Thursday, December 01, 2005

The 1% (or so) Solution...And The Radio Interview That Spells it All Out

The following two links will download two radio broadcasts that are the most significant commentaries on the naked short selling situation to date. Here is the first - A must listen radio interview with industry consultant Bud Burrell - he describes the scope of the problem as multi-trillion dollar fraud - larger than all other American frauds combined. And here is today's show, which concludes this segment of interviews - every politician and lawmaker and regulator should listen carefully to this, and then consider how long they want to be part of the problem rather than the solution.

Bud is an old hand at this, and has forgotten more than most know about the system and the problem. This is an incredibly articulate, blow-by-blow description of how bad the problem is, how it has impacted the economy and our futures as citizens. I am enraged as I listen to this - the information is knowable, guys like Bud know it, and yet the mass of the media and Wall Street pretend that there is no problem - and a complicit media follows along.

Please listen to this - and distribute it to everyone that believes this is no big deal. It is damning.
Additionally, Bud will be back on the radio on Monday for a continuation of his information download - tune in.

Now to the Sanity Check portion of today's program.



One percent.

Sounds trivial. Nothing to speak of, really.

When the SEC's Brigagliano spoke about naked short selling at the NASAA conference on November 30, he tossed out the number 1% like billionaires toss out buck cab fare tips.

One percent of the daily stock transactions on the exchanges fail, every day.

Let's contrast that against the number the DTCC came out with in their interview.

$6 billion a day of fails - trades that don't clear - occur every day. Per Thompson of the DTCC.

Now, the DTCC says that is a rolling total including aged fails.

Fine. So how do we reconcile that with the SEC's statement that 99% of trades don't fail, leaving 1% which do? If that is accurate, then $4 billion per day (potentially - it could be smaller, as many of the fails are likely in low price stocks, thus in number of trades they could comprise the 1%, but not in dollars - but we don't really know, do we?) are the new fails, leaving $2 billion per day as old fails. Fine.

So what happens tomorrow, when another $4 billion (or $1 billion, or $600 million - you get to pick your number as the actual number is a secret) fail? And the day after that? How does it stay at $6 billion per day, inclusive of aged fails, if tons of new fails are added every day...does that mean that most clear within one day of failing? That seems odd, given that Professor Boni's paper indicated that the average FTD was 56 days.

Something doesn't add up. Either the DTCC is being less than straightforward with us, or the SEC is, but the numbers do not add up, any way I can make them.

Then again, I never was good at math. Still, ya gotta love the numbers.

Here's another fun number. I love fun numbers. You should too. Numbers are revealing.

How are those $6 billion dollars of failed trades distributed?

Are they showing up in GE and Microsoft and Intel and Dell? Nope. They are not. Why is a topic of a future Sanity Check, the short version being that those companies are too large to successfully manipulate.

Suffice it to say that they aren't.

Those fails are hitting 30, 40, maybe 100 companies. Maybe 200. But likely the largest distribution is in a few companies.

So suddenly the idea of 1% per day of fails takes on a bit more magnitude when contextualized. Let's say that fails represent more like 40% or 50% or 75% of the trades in the victimized companies - a bell curve wherein the peak is a sharp spike.

It doesn't sound so trivial now, does it? If 75% of the stock sold in OSTK on a given half million share day fail, that has a PROFOUND impact on the company's valuation.

Mr. Brigagliano seemed to love the 1% number, but didn't even like the idea of addressing the questions from the audience that would have shown the lie to the notion that this is a small affair. I don't blame him. When bureaucrats start trying to downplay the size of a problem by speaking in percentages rather than in hard dollars, hold on to your wallet. I'm sure that the percentage of soldiers killed in Iraq is minuscule compared to the population of the US, or even the total size of the military apparatus, but to every mother that loses a son the impact is real, and significant. But I digress - the point is that the FTD's are a huge annual number, per Brigagliano (1% per day of trades fail every day - hard to misinterpret that), and that those fails are distributed in a small number of stocks, representing a huge problem for those 50 or 100 companies. So one might well ask why it is acceptable for those companies to have a substantial amount of their trading fail, and buyers defrauded out of their cash, receiving nothing for their payment? Apparently the SEC will "study" that and get back to us. Maybe.

As to the NASAA conference and Brigagliano's performance, one has to feel a little sorry for the man, even though his pomposity and arrogance came through loud and clear. I mean, how would you like to have to explain to the American public that 10, 20, 50% of the stock sold in any company on the SHO list was fails, and that the best you could do is "study" this curious affair?

That's our SEC hard at work.

My message here is simple - the high concentration of the FTD's per day in just a handful of companies - the SEC is deliberately trying to make it seem trivial with some statistical sleight of hand, while simultaneously defending keeping the numbers secret.

They clearly think we, the American public, are dimmer than burned out refrigerator bulbs.

And the SEC is just too GD busy to actually do anything. Huh. They will study the impact of naked short sales and Reg SHO into the mummy stage, and ignore that every expert in the country says that keeping the system opaque is a huge problem for any faith in fair markets - hey, maybe another 2 or 3 years of studying it and they will be ready for an in-depth focus group, or maybe a tiger-team work group!

Meanwhile, the public gets screwed to the tune of approaching a trillion dollars of fraudulent trades per year - conservatively.

Hell, that's real money even by Beltway and Wall Street standards.

But nobody will do anything.

Sick yet? I could tell you the story of the SEC office that is paying double fair market rates for their first class office space, and yet hasn't filed a single enforcement action for this year. But I won't.

My favorite book from a few years ago chronicled stories of $400 Pentagon hammers and such. Believe me when I tell you that the SEC makes the Pentagon look like a coupon-clipping Granny.


Blogger SECFOInfo said...

Too many numbers. All of them wrong and/or selectively chosen by regs and DTCC.

Not your fault. Just alot of disinformation being tossed around by the obfuscators.

10:33 AM  
Anonymous Anonymous said...

Oh, wow! Great comment 'secfoinfo', just great! You could be more specific, couldn't you? Who's numbers are wrong? SEC's? DTCC's? Bob's? And, which numbers are wrong and what are the correct numbers? Do you know? If not, then you don't know if 'the numbers' you say are wront are wrong, now do you?

PS: Way for the SEC to end this whole problem is to simply make naked shorting legal. Then THEIR problem goes away--and our problem gets larger. But it would make their problem go away, wouldn't it?

During the

11:06 AM  
Blogger bob obrien said...

The problem the SEC has is that to do so would destroy the capital markets, violate 17A directly, and make a mockery of 15(c)-3, and most of the other delivery and honest dealing rules.

While they are at it, they need to legalize ritual suicide, prostitution, drug use, and eliminate common law property rights. Then the DOJ and police would get a break as well.

11:22 AM  
Blogger SECFOInfo said...

The SEC's 1 % is wrong because the DTCC says it's 1.5% but they wrong too because it's based on a number involving doublecounts and non-equity transactions. And it's also wrong because the fails are only in 20% of the stocks. It should be based on the dollar volume of the trading in those 20%.

The 400 billion is wrong because the NYSE, NASDAQ and Pink sheets dont do 400 billion a day in stock transactions.

the 6 Billion is wrong because it represents a mark to market value. That number is closer to 100 billion over the last ten years. Ina ddition put that 6 Billion in terms of 20% of the market and we are talking big bucks considering they are mostly small companies.

Bob is just citing numbers from others so he is not wrong.

You see it's all game of numbers they play to obfuscate the relity of the situation.

1:05 PM  
Blogger SECFOInfo said...

Consider the problem in terms of a hurricane (naked short selling), it comes in and wipes out 100% of a town in florida. The gov't comes in and says no,no,no it only wiped out 10% of 10 towns (The one in florida and one each in NY,NJ,ME,NH,CT, MI,OH,MD and WA that didn't have a wind blow harder than passed gas.)

Lumping irrelevent entities into a statistical argument is classic obfuscation.

In the case of naked short selling it's lumping the majority of unaffected stocks and non-equity transactions to make the problem seem smaller than it really is.

The only reason the SEC would buy into this game is because they're hapless and they have become owned by the industry. Plain and simple. Too many bean counters for them not to see this forest through the trees.

5:31 PM  
Blogger bob obrien said...

I think Bud has it correctly framed here - that's why his radio appearances are landmark - it's the first time you can hear a guy who knows the game tell you how it is played.

My personal theory is that they know, they understand, and the industry has either worked long and hard to place their own quislings into the key positions that decide policy implementation, or has co-opted those at that level after the fact.

The solution to this problem is simple - really couldn't be simpler, actually:

Withhold all funds from the seller until the share is delivered, and impose financial penalties for failing to deliver that have some meaning.

That would dry it up almost overnight. Make it cost the industry money and you will see a reticence to be bad.

Right now there is lots of talk, but no meaningful action - and that has been the case now for years and years. I can only conclude that those operating from the short side of the fence have become such a powerful faction that everyone will favor them over investors - the companies that use them to kill their upstart competitors favor their actions, the VC's that want to kill development stage financing from anyone other than VC's favor their actions, those in the SEC that view all pink sheet companies as bankruptcies waiting to happen favor their actions, the brokers and IB's who depend upon their business favor their actions - everyone in the entire financial system food chain loves them - except those who are being driven out of business, and the shareholders stupid enough to believe that the markets are anything but a giant fraudulent device for wealth transfer from Main Street to Wall Street.

That is my conclusion after almost a year's research into the issue for the book, which I still am not finished with as the story keeps evolving. It is difficult to not write it in a hyperbolic manner, as the facts are so base and loathsome as to anger even the detached.

7:17 PM  
Blogger mfairview said...

Solid stuff



Thanks for writing. It will not shock you to learn that I disagree with your line of reasoning, but will assume it is well-intentioned and sincere. I ahve thought of a counter-example that I will write when I have more time, but since it is late for me and my metaphors tired, I will just stick to a few lines of yours.

The thrust of your rebuttal is captured in these words: But, at the end of the day, we don't have that info. In the absence of info, I don't draw any conclusions about it.

I respectfully suggest that your point that "in the absence of info, [one cannot] draw any conclusions" is surely misguided here. I agree that we do not have perfect info. However, that is not really the question: the question is simply, "Is there enough info to draw any (even a tentative) conclusion?" You are claiming that there is not enough information from which to draw "any" conclusion. I believe this claim is an error, for three reasons: you make no explicit argument in support of it; you make no real attempt to wrestle with the information I ahve cited; and you yourself drraw your own conclusions on even weaker grounds. I will develop these claims below (leaving out NFI, on which I ahve no opinion).

...I don't think .... OSTK ... stock has been negatively affected. They seem to be trading normally, within a range that most people would consider close to fairly valued, with ample trading volume. There are some weird things: ........ you have your trades that did not settle T+3. But overall I believe that people can get in and out of the stock when they want to and it seems fairly valued, so I don't see any evidence of harm....

This is simply a slew of claims with no evidence adduced to support them. Moreover, they assume precisely what you are trying to prove. OSTK "seems[s] to be trading normally"? "Within a range that most people would consider close to fairly valued"? "It seems fairly valued"? This is all argument by intuition. For a guy who has been jumping up and down about demanding evidence (and who is quick to dismiss hard evidence that conflicts with his point of view), you seem remarkably quick to back up your own claims with nothing more than what "seems" to be "fair value" to you and how you think "most people" would value something, etc. Imagine how you would excoriate someone who came on the board and said they believed OSTK was being naked shoritng because the value "seemed" low and that he thought "most people" would think it was low too: you would be demand evidence to back up such flimsy assertions. Yet you make logically identical claims without any attempt to adduce evidence. If I'd known that this was going to be an argument about what "seems" a fair value I would not have bothered: I was under the impression that I was debating someone who wanted to talk about "evidence". None of your positive claims mention any: there is simply no there there.

Much of the rest of your message runs along the lines of explanations that do not involve conscious manipulation: I personally would lean towards some kind of systemic/technology incompatibility or inefficiency,, that is, "quirks" and "incompatible ... trading systems" or "some archaic paper system" or a "market maker on a foreign exchange was slow in delivering shares." And so on and so forth.

The thing is, a University of New Mexico economist named Lesli Boni was hired by the SEC to study just this question: does the distriution of FTD's exhibit the kind of distribution that would be normal if these "quirks" were really behind the problem of FTD's? She was given access to a tremendous amount of trading data, and while part of her work was classified to shield the public's eyes from it, the part that is unclassified answers with a resounding "no!" There is simply no way to explain the distribution of FTD's as the result of such quirks: their distribution is "strategic" in tht it exhibits conscious attempts to avoid high borrowing costs.

"Using a unique dataset of the entire crosssection of U.S. equities, we document the pervasiveness of delivery failures and provide evidence consistent with the hypothesis that market makers strategically fail to deliver shares when borrowing costs are high. We also document that many of the firms that allow others to fail to deliver to them are themselves responsible for fails-to-deliver in other stocks. Our findings suggest that many firms allow others to fail strategically
simply because they are unwilling to earn a reputation for forcing delivery and hope to receive quid pro quo for their own strategic fails."

I suggest you see also the paper cited therein: Evans, Geczy, Musto, and Reed, 2003, “Failure is an Option: Impediments to Short Selling and Option Prices,” working paper, Wharton and University of North Carolina.

Great title, huh? Anyway, these papers dispel any doubt about whether the FTD's experienced by the system are the result of the kinds of quirks, "archaic" or "incompatible ... trading systems" and the proverbial "market maker on a foreign exchange [who] was slow in delivering shares." The statistical distribution of the FTD's do not display any of the patterns one would expect from the causes you suggest as the ones that you "personally would lean towards" but for which you offered no evidence (which is entirely appropriate because there is none, as all the evidence is on the side of conscious design, as these papers show).

Well, all the rest of your posting is devoted to constructing circumstances where the FTD's in OSTK might not be "significant". Alas, what you have neglected to deal with is the fact that my belief (that Reg SHO stocks taken as a class have a level of FTD's that is significant) is not a belief I pulled out of thin air. I believe it because the SEC says that they are significant. They admit that the levels are so significant that they had to grandfather all fails prior to January 3, 2005, and are currently unable to divulge their size, for fear of the "volatility" it would create. That's not me, that's the SEC saying that. And we know of this set of stocks whose FTD's are so significant the SEC had to grandfather them and keep their amount secret for fear of creating market-disturbing volatility, that one member of the set, OSTK, has been on the list more than almost anyone, and that its current level of legal shorts (7.2 million out of 9.5 million in float, or 75.3%) is about the highest percentage of the float of any company on the list, and that its repo rate (often touching 30%) is higher than anyone's on the list, and so on and so forth. If the whole set of stocks has the characteristic that their FTD's are "significant" enough to warrant such strange behavior from the SEC, then that fact alone might be taken to establish a prima facie case regarding any member of the set: but surely it establishes a good prima facie case with regard to this one member, which is so extreme in all these relevant respects.

Now of course you can construct a case where the set of stocks as a whole has the characteristic of having a "significant" level of fails, and one of its members has all these extreme relevant characteristics, but somehow its level of FTD's is itself not "significant". I admit that as a remote mathematical possibility (just as it is possible that in a maximum security prison, the man who has been there the longest, and has spent the most time in punitive solitary, is in fact in there for the least pernicious crime, say, an endless series of jay-walking tickets). And the remoteness of this possibility is compounded by the other oddities we have witnessed, such as trades that do not clear for months, and brokers refusing to sell if certs are going to be demanded, and so on and so forth.

Yes, there are always remote alternative constructs that could explain these events. But Occam's Razor slices this way: the class as a whole (per the SEC) has a "significant" number of fails which, if not grandfathered and hidden would create market-distrubing volatility; OSTK stands out in every way as a member of that group (tenure, % of float shorted, repo rate); OSTK likely has a "significant" (or "uber-significant") level of FTD's as well.

If you just want to keep saying that none of what I have written counts as evidence in your high standards, but simultaneously argue from intuitions about how "fair" this or that valuation "seem" to you, or how you "personally would lean towards .... systemic/technology incompatibility" explanations regarding "archaic" foreign exchanges (with no coresponding attempt to adduce evidence to support such views), and ignore the work of the economists cited above who conclude that those kinds of of explanations are completely incapable of explaining the distributions of FTD's that obtain in the market....more power to you. But I don't think anyone here will be fooled.



3:07 AM  
Anonymous Anonymous said...

It isn't the SEC that is corrupt, it is specific individuals at the SEC that are corrupt.

As much as possible, we need to identify the actual decision makers at the SEC that work for the shorts.

For example, I'd love to see the minutes of the meeting where they decided to grandfather illegal stock fraud. Who were the individuals involved and what were the comments, both pro and con?

Can we get that under the freedom of information act?

10:52 AM  
Blogger SECFOInfo said...

Two comments:

1.) Regarding the Individuals. It's Money and it's political and it's corrupt. The 5 commissioners need to be seperated from political party influence. The short rule was voted yes by the two Dems and Donaldson and no by the two repubs.

Far too much money is being thrown at the regulators in the form of lobbying by the Industry. If you noted in the NASAA conference Peter CHev (an ex-SEC guy who worked on Reg Sho) said the grandfather was a compromise. Why? Because the lobbyists wanted the SEC to do nothing. Donaldson and the Dems compromised while the Repubs sucked the Industry's teet.

2.) i disagree with Bob on one point about Bud Burrell (only one, Bud was great otherwise). I don't think tossing around the word 'Trillions" serves any purpose other than to open the door to tinfoil hats. The loss of trillions in market cap does not equate to the naked shortsellers getting "trillions" in their pockets. for example: a naked could sell 1 million in stock but the affect on the market cap could be 10,20 50.... depending on the liquidity of the stock. My own personal opinion is it's around 80- 100 Billion over ten years in the pockets of the offenders.

The trillion dollar market cap decline story has far to many factors to be directly related to NSS in it's totality. I don't buy it.

11:51 AM  
Blogger bob obrien said...

I don't disagree that the idea of trillions of dollars being redistributed is hard to swallow.

I also agree that it is likely that only 10% or so of the lost market cap from the dot com implosion might have been due to coordinated short attacks.

Still, 10% of 10 trillion is a big number. Even of 5 trillion.

12:45 PM  
Anonymous Anonymous said...

So according to Mr. Burrell, thanks to being accurately informed, Shelby is compromised and will eventually fall on his sword. He is an old man and will collect his fat Senate pension regardless.

Then what hope of a solution is there?

Realistically, is the best course one where at least the growth of the problem is permanently arrested, perhaps a rule which requires a share to be delivered before it can be sold short? They will scream bloody murder about liquidity, but "they" are the ones who almost to a firm have proven they cannot be trusted otherwise. Furthermore, wouldn't this more accurately reflect a true supply-demand auction market, where "real" items are being exchanged?

1:03 PM  
Blogger mfairview said...

Yet another example of a captured journalist. Patrick responds to this article:


With that kind of article shouting "never buy from overstock", can rulebreakers really continue recommending it?

Don't know: it depends on if they have outgrown the average 7th grader's uncritical acceptance of the press, I suppose.

For the record, I have no opinion on whether rulebreakers should or should not recommend us. But I thought I would give you Fools more details on this reporter:

1) He called repeatedly saying he was having problems with his order, but when we asked for his order number he refused to give it, claiming he did not want special treatment. He even got me directly and at first played the same game, refusing to accept that I take care of customers all the time when they contact me and that all who do get the same "special treatment" ( yes, that is I, accept no substitutes). Thus, we were put in the rather strange position of having someone calling to harang us about an order he allegedly did not receive, while refusing to give us any order number, name, or other way to track down his order. On the other hand, it created the opportunity for him to claim that he could not get us to resolve his problem.

2) He apparently knew enough to know that records are kept of when UPS delivers boxes, and so that if he lied about receiving a box we would be able to prove him wrong. Thus, he claimed that, while the box did arrive on time, it did not have all 7 of his MP3's players in it. What he did not know at first (according to those who dealt with him) was that records are kept of the weight of all boxes, and his weighed what it should have had it had his full order in it. Hmmm. That said, our customer service staff attempted to mollify him by taking him at his word, even though the customer service agents were convinced he was lying.

3) I got this message today from someone who read this article, and who handles our relationships with the Utah state government:

"I know. I called Stormy about it 4 weeks ago when he contacted the Utah Dept. of Commerce and asked XXXX if they 'had a lot of complaints about customer service.' XXX said 'no' and 'nothing out of the ordinary.' Obviosuly the shit head did not get what he looked for because XXXX is not quoted."

4) I don't know what days this fellow putatively telephoned customer service, but at the moment we are answering 96% to 98% of our calls, a 2-4% abandonment rate: (typically our abandonment rate is <2%, but this is Christmas). At this rate, the chances that someone could call and not be able to reach someone in 20 out of 22 calls is equal to 3.69 X 10^-40 (that is, .000000000000000000000000000000000000000369).

5) There is lots of other stuff he left out. For example, for all his comparisons with Amazon, he neglected to mention that it is nearly impossible to find a phone number on Amazon and get them to answer a call: I challenge anyone to find Amazon's customer service number on their site in under 10 minutes (without using Google). We, on the other hand, put ours in our TV commercials: 1-800-the-Big-O. Somehow that slipped through his acute investigative but fair-minded analysis and comparison.

6) All that said, we took the blame and took care of the guy anyway.

The astute reader might string these facts together and come to her own conclusion. I am much to detached (in my Buddhist way) to venture a guess as to how these facts add up. However, I encourage readers to post their own guesses as to what is going on here. I'm curious.

Actually, I think this is one of those rare cases where the reader need not take anyone's word for anything: just test it yourself. Please call 800-the-big-o and see how long it takes to get someone to answer. Post your answers here as well.


5:53 PM  
Blogger bob obrien said...

Require shares to be borrowed first, require market makers to buy all naked shorts used in a day back by day's end (no exceptions), and eliminate access to the dollars by the short seller until he has delivered - period.

And don't pay commissions on trades until delivery is made.


Problem solved.

You can send the $10 million to my PO box. Thank you. Thank you very much.

Now I'll go work on world peace.

9:50 PM  
Blogger Tommy said...

People ask, why don't brokers just request a buy-in of those FTDs. Good question.

Everyone needs to understand that for naked shorting to be effective, there must also be a willingness on the part of buying brokers to carry those FTDs and NOT request a buy-in.

That's where 15c3-3 comes in.

Theoretically, if a buying broker holds too many FTDs, then they are violating 15c3-3, just as if they had lent out too many shares. It's the same thing. In both cases the broker holds too many IOUs and not enough real shares, as required per 15c3-3 and so issues PIL rather than DIV.

So there are two parts to open naked short positions beyond 3 days.

1. The naked sale by the selling broker

2. Carrying the failure by the buying broker

15c3-3 deals with #2

If all brokers would immediately request a buy-in of the failed deliveries, naked short selling wouldn't be a problem at all.

Now think of shares that are not marginable, that have to be paid for 100%. This applies to securities trading a low dollar amounts and I OTC traded securities. Yet it is precisely these that have been favorite targets for naked short sellers.

Again this is where 15c3-3 comes in.

If these securuties have to be fully paid for at all times, then they can't be lent out at all by brokers and brokers must have 100% of the shares on hand at all times per 15c3-3. Yet in the Nanopierce case and other small cap companies case, delivery if certificates was delayed if ever even possible.

This means that the brokers did not have real shares on hand as required by 15c3-3, because :

1. They were accepting FTRs as IOUs from naked sellers

2. They were lending out the shares

But if the shares are not marginable and are fully paid for, neither 1 or 2 above is permitted per 15c3-3. They buying brokers are just as liable as the naked short sellers.

Now on to our OptionsXprss example.

Here's how I think a case against OptinsXpress can play out if deuspronobis' scenario is what it appears to be :

Deus can file a suit against his broker seeking damages and recovery of losses to his NFI investment due to his broker's violation of rule 15c3-3 which has the effect of illegally increasing the share supply and reduction of price. The argument would be that they and Goldman - their agent for margin accounts - lent out sufficient shares illegally from all accounts, to effect a price drop.

We know this has happened to deus, because he has received PIL on fully paid for shares that are not pledged - they have therefore been lent out - all of them.

Discovery to see if OX's and Goldmans stock lending desk is short shares per 15c3-3 or not will show what has been going on and prove the point.

God knows how many other things can be claimed included dishonest dealing with him, lying on his account statement, fraud in the inducement to purchase, etc...

So OX and Goldman are going to first say it was a clerical error and adjust his PIL back to DIV. But that won't hold water because if they don't have proper controls as to which shares a re lent or should receive proper DIVs, what else is going on? The short interest in NFI has been rising steadily - where have these lendable shares been coming from if not from accounts managed by brokers and agents like OX and Goldman?

Here's where the request of discovery to see if OX's and Goldmans stock lending desk is short shares per 15c3-3 or not comes in.

IF their stock lending desks are short a significant number of shares per 15c3-3 - that's it.

But it's just the beginning for every other NFI shareholder, regardless of which broker they use. It'll be open hunting season on OX and Goldman. IF they're liable to pay deus for his losses, they'd be liable for every single shareholder.

The floodgates would open. I'd think that Goldman and OX would want to share the liability burden and drag in other culpable parties they know of that have also been violating 15c3-3.

It's not just the short selling brokers that are liable, it's also the buying brokers that are unwilling to buy-in the FTDs in a timely manner, accepting the FTDs as IOUs for their customers without telling them and in violation of 15c3-3, that make naked shorting as damaging as it is today.

If the pain and liability to hold on to FTDs on the part of buying brokers is too high, the FTDs will be bought in much much quicker and the selling part won't work nearly as well to manipulate the price down (10b-5 violation).

Instead of months and months, FTDs may be bought in in a matter of days from when they occur.

Bellow is what triggered this whole thing :

My Query to OptionsXpress...
by: deuspronobis
Long-Term Sentiment: Strong Buy 12/02/05 01:49 pm
Msg: 373814 of 374151

Just sent this email to OX customer support:

"I recently learned that OptionsXpress loaned all of my shares of Novastar (NFI) to short sellers. According to the OX User/Customer Agreement Terms and Conditions, Appendix A - Margin Account Terms, item six, Maintenance of Collateral: "In the event I no longer retain a debit balance or an indebtedness to you it is understood that you will fully segregate all securities in my accounts in your safekeeping or control (directly or through a clearing house) and/or deliver them to me upon my request." My account has not had a debit balance for several months. According to SEC rule 15C3(3), any fully paid for shares cannot be loaned or hypothecated. It appears that your margin account terms recognize this, yet the shares were still loaned. Why?"

12/02/05 05:42 pm
Msg: 373961 of 374004

OptionsXpress Replies to my Query...
by: deuspronobis
Long-Term Sentiment: Strong Buy 12/02/05 05:42 pm
Msg: 373961 of 374151

Well, well, well, guess who reads the Yahoo NFI board? Here is the email I got back from OX. As I suspected, they said the shares can be loaned since I am using them as collateral for naked puts:


I am curious as to how you learned that optionsXpress loaned your shares, because that is not quite accurate. I am aware of a Yahoo NFI chat board thread containing misinformation about the situation, but would like to know how you formed this conclusion. Just so you know, optionsXpress does not loan shares, our clearing firm Goldman Sachs Execution & Clearing is agent for us and has custody and a loan facility for margin accounts.

You received payment-in-lieu dividends because your margined NFI position is being used as collateral for your naked short options in NFI. This leverage requires that the NFI position be held in the margin location and may allow our clearing firm to hypothecate the securities given that your stock is being used as collateral. If you wish to change the situation, you would have to deposit cash in the amount of the requirements on the naked options, or you may need to close the options so that there is no further leverage, but that is up to you.

In order to determine whether those shares were, in fact, loaned out we would need to request that information from our clearing firm. It is possible, however, because you have used the shares as collateral in a margin account.


Xxxxxxxx Xxxxx
CCO - optionsXpress, Inc.

My Follow-up Query...
by: deuspronobis
Long-Term Sentiment: Strong Buy 12/02/05 05:45 pm
Msg: 373963 of 374151

Mr. Xxxxx,

An OptionsXpress employee told me the shares were loaned to short sellers. Here is a transcript of a recent online chat with your customer service reps Tess and Mike. The chat began at Nov. 23, 2005 1:47:24 PM EST if you want to check your records. Note Mike's statement that "when you see the entry for non-qualified manufactured income, that means that you were paid the dividend from a short holder of the security."

Regarding your explanation that the shares can be loaned to short sellers if they are used as collateral for naked puts, can you please show me where that exception is specified in either the OptionsXpress account agreement or SEC rule 15C3(3)? All I saw there was that if the account has no debit balance, the shares cannot be loaned. I would feel better about the situation if I understood that it was somewhere in the fine print and I just missed it.

Please do find out from the clearing firm whether these shares have been loaned and let me know what you find out. This stock is heavily shorted, even abusively and illegally shorted, as evidenced by its persistent presence on the Reg-SHO list. I believe the short selling artificially depresses the share price. This is materially significant to an MREIT such as Novastar, as the business must periodically raise funds for continuing operations via secondary offerings. An artificially depressed share price therefore causes undue dilution for existing shareholders. Not only that, as an owner of the security, I would feel much more comfortable knowing that my account held actual shares rather than an IOU. I would like to take steps to remove my shares from the pool available for shorting.

If the shares have been loaned, can you please find out how many shares were loaned? It is my understanding that SEC rule 15C3(3) stipulates that the value of the loaned shares cannot exceed 140% of the debit balance. In my case the value of the shares loaned is more than three times the margin requirement for the naked puts. If the margin requirement is treated as a debit balance, then clearly not all of the shares should be loaned.

Thank you,

Xxxxxx Xxxxx

5:38 AM  
Blogger SECFOInfo said...

great post Tommy!!

The system is broken and our regulators are afraid to cut off the hand that feeds Washington.

I think most folks at the SEC are good people that want to do the right thing. The problem lies above with the political appointees and the top of the Reg dept. When this shite hits mainstream, and it will, the two appointees that voted aginst reg Sho are going to have one very difficult time justifying their position.

Who are they protecting?

7:00 AM  
Blogger SECFOInfo said...

I have to correct one thing I said above. The vote was not 3-2 it was unanimous, however the comments regarding the Industry's teet stand but it was all five.

In fact, upon further review both parties were influenced to accept watered down regulation and compromise.

The 3-2 vote is the hedge fund regulation vote.

4:08 AM  
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6:43 PM  

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