House Financial Services Committee Chairman Barney Frank has a new proposal to regulate bank transactions. Some of it is OK and some of it perpetuates the abuses that brought Lehman and other financial institutions to their knees.
First the OK part. Frank's proposal would require over-the-counter derivatives to be traded on listed exchanges and sold on exchanges or processed through a regulation platform. This is not good enough. We need transparency for each and every trade done by each and every financial institution. That means that all trades must be done on a listed exchange and cleared through a clearinghouse. All of this data can be put on computers and monitored daily. Then if some trader goes beyond established guidelines, he will be shut down immediately.
The Securities and Exchange Commission has a new point man to head up the compliance division of the agency. His name is Robert Khuzami. Mr. Khuzami is former federal prosecutor.
Mr. Khuzami wants to use subpoena powers to gain cooperation with the SEC in fraud and all kinds of trading schemes and violations. The subpoena power would be given to staff investigators. This is a marked change from the previous policy, which required the Commission to grant subpoenas. Other changes would include plans to submit more immunity requests to the Justice Department.
Remember the fall of Lehman Brothers? During that debacle, 38 millions shares of Lehman were sold as naked short sales, driving the price of Lehman shares to practically zero. The U.S. Securities and Exchange Commission (SEC) stood by and did nothing. To this day, whatever investigation into the Lehman failure was due to short selling is not clear. The SEC has not made the names of the naked short sellers public. The Lehman bankruptcy involved securities fraud under SEC regulations. Why aren't the principals being prosecuted and convicted? The SEC has the power to ban firms and individuals from doing business and impose harsh fines on those convicted in this case.
Newly-installed SEC Chairman told a public round-table meeting that she has "made it a priority to evaluate the issue of short-selling regulation, and ensure that any future policies in this area are the result of a deliberate and thoughtful process."
The SEC has floated a number of potential proposals for dealing with the short-selling "problem," including making it illegal to short sell stocks that are down 10% or more. One popular "solution" is to bring back the recently revoked uptick rule that required short sellers to execute trades only on an uptick -- if the last trade was at $20.00, you could only sell short at $20.01 or higher.
Short selling has gotten a bad rap lately. If you look at the markets with an open mind you will see that there are people who believe that stock XYZ is going up and Joe the investor wants to buy it to make money. Yet if you talk to a dozen people there will be those among them who say that stock XYZ is no good, that earnings are bad and that the stock will drop further. Here is where the notion of short selling comes into play. If you allow an investor to buy XYZ stock, it is not fair to prevent an investor from selling XYZ stock. Markets are always two sided. There are buyers and there are sellers, otherwise... why have a market?
The Wall Street Journalreports (subscription required) that "The Securities and Exchange Commission received 5,000 complaints over a year and a half about an aggressive form of short selling that critics call market manipulation, but it didn't bring any enforcement cases, according to a report by the agency's inspector general."
With conspiracy theorists and corporate crybabies up in arms about short sellers and their exhibitionist twins -- naked short sellers -- manipulating markets and causing the collapse of companies like Bear Stearns, the man in charge of regulating the British market, says that's just a bunch of poppycock.
Adair Turner, the chairman of the Financial Services Authority, said that the FSA's lifting of the ban on short-selling last Friday had not played a "significant" part in the meltdown that has occurred in the interim.
"So far, we have not seen stuff (that) suggests that short-selling and in particular abusive short-selling has a significant role in what has occurred, he told the BBC.
Let's recap: Last September short-selling was banned and then the ban was lifted and the market absolutely crumbled within a week. Why? Because people were concerned that the financial stocks had no value because they would require nationalization to avoid outright failure.
Short-sellers are a convenient scapegoat for the current mess but so far there's very little to indicate that it has any relevance at all.
In the UK, a number of hedge funds are about to sue the Financial Services Authority claiming that it did not have the proper authority to curb short-selling, which cost the funds million of pounds. The FSA is a first cousin of the SEC and performs a similar role.
According to The Telegraph, "Lawyers are being galvanised on behalf of a raft of hedge funds which claim the financial watchdog has illegitimately extended its powers and caused 'wide-spread capital destruction.'"
Whether or not their argument has legal merit, it does have a certain amount of fairness on its side.
Naked shorting, a practice in which investors bet a stock will go down without properly borrowing shares to cover the trade, has always been illegal. The act of shorting itself has for decades been a legitimate enterprise. It acts as a check-and-balance system so that stocks do not rise relentlessly without those who believe they should fail having a stake in the matter.
The SEC has not only done financial harm to a number of hedge funds, it also has taken all of the teeth out of a process that has given trading in stocks an economic and market legitimacy.
If hedge funds sue, they are in the right and ought to prevail.
Douglas A. McIntyre is an editor at 247wallst.com.
TheStreet.com's Jim Cramer says they had no idea how catastrophic pulling the naked-shorting rules would be.
Christopher Cox and his crowd of academics and theoreticians did more to destroy the confidence of this market with their adherence to free-market destruction of stocks than any of the managements of the companies themselves.
I know that is a strong statement, but you have to understand that the rules against naked shorting and shorting without upticks were about having firebreaks in the system. Consider these rules a swath of chopped-down trees meant to slow a fire so firefighters have a real chance to put out a monster conflagration.
Let's take AIG (NYSE: AIG) (Cramer's Take). Here's a company that has lots of liabilities but also lots of assets. While its liabilities are liquid -- meaning it has to pay them off quickly if there is an event that triggers payment -- its assets, such as its great life insurance and aircraft leasing businesses, are illiquid. AIG couldn't just turn around and sell them.
Still, new management came in at AIG and decided to work on a plan, meant to be revealed at the end of September, that would detail asset disposals that could make the company a more solid credit with an ability to make good on their policies on financial instruments. It would also be able to access capital in the markets once those illiquid assets were disposed of.
A lot was said this past week in regard to the SEC attack on rumor mongering and willful misrepresentation of facts for the benefit of naked short sellers. One point that I'd like to make perfectly clear is this: The SEC's indicated desire to quash the spreading of false negative information by, and for the benefit of, manipulative short sellers, is nothing even remotely akin to a First Amendment issue. The First Amendment does not give protection to slanderers, liars, and sabotage artists. I'd also like to make clear my opinion that honest short selling is a positive, healthy, and necessary practice. I believe it helps to define and benchmark real value within the markets.
The Los Angels Times reported that SEC Chairman Christopher Cox may have his hands full in the wake of a measure that protects nearly two dozen large financial firms from naked short selling. The measure requires "anyone effecting a short sale in these securities (to) arrange beforehand to borrow the securities and deliver them at settlement." It's a rule that is long over due for enforcement and that shall most probably, at least temporarily, lay to rest some serious market abuses.
Naked short selling whiner Biovail (NYSE: BVF) has settled accounting fraud charged with the SEC, agreeing to pay a fine of $10 million. According to the SEC's complaint: The SEC's complaint alleges that present and former senior Biovail executives, obsessed with meeting quarterly and annual earnings guidance, repeatedly overstated earnings and hid losses in order to deceive investors and create the appearance of achieving earnings goals. When it ultimately became impossible to continue concealing the company's inability to meet its own earnings guidance, Biovail actively misled investors and analysts about the reasons for the company's poor performance.
The SEC adds that former chairman and chief executive officer Eugene Melnyk, former chief financial officer Brian Crombie, current controller John Miszuk; and current chief financial officer Kenneth G. Howling still face charges.
Biovail's allegations of a naked short selling conspiracy and menacing antics intimidated analysts, convincing Banc of America Securities, which had been negative about the company, to drop coverage of the stock. On his blog, financial journalist Gary Weiss writes that "Despite all the post-Enron rhetoric about the sanctity of independent analysts, the SEC has done woefully little against companies like Biovail and Overstock that want analysts to be obedient little puppies."
It seems like every few weeks, another naked short selling poster child is exposed as a securities fraud. Back in 2006, then-CEO Eugene Melnyk told 60 Minutes that "When you've got these companies, these people out there trying to bring you down, we're lucky we survived."
Moral of story: when a company starts complaining about naked short sellers conspiring to drive down the share price, sell the stock and ask questions after.
One of my heroes of tell-it-like-it-is business journalism (which is something I aspire to) is Gary Weiss. He covers the seedier side of Wall Street, and one of his favorite topics is the naked short scandal which he believes, as do I, is a red herring designed to distract investors from the real issue at the companies crying fail to deliver: their own failure to deliver profits.
When it was announced that the SEC was cracking down on naked short selling on Thursday, Weiss responded with (SEC head) Chris Cox OD's on Bologna. Never one to mince words, Weiss wrote that "As I pointed out a few days ago, the SEC's meeting yesterday resembled a cheaply stocked delicatessen more than it did a regulatory agency, with half the agenda devoted to baloney -- the nonexistent "naked short selling" scandal, promoted by a handful of crackpots and corporate losers in the Baloney Brigade."
He went on to say "OK, so where's all the punishment? Where are all the SEC enforcement actions? Where are all the customer complaints of genuine harm committed by genuine naked shorting of genuine, sound, non-money losing companies?"
I'm extending a challenge on BloggingStocks. If anyone can send me the name of a genuine, sound, non-money losing company along with evidence of how the company has been damaged by naked short-selling, I will post a detailed apology.
If you enjoy following the nakedshort-selling "scandal," you absolutely must bookmark Gary Weiss's blog. He tracks the ongoing shenanigans surrounding Overstock.com Inc. (NASDAQ: OSTK), which he referred to this morning as a "fascinating slow-mo corporate train wreck." You can also read his commentary on lesser-known but still interesting market scandals.
On Monday he wrote about CMKM Diamonds, a little-known penny stock that blamed its precipitous decline on naked short-selling. Its shareholders bought the explanation wholesale, and some even went to New York and Washington to stage loony protests against the evils of naked short-selling. Turns out it wasn't naked shorts after all. It was the company's dishonest management, which is currently being sued by new management for fraud and "looting" the company. They sold over $200 million in stock to the public, but almost none of it went to the company.
This is a great example of the tactic of diversion in action. Corporate criminals will often toss red herrings to divert the public's attention from their own misdeeds and poor management. Blaming naked short-selling seems to be the diversionary tactic du jour, and investors should probably head for the hills anytime a company complains about it.
In the midst of outcries about naked short selling from a group of conspiracy theorists deemed the "Bologna Brigade" by one of my favorite investigative journalists, Gary Weiss, the SEC has found no evidence of manipulative naked short selling of IPOs.
The agency studied 295 IPOs over 16 months and, according to the Wall Street Journal, didn't find evidence that traders engaged in naked short selling were the cause of fails to deliver. According the SEC, failures to deliver in IPOs "cannot be explained by short selling in general or 'naked' short selling specifically."
This could be bad news for the anti-naked short selling zealots led by the entertainingly insane Patrick Byrne, CEO of Overstock.com (NASDAQ: OSTK). They have long held fails to deliver as being the indicator of widespread naked short-selling but, according to the SEC, that isn't the case, in least in the case of recent IPOs.
The naked short selling issue looks like a red herring to me, tossed around by CEOs whose stocks are underperforming because management has established a track record of OPUD -- Over-promise, under-deliver. In the case of OSTK, the only fail-to-deliver investors need to worry about is Patrick Byrne's failure to deliver profits.
Whether you are seriously concerned about naked short selling or think it's an overblown conspiracy theory, it's an interesting story to follow. Bloomberg recently did a special on the scandal, and that video is now available on YouTube: Do you want to know what naked short selling has in common with The Producers? Watch this show to find out.
The Bloomberg video is one of the few mainstream sources to provide detailed coverage of naked short selling. While I have tended to think the scandal was much ado about nothing, this video makes me reconsider.
House Financial Services Committee Chairman Barney Frank has a new proposal to regulate bank transactions. Some of it is OK and some of it perpetuates the abuses that brought Lehman and other financial institutions to their knees.
The Securities and Exchange Commission has a new point man to head up the compliance division of the agency. His name is 
Remember the fall of Lehman Brothers? During that debacle, 38 millions shares of Lehman were sold as naked short sales, driving the price of Lehman shares to practically zero. The U.S. Securities and Exchange Commission (SEC) stood by and did nothing. To this day, whatever investigation into the Lehman failure was due to short selling is not clear. The SEC has not made the names of the naked short sellers public. The Lehman bankruptcy involved securities fraud under SEC regulations. Why aren't the principals being prosecuted and convicted? The SEC has the power to ban firms and individuals from doing business and impose harsh fines on those convicted in this case.
Newly-installed SEC Chairman 
A lot was said this past week in regard to the SEC attack on rumor mongering and willful misrepresentation of facts for the benefit of naked short sellers. One point that I'd like to make perfectly clear is this: The SEC's indicated desire to quash the spreading of false negative information by, and for the benefit of, manipulative short sellers, is nothing even remotely akin to a First Amendment issue. The First Amendment does not give protection to slanderers, liars, and sabotage artists. I'd also like to make clear my opinion that honest short selling is a positive, healthy, and necessary practice. I believe it helps to define and benchmark real value within the markets.
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