list. What follows is an abridgement of one of them.

The thread begins with Weiss sock Samiharris lamenting the failure of an effort to silence Wikipedia editor Cla68, who had engaged in multiple attempts to make the article on Gary Weiss himself (which was, in fact, written by Weiss) read a little less like a promotional brochure.

The matter became so contentious that Jimbo Wales himself and Cla68 exchanged emails in an attempt to find some common ground. By the time that exchange was over, Jimbo wrote to the members of the Wikipedia Cyberstalking list:

“Cla68 has written to me, and what he has written confirms what I have thought for a long time… I am not the only sane and reasonable person who thinks it very likely that Mantanmoreland is Gary Weiss and who would be thrilled to have a proof otherwise.”

Shortly adding:

“If Mantanmoreland would properly identify himself to me and prove that he is not Gary Weiss, we could put all this to bed quite easily.”

Of course, Mantanmoreland (Weiss) did not appreciate this, and responded:

“I am disheartened by Jimbo’s private comments, disgusted by his handling of stalkers when they correspond with him, and have absolutely zero faith in his ability to properly handle stalker issues himself.  I am sorry, but this is something he should delegate to others. When he privately corresponds with a stalker like Bagley or a helper like Cla68 his heart melts and he gets all mushy. It has happened before and it has happened again. It’s not going to stop. Wikipedia’s handling of stalkers is going to fail as long as stalkers can make headway by privately corresponding with Jimbo.”

Jimbo’s slight mangling of Shakespeare can be forgiven by this, his pitch-perfect response:

“The queen doth protest too much, Gary.”

Weiss’s reply barely manages to contain his rage:

“Oh I missed the “Gary”. Please be sure to use that name every time you refer to me, as I want to be reminded of your behavior tonight…because tonight was the night you officially became a stalker.”

That’s right. Weiss, having found some success labeling me and everybody else intent on enforcing some accountability for his actions “stalkers”, actually applied the label to Wikipedia founder Jimbo Wales himself.

At that point, Samiharris (also Weiss, remember) decides to offer himself some support in condemning Wales:

“I have to sleep on it to absorb the magnitude of the founder of Wikipedia acting this way.”

With that, Mantanmoreland and Samiharris signed off.

The next day, Samiharris started a new thread, hoping to recast Mantanmoreland’s earlier attacks on Wales:

“At its very lowest point, Jimbo precisely replicated the tone and content of a [Wikipedia criticism site] Wikipedia Review attack. I mean that literally. His response to Mantanmoreland, calling him “Gary,” could have been made by [Wikipedia Review administrator] Somey.”

To this, Wales offered the response of his life:

“I am frustrated that Mantanmoreland has not been more helpful to us in confirming that he is not Gary Weiss.  I think that the evidence for that is insufficient for us to know for sure, but that on average it tends to suggest it.  I have proposed a few different ways that Mantan could resolve this, but he is unwilling to even consider it.

And I am frustrated with you for your repeated personal attacks on me and complete refusal to assume good faith.  Any allegation against me, no matter how trivial or unsupported by evidence, is accepted by you as fact.  I think that’s unfortunate.

That frustration caused me to be inappropriately blunt with Mantan. But the issue is real. My concern is that if Mantanmoreland is really Gary Weiss, then it is only a matter of time until this is proven…either by Bagley or someone else…and we will find that we have been manipulated in a pretty sad way.

The evidence that Weiss has sockpuppeted all over the Internet is pretty compelling, and even the mainstream press has commented over his refusal to directly address it. Is Mantan one of those socks? We have no proof either way, but I think the evidence tends to suggest it.

It upsets him that I think that, but there you go.  Speaking the truth as I see it seems to me to be the most simple and direct way to correct any errors that I may have.”

Of course, everything I alleged linking Weiss with Mantanmoreland and Samiharris eventually was very publicly proven, and as Wales predicted, the clout once enjoyed by Weiss’s inner circle defenders was forever diminished.

This exchange, and many others like it involving Jimbo Wales and Gary Weiss in his multiple forms, also convinces me that – contrary to what I have openly wondered in the past – Jimbo’s public denial of the Weiss/Mantanmoreland+Samiharris connection, despite his private acceptance of the same, was based primarily on a desire to avoid damaging Wikipedia, as opposed to any theorized influence brought to bear by his associates in the Chicago options trading community (where a key component of illegal naked short selling takes place). I was wrong about that.

There are a few other insights we can take away about Gary Weiss from this exchange.

• First, when backed into a corner, Weiss will reflexively and irresponsibly lash out at his accusers.
• Second, Weiss seems programmed to characterize any efforts at investigating his online misbehavior as “stalking.” That, together with cries of “anti-Semitism,” are the two most well-worn tools in his chest.
• And third, Weiss’s willingness – even eagerness – to go to great lengths to mislead all around him is pathological. He can’t help himself.

Put it all together, and it’s easy to see why Gary Weiss was the logical choice when proponents of illegal naked short selling sought a resolute apologist for their repugnant practice.