This post may be a little inside-baseball. I will not explain at length the significance of this (if it does not make sense, you will have to read around in DeepCapture to understand it fully), but the short version is as follows.

My battle with Wall Street started off as a fight regarding slop in the settlement system and how it could be used to rig the stock market (the battle later expanded into other areas, including organized crime, economic warfare, and what I felt was an insufficiently proactive regulatory environment, the latter of which, I am happy to say, is showing signs of real improvement). For a decade I have asserted that one of the sources of that slop has been the system that governs short selling. One of the sources of that slop has concerned how hedge funds locate stock to short sell. And one form of that slop originates in the “Easy to Borrow List” that prime brokerages put out each day.

Every day each prime broker (e.g., Goldman, JP Morgan) looks at the stock it has available to lend to short sellers. Assume that a prime broker has 100,000 shares of Martha Stewart Omnimedia (ticker: MSO) “in the box,” which is to say, “available to lend.” They put that on a list of “Easy to Borrow” stocks that it then faxes in the morning to its hedge fund clients. A hedge fund who wants to short MSO then looks at this morning’s fax, and can short sell sell 100,000 shares of MSO. It can claim it has met its requirements to have a good faith belief that it will be able to locate stock to deliver in three days  based on its having seen this morning’s Easy to Borrow list from its prime broker.

Of course, three high school kids and a pet turtle can figure out the flaw in this system: there is nothing to keep five different hedge funds who all receive the same fax from all short selling that same 100,000 shares MSO, and thus, selling 500,000 shares  into the market place (while only 100,000 are able to be delivered). Yet the authorities have traditionally done nothing to stop this, because the prime broker can say, “We didn’t lie, there were 100,000 MSO in the box this morning when we faxed out that list.” And the five individual hedge funds could not be pursued because each one could say, “I saw it on the Easy to Borrow list this morning, so I had a ‘good faith reason to believe’ I had located shares available to borrow.” Believe it or not, while the nefarious activities described within DeepCapture often use a lot of jargon, and likely seem highly arcane to outsiders, at their heart they are often no more complicated than that. Therein lies the brilliance of these illegal schemes: there is not one pair of dirty hands to cuff, just a bunch of smudgy fingers scattered throughout the system.

Seven weeks ago the SEC (towards which I, having been quite a scold for many years, now feel compelled to give significant credit) tagged Merrill Lynch/Bank of America with an $11 million fine regarding their participation in such loosey-goosey activities over many years. See Merrill Lynch pays $11 mln to settle short sale violations (Reuters, June 1, 2015). In full disclosure, I should mention that Merrill Lynch/Bank of America are on the business end of a lawsuit concerning precisely these activities, a lawsuit which I filed years ago in California, which a few months ago received a green light from the California Supreme Court, which just this week had a judge assigned to try the case (who herself has called a Case Management Conference for August 12), and which, with a little bit of luck, will be being heard later this year or early in 2016 by twelve California citizens good and true.

In a major development, yesterday afternoon Goldman circulated an internal memo announcing that it is discontinuing its long-standing use of Easy to Borrow lists. (To protect my source within Goldman I am sanitizing things by just posting a screen shot of the relevant portion):

I remember not too long ago people who said that Wall Street is full of crooks were considered to be off-kilter. At the same time, it was commonly understood that they were saying the obvious, but for some reason they weren’t supposed to say it.

Things have changed.

Have a listen to a speech recorded in the video below. The speech begins at 2:08, after the intro by the off-kilter guy in a t-shirt (don’t know who he is), and the speech was given at (of all places) the Philadelphia Federal Reserve by (none other than) economist Jeffrey Sachs, named by Time magazine as one of the 100 “Most Influential” people in the world.

Sachs says that Wall Street is full of crooks.

Not just that. Sachs said that, “I meet a lot of these people on Wall Street on a regular basis. I’m going to put it very bluntly. I regard the moral environment as pathological. I’m talking about the human interactions I have. I have not seen anything like this, not felt it so palpably…they have  no responsibility to their clients, they have no responsibility to counterparties in transactions. They are tough, greedy, aggressive, and feel absolutely out of control, in a quite literal sense. And they have gamed the system to a remarkable extent, and they have a docile president, a docile White House, and a docile regulatory system that absolutely can’t find its voice….We have a corrupt politics to the core.”

Or in the DeepCapture vernacular, Washington has been “captured” by financial miscreants.

Sachs also rails against (among others) Goldman Sachs and short seller John Paulson for manufacturing synthetic CDOs (i.e mortgage derivatives deliberately designed by short sellers to self-destruct). Basically, he says what we’ve been saying for years, but what most prominent economic professors dared not say in speeches at the Federal Reserve—not, anyway, until now. And when prominent economists start talking like this (he even criticizes fractional reserve banking) in speeches at the Federal Reserve—well, that’s a revolution in the making. Wait and see.

Click here to listen to the speech.

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.

The most clichéd, yet satisfying, moment in any movie comes when the brutally bullying antagonist discovers he’s lost that which had empowered his abusive nature. Wait…I take that back. Seeing that fear in the bad guy’s eyes is the second most satisfying movie moment, the first being the inevitable administration of long-overdue justice that follows.

Though evidence has mounted for a while, today it became official: Goldman Sachs (NYSE:GS) is now on its own, as the guardian angel/demon that once enabled the firm’s assault on our capital markets has clearly severed that relationship. At least that’s the conclusion I draw from the news that Goldman was censured and fined by NYSE and the SEC for specific faults in “execution and clearing” (another way of saying “naked short selling”).

What changed? After all, Goldman is still rich, right?

Well…sort of. Goldman may be flush with cash, but with pressure mounting on politicians to reject any of it in the form of campaign contributions, suddenly that cash doesn’t spend nearly as well as it used to.  At the same time, it’s probably safe to assume Goldman’s allure as a future client has been severely degraded in the eyes of private sector career-minded regulators.

In other words, Goldman’s gold has lost its luster, and with it, the firm’s political ‘juice’. I can only imagine the look on their faces when Goldman brass first realized why their calls were not being returned: their power was gone. And folks with badges were knocking on the door.

Goldman’s role as a facilitator of illegal, short-side market manipulation will never come to symbolize its villainy in the mind of the public the way knowingly selling its clients garbage CDOs on behalf of John Paulson will. But that’s what makes this latest development even more significant: it suggests a sort of “piling on” mentality that was inconceivable just one month ago (keep in mind this is the company that, evidence suggests, successfully lobbied to have even legitimate short selling banned once the practice began to impact its share price). This, in turn, may be an inadvertent signal from regulatory “insiders” that Goldman’s prospects of emerging intact from this storm are slim.

Do not mistake the tone of this post for contentment, for this particular action doesn’t come close to addressing what I suspect is the true breadth and depth of Goldman’s role in short-side market manipulations. Indeed, the bulk of this particular complaint focuses on a few infractions observed over a few weeks in late 2008. Goldman, for its part, attributes the problem to an inconsequential bookkeeping error. If that’s true, a half-million dollar fine for an accounting mistake makes Goldman’s plight seem even more dire.

In the end, what’s most significant about this complaint is the insight it provides into how the system works when inappropriate influence ceases to be a factor in the regulatory process (something we’ve grown accustomed to not seeing): investigators investigate, infractions are cited, penalties applied, juice ignored.

I’m not convinced it’s within human nature to develop a financial markets regulatory paradigm able to consistently achieve this ideal (though I’m certain we can do better than what we’ve got). The alternative is to focus on the other side of the equation by limiting the capacity of any market participant to become so influential the rules cease to apply.

It is perhaps beyond the ability of an innocent public to believe this, but there is a growing body of evidence that a few mad scientists might have engineered the near-destruction of the American financial system. Except they weren’t scientists, per se – they were unscrupulous, market manipulating hedge fund managers, and we can almost hear them cackling with glee as they haul their ill-gotten billions to the bank.

In a civil suit filed Friday, the Securities and Exchange Commission charged Goldman Sachs with fraud for helping hedge fund manager John Paulson create collateralized debt obligations that he had secretly designed to self destruct. That is, Goldman Sachs, at the direction of Paulson, hand-picked mortgages that were certain to go bad, and stuffed the mortgages (or rather, “synthetic” derivatives of the mortgages) into collateralized debt obligations that temporarily masked the true value of the loans.

Goldman did this for only one reason: to create instruments against which Paulson and other hedge fund clients could bet with virtually no risk. Meanwhile, Goldman cheerfully sold the CDOs to unwitting customers, knowing full well that those customers would be wiped out when the reference loans inevitably defaulted. Goldman and its hedge fund clients also surely knew that the losses on these synthetic CDOs would crash the overall market for CDOs, hobble competing investment banks that had CDOs on their books, and do serious damage to the financial system.

Goldman isn’t the only bank that created these CDOs. Deutsche Bank, UBS, and smaller outfits, such as Tricadia Inc., perpetrated similar scams. All told, well over $250 billion worth of these  “synthetic” CDOs were sold into the market in the two years leading up to the financial crisis of 2008. Indeed, there is a distinct possibility that a majority of all the CDOs sold during those two years were deliberately designed to implode by hedge fund managers who were betting against both the CDOs and the financial system as a whole.

For more than three years, the media has swallowed the hedge fund party line that our economic troubles were solely caused by mortgage companies lending too much money to undeserving home buyers. No doubt, there was over exuberance and fraud in the world of subprime lending, but that is not the full story. It is now clear that the so-called “real estate bubble” was fueled by an expanding market for CDOs. And the market for CDOs was driven, in turn, by fraudulent deals similar to the ones that Goldman did for Paulson. In short, we witnessed a classic pump-and-dump scheme, only this time it was writ large, on the scale of the U.S. financial system.

I predict that as the details of this doomsday machine come to light, we will see that the hedge funds that profited from it all know each other well. I predict further that it will become apparent that what ties these hedge funds to each other is a common acquaintance with associates of Michael Milken, the famous financial criminal who pioneered the market for CDOs, and whose criminal debt machine nearly brought the economy to ruins in the 1980s.

John Paulson, who launched his career with the assistance of a host of Milken cronies, including Jerome Kohlberg and Leon Levy, is one of the hedge fund managers in this network. He has been described as a genius by the media, and perhaps that is what he is, but we now know that he abides by the Milken code, which has it that there is virtue in a clever con well-orchestrated. And never in history has there been a more profitable con than Paulson’s. His bets against the CDO market – the market that he helped set up to collapse — earned him more than $3 billion over the course of just a few months in 2007.

Another hedge fund in this network is Magnetar Capital, whose chairman and senior partner is Michael Gross, formerly a founding partner of Apollo Management, which is run by Milken’s closest crony Leon Black. Magnetar featured prominently in the Milken network’s attack on biotech company Dendreon (see “The Story of Dendreon” for details). This hedge fund is currently under SEC investigation for helping to manufacture and sell doomsday CDOs that it was simultaneously betting against with credit default swaps. Reporter Yves Smith, who has been working on this story from day one, reckons that Magnetar’s bogus CDOs accounted, incredibly, for between 35% and 60% of the total demand for subprime mortgages in 2006.

Given that the economy was being set up for a collapse by hedge funds in this network, it is not surprising that it was Milken-affiliated hedge fund managers who were most prominently and vigorously shorting Bear Stearns, Lehman Brothers and other big investment banks that were on the receiving end of the fraudulent CDOs. These hedge fund managers include Greenlight Capital’s David Einhorn (who launched his career with the former top partner of Milken crony Carl Icahn, and likely worked in cahoots with Milken to attack a company called Allied Capital); SAC Capital’s Steven Cohen (who was investigated by the SEC for trading on inside information provided by Milken’s shop at Drexel Burnham); and Third Point Capital’s Dan Loeb (who got his start dealing in Drexel Burnham paper alongside Milken’s former employees at Jeffries & Co.).

It is also important to note that the pump-and-short CDO scam could not have happened without the help of American International Group’s financial products unit, which sold a lot of the credit default swaps that the hedge funds used to bet against the CDOs. That unit at AIG was run by Joseph Cassano, formerly one of Milken’s top lieutenants at Drexel Burnham. Did Cassano know that the CDOs were designed to implode? Perhaps not, but it is safe to assume that his relationships with the hedge funds creating the CDOs influenced his decision to insure them.

It is also a matter of significant interest that Cassano was ordered to stop selling the credit default swaps in 2007, a sure sign that somebody at AIG saw that a cataclysm was imminent, but he did nothing to protect AIG from the massive losses that the cataclysm was sure to entail. When presented with evidence that the CDOs were rotten, Cassano held on to the CDS positions, rather than sell them off to people who, unlike AIG, would not have the resources to pay the hedge funds in the event of defaults.

This is not to suggest that these people hatched some kind of dark conspiracy to destroy America. But it is to suggest that relationships matter a great deal in the world of finance, and there is one network of miscreants that has consistently shown itself willing to profit from crookery, financial destruction and the misery of others.

One thing is certain: we will learn more about this scam in the weeks and months to come. And while news organizations like the New York Times should be commended for bringing bits and pieces of this story to light, their tepid prose fails to convey both the odoriferousness of the short sellers’ misdeeds and the magnitude of a scandal that helped bring the American financial system to its knees.

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

Too many stinging disappointments, I suppose.

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

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

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

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

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

But first, an overview.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

That was the first surprise.

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

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

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

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

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

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

Deep Capture goes to Washington.

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

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

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

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

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

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

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

For eight hours.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

(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?

Let’s pick up “The Story of Deep Capture” where it left off – with the demise of Bear Stearns and the near collapse of the American financial system.

It’s April 2, 2008, and CNBC reporter Charlie Gasparino has just reported that Lehman Brothers CEO Richard Fuld claims to have evidence that short-sellers, who profit from falling stock prices, actively colluded to bring down Bear Stearns.

Indeed, the SEC is already investigating precisely this possibility. The regulator has said that it would like to know whether short-sellers circulated false rumors about Bear Stearns’ liquidity and credit risk in order to spark a run on the bank. And it has announced that it is investigating allegations that hedge funds engaged in “naked short selling” to drive down Bear Stearns’ stock. This isn’t surprising considering that SEC numbers show, for example, that in the week of Bear Stearns’ destruction, up to 13 million of its shares were shorted naked – ie. sold and not yet delivered. That’s 13 million shares of phantom stock — and most experts assume there was much more of it, perhaps 100 millions fake shares, in parts of the system that the SEC doesn’t monitor.

Live on CNBC with Gasparino is reporter Herb Greenberg. Herb is a dishonest journalist. He has quite literally made a career out of taking dictation from a small group of closely affiliated short-selling hedge funds. Virtually every story he has ever written or broadcast has come from these people. He protects his hedge fund friends by repeatedly denying that phantom stock is a problem. And a former employee of a financial research shop called Gradient Analytics claims to have witnessed Herb conspiring with at least one short-seller, David Rocker, to hold his negative stories until Rocker could establish short positions. This is called front-running — a jailable offense.

CNBC is not concerned about this. Nor is it concerned that, in addition to his duties as a “journalist,” Herb is now also running his own financial research shop that caters to short-sellers. Yes, after years of denying that he has too-cozy relationships with short-sellers, Herb is now seeking to profit from those very relationships. His new company’s slogan is “bridging financial journalism and forensic analysis.” Anybody who believes that media and money don’t mix should be appalled.

Anyway, it is unsurprising that Herb is live on CNBC reporting that short-sellers had nothing to do with the demise of Bear Stearns. Instead, Herb says, Bear Stearns was taken down by a “crisis of confidence.” Could short-sellers have caused the “crisis of confidence?” Herb thinks not.

Herb says, “….if you take a look at [fellow CNBC reporter] David Faber’s reporting which was very interesting…”

* * * * * * * *

Good idea, Herb. Let us take a look at David Faber’s reporting. It was not just interesting. It was jaw-dropping – an utterly grotesque display of journalistic malfeasance.

Indeed, Faber’s reporting probably contributed a great deal to the precipitous collapse of Bear Stearns – an event so potentially calamitous that the Federal Reserve had to meddle in the investment banking sector for the first time since the great stock market crash of 1929.

On Tuesday, March 11, rumors were circulating around Wall Street that Bear Stearns was out of cash and that other banks were no longer accepting its credit risk. If anybody were to think these rumors were true, there would be panic – a run on the bank. If the rumors were false, as they quite demonstrably were, it was the job of the media to quash them.

CNBC’s Charlie Gasparino did his job. On that afternoon, he noted that there were “serious doubts” about Bear Stearns business model. He said that Bear Stearns was a “mediocre bank.” But he also noted that the rumors on Wall Street were suggesting something far worse –imminent bankruptcy–and that there was not a scrap of evidence suggesting that these rumors were true.

Gasparino quoted Bear Stearns CFO Sam Malinaro as saying “Why is this happening? I don’t know how to characterize it. If I knew why this was happening I would do something to address it. I spent all day trying to track down the sources of the rumors, but they are false. There is no liquidity crisis, no margin calls. It’s all nonsense.”

Gasparino stressed that there was no reason to doubt Bear Stearns’ claims. “I know Sam Malinaro pretty well,” he said. “He’s one of the best straight shooters in the markets.”

If Gasparino had stayed on the case, the uncertainty surrounding Bear Stearns’ liquidity and credit risk might have subsided, and the bank might have survived. But the next day, for some reason, Gasparino was taken off the Bear Stearns story, and David Faber took over.

A few rumors – even doctored memos falsely claiming that big banks had refused to accept Bear’s credit — were still circulating around Wall Street. Early that morning — Wednesday, March 12 — Faber interviewed Bear Stearns’ CEO, Alan Schwartz.

Actually, it was more like a prison interrogation than an interview. Faber demanded that Schwartz explain the rumors. Schwartz said the rumors were not true. Quite in contrast to Gasparino, Faber made it clear from his tone that viewers shouldn’t trust Bear’s executives.

Then Faber delivered this whopper: “…I’m told by a hedge fund that I know well…I’m told that [last night] Goldman would not accept the counterparty risk of Bear Stearns.”

Bang! The beginning of the end.

Understand how important this is. Previously, most people assumed that the rumors about Bear’s access to leverage were nothing more than…rumors. No reporter had suggested otherwise.

Now, for the first time – live on CNBC, in the middle of a mission-critical interview with Bear’s CEO — a prominent journalist was reporting that the rumors were true. He stated — as if it were fact — that Goldman Sachs, one of the biggest investment banks in the world, had refused to take Bear Stearns’ credit.

Faber was generous enough to note that this information came from a hedge fund “friend,” and it wouldn’t take a genius to see that this hedge fund “friend” was probably some skeezy short-seller of Bear Stearns’ stock – but still, Faber’s comment was nuclear explosive.

Soon after Faber’s comment, Schwartz is about to provide details proving that Bear Stearns is not at all illiquid – that it has ample cash (and is therefore hardly a credit risk). He says: “…none of the speculations are true, but….”

Just then, a woman’s voice interrupts: “I’m sorry! I’m sorry!”

What? Can this possibly be happening? The CEO of a giant investment bank is about to provide evidence that the bank is not insolvent – that the American financial system is therefore not on the brink of collapse. This is perhaps the most important financial news moment of the past ten years, and now CNBC has cut off the CEO in mid-sentence!

“I’m sorry,” the CNBC woman says. “David, I’m sorry breaking news, I just want you to know that we have New York state officials confirming that New York governor Elliot Spitzer will resign today. Formal resignation, we don’t have it, but it is now confirmed that the governor of New York will resign today.”

“Thanks for that not unexpected news,” says David Faber.

This was probably straight-forward idiocy – nothing more sinister than that. But you’d think CNBC could have waited a few minutes for this “not unexpected” news. And anybody with a healthy sense of irony might chuckle and point out that Jim Cramer, the former hedge fund manager who is now CNBC’s top-rated personality and basically runs the place, was Elliot Spitzer’s best friend and college roommate. The irony is all the richer when you consider that Elliot Spitzer’s career was built almost entirely on the funding and machinations of a small group of short selling hedge fund managers – including Dan Loeb, David Einhorn, and Jim Chanos (owner of the beach house where Spitzer’s favorite hooker lived rent free), and that these very same hedge fund managers are the ones who are quite aggressively attacking Bear Stearns.

Schwartz looked mighty pissed off. After the interruption, he tried to continue: “We put out a statement that our liquidity and balance sheet are strong. Maybe I should expand on that a little bit…”

“Well, yeah,” Faber interrupts. “Why don’t you.”

The reporter’s tone again suggests that the CEO is not to be trusted. Tone aside, Faber doesn’t let Schwartz answer. Instead, he launches into a long and completely irrelevant monologue about the markets generally being in bad shape.

“Well, the markets have certainly gotten worse,” says Schwartz, clearly baffled by all of this.

Then, finally, the CEO manages to provide the salient information – the information that Bear Stearns customers and traders around the world have been waiting to hear. He says, “Our balance sheet has not changed at all. So let me just talk about that for a second….When we finished the year we reported that we had $17 billion of cash sitting at the parent company as a liquidity cushion…Since year end, that liquidity cushion has virtually been unchanged. So we still have many many billions of excess cash…we don’t see any pressure on our liquidity let alone a liquidity crisis.”

That certainly should have calmed the waters. There was no evidence that Schwartz was being disingenuous about having that $17 billion. Bear Stearns might have been the crappiest bank on Wall Street, but as long as customers knew that Bear Stearns had that $17 billion in cash, there was unlikely to be a run on the bank.

Unless, that is, a “reputable” media source was to suggest that, say, Goldman Sachs, had cut off credit.

Astonishingly, in the ensuing 24 hours, CNBC never once repeats the news that Bear Stearns has $17 billion in cash. And though it repeatedly references the interview with Schwartz, the network does not once replay the CEO’s strongest comment: “We don’t see any pressure on our liquidity, let alone a liquidity crisis.”

But Faber does repeat the startling “news” about Goldman.

At 8:48 AM on Wednesday, he says, “There are a lot of concerns out there…about counterparty risk. Frankly, I’ve been hearing from people whom I trust that there are some firms out there unwilling to put on new – new — counterparty risk with Bear Stearns…You had it at Goldman…Goldman said no we’re not taking Bear’s counterparty risk – this was yesterday.”

The hedge fund manager whom Faber “trusts” was lying. Goldman was not turning down Bear’s credit. We know this because some minutes later in the broadcast, Faber says so. He says it very quickly, just as an aside, as if it doesn’t matter at all. He says, by the way, “I have heard that that trade did actually go through—Goldman did say alright, now we will accept Bear as a counterparty.”

So Faber has just admitted, in an off-handed kind of way, that he was lied to by the hedge fund he “trusts.” In other words, up until this point, there is no evidence at all that rumors being circulated by hedge funds have any merit whatsoever.

Despite this, Faber proceeds to unleash this gobbledygook: “At the end of the day, while they say over and over they have plenty of liquidity, and in fact they may, it all comes down to confidence. They need to have access to capital, access to leverage. Otherwise, they’re dead! And it can happen very quickly.”

With this, Faber looks at his computer, and says, “Let’s see where the stock is.” Then he declares with glee: “Oops! It’s down!”

So now Faber has just pronounced that Bear Stearns might be “dead!” Why might Bear Stearns be “dead?” Because, Faber says, Bear needs “access to capital” – this in the same sentence where he says “in fact they may” have plenty of liquidity (ie. access to capital). Perhaps by “may” he meant to suggest that Bear “may not” have access to capital. Either way, he carefully omits the fact that the bank has told him it has $17 billion in cash.

The other reason Bear is “dead” is because it needs “access to leverage.” Is there any evidence that it does not have access to leverage? So far, there is none other than the Goldman news, which Faber has just admitted to be a complete fabrication delivered to him by a hedge fund “friend” whom he “trusts.”

Meanwhile, in an effort to send Bear Stearns’ share price spiraling downward, hedge funds are selling tens of millions of dollars worth of phantom stock. SEC data shows that more than 1.2 million shares sold that Wednesday were not delivered on time.

It only gets worse. The next morning — Thursday, March 13 — there is still no evidence that anybody is turning away Bear’s credit or pulling out money. CNBC still has yet to repeat the all important $17 billion figure. And now, Faber is back on television, fanning the flames, and repeating the bogus Goldman news.

He says, “I talked [yesterday] about a particular trade I was aware of where Goldman Sachs did not want to stand up as a counterparty and face Bear on new counterparty risk.”

Yes, David, you did talk about Goldman – and you admitted that your information was false. Why are you repeating this?

In a stuttering attempt to explain himself, Faber says to his television audience, “Now ultimately that trade did take place [ie. Goldman did accept Bear’s credit] after my interview with Mr. Schwartz concluded, but the day prior, Goldman did not want to. I have incontrovertible proof of that.”

Right. Whatever. The SEC should subpoena Faber to find out which market-manipulating hedge fund fed him the false information about Goldman.

Of course, if the SEC were to do this, the Media Mob would go berserk and start waving the First Amendment right to protect hedge funds who take down public companies by feeding journalists false information. Remember that the SEC once tried to subpoena Herb Greenberg and Jim Cramer, only to back down after Cramer vandalized his government subpoena live on CNBC and a bunch of Herb and Cramer’s media pals rose up in their defense.

But enough of this, already. These journalists are not protecting whistleblowers or freedom of speech. These journalists cannot even properly be called “journalists.” They are, or at least aspire to be, market players. They are helping slippery hedge fund managers who are destroying public companies for profit, and putting the American financial system at risk. I’m all for real reporters standing up to federal agencies, but these “journalists” are special cases. The SEC should not allow itself to be intimidated by them.

Alas, it’s too late for Bear Stearns. On the morning of March 13, there was still no evidence that anybody had pulled money out of Bear Stearns or denied its credit, but after repeating the Goldman falsehood, Faber reported: “I remember when Drexel Burnham went down [the smarmy inference being that Bear Stearns is a crooked company similar to Drexel]…It happens fast, very fast. It happens because those who do business with a firm such as that [read: `a crooked firm’] lose confidence.”

“And when they lose confidence,” Faber continued, “they pull their lines, and that’s it. It’s done. Pack your bags. Go home. It can end in an hour.”

About an hour later, a hedge fund called Renaissance Technologies Corp., shifted $5 billion out of Bear Stearns. That was the first client to “pull its lines.” Many others followed suit.

With Faber blowing taps, panic ensued.

And by that evening, Bear was, indeed, “dead.”