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Saturday, August 9, 2008

Stock Manipulation

If it seems odd to you that respected and influential news publications would urge the government to provide get-out-of-jail-free cards to criminal stock manipulators…well, welcome to the Deep Capture team. We’ve witnessed a lot of freakish journalism during the past few years, but it never ceases to amaze.
A nice example can be found in the latest Barron’s magazine, where the lead editorial chides the SEC for issuing an emergency order to “stop unlawful manipulation” that threatens to crash the American financial system.
According to Barron’s, the SEC “waved a newspaper and swatted the imaginary fly of naked short-selling. It made a big noise, but there’s no dead bug.”
That word “imaginary” has a ring of familiarity. “Seeing shadows on the wall,” is how Bethany McLean of Fortune magazine once described concerns about naked short sellers. “Seeing UFOs” was the phrase employed by CNBC’s Herb Greenberg, then writing for MarketWatch. But in the face of all the evidence, those journalists have been silent on the issue for months, and now everybody from the Secretary of the Treasury on down says that illegal naked short-selling is an abomination.
Certainly, there is nothing “imaginary” about the SEC data showing that as of March 31, $8.7 billion worth of stock had “failed to deliver.” Most of those failures were the result of illegal naked short selling – hedge funds and their brokers offloading stock that they had not, and never intended, to borrow. Experts agree that there is at least ten times more of this phantom stock in parts of the system – such as “ex-clearing” – for which the SEC provides no public data.
Barron’s is right, there’s “no dead bug” – naked shorting is alive and well. But that doesn’t mean it shouldn’t be swatted. Maybe the SEC just needs a better newspaper – something other than the limpid Barron’s.
But wait. Here’s a newsflash: Naked short selling is good clean fun – nothing illegal about it. “Aggressive short-selling isn’t a crime,” Barron’s writes. “Even naked short-selling – selling shares before borrowing them – hasn’t been against the rules. Until last week, a short-seller could enter a naked trade in almost any stock if his broker had reasonable grounds to expect that an adequate number of shares could be borrowed by the day of settlement.”
That is technically true, but its is plainly disingenuous for Barron’s to suggest that the SEC is cracking down on legal behavior. The problem, as Barron’s editors surely know (they do cover Wall Street, don’t they?), is that short-sellers and their brokers routinely offload stock without having “reasonable grounds” that they can borrow it. That is why more than $8 billion of stock “fails to deliver” on a typical “day of settlement.” Moreover, the data shows that most of this phantom stock is targeted at specific companies, and that much of it remains undelivered for months, even years, at a time.
In an earlier issue, Barron’s itself described the case of Cal-Maine Foods, the country’s largest egg producer, noting that, “Of the 55% of Cal-Maine’s stock that’s available to the public, more than 100% is sold short. That suggests short sellers…are executing sales before taking the normal step of securing shares to borrow.”
There is no legal gray area where hedge funds are allowed to sell more of a company’s stock than actually exists. This sort of naked short selling is not some technical glitch. It is illegal market manipulation. It is clear-cut fraud. And it is happening on a massive scale.
That is why the SEC seems to want to crack down. Its emergency order protects only 19 big financial firms, but hopes are high that the Commission will extend its protection to the many companies, such as Cal-Maine, that are far more seriously affected. The hedge fund lobby and Barron’s will whine loudly, but it seems like common sense that short-sellers market-wide should be required to pre-borrow (i.e. have real stock) before they dump it on unsuspecting investors.
Really, I challenge Barron’s, or anybody else, to name just one expert (people working for hedge funds don’t count) who has published a study casting doubt on the thesis that naked short selling is routinely used to illegally manipulate markets – with potentially catastrophic consequences. I have yet to come across any such expert, and there is no evidence that Barron’s has either. Indeed it’s editorial contains no facts or data – just platitudes.
It’s only real-world example is the much-discussed demise of Bear Stearns. Short-sellers, we are told, had nothing to do with the bank’s collapse. All the rumors were true. The only falsehoods were told by Bear Stearns spokesmen, “who declared that everything was hunky-dory.” That’s how it happened – take Barron’s word for it.
Ugh. This “debate” is like arguing over how many Froot Loops are in the box. It’s absurd – let’s just take them out and count. We did that, and the number we got was 1.2 million. That’s the number of Bear Stearns shares that were sold on March 12, but remained undelivered after the 3 days allotted for settlement. The shares were undelivered because they were as fake as the Froot in your Loops.
And note that the increase in phantom shares on March 12 was at least ten times the increase in the total volume of trading in Bear Stearns stock, suggesting that selling of real shares was comparatively light. In other words, there was no panic among investors until after those 1.2 million phantom shares (and probably a lot more in ex-clearing) flooded the marketplace, creating the illusion that somebody was panicking. .
That afternoon, CNBC, working from information provided by a hedge fund, reported (as if it were fact) the bombshell that Goldman Sachs had cut off Bear’s credit. This was the first time the media had reported anything so drastic about the bank. And the report was completely false. Message to Barron’s editors: the rumors were not true. May I humbly suggest that you investigate this.
The truth is that on the morning of March 12, Bear Stearns was an unhealthy company, but it had $17 billion in cash, and few people believed that it was on the brink of collapse. Nobody had cut off its credit. No major clients had pulled out their money.
The next day, everybody pulled out their money. Bear Stearns was gone. What was the trigger? I’m open to other suggestions (Barron’s provides none), but it seems quite obvious there is only one explanation: A whole lot of phantom stock (the illusion of panicked selling) on March 12, combined with a well-timed media atrocity that afternoon, precipitated a real panic the following day.
We can assume that the SEC agrees with this version of events. That is why it believed that rumor-mongering naked short sellers had the potential to destroy 19 big financial firms. Maybe those 19 institutions are all bad companies. Maybe they should all be out of business. If so, let them fail naturally and gradually. Don’t allow law-breaking hedge funds to manufacture mass hysterias that could crash the financial system.
It’s hard to say why Barron’s doesn’t grasp this, but perhaps it is significant that it felt compelled to include in its editorial a little disclaimer about the magazine’s relationships with short-sellers. The editorial notes with apparent pleasure that Barron’s is “sometimes known on the Street as ‘Bear-ons’….[and] it prides itself on offering accurate negative news about companies as much as it does about passing on accurate good news. Good news is plentiful, and therefore cheap. Bad news has to be dug up….Short-sellers read Barron’s with special interest, and they also make good sources of information that our reporters can check and publish if true.”
I’d be hard pressed to provide a better description of what plagues certain segments of our financial media. Start with the appalling notion that “good news” is “cheap.” The way I see it, all news is equally valuable – so long as it’s true and interesting. It’s a bit rich to suggest that good news is more “plentiful” when short-sellers have become such “good sources of information.” In any case, interesting, nuanced truths usually contain some good news, some bad. And they tend to be discovered by independent thinkers who do their own research, not by some ping-pong headed note-taker who bounces between the conniving short and the corporate VP of Puff until deadline comes and confusion reigns, but one thing is certain – the editor has decreed that good news is “cheap.”
Even worse than the bias for bad news is Bear-on’s implicit assumption that because short-sellers are “good sources of information,” the government (and the media?) should leave them alone, even if they’re committing crimes. There is nothing wrong with journalists talking to short-sellers. But while they’re at it, they might ask some short-sellers why their target companies are buried under heaping piles of phantom stock.
Barron’s has worked closely with some pretty dastardly shorts while obligingly keeping its nose out of their shady business dealings. Short-seller David Rocker, for example, was a popular source and Barron’s columnist while he was conspiring with a disreputable outfit called Gradient Analytics. Gradient advertised itself as providing “independent” research, but former employees say its falsehood-laden hatchet jobs were often dictated by Rocker, who illegally traded ahead of them, while one of Gradient’s managers was accumulating multiple aliases and fake IDs to hide his activities.
Most of Rocker’s short targets appeared on the SEC’s list of companies victimized by excessive levels of phantom stock – purely coincidence, no doubt, but Barron’s might have asked him about it.
For a long time, Barron’s editor Cheryl Straus Einhorn published a steady stream of biased stories that generated financial rewards for associates of her husband, a hedge fund manager and master of distortion named David Einhorn. Meanwhile, Barron’s couldn’t get enough of the “good information” provided by short-seller Anthony Elgindy, a gun-toting, Mafia-connected goon who was well-known for selling phantom stock, bribing FBI officials, extortion, blackmail – you name it.
Barron’s has since fired Ms. Einhorn, Elgindy is now doing 11 years in a federal penitentiary, and Rocker slunk into retirement in Florida (and got a “homestead exemption” protecting his assets from seizure) after the government issued him with a subpoena.
Fortunately, Barron’s still has some “good sources of information” and no doubt they are all model citizens. But the latest editorial shows that the magazine is as reluctant as ever to publish the bad news about short-sellers’ crimes.
Funny that – with good news being so “cheap” and all.
Mark Mitchell is the former editor of the Columbia Journalism Review’s on-line review of business journalism. He has also worked as an editorial writer for the Wall Street Journal in Europe, and as a correspondent for Time magazine in Asia, and the Far Eastern Economic Review.