What do the Wall Street Journal, other members of the media, a $40 trillion company (yes, you read that right), Lehman Brothers, Merrill Lynch, Fannie
Mae and Freddie Mac all have in common?
But not just in the way you assume...
Keep reading, because some of this may surprise you.
Late last month, Forbes finally published an Op Ed piece written by Patrick Byrne,
Overstock.com's CEO, which had been written for the Wall
Street Journal more than two years earlier, but ultimately refused by them in the eleventh hour.
In the piece, Byrne blew the lid off of a widespread criminal practice in the trading markets, known as naked short selling.
But first, a little history...
In 1999, the Depository Trust & Clearing Corporation (DTCC)
was created as holding company for the Depository Trust
and National Securities Clearing Corporation (NSCC)
. Each of those companies had been established decades earlier in an
effort to convert paper trading transactions into electronic transactions.
DTCC's DTC depository provides custody and asset servicing for 3.5 million
securities issues, comprised mostly of stocks and bonds, from the United States and 110 other countries and territories, valued at $40 trillion, more
than any other depository in the world.
Wall Street's "Paperwork Crisis"
With the New York Stock Exchange (NYSE) handling 10 to 12 million shares daily, brokers were literally buried in paperwork, and concern about risk was
growing in Congress, the Securities and Exchange Commission, and elsewhere.
The crisis became so severe that, in order to help reduce the backlog, the exchanges closed every Wednesday, shortened trading hours on the other
days, and extended settlement to T+5 from T+4. Eventually the industry developed two separate and distinct approaches to solve the paperwork problem.
One Solution: Immobilization
The first solution was to immobilize physical stock certificates by maintaining them in a central location or depository, and to record changes of
ownership using "book-entry" accounting methods where no certificates actually change hands. Initially, this was done by the NYSE and its Central
Certificate Service. That led to the creation of DTCC's depository subsidiary in 1973.
Another Solution: Netting
The second approach to solving the paperwork crisis involved a concept called multilateral netting. If one broker does 100 trades in IBM, both buying
and selling at different prices with a variety of different brokers, there are few opportunities for netting. By interposing a central organization as
the counterparty to all trades, all that broker's trades in IBM can settle to one net position, and all money for trades in all securities can settle
to a single dollar figure owed to or from the central counterparty.
In 2007, DTCC settled the vast majority of securities transactions in the United States, more than $1.86 quadrillion in value.
Some of you may still be unclear as to what all of this really means.
The following article describes what the DTCC does in another way:
In brief, they process the vast majority of all stock transactions in the United States as well as for many other countries. And - and that's the
real interesting part - 99% of all stocks in the U.S. appear to be legally owned by them.
In the old days, when you owned stocks you would have the stock certificates lying in your safe. And if you needed to trade them, you needed to get
them shipped off to a broker. Nowadays that would be considered very cumbersome, and it would be impractical to invest via computer or over the phone.
So the shortcut was invented that the broker would hold your stocks instead of you. And in order for him to legally be able to trade them for you, the
stocks were placed under their "street name". I.e. they're in the name of the brokerage, but they're just holding them in trust and trading them
for you. And you're in reality the beneficiary rather than the owner. Which is all fine and dandy if everything goes right. Now, it appears the rules
were then changed so the brokers are not allowed any longer to put the stocks in their own name. Instead, what they typically do is to put the stocks
into the name of "Cede and Company" or "Cede & Co" or some such variation. And the broker might tell you that it is just a fictitious name, and
will explain why it is really more practical to do that than to put it in your name.
The problem with that is that it appears that Cede isn't just some dummy name, but an actual corporation that DTCC controls. And, well, if you ask
anybody about this, who actually knows about it, they will naturally tell you that it is all a formality. To serve you better, of course. And, well,
maybe it is. DTCC seems like a nice and friendly company. It is a private company, owned by the same people (major U.S. banks) who own the Federal
Reserve Bank. And if they all stick to their job, and just keep the money and your stocks flowing smoothly, I'm sure that is all well and good. But
if somebody at some point should decide otherwise, and there's a national U.S. emergency and/or the U.S. government becomes unable to pay its debts,
well, they might just not give you your stocks back. Because legally they own them. Something to think about.
Ming the Mechanic: The unknown 20 trillion dollar company
Now THAT should be clear as a bell. The implications are staggering!
But back to the main subject of this thread...
Naked short selling.
Wikipedia describes the term as follows:
Naked short selling, or naked shorting, is the practice of selling a stock short, without first borrowing the shares or ensuring that the shares can
be borrowed as is done in a conventional short sale. When the seller does not obtain the shares within the required time frame, the result is known as
a "fail to deliver". However, the transaction generally remains open until the shares are acquired by the seller or the seller's broker, allowing a
trade to occur when the order is filled.
In other words, a trader sells a stock he doesn't actually own.
(A word of caution: For reasons described more fully below, you have to treat the remainder of the Wikapedia entry above on naked short selling with
some level of suspicion.
Again, you'll see why shortly...)
On September 23, 2008, Patrick Byrne's piece published by Forbes, described the following:
Recent concerns about short-selling have culminated in a regulatory flurry of emergency orders and amendments. What should be of concern, however, is
not short-selling per se: As its devotees frequently remind us, short-selling is a vital and legitimate market activity. What should be of concern are
specific types of stock manipulation that cloak themselves within legitimate activities such as shorting, and which, in one way or another, rely upon
loopholes in our nation's system of stock settlement.
"Settlement" is the moment in a stock trade when the seller receives money and the buyer receives stock. Our settlement system has gaping
loopholes that allow sellers to sell shares but fail to deliver them. In such cases, the system creates IOUs for shares, and lets those "stock IOUs"
circulate in the expectation the seller will soon correct his error. This is harmless--as long as the IOUs are inadvertent, temporary and few.
Manipulators are exploiting these loopholes, however, selling stock they do not intend to deliver. This is often referred to as "naked
short-selling" (short-selling because they feign selling borrowed shares; naked because they don't really borrow shares, but instead deliberately
rely on loopholes to generate and hide stock IOUs).
Naked In Wonderland
Sounds pretty wild, huh?
However, naked short-selling is just one form this manipulation takes. Other forms include failed long-sales, abuse of the option-market-maker
exception, failed offshore deliveries and ex-clearing abuses. The common denominator of these manipulations is that they flood the system with stock
IOUs that are deliberate, persistent and massive.
How could this be????
Byrne points out:
According to former Undersecretary of Commerce for Economics Dr. Robert Shapiro, "There is considerable evidence that market manipulation through
the use of naked short-sales has been much more common than almost anyone has suspected, and certainly more widespread than most investors
His research turned up at least 200 companies that were destroyed, for "a combined market loss of more than $105 billion." Shapiro added, "we
believe that this type of stock manipulation has occurred in many hundreds and perhaps thousands of cases over the last decade. ... Illicit
short-sales on such a scale or anything approaching it point to grave inadequacies in the current regulatory regime."
See also, Robert Shapiro on Naked Short Selling.
So when Byrne wrote his article for the Wall Street Journal, and at the request of one of its editors, he knew he'd be facing some stiff opposition
to his claims.
[edit on 7-10-2008 by loam]