Today, short-selling hedge fund Rocker Partners paid Overstock.com (NASDAQ:OSTK) $5-million to settle the lawsuit filed against them in August of 2005. Rocker Partners also entirely dropped its own countersuit.

Overstock.com CEO Patrick Byrne is a frequent contributor to DeepCapture.com.

This is a major victory, not only for Patrick and Overstock.com, but for all public companies targeted by bear raiding hedge funds.

But thanks to the unusually skewed reporting surrounding it, chances are you either hadn’t heard about the suit, or were under the impression it was frivolous and certain to fail.

This presentation explains part of the story behind the coverage of the suit, using some innovative methods to explain why what you heard about the suit and its merits likely had little in common with the reality of it.

I need some input on the book I’m writing (more information on that here).

I’m looking for the best, most colorful examples of post-1934 short-side stock manipulations.

As I see it, stock manipulation comes in three general flavors…

1. Trade-based: on the short side, this is the essence of abusive, illegal short selling, is the general focus of this blog, and not something I need more examples of. Instead, please consider the following two types.
2. Action-based: where the manipulator, usually (but not always) from within the company, takes steps to literally affect the real or perceived value of the company for the purpose of benefiting an existing stock position. There are myriad examples of this sort of thing happening prior to Securities Exchange Act of 1934, but not nearly as many since, and most of those are long-side. If you know of any great examples of short-side, action-based stock manipulation, pleases add them as a comment below.
3. Information based: where the manipulator intentionally disseminates incorrect information about a company’s prospects for the purpose of benefiting a stock position. Much of DeepCapture.com is dedicated to exposing examples of this sort of abuse, primarily on the short side. This was also technically outlawed in 1934, but as I suspect we’ve all seen, happens on a grand scale nonetheless.  But if you know of any particularly interesting or outrageous examples not yet discussed here, please add them as a comment below.

Please limit your suggestions to cases that went to trial or otherwise experienced some level of fact-finding or other official response.

As always, if you’d rather add your insights privately, my email is jbagley@deepcapture.com.

(As I mentioned in an earlier post, I’m looking for extra feedback on the ideas presented here, as they are currently under development and able to benefit greatly from your insights.)

I think we can all agree that the middle of last September was as strange a time as our financial markets have ever experienced.

In case you’ve forgotten, let me remind you with a simple timeline. As you read it, keep in mind that following the demise of Bear Stearns, the strictest interpretation of the so-called investment bank “Bulge Bracket” included just four entities: Goldman Sachs, Lehman Brothers, Merrill Lynch and Morgan Stanley.

• September 9: The short attack on Lehman Brothers begins in earnest.
• September 14: The New York Times reports Lehman will file bankruptcy.
• September 15: Goldman Sachs share price begins to wilt. Merrill Lynch announces it will be sold to Bank of America.
• September 17: Goldman Sachs’ share price continues to plummet. The SEC announces “new rules to protect investors against naked short selling abuses”.
• September 18: Goldman Sachs’ share price continues to plummet.
• September 19: The SEC “halts short selling of financial stocks to protect investors and markets”.  Goldman Sachs’ share price posts a strong gain.
• September 22: Goldman Sachs and Morgan Stanley, the two remaining members of the “Bulge Bracket” announce their intentions to transition to bank holding companies, giving them access to lending facilities of the US Federal Reserve (an organization with which Goldman has an uncommonly tight relationship).

As I see it, the most interesting event to come of that most eventful period was the SEC’s September 19 ban on legitimate short selling. What makes it so enigmatic is the fact that not even the most vocal opponents of illegal naked short selling have ever even hinted at the need to restrict legitimate shorting. In fact, Patrick Byrne himself compared the ban to limiting motorists to making only right-hand turns.

However, I have a theory that might explain what was going on.

An examination of the volume of both naked and legitimate shorting of Goldman Sachs in September of 2008 reveals something very interesting: while there was an enormous amount of short selling taking place, there was essentially no naked shorting of Goldman shares. Indeed, short selling accounted for a third of total volume on September 15 and 16, while failed trades accounted for less than 0.07%, suggesting shortable Goldman shares were in abundant supply.

This conclusion is supported by an analysis of the stock loan rebate rate that prevailed for Goldman shares during the period in question: a very reliable indicator of the scarcity of shares available for short sellers to borrow, where a lower rebate rate indicates a more limited supply.

In the case of Goldman, from May through August 29 of 2008, the rebate rate averaged 1.80%. And, between September 1st and the September 19^th short selling ban, Goldman’s average rebate rate remained exactly the same: 1.80%.

By way of comparison, the average rebate rates for Lehman Brothers shares over the same periods were 1.18% and 0.16% (bottoming out at -0.25% during Lehman’s last week), respectively.

By contrast, Goldman shares appear to have been easy to borrow right up to and in the midst of its stock price free-fall.

This scenario is consistent with the levels of naked short selling of Lehman and Goldman during the same period: extremely high in the case of Lehman, and almost non-existent in the case of Goldman; furthermore, this suggests that, given abusive naked shorting does not tend to occur until after short sellers have exhausted the supply of borrowable shares, it was legitimate shorting that pushed Goldman’s share price over the edge.

With that in mind, let’s revisit the above timeline, focusing on Goldman, with my interpretation appended.

• September 15: Lehman declares bankruptcy. Goldman Sachs share price begins to fall. Following the destruction of Lehman Brothers at the hands of short selling hedge funds, the financial world is keenly aware of the capacity of naked shorting to decimate the share prices of financial firms. Furthermore, given the role Goldman undoubtedly played as broker in the criminal short selling hedge funds’ attack Lehman, the firm is justifiably concerned that the karma train is heading its way.
• September 16: Goldman lobbies its extremely well-placed (and well-documented) federal government contacts for a temporary ban on naked short selling.
• September 17: The SEC temporarily bans naked short selling.
• September 18: Despite the ban on naked shorting, Goldman Sachs’ share price continues to fall, suggesting legitimate short selling, not illegal naked short selling, is the cause of Goldman’s problems. Goldman lobbies for the SEC to temporarily ban legitimate shorting.
• September 19: The SEC temporarily bans legitimate shorting of all financial stocks. Goldman’s share price rises.

Might the SEC have been acting in the best interest of the market when it issued both emergency orders? I suppose that’s possible. But given the utter disinterest – even contempt – that organization has demonstrated toward investors and small public companies that have complained about the issue, I find it very difficult to believe.

Meanwhile, the SEC stood by and watched as naked short selling destroyed Bear Stearns and Lehman Brothers. Merrill Lynch then took itself out of the game, leaving a Bulge Bracket consisting of only Goldman Sachs and Morgan Stanley.

Of those two, which has uncommon influence over the federal government?

Goldman Sachs, of course.

And if this is true, does it leave any doubt as to the lengths the SEC might have gone to preserve a corrupt system when it benefited the company?

As many of you already know, I’m currently writing a book dedicated to a much deeper examination of the subjects addressed in this blog.

As always, I’m going to great lengths to ensure that every assertion in the book is defensible. However, because finance is not my primary (nor secondary, nor tertiary) vocation, I frequently rely on more experienced associates when it comes to testing the integrity of hypotheses formed by observation of data and events.

Recently, it occurred to me that, when it comes to the development of these theories, I ought to make better use of the expertise of the large and growing following we’ve been fortunate to build up here at deepcapture.com. Thus, starting later today, you’ll find the occasional post under the category “Deep Capture Book”, where I will present ideas being considered for the book, which could benefit from input by experts.

Am I overstating my case, or possibly understating it?

Is there another explanation?

What additional insights might strengthen my point?

These are all things that I’m hoping you folks will volunteer, via each post’s comment section.

Of course, if you should prefer to make your comment to me directly, you may do so via email: jbagley@deepcapture.com

As I said, look for the first of these posts in the next few hours.