Color Me Stunned

I was an interested observer of the short selling wars that went on from about 2003 until the meltdown in 2008.

When the appetite of the short sellers was no longer satisfied by destroying small financial companies and hi-tech or pharmaceutical startups, they turned on Wall Street itself.  At that point, even legal short selling was halted.

There have to be limits after all.

Throughout those years, certain “target” companies had so many shares sold short that investors were not getting delivery of the shares they bought.  This practice, called naked short selling, is basically a kind of fraud except for temporary selling by legitimate market makers.

Needless to say, some clever short sellers figured out how to get themselves called “market makers.”  Still others “rented” the market maker exemption by buying huge numbers of options, and then just didn’t deliver, for years.

So millions of shares of stock were sold and paid for, but never delivered.  Unfortunately, those shares were bought by retail suckers, who don’t matter, after all.

The ever-compliant SEC spent literally years thinking about whether those buyers deserved to know whether the stock they were buying was even issued by the companies.  Several times they re-opened comment periods on their Regulation SHO, creating additional months of delay.

Even when they did finally start to disclose which stocks were heavily shorted, all the old short sales were “grandfathered.”

But hey, the short sellers were the guys in the white hats, according to the head of SEC enforcement who got himself a very nice job working for a short seller after he left his perch high up in the SEC.

During that time, the unpenetrable wall was the DTCC (Depository Trust and Clearing Corp).  Their Chief Counsel even insisted that investors had no right to expect delivery of stock when they traded in the market, since they paid their money not for stock, but for stock “entitlements.”

The DTCC went on to say that if they recorded an “entitlement” for a stock purchaser, that stock purchaser had what he paid for.

Except voting rights, of course.

But the DTCC worked out a system for that, too.  They just took all the votes submitted by stock and entitlement holders, and divided that by the number of authorized shares before reporting the outcome of votes to the companies.

I was once quite amazed to read that every stock on the NYSE had had more shares voted than existed.

Just imagine a car dealer making an absurd argument like that!  You pay for the car, and go to pick it up, and they tell you that you paid your money not for a car, but for the right to have a car if and when they have one to give you.

Even after the SEC adopted a pathetic set of rules that forced disclosure of which stocks had persistent large “Failures to Deliver,” or FTD’s, the DTCC held onto its position that those who had sold the stock and not delivered needed to have their names protected because such disclosure might hurt them by exposing their proprietary trading strategies.

Critics responded by saying that much of the activity was illegal, not proprietary, but DTCC held fast, and never disclosed who was behind the flood of nonexistent shares sold into the market for certain stocks.

After years of helping criminal fraudsters hide their naked short selling activity, Depository Trust has decided to stop providing cover, at least for those who (perfectly legally) sell debt short by buying CDS.

Strangely enough, they are doing so in a sector that doesn’t even have laws designed to prevent unlimited bearish bets, unlike the listed stocks that they allowed to sit in a permanent state of Failed To Deliver (FTD).

Here are some excerpts of a short article in yesterday’s Financial Times:

Regulators from around the globe including the Securities and Exchange Commission will now be able to obtain breakdowns of trading activity in credit default swaps, including the identity of the investors.


In a letter sent to regulators last week and seen by the Financial Times, the DTCC said that “regulators and other governmental entities can expect that, upon the formal request of any regulator, counterparty names will be included in both aggregate and trade-level information provided by the warehouse”.

The DTCC had previously agreed with the banks and dealers that provide trade information that it would not reveal details of counterparties unless they had their explicit consent.

“There is always a balance between customer confidentiality and regulatory interests,” said a DTCC spokesperson. “In light of recent events, it has shifted slightly.”

What?  Is this the same group that even tried to redefine buying a security to protect the names of those selling stock they couldn’t deliver?

It seems that this is because of the relatively small potatoes of the Greek sovereign CDS.  Still not a peep out of the main stream media about the trillions of dollars in subprime mortgage bond CDS that existed without disclosure, but were hidden, the root cause for our meltdown.

But it’s only me, I suppose, that thinks losses ten to a hundred times bigger than the actual mortgage bond losses matter, and the system that allowed it needs fixing.

Maybe the DTCC is caving because the international regulators have come down on them, the keepers of the official bits and bytes?  Maybe our own lapdog SEC (who come down hard on penny ante cheats like Martha Stewart while protecting and ignoring the multi-billion dollar crooks) just became that much more irrelevant.

Well, if this is thanks to the UK’s FSA asking instead of our guys, color me gobsmacked.

And thankful.



3 Responses to Color Me Stunned

  1. W.Kinsolving says:

    Thanks, Howard. That was a painful time, particularly for a neophyte that believed in the system and the law. I kept waiting for the sheriff to show up and clean out the stygian swamp of the DTCC and all those who used it for their corruptians. But then I discovered that the sheriff was that great American Christopher Cox!! Oy.

  2. home2468 says:

    Short selling is fraud.
    Naked short selling is just more of it.
    For example, suppose you own a car.
    Where in the world can one actually borrow the car…
    ….and then sell it? Avis, Hertz, others?
    Since one borrowed the car, one did not OWN it.
    Even if you replace the car, before the rental company finds out…you’ve still committed FRAUD.
    Selling something you do not own is FRAUD.

    More regulation is going to fix this?
    Transactions requiring more government effort to review them should cost more. Lots more.
    I figure Madoff’s PONZI scheme couldn’t have worked if short selling didn’t exist.
    So regulation costs for short selling should be about $6B in fees every year.
    Just my opinion.

    • hhill51 says:

      I have no problem with legitimate short selling, where the owner of the stock is informed and compensated for the borrow.
      Too many brokerage firms (eg Fidelity, Merrill and e*trade) simply borrow every share from margin accounts (up to 140% of the margin balance) and keep the money for themselves rather than paying the owner of the stock. THAT is the fraud, not the short selling itself.
      As shares get harder to borrow, the cost would go up, thus limiting through market economics the amount of the float that could be sold short.

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