Naked Short Selling. What is the danger, how does one protect oneself?

[Jim Nickerson]

Charles Mackay post #4 http://www.itulip.com/forums/showthread.php?t=724 in the guest commentary World Needs Better “Face of American Capitalism” than Private Equity said,

Very glad to see more people sounding the alarm on this "freak show" ....This Frankenstein that Goldman built. Gary Weiss's "Wall Street Versus America: The Rampant Greed and Dishonesty That Imperil Your Investments" is another one. Or Dan Reingold's Confessions of a Wall Street Analyst: A True Story of Inside Information and Corruption in the Stock Market. Patrich Byrne, CEO of Overstock.Com has exposed how hedge funds are destroying small companies with Naked Short Selling. He has formed this organization to change the rules http://www.ncans.net/

I am trying to find the link to the presentation Byrne gave that explains the mechanics of this but have misplaced it ... I will look and post later.

The last time this level of greed and fraud took place (the 1920's) people didn't come back to the stock market for 25 years. A whole generation had had enough.

p.s. Here is that link: http://www.businessjive.com/nss/darkside.html I also think this presentation format for educational material is about the best I've seen. Would have far preferred this over 300 fellow students in a crowded lecture room in College! I realize Anon is speaking to the fraud of Private Equity but the corruption is so broad where do you even begin? Does the SEC regulate Goldman or vice versa?

The link immediately above is an 80-minute slide presentation and commentary by Patrick Byrne which as I said on that thread is perhaps the most informative bit I have read or heard regarding just how screwed up are the regulatory mechanisms at play in the US markets. I am a bit hestitant to strongly suggest everyone should listen to what Byrne demonstrates and informs with regard to naked short selling, the resultant failure to deliver (FTD) of the security sold short.

There are many things about which I know nothing and naked short selling is or was one thing. It seems to me that anyone who "owns" a stock based on having seen the money taken from one's account and a position then showing that the stock was "bought" and now "possessed" could be wrong.

If one goes to Byrne's site http://www.ncans.net/ there are many, many links--most of which I have not read. One http://www.nyse.com/Frameset.html?di...ge=/threshold/ shows daily lists of stocks or ETF's for which there are at least 10,000 shares of undelivered stocks or the number of failed deliveries equals at least .5% of the issuer's total shares outstanding, etc.

The Nasdaq also publishes such a daily list http://www.nasdaqtrader.com/aspx/regsho.aspx

I did not count the issues on both lists for just the last day's postings, but if each security listed represents at least 10,000 shares, and I take it no one in the public can know what is the actual number, then the sheer numbers of these securities on these two lists suggest there are lots of people who are wrong when they look at their brokerage statements and deduce that he or she actually owns the position for which they had money taken out of their account three days after "buying" whatever the position.

Byrne in his presentation points out that the accounting made known to the public, i.e, you and me, of these failed to deliver securities may represent only a very small portion of all that may exist.

Charles Mackay http://www.itulip.com/forums/showthread.php?t=724 post #13 wrote

after viewing Byrne's presentation, I created a separate cash account to hold my securities in. One margin account to "do stuff" in and then the cash account to "hold stuff" in.

I asked for some clarification from anyone as to how does all this potentially affect me, or anyone reading this who thinks he or she "owns" shares that might be on one of these lists, or it could be that one thinks a position one "owns," and the numbers of FTD's is less that 10,000 issues and is thus not disclosed for such an issue, and there are other ways also that what you believe you hold may not be true.

Charles Mackay's comment above suggests to me in a cash account, that an FTD cannot exist. I don't know if that is true or not.

To my simple mind, an IRA is like a cash account, but perhaps it is not as far as this issue of FTD's is concerned. I do not know.

I have asked the person who is my assigned account executive at Schwab about this stuff. Basically the question: is it possible in such a Cash account, and importantly in an IRA account, that any position represented on a statement or a web-look at the positions in fact represents a strategic failed to deliver of a security?

When I asked him that on the occasion of a perchance meeting while in the local office at Schwab to transact something, I gathered either he did not know about what I was asking, or I did not do well in raising the question. So I sent him the above links and asked the question again in an email. So far he has not answered.

Despite what that dude answers, I would like some others' perspectives about this issue of naked short selling, which is illegal as is the resultant failure to deliver the security that was sold short, but as I understand the actuality of naked short selling is represented as having occurred for every security listed at the above referenced NYSE and Nasdaq sites, and according to Byrne these lists may be or are woefully inadequate in accounting for the actual numbers of failed to deliver securities when accounting between brokerage firms is considered.

If anyone really wants to understand how screwed up are our markets, it strikes me that listening to Byrne's presentation is a must.

If anyone wants to assert that all this is nonsense, then I would like to read such opinions too.

If anyone knows how one can best protect oneself from "owning" a security that one does not really own, I would like to know that.

[Finster]

Re: Naked Short Selling. What is the danger, how does one protect oneself?

...I asked for some clarification from anyone as to how does all this potentially affect me, or anyone reading this who thinks he or she "owns" shares that might be on one of these lists, or it could be that one thinks a position one "owns," and the numbers of FTD's is less that 10,000 issues and is thus not disclosed for such an issue, and there are other ways also that what you believe you hold may not be true.

Charles Mackay's comment above suggests to me in a cash account, that an FTD cannot exist. I don't know if that is true or not.

To my simple mind, an IRA is like a cash account, but perhaps it is not as far as this issue of FTD's is concerned. I do not know.

I have asked the person who is my assigned account executive at Schwab about this stuff. Basically the question: is it possible in such a Cash account, and importantly in an IRA account, that any position represented on a statement or a web-look at the positions in fact represents a strategic failed to deliver of a security?

When I asked him that on the occasion of a perchance meeting while in the local office at Schwab to transact something, I gathered either he did not know about what I was asking, or I did not do well in raising the question. So I sent him the above links and asked the question again in an email. So far he has not answered.

Despite what that dude answers, I would like some others' perspectives about this issue of naked short selling, which is illegal as is the resultant failure to deliver the security that was sold short, but as I understand the actuality of naked short selling is represented as having occurred for every security listed at the above referenced NYSE and Nasdaq sites, and according to Byrne these lists may be or are woefully inadequate in accounting for the actual numbers of failed to deliver securities when accounting between brokerage firms is considered.

If anyone really wants to understand how screwed up are our markets, it strikes me that listening to Byrne's presentation is a must.

If anyone wants to assert that all this is nonsense, then I would like to read such opinions too.

If anyone knows how one can best protect oneself from "owning" a security that one does not really own, I would like to know that.

Unless you own significant positions in specific (particularly illiquid) stocks, I wouldn't worry about the impact of naked short selling. The impact of asset allocation and old-fashioned investment prudence on your portfolio so overwhelm it that any attention diverted from these latter issue is likely to be more detrimental than helpful.

The question of using a "cash" account, versus one enhanced with margin, short-selling, and option privileges, however, is more relevant to most investors. One reason is that in the latter case, you normally give the broker permission to borrow shares from your account at the time you open it. If that happens with a dividend paying stock, you may receive payments in lieu of dividends rather than actual dividends on the shares you've lent out (ordinarily without knowing at the time it happens).

No problem, you say, because those "in lieu of" payments make you whole. Well, yes they do, except when it comes to taxes. Actual dividends are eligible for the preferred 15% rate cap on qualified dividend income, but "in lieu of" payments are not. This is probably not a huge issue monetarily, but the tax headache may be huge.

There are two possible solutions. First, simply determine that margin, short-selling, and option trading are not necessary to successful investing and forgo them. K.I.S.S. is a better strategy for the vast majority of investors. Get yourself a cash account, invest wisely for the long term, and sleep well.

Second, if you are hell-bent on playing with margin, short-selling, or options, open a separate account for these activities.

[Jim Nickerson]

Re: Naked Short Selling. What is the danger, how does one protect oneself?

Unless you own significant positions in specific (particularly illiquid) stocks, I wouldn't worry about the impact of naked short selling. The impact of asset allocation and old-fashioned investment prudence on your portfolio so overwhelm it that any attention diverted from these latter issue is likely to be more detrimental than helpful.

The question of using a "cash" account, versus one enhanced with margin, short-selling, and option privileges, however, is more relevant to most investors. One reason is that in the latter case, you normally give the broker permission to borrow shares from your account at the time you open it. If that happens with a dividend paying stock, you may receive payments in lieu of dividends rather than actual dividends on the shares you've lent out (ordinarily without knowing at the time it happens).

No problem, you say, because those "in lieu of" payments make you whole. Well, yes they do, except when it comes to taxes. Actual dividends are eligible for the preferred 15% rate cap on qualified dividend income, but "in lieu of" payments are not. This is probably not a huge issue monetarily, but the tax headache may be huge.

There are two possible solutions. First, simply determine that margin, short-selling, and option trading are not necessary to successful investing and forgo them. K.I.S.S. is a better strategy for the vast majority of investors. Get yourself a cash account, invest wisely for the long term, and sleep well.

Second, if you are hell-bent on playing with margin, short-selling, or options, open a separate account for these activities.

Finster, I appreciate what you are saying with regard to the dividend and "in lieu of" payments, and that I guess could be a problem.

But I do not see where your answer is pertinent with regard to my believing I bought and own a security, when some miscreant (as Byrne calls them) is able to cheat in the system by not actually delivering the security. I personally, nor you probably, cannot get away with selling a security, getting the money, but failing to give up the security. According to Byrne people is high, or perhaps low, places can and do accomplish this.

The example Byrne put forth was the guy who oversaw what I guess is called the "shorting desk" at Refco. Rather than actually finding someone willing to loan shares from a margin account for me to buy, he screws the system and sends an "IOU" that shows up in my account suggesting that I got what I gave money to get, but then the guy who should insure the delivery of the actual security goes on and on in failing to provide remedy for the 'IOU." The "IOU" appears in my account not as an undelivered security, but as a position I own--which in fact I wouldn't own if the security was not delivered. This is all illegal, but according to Byrne is perhaps widespread, and as I originally noted is proven to be occurring by the NYSE and Nasdaq listing of those securities that have not been delivered to the buyers--Euphemized as "Threshold Securities" on NYSE site. I hope "euphemized" is a word.

[Jim Nickerson]

Re: Naked Short Selling. What is the danger, how does one protect oneself?

I am sure I was told as a child not to pull the dog's tail, but I don't know if I learned from the warning.

Finster, I think you are flummoxed regarding this issue, or is it I who is confused? I'm not inferring you are a dog, but I am trying to pull your (or anyone else's) "tail" to try to engender some fruitful discussion

http://www.thesanitycheck.com/ below is taken from the sanitycheck


"How big is the delivery failure problem? Try $63 billion as of Q2, 2006, for just NYSE member firms - and that is at today's mark to market value, not the price at which the sales were made - likely 5-10X or more higher. See the totals for yourself in the Securities Industry Association's own summary of NYSE member firm financial performance, and contrast that to the DTCC/SEC's $6 billion fairy tale. Lines 69 and 103. And read Bobo's blog explaining why the money is now gone, taken from investors and exchanged for nothing but lies."


"The Sanity Check website is intended to be an independent news source covering the Market Reform Movement. "Market reform", because much evidence suggests that our U.S. equities markets are out of control, and will either collapse under the weight of their own larceny, or be reformed, and operate in a fair and reasoned manner. The most pressing issue concerning many is the Naked Short Selling crisis affecting the stock market. This is a cancer - a malignancy that threatens popular faith in the integrity of the entire system. Lest you think this is all a flight of fancy, view footage of Senator Bennett discussing the issue with former SEC Commissioner Donaldson in a Senate Banking Committee hearing by clicking here - move the slider to 1 hour, 19 minutes and 35 seconds."
[emphasis JN's]


http://banking.senate.gov/05_03hrg/030905/live.ram

The link immediately above takes one to the video quicker than the "clicking here" link above and the time suggested as to when to begin to listen worked for me. Listening to the Senator explain a real life example of "naked short selling" only takes a few minutes.

So again I post

If anyone wants to assert that all this is nonsense, then I would like to read such opinions too.

If anyone knows how one can best protect oneself from "owning" a security that one does not really own, I would like to know that.

Unless you own significant positions in specific (particularly illiquid) stocks, I wouldn't worry about the impact of naked short selling. The impact of asset allocation and old-fashioned investment prudence on your portfolio so overwhelm it that any attention diverted from these latter issue is likely to be more detrimental than helpful.

One stock on the current NYSE's current Threshold Securities list is NYX, NYSE Group Inc., lowest daily volume last week was 1,656,800 shares (and last week was a week of negligble volume on the exchanges) and looking back to 6 Nov using bigcharts.com with a few exceptions more than 3M shares traded daily. Last week NYX traded about 2.9M shares daily.

For contrast, KSS, Kohl's Corp not on the Threshold Securities list, was the least active of the top 100 most active issues Friday 12/29 and averaged about 2.5M shares/day last week.

DJP, a commodities based issue that is on the NYSE Threshold Securities list, averaged trading about 95K/day shares since 11/6/06. I think the current NYSE list contains about 15 ETF's.

Compared to DJI 30 stocks an average 3M shares per day would be light volume. Of 170 ETF's I have begun tracking, (mostly HLDRS, iShares, Proshares, Vipers, Powershares) since 11/6/06 only GLD, EFA, EEM, XLF, OIH, SMH, EWJ, XLE, IMW (9 issues) have averaged over 3M shares/day, and an additional 9 have averaged more than 2M shares/day, and 14 more averaged over 1M shares/day. So even if 1M shares/day were granted to be a threshold of liquidity (which I cannot argue is necessarily valid), I conclude that most ETF's, ETN are not highly liquid. Yet I surmise these vehicles have become widely popular, if not in the sense lots of people owning them, then certainly in the sense that companies that have developed these ETF's have bought up lots of shares in order to create the ETF's.

If it takes 10,000 undelivered shares to make it on the NYSE Threshold Securities list and FTD's that exist between brokerage firms are unknown to the public, then how many thinly traded ETF's might people think they own, when all they truly possess are "IOU's"? That question cannot be answered by anyone in the general public who owns or think he or she owns ETF's, ETN's.

How big of a problem are FTD's? I think the only answer is: no one knows.

What can one do to protect oneself? So far, I do not know if anyone really knows.

[Finster]

Re: Naked Short Selling. What is the danger, how does one protect oneself?

I am sure I was told as a child not to pull the dog's tail, but I don't know if I learned from the warning.

Finster, I think you are flummoxed regarding this issue, or is it I who is confused? I'm not inferring you are a dog, but I am trying to pull your (or anyone else's) "tail" to try to engender some fruitful discussion...

I'm afraid you are right, Jim. Bloomberg ran a special on this exact issue last night. It is bigger than I thought. Maybe much bigger. Apparently this is not just a few cowboys, but Wall Street big money firms.

A significant volume of sales transactions just never seem to get settled, effectively increasing the float of shares far beyond what has been issued; a form of counterfeiting - outright theft. I have no idea why this is being allowed to continue.

As for what to do about it though, there's not much you can do to protect yourself except be very, very careful about taking substantial positions in smaller illiquid stocks. As for the broader issue, you can write your congressman, maybe contact securities regulators. There is simply no excuse for people being permitted to sell what they don't have.

[Jim Nickerson]

Re: Naked Short Selling. What is the danger, how does one protect oneself?

I'm afraid you are right, Jim. Bloomberg ran a special on this exact issue last night. It is bigger than I thought. Maybe much bigger. Apparently this is not just a few cowboys, but Wall Street big money firms.

A significant volume of sales transactions just never seem to get settled, effectively increasing the float of shares far beyond what has been issued; a form of counterfeiting - outright theft. I have no idea why this is being allowed to continue.

As for what to do about it though, there's not much you can do to protect yourself except be very, very careful about taking substantial positions in smaller illiquid stocks. As for the broader issue, you can write your congressman, maybe contact securities regulators. There is simply no excuse for people being permitted to sell what they don't have.

Finster,

You have a wonderful mind to have recalled this thread.

The entire issue to me is this points one more thing that seems to demonstrate how the presumably regulated markets of a developed country, if that is what the USA is, can be so screwed up.

Look at the NYSE threshold securities list and some of those on it do not strike me as illiquid issues.

The excuse is that some people operating in the markets are miscreants, as are the law makers and the regulators.

[Finster]

Re: Naked Short Selling. What is the danger, how does one protect oneself?

Finster,

You have a wonderful mind to have recalled this thread.

The entire issue to me is this points one more thing that seems to demonstrate how the presumably regulated markets of a developed country, if that is what the USA is, can be so screwed up.

Look at the NYSE threshold securities list and some of those on it do not strike me as illiquid issues.

The excuse is that some people operating in the markets are miscreants, as are the law makers and the regulators.

You were the first thing I thought of when that Bloomberg special started.

We arguably have over-regulated markets. Unfortunately, the regulation is aimed at the wrong things. In many cases, it creates a false sense of security when it's really buyer beware. Meanwhile, the major abuses, such as minting of shares to buy executives stock options and to be sold short, go unchecked.

The illiquidity issue is not one of bright lines, but relative risk. It's just a lot harder to manipulate the price of GE, XOM, or MSFT than it is XYZ.COM.

[Finster]

Re: Naked Short Selling. What is the danger, how does one protect oneself?

Finster,

You have a wonderful mind to have recalled this thread.

The entire issue to me is this points one more thing that seems to demonstrate how the presumably regulated markets of a developed country, if that is what the USA is, can be so screwed up.

Look at the NYSE threshold securities list and some of those on it do not strike me as illiquid issues.

The excuse is that some people operating in the markets are miscreants, as are the law makers and the regulators.

You were the first thing I thought of when that Bloomberg special started.

We arguably have over-regulated markets. Unfortunately, the regulation is aimed at the wrong things. In many cases, it creates a false sense of security when it's really buyer beware. Meanwhile, the major abuses, such as minting of shares to buy executives stock options and to be sold short, go unchecked.

The illiquidity issue is not one of bright lines, but relative risk. It's just a lot harder to manipulate the price of GE, XOM, or MSFT than it is MCRCP.COM.

[renewable]

Re: Naked Short Selling. What is the danger, how does one protect oneself?

Isn't this a good reason to buy certificated shares? This would prevent your broker from hiring out your shares (held in their nominee account) to shorts who need to temporarily cover naked short bets that go wrong.

[Pervilis Spurius]

Re: Naked Short Selling. What is the danger, how does one protect oneself?

In theory this could work, but only if all retail holders called for their certs or bought them in DRS. At least as far as I can tell, the retail brokerage side of the stock market acts essentially as a fractional reserve bank, only with shares instead of "Money". However, at this "bank", there appears to be NO reserve requirement. Thus, if simply one shareholder owns stock in a streetname margin account at a brokerage, those shares may be loaned out over and over again.

[AMaltsev]

Re: Naked Short Selling. What is the danger, how does one protect oneself?

Thus, if simply one shareholder owns stock in a streetname margin account at a brokerage, those shares may be loaned out over and over again.

Why not to visit a broker to cancel a margin agreement? The one which allows the loan of shares?

[Jim Nickerson]

Re: Naked Short Selling. What is the danger, how does one protect oneself?

Why not to visit a broker to cancel a margin agreement? The one which allows the loan of shares?

As I understand this, and I am not very smart about it, anyone who has the ability to sell shares short but does not have those shares properly borrowed by the brokerage firm to deliver to the buyer, can result in the buyer of those shares that were sold short receiving an "IOU" rather than actually gaining ownership of the shares. Thus anyone in any type of account who buys shares could in fact be receiving the IOU of a brokerage desk that was responsible for borrowing the shares that were sold short.

No one I see is necessarily protected.

The only protection that seems certain would be to request certificates for all shares that one buys. That includes increased costs for certificate delivery I believe and to me unimagineable leg work, if one in inclined to trade more than every half-decade or so.

[AMaltsev]

Re: Naked Short Selling. What is the danger, how does one protect oneself?

It's a pity two threads have been created on the same subject (See: "Not A Conspiracy - A System" in AntiSpin section, here: http://www.itulip.com/forums/showthread.php?t=567).
FWIW, more or less "protected" seem the ones who own shares of mutual funds, 'cause the fund knows precisely whether it got shares, IOUs or FTDs.
Anyway, to cancel a margin agreement sounds so simple! And this action alone could legally prevent your broker from shorting your shares (whether it'll continue to lend your stocks de facto, is another question). I just can't see a reason why a 'Joe average' would allow someone to lend his property, unless he's an experienced trader and unless he shorts and takes on leverage himself...
Miscreant broker activity is based on the margin agreement, in the first place. So why doesn't 'Joe' cancel it, if the agreement doesn't serve him at all? This anyone can do!
I don't know how to address the second base for a criminal brokers, though. How to make them disclose, what you have (and what you don't have) on your account? How to prevent them from creating FTDs? New laws, and a new law enforcement agency would do, of course - maybe, that's the ultimate solution to the problem... if you'd like to create a new agency! :cool:
Ah, no! The ultimate solution would be to prohibit short selling at all!!! :p
(I'm nearly serious on this one! Does anyone know, when short selling op appeared first? In 1870s? In 1920s? In 1970s? Or was it invented by Brits in 1720s?)

[Pervilis Spurius]

Re: Naked Short Selling. What is the danger, how does one protect oneself?

Jim Knickerson has it closer to reality. There is know way to keep the retail holder from receiving an IOU because pension funds, mutual funds, insurance companies, routinely lend their shares to the banks to be sold short if the rate they can receive on this stock lending activity is large enough.

I think this is also contibutes to the FTD activity being concentrated in certain stocks. When the legitimate borrow becomes tight on heavily shorted stocks, this drives up the price on stock lending and the Institutional managers are then enticed to lend their stock. I've heard of institutions receiving 12%+ on some heavily shorted issues.