It’s been a long time coming, but the guys with guns and badges might soon be slapping handcuffs on some of Wall Street’s most destructive miscreants. According to a report posted over the weekend on The Wall Street Journal’s webpage, “Federal authorities are preparing insider-trading charges that could ensnare consultants, investment bankers, hedge-fund and mutual-fund traders and analysts  across the nation…”

The New York Times on Sunday followed up with its own report, quoting Preet Bharara, the United States attorney in Manhattan, who bemoaned “the lengths to which corrupt insiders will go to misuse confidential information for their own personal gain.” As the Times noted, the rhetoric is reminiscent of the 1980s, when the Feds busted the massive stock manipulation and insider trading ring led by the famous financial criminal Michael Milken – and, indeed, it might not be a coincidence that this weekend’s announcement of imminent indictments came exactly 20 years after Milken was sentenced to prison.

The names of some of the hedge funds mentioned in the press as likely DOJ targets – hedge funds like SAC Capital and Ziff Brothers – will be completely familiar to readers of DeepCapture.com. In fact, this website was founded in large part to expose the depredations of precisely this network – a network that has its origins (at least to some extent) in the criminal enterprise that Michael Milken built in the 1980s.

As we have long explained, this network not only regularly trades on inside information, it has pioneered new variations of the practice by, for example, manufacturing information (often false) which they can front-run in the market, employing abusive (and likely illegal) short selling techniques to manipulate the stock of public companies; and “capturing” some of the institutions this nation relies upon to curtail such behavior.

Most notable among these institutions are the financial press (large swaths of which have grown inappropriately close to precisely this network of hedge fund managers), and the SEC, which has not only failed in its regulatory duties, but has often assisted the hedge funds’ schemes by launching misguided (and go-nowhere) investigations of the companies the hedge funds have targeted, and providing the hedge funds with confidential information about those investigations.  All of this has been thoroughly documented within the pages of Deep Capture.

It was more than five years ago that Overstock.com CEO and future Deep Capture founder Patrick Byrne first gave a famous public conference call that he dubbed “The Miscreants Ball”. With more than 500 Wall Street executives and a few journalists listening in, Patrick outlined the existence of a “network” of miscreant hedge funds and “independent” financial analysts that he said was using underhanded methods to trade on privileged information and do serious damage to the financial markets.

In “The Story of Deep Capture”, we sought to explain the origins of the Deep Capture project by telling the tale of our extensive (and at times, arguably over-the-top) investigation of this network of hedge funds – a network that included SAC Capital (whose founder, Steven Cohen, was investigated by the SEC in the 1980s for trading on inside information given to him by Milken’s shop at Drexel, Burnham), Ziff Brothers, and others. This story was (I admit) exceedingly  long – it demanded its readers’ patience – but it provided plenty of detail of how the network operates.

Among the tactics we cited in that story was the use of so-called “independent” experts – experts who had been hired by hedge funds to ferret out inside information about companies targeted by the hedge funds, or to badmouth companies the hedge funds were selling short. It now appears that the Feds have themselves independently discovered how these “expert networks” actually operate and, as a result, some of these “experts” seem to be looking at possible jail time.

Another tactic we detailed at length was the use of supposedly “independent” financial research shops, such as Gradient Analytics, which were, in fact, in the business of publishing spurious reports for the benefit of their hedge fund clients, which would obtain the reports before they were made public and place trades that would profit from the effect that the reports would have on stock prices. Over and over again we noted how the false information in these reports ended up regurgitated in stories written by a small clique of journalists who appeared to have developed exceedingly close relationships to a small circle of hedge funds, and had come to depend on the hedge funds’ bogus analysis to the exclusion of all dissenting views.

The journalists (some of whom worked for The Wall Street Journal and The New York Times, whose editors must have swallowed hard before publishing this weekend’s stories announcing the imminent indictments) had, like the SEC, been “captured” by the hedge fund managers.

Some of these journalists even went to lengths to cover up the hedge funds’ shenanigans, insisting all along that their favorite hedge fund managers were innocent of any crime – indeed, insisting that the hedge fund managers were heroes and the smartest people on Wall Street. (The hedge fund managers were clever, to be sure, but apparently not clever enough to avoid becoming targets of what now appears to be the biggest criminal investigation in the history of Wall Street.).

In January 2009, in a story titled “Hedge Funds Reading Tomorrow’s Headlines Today”, Deep Capture reporter Judd Bagley provided indisputable evidence that SAC Capital, Ziff Brothers, and some of the network’s other major figures, such as James Chanos of Kynikos Associates, received advance copies, and traded ahead of bogus financial research produced by Morgan Keegan, a supposedly “independent” research shop that was, in fact, working for those same hedge funds.

Even after this evidence was posted for all to see, the press continued to use these hedge fund managers as sources, and never once cast doubts as to whether they really were wholesome geniuses who deserved the final say on the health of public companies. Meanwhile, James Chanos, who heads a hedge fund lobby, could be found regularly roaming the halls of the SEC, where he successfully convinced regulators to flinch from enforcing the rules against manipulative trading that he and his associates were skirting.

Some time ago, Deep Capture published another treatise titled “Michael Milken, 60,000 Deaths, and The Story of Dendreon.” In this book-length story (which might, indeed, have been the longest blog post ever published), we provided excruciating detail about the lengths that the Milken network of hedge funds – including SAC Capital – went to obtain (and manufacture) inside information about biotech companies.

We noted in that story that the hedge funds and  Michael Milken apparently even managed to “capture” doctors working for the Food and Drug Administration – prominent doctors who abandoned their duty to the public and served the interest of the most destructive network of financial operators in America. And we explained in that story that the hedge funds did not just trade on inside information, they also deployed their information advantage and abusive short selling to hobble public companies that were developing medicines that could have saved lives.

During the many years that Deep Capture has sought to expose these miscreants, we have struggled with our despair – our belief that the system might be so thoroughly corrupted that justice would never see the light of day.  In our view, the DOJ officials and FBI agents who are now going after this network of hedge funds deserve medals. They are “public servants” in the true meaning of the phrase.

If the indictments are indeed imminent, they are proof that there are some officials who will do what is right for the country in the face of great pressure — pressure from the media, which insisted on defending the hedge funds, and from an immensely powerful hedge fund lobby that had a lot of regulators and politicians on its side.

And make no mistake: the hedge funds that the Feds are targeting are not just “insider traders” – a term that makes it seem as if they are nothing more than outsized versions of Martha Stewart. These hedge funds’ tactics have damaged the integrity of the markets. And they have hobbled – perhaps even destroyed –  countless public companies. They even helped bring about our current economic troubles.

Indeed, it might not be a coincidence that the hedge funds named as likely to be facing indictments – SAC Capital, Citadel, Ziff Brothers, and others in their network – are the same hedge funds that attacked Lehman Brothers and Bear Stearns, the collapse of which contributed mightily to market cataclysm of 2008.

Bear Stearns executives reported seeing the managers of SAC Capital and Ziff Brothers celebrating the demise of that bank at a special breakfast meeting days after its collapse. The creditors of Lehman Brothers are suing some of these same hedge funds — SAC Capital, Och-Ziff (run by Dirk Ziff, also of Ziff Brothers) and Citadel –  because they seem to be the  most likely suspects in the illegal short selling and rumor mongering that helped topple or almost topple, not just Lehman, but multiple other pillars of the American economy.

Yes, make no mistake – these hedge funds are not just small-time insider traders. I do not even think it is a huge stretch to say that some of these hedge funds are a threat to the security of our nation.

As it happens, it is on this subject – the threat that some traders pose to national security – that Deep Capture is now on the verge of publishing an immensely long and detailed piece of research. For now I will refrain from revealing too much of the article’s contents except to alert you that it includes excruciating detail about this Milken network, shocking facts about some traders who are dangerous in every sense of the word, and a tremendous amount of information regarding some singularly ruthless organized crime groups and people tied to the world’s most violent terrorist outfits.

Given this, readers will understand if I remind them that immediately before Deep Capture published my work on Dendreon, Patrick Byrne posted a short piece, “Coming Attraction: Michael Milken, 60,000 Deaths, and The Story of Dendreon“. In it, he wrote:

Incidentally, I feel it only prudent to mention that, on the remote chance that anything happened to interrupt the serialization of this piece on DeepCapture (say, for example, a power failure), then arrangements have been made for it to receive immediate publication, in full, in a way that would reach 20 million people, instantly.  In addition, the whole package is already in the hands of some politicians who care.  Lastly, over the last couple of years I constructed a Doomsday Machine (and of course, there’s no point in having a Doomsday Machine if you keep it a secret). The reader who gets but a few pages into it will understand why I make this cautionary mention.

We will begin publishing this new story as a series in a few weeks. We apologize to our regular readers for not updating the Deep Capture site regularly during recent months. And we thank our readers for having the patience to wade through our previous stories, and for staying tuned for what will be by far our longest and most comprehensive story to date.

In other words – more bad news on the way.

I received an email a while back from Jim Brickman, a crony of short selling hedge fund manager David Einhorn, demanding that I post the Securities and Exchange Commission inspector general’s report on the commission’s investigation of Allied Capital. According to Brickman, the report proves that Einhorn was right about Allied being a massive fraud. Moreover, says Brickman, the report definitively establishes that Einhorn did not seek to drive down Allied’s stock price. The report, which I gladly post below, does nothing of the sort. I will discuss the report in further detail, but first a little history.

Eight years ago, Michael Milken, the famous financial criminal, appeared in the offices of a top Allied Capital executive. “You know,” Milken told the executive, “I already am quite a large shareholder of your stock – but my name will never show up on any list you’ll see.”

This might have been a reference to a practice called “parking stock” (owning stock but “parking” it in the accounts of friends with whom one has made under-the-table arrangements), a practice that figured in the high-count indictment that sent Milken to prison in the 1980s. It appeared to the Allied executive that Milken was fishing for inside information about Allied and threatening an attack. For a variety of reasons, short-side stock manipulators in the Milken network often accumulate large numbers of shares in the companies that they seek to destroy.

Not long after Milken’s strange appearance, David Einhorn was at a hedge fund luncheon, sitting next to Carl Icahn, one of Milken’s closest cronies. Einhorn launched his career working for Gary Siegler, who was formerly a top partner in Icahn’s investment fund, and is certainly part of the Milken network. So, it was not surprising to Allied’s executives when, halfway through the luncheon, Einhorn declared that “Allied Capital is going to zero!”

For the next eight years, Einhorn led a vicious campaign against Allied, loudly and publicly pronouncing that the company was a massive Ponzi scheme and an all-around fraud that could be as big as Enron. Of course, Einhorn’s vituperative remarks had nothing to do with the massive profits that Einhorn stood to earn from short selling Allied’s stock. Rather, Einhorn was just doing his duty as a concerned citizen – or so his slick public relations operation would have us believe.

I will give Einhorn credit. He is a master of spin. In 2008, he published an aptly titled book, “Fooling Some of the People All of the Time”, wherein he provided an ingeniously self-serving portrait of himself as a tenacious hero doing battle against not only the evil Allied Capital, but also powerful Washington insiders, financial journalists, and government regulators – i.e. all the people who reviewed his “evidence” and concluded that Allied was by no means a massive fraud.

Really, Einhorn’s book should be placed in a glass case at the Museum of Contemporary Propaganda, as it is such a work of art. Anyone familiar with the world of abusive short selling will read this book and see that Einhorn engaged in all manner of shenanigans to obtain inside information and drive down Allied’s stock price. But the dark genius of Einhorn’s book is that it manages to portray his malefaction as par for the course – just another day in the life of a noble fraud-buster.

For example, Einhorn admits in his book that he invested in a fund run by a man who had recently served as the chairman of Allied Capital’s board of directors. Could this investment have been a bribe? Was Einhorn seeking inside information about Allied? Certainly not. The investment was purely incidental, Einhorn assures us. And you, dear reader, should be ashamed of yourself for even asking such questions. Indeed, your suspicions make you part of the problem. You are an ignorant thug who wants to “intimidate” Einhorn and other short selling “critics” who selflessly do battle with public corporations.

In his book, Einhorn notes the SEC initiated an investigation into his short selling of Allied Capital. In the course of this rather cursory investigation, an SEC official sought to determine whether Einhorn was colluding with other hedge funds, including William Ackman’s Gotham Partners (now called Pershing Square Capital) and Whitney Tilson’s T2 Partners, to drive down Allied’s stock. The official asked this question:  “Mr. Einhorn, have you ever compensated [short selling hedge fund] Gotham Partners…for providing you with an investment idea?”

Einhorn answered, “Except in-kind, no.” Then Einhorn consulted with his lawyer and changed his mind. He went back to the SEC official and said, “I think the more correct answer to your question is that there’s been no compensation for the ideas.” The moral of this story, according to Einhorn’s book, is that the investigator was a bumbling idiot for asking such a question. And, you, dear reader – don’t even think of asking the same question. If you do, you’re part of the problem. You’re trying to “intimidate” Einhorn.

You see, it is perfectly natural for hedge funds to share ideas. Of course, hedge funds must not be required to report their short positions to the SEC or otherwise disclose their “proprietary trading strategies.” Hedge fund trading is top-secret so far as the public is concerned. But, says Einhorn, when we hedge funds “share ideas,” it’s just us pros talking shop. Really, says Einhorn, you can trust me…and, oh, did I say “payment in-kind”? Oops — slip of the mind.

Is it possible that hedge funds exchange “ideas” because it is profitable for them to do so? Surely not. Is it possible that these “idea” exchanges are nothing more than collusion – hedge funds agreeing to pile on to the same companies to put downward pressure on stock prices? How dare you ask such a question. Allied Capital asked that question. And Allied is very bad, says Einhorn — Allied tried to “intimidate” me!

Really, Einhorn says this all the time – people tried to “intimidate” him. He was hurt. But he’s a hero. He stood up to the critics. And, he assures us in his book, it was perfectly natural for him to collude (sorry, “share ideas”) with not just Tilson and Ackman, but also Eastbourne Capital’s Jim Carruthers. You see, Carruthers is really smart guy who does good research.

What Einhorn does not mention in his book is that Carruthers has sometimes spelled his name with a ‘K’ to disguise his identity while passing himself off as a friendly private investigator in order to deceptively acquire inside information from companies like Allied Capital. But let’s not criticize Carruthers. We don’t want to “intimidate” him. We don’t want to be part of the problem.

And shame on the SEC for having the temerity to investigate Einhorn. In fact, the SEC did nothing but ask Einhorn a few questions. Meanwhile, Einhorn convinced the SEC to launch an investigation of Allied. Then Einhorn all but directed this massive but ultimately misguided investigation for a period of three long years.

As Einhorn admits in his book, his hedge fund partner had a “social” relationship with William Donaldson, then the Chairman of the SEC. That’s how Einhorn got the investigation of Allied started. As the investigation progressed, Einhorn says, SEC officials even asked him to be their “cartographer” – outlining all the ways in which Allied was supposedly a massive Ponzi scheme, and also failing to mark its assets to “fair value” (i.e. the arbitrary value at which Einhorn believed the assets could be sold in a fire sale).

Clearly, Wall Street miscreants like Einhorn had captured the SEC to the point where the Wall Street miscreants were virtually running the place. But in the upside down reality presented by Einhorn’s book, the fact that a few SEC officials doubted the hedge fund manager’s sincerity is proof that the commission had been corrupted, not by Wall Street miscreants, but by corporate executives who wanted to “intimidate” Einhorn.

That’s right, the SEC, following Einhorn’s orders in microscopic detail, conducted an investigation of Allied that was so huge that Allied had to create a “Department of Investigations” to handle all of the commission’s requests for new information. But it was Allied’s executives, not Einhorn, who were peddling influence at the SEC. You don’t believe it? Read Einhorn’s book – agitprop at its best.

As for the media – well, Einhorn is deeply disappointed. Of course, Einhorn heaps praise on journalists such as Jesse Eisenger, then of The Wall Street Journal; Carol Remond of Dow Jones Newswires; and Herb Greenberg, formerly of MarketWatch.com and TheStreet.com. These journalists wrote multiple negative and false stories about Allied Capital, precisely mimicking Einhorn’s allegations that the company was a massive fraud.

As it happens, these are the same journalists that Deep Capture has shown to have had too-cozy, and in some instances, outright corrupt relationships with a select crew of short selling hedge fund managers, including David Einhorn. Indeed, it is fair to say that Einhorn and others in his network had captured some of the biggest names in financial journalism to the point where the hedge fund managers were able to virtually dictate the journalists’ stories.

But Einhorn was disappointed – the media failed him. That is to say, a number of honest journalists looked at Einhorn’s “evidence” and concluded that it was balderdash of the highest order. But, no, these journalists were not honest. They were ignoramuses. They are part of the problem. They should be publicly shamed. One of them even investigated Einhorn. This was an outrage. It was hurtful. It was “intimidation.”

Look, lying and cheating short-sellers are essential watchdogs, they add liquidity to the markets, and they are really very fragile people. Nice people, too. They don’t even care about money. You don’t believe me? Read Einhorn’s book. “I remember Grandpa Ben…,” Einhorn writes on page one, and after that he regales with countless folksy anecdotes and assorted other bullshit that – well, believe me, it brings tears to the eyes.

Einhorn even lets us know that he is going to donate some of the proceeds from his short selling of Allied to needy children. “I have been waiting,” he writes, “but the children should not have to wait.”

As far as I know, the children are still waiting. Although Einhorn has made enormous profits from his short selling of Allied, he has provided no evidence that his contributions to charity have significantly increased. But it is clear that the purpose of his book was not to tell the truth. It was to inoculate himself from public criticism and regulatory scrutiny in preparation for his next big project – the destruction of Lehman Brothers.

In May 2008, soon after releasing his book on Allied Capital, Einhorn’s launched his attack on Lehman in a speech that he gave at an event that was ostensibly held for the purposes of – what else? – raising money for needy children. Einhorn began this speech by discussing his supposedly philanthropic fight with Allied. He then  proceeded to give a grossly exaggerated account of Lehman’s problems, suggesting that Lehman was a massive fraud for precisely the same reasons that Allied was a massive fraud – namely, that it had failed to mark down its real estate assets to “fair value,” with “fair value” defined not by any reasonable metric, but by Einhorn himself.

Lest there still be any doubt that Einhorn really was a crusading crime-fighter, rather than a profit-seeking hedge fund manager, he hired an expensive lobbying outfit called the Gordon Group to orchestrate an astounding public relations campaign. The Gordon Group, whose key clients seem to be Einhorn and Einhorn’s network of hedge fund managers (including the above mentioned William Ackman and Whitney Tilson) is staffed by real professionals. Their Einhorn campaign was marked by the sort of hype that normally accompanies the launch of a new teen-idol band.

But it wasn’t just hype. It was also a particularly greasy sort of deception – imagine a pimp marketing a cheap 42nd Street hooker. Really, she’s not in it for the money. She’ a virginal college undergrad who loves her teddy bear.

Well, the media swooned for the cuddly Einhorn. This was the same media that Einhorn had accused of bungling idiocy, but never mind that – now he had glowing profiles in many of the top news publications, and a three-hour appearance on CNBC.  Half-way through his CNBC debut, Einhorn put on a cute t-shirt painted by his young kids — just to show that he was a regular guy and a lover of children, as opposed to a marauding hedge fund manager seeking to obliterate one of America’s largest investment banks.

In all his media interviews, Einhorn reminded journalists that Allied Capital had “intimidated” him. He said he had stood up to the bullies and proven that Allied was a massive fraud. Then he smoothly transitioned into a discussion of Lehman Brothers, suggesting to the journalists that Lehman was just like Allied, a massive fraud. He said Lehman was trying to “intimidate” him, but he would fight on in the name of truth and justice. The journalists swallowed this nonsense without an ounce of skepticism.

I do not mean to suggest that Lehman Brothers was a clean bank. Clearly, it engaged in some shady accounting, including its now notorious Repo 105 transactions. Its brokerage probably catered to criminal market manipulators. But while Lehman was a deeply troubled bank, it is also true that it was subjected to a wave of false rumors, each one accompanied by illegal naked short selling. With all the manipulation that accompanied the attack on Lehman, it was difficult to know what the truth about the company really was.

In the midst of the attack on Lehman, Adam Starr, the manager of hedge fund Gulfside Partners, was moved to write a letter to Lehman’s CFO, stating, “I have never witnessed more disruptive behavior than that displayed over the past year by David Einhorn.” In a recent interview with Reuters, Starr said that Lehman had clearly had serious problems, but that was besides the point. The point, Starr said, was that Einhorn was up to no good – “manipulating the market and running a high publicity business is just not appropriate behavior and disruptive to free and open markets.”

As for Einhorn being “right” about Lehman, it is important to note that the court-appointed examiner’s report on the Lehman bankruptcy does not support Einhorn’s principal claim – that Lehman’s executives fraudulently and massively overvalued the bank’s commercial real estate assets. “With respect to commercial real estate,” says the report, “the Examiner finds insufficient evidence to conclude that Lehman’s valuations of its Commercial portfolio were unreasonable as of the second and third quarters of 2008.”

Lehman’s valuations might have been high, but Einhorn’s shrill exaggerations and insinuations of fraud were clearly designed to induce panic. And sure enough, panic ensued. With potential business partners wondering whether Lehman was, in fact, massively overstating the value of its commercial real estate, the bank was unable to raise new capital.

To protect itself, Lehman sought to spin off the real estate assets, but by that time it had come under a brutal and criminal naked short selling attack, with more than 30 million of its shares failing to deliver. The plummeting stock price and continuing false rumors in the marketplace derailed Lehman’s other efforts to protect itself and triggered a run on the bank that ended with Lehman’s demise.

In short, Lehman was a bad bank. Regulators should have forced it to reform. Instead, they and the media allowed short selling “vigilantes” like Einhorn to manufacture a much bleaker reality and bring a major investment bank to its knees. It is quite possible that if it weren’t for Einhorn and other dissembling investor “activists”, Lehman would have survived, and the financial system would have had a much softer landing.

Lehman has subpoenaed records from Einhorn and his close colleague, Steve Cohen of SAC Capital,  in hopes of determining the extent to which the hedge fund managers had a hand in its demise. Perhaps those subpoenas will give us a clearer picture of what really went down, but meanwhile we can expect Einhorn’s PR machine stay “on message” – constantly repeating that Einhorn was “right” about Lehman, just as Einhorn was “right” about Allied Capital.

Which brings us to the inspector general’s report on the SEC’s investigation of Allied. Given that Einhorn, his minion Jim Brickman, and the rest of his PR machine are waving this report with glee, and no doubt preparing to use it as cover for Einhorn’s next attack on a public company, it is important that we subject the contents of the report to close scrutiny.

The report concludes that “serious and credible allegations against Allied were not initially [my emphasis] investigated” by the SEC, but contrary to Einhorn’s ridiculous claims that nobody listened to him, the inspector general notes that the SEC did ultimately conduct “a lengthy examination of Allied as a result of Einhorn’s allegations…”

SEC officials met with Einhorn on multiple occasions to review his allegations. They also scoured through millions of Allied emails and the cart-loads of other documents that Allied supplied every time Einhorn came to the SEC with a new set of accusations.

Having conducted this gargantuan investigation, the SEC concluded that most of Einhorn’s allegations were bogus. Allied was fined for having mildly inadequate accounting methods that might have overvalued some of the company’s assets, but the SEC determined that Allied certainly was not the “massive fraud” that Einhorn claimed it to be.

In addition, Allied was not, as Einhorn claimed, a massive Ponzi scheme. Einhorn had made the smarmy suggestion that Allied was a Ponzi because it supposedly raised money from the markets to pay its dividends. An SEC official told the inspector general that this claim was patently false – it was perfectly obvious that Allied legitimately paid dividends out of earnings.

The inspector general’s report notes that one SEC official claimed to have gotten “push back” when she tried to dig deeper into the Ponzi scheme allegation. But nowhere in the report does the inspector general conclude that any such Ponzi scheme existed. Clearly, Einhorn is no Harry Markopolos. Markopolos uncovered a $50 billion fraud (that of Bernie Madoff). Einhorn blew the whistle on a crime that didn’t exist. Yet, Einhorn’s slithering PR effort never ceases to amaze – somehow he has managed to attach himself to Markopolos, and even wangled a deal to write the introduction to Markopolos’s blockbuster book.

The inspector general seems to believe that the investigation of Allied could have been more thorough in some respects. For example, SEC officials didn’t visit Allied’s offices, and one SEC official was a bit too quick to believe that Allied was innocent just because former SEC officials worked for the company. But, again, the inspector general does not state that the SEC was wrong to conclude that Allied was innocent of any major crime.

The inspector general’s most damaging conclusions about Allied concern the company’s efforts to lobby the SEC. Apparently, some Allied lobbyists secured an unusual meeting with SEC officials and managed to convince these officials that Allied deserved a lighter fine. It also appears that a former SEC official went to work as an Allied lobbyist and might have gotten his hands on Einhorn’s phone records.

The inspector general is right to suggest that Allied’s lobbyists crossed the line. It is not kosher for a public company to pry into a private citizen’s phone records. But given that Einhorn had all-but moved his offices into SEC headquarters, and given that Einhorn had his own private investigators going to unknown lengths to dig up “dirt” on Allied (he admits in his book that he hired Kroll, a private investigative agency that owes its existence to Michael Milken, who was its first big client), Allied can hardly be blamed for taking steps to defend itself.

In any case, the inspector general’s report is more an indictment of the SEC than of Allied’s lobbyists. The overall picture that emerges is one of a government agency split into two factions, one populated by friends of Allied’s lobbyists, the other populated by officials who were basically taking orders from hedge fund managers like David Einhorn. It seems that nobody at the SEC was capable of conducting an investigation without having his or her hand held by some self-interested party. But it is clear from this case and many others like it that the hedge fund faction won the day.

The inspector general states in his report that it was Allied’s lobbyists who convinced the SEC to investigate Einhorn. The report concludes that the SEC initiated this investigation “without any specific evidence of wrongdoing.” That might be so, but officials do not generally obtain “specific evidence” unless they seriously look for it. And it is clear from the contents of the inspector general’s report that the SEC’s investigation of Einhorn was an unmitigated joke, even though officials had good reason to suspect that Allied’s stock was being manipulated.

The report notes, for example, that the SEC subpoenaed Einhorn’s client list in response to Allied’s complaints and discovered that Einhorn had a certain “celebrity client”, whom the inspector general does not name. Could this “celebrity client” have been Michael Milken? We cannot know for certain, but it seems like a good guess, given that the discovery of this “celebrity client” followed Allied’s complaint to the SEC, and given that Allied had complained that Einhorn might be colluding (sorry, “sharing ideas”) with one specific celebrity – Michael Milken.

In any case, it appears from the inspector general’s report that the SEC did nothing to determine how Milken, who is banned from the securities industry, became “quite a large” shareholder of Allied’s stock. Nor did the SEC seek to determine what Milken was doing that day in Allied’s offices.

Meanwhile, some SEC officials seemed to believe that Einhorn was colluding with other hedge fund managers to drive down Allied’s stock. To see whether the hedge fund managers called each other and then placed their trades at precisely the same time, the SEC subpoenaed Einhorn’s phone records. But according to the inspector general’s report, Einhorn did not bother to comply with this subpoena. He never handed over the phone records, and nobody at the SEC seemed to notice or care. Which is funny, because Einhorn states in his book that he did hand over his phone records. Indeed, he goes to great lengths to describe how hurt he felt about this. The SEC was “intimidating” him.

Perhaps because it was weary of “intimidating” hedge fund managers, the SEC also apparently did nothing to investigate illegal naked short selling of Allied’s stock. From the moment that Einhorn declared that Allied was “going to zero”, and for many months afterwards, Allied’s stock “failed to deliver” in massive quantities – a sure sign of criminal naked short selling. We do not know that Einhorn, others in the Milken network, or their brokers were committing this crime. Maybe it was someone else. Either way, it was not beyond the pale for Allied to ask the SEC to investigate. Or maybe it was. After all, the SEC wouldn’t want to “intimidate” criminals.

It is also notable that literally minutes after Einhorn declared that Allied was “going to zero”, the corrupt law firm Milberg Weiss filed a class action lawsuit against Allied that almost precisely mimicked Einhorn’s allegations. Indeed, Milberg filed a class action lawsuit against nearly every company attacked by short sellers in the Milken network.

A couple of years ago, Milberg’s top partners went to jail after prosecutors determined that the partners routinely bribed the plaintiffs in such lawsuits and knew in advance that some event would collapse the stock prices of the companies named in the lawsuits. Einhorn claims that the timing and contents of Milberg’s lawsuit were coincidences. We’ll never know the truth because the SEC doesn’t want to “intimidate” short sellers and corrupt law firms.

There were other “coincidences”. For example, supposedly “independent” financial research shops, such as Off Wall Street Research and Farmhouse Equity Research, published reports that closely paralleled Einhorn’s negative analysis of Allied Capital. The Motley Fool reported in 2007 that Einhorn’s confederate Jim Brickman helped Farmhouse write its research on Allied, and received a copy of at least one of these research reports one week prior to its publication.

Brickman, who is a bit of a mystery character (he refused to provide me with any information about his background), told the Motley Fool that he and Einhorn didn’t see the advance copies of the reports because of “travel constraints.” Allied complained to the SEC that the research shops were helping Einhorn manipulate its stock price and illegally trade ahead of their research. Einhorn said Allied was trying to “intimidate” the research shops. Who was right? It was all so confusing. The deep thinkers at the SEC picked their noses and tried to figure it all out. Then they went to lunch.

The inspector general has been on a mission to expose ineptitude at the SEC, and for this he deserves praise and gratitude. However, given the facts, I think his report on the investigation of Allied Capital was a bit too kind to David Einhorn. The inspector general notes that his office “conducted a comprehensive investigation of the allegations in Einhorn’s book.” But the report offers no solid verdict as to the accuracy of those allegations, and fails to acknowledge the extent to which the SEC had been manipulated by Einhorn and affiliated Wall Street hedge funds.

It should be noted that not only the SEC, but also the Department of Justice, the Small Business Administration, federal courts, attorneys general, and other government bodies investigated Einhorn’s allegations against Allied. All of these investigations yielded the same conclusion: Einhorn’s allegations were, for the most part, eminently ridiculous.

The only criminal fraud discovered by any of these investigators was committed by executives of Business Loan Express, a subsidiary that represented a tiny fraction of Allied’s overall portfolio. The BLX executives were apparently handing out Allied’s money to unqualified borrowers who were their cronies. In other words, Allied was the victim of this fraud. That anyone at the SEC still gives credence to David Einhorn is, therefore, rather odd.

But this story has a happy ending. Last October, Allied Capital was purchased by Ares Capital Corporation, a company that was founded by Anthony Ressler and John Kissick – both partners in the private equity firm Apollo Management. The head of Apollo is none other than Leon Black, who is Michael Milken’s closest business crony. That could be a coincidence. Or it could be that Einhorn’s attack on Allied was meant from the beginning to drive down Allied’s stock price to the point where it would be ripe for a takeover by Milken’s pals.

In any case, Einhorn mysteriously ended his “crusade” agains Allied as soon as Allied was purchased by his friends. So, for the time being at least, we don’t have to listen to his blather. And we promise – never again will we “intimidate” Einhorn. Really, no more “intimidation” — not from us. Mr. Einhorn, you are noble man. You did it for the children. You did not deserve to be “intimidated.” And, Mr. Einhorn, one more thing — boo!

Oops, did it again.

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Click here to read the inspector general’s report

Everyone from U.S. Senators to prominent hedge fund managers say that criminal naked short sellers had a hand in the financial collapse of 2008, but the regulators aren’t listening. Not a single criminal has been prosecuted. Indeed, the regulators continue to allow the miscreants to manipulate the markets — not just the stock markets, but also the markets for corporate bonds, derivatives, U.S. Treasuries, and all manner of commodities – even when the regulators are provided with indisputable evidence of a massive crime in progress. They could easily fix the flaws in the settlement system that allow much of the manipulation to occur, but they refrain from doing so either because they are too captured by the miscreants or too cowed by the possible consequences of throwing the lights on what may be an enormous confidence game.

So I am inclined to say that it is hopeless. Everyone loves an optimist – but, yes, it is hopeless. We are like the audience in one of those cheesy horror flicks – yell and scream all you like, but the dumb blonde is still going to walk into that room and get hacked to pieces. Except that it is not a movie. It is real. And it’s not just the dumb blonde who is going to get slaughtered. It is all of us. It is our economy. It is our standard of living. It is our financial system – the lifeblood of the nation.

The latest case of regulatory indolence was recently exposed by Andrew Maguire, a successful metals trader and whistleblower who went to the Commodity Futures Trading Commission with data that strongly suggested that a small number of criminal short sellers had rigged the markets for silver and gold. Maguire not only provided the regulators with a Dummies’ guide to how the manipulation generally worked, but also warned them of a specific crime – a dramatic take-down of the gold and silver markets – that he said would occur at an exact time on a specific date in the near future. That is, Maguire told the regulators that a massive crime was about to happen, and the crime happened precisely as he predicted it would.

With Maguire’s warning, the regulators were able to watch a crime unfold, right before their eyes, in real time. Then the regulators thanked Maguire by saying, in essence, “you’re a nuisance, go away.” This is not just appalling, but scary, because the criminal activity that Maguire exposed is much bigger than the Madoff Ponzi scheme, and more likely to result in serious damage to the American economy. Indeed, there is a strong case to be made that our national security is at stake. As Maguire stated in a recent interview with King World radio, the manipulators have likely created a massive naked short position that can easily be exploited by foreign entities who might see financial or even political gain in eviscerating the dollar.

Maguire’s email exchange with the CFTC is remarkable reading. In one email he writes:

“Thought it may be helpful to your investigation if I gave you the heads up for a manipulative event scheduled for Friday, 5^th Feb. The non-farm payrolls number will be announced at 8:30 ET. There will be one of two scenarios occurring, and both will result in silver (and gold) being taken down with a wave of short selling designed to take out obvious support levels and trip stops below. While I will no doubt be able to profit from this upcoming trade, it is an example of just how easy it is to manipulate a market if a concentrated position is allowed by a very small group of traders…I sent you a slide of a couple of past examples of just how this will play out.

“Scenario 1. The news is bad (employment is worse). This will have a bullish effect on gold and silver as the U.S. dollar weakens and the precious metals draw bids, spiking them higher. This will be sold into within a very short time (1-5 mins) with thousands of new short contracts being added, overcoming any new bids and spiking the precious metals down hard, targeting key technical support levels.

“Scenario 2. The news is good (employment is better than expected). This will result in a massive short position being instigated almost immediately with no move up. This will not initially be liquidation of long positions but will result in stops being triggered, again targeting key support levels.

“Both scenarios will spell an attempt by the two main short holders to illegally drive the market down and reap very large profits.”

It would be hard to get more specific than that. As Maguire says in the same email: “The question I would expect you might ask is: Who is behind the sudden selling and is it the entity/entities holding a concentrated position? How is it possible for me to know what will occur days before it will happen? Only if a market is manipulated could this possibly occur.”

The CFTC had previously had the courtesy to call Maguire and listen to his concerns, but by the time Maguire sent the message laying out the crime, the CFTC had stopped returning his emails. The regulator showed no real interest, and let the crime happen. After the crime occurred, Maguire wrote another email:

“A final email to confirm that the silver manipulation was a great success and played out EXACTLY to plan as predicted. How would this be possible if the silver market was not in the full control of the parties we discussed in our phone interview?…I hope you took note of how and who added the short sales (I certainly have a copy)…Surely some discussions should have taken place between the parties by now. Obviously they feel they can act with impunity…”

After that, Maguire sent several more emails detailing manipulation of the gold and silver markets. He received no replies. So he wrote a final email, providing still more evidence in support of his case and stating: “I have honored my commitment to assist you and keep any information we discuss private, however if you are going to ignore my information I will deem that commitment to have expired.”

To that email, a CFTC official finally replied: “I have received and reviewed your email communications. Thank you so very much for your observations.” That was it. Thanks a lot and goodbye. No follow up questions. No acknowledgement that a crime had occurred. No apparent interest whatsoever.

Maguire was understandably peeved. As he said in his radio interview, “I kept a live commentary going on that entire scenario. How they were going to flush it down below 15, how it then went down below 15, and how then they were putting big block offers hitting all the bids to stop it getting back through the technical level of 15 so as not to trigger covering by the shorts and inviting longs to get long again. To me, you don’t get any better than that, how could anyone predict that unless they knew what was going to happen, not just saying it’s going to move in one direction, but it’s going to move in one direction then another direction – all in a matter of minutes.”

Not long after the massive crime took place, the CFTC held a public hearing on manipulation of the metals markets. Maguire was specifically barred from participating. He told King World radio that he believed one CFTC official, Bart Chilton, wanted him to attend the hearing, but Chilton is a lone “Elliot Ness” crime fighter working in an agency that is dominated by the feckless and the corrupt. “There are a lot of people at CFTC wanting to look the other way,” Maguire said.

However, the hearing (a partial transcript and video of which can be found at the excellent financial blog Zero Hedge) did yield an interesting piece of information. In the course of answering an unrelated question, Jeffrey Christian, a former Goldman Sachs staffer who is now the head of a metals trading firm called CPM Group, stated that “precious metals…trade in the multiples of a hundred times the underlying physical…” (the italics belong to me and a lot of other people whose eyes popped out of their heads when they heard this).

What Christian was saying is that every ounce of gold or silver is being sold 100 times. This would not be problematic if we were speaking of some dusty market in Central Asia with rows of traders’ stalls wherein some commodity (such as gold, silver, radios or Kalashnikovs) were being sold and resold in rapid-fire succession: there, our sensibilities about scarcity, value, and price discovery would actually grip reality. Here, however, we are talking of markets where the distinction between reality and representation has become as blurry as the last round of a game of musical chairs, enabling some sellers to offload  paper IOUs promising eventual delivery of silver and gold – promises that would be impossible to keep if some small segment of the buyers were to demand delivery of the real thing.

This is quite similar to the naked short selling of stocks, where traders sell stock that does not exist, but enter IOUs in their computers, and then “fail to deliver” what they have promised. It is hard to distinguish this from fraud (notwithstanding the Efficient Market Hypothesis of financial theory, which maintains, essentially, that it shouldn’t matter).  Christian, the fellow who inadvertently revealed the massive naked short positions in gold and silver, said that he didn’t see this as a problem because “there are any number of mechanisms for cash settlement,” and “almost all of these short positions are in fact hedges…”

This is slightly absurd. Later in his testimony, Christian himself said that it was “exactly right” to say that the hedges are nothing more than hedges of “paper on paper” – a particular sort of merry-go-around where one IOU is settled by another IOU, with these IOUs outnumbering real gold and silver by multiples of a hundred times.

As for the notion that cash settlement solves the problem, Maguire noted in his radio interview that cash settlement “is the very definition of default. If somebody wants to buy gold and silver and instead they’re given cash, that is a default.” In addition, “there are people who will not want cash – Chinese, Vietnamese, Russians – people looking for the metal, they will want to take it, and that will cause a default on the Comex [the metals exchange] because the Comex will be drained…that was the word that was used by several people making testimony [at the CFTC meeting], that the Comex would be drained…”

Maguire added: “What’s going to happen, if you’re an Asian trader, or a non-Western trader, who has no loyalty, or doesn’t care about homeland security or anything else, who says, now wait a minute, if I can establish in my mind that there is 100 ounces of paper gold, paper silver for example, for each ounce of real silver, than I have a naked short situation here that I can squeeze and they can go on the spot market which is basically a foreign exchange transaction, short dollar, long silver to any amount they want – billions, trillions — whatever they want, and they can take this market, squeeze this market, and blow it up…”

In other words, the problem isn’t just that criminal naked short sellers manipulate the metals market downwards. It is that they have created a condition where a foreign entity can merely demand delivery of real metal to induce a massive “squeeze” that sends the price of metals skyrocketing, putting huge downward pressure on the dollar. Meanwhile, says Maguire, with prices rising, “for 100 customers who show up there is only one guy who is going to get his gold or silver and there’s 99 who will be disappointed, so without any new money coming into the market, just asking for that gold and silver will create a default.”

“There are no prisoners taken in this kind of environment,” Maguire added. “All they need to establish is that it is naked, and by the admission of [former Goldman staffer] Christian at the meeting…we have a definition of physical actually being paper…They get that in their heads and its locked, it’s a done deal, then we don’t have to wait…there is a profit to be made here, and there is nothing [anybody] can do about it because it’s a foreign exchange transaction, and there are no limits on a foreign exchange transaction, and obviously foreign exchange transactions are coming to light, there [is talk] of manipulation…”

Indeed, Maguire says that he has received phone calls from wealthy individuals in Asia looking for the go ahead to exploit the naked short position. “The only question they have in their mind is can we establish that this is a naked short position, that’s the only thing they had to clarify, it’s become clear, it is now clear [that the naked short position is massive], and no doubt they do their own due diligence, but basically [the naked short position] has been admitted at the only metals meeting [the CFTC hearing] that we’ve ever had…”

Maguire says that the naked short selling scam is in the trillions of dollars, making it by far the biggest financial fraud in history. He calls it “financial terrorism” and accuses the naked short sellers of “treason” for putting national security at risk. It might be hard to believe that foreign entities are plotting to crush the U.S. economy, and perhaps they are not, but there is no doubt that loopholes in the clearing and settlement system – not just for metals, but also stocks, bonds, Treasuries, and derivatives – could quite easily be exploited by any foreign entity desiring to do harm to the U.S. economy. The only dispute is whether such a desire exists.

Maguire and Adrian Douglas of GATA, an organization that lobbies against manipulation of the metals market, took their concerns to the mainstream media and had a number interviews scheduled. However, every one of those interviews were suddenly cancelled. This is not surprising. The mainstream media has consistently shied away from stories about illegal naked short selling and market manipulation, partly because the media outlets are captured by the powers that be on Wall Street, and partly because investigative journalism is now viewed as an anachronism – a time-consuming effort that might have been suited to Woodward and Bernstein back in the 70s, but not to the downsized news rooms tasked with churning out tepid and meaningless “he said, she said” mimeographs for a population of readers who (so it is said) want their “news” fast, and don’t care a whit for in-depth reporting.

Meanwhile, just as the stock manipulators have engaged in a coordinated effort – deploying threats, ruthless smear campaigns, and slick lobbying – to keep their crimes out of the spotlight, so too will the gold and silver manipulators. Adrian Douglas of GATA notes that at the precise moment that his GATA colleague Bill Murphy began to speak at the CFTC meeting, the video camera recording the event experienced “technical problems” – problems that were fixed at the precise moment when Murphy stopped talking. Douglas concedes that this might have been a coincidence, but when this sort of thing happens often enough, a little healthy paranoia is probably a good thing. That said, everyone loves an optimist, so I’ll say the camera really went kaput.

But…ack…another coincidence: The day after Maguire gave his radio interview, he was the victim of a hit and run collision. Somebody sped out of a side alley at top speed, smashed into Maguire’s car, and then tried to escape. A high-speed chase ensued, and the perpetrator was caught by police. The British press has reported that this might have been an assassination attempt, or a threat, but as yet there has been no word from the police. Maguire was injured, but not seriously. Let’s be optimistic, and say this was an accident – assassinations and threats only happen in the movies.

But…ack…another coincidence: Shortly before somebody crashed into Maguire’s car, the CFTC caught on fire. This fire happened to be located in the one small basement room where gold and silver trading data and other pertinent documents were kept. The CFTC claims that its investigation of metals manipulation, for what it was, did not burn.  So maybe it was just an accident. Maybe some eager CFTC regulators were down there smoking cigarettes. Maybe it was stress. Maybe they’ll keep investigating. Maybe they’ll bust the criminals.

Maybe, just maybe…yes, everyone loves an optimist, so let me make this clear – the horror show that is our regulatory system is going to have a happy ending. There will be no massacre. The financial system will be just fine…really…maybe… or maybe not.

* * * * * * * *

Update: Another coincidence: GATA reported recently that there has been an attack on the King World website — the website that contains the radio interview of Maguire and his emails to the CFTC. This was an apparent attempt to shut down the website and prevent the scandal from being exposed further. The Internet company that hosts the King World website reported to King World the following: Your hosting account is the target of a distributed denial of service attack…Computers were attacking your account.”

Steps were taken to protect the website, which is once again up and running.

You don’t hear much about it, but the March 2007 bankruptcy of a company called New Century Financial was arguably one of the most important events leading up to the financial crisis that nearly caused a second Great Depression.

It was the demise of New Century, then the nation’s second largest mortgage lender, that triggered the collapse of the market for collateralized debt obligations. And it was the collapse in the value of collateralized debt obligations (a majority of which contained New Century mortgages) that hobbled a number of big financial firms. Once hobbled, the likes of Bear Stearns and Lehman Brothers were ripe targets for unscrupulous hedge fund managers who amplified their problems by spreading exaggerated rumors while bombarding them with illegal naked short selling.

So we must ask: Why did New Century Financial go bankrupt? Did the company die of natural causes, or did miscreants orchestrate its destruction? And if miscreants destroyed New Century, did they do so planning to profit from the broader economic calamities that were certain to result from its collapse?

I do not yet have definitive answers to these questions. But interviews with sources close to New Century and a review of documents, including the oddly biased 500-page New Century bankruptcy report, make it clear that at least two hedge fund managers — David Einhorn of Greenlight Capital and Dan Loeb of Third Point Capital — played a significant role in creating the conditions that made New Century vulnerable to catastrophe. And they did so while building massive short positions in Bear Stearns, Lehman Brothers, MBIA and other companies that were likely to be seriously damaged if New Century were to go bankrupt.

Einhorn was a major investor in New Century and took a seat on the company’s board in early 2006. He has gone to lengths to suggest that he lost a lot of money from his investment. But given that his activities on the board were so contrary to New Century’s best interests, and given that he was otherwise so heavily invested in the collapse of the mortgage markets, it is reasonable to ask if he was  in fact short selling New Century’s stock, or buying credit default swaps that would pay out in the event of the company’s bankruptcy.

Moreover, some banks, most notably Goldman Sachs, created and sold collateralized debt obligations containing New Century mortgages while simultaneously betting that the CDOs would plummet in value. Multiple media stories (such as this one in “Investment News”) have speculated that Goldman Sachs actually designed these CDOs in such a way that they would be certain to implode, delivering large profits to Goldman and preferred hedge fund clients. Those CDO could not have been created without Einhorn and his allies inside New Century delivering the mortgages that went into them. And there is no doubt that Goldman Sachs delivered the knock-out punch that put New Century out of business, ensuring that the CDOs would, in fact, implode. This constellation of facts may be coincidental, of course. Or not. This essay lays them out, and leaves it to the reader to decide.

New Century’s problems began in December 2005, when board member Richard Zona drafted a letter in which he threatened to resign if senior executives did not agree to sell a greater percentage of the mortgage loans on its books to various banks, such as Goldman Sachs. In his letter, Zona explicitly stated that he was making this demand in league with David Einhorn and Dan Loeb.

Unfortunately, according to the bankruptcy report, New Century’s executives never saw that letter. Zona stashed the draft letter on his computer and instead submitted a letter making a similar demand, but omitting all mention of Einhorn and Loeb. In all likelihood, Zona changed his letter because he knew that New Century’s executives had good reason to doubt whether Einhorn and Loeb, who had recently reported large shareholdings in New Century, were acting in the company’s best interests.

As Deep Capture has thoroughly documented, Einhorn and Loeb are part of a network of hedge fund managers and criminals who use a variety of dubious tactics to destroy, seize, and/or loot public companies for profit. It is not unusual for money managers in this network to appear as long investors in the companies they are attacking, and sometimes they seek to obtain a seat on a target company’s board in order to be better placed to run the company into the ground for their own private profit.

Essentially everyone  in this network – including Einhorn and Loeb — are connected in important ways to Michael Milken, the infamous criminal who specialized in loading companies with debt, looting them, and then profiting still more from their inevitable bankruptcies.

Einhorn spent his early career working for Gary Siegler, who was formerly the top partner in the investment firm run by Carl Icahn, a corporate raider and ne’er-do-well who owes his fortune to the junk bond finance that he received from Michael Milken in the 1980s. Icahn has various other seamy connections, and has employed people with ties to the Mafia (see “The Story of Dendreon” for details).

Prior to his attacks on Lehman Brothers and Bear Stearns, Einhorn was best known for his eminently dishonest attempt to demolish a financial company called Allied Capital. The attack on Allied began in 2002 at a hedge fund luncheon. Halfway through that luncheon, Einhorn stood up and declared that “Allied Capital is going to zero!” Sitting next to Einhorn at that luncheon was Carl Icahn.

Some weeks before the luncheon, Michael Milken had appeared in the offices of a top Allied Capital executive. “You know,” Milken told the executive, “I already am quite a large shareholder of your stock – but my name will never show up on any list you’ll see.” This may have been a reference to a practice called “parking stock” (owning stock but “parking” it in the accounts of friends with whom one has made under-the-table arrangements), a practice that figured in the high-count indictment that sent Milken to prison in the 1980s. Milken appeared to the Allied executives to be threatening Allied and fishing for information, paving the way for Einhorn’s more public vitriol.

The Allied story is outside the remit of this article, but it is enough to know that Einhorn proceeded to accuse the company of massive fraud and of failing to account for its loans at “fair value”. With some minor exceptions, none of Einhorn’s allegations of fraud were ever proven to have merit. And it was clear from the get-go that Einhorn’s notion of “fair value” had nothing to do with “fair” (as in “what the market was paying”). Rather, “fair value” was an arbitrary metric that could be taken to mean whatever Einhorn said the value of the loans should be. This is important because Einhorn’s outlandish “fair value” calculations featured prominently in his attacks on Lehman Brothers and Bear Stearns. In addition, as we will see, arbitrary and over-the-top “fair value” assumptions about mortgage loans featured in the bankruptcy of New Century.

As for Loeb, he is a long-time Einhorn accomplice who worked side-by-side with many of Milken’s former traders at Jeffries & Co. He got his first big break by obtaining preferential access to certificates of beneficiary interest that had been issued by Milken’s bankrupt operation at Drexel, Burnham, Lambert. Loeb seems to take a certain pride in his bad boy image, and has distinguished himself in all manner of chicanery, such as hiring a cast of convicted criminals and scofflaws to spread false information about public companies on the Internet. (Please search Deep Capture’s archives; we have compiled substantial evidence implicating Loeb in various misdeeds).

Given their backgrounds, there was every reason to doubt the merits of the demand that Einhorn and Loeb had articulated through New Century board member Richard Zona. Indeed, the majority of New Century’s top managers (the company had three CEOs at the time) were opposed to the Einhorn-Loeb demand to sell off all of New Century’s mortgage loans, and for good reason. Selling off all the loans would make the company entirely dependent on the banks, such as Goldman Sachs, that bought the loans. If, for some reason, the banks were to demand that New Century buy back its loans, the company would go bankrupt.

Shortly before Zona submitted his letter demanding that New Century sell off its loans, one of the company’s co-founders, Patrick Flanagan, said by sources to be an ally of Einhorn and Loeb, left the company. After a brief time, Flanagan went to work for hedge fund Cerberus Capital. Cerberus Capital was run by Ezra Merkin, famous for being one of the biggest feeders to the Bernard Madoff fraud, and Stephen Feinberg, who was formerly a top employee of Michael Milken. Cerberus is also the proud owner of an Austrian bank called Bawag, which was at the center of a scandal that wiped out Refco, once one of the most abusive naked short selling outfits on Wall Street. (Refco’s former CEO, Phillip Bennett, and executive Santo Maggio have been convicted and are serving prison sentences, while one of its naked short selling clients, Thomas Badian, is still living in Austria as a fugitive from US law)..

Sources tell Deep Capture that Cerberus made massive profits from the demise of New Century, and if so, it is likely that Flanagan had a hand in this. It is perhaps also no coincidence that Cerberus now also employs Thomas Marano, the former head of mortgage trading at Bear Stearns, and Brendan Garvey, the former head of mortgage trading at Lehman Brothers. Marano and Garvey helped sink their companies by buying New Century’s repackaged loans from Goldman Sachs and a few other banks.

While still at Bear Stearns, Marano seemed almost eager to see the bank collapse. At one point he called Roddy Boyd, a reporter with close connections to the Einhorn-Milken nexus of hedge funds, to leak an  account of  Bear Stearns’ problems, though as we have documented, that leak seems to have been exagerrated when Marano made it.  One has to wonder why he was leaking about his employer, and also wonder at the coincidence of the fact that he was doing this while preparing to go to work for a large hedge fund that was betting against that employer.

After Flanagan left New Century, Zona organized a highly unusual “off site” board meeting. The directors at this meeting (which excluded all opposing viewpoints) decided to implement a radical change to New Century’s management structure. Among other changes, CEOs Ed Gotchall and Bob Cole were removed from their posts, and the company was put under the sole leadership of the third CEO, Brad Morrice.

Einhorn and Loeb orchestrated this change. Sources say the two hedge fund managers had considerable input at the “off site” board meeting even though Einhorn was not yet a director. And Zona stated in the initial draft of his letter (the one that stated that he was making his demands in alliance with Einhorn and Loeb) that Gotschall was “immature and disruptive,” while Cole was “not fully engaged” – because they opposed the demand to sell off the loans.

In Morrice, Einhorn and Loeb had a CEO whom they could work with. Prior to entering the mortgage business, Morrice had been the founding partner, along with Richard Purtrich, of law firm King, Purtrich & Morrice. In 2008, Purtrich was sentenced to prison for funneling illegal kickback payments from a crooked law firm called Milberg Weiss. Milberg’s top partners, Bill Lerach and Melvyn Weiss, were also indicted in the scheme.

According to the DOJ, the kickbacks were paid to plaintiffs who filed bogus class action lawsuits against public companies “anticipating that their stock prices would decline.” Deep Capture has published extensive evidence showing that Milberg prepared those bogus lawsuits in cahoots with hedge funds in David Einhorn’s network. The hedge funds, of course, profited from short selling the targeted companies, and it is indeed likely that the bribed plaintiffs were  “anticipating that the stock prices would decline” because they knew that the hedge funds were going to attack the companies via illegal naked short selling and other tactics.

So it is fair to say that Morrice (whose former partner was funneling kickbacks to plaintiffs who were conspiring  with Einhorn’s hedge fund network to attack public companies) was intimately familiar with the tactics of Einhorn’s hedge fund network.

In any case, soon after Morrice took the helm at New Century, he quickly set about meeting Einhorn’s demand to sell off New Century’s mortgage loans. Whole loan sales comprised less than 70% of New Century’s secondary market transactions in 2005. By September of 2006, whole loan sales comprised a full 95% of New Century’s mortgage lending. As a result, whereas in all of 2005, New Century had sold a mere $256 million worth of loans at a discount, during the first nine months of 2006, New Century sold $916 million worth of loans at a discount.

Much of the income from those loan sales was not used to build New Century’s liquidity. Rather, at Einhorn’s suggestion, it was used to buy back stock and pay out massive dividends to shareholders like Einhorn. At the end of 2005, New Century was paying $1.65 a share in dividends. In January 2007, two months before New Century’s bankruptcy, the company was paying dividends of $1.90 a share. If we accept the proposition that Einhorn might have profited from New Century’s collapse, it is clear that he planned first to profit from his long position. This is similar to a classic “pump and dump” scam, except that the strategy is to pump and destroy.

In March 2006, with the support of Morrice and Zona, Einhorn obtained a seat on New Century’s board of directors. At this point, according to one member of senior management, the “activist investors” on the board did become extremely “active,” agitating for more loan sales while pushing for changes in  New Century’s accounting. Many of these changes were based on the premise that New Century was not accurately recording the “fair value” of  loans that it had to repurchase from Goldman Sachs and other buyers.

Meanwhile, Einhorn convinced the board to create a finance committee and presented himself as the man to run it. According to the bankruptcy report, this committee met “unusually often,” and according to sources, its principal activity was to handle New Century’s relationships with Goldman Sachs and the 13 other banks that were buying New Century’s mortgage loans. In June 2006, at Einhorn’s behest, New Century hired a woman named Lenice Johnson to serve as chief credit officer, responsible for managing those same relationships.

As we shall see, two of those relationships – especially the one with Goldman Sachs – would later  mysteriously deteriorate, leading to New Century’s demise. And soon after New Century went bankrupt, Johnson went to work at the above-mentioned Cerberus Capital (the Milken-crony hedge fund).  You may remember that Cerberus Capital was mentioned above because  Thomas Marano the head of Bear Stearns’ mortgage trading desk, sunk Bear Stearns by buying Goldman-packaged new Century debt, then leaked information about Bear Stearns’ financial condition to New York Post reporter Roddy Boyd (Boyd is Deep Capture All Star; his dishonesty has been fodder for many of our stories), a few weeks before joining the hedge fund – Cerberus Capital — that was betting against Bear Stearns. In sum, then: Cerberus Capital bet that New Century would face a credit crunch and bet against Bear Stearns for buying New Century’s debt, then hired the New Century chief credit officer and the head of the Bear Sterns desk that was making the bad bets.

As Einhorn and Morrice eagerly sold off all of New Century’s loans, other board members became alarmed. In August 2006, board member Fred Forster wrote a letter to Einhorn stating: “Whatever we do, we need to be very comfortable that less capital/liquidity does not in any material way threaten the very existence or viability of New Century.”

It needs to be stressed that at this point New Century was seemingly in good health. Defaults on its mortgages had increased only slightly, and in the third quarter of 2006, the company recorded a profit of more than $200 million. The problem was that nearly 100 percent of the mortgages it wrote were now being sold to Goldman Sachs and 13 other banks. With no mortgages on its books, the company depended entirely on the banks for income. If just one of those banks were to pull the plug, the company would go bankrupt. And as we know, one of those banks, Goldman Sachs, was placing large short bets on CDO’s containing New Century mortgages, meaning that Goldman had a motivation to see New Century fail. In other words, New Century climbed into Goldman’s life support chamber while Goldman kept its hand on the plug and bought insurance that would pay out in the event of New Century’s death.

Of course, as we know, Goldman was also selling CDOs that had been stuffed with New Century’s subprime mortgages. No doubt, Einhorn and his allies at New Century aided the proliferation of these CDOs by selling Goldman ever-larger numbers of subprime mortgages. Again, the problem was not that the subprime mortgages had high default rates. The mortgages were always expected to have high default rates. That’s why they were called “subprime.” The problem was that Goldman (perhaps with encouragement from their key client Einhorn) was selling the subprime mortgages in essentially fraudulent CDOs that disguised the subprime mortgages as AAA rated debt.

It was just a matter of time before the markets would discover the true nature of these CDOs. That, no doubt, is one reason why Goldman was simultaneously shorting them. All the better for Goldman if New Century were to collapse before the CDO scam was discovered. According to a McClatchy news report, when New Century did collapse, Goldman was prepared with shell companies in the Cayman Islands through which it could offload the last of its New Century debt to unwitting foreign investors.

Supposing that miscreants did want New Century to go bankrupt, all that was required was some precipitating event – an event that would allow one of the 14 banks (say, Goldman Sachs) to force New Century to repurchase its mortgage loans under the terms of its contractual repurchase agreement.

As it happened, the foundations for that precipitating event were laid in November 2006, when New Century demoted its chief financial officer, Patti Dodge, and hired a man named Taj Bindra to take her place. As Morrice, the New Century CEO, told the bankruptcy examiner, Zona and Einhorn “had expressed doubts about Dodge’s capabilities and competence to be the company’s CFO,” and sources tell Deep Capture that Bindra was hired at Einhorn’s behest.

Prior to joining New Century, Bindra had been the vice president of mortgage banking at Washington Mutual. A lawsuit filed by a consortium of respected insurance companies that were investors in Washington Mutual alleges that JP Morgan conspired with “investors” (read: “short sellers”) to drive down Washington Mutual’s share price and manufacture falsehoods about its financial health so that JP Morgan could take the company over at a substantial discount. As part of this scheme, the lawsuit alleges, JP Morgan “deceptively gained access to Washington Mutual’s confidential financial records through the use of ‘plants’ and ‘moles’ engaged in corporate espionage.” The lawsuit alleges that one of the “moles” was … Taj Bindra. It is this same Taj Bindra who then went on to bigger things as CFO of New Century Financial.

Whether or not you believe that Bindra was part of a conspiracy to take down Washington Mutual, it is clear that his actions as CFO of New Century Financial were strange. Understanding why, however, requires delving into a bit of accounting arcara.

According to one source, Bindra had been CFO for “no more than two days” before he began asking questions about New Century’s accounting for mortgage loans that the company had so far repurchased from Goldman Sachs and the 13 other buyers. Specifically, Bindra asked why New Century did not include so-called “income severity” (i.e. a mark down of the value of repurchased loans to reflect their actual resale value) in its reserve calculation.

Normally, one wants reserves in any financial company to properly estimate the risks of certain events, and their potential costs. However, Bindra’s  question was somewhat esoteric (especially for  a CFO who had only been at New Century for two days) because it referred specifically to an obscure change in New Century’s accounting that had been made in the second quarter of 2006. That change was as follows: instead of recording the mark-down in its reserves, it recorded it in “loans held for sale.”  This does not mean that New Century had stopped including income severity in its calculations, but rather, had  moved it to another (and equally or more visible) part of its balance sheet.  The books continued to balance (that’s why they call it a “balance sheet”) and, accounting experts tell Deep Capture, the change had absolutely no effect on New Century’s  bottom line, nor was it any less transparent. Multiple New Century executives explained this to Bindra. In addition, KPMG, New Century’s accountants, confirmed to Bindra that the change did not affect earnings.

But Bindra persisted. And, according to the bankruptcy report, “such inquiries by Bindra led in relatively short order to the discovery of material accounting errors.”  Those “material accounting errors” were none other than the obscure change in accounting for income severity – i.e. the change that had no effect on New Century’s earnings. By remarkable coincidence, just as Bindra discovered this supposed “error” in December 2006 (which was long before the “error” was mentioned in any other public forum), the Center for Financial Research and Analysis, an outfit known to cater to short sellers, published a report that alluded to this very same “error.”

When Bindra took this supposed “error” to the board, there was much confusion among most of the directors. But Einhorn and Zona insisted adamantly that New Century would have to restate its earnings. This was strange not only because the change in how the company recorded income severity had no material effect on earnings, but also because Einhorn had eagerly signed off on the change in the first place. In fact, the change had been  one of the board’s first initiatives after Einhorn took over the finance committee. Given this, it certainly appears possible that Einhorn  initiated the accounting change so that his hand-picked CFO would have some “irregularity” to point to a few months later.

In any case, on February 7, 2007, New Century announced that it had violated accounting rules and would have to restate earnings for the previous year. Oddly, New Century never indicated by how much it would have to restate earnings. It simply said that it would restate. Given that the “violation” discovered by Bindra had no effect on earnings, it makes sense that the company would not provide a figure. That is to say, the figure could not be provided because, as far as anyone at New Century knew at the time, the figure was zero.  But this “restatement” announcement was nonetheless catastrophic for New Century, and the beginning of the end for the stability of the American financial system.

It was catastrophic because Goldman Sachs and the 13 other banks that were buying New Century’s mortgage loans had small print in their contracts that allowed them to cut off finance and force New Century to buy back its loans if New Century were to restate earnings. Indeed, a restatement was one of the only events that would allow the banks to force New Century to repurchase all of its loans.

Still, nobody actually expected any bank to act on this small print.  Presumably it would be mutually assured destruction, with New Century going bankrupt and the banks losing a fortune in the market for CDOs. Several weeks after the earnings restatement, Citigroup made a large investment in New Century, obviously reckoning that the fundamentals of the company were just fine.

But as we know, Goldman Sachs was impervious to mutually assured destruction because it had been short selling the CDOs all along. And sure enough, on March 7, 2007, Goldman, acting on that small print in its contract, sent a non-public letter demanding that New Century repurchase every single one of its Goldman-financed loans. The next day, IXIS Real Estate Capital, then a subsidiary of the French bank Natixis, sent New Century a similar letter. David Einhorn had recently become a major investor in Natixis and had been threatening to topple its management, but that is no doubt another coincidence.

Certainly not a coincidence is the fact that a massive illegal naked short selling attack on New Century began just before Goldman Sachs sent its letter. SEC data shows that there were “failures to deliver” of more than 4 million New Century shares on March 8, 2007. Since failures to deliver occur three days after the selling date, those 4 million phantom shares must have been sold by March 6, one day before Goldman sent the letter. It appears that somebody knew what Goldman had in store for New Century.

An independent company that tracks the trading of hedge funds reports that the biggest traders in New Century stock at this time were SAC Capital, run by Steve Cohen, who was once investigated for trading on inside information provided by Michael Milken’s shop at Drexel Burnham, and none other than Dan Loeb, who was Einhorn’s early ally in the ultimately successful effort to force New Century to sell off all its loans. We do not know for certain that those trades were short sales because the SEC does not require hedge funds to report their short positions (on the grounds that it might reveal their “proprietary trading strategies” which  are, in some cases, flagrantly illegal), but it would be unlike Cohen and Loeb to invest in a company that was about to be wrecked by Goldman Sachs.

In the days after Goldman and IXIS cut off credit, New Century’s remaining bankers panicked. With Goldman pulling out and naked short sellers on the rampage, it was clear that New Century’s days were numbered. The other bankers pulled the plug and within a matter of weeks, New Century, a company that had reported a strong profit a few months before, declared bankruptcy. The news of the bankruptcy immediately crashed the CDO market (the market actually began to sink around the time Goldman sent New Century its letter, but it went completely under on the news of the bankruptcy). This set off shockwaves that ultimately collapsed the American economy. Meanwhile, of course, Goldman made a handsome profit, having bet that all this was going to happen – that is, it bet that the instruments with which it was flooding the US financfial system would turn toxic.

As we also know, Einhorn also earned a tidy sum — from his short sales of MBIA, which insured the CDOs, and later from his short selling of Bear Stearns and Lehman Brothers, which had bought the CDOs. Did Einhorn or others in his network profit more directly from the collapse and naked short selling of New Century? That is for the SEC to decide.

But, of course, the SEC is unlikely to look into this. Instead, it has charged New Century’s former CFO, Patti Dodge, and two other New Century executives for violating accounting rules.

Yet to this date, no reputable independent body has provided evidence that the change in accounting that Bindra “discovered” in December 2006 actually affected earnings. And it is that change that prompted the disastrous announcement two months later that New Century was going to restate. KPMG, New Century’s accounting firm, was never consulted about the “restatement” and was fired before it had a chance to object. The decision to announce this restatement (and to not specify by how much the restatement would affect earnings) seems to have been made entirely by Bindra, the CFO, and one of Bindra’s minions, with the encouragement of David Einhorn and his ally Richard Zona.

In prosecuting Dodge and her colleagues for accounting violations, the SEC seems to have taken its cues from the bankruptcy examiners’ report, which goes to lengths to paint Dodge and other New Century executives (namely, those who were not allied with David Einhorn) as criminals. But strangely, while the bankruptcy examiner insists that there were all manner of misdeeds, it nonetheless admits that it is possible that no actual accounting rules were violated.

Indeed, the bankruptcy report is convoluted  beyond belief, and to this eye, biased beyond explanation. The examiner who authored this report stated that he “found no persuasive evidence” that New Century had deliberately inflated its repurchase reserve calculation. He notes that the all-important income severity component was indeed recorded in “loans held for sale” (and therefore had no effect on earnings). But he nonetheless suggests that earnings were inflated, noting that the “elimination of Inventory Severity in the LOCOM valuation account increased earnings by approximately 23.4 million” in the second quarter.

This is a actually a neat trick. The examiner is not stating here that income severity wasn’t recorded accurately. He is saying that it wasn’t recorded in the “LOCOM valuation” – i.e. at “fair value.” As I have mentioned, notions of “fair value” are often arbitrary. Indeed, from the report itself, it would appear that the examiner  pulled that $23.4 million figure out of thin air. The tactic seems to be to point to a change in accounting (one that had no effect on earnings) and suggest that this change did inflate earnings by alluding to something altogether unrelated – i.e. random assumptions about fair value.

That is, the argument (which, incidentally, is the same argument that was heard from Einhorn at New Century board meetings) seems to go like this:

Einhorn/bankruptcy examiner: “New Century changed its accounting. It didn’t book income severity in repurchase reserves. Therefore, New Century inflated earnings.”

Innocent executive: “But we did record income severity, in ‘loans held for sale.’ Earnings aren’t affected by the change.”

Einhorn/bankruptcy examiner: “New Century changed its accounting. Therefore, New Century must have inflated earnings.”

Innocent executive: “But Einhorn signed off on the change. In fact, it was his idea. And, again, it had no effect on earnings.”

Einhorn/bankruptcy examiner: “Well, there was a change. That must mean something is wrong.”

Innocent executive: “No”

Einhorn/bankruptcy examiner: “Look, the problem is that income severity wasn’t recorded at ‘fair value.’”

Innocent executive: “What is ‘fair value’?”

Einhorn/bankruptcy examiner: “Here’s a number. I found it in my underpants.”

Innocent executive: “That’s completely arbitrary. We have a formula for marking to market that has served us for years.”

Einhorn/bankruptcy examiner: “No, we should use the number from my underpants. To prove my point, I will note that New Century changed its accounting.

Innocent executive: “Changing the accounting had no effect on the calculation of the expense!”

Einhorn/bankruptcy examiner: “Right, but you changed the accounting.”

Innocent executive: “I give up. This may wreck the American economy, but I give up.”

Aside from the income severity issue, the bankruptcy examiner provides a litany of other accounting violations that might have been committed by New Century even though the examiner says it found no evidence that any were broken. None of these supposed misdeeds had anything to do with the restatement announcement that enabled Goldman to torpedo New Century, and most of the alleged violations concern supposed miscalculations of “fair value.” Time after time, the examiner opines as to what the fair value of various loans should be, but not once does he explain where in the world he is getting his numbers. If anyone were to ask where he got his numbers, his answer would no doubt be: “They changed the accounting.”

This sort of shifty eyed, misdirecting gobbledygook defines David Einhorn’s style, so it is perhaps no surprise that the bankruptcy examiner seems to think that Einhorn is the one New Century insider who is actually a terrific fellow (though he is the one who instigated the accounting change that the bankrupcy examiner thinks is so evil).

The examiner, by the way, is named Michael Missal. Prior to becoming a bankruptcy examiner, Michael Missel was a defense lawyer for the above-mentioned, infamous Michael Milken. But that is probably another coincidence.

By now, everybody knows that the market for collateralized debt obligations was riddled with fraud in the lead-up to the financial crisis. What is less known is the fact that hedge fund managers helped create and inflate the market for these toxic securities specifically so that they could bet against them and profit from the inevitable collapse.

An example of a particularly sordid scheme, orchestrated by hedge fund billionaire John Paulson, was discovered some time ago by David Fiderer, a blogger for the Huffington Post. The information in Fiderer’s blog is rather incriminating, and, of course, the mainstream media is not on the case, so I think it bears repeating.

In a close reading of Wall Street Journal Gregory Zuckerman’s book, “The Greatest Trade Ever”, an otherwise starry-eyed account of Paulson’s bets against the mortgage market, Fiderer discovered this nugget:

“Paulson and [partner Paolo Pellegrini] were eager to find ways to expand their wager against risky mortgages. Accumulating it in the market sometimes proved to be a slow process. So they made appointments with bankers at Bear Stearns, Deutsche Bank (NYSE:DB), Goldman Sachs (NYSE:GS), and other banks to ask if they would create CDOs that Paulson & Co. could essentially bet against.”

As Fiderer explains, Paulson asked the banks to create those CDOs “so that they could be sold to some suckers at close to par. That way, Paulson’s hedge fund could approach some other sucker who would sell an insurance policy, or credit default swap, on the newly minted CDOs. Bear, Deutsche and Goldman knew perfectly well what Paulson’s motivation was. He made no secret of his belief that the CDOs subordinate claims on the mortgage collateral were close to worthless. By the time others have figured out the fatal flaws in these securities which had been ignored by the rating agencies, Paulson could collect up to $5 billion.

“Paulson not only initiated these transactions, he also specified the terms he wanted, identifying which mortgages would be stuffed into the CDOs, and how the CDOs should be structured. Within the overall framework set by Paulson’s team, banks and investors were allowed to do some minor tweaking.”

It is not clear which banks ultimately participated in Paulson’s scam, but Fiderer quotes Bear Stearns trader Scott Eichel as saying that his bank refused. “It didn’t pass the ethics standards;” Eichel said, “it was a reputation issue and it didn’t pass our moral compass. We didn’t think we could sell deals that someone was shorting on the other side.” Bear Stearns’ moral compass was usually pointed towards the darker regions, but perhaps this is why Paulson subsequently became one of the more eager short sellers of Bear Stearns’ stock.

Fiderer continues: “Prior to 2006, there were not many opportunities for naked short selling on subprime securitizations. But in January of that year, investment banks launched a new product, which enabled Paulson to place those bets on a large scale. The ABX index, a sort of Dow Jones Average of subprime mortgage securities, facilitated benchmarking the price of credit default swaps.”

In fact, it was a black box company called the Markit Group that created the ABX index. The banks were minor shareholders in Markit Group and provided data. I have noted in a previous blog that the Markit Group is a dubious outfit to say the least, and there is good reason to suspect that the direction of the ABX index was influenced by hedge fund managers and their allies at the big banks. I do not have evidence that Paulson was one of those hedge funds, but authorities ought to be asking questions.

Fiderer goes on to suggest that bad loans to homeowners were a significant cause of the financial crisis. On this front, I disagree with him. Certainly, some mortgage lenders were unscrupulous, and there was a certain amount of predatory lending, but the conventional wisdom that this is what crashed the economy is simply false.

At the time that the mortgage securities markets began to go south in 2007, defaults on subprime loans had increased only slightly month-to-month, and were in fact considerably lower than in earlier years. In the second quarter of 2007, for example, only 7.7 percent of subprime loans were 30 days past due, slightly up from 6.76 percent in the second quarter of 2006, but considerably lower than the 9.9 percent in the second quarter of 2001.

The problem lied not in the loans themselves, but in the fact that the loans had been packaged (apparently, to a large extent, at the behest of John Paulson and perhaps other bearish billionaires) into fraudulent securities that were traded and probably manipulated by a select number of hedge funds and large banks. In a somewhat similar scheme, hedge funds often pump up the stock of public companies before initiating short selling attacks aimed at demolishing those same companies.

The economy was brought to its knees by a few powerful and eminently dirty players on Wall Street, not by poor people who had the temerity to buy themselves houses.

Although much attention has been directed at the contribution made by credit default swaps  to the financial crisis, most discussion has focused on the companies, such as American International Group, that posted big losses because they sold these instruments without sufficient due diligence.

Another line of inquiry has not been pursued, however, though it is of equal, and perhaps greater, significance. That line of inquiry concerns the way in which the prices of credit default swaps effect the perceived value of all forms of debt — corporate bonds, commercial mortgages, home mortgages, and collateralized debt obligations — and as a result, the ability of hedge funds manipulators to use credit default swaps to enhance their bear raids on public companies.

If short sellers can manipulate the price of credit default swaps, they can disrupt those companies whose debt is insured by the credit default swaps whose prices are manipulated.  The game plan runs as follows: find a company that relies on a layer of debt that is both permanent, and which rolls over frequently (most financial firms fit this description). Short sell that company’s stock. Then manipulate the price of the CDS upwards, preferably into a spike, as you spread the news of the skyrocketing CDS price (perhaps with the cooperation of compliant journalists at, say, CNBC).

Because the CDS is, in essence, an insurance policy on the debt of the company, the spiking CDS pricing will cause the company’s lenders to panic and cut off access to credit. As this happens, the company’s stock will nosedive, thereby cutting off access to equity capital. Thus suddenly deprived of credit and equity, the firm collapses, and the hedge fund collects on its short bets.

Moreover, credit default swap prices are the primary inputs for important indices (such as the CMBX and the ABX) measuring the movement of the overall market for commercial and home mortgages.  In the months leading up to the financial crisis of 2008, short sellers pointed to these indices in order to argue  that investment banks – most notably Bear Stearns and Lehman Brothers – had overvalued the mortgage debt and property on their books. Meanwhile, several hedge funds made billions in profits betting that those indexes would drop.

It should therefore be a matter of some concern that credit default swap “prices” and the indexes derived from them are determined almost entirely by a little company with zero transparency and, it appears probable, a high exposure to influence from market manipulators. The company is called Markit Group, and there is every reason to believe that its CDS-driven indices (the CMBX, the ABX, and several others) are inaccurate, while the credit default swap “prices” that they publish  and which rock the market are in fact  nowhere close to the prices at which credit default swaps actually trade.

Last year, the media reported that New York Attorney General Andrew Cuomo had sent subpoenas to Markit Group as part of an investigation into possible manipulation of credit default swap prices by short sellers. This investigation, like Mr. Cuomo’s other investigations into market manipulation, have yielded no prosecutions.

The Department of Justice is reportedly investigating Markit Group for anti-trust violations. This investigation (which is reportedly focused on how Markit Group packages and sells its information) seems to acknowledge that Market Group has near-monopolistic control of information about credit default swap prices. However, if the press reports are correct, the DOJ has not considered the possible appeal of this monopolistic control to market manipulators.

Meanwhile, Henry Hu, the director of the Securities and Exchange Commission’s division of risk, has said that it has been nearly impossible for the SEC to conduct investigations into any matter concerning credit default swaps because the commission does not have access to any data on the trading of CDSs. In itself, this is a shocking admission.  It is all the more shocking when one considers that the necessary data exists and might be in the hands of the Markit Group – a black box company based in London.

A thorough investigation of Markit Group is urgently required.

Here is what we know so far:

• Markit Group was co-founded by Rony Grushka, Lance Uggla, and Kevin Gould. Prior to founding Markit Group, Mr. Grushka’s main line of business was investing in Bulgarian property developments. He recently resigned from the board of Orchid Developments Group, an Israeli-invested company based in Sophia, Bulgaria. Messrs. Uggla and Gould formerly worked for Toronto-Dominion Bank in Canada.

• Markit Group’s founders also include four hedge funds. However, Markit Group refuses to disclose the names of those hedge funds. In response to an inquiry, a Markit Group spokesman said it was “corporate policy” to keep the names of the hedge funds secret, but he would not say why Markit Group had such a policy. It seems worth knowing whether those hedge funds have any influence over Markit Group’s published information or indexes, and whether those hedge funds are trading on that information. It would also be worth knowing whether those hedge funds or affiliated hedge funds have engaged in short selling of public companies whose debt and stock prices were profoundly affected by the information that Markit Group published.

• Goldman Sachs, JP Morgan and several other investment banks also have ownership stakes in Markit Group. The investment banks received their stakes in exchange for providing trading data to Markit Group. It would be worth knowing whether these investment banks engaged in short selling ahead of Markit Group’s published indexes and price quotations.

• Markit Group is secretive about how it creates its indexes. In early 2008, the Wall Street Journal noted that the CMBX simply “doesn’t make sense” and that Markit Group’s indexes “might be exaggerating the amount of distress” in the home and commercial mortgage markets. In 2008, the average prediction for defaults on commercial mortgages was 2%. The CMBX implied that the default rate could be four times that level.

• When short seller David Einhorn initiated his famous public attack on Lehman Brothers, one of his central arguments was that the CMBX (the index that was likely “exaggerating the amount of distress”) proved that Lehman had overvalued the commercial mortgages on its books.

• In March 2008, the Commercial Mortgage Securities Association sent a letter to Markit Group asking it disclose basic information about how the CMBX index is created and its daily trading volume. “The volatility in the CMBX index, caused by short sellers, distorts the true picture of the value of commercial-mortgage-backed securities,” the group said in a statement.

• Markit Group is equally secretive about how it derives its “prices” for credit default swaps. A spokesman for the company spent close to one hour talking to Deep Capture. He did his job well and sounded like he was trying to be helpful. But he told us as little as possible.

• However, in the course of this conversation, we did learn that Markit Group’s “prices” are not actual, traded prices. They are mere quotations. The Markit Group has what it calls “contributors” – hedge funds and broker-dealers that provide it with information. Markit Group has a grand total of 22 “contributors.” Deep Capture asked Markit Group’s spokesman for the names of these “contributors.” The spokesman said he would try to find out the names and call back later. He never called back.

• The 22 “contributors” provide Markit Group with quotations, and these quotations become the Markit Group’s “price.” In other words, the “contributors” can quote any price for a CDS that they choose, regardless of whether anyone is actually willing to buy the CDS at that price. Markit Group looks at these quotations. Then it somehow decides which quotations make the most sense. Then it publishes information that purports to represent the actual market price of that CDS. This process is certainly unscientific. And it is ripe for abuse.

• Consider, for example, the Markit Group “price” for CDSs insuring the debt of company X.  The Markit Group price strongly suggests that company X is going to default on its debt in the immediate future. Short sellers eagerly point to the Markit Group CDS “price” as evidence that company X is doomed. Panic ensues, and suddenly, company X really is doomed. But the fact is, nobody ever bought a company X CDS at the price quoted by Markit Group. Rather, that panic-inducing “price” was, in effect, pulled out of a hat. Who pulled it out of a hat? That is matter of immense importance. There are two possible scenarios:

• The first possible scenario is that the 22 “contributors” report their quotations in good faith. They should be sending the actual traded price, not just a quotation, but assume they are just doing what was asked of them. From these quotations, Markit Group somehow decides what the “price” should be. It is possible that this decision is based on some secret formula (which would be worrisome); or it is possible that Markit Group executives sit around a table debating what the price should be and take a shot in the dark (which would be even more worrisome); or it is possible that Markit Group deliberately chooses the most horrifying price possible in order to assist the short sellers who are affiliated with its owners (which would be a matter for the authorities).

• The second possible scenario is that Markit Group acts in good faith (if not scientifically), but one or more of the 22 “contributors” or their affiliates has an interest in seeing company X fail. If just one of those “contributors” sends in an astronomically high quotation, that could be enough. Markit Group factors the absurd quotation into its posted “price” and it suddenly becomes possible to convince the world that company X is about to default on its debt.  Panic ensues, the firm’s layer of debt dries up, the stock price plunges, and perhaps the “contributor” or its affiliate make a lot of money.

• As Deep Capture understands it, CDS quotations suggested by the 22 “contributors” also help determine the movement of the CMBX and ABX indexes. The movement of these indexes did serious damage to the American economy in multiple ways. The  indexes prompted write downs at most of the major banks and mortgage companies. They were ammunition for short sellers, like David Einhorn, who claimed that companies had cooked their books by not writing down to the rock bottom prices suggested by the Markit Group indexes. They helped precipitate the decline in prices of mortgage securities, and contributed mightily to the panic that spread across the markets.  A lot of people made a lot of money as result of those indexes moving downward. So, it is rather important to know more about how those indexes are formulated, and if they can be driven by the same people who are making directional bets on their movements.

Conclusion: Ten years ago, there was no such thing as a credit default swap. Six years ago, a very small number of investors traded credit default swaps as hedges against the long-shot possibility of corporate defaults. Nobody looked to credit default swaps as reliable indicators of corporate well-being.

Then, suddenly, there were over $60 trillion in credit default swaps outstanding. That is, over the course of a few years, somebody had made over $60 trillion (many times the gross domestic product) in long shot bets that borrowers would default on their debt. As this derivative risk marbled through the system, the trading in credit default swaps was completely opaque. Nobody knew who bought them, who sold them, or at what price.

But starting in 2001, we knew the “prices” of CDSs. We knew the “prices” because two Canadians, a developer of Bulgarian real estate, and four mysterious hedge funds had founded a small, black-box company in London. That company, the Markit Group, achieved near-monopolistic power to publicize the “prices” through its magic process of aggregating quotation information provided by 22 hedge funds and broker-dealers who could well have been betting on the downstream effects of sudden price changes.

These “prices” were not prices in any meaningful sense of the term.  But, suddenly, these “prices” became perhaps the single most important indicator of corporate well-being. Assuming that those four hedge funds and the 22 “contributors” (or hedge funds affiliated with them) bet against public companies, it seems more than possible that short-sellers got to run the craps table, call the dice, and place bets, all at the same time.

So perhaps it is not surprising that a lot of long-shot rolls paid off quite nicely.

“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 (NYSE:BSC) 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.

What follows is PART 10 of a 15-PART series. The remaining installments will appear on Deep Capture in the coming days, after which point the story will be published in its entirety.

Click here to read PART 1

Click here to read PART 2

Click here to read PART 3

Click here to read PART 4

Click here to read PART 5

Click here to read PART 6

Click here to read PART 7

Click here to read PART 8

Click here to read Part 9

Where we left off, we had learned that on March 29, 2007, an FDA advisory panel had voted overwhelmingly that Dendreon’s promising treatment for prostate cancer should be approved. As a result, most financial analysts and investors were expecting that Dendreon would become a profitable company. However, ten hedge funds (out of a universe of 11,500 hedge funds) held large numbers of Dendreon put options (bets against the company), suggesting they had reason to believe that Dendreon would be derailed. At least seven of those hedge funds can be tied to Michael Milken or his close associates.

We had also learned that Michael Milken himself stood to profit if Dendreon were to experience any unexpected problems receiving FDA approval. This is because Milken was the early financier and principal deal maker for ProQuest Investments, a fund that (along with an affiliate) controlled a company called Novacea, which was one of Dendreon’s competitors in the race to produce a new treatment for prostate cancer. Meanwhile, a Milken crony, Lindsay Rosenwald (who once helped run D.H. Blair, a Mafia-linked brokerage which specialized in pumping and dumping fake biotech companies) controlled Cougar Biotechnology, which was Dendreon’s second competitor in the race to develop a treatment for prostate cancer. In addition, we had learned that Milken’s “philanthropic” outfit, the Prostate Cancer Foundation, had supported Novacea and Cougar, while turning its back on Dendreon.

Finally, we had learned that on April 13, 2007, The Cancer Letter, a newsletter with a record of publishing information leaked from the FDA in the service of select Wall Street hedge funds, published another FDA leak. This leak was a letter written to the FDA from a doctor named Howard Scher, who was a board member and executive of ProQuest Investments and the chairman of the “Therapeutic Consortium” of Milken’s Prostate Cancer Foundation. In that letter (an unprecedented attempt to lobby the FDA after an advisory panel had already voted), Dr. Scher argued vehemently that Dendreon’s treatment should not be approved.

One of Dr. Scher’s principal arguments against Dendreon was that the FDA advisory panel had improperly “changed the question” regarding the efficacy of Dendreon’s treatment. As we saw in Chapter 9, that claim was false, and Dr. Scher’s other arguments were specious.

But Dendreon’s enemies continued to whisper in reporters’ ears about this issue of “the question,” and the unprecedented lobbying of the FDA continued.

Now we meet another conflicted doctor and the sixth of those seven hedge funds that bet big against Dendreon right before the lobbying began….

* * * * * * * *

On April 20, three weeks after the advisory panel vote, and one week after Dr. Scher’s missive appeared in The Cancer Letter, Forbes journalist Matthew Herper published a story arguing that there was a good chance the FDA would not approve Dendreon’s cancer treatment outright. “If the agency wants to ask Dendreon for more data, it certainly has some outs,” Herper wrote. “The FDA changed the wording of the question…”

Three days later, Dr. Maha Hussain, one of the panel doctors who had quickly voted “No” on the bogus question, wrote a letter to the FDA arguing that Dendreon’s treatment should not be approved. This letter, like Dr. Scher’s, was addressed to FDA commissioners and was presumably confidential. And this letter, like Dr. Sher’s, found its way to The Cancer Letter, which posted it for all to see just three days after it was written.

Dr. Hussain’s arguments were precisely the same as those employed by Dr. Scher and the whispering folks on Wall Street. “The recommendations for approval…are based on data that can only be characterized as best as ‘suggestive’ of possible benefit,” she wrote. “From the scientific and procedural aspects, in general, it would seem that at the end of the day what should determine a positive verdict in any therapeutic trial is the strength of the evidence as critically reviewed by an Advisory Committee…with clear guidance on the question posed to the committee within the framework of the regulatory guidelines and requirements of the FDA for approval.” [Italics mine]

That is, Dr. Hussain—like Dr. Scher, the singing Sendek, and whoever was feeding the journalist Matthew Herper–was suggesting that the FDA panel had voted on the “wrong question.”

Meanwhile, Jonathan Aschoff, the physician-impersonating financial analyst who’d set a target for Dendreon’s stock price to reach a mere $1.50, was telling journalists that the FDA panel would not have voted to approve Dendreon’s treatment if it weren’t for the “substantial” rewording of “the question.” On April 25, Aschoff issued another damaging report, this one asserting, once again, that the FDA would ignore its panel because the panel had voted on the “wrong  question.”

By this time Dendreon supporters were busily circulating transcripts showing that the FDA panelists had, in fact, voted on the legal question. The supporters had also discovered Dr. Scher’s ties to Novacea, Cougar Biotechnology, Proquest, and Michael Milken, and began explaining to all and sundry that ProQuest and Novacea would cash in if Dendreon were not approved. Moreover, the supporters had revealed that Dr. Hussain, the second letter writer, had also done work for the Milken-invested Novacea, and was a member of the “Therapeutic Consortium” of Milken’s Prostate Cancer Foundation.

On April 26, Matthew Herper of Forbes published another article – this one repeating the arguments in Dr. Hussain’s letter. Herper, who had been told about Scher’s conflicts of interest, had apparently decided to investigate. This investigation seemed to have involved nothing more than asking Dr. Scher if he had any conflicts of interest. In his April 26 article, Herper  reported that Scher’s spokesman said “that Scher had nothing to do with his letter leaking [and appearing in The Cancer Letter], and that he knew of no family members who would benefit financially either way if Provenge were approved.”

To reinforce Scher’s credibility, and to make Dendreon’s supporters look silly, Herper added that the supporters had alleged that “Scher’s wife works for a hedge fund that might be short Dendreon…This is not true. She works in human resources for a nursing home company that could not conceivably benefit materially from any news about Dendreon.”

Aside from ignoring Scher’s ties to Milken’s ProQuest Investments, which would profit handsomely if Dendreon were not approved, Herper misconstrued the information about Scher’s wife. The truth was, Dendreon’s supporters had revealed that Scher’s wife had a cousin, Barry Lafer, who was a hedge fund manager. Phone records legally obtained by Deep Capture show that Scher called Lafer, at his office, on April 23, while Herper’s article was in the works.

But the main point of Herper’s article was that “all this debate” (i.e. the Wall Street whispering and the conjectures of two conflicted doctors) made “Dendreon an even riskier stock than other biotechs.” Herper added that according to unnamed “others,” Dendreon’s “studies do not rise to the level usually required for approval.”

Besides being false, this was another way of suggesting that the FDA panelists, all experts in their field, voted in favor of Dendreon because they had misunderstood the standards for approval. They had been asked the “wrong question.”

On April 29, Bloomberg News reported that Dendreon’s shares were being sold at “a record pace” as investors “bet the company’s experimental prostate-cancer drug will fail to win approval from U.S. regulators.”

Then, on May 4, there was yet another letter.  This one was from a University of Washington biostatistician named Dr. Thomas Fleming. It is perhaps noteworthy that Fleming had done work for Gerson Lehrman, an outfit that is owned by former hedge fund managers.

Gerson Lehrman has a remarkable business model which can best be described as “institutionalized bribery.” Clients, mostly hedge funds, hire Gerson to put doctors and other experts on the payroll. In exchange for the payments, the doctors agree to provide hedge funds with “insight” (some say they provide inside information) about clinical trials of drugs that are marketed by public companies. The doctors also agree to talk to reporters (and perhaps also to the FDA) about these drugs. In at least one case it has been clearly established that these hired sources lied (which could well explain, of course, why they were hired).

Like the letters from Dr. Scher and Dr. Hussain, within days of its creation Dr. Fleming’s missive miraculously ended up in the hands of The Cancer Letter, which eagerly published it.

“Reportedly Scher felt motivated to write the letter after being kept awake the night following the [advisory panel],” wrote Dr. Fleming. “I also was kept awake the night following the panel.”

In addition to knowing about Dr. Scher’s sleeping habits, Dr. Fleming shared Dr. Scher’s concern that approving Dendron’s treatment might derail Asentar, the drug that was being developed by Milken’s Novacea. How “could one defend internal consistency at FDA if [Provenge] were to be approved before the [Asentar] trial?” Fleming asked.

By this time, Dendreon’s supporters (a rambunctious bunch) were screaming and howling about the dishonesty of those who had suggested that the advisory panel had been asked the “wrong question.” So the party line changed a bit. Now it was that the panelists who had voted in Dendreon’s favor must have been somehow confused. Dendreon trials did not “provide ‘substantial evidence of efficacy’, Dr. Fleming wrote. “Rather at best, these trials provide plausibility of efficacy…”

I’ll leave it to the reader to parse the difference between “plausibility” and “substantial evidence.” But clearly, this letter was yet another strange occurrence.

Four days later – May 8, 2007 — the FDA told Dendreon that it was rejecting the company’s application for Provenge, a paradigm-shattering vaccine for those terminally ill with prostate cancer.

* * * * * * * *

The SEC’s partial data shows that more than 12 million Dendreon shares “failed to deliver” on May 10, 2007.  Traders are given three days to produce stock before their trades are registered as “failures to deliver,” so it is clear that hedge funds had sold the 12 million shares of phantom stock on May 7 — the day before the FDA made its decision. This suggests that somebody was aware of this imminent decision. We don’t know who engaged in that naked short selling because, as far as the SEC is concerned, it’s a big secret.

But we do know that a mere 10 hedge funds held large numbers of put options (a bet that the stock price would fall) as of March 31, a few days after the advisory panel’s nearly unanimous vote in Dendreon’s favor. Obviously, these were hedge funds with remarkable foresight concerning a long-shot event (the FDA’s decision to go against the overwhelming recommendation of its advisory panel to approve a drug for terminally ill cancer patients). Seven of those hedge funds belong to a mischievous Wall Street network that is known for its foresight – and for attacking companies that, coincidentally, are victims of illegal naked short selling.

Five of these hedge funds I have already named. All have ties to Michael Milken or his close associates. Some have ties to the Mafia. They are: Bernard L. Madoff Investment Securities, Perceptive Advisors, Millennium Capital, Steve Cohen’s Sigma Capital, and Pequot Capital.

In preparation for naming the sixth, we need to hearken back to September 2001, when two airplanes crashed into the twin towers of the World Trade Center, one crashed into the Pentagon, and a fourth dove into a field in Pennsylvania. On the day before that attack, a short seller named Anthony Elgindy called his broker and ordered him to liquidate one of his accounts, giving the explanation that a big event was about to occur. Mr. Elgindy said that on the following day (that is, on September 11, 2001) the market was going to  lose two-thirds of its value.

After the 9-11 attacks, that broker notified the FBI of Elgindy’s eerie prediction, and the FBI launched an investigation. In the course of this investigation, the government learned  that Elgindy had sold massive amounts of phantom stock, and that he routinely blackmailed and threatened companies that he was selling short. The government also learned that Elgindy had ties to terrorist outfits in the Middle East, and for a time prosecutors argued in court that Elgindy had advance knowledge of the 9-11 disaster.

Ultimately, though, Elgindy was convicted and sentenced to 11 years in prison for the more demonstrable crimes of stock manipulation and paying bribes to two FBI officials who fed him information from the FBI’s National Crime Information System (one of those FBI agents actually kept Elgindy informed of the progress of the investigation into Elgindy’s connection to the 9-11 attacks). In June, 2009, it was learned that the SEC’s inspector general had begun investigating SEC officials who are also alleged to have collaborated with Elgindy, either by providing inside information on commission investigations, or launching destructive, dead-end investigations of companies that Elgindy was selling short.

Elgindy, like Bernard Madoff  (the Dendreon short and Ponzi schemer who helped write the SEC’s rules on naked short selling), is believed to have ties to organized crime. He once worked for a now-defunct Mafia-connected brokerage called Blinder Robinson (known on the Street as Blind’em, Rob-em), and a source close to the Elgindy investigation has told Deep Capture that, shortly before Elgindy appeared for sentencing, Russian mobsters forced Elgindy to saw off the tip of one of his own fingers as a reminder not to squeal on other members of his network.

There is evidence – including transcripts of Elgindy’s private Internet message board – that shows that Elgindy routinely attacked public companies in collaboration with certain hedge fund managers. A significant number of these hedge fund managers were part of the Milken network.

One of them was Jeffery Thorp, whose father once worked with the Genovese organized crime family to develop a method for cheating Las Vegas casinos. The government’s investigation of Elgindy eventually led to Thorp, who was charged in 2006 with providing fraudulent “death spiral” PIPEs financing to 22 companies. The SEC’s case, one of the rare instances in which the commission has identified a naked short seller by name, makes it clear that Thorp sold massive amounts of phantom stock, ultimately destroying the 22 companies that had received his fraudulent PIPEs.

Recall that similar “death spiral” PIPEs were arranged by Carl Icahn’s Ladenburg Thalmann, ending in the phantom stock ruination of more than 20 companies. Icahn is the “prominent” investor who owes his status as a billionaire to Michael Milken and the Mafia-connected Zev Wolfson. Icahn is also the “prominent” investor who, along with Ziff Brothers and Steve Cohen, called ImClone immediately before The Cancer Letter published the “leaked” news of an FDA decision.  Icahn is also the “prominent” investor whose former employee was the last man to see Alain Chalem (a Mafia-connected naked short seller) before Chalem’s head was riddled with bullets by Russian mobsters.

Do you still not believe that this network has ties to the Mob? Consider that Thorp’s father, in addition to working for the Genovese organized crime family, was the single most important player in the stock manipulation network that Milken operated in the 1980s.

The father, Edward Thorp, ran a hedge fund called Princeton-Newport. The FBI eventually raided that operation, hauling away phone recordings and documents. Thorp was not ultimately charged, but the evidence that the FBI retrieved that day featured prominently in the prosecution’s 98-count indictment of Milken. Indeed, people who worked on the case say that the Princeton Newport evidence was far more important to the prosecution than the testimony of Milken’s more famous co-conspirator, Ivan Boesky.

Do you still not believe that people in this network employ precisely the same ruthless tactics? Consider that when the FBI investigated Elgindy, it also stumbled upon a hedge fund called Gryphon Partners. One of Gryphon’s portfolio managers, Jonathan Daws, was eventually charged with participating in various short selling schemes hatched by Elgindy and his bribed FBI agent. In pleading guilty, Daws said, “others at Gryphon made trades in some of the relevant stocks, independent of me, and not at my direction.” Daws was convicted.  No charges were immediately filed against Gryphon.

However, in 2006, the SEC sued Gryphon for providing fraudulent “death spiral” PIPEs financing to 35 companies. Like Thorp and the hedge funds introduced by Carl Icahn’s Ladenburg Thalmann, Gryphon provided its PIPEs financing knowing that it would cause stock prices to fall. The hedge fund then hammered the companies with naked short selling, sending their stocks into “death spirals.” Most of the 35 companies were destroyed.

So, at this point in the story, we have identified more than 70 companies that have been vaporized by “prominent” investors, all part of the same network.

At any rate, Gryphon Partners, the Elgindy-connected, PIPEs-financing, 35 company-destroying SEC-sued death spiral finance house, was founded by G. Stacy Smith and Reid S. Walker, two “prominent” investors who have since gone on to greater things. They now run a hedge fund called WS Ventures.

And WS Ventures is the sixth of our seven “colorful” hedge funds that had the foresight to own large numbers of put options in Dendreon at the end of March 2007, just after the seemingly fantastic news that the advisory panel had voted overwhelmingly in Dendreon’s favor, and during the period when Dendreon was awash in illegal naked short sales, and just before the disastrous news that the FDA had rejected the advice of its own advisory panel.

A few months later, Dendreon, on the verge of collapse and desperate for money to support its sabotaged prostate cancer treatment, went ahead and signed a deal to receive its first “death spiral” PIPEs finance.

* * * * * * * *

To be continued….Click here for Chapter 11.

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

1) email it to a dozen friends;

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

What follows is part 1 of a 15-part series. The remaining installments will appear on Deep Capture over the next several weeks, after which point the story will be published in its entirety. It is a story about the travails of just one small company, but it describes market machinations that have affected hundreds of other companies, and it contains a larger message for anyone concerned about the “deep capture” of our nation’s media and regulatory bodies.

This story, like too many others, begins with Jim Cramer, the CNBC personality, making “a mistake.”

On September 26, 2005, Cramer  announced to his television audience the sad news (punctuated by funny sound effects – a clown horn, a crashing airplane) that Provenge, an experimental treatment for prostate cancer, had flopped. Thousands of end-stage patients had been pinning their hopes on Provenge, but according to Cramer the treatment had just been rejected by the Food & Drug Administration. It would never go to market.

This seemed odd, because Dendreon (NASDAQ: DNDN), the company developing Provenge, had not yet submitted an application for FDA approval. As everybody in the biotech investment community knew, Dendreon had, in fact, only recently completed Phase 3 clinical trials and probably would not face scrutiny from an FDA advisory panel for at least another year.

As for the likelihood that the advisory panel would eventually vote in favor of Provenge, the odds looked quite good. The Phase 3 trials had demonstrated that Provenge significantly increased patient survival with only minimal side-effects, such as a few days of mild fever. Moreover, Provenge was an altogether different sort of treatment – one that fought tumors by boosting patients’ immune systems rather than subjecting them to the ravages of chemotherapy.

Provenge was not a magical elixir of life, but Dendreon was doing more than just developing a new technology. It was pioneering a treatment that could revolutionize the way that doctors fight prostate cancer. By some conservative estimates, the market for Provenge alone could reach more than $2 billion a year. If the treatment could be applied to other cancers, the market would be even larger.

The morning after Cramer declared Dendreon and Provenge to be dead in the water, Mark Haines, the anchor of  CNBC’s “Squawk Box” program, apologized for Cramer’s “mistake.” That afternoon, at an important UBS investor conference, Dendreon presented still more promising data. This would normally have given a significant boost to the company’s stock price, but the value of Dendreon’s shares stayed flat for the day, and then began a gradual decline.

This had partly to do with Cramer. The next evening, on his “Mad Money” program, the journalist (or entertainer, or self-confessed criminal, or… whatever Cramer is) acknowledged that the FDA had not yet rejected Provenge, but drawing upon his medical expertise, Cramer maintained that Provenge was not effective. In characteristically level-headed fashion,  he announced that Dendreon shareholders were drunken, carousing, gambling Falstaffs who “might as well take their money to Vegas.”

Dendreon, Cramer added (rather ominously), was  a “battleground stock.”

What Cramer meant by “battleground ” has since become all too apparent. For the past four years, Dendreon has been one of the most manipulated stocks on NASDAQ. During some periods the volume of trading in the shares of this little company has exceeded the trading in America’s largest corporations – a good sign that hedge funds have been churning the stock to move the market.

And with every burst of good news, the company has faced waves upon waves of naked short selling – hedge funds illegally selling millions of shares that do not exist to flood the market and drive down the stock price. Along with the phantom stock, people seeking to diminish Dendreon have deployed false financial research , biased media, bogus class action lawsuits, Internet bashers, dubious science, and other familiar weapons of the “battleground.”

The denouement of this stock market “battle” occurred recently, on April 28, 2009, when Dendreon was to present all-important results at the American Urological Association’s annual meeting in Chicago. Some days prior, Dendreon’s CEO, Mitch Gold, had announced that the results of an Independent Monitoring Committee study were “unambiguous in nature…a clear hit” for Provenge.

If a CEO uses language like that and does not produce the data to back it up, he is guaranteed a visit from the Securities and Exchange Commission. Unless the CEO or his allies have juice with the SEC, the commission will usually charge the CEO with making false statements to pump his stock.  Gold was unlikely to take that risk, so it was clear to most people that the meeting in Chicago was going to be a triumph for Dendreon.

And it indeed it was.  The data presented that day showed that Provenge lowers the risk of prostate cancer death by 22.5 percent, with little or no toxicity. With a few notable exceptions (some of whom are to appear as prominent characters in this story), nearly every medical professional on the planet now concurred that Provenge was a blockbuster drug – one that should receive FDA approval and make Dendreon a highly profitable company.

But the hedge funds weren’t finished. In the days following Gold’s announcement, short sellers piled on with a vengeance, returning Dendreon to the leagues of the world’s most heavily traded stocks. The firm once again found itself on the SEC’s “Reg Sho” list of  companies whose stock was “failing to deliver” in excessive quantities –a sign of illegal naked short selling.

On CNBC, meanwhile, Cramer had hammered Dendreon. On April 6, 2009,  amidst ear-rattling sound effects –dogs fighting, and (inexplicably) a baby crying — Cramer had said “I don’t like Dendreon.”  He had shouted that Provenge had no chance of getting FDA approval and Dendreon shareholders should “SELL! SELL! SELL!”

Then, on April 28, at 10:01  am central time — just hours before Dendreon’s triumph in Chicago – an anonymous message board author on Yahoo! Finance posted this message: “HIGH PROBABILITY OF MASSIVE BEAR RAID…DNDN [Dendreon] could easily drop 50% on a massive bear raid…its coming today@12:30 pm central.”

Just minutes before 12:30 pm central, Dendreon’s stock price began to fall. It didn’t just fall–it nosedived from $24 to under $8 … in 75 seconds.  That’s correct, during a period of 75 seconds, more than 4,000 trades were placed, totaling 3 million shares, or about 50% of Dendreon’s (spectacularly high) average daily volume. Given that the message board poster knew what was coming more than two hours beforehand, and predicted the timing almost precisely, it is a safe bet that this was a coordinated, illegal naked short selling attack. And just in case you still didn’t get this – it caused Dendreon’s share price to lose more than 65% of its value – in just 75 seconds flat.

“My desk was floored,” one trader wrote on a message board. “We all just stood up swearing, headsets and other assorted desk items being thrown at monitors…I haven’t heard that much swearing in years…”

It was, say others, one of the strangest occurrences in Wall Street history.

In fact Dendreon had witnessed even stranger occurrences – brutal naked short selling attacks occurring simultaneously with antics that simply have no precedence in the world of medicine. As will be described presently, these strange occurrences very nearly destroyed Dendreon in 2007.  These strange occurrences have also prevented patients from having access to Dendreon’s treatment – a treatment that, as will become clear, should have reached the market some time ago.

And from the day of that first strange occurrence in September 2005, when Cramer predicted that Dendreon would become a “battleground” stock, to the latest strange occurrence in April 2009, when Dendreon’s stock nosedived by 65% in 75 seconds, more than 60,000 men in the United States died of prostate cancer.

So we must ask: Who did this? Who stood to profit from Dendreon’s demise? Were the extremely odd delays in getting Provenge to market purely accidental? Or, were the remarkable trading patterns and volatility accompanying those delays in fact an expression of stock manipulation, and if so, who were the manipulators?  Since we know that Dendreon experienced naked short selling, and naked short selling is a crime, who are the criminals?  And when much of the medical community rallied around Provenge last month, which manipulators crashed the stock to single digits – possibly to make the company ripe for a hostile takeover by the very people who once sought to destroy it?

It is one of the peculiarities of the Securities and Exchange Commission that while it is ever-eager to hassle CEOs of small companies, it goes to considerable lengths to protect billionaire hedge fund managers. The SEC has publicly stated that naked short selling is a crime. It has said that it has evidence that illegal naked short selling occurs on a large scale and does serious damage to public companies. But it almost never says which hedge funds are responsible. It never says who is flooding the market with  phantom stock.

As far as the SEC is concerned, it’s all a big secret. As the commission states on its website, the naked short selling statistics “of individual firms and customers is proprietary information and may reflect firms’ trading strategies.” It seems not to matter to the SEC that those “proprietary” trading strategies are illegal.

Meanwhile, the SEC does not require hedge funds to disclose even their legal short positions. As a result, it is impossible for any journalist to present photo-perfect portraits of attacks on companies like Dendreon.

But brokers and other sources can tell us who some of the short sellers are. And by analyzing public information (such as data that hints at various hedge funds’ options strategies) we can make educated guesses as to who has the most to gain from a company’s decline. We can also come to understand the relationships that bind certain hedge fund managers and miscreants, and ask whether these people might have been acting in concert.

If the relationships are few in number, or separated by six degrees, we must abandon the project – a spatter of dots on the wall is not a work of art. But if the dots are plentiful, precise, and show a recognizable pattern, then we have something valuable – a sort of pointillist painting of market behavior.

In the case of Dendreon, we have such a painting. And when we look at this painting, with its dozens of data points, we can see quite clearly the familiar smirk of Michael Milken, the famous “junk bond king” and criminal stock manipulator.

During the times when Dendreon has been most evidently a “battleground stock,” nearly every hedge fund known to have placed large bets against Dendreon and a significant number of Dendreon’s detractors — esteemed medical professionals, financial research analysts, government officials, and Jim Cramer himself – have been tied to Milken or his close associates.

Most of the hedge fund managers who appear in this story are part of a tight network that has been in operation – exchanging information, attacking the same stocks, employing the same tactics – for upwards of twenty years. This is the same network that attacked the major financial institutions in 2008, possibly contributing to the collapse of the American financial system. And though I recognize that some people find this hard to absorb, I will present further evidence that a good number of the people in this network have ties to organized crime – the Mafia.

As for Milken, he was released from prison in 1993, at which point he went to considerable lengths to rebrand himself as a “prominent philanthropist.” One of the “philanthropic” outfits that he founded is the Prostate Cancer Foundation, and for this he has received widespread applause from the media, government officials, and the business elite. Because Milken has effectively bathed himself in the glow of his “philanthropy” (and because his public relations machine is so indisputably clever), many people find themselves saying that Milken’s financial crimes were but misdemeanors – the slight over-exuberance of a “market innovator.”

But the Dendreon story raises serious questions about the nature of Milken’s “philanthropy” – and about a society that venerates and even seeks guidance and favor from the most destructive financial criminal the world has ever known.

To be continued…Click here for Chapter 2.

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