Followers of the twisted tale of DeepCapture may remember that on August 12, 2005, I gave a webcast of which I will always remain proud. It was titled, “The Miscreant’s Ball” (see slidedeck and accompanying transcript).  Contrary to popular “journalism” (if mindless back-and-forth parroting by hedge fund choagies Bethany McLean, Roddy Boyd, Herb Greenberg, Ron Insana, Joe Nocera, Carol Remond, Jessie Eisenger etc. of research so shoddy it would make sophomore poetry students blush can be called “journalism”), that talk did not primarily concern Overstock.  In fact, only 9 of the 40 slides (2 at the opening, 7 at the end) concerned Overstock.

The bulk of the Miscreant’s Ball presentation discussed the modern bear raid in the context of a web of relationships among a number of Wall Street players, including certain prominent hedge funds and journalists (relationships which I depicted as intersecting through Jim Cramer), a law firm named Milberg Weiss (which since imploded under a DOJ indictment), the SEC (which I claimed had stopped protecting the USA due to its having become hopelessly captured by Wall Street), Eliot Spitzer, and Kroll, a corporate intelligence service which was, I said, employed by hedge funds (which Einhorn has since confirmed) to build networks of corporate insiders (which may ring a bell if you are following the news now emerging regarding the recently indicted Raj Rajaratnam).

The original Miscreants Ball relationship web. Click to see full version.

The Machine went apoplectic in an attempt to spin, deride, downplay and obfuscate those claims, sacrificing with wild abandon all vestiges of journalistic ethics.  Their method of argument was simply to cover the Miscreant’s Ball as though it had only concerned Overstock (though less than 1/4 of it even mentioned Overstock). To a journalist, they utterly refused to cover, describe, or even mention the claims concerning this web of relationships, claims which formed 3/4 of the Miscreant’s Ball presentation. CNBC’s Ron Insana went so far as to trade taping an interview with me regarding these claims in return for access to affidavits supporting some of their aspects: once Ron Insana had the affidavits, CNBC refused to air the interview, and days later, the affidavits turned up in the hands of Roddy Boyd. How odd.

Their stylistic technique, mindlessly rehearsed with all the creativity and originality of a Lawrence Welk repeat, was to ridicule my use of the term “Sith Lord” (note to Hedge Fund Choagies Local 107: only stupid people pretend not to understand metaphors).  Doubtless, salting shibboleths into the presentation such as this and a few other moments of color was not as productive as I had hoped, for they proved insufficiently granular (i.e., they all tested out to be Ephraimites).

As a result, publicly I soon refined the metaphor to “Al Queda” (a network of people sharing operating methods and goals, but not necessarily communicating extensively). Yet when interviewers asked about the Sith Lord comment  (for example, see my correspondence with BusinessWeek’s Tim Mullaney, and numerous other interviews as well) I made a rule of including something along the lines of:

“I really think in terms of a composite of two people. Some day I might sack up and let the world know who the master minds are, but not now.”

I suppose I should have made it more obvious.  Because as far as I can tell, only the Bunny ever got the joke.

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

Reuters reports that Richard Choo-Beng Lee will testify that he “engaged in illegal insider trading while working at Steven Cohen’s SAC Capital, a Connecticut-based hedge fund.”

I’m predicting that much will be made of this development, and rightly so.

As you encounter conversations on this topic in the days to come, it is a good opportunity to point out that Deep Capture published irrefutable evidence of insider trading at short selling hedge funds SAC Capital, Kynikos Associates and Third Point Partners almost one year ago.

Read about it here: “Hedge funds reading tomorrow’s headlines today“

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

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

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

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

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

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

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

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

Rhino Trading Founder Damon Rein (on right)

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

But it happened.

In fact, it happened yesterday.

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

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

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

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

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

Brilliant.

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

Take that!

It was perhaps the single most important moment leading to the downfall of Bear Stearns.

On March 13, 2008, reporter David Faber, live on CNBC, said, “I’m told by a hedge fund that I know well…I’m told that [last night] Goldman would not accept the counterparty risk of Bear Stearns.”

Faber and that hedge fund might as well have flown an airplane into the side of Bear Stearns’s headquarters on 47^th Street.  Previously, there had been rumors about Bear Stearns, but this was the first time that anyone had stated as fact that a major bank was refusing to accept Bear Stearns risk. It wasn’t until Faber and that hedge fund unleashed the explosive news — right in the middle of a crucial interview with Bear Stearns CEO Alan Schwartz – that the run on the bank began.

This raises two important questions:  Which hedge fund told Faber that Goldman wasn’t accepting Bear’s counterparty risk? And, was the news true?

The answer to the second question is a definitive “No.” We know this because some hours later, Faber reported that, actually, “Goldman did say alright, now we will accept Bear as a counterparty.”  Oops. Of course, at this point it was too late – clients were fleeing Bear Stearns in mass, panicked by the news that Goldman might or might not have accepted Bear Stearns as a counterparty. The run on the bank had started, and Faber’s retraction did nothing to stop it.

To answer the first question, it is necessary to understand that short selling hedge funds often “foment” the markets by spreading incendiary information about the companies they are attacking. In a video sold to hedge fund managers and other high paying subscribers, CNBC’s Jim Cramer, a close associate of David Faber, once encouraged hedge fund managers to “foment.” He said, “Now you can’t foment. That’s a violation of…But you do it anyway because the SEC doesn’t understand it…This is actually blatantly illegal…But I think it’s really important to foment.”

It is also necessary to understand that one particular network of hedge funds has, for several years, have accomplished much of their “fomenting” by placing false or hysterical stories with a specific group of dishonest journalists. After the hedge funds have demolished a company’s stock price, they turn to those same journalists to cover up their misdeeds and present skewed versions of what happened to the company.

One of these journalists is Jim Cramer. Another is David Faber. A third is Roddy Boyd, formerly of Fortune magazine.  Roddy is particularly humorous because he unwittingly tends to reveal the miscreancy of his hedge fund sources. By reading between the lines of his stories and turning a keen ear to his public boasting, we can often discover nuggets of truth. So it is that Roddy has revealed the likely identity of the hedge fund that crashed that airplane into the side of Bear Stearns.

In a story published on March 28, 2008, Roddy repeated the assertion that Goldman had refused to serve as a counterparty to Bear Stearns. He noted that Goldman had stated this refusal in an email that Goldman sent on March 11, 2008. And in support of this assertion, Roddy quoted Kyle Bass, the manager of a Dallas-based hedge fund called Hayman Capital. “I was astounded when I got the [Goldman] e-mail…” Bass said to Roddy. “Goldman told Wall Street that they were done with Bear, that there was [effectively] too much risk. That was the end for them.”

Kyle Bass is known to be a close friend of David Faber. The two men worked together on “House of Cards,” Faber’s CNBC special documentary on the collapse of Bear Stearns. It appears quite likely that it was Bass’s hedge fund, Hayman Capital, that fed Faber the death-knell news that Goldman had refused to serve as a counterparty. And to convince Faber that Goldman had cut Bear off, it is likely that Hayman alluded to the same supposed “email”  from Goldman to Hayman that was later cited by Roddy Boyd.

Beyond these suppositions, the story gets a bit murky. Depending on whom you ask, there was either no such email, or there was an email, but it was an utterly routine email that merely stated that Goldman could not immediately process counterparty requests, but would do so in short order. While Roddy gives absolute credence to Bass’s claim that “Goldman told Wall Street that it was done with Bear Stearns,” he also states, in parenthesis, that Goldman denied that it had refused to accept Bear’s counterparty risk, which is another way of saying that Bass’s claim was an exaggeration to say the least.

In hopes of getting to the bottom of this, I called Hayman Capital. Hayman’s lawyer, Chris Kirkpatrick, told me that neither Bass nor anyone else at the hedge fund would comment on the matter. Apparently, Hayman only speaks to Roddy Boyd, David Faber and a few other journalists known to be tools of short selling hedge funds. Certainly, Hayman would not provide me with a copy of the famous email.

The most I could get out of Kirkpatrick was a vague statement that “what has been reported in the media is not accurate.” I do not know if he meant that Roddy’s story was inaccurate – that Bass, in fact, no longer claims that “Goldman told Wall Street that it was done with Bear Stearns.”  I do not know if he meant that it was inaccurate to suggest that Bass had received an email that said as much.

What I do know is this: at the time that Faber and his hedge fund source (probably Hayman) delivered that deadly blow to Bear Stearns, Goldman Sachs was accepting Bear Stearns counterparty risk. That is an absolute fact.

So here’s the kindest scenario:  Goldman at one point sent out some kind of email. It is possible that Goldman is lying (it does that sometimes), and this email did, in fact, state that Goldman would not serve as a counterparty to Bear Stearns. Or it is possible that the email stated no such thing. Either way, by the time of Faber’s report Goldman was accepting Bear as a  counterparty so the email was no longer relevant.

Although the email was no longer relevant, Hayman Capital was either confused or super-excited by said email, and in its tizzy, Hayman couldn’t control itself – it just had to call David Faber with the shocking news right before Faber was to conduct a life-or-death interview with Bear Stearns CEO Alan Schwartz. But that’s all it was – an innocent tizzy. Hayman certainly did not mean to spread inflammatory information about Bear Stearns.

The other scenario is that a cabal of hedge funds, including Hayman capital, orchestrated a “conspiracy” to destroy Bear Stearns for profit. That is the scenario that Bear Stearns’ former CEO, Jimmy Cayne, laid out for Fortune magazine. When a Fortune reporter (not Roddy Boyd) quoted Cayne’s “conspiracy” remark, Hayman Capital’s lawyer, Kirkpatrick, wrote a letter to Fortune in which he stated that “Cayne’s rant” was a “feeble attempt to deflect blame…”

Hayman’s lawyer added that Hayman “did not have any positions in Bear Stearns’ securities at the time of its failure…In short, Hayman did not stand to profit from [Bear Stearns’s] failure.”

Because our markets are defined by their opacity there is no way to confirm whether Hayman had any “positions in Bear Stearns’ securities” or any other kind of bet against Bear Stearns. The SEC does not require hedge funds to report their short sales, their credit default swap positions, or any of the myriad other derivatives by which a hedge fund might profit from the demise of an investment bank.

But given that Hayman reportedly was betting big  iagainst subprime mortgage derivatives, and given that the value of such derivatives plummeted as the result of the Bear Stearns fiasco, it is a bit disingenuous for Hayman to suggest that it “did not stand to profit” from Bear’s failure.

Moreover, Hayman failed to mention that one of its most important investors was Dan Loeb, manager of a hedge fund called Third Point Capital. As Deep Capture has detailed elsewhere, Loeb is very much a part of that network of short sellers that has habitually disseminated false information through a clique of dubious journalists, including David Faber and Roddy Boyd.

Most of these hedge fund managers, including Loeb, are connected in some way to the famous criminal Michael Milken or his close associates. (Loeb worked side-by-side with many of Milken’s former traders at Jefferies & Co., and got his first big break by obtaining preferential access to certificates of beneficial interest that had been issued by Milken’s bankrupt operation at Drexel Burnham Lambert). And members of this network, including Loeb, were by far the biggest short sellers of Bear Stearns stock.

Most of these hedge funds invest in smaller hedge funds with the expectation that the smaller hedge funds will somehow participate in their attacks on public companies. I do not know what preconditions came with Loeb’s investment in Hayman, but I think it’s fair to say that Hayman is an honorary member of the network.

As a measure of the lengths to which this network goes to spew false information, consider that Loeb once contracted with an outfit called Magic Consulting – owned by convicted stock manipulator Michelle McDonough (formerly Michelle Sarian). Emails obtained by Deep Capture show that McDonough’s job was to coordinate a stable of internet stock message board posters and journalists who bashed stocks shorted by Loeb and his friends. McDonough was herself a fairly prolific message board basher, prior to going to prison.

One of the internet message board bashers in McDonough’s stable was Floyd Schneider, a former employee of a Mafia-connected short seller named Anthony Elgindy, who is currently serving an 11-year sentence for short selling crimes. One of the journalists in McDonough’s stable was the above-mentioned Roddy Boyd.

In one email to Schneider, Roddy refers to McDonough as “our mutual best friend.”

So we might question Roddy’s version of the Goldman email story. We might question Roddy’s relationship with Hayman Capital. We might question Hayman Capital’s relationship with Loeb and his network of “fomenting” short sellers. And we might also question whether these short sellers deliberately set out to destroy Bear Stearns.

Actually, it is not we who must question. It is the SEC. But as Jim Cramer said, the SEC “doesn’t understand.”

SB 605 is a bill on Capitol Hill

Something of great importance in our effort to finally end illegal naked short selling took place recently.

Senator Ted Kaufman of Delaware, together with three colleagues, distributed a letter to the remaining 96 members of the Senate formally requesting co-sponsors for SB 605: A bill to require the Securities and Exchange Commission to reinstate the uptick rule and effectively regulate abusive short selling activities.

You can find a copy of the letter and the bill itself here.

This is a very good sign that this most vital bill has momentum. However, this is always a very tenuous time for any bit of nascent legislation. That’s why I encourage all supporters of true market reform to contact their US senators (remember you each have two!), encouraging them to co-sponsor Senate Bill 605.

Every additional co-sponsor’s name added to the bill reduces the likelihood that backroom shenanigans — something at which our adversaries are experts — will kill our best opportunity for true reform yet, while still in its cradle.

Please reach out to your senators today. Click here to find his or her contact information.

“Telling the truth is only possible by accident through a special sort of boastfulness…”

- Fyodor Dostoevsky, “The Idiot”

Regular readers of Deep Capture are aware that we have sought to expose certain journalists who seem to serve the interests of a network of market miscreants, many of whom are tied to the famous criminal Michael Milken or his close associates.

One of these journalists is Roddy Boyd, who worked at the New York Post before moving to Fortune magazine. It has come to our attention that Roddy has left Fortune. The magazine did not return a phone call seeking comments on the circumstances behind his departure, but whatever those circumstances might be, it seems fit to honor his departure by publishing an excerpt from a book called “House of Cards.”

In this book, which is written by a Wall Street insider named William Cohan, Roddy is quoted at length, and one particular passage stands out for being quintessentially Roddy. While you are reading the passage, keep in mind that I spent a number of hours talking to Roddy some years ago, and can report that he has a manner of speaking that is similar to what Dostoevsky called “a special sort of boastfulness” –which is to say that Roddy likes to stroke his own back, and in so doing, he often rambles in such a way as to unintentionally admit to his own buffoonery, or to some form of miscreancy on the part of his favorite Wall Street sources.

In this passage, Roddy tells the story of certain communications he had with Tom Marano, Bear Stearns’s top mortgage trader, on March 6, 2008 – a few days before false rumors began swirling about Bear Stearns’s access to credit. The following week, the false rumors were rampant, and those rumors, along with naked short selling, quickly brought Bear to its knees.

A couple of weeks after the collapse of Bear Stearns, Marano found a new job – with Cerberus Capital Management. As I have detailed elsewhere, Cerberus is run by Steve Feinberg, who was once one of Michael Milken’s top traders at Drexel Burnham. After working for Milken, Feinberg moved to Gruntal & Co., a criminal-infested brokerage, where he worked closely with Steve Cohen, who was once investigated by the SEC for trading on inside information fed to him by Michael Milken’s staff at Drexel.  Cohen now runs SAC Capital, believed to be one of the biggest short sellers of Bear Stearns’s stock.

I am not yet going to state what I think is important about the passage quoted below. But I have other reasons to believe that the facts that Roddy drops in the course of his braggadocio are key to understanding what happened to Bear Stearns. Read the passage yourself, focusing on the facts, not on Roddy’s version of the facts. Consider that Roddy’s conversation with Marano took place on March 6, when there were not yet any rumors in the market, and Bear’s stock was trading above $60. Then, let me know if you spot what’s important.

Here’s the passage:

“…at eleven in the morning on March 6 Marano placed a phone call to Roddy Boyd, then a writer at Fortune. Marano had been a source of Boyd’s for years, when the journalist was covering Wall Street at the New York Post, and had freely offered commentary about his competitors and the markets generally. Boyd had been a trader for eight years before switching careers to journalism, and the two men spoke the same language. ‘I know the mortgage product dead cold,’ Boyd said. Their relationship was a well-defined pas de deux.  ‘It was unusually well defined,’ [Boyd] explained. ‘We knew exactly what we were saying. I could have a very long conversation in two minutes. I protected him always. I never BS’d with him. I never got him in hot water. The corollary was he never BS’d with me, and he would give me good stuff.’

“This time, Marano called Boyd to talk about Bear Stearns, and specifically about his concern that the firms he had traded with for years were suddenly asking him whether Bear had enough cash on hand to execute his trades. ‘He called me at 11:00 A.M. that day and we talked about one or two things,’ Boyd continued. ‘It was weird. He knew it was weird. We did small talk in under ten seconds. I said to him, ‘What’s up?’ He said, ‘What are you hearing about Bear?’ I said, ‘You know what I’m hearing and you know what I’m seeing. He said, ‘I know what you’re hearing and you’re seeing. It’s just baffling.’ Now here I’m playing him a little because I’m hearing things and I’m seeing some things, but he’s not saying much more than I am, so I let him walk and talk. He said to me, ‘Roddy, our guys, our senior guys here, are hearing a really strange thing from custies.’ That’s customers. He said, ‘We were not prepared to hear stuff like this. This is baffling. People are quite literally questioning our solvency, questioning our ability to go on. The shorts are having a lot of fun with us today.’…

“‘He’s thinking two things,’ Boyd continued. ‘One, he’s got to stop this whole line of inquiry right here, right now, because if you have to ask the question, oh my God. Second, he’s thinking about the trajectory of rumor and supposition, and that thesis of smoke versus fire….With a question of their ability to act as a counterparty on the table, that’s unimaginable. I mean, this is Bear Stearns….Now they’re being questioned from the standpoint of fundamental liquidity. He [Marano] said that he believed that these short sellers had been speculating in the credit default swap market and telling counterparties at other firms that they had concerns about Bear Stearns’s liquidity and solvency, and that was driving the cost of spreads wider. What that was doing was making their overnight funding more expensive. That was cutting into their profit margin, and in turn was also starting a sort of cottage industry of rumors about Bear Stearns.’

Roddy continued: “‘There’s no need to explain anything between us,’ he [Marano] said.  I said, ‘Are you sure you’re seeing this?’ He said, ‘Look at [the credit default] swaps.’ So I looked them up and then I see the hockey sticks’ –  a sharp spike up in their cost… ‘He said, ‘It’s unbelievable. It all bullshit.’ At that point—he’s very much a corporate guy—but he had left me [with a clear message]. I’m not stupid. Hedge funds and prime brokerage accounts are unusually skittish about questions of financial health, financial solvency, and he said, ‘I’m hearing there’s questions about our financial health.’ At that point, Marano is telling me he knew he was done, because once that question of credibility goes out there, and serious people say it to you enough, you’re done. It’s all that there is to it. It’s all that there is to it. Where do you go to get your reputation back.’ …

“Boyd worked hard [the following night] and over the weekend trying to figure out which bank—said to be European—had decided it would no longer be a counterparty to Bear Stearns in the overnight financing markets. Obviously, this would be a huge negative development for the firm…‘At that point, I’m pulling my fucking hair out—pardon my language—calling everybody,’ [Boyd] said. ‘I’m calling Deutsche Bank, I’m calling UBS, and I’m very aggressive. Get your senior guys on the phone. Get your financing desk on the phone. I don’t want to talk to some stupid flack. I spent eight years on a desk. I’m smarter than all those flacks. They’re all Kool-Aid drinkers. They don’t honestly know a derivative from a bond from a stock. None of them are going to be able to ask their financing desk. They don’t even know enough to call the repo guys on the financing desk. I told them, Get your financing guys or get your credit guys on the phone with me, or you’re going in Fortune. Here’s the New York Post coming out of me. I said, There’s two ways this is going to work: bad or good. This hand is good; this hand is bad. I shake your hand or I punch you. Let me know…I’m talking to the guys in New York, and they’re saying, We swear to Christ we are not the ones to have done that [cut financing]. If Deutsche Bank had done it, I’m thinking, ‘Okay, that’s the story right there.’ The minute a repo line gets pulled, you die, okay? They die a terrible death.’…

Roddy continued that, after the March 6 call with Marano, ‘“I was thinking, I’m going to poke around in this more…but then I was thinking, This is strange. This is like a situation where you can abuse your position as a reporter. When you’re at Fortune, you have to do stuff right. When you’re at the New York Post, you have to be there first and fastest. At Fortune, you write the first draft of history, and you have to get it right and you have to be consistently right. I’m thinking, I don’t really want to screw with this company – I don’t want to spread rumors. I don’t want to become part of the story. I don’t want to hurt people unnecessarily. I’m an aggressive guy and I’ll pick fights with anyone or anything, but there’s a right way of doing my job and there’s a wrong way. I weighed my duty as an employee here versus the right thing to do.”

Do you see what happened here? Feel free to post your opinion in the comments section. Or contact me privately by email at mitch0033@gmail.com.

As should be clear from the contents of Deep Capture, the world of illegal naked short selling is a weird one, populated by sociopathic billionaires, slick lobbyists, famous felons, bent regulators, crooked law firms, corporate spies, message board maniacs, sinister banks, shifty private investigators, mendacious professors, professional dissemblers, propagandists, grifters, thugs, liars, and the Mafia.

Things become all the more weird when you consider that regulators and law enforcement do almost nothing to stop naked short selling, even though a growing number of prominent people – everyone from U.S. Senators to George Soros – insist that criminal naked short sellers helped take down Bear Stearns, Lehman Brothers, and the American financial system. Then there’s the weird fact that anybody who tries to shed light on this weird state of affairs is quickly subjected to smear campaigns that are…weird.

Anyway, message to Matt Taibbi: Welcome to our world.

Taibbi, as many people know, is the star reporter who published a major expose about naked short selling in the most recent issue of Rolling Stone magazine. In addition, he has published a few blogs providing more evidence to support his claim that illegal naked short selling is a big deal and it’s pretty “hilarious,” as he puts it, that the government hasn’t prosecuted the people who might have helped crash the financial system.

In one of his blogs (which you can read here), Taibbi posts a video that seems to show a day trader conducting a short sale of stock in an unnamed big bank through a brokerage called Penson Financial. The SEC says that short sellers have to have “reasonable grounds” that they can locate actual stock to deliver to their buyers. As Taibbi rightly points out, this is a “very  funny piece of regulatory policy – asking greedy ass financial companies to determine what to them is a ‘reasonable’ effort to follow the rules. “

At any rate, if you believe what you see in Taibbi’s video, Penson Financial gave that day trader a phony “locate” on quite a few of the unnamed big bank’s shares. In fact, the video seems to show Penson Financial confirming that it had “located” many billions of the unnamed big bank’s shares – altogether, five times as many shares as were then in circulation. In other words, it seems that if this trader had had the inclination and the funds, Penson would have accepted a massive naked short sale, helping the trader flood the market with billions upon billions of shares that simply did not exist.

This is rather important, because Deep Capture has reviewed evidence showing that little Penson Financial and one other relatively unknown firm were by far the biggest traders in financial stocks in the first nine months of last year, handling more than 80 percent of volume. To repeat, Penson Financial, a little firm in Dallas, Texas, and one other relatively small firm handled by far the biggest volume of trading in the stock of all those big banks that collapsed last year, leading to the worst financial crisis since the Great Depression. When it came to clearing trades in financial stocks, Penson was bigger than Goldman, bigger than Merrill, bigger than every major brokerage on Wall Street.

We do not know for certain that the trading through Penson was naked short selling. We know only that naked short selling accounted for much of the overall trading last fall in companies like Lehman Brothers. And we know that a preponderance of the overall trading went through Penson. Perhaps Penson carefully weeded out the naked short sellers, in which case it handled almost all of the trading in financial stocks except for naked short selling. But if Taibbi’s video is any indication, Penson was certainly willing to locate stock that did not exist.

If I have anything to add to Taibbi’s terrific reporting, it is this: Penson Financial’s vice president in charge of stock clearing (that is, the head of the division that appears to have located stock that did not exist) is a man named Christopher Sandel. From 1985 to 1995, Sandel was a top executive at Adler Coleman, best known for being the clearing firm to the Genovese Mafia family.

Adler Coleman famously went bust when its top customer, the Genovese-controlled brokerage Hanover Sterling, self-imploded in one of the greatest naked short selling scandals of all time. Several traders tied to the Gambino crime family were charged with naked short selling companies that were underwritten by Hanover. That the Genovese Mafia brokers at Hanover were not charged in this case seems odd, because the most likely scenario is that the Genovese underwrote hapless companies, pumped their stock prices, and then called in the Gambinos to vaporize the companies, with everybody profiting on the way down.

Anyway, when some of America’s biggest financial companies collapsed under a barrage of short selling last fall, an enormous chunk of that trading was being cleared by a fellow who used to work for a company that seemed to specialize in clearing trades for the Mafia. Should this concern us? Might the Mafia have played some role in the collapse of the financial system? If I were more heavily armed, I would venture an opinion.

Now, of course, there is a concerted effort to portray Taibbi as a sucker, and his video as a fake. One blogger who has suggested as much is Gary Weiss, a former BusinessWeek reporter. As we have documented elsewhere on Deep Capture, Gary Weiss is a corrupt pseudo-journalist whose sources have included naked short sellers with ties to the Mob. Among Gary’s favorite sources were John Fiero (fined $1 million in Hanover Sterling scandal), Anthony Elgindy (currently serving an 11 year prison sentence for short selling crimes and alleged to have had his finger sawed off by Russian mafiosi who were concerned that he would become a government informer), and Manuel Asensio (who once worked for a Mafia-controlled brokerage called First Hanover).

Weiss has reported extensively on the Mafia’s infiltration of Wall Street, but he has, for years, insisted that only conspiracy theorists believe naked short selling is problem. He wrote a great deal about Hanover Sterling, but not once did he mention that naked short selling was central to that case. In his book, “The Mob on Wall Street,” Weiss told the story of a Genovese Mafia broker, and mentioned that this Mafia broker claimed to clear his trades through none other than…Penson Financial.

But, of course, Gary insisted that the Mafia broker must have been lying, because Penson is a “legitimate firm.”

Meanwhile, a blog called ClusterStock has also suggested that Taibbi’s video is a “hoax.” Taibbi has written a fine rebuttal to that claim (which you can read here), so I have nothing to add, except that ClusterStock was founded by Henry Blodget, who was famously charged with securities fraud in 2002, and by the former co-owners of DoubleClick, a company that was once defrauded by the Colombo Mafia family. DoubleClick was never charged with any crimes, as it was, alas, the victim.  Such is the sad fate of many firms that  have business dealings with the Mafia (of course, this fate may be avoided by adhering to a simple dictum: “Avoid having dealings with the Mafia”).

I tell you this not because I think there is some kind of conspiracy, but  merely because I am fascinated by the always colorful biographies of people who attack those who seek to expose the crime of naked short selling. Blodget is, by all accounts, a reformed criminal, and I’m sure the other people at ClusterStock  are law-abiding people. Gary Weiss would be perfectly innocent, too — except that he’s an out-and-out fraud.

Recently, Deep Capture reporter Judd Bagley revealed that Weiss was the anonymous author of a blog on the popular website Daily Kos. This blog, of course, denied that naked short selling is a crime, while smearing those who said otherwise. To support its smears, the blog, written by the anonymous Gary Weiss, referred readers to another blog, written by none other than Gary Weiss.  Indeed, Gary Weiss has had a great many phony on-line aliases, and all of these Gary Weiss aliases proclaim that Gary Weiss is right and great.

In a variation of this on-line chicanery, ClusterStock’s writers littered the comments section of Taibbi’s blog with allegations that his video was a “hoax.” To support these allegations, the ClusterStock writers provided links to another blog…ClusterStock. Presumably, Gary Weiss will also provide links to ClusterStock. Oh wait, he already did that.

Meanwhile, Penson Financial, has written a letter to the SEC, suggesting that Taibbi’s video was (what else?)…”a hoax.”  In the letter, Penson Financial, which was fined in 2006 for naked short selling, promises that it does not engage in naked short selling.

The SEC no doubt believes this.

Matt Taibbi has published a story in Rolling Stone magazine that nobody should miss. It’s not yet available on-line, so you’ll have to pick it up at the newsstands, but here’s a quick summary.

Taibbi writes:

“On Tuesday, March 11^th, 2008, somebody – nobody knows who – made one of the craziest bets Wall Street has ever seen. The mystery figure spent $1.7 million on a series of options, gambling that shares in the venerable investment bank Bear Stearns would lose more than half of their value in nine days or less. It was madness – “like buying 1.7 million lottery tickets,” according to one financial analyst.”

Bear’s stock would have to drop by more than half in a matter of days for the mystery figure to make a profit. And that is what happened.

As Taibbi explains, “the very next day, March 12, Bear went into a free fall…Whoever bought those options on March 11^th woke up on the morning of March 17^th having made 159 times his money, or roughly $270 million. This trader was either the luckiest guy in the world, the smartest son of a bitch ever or…Or what?”

Taibbi speculates (as has Deep Capture) that these options might have been purchased by somebody who was abusing the options market maker exemption to engage in illegal naked short selling. And Taibbi goes beyond speculation to state, as an obvious fact, that illegal naked short selling helped bring Bear Stearns to its knees.

Presumably operating under that assumption, the SEC issued more than 50 subpoenas to Wall Street firms in the wake of Bear’s collapse, but “it has yet to indentify the mysterious trader who somehow seemed to know in advance that one of the five largest investment banks in America was going to completely tank in matter of days.”

Taibbi continues: “The SEC’s halfhearted oversight didn’t go unnoticed by the market. Six months after Bear was eaten by predators, virtually the same scenario repeated itself in the case of Lehman Brothers – another top-five investment bank that in September 2008 was vaporized in an obvious case of [naked short sellers engaging in] market manipulation. From there, the financial crisis was on, and the global economy went into full-blow crater mode.”

Taibbi notes that there were many other factors that made the economy weak. But he says that naked short selling is what pushed Bear and Lehman over the edge. If it weren’t for naked short selling – a massive “counterfeiting scheme,” in Taibbi’s words — those banks would likely have survived, and we might have avoided an all-out financial catastrophe.

This cannot be stressed enough. Criminals deliberately destroyed two of America’s biggest investment banks, precipitating the greatest financial cataclysm since the Great Depression. And the government has done absolutely nothing to bring those criminals to justice. In fact, as Taibbi makes clear in his story and on his blog, the most likely culprits are feted by top government officials in closed door meetings.

I’d call this the biggest financial and political scandal in the history of this country.

Certainly, it is, as Taibbi writes, “one of the most blatant cases of stock manipulation in Wall Street history.” Certainly, it is, as Taibbi writes, “the two biggest murders in Wall Street history.” And, certainly, it is odd that this very big story has appeared in Rolling Stone, but has yet to be covered by a single mainstream news publication.

The Wall Street Journal, The New York Times, Fortune, BusinessWeek – they have all known about naked short selling since Deep Capture reporter Patrick Byrne began hollering about it in 2005. But none of them write about it. Instead, we find a competent financial journalist, and the only major story about one the greatest financial crimes of all time, published in a slightly alternative magazine about music.

I worry for the Republic.

* * * * * * * *

I’m usually a real optimist. Sometimes to a fault, according to my more balanced wife. But when it comes to financial market reform, I’ve devolved into a deeply cynical pessimist.

Too many stinging disappointments, I suppose.

Too many instances of people behaving badly, to be certain.

But as they say, there’s some value in expecting the worst…you’ll never be disappointed.

And so it was with today’s second and concluding session of the SEC’s roundtable on securities lending and short selling: I expected the absolute worst, but in the end was pleasantly surprised to find that it wasn’t quite as bad as I feared.

That’s not the same as proclaiming it a good thing, because it was not. Indeed, I stick by yesterday’s characterization of the event as farce with a pre-determined outcome.

Having said that, I was deeply impressed by two surprises I clearly had not anticipated. And I’ll get to those in a moment.

But first, an overview.

There were two panels. The first examined proposed pre-borrow and hard locate requirements — keys to closing two of the most dangerous remaining loopholes in the US stock settlement system. The second panel examined proposals requiring enhanced disclosure of short selling data — a good idea but ultimately one that would be much less necessary were the proposals discussed in the first panel enacted.

I’ll start with the second panel, which surprised me by coming down overwhelmingly in favor of more transparency in short selling.

Georgetown University Professor James Angel pointed out that greater disclosure would essentially be doing legitimate short sellers a favor, by vindicating them in cases when they are incorrectly accused of manipulation in response to stocks dropping in value.

David Carruthers, of short selling analytics firm Data Explorers, supported greater transparency in short selling where the goal was to “prevent market abuse and prevent the development of a false market, or to prevent situations where market participants take advantage of a vulnerable company.”

Richard Gates, founder of short selling hedge fund TFS Capital, denied that shorting exacerbated the onset of the current financial crisis, but went on to concede that there should be greater disclosure parity on the short and long sides of market activity.

Michael Gitlin of investment manager T. Rowe Price echoed the position of Professor Angel in saying real time reporting of short versus long sales would result in the “demystification of short selling,” adding, “The ongoing debate of what caused an individual security to decline would largely disappear with this added level of transparency.”

As the lone issuer represented on the panel, Jesse Greene, Vice President of Financial Management at IBM, was enthusiastically in favor of a general overhaul of the SEC’s short selling regulatory framework, including public disclosure of short positions, in order to “improve market stability and restore investor confidence.”

Joseph Mecane, Executive VP at NYSE, noted that market fragmentation has made it more difficult to detect manipulation, requiring regulators have access to more short selling data in order to better conduct market surveillance.

In other words, the second panel was a slam dunk in the right direction.

The first and ultimately more meaningful panel, on the other hand, was the Yin to the second panel’s Yang.

Appropriately enough, Managing Director of the Equities Division at Goldman Sachs William Conley kicked things off, lamenting that “both the pre-borrow and hard locate requirement would require significant infrastructure builds on the part of the industry as well as its participants.”

By “infrastructure builds”, Conley is referring to the development of new software able to track down real shares for short sellers to borrow. He seems to have forgotten three things:

1. When there’s money to be made, Goldman Sachs has a rare talent for developing extremely complicated software. Could it be that Conley never met former co-worker Sergey Aleynikov?
2. LocateStock.com, then a bootstrapping startup, developed software that accomplishes precisely the same task Conley regards as so burdensome, on a shoestring budget.
3. If Goldman Sachs has enough cash on hand to spend nearly $12-billion in employee bonuses this year, it can probably set a couple hundred thousand aside to write some crumby software.

As I predicted yesterday, much of the balance of Conley’s mic time was spent echoing the anti-reform talking points currently being circulated on Capitol Hill by his employer’s army of lobbyists — in some cases, verbatim.

William Hodash, Managing Director at DTCC, took us on a trip to his organization’s mindset circa 2005 by pointing out that fails to deliver are not necessarily evidence of naked short selling. With one foot remaining firmly in 2005, another in 2009 and a third in a pile of his own illogic, Hodash then said that the reduction in fails observed before and after the SEC’s implementation of Rule 204 “may be relevant to the discussion of whether naked short selling remains a problem.”

No, you didn’t miss anything. That’s what he said, with all remaining panelists basically pleading some variation of the on his and Conley’s approaches.

With one very prominent exception: Dennis Nixon, Chairman of International BancShares Corporation (IBC).

Looking at the program, I had assumed that IBC’s role on the panel was that of a broker or other market intermediary. Well I was very wrong. IBC was there in the role of an issuer targeted by naked short sellers, and Nixon very poignantly expressed the anguish of someone in his position, after a 45-day long bear raid removed $1.2-billion in IBC shareholder value.

“And I think it was all attributed to this predator-type short selling that goes on in this market today that’s uncontrolled. It’s unbelievable,” Nixon said.

That was the first surprise.

The second surprise came from an even less likely source:Commissioner Elisse Walter.

Mostly silent throughout the previous day’s panels, today Walter made it clear that she’s not buying the excuses offered by industry representatives insisting this problem is too much for them to tackle.

“I’m sort of surprised that the industry hasn’t come up with a solution, particularly as this controversy has continued to swirl and does not go away,” Walter said, adding that by failing to address the issue, the industry is essentially passing the cost of non-compliance on to the SEC’s own Division of Enforcement.

I think she’d make a stronger case had the Enforcement Division brought more than two cases against naked short sellers in its entire history, but that’s a topic for another post.

The bottom line is, this panel was undeniably stacked against any additional meaningful steps to limit illegal naked short selling, but the contributions of Dennis Nixon and Elisse Walter were as welcomed as they were unanticipated.

The entire affair could have been much better, but also could have been much worse.

Deep Capture goes to Washington.

(Washington, DC) The SEC’s roundtable on securities lending and short selling got started today, and Deep Capture was there.

What follows is my assessment, based on my observations thus far.

In the simplest terms, I’d say the situation at the SEC is one of extreme disconnection. This is an agency that has completely lost track of its founding mission.

The day consisted of four panels, all dedicated to examining different aspects of securities lending. The panelists included one academic, one public employees’ pension fund manager, the CEO of FINRA, and 20 representatives of hedge funds and brokerages or companies that provide services to hedge funds and brokerages.

Not a single representative or advocate of retail investors had a voice on any panel, and the substance of the panelists’ comments was consistent with the thinking that obviously called them all together: the discussion never got beyond reforms to benefit the institutions that get rich from lending out the shares entrusted to them by the rest of us.

Nor did retail investors get any more than a passing reference in any other context. The industry was there to talk about the needs of industry. Period.

The result was eight hours of possibly the least interesting discussion I’ve voluntarily endured. In fact, it more resembled two dozen high school book reports on a handful of facets of a single industry, as the same thing was said over and over in the lest interesting way possible.

For eight hours.

Meanwhile, the subject that really matters: illegal naked short selling, is scheduled for just three hours tomorrow (including a break!), with panelists hailing from four hedge funds, Goldman Sachs, DTCC, the Security Traders Association, NASDAQ, NYSE, one academic, and one fish-out-of-water from IBM.

Is there any question how those panels are going to come down on the issue?

This entire exercise, I’m nearly prepared to declare, is little more than a farce.

Lest I leave you with the impression that everything was devoid of meaning, allow me to recount one of those moments of cosmic synchronicity that make days like today all worthwhile.

It happened during the fourth panel. Specifically, during the opening remarks given by Leslie Nelson (yes, a male, but sadly no, not the guy from The Naked Gun movies), Managing Director of Global Securities Lending at Goldman Sachs.

Just as Mr. Leslie Nelson was beginning to talk, about 15 of you emailed me a link to Matt Taibbi’s recent post where he announced that naked shorting will be a major component of his upcoming piece in Rolling Stone.

Included in that post was a link to a pamphlet apparently being circulated broadly on Capitol Hill by Goldman Sachs lobbyists, intent on preserving the status quo with regard to loopholes permitting illegal naked short selling. Trusting my audio recorder not to miss anything, I decided to tune Mr. Nelson out slightly to read the words of his notorious employer.

In the Goldman pamphlet, the first sub-point of bullet point one reads:
“Rule 204 of Regulation SHO has been effective at reducing fails in the marketplace.”

At precisely the same time read that line, I heard Nelson read the following from his prepared statement (prefatory to what — consistent with the rest of the day’s panel — had nothing to do with delivery failures):
“Rule 204 has been undeniably effective at bringing US equities fails to levels that are truly de minimis.”

See…I read and heard those lines at precisely the same moment.

It was as though the Goldman Sachs government relations team had briefly hijacked my eyes and ears.

It’s also indicative of how very seriously Goldman is taking this challenge to what is likely one of that company’s most plumb sources of revenue.

Finally, I’d say it’s predictive of the message what we can expect to hear repeated over and over again as the issue makes its was earnestly through Congress and flaccidly through the SEC.

You know, I do not drink, but if I did, I’d suggest everybody take a shot whenever they hear that phrase repeated during the three short hours (including a break) of the roundtable’s second and final day. That might just make the thing tolerable.