Tag Archive | "regulatory capture"

Anarcho-Regulation

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Anarcho-Regulation


Short-side stock manipulators are slippery and, by definition, dishonest. These people thrive on the internet, where they can anonymously spread misinformation and then away, with little fear of being held accountable. Still, on a few occasions, I’ve observed anonymous defenders of illegal naked short selling attempt to mount a philosophical defense of their actions. When they do, the best case they can make sounds like this:

“America’s capital markets are too large and complex for our regulators to handle. As a result, overvalued, scamming companies run rampant, defrauding investors. We, the naked short sellers, are doing the rest of you a favor by taking the law into our own hands in an effort to short these companies out of existence, or at the very least depress their share prices such that when they finally do fail, the rest of you will not lose as much as you would have. So you’re welcome.”

This silly idea is taken directly from anarcho-capitalism: an economic and political philosophy describing how market participants themselves, operating in the absence of government regulation, might find a profit motive in the maintenance of order.

To be fair, these “principled” naked short sellers and I do in fact agree on one matter: the fact that our markets are operating without an effective regulator. And I’ll also concede that there was a time when the rest of this anarcho-capitalist manifesto might have applied; specifically, many years ago, when manipulative short sellers limited their activities to micro-cap companies that were expert at selling: not goods or services, but stock. And because the world of penny stocks is recognized by all as a financial Wild West to begin with, this form of frontier justice – though distasteful – was allowed to fill a niche in the great financial ecosystem…akin to the fleas biting the rats feeding on the scraps fallen from the table of American capitalism. Then, for reasons too complicated to fully explain here, following the market crash of 1987, predatory short selling began to move from the shadowy back alleys and onto Wall Street, where, within less than two decades, these parasites had moved far up the food chain, never quite able to satisfy their blood-lust, while regulators continued looking the other way.

I offer all this information as background, in order to help you more fully appreciate what follows.

Last month, the Deep Capture team began to spot patterns in the equities and options trading of companies whose stock experienced unusually high levels of sustained delivery failures: a sure sign of manipulative naked short selling. We determined that certain pairs of transactions (what we’ve come to call “matched blocks”) faithfully predicted the numbers of shares that would go on to be reported as undelivered by the seller two trading days later. Because delivery is only considered “failed” after three trading days (T+3), and these transactions were taking place on T+1, we realized that they must be happening in response to the naked shorts generated on T+0; specifically, that these trades are likely intended to give the appearance that the SEC’s mandatory close-out requirement has been met, thus “resetting” the three-day clock ticking down until delivery is forced.

This sort of thing is not supposed to be happening, by the way. It’s illegal, and, under significant political pressure, last year the SEC lightly reproached three other firms for engaging in identical activity.

Whatever the case, these matched blocks, which we can observe in near-real time, proved uncanny predictors of failed trades reported by the SEC in much-less-than-real-time (usually delayed by two to three weeks). We took advantage of this reporting time lag to publicly predict – based on the matched blocks – delivery failures in shares of Sears Holdings (NASDAQ:SHLD) several days before those figures were released.  When they finally were, our predictions proved accurate to within 2.5% — including faithfully anticipating a near 50% drop from one day to the next.

After publishing these predictions for Sears, I posted messages alerting readers of stock message boards dedicated to discussing Amedysis (NASDAQ:AMED) and Mannkind Corp. (NASDAQ:MNKD): two other companies whose trading data demonstrated links between matched blocks and delivery failures nearly identical to that of Sears, and where many posters were attempting to understand – though with only fragmentary information – what was going on.

All along, it was my intention, upon finishing my analysis of apparent manipulation in Sears, to raise awareness of the same sort of activity in Amedysis and Mannkind; however I never really had the chance, because it appears the would-be manipulator got spooked by the attention and decided to move on, covering at what was almost certainly a hefty loss.

In fact, the similarities observed in the trading of these three stocks from unrelated sectors (a brick-and-mortar retailer, a biotech firm and a provider of home health care), is somewhere between striking and spooky. In each case, the volume of the matched blocks reached their peaks on February 17 (the date of publication of my Sears prediction), and then abruptly tapered off. By March 2, Mannkind was off the Threshold list. By March 3, Sears Holdings was off the Threshold list. By March 22, Amedysis was also off the list.

It’s impossible to be certain whether the attention brought by Deep Capture had anything to do with the sudden abandonment of what had been a concerted effort at downward manipulation of the stock prices of three decidedly non-scam companies; yet the coincidences are too many to be ignored (there are others, by the way).

The idea that we might have had something to do with helping to restore fairness to the markets for these stocks, combined with my remembrances of the so-called anarcho-capitalist ideal described above, got me thinking about a new way of approaching this blog:

Because our financial markets are so large and complex, and our financial markets regulator so captured and inept, stock manipulating hedge funds have been running rampant, damaging companies and defrauding investors.  We, the investigative bloggers, are stepping in to do the job the SEC either cannot or will not do, by shining a bright light on acts of  manipulation when we see them, and publicly identifying the perpetrators (yes, we’ve figured out ways to potentially accomplish this, as well) when able. And we’ll continue doing it, until either America’s stock settlement system is repaired, or the SEC returns from its several decades-long coffee break.

That’s right. The naked short sellers offer anarcho-capitalism, and DeepCapture.com responds by giving them a dose of anarcho-regulation.

Posted in Featured Stories, The Deep Capture CampaignComments (18)

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It Only Hurts When I Laugh


The Congressional Research Service is a Library of Congress think-tank with just one client: Congress.  A member of Congress requests a study on a subject of interest, and CRS researchers generate it. The CRS is one of the most respected institutions in Washington, DC, and its output is universally considered non-partisan, objective, and thorough.

Last Tuesday, February 24, 2009, the Congressional Research Service published a 40 page report, “Who Regulates Whom? An Overview of U.S. Financial Supervision” (Mark Jickling, Edward Murphy, CRS, February 24, 2009)  As the title suggests, the report is a primer on the parts of the US financial system, and who regulates which part.  As the Summary section puts it:

“This report provides an overview of current U.S. financial regulation: which agencies are responsible for which institutions and markets, and what kinds of authority they have….This report does not attempt to analyze the strengths and weaknesses of the U.S. regulatory system. Rather, it provides a description of the current system, to aid in the evaluation of reform proposals.” (Page 2)

And in the Introduction:

“A number of studies and reports have already proposed broad changes to the division of supervisory authority among the various federal agencies and in the tools and authorities available to individual regulators. This report provides a basis for evaluating and comparing such proposals by setting out the basic structure of federal financial regulation as it stood at the beginning of the 111th Congress.” (Page 5)

And describe the basic structure of the the financial system, its regulators, and their regulatory principles, it does, thoroughly, in 35 more pages of clear and informative, if not exactly gripping, prose. It covers US banking regulation and federal securities regulation, the regulation of derivative trading and of GSE’s such as Freddie Mac and Fannie Mae, and the non-regulation of foreign exchange and US Treasuries, nonbank lenders, hedge funds and venture capitalists. I confess it answered every question I could think to ask regarding the parts of the US financial system and which office of government regulates each part. I commend Messiers Jickling and Murphy for so thorough and well-organized a review of that subject.

There’s just one thing: it does not mention the Depository Trust and Clearing Corporation. In fact, it does not mention securities settlement.

Does that seem strange?

Consider this: The regulatory structure of the US capital market was set in the Secuties Exchange Act of 1934. It devoted a section (immediately after the section on Directors, Officers, and Principle Shareholders, and the section establishing the need to keep records), to describing the need for a “National System for Clearance and Settlement of Securities Transactions” (Section 17a). Its opening is instructive:

“a. Congressional findings; facilitating establishment of system

“1. The Congress finds that–

“A. The prompt and accurate clearance and settlement of securities transactions, including the transfer of record ownership and the safeguarding of securities and funds related thereto, are necessary for the protection of investors and persons facilitating transactions by and acting on behalf of investors.

“B. Inefficient procedures for clearance and settlement impose unnecessary costs on investors and persons facilitating transactions by and acting on behalf of investors.

“C. New data processing and communications techniques create the opportunity for more efficient, effective, and safe procedures for clearance and settlement.

“D. The linking of all clearance and settlement facilities and the development of uniform standards and procedures for clearance and settlement will reduce unnecessary costs and increase the protection of investors and persons facilitating transactions by and acting on behalf of investors.”

It seems that in 1934 Congress thought having securities transactions clear and settle promptly was pretty important.

Which makes it especially odd that in 2009, in the Congressional Research Service’s admirably thorough report on the parts of the US financial system and the regulators who oversee them, no mention is made of that “”National System for Clearance and Settlement of Securities Transactions”  whose establishment Congress in 1934 found “necessary for the protection of investors.”

I am reminded of an event from early 2005. It was the early days of the Mitzvah. I was having trouble synthesizing the data. It would be more honest of me to say: the data suggested that our settlement system was Swiss Cheese, an enormous derivative risk was building up that no one understood, the same SEC to which I had spent a lifetime looking up in awe and fear was actually lapdog to a tight circle of Wall Street crooks, the savings of America were being looted, and it was all going to end in systemic collapse.  But clearly, I thought, that’s crazy. So I was having trouble forming a hypothesis to fit the data, other than a crazy one.

I decided to find out who regulated the DTCC. Listen to what they had to say. No doubt I’d learn some piece of the puzzle that I was missing, something that would cause the light bulb to go on and me to say, “Oh, that’s where this is coming from. Oh, I see, there’s nothing to worry about after all.”

The problem was, I could not find out who regulated the DTCC. It was not on their website. I couldn’t find any government agency that claimed to regulate the DTCC, or any news story that mentioned the subject of DTCC regulation. A core finding of Congress in 1934, in the foundational document of modern regulation, established that something had to be done, but 71 years later I could find no evidence that it was the job of anyone in the federal government to do it. And that’s odd because usually government agencies fight turf wars over who gets to regulate this or that. But here was a great vital section of the Securities Exchange Act of 1934, authorizing the establishment of a crucial component of the system, yet no one seemed to be doing it.

That can’t be right, I thought. Clearly just another moment of bad craziness.

So I went to see two securities lawyers whom I knew socially. I asked them if they would research something for me, that I would be willing to pay them for their time, and that they did not have to worry about writing anything formal. I just needed from them one simple sentence of the form, “The DTCC is regulated by _____ .” They agreed to produce it.

A week later I went to visit them. For some time they sat hemming and hawing and scratching their heads, until finally they told me: “We can’t seem to find anything that establishes who regulates the DTCC, or even if it is regulated. We found one mention of the subject, in a footnote in a GAO report from a couple years ago. They say they think the SEC regulates the DTCC, but they don’t sound very sure.”

From the looks of it, neither is the Congressional Research Service.

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?

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Regulators Spring Into Action Against Naked Short Sellers. Or not.


As is explained in numerous pieces in DeepCapture, there are many cracks in the settlement system, one of them being the DTCC’s Continuous Net Settlement system, or CNS. I am highly confident that the federales (at least, the SEC) are not permitted to explore the other cracks, that the failures to deliver that they see within the CNS are thus but a small fraction of all that exist, and that, therefore, trying to gauge the depth of the naked short selling problem from the level of FTD’s in the CNS is like trying to guess the condition of an automobile from the level of water in its radiator.

But it’s a start. Given that the CNS system is the one place the SEC can look, and might be able to do something about, it is instructive to see how well they are cleaning up unsettled trades there.  Towards that end, DeepCapture has analyzed the data that the SEC released last week. These graphs show their fine progress in that regard.


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Any questions?

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?

Posted in Deep Capture the Data, Our Captured Federal Regulator the SEC, Unsettled Trades & Systemic RiskComments (37)

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The DTCC’s CNS naked short selling residue


In a previous post I named various places where unsettled trades can accumulate: in the desks of brokers, in pre-netting among brokers, in the Continuous Net Settlement (CNS) system, in the Stock Borrow Program (SBP), through ex-clearing, and in delivery mechanisms from offshore exchanges. For all I know, these represent just a subset of the cracks in the system. The great unanswered question is, How much financial toxic waste has naked short selling and its various equivalents left scattered throughout these cracks?

The answer is: I don’t know, and I think no one knows. I suspect no one agent has the full picture of what is going on across all of these cracks. In fact, I suspect some of these cracks are so obscure no one has a clear picture of what is going on in them individually, let alone collectively.

To some degree this is knowable a priori. We have a system that is shielded from scrutiny of every type. State regulators cannot successfully subpoena it (as various state regulators have told me) because the DTCC argues it is shielded by federal regulation. Yet when Feds try to look inside it they are simply rebuffed, and are helpless to assert themselves (as a high-level SEC official told some colleagues of mine). The Feds do not understand it (as a former DTCC employee and various Feds have told me). On those occasions that the Feds do get to look inside the system,  they get shined-on (as a former DTCC official tells me and a former SEC official confirms).  In fact, four years ago when I began this quest, the first thing I tried to do was to find out who regulated the DTCC, and quickly discovered that, other than a brief mention in an obscure GAO report, even the Feds are not sure if they regulate it.  And yet, through this opaque system the treasure of the ages passes every week. Such system-design is a recipe for disaster.

To a lesser degree this is knowable a posteriori, though getting data about the system from the system is an exercise in Kafkaesque futility. There are endless anecdotes of trades that won’t settle, of course. There is also the partial information expressed by the Reg SHO list.  There are various FOIA responses which have been pried from the SEC. And for the true aficionados, there are, lately, data files that the SEC periodically releases to the public regarding failures in one of the cracks mentioned, the CNS. Making use of these files is impractical for any members of the general public who do not employ an economist, statistician, and database expert to work the data.

Fortunately, DeepCapture employs an economist, a statistician, and a database expert to work the data. In the following series of posts I am going to reveal their output, stressing again that the failures I will be disclosing are not the totality of failures, but simply a fraction of the total, residing in just one of the cracks (the CNS) into which our federal regulator is permitted to peer.

Here is a chart showing the CNS failures from 2004, the year Reg SHO was adopted, through Q1, 2008:

Here is the same data with some key Reg SHO dates noted:

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?

Posted in Deep Capture the Data, Unsettled Trades & Systemic RiskComments (26)

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The DTCC's CNS naked short selling residue


In a previous post I named various places where unsettled trades can accumulate: in the desks of brokers, in pre-netting among brokers, in the Continuous Net Settlement (CNS) system, in the Stock Borrow Program (SBP), through ex-clearing, and in delivery mechanisms from offshore exchanges. For all I know, these represent just a subset of the cracks in the system. The great unanswered question is, How much financial toxic waste has naked short selling and its various equivalents left scattered throughout these cracks?

The answer is: I don’t know, and I think no one knows. I suspect no one agent has the full picture of what is going on across all of these cracks. In fact, I suspect some of these cracks are so obscure no one has a clear picture of what is going on in them individually, let alone collectively.

To some degree this is knowable a priori. We have a system that is shielded from scrutiny of every type. State regulators cannot successfully subpoena it (as various state regulators have told me) because the DTCC argues it is shielded by federal regulation. Yet when Feds try to look inside it they are simply rebuffed, and are helpless to assert themselves (as a high-level SEC official told some colleagues of mine). The Feds do not understand it (as a former DTCC employee and various Feds have told me). On those occasions that the Feds do get to look inside the system,  they get shined-on (as a former DTCC official tells me and a former SEC official confirms).  In fact, four years ago when I began this quest, the first thing I tried to do was to find out who regulated the DTCC, and quickly discovered that, other than a brief mention in an obscure GAO report, even the Feds are not sure if they regulate it.  And yet, through this opaque system the treasure of the ages passes every week. Such system-design is a recipe for disaster.

To a lesser degree this is knowable a posteriori, though getting data about the system from the system is an exercise in Kafkaesque futility. There are endless anecdotes of trades that won’t settle, of course. There is also the partial information expressed by the Reg SHO list.  There are various FOIA responses which have been pried from the SEC. And for the true aficionados, there are, lately, data files that the SEC periodically releases to the public regarding failures in one of the cracks mentioned, the CNS. Making use of these files is impractical for any members of the general public who do not employ an economist, statistician, and database expert to work the data.

Fortunately, DeepCapture employs an economist, a statistician, and a database expert to work the data. In the following series of posts I am going to reveal their output, stressing again that the failures I will be disclosing are not the totality of failures, but simply a fraction of the total, residing in just one of the cracks (the CNS) into which our federal regulator is permitted to peer.

Here is a chart showing the CNS failures from 2004, the year Reg SHO was adopted, through Q1, 2008:

Here is the same data with some key Reg SHO dates noted:

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?

Posted in Deep Capture the Data, Unsettled Trades & Systemic RiskComments (0)

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