One of the great episodes of The Simpsons follows Homer as he comes to realize that not all Springfield citizens are treated equally.
The difference, Homer eventually discovers, is membership in a secret society known as the Stonecutters. Once on the inside, Homer is delighted to find his new affiliation subjects him to an enviable set of alternate rules.
Obviously, this is parody, but it succeeds because it’s based on a truth to which we can all relate: the belief that status bestows disproportionate advantage upon a privileged few – up to and including license to engage in illegal behavior.
Homer and the Stonecutters immediately came to mind upon learning that, from 2005 through 2009, Deutsche Bank (NYSE:DB) selectively disabled a system intended to block customers’ short sale orders when placed without valid locates, while the Fidelity-affiliated National Financial Securities (NFS) achieved the same end by creating an entirely separate system for certain customers disinterested in compliance with the rules governing how the rest of us can trade.
Shorting shares that have neither been borrowed nor, at a minimum, located for eventual borrowing, is an illegal and manipulative practice and the essence of naked short selling; and yet, Deutsche Bank and NFS decided certain customers were entitled to do it.
Back in 2006, small-time hedge fund manager Jeff Matthews announced he doubted naked shorting was possible because he didn’t know how to do it. In reality, the thing Matthews didn’t know (possibly to his credit) was the secret knock used to gain entrance to the mega-hedge fund speakeasy, where the real debauchery goes on.
Why should Matthews and others be excluded?
The better question is: why should anybody be included? I suspect the clients allowed to violate the law in this way also happened to be the ones paying Deutsche Bank and NFS the most in commissions. But this isn’t like a hotel claiming it’s full while holding a suite in reserve for someone more important than you, or NBA refs not calling traveling on the players everybody’s really paying to watch. Instead, when these two banks enabled such manipulative trading, they were silently transferring wealth from the masses into the accounts of the privileged few.
This is true of both long buyers and short sellers, for the longs saw their investments devalued by the naked shorting of stocks in their portfolios, while the shorts were forced to pay high premiums for hard-to-borrow stocks even as others were exempted from such inconvenient market forces as supply and demand. This happened across the market, but those who should be particularly bothered are the many Deutsche Bank and NFS account holders whose brokerages acted contrary to their best interests.
In fact, they ought to sue, in my opinion, to say nothing of what the Department of Justice ought to be doing about it.
Exactly how much did these years of market manipulation extract from investors? That’s impossible to know, however what I can say without doubt that it exceeds the combined $925,000 fine imposed by FINRA.