Wednesday, March 30, 2005

Do I Seem Annoyed To You?

Do I seem a little testy? A little jittery? On edge? Maybe a tad out of sorts? Try this quote from the March 25 issue of Euromoney, a respected periodical from Europe that just released a stunningly complete assessment of the fail to deliver phenomena and the SEC's shocking lack of interest in enforcing any of the laws designed to protect investors, and hence deciding to grandfather in all fails prior to January of this year:

<<The SEC's Brigagliano says the commission made a choice. "We were concerned about generating volatility where there were large pre-existing open positions, and we wanted to start afresh with new regulation, not re-write history." >>

Come again? Huh? Let me get this straight. The SEC decided that they didn't want to "generate volatility" - a euphemism for not wanting to cause short squeezes for those who had systematically violated the law and created large slugs of counterfeit stock. Tut tut, we wouldn't want to inconvenience those that had robbed investors and companies by systematically printing bogus stock, abusing the DTCC and NSCC's borrow programs (which the DTCC conflictingly says doesn't occur) - no, wouldn't want them to have to experience the volatility that comes from having to buy in those profitable fail positions that had bankrupted investors and companies alike.

Of note is that the SEC acknowledges that there are large pre-existing failed positions. Doesn't dispute it, as people like Mark Cuban and Jeff Matthews do. They don't try to say there aren't large positions, nor that they aren't a huge problem. Nope. Just that they made an executive decision that they aren't empowered to make, namely to effectively grant a pardon to those who by their own admission broke the laws on the books. That's what it means, folks. No translation necessary, really.

So we go from the DTCC's position, which is "it's all in your head," to the SEC's admission that it isn't, that there are large positions of fails, but that instead of doing their duty and enforcing the law, they chose to hand out get out of jail free cards.

Two points. 1) Under what authority can the SEC decide to just allow a large, unauthorized float of unregistered securities to exist in perpetuity? And 2) Who at the SEC decided that the interests of the brokers and hedge funds that had systematically created those huge fail positions that the SEC isn't even disputing are real were more important than protecting the interests of the investors and companies they are chartered with protecting?

I´d love to understand that reasoning. As an investor who has lost a considerable sum of money in a Reg SHO list company - NFI - I would be very interested in what specific individual decided that my lost money was OK to leave lost, so that those that stole it wouldn't be troubled by volatility. I would bet that investors can find an attorney that would be willing to name them personally for dereliction of their duty - in fact, I'll bet that they can find several guys willing to file a class action naming the individual for deciding to protect the brokers, over doing their mandated duty.

Here´s another gem from the articles:

<<Susan Petersen, a special counsel in the SEC's division of market regulation, says that it does not make public the exact amount of fails-to-deliver, as it would potentially have negative effects on investors and broker/dealers by revealing trading strategies.>>

Huh? You mean it would reveal the illegal trading strategies that are creating large fail to deliver positions? Wow. Wouldn't want to do that, would we? Isn´t the charter of the SEC to protect those that are using illegal trading practices to profit, and to hide information that would reveal their illegal activities at all costs?

Did I miss that memo? Here is an SEC official, on record, stating that the exact reason that they won´t publish the number of fails is the reason I have publicly speculated: they don´t want the light of exposure to reveal illegal and manipulative trading techniques, and they are choosing to protect the investors (hedge funds) and broker/dealers employing those trading techniques rather than the companies and investors they are chartered with protecting. And they are now on record as stating as much.

So how badly broken does the system have to admit that it is before someone does something about it? These are just two quotes from our regulators that clearly, unequivocally articulate that the SEC is not doing its job, is in fact aiding and abetting those that are breaking the rules, and is covering up the info that would reveal how big the problem is. They don´t even bother to deny it - they just come right out and say it.

Do any of the apologists who deny the existence of the problem want to bite this one off? Perhaps help Senator Bennett and the Senate Banking committee understand how approving an unauthorized, unregistered float of unknown size is a good thing, how refusing to divulge information as to the extent of the problem (for the sole and admitted reason of protecting the bad guys from the consequences of their actions) is a good thing, how dismissing the chronic, acknowledged large fail problem that came about from failing to enforce the rules with a regal wave of the hand (we want to start off with a blank canvas, after all, and all those prior episodes of violating the rules on the books for 71 years are just so, well, messy and inconvenient) is a good thing, and how allowing people with this mindset (blame the victim, protect the criminals, dismiss investors as dispensable and unworthy of protection) to continue in their roles is a good thing?

This sickens me. I could go on. There are plenty of other examples of the SEC´s imperious disregard for our wellbeing in the articles. It becomes clear as you allow these people to talk that they view their job as maintaining the status quo and easing the way for Wall Street to screw us. Protecting us is of no concern. Protecting the entities who are destroying the markets and violating every rule they come across is the imperative.

If you aren´t furious, you are an idiot. Or one of the criminals. It´s that simple. And it took a European magazine that goes out to European CEO´s and CFO´s to capture the extent of the morbidity and corruption - not an American publication. Our reporters are far too busy reassuring everyone that there is no problem - that´s the popular bromide du jour of the American press, with few exceptions. Any of you high minded media wonks want to tackle these statements by our regulators? Or will we be treated to more "pay no attention to the man behind the curtain" dross from an industry where comprehension of the problem, much less the honest reporting of it, is off-limits?

I am sickened. It is as bad as previously thought. Worse. Dateline will undoubtedly blow the lid off this, as will the outrage generated by quotes like the two I highlighted. The video at that many of the apologists for Wall Street have been busy trying to dismiss and undermine as being alarmist actually is moderate, and fails to reveal the full extent of the corruption of our system. Then again, it only has 3 minutes to get the point across. The text of two of the articles is an astounding indictment of a system run amuck.

You should be very, very worried. The message is clear - the equities markets are not safe, the regulators are uninterested in making them so, and there is so much money being made by the bad guys that they have been able to co-opt the system for their personal benefit. And that is the tame version. Anyone with the ability to read the articles will get the not so tame version. It is as ugly as anything I could conjur up in my most ugly, dark moments.

And that says a lot.

Friday, March 25, 2005

A Picture's Worth a Thousand Words

Anyone that hasn't seen it should go to and check out the news piece that features among others Dr. Patrick Byrne of, Dr. James Angel, one of the foremost authorities on the capital markets, and Bob O'Brien - the protagonist in this little unfolding drama.

The piece has been called an infomercial by some. Not so. Commercials are paid advertising. You pay to have them aired. And they sell something, or solicit donations - there's a call to action at the end, usually designed to separate you from your money. This has no call to action other than for our regulators to enforce the rules, and stop the fail to deliver problem - or we can't conscience privatizing social security.

This is a news piece that was created by friends of mine from around the country - New Jersey, Texas, Nevada, California. Is it an "independent news piece?" Huh. Show me one of those. The same 3 or 4 conglomerates own all the outlets. A better question is does it accurately portray the issue? That answer is yes. Professor Angel, Dr. Byrne, Mary Campbell, your's truly - all answered the questions asked truthfully, and it doesn't matter who held the camera - the truth is still the truth, and news is still news.

Now there are those that will howl that this is somehow unfair, and propaganda, and bad. Funny, given that there are financial "news" sites devoted to writing hatchet jobs on some hedge funds' picks. No one is howling that they are propaganda machines. At least no one in the mainstream media. Everything is just fine, until a piece that puts a human face on the illegalities of Wall Street surfaces, and then you can hear the howling coast to coast. God forbid the little guy figures out that he is getting screwed by the system designed to protect him.

It would have been nice to get an SEC representative on, but time constraints and their general reluctance to talk about this issue are such that it wasn't practical.

I figure that a CEO, a professor, an investor and a masked man will have to do this go around. But what do I know?

Send the URL to every elected official you can think of, folks - the Web is far more powerful than TV these days anyway. Let's show them some footage of the people this is impacting - they need to understand this isn't rich white guy A losing a little money to rich white guy B.

This is America. And we are being fleeced. And the Video says "make them stop." Just like the ad did. Make the regulators do their job, make Wall Street obey the rules, and stop the cover up. Now.

How can anyone be against that? How can anyone take the position that asking our regulators to enforce the rules that were written to protect us is bad, or despicable, or some sort of a scam? The only folks I could think of that would want to let illegal behavior continue are those engaging in and profiting from that behavior. Then again, perhaps I've got it all wrong.

If you go to the NFI message boards you will find that since I posted the link to this video there, we have seen an unprecedented number of posts designed to clog the boards and bury the information. Why would someone throw so much effort into clogging the message boards on a day when the stock isn't even trading? I even noted 2 or 3 obvious computer generated messages saying that the stock is about to plunge in the next half hour - on a day the market is closed. I couldn't make this stuff up. And yet where are the SEC agents looking at these people attempting to systematically manipulate the share price? Isn't it illegal to spend time and money disseminating false and misleading information, essentially to stage a disinformation campaign, to tarnish a company's reputation and stymie the ability of their shareholders to communicate?

I don't understand those that are critical of demanding that the SEC enforce the rules and that the DTCC be forced to disclose the size of the fail problem, so that illegal market manipulators can't get away with their nefarious business any longer - but I'm sure there are those that will find a way.

And by their deeds shall you know them...

Thursday, March 24, 2005

The Old Shell Game

I’ve written a lot lately about the shenanigans that are part and parcel of our equity markets, and how the current ghost in the machine appears uniquely predisposed to favoring the companies that derive their income from handing our money. I’ve speculated about how the Depository Trust Clearing Corporation (DTCC) abuses the public trust in order to effectively counterfeit shares of publicly traded companies, and how our regulators appear happy to stand by doing absolutely nothing while the American public gets fleeced.

I was at dinner last night, and a friend of mine asked me how long I thought that the abuses had been going on, and how large I thought the problem really was, and why nobody is doing anything about it.

First, as to the question of how long.

In 1999, the Depository Trust Corporation (DTC) bought the National Securities Clearing Corporation (NSCC) and created a new uber-entity – the current Depository Trust Clearing Corporation (DTCC) – entrusted with not only dematerializing every paper share and holding them all, but also now with clearing the trades and lending shares out to make the system run more efficiently. I believe that the real fail to deliver problem began in earnest then, when you had the same accounting firm doing both companies’ books, and you had like minds all thinking alike with the same imperative: how to make the maximum amount of money from the clearing and settlement and holding process. I believe that the real abuse began then, and has continued in an ever more ominous and dangerous manner, to this day.

The NSCC’s stock borrow program was set up to handle short term failure to delivers – like a day or two over the line. No problem there. But I believe that the system, and the avarice that is a natural lubricant for it, saw a way to create more trades, more commissions, more interest from the borrow, and more “liquidity.” Just abuse the short term system and convert it into a long term stock printing system – more commissions for the owners of the DTCC and NSCC (the brokerages) due to more shares available to trade every day, more fees from the borrow program, more fees from hedge funds who require a greater number of shares than the company ever authorized in order to achieve their goals of reducing prices to the point where their shorts were in the money. In short, everyone benefited from the practice financially, except of course the companies and their shareholders – but they are a fragmented lot, and the system, like most systems, is in place to perpetuate its own power and profitability, not be fair to the pawns in the game.

As to how large a problem it is, that is a little harder to pin down. is one of my favorite cases, not just because I believe that Dr. Byrne is a man of genuine integrity and courage, but also because the timing of their manipulation is such that it provides us with a handy test case. OSTK showed up on the Reg SHO list on January 27. If SHO was working, it would have been off within 13 days. It is still on the list to this day. That tells us that any facile explanations involving prior grandfathered fails keeping the company on the list don’t apply. It also tells us that the rules are not being enforced, and that the system continues to fail us as investors, and as owners of companies we invest in.

The truly staggering part about all of this is the studied lack of any official response from the SEC. They are strangely silent on the matter. Not a peep out of them.

Now, where I come from, I would think that if the regulators have a pretty basic charter – keep the markets fair – and if they clearly aren’t doing so, well, that there would be a lynching at some point. Apparently that’s not the case with the SEC. They have allowed flagrant abuse of the system, as evidenced in my personal favorite case of the moment, the Compudyne matter, where a New York hedge fund sold over a third of the float of that company short in 975 separate transactions, EVERY ONE A FAIL TO DELIVER, and yet not one was flagged or stopped or caught by the system. Or another fun one, from Professor Leslie Boni’s paper, wherein she reviewed the trading of one market maker, where over 68,000 failed trades were put through for this one group, and a whopping total of 86 were bought in as the rules mandate. The rest were allowed to fail. And nobody did anything.

Now, I don’t know about you, but if I was allowed to break the rules in any business for profit 68,000 times, and only got penalized 86 times, I’d be thinking that I had a pretty good gig going.

Why are these noteworthy? Well, in the Compudyne case, because it is the NASD bringing the charges, not the SEC. The SEC is silent. And because the Boni paper was written while she was doing research for the SEC at the SEC.

So how big is the problem? As discussed many times before, the DTCC won’t tell us, or the companies. The SEC isn’t asking them (supposedly), although they haven’t really articulated why they aren’t asking them. And the exchanges aren’t telling, supposedly because the data is the DTCC’s and they aren’t allowed to disclose it.

So what it adds up to is a conspiracy of silence on what I believe will turn out to be the single biggest scandal to hit the regulatory environment as well as Wall Street in a century. I believe that the problem is pervasive, endemic to the system, and so widespread that the SEC is afraid to pull back the system and show the public what has occurred on their watch. I think they know it would horrify us, and drive capital out of the markets, and BK many of Wall Street’s finest. Now, all that might seem nutty at first blush, but in parting, consider this:

Not one person, not the SEC, nor the DTCC, nor the exchanges, is willing to just show us what the level of the failures are.

And that is the single most frightening aspect of it all. The silence is deafening.

Tuesday, March 22, 2005

Heavy Lies The Head

I was doing some light reading the other night, browsing through some of my favorite publicly traded brokerages' 10K's, when I was struck by an amazing omission.

I couldn’t believe my eyes, so I called some of my accountant and attorney friends to verify that I was reading them correctly.

I was.

First, the ground rules: publicly traded companies are required to disclose to their shareholders all material risks they're aware of - it's pretty simple, actually. If you know it's a material risk, disclose it.

So my question was what's material? Turns out there’s a formula. If you have a trillion dollar contingent liability, and there is a 10% chance of someone suing you and winning damages that amount to 2% of the contingent liability, that would be material. 2% of a trillion is two billion dollars – real money by anyone’s metric. Or if there’s a 5% chance of that contingent liability being actualized, that’s material.

So how, I asked myself, do these publicly traded companies not list the huge contingent liability from the fail to delivers and the margin shares loaned out to short sellers - both in terms of runaway prices if there's a squeeze that results in a liquidation of the customer account, or if there are large class action awards, as in the case of Worldcom or Cendant?

Follow along on the squeeze part. If they sell shares and then fail to deliver, and then the DTCC lends the NSCC the shares to give to the buyer, technically that is an unsettled trade, which means that the liability rests with the broker who sold and failed, until such time as the trade is settled. So they have the liability for those shares, above and beyond whatever the buy-in is at today’s mark to market.

Now to the lawsuit risk - what do I mean by that? Well, if it turns out that company ABC is a sham, or has been up to no good, and the shareholders sue for 5 billion dollars, everyone that is holding a “share” that is a fail to deliver or one that has been lent out as part of their margin agreement to a short doesn’t have the right to extract their share of the settlement from the company – it’s the broker who owes them their portion. That’s how the law's written. So that’s what I mean by liability. The brokers are legally on the hook for any shares they failed, or lent out from margin accounts.

So where’s the disclosure as to how big that contingent liability is, and the description as to what reserves the broker's put into place to cover it?

Simple question, really. Where is the mandated disclosure of that material risk, along with a description of the size and scope of the risk, so that investors in these brokerages understand what they are buying into? Wouldn’t you want to know if your bank had an off-balance sheet liability of hundreds of billions of dollars that wasn’t disclosed anywhere on their financials? Wouldn’t you expect that to show up in their filings? I would. And yet it doesn’t.

So who is in violation of the fair disclosure rules? Certainly the brokers, in my opinion. But also the big accounting firms. They have to buy off on the audits, and they aren’t demanding that those contingent liabilities be accounted for appropriately. That puts them in the class action line of fire.

Could it really be possible that our financial community has failed to disclose a trillion dollar contingent liability, placing them at risk for huge class action suits, regulatory action, etc.? And the big accounting firms as well? And with Sarbanes-Oxley, aren't the CEO's and such personally liable for this sort of a material omission? What kind of a financial reward has to be at stake to take this sort of a risk?

Wouldn’t it be wild if I've just stumbled onto the biggest sham to take place in the financial sector in a hundred years, and one that is provable just by reading things like 17(a) and following the liability chain through the settlement phase? I think that it warrants everyone placing a call to the brokerages' and accounting firms' investor relations folks, and writing the SEC, and to Spitzer, and the like.

Unless of course their position is that public companies on Wall Street don’t have to make full and complete disclosure of all material risks in their 10K’s and 10Q’s, in which case that is a fun bit of information to have as well.

Is this the next scandal for the Class Action boys to go after? If so, it could make Enron look like forgetting to give you a receipt at Mickee Dee’s.

The Color Of Money

Well, I've been resistant to the idea of creating my own blog, but since everyone and their brother seems to have gotten into the blogging mood, I figure I might as well offer my fans and detractors an opportunity to vent. The intention is to encourage discussion about the various topics on the site, specifically the Sanity Check editorials. Rather than hearing several dozen people tell me via email that I'm an arrogant, opinionated megalomaniac, I thought it would be more fun to enable them do it in an open forum. That way I can mock them, or congratulate them on their spectacular taste (presuming they agree with me), or otherwise engage them while the world watches. So come one, come all, lapdogs and leaders alike, and welcome. Pull up a chair, set awhile, and let's see if we can be interesting in short bursts.