Honor Among Thieves

            For years many people, from industry to academia, have identified problems inherent in our securities industry.  Patrick Byrne, CEO of Overstock.com, together with Judd Bagley and Mark Mitchell through the Deep Capture website (www.deepcapture.com) has provided a template.  But the problem is much larger, inherently entrenched within the intertwined operating segments of the networked system that clears each and every trade, the Depository Trust & Clearing Corporation (“DTCC”).  The system is flawed as it is essentially controlled by those who utilize its functionality obtaining anything other than rudimentary forensic information and data remains futile.  Using an article published in the Houston Law Review in November of 2006 as a template, this article will provide an overview of the current operations of the DTCC prior to discussing techniques employed by naked short sellers, their counterparties and partners in the furtherance of perpetuating their dishonest deeds.

            The DTCC, a holding company comprising “the largest financial services post-trade infrastructure organization in the world,” consists of two main subsidiaries, the Depository Trust Company (“DTC”) and the National Securities Clearing Corporation (“NSCC”).  On the surface the DTCC functions innoxiously in providing clearance and settlement services for equities, debt, government securities and more.  The problems inherent in the DTCC however are encompassed in the composition of its senior management team and board of directors.  The same customers the DTCC serves, the street’s investment banks, prime brokerage and related securities houses and the stock exchanges that transact their business, comprise the senior management team and board of directors of the DTCC.  The DTCC, although chartered to run as a non-profit entity, is far from that.  Not only does it operate profitably, the DTCC distributes a portion of its revenues back to its brokerage industry client owner operators.

            One of the original mandates of the DTCC in the 1970s was to facilitate the exchange of cash and the physical stock certificates held by investors.  The establishment of the DTC accomplished this giving rise to the DTC essentially holding the majority of these certificates, under the name of its nominee, Cede & Co., in its vaults.  This enabled what we have come to know as “electronic trading” as the exchange of cash for stock certificates was essentially extinguished.  It also facilitated the illegal naked short selling so prevalent in today’s markets.

            Also in the 1970s the NYSE, AMEX and NASDAQ exchanges, entities that prior performed their own stock clearing function, merged to form the NSCC, with other regional exchanges joining in shortly thereafter.  The NSCC provides clearance and settlement services through a system called multilateral netting, a process that reduces paperwork within the securities industry.  The NSCC also nets trades through a more complex process called Continuous Net Settlement (“CNS”).  Through this system, the NSCC is able to calculate daily net long and net short positions for its client owner operators.  It is within this process that the problems directly related to naked short selling arise.  Once this net number is calculated, if there is a short fall in the delivery obligations of a client owner operator’s net short position as reported to the DTC, the NSCC looks to borrow shares internally within its matrix of client owned operators through the Stock Borrow Program to cover the shortfall.  It is within this Stock Borrow Program, among other illegal trading operations, that naked short sellers are able to hide long term Failures to Deliver (“FTD”).  Needless to say, the NSCC is a profit generating arm of the DTCC. 

            If the DTCC was a privately operated entity, subject to external oversight controls of those not directly affiliated with the companies it provide services for, the remaining paragraphs of this article might never have been written.  Then again, the problems inherent with naked short selling would probably not exist either.  The fact is that the DTCC is again, a client owned and essentially controlled operation, run by those who benefit from the services it provides.  This structure maximizes profits of the DTCC as well as the companies comprising its ownership.  With no true oversight, the client owner operators hold the key to the vault while simultaneously enabling their largest hedge funds clients transacting business with them to not only avoid the rules but create new ones as the playing field changes.  Something is really wrong here.

            There are no controls within the DTCC that work to extinguish what has developed in our securities markets, the creations of mountains of phantom shares.  If you take a look at many of the names, both those currently on the SHO List as well as others who frequented the list in days, months and years gone by, the problem is unveiled.  In several instances, the total number of shares in existence far exceeds the number of shares authorized by the issuer.  This may come as a surprise for many readers but our research suggests this to be the case with amounts exceeding 150% of the issued float of some securities.

            The lending pool as run by the DTCC is essentially boundless and illegitimate.  There are simply more shares available in that trust pool than should naturally exist but that is just part of the problem that encompasses the lack of enforcement and oversight in our system.  There are other illegal forms of trading that further exacerbate the problem.  “Parking” and “freeriding” are trading tools that enable the naked short seller to avoid the requirements in place to locate shares of its target company so that they are legally located and borrowed.

            Parking, as defined, is comprised of (1) a pre-arrangement to transact securities; (2) on the same or substantially the same terms; and (3) for a bad faith purpose.  The rules pertaining to naked short selling require an effective locate to be obtained within a three day period (“T+3”).  By essentially parking, or moving shares between accounts of the same hedge fund, between accounts of different hedge funds and between industry participants and market makers, the requirement to locate shares can be precluded indefinitely.  In recent weeks, due in part to the growing pressure on the securities industry to rein in the illegal operations of the naked short sellers several stocks that have regularly appeared on the SHO List are no longer on the list.  This is due in part to the fact that the illegal activity has again, figured out a way around the rules, parking being but one of the tools implemented.

            Freeriding has often been defined as the purchase and sale of a security in a short period of time without putting up any money.  In the case of the naked short sellers, in essence the direction of the purchase and sale has been reversed.  If a naked short seller opens a transaction in the morning and closes the transaction out before the end of the day, under the current systems in place at the DTCC, there would be no net effect.  Freeriding, at least in the retail brokerage side of the industry, is controlled by the introducing or clearing broker.  If a client engages in the practice of freeriding inevitably their account would be frozen and their ability to transact future business extinguished.  Such is not the case with respect to the prime brokerage industry.  It would be difficult to envision a prime broker telling one of its larger hedge fund clients to take their business elsewhere because they are breaking the rules.

            Many of the practices that encompass naked short selling are illegal.  The information and data to prove the crime, to establish culpability that, if discerned and reconstructed properly could lead to bona fide RICO indictments, exists.  Therein again is where the problem remains as the information necessary to expose these crimes is controlled by, you guessed it, the DTCC.  It was the perfect crime and the client owner operators of the DTCC in their own and to the benefit of their clientele have made billions.

            Patrick Byrne and his associates have been speaking about issues of this nature and more over the recent years.  In joining the fight we seek to establish, cross security and sector, patterns illustrating that the illegal techniques employed by the client owner operators of the DTCC, and their respective larger hedge fund clients, have turned what was once a capital formation system one of capital destruction.  Through a consortium matrix of publicly listed companies, it is our intention to expose the methods and transactions facilitated by the overt criminal client owner operators’ actions, or inactions as it may be, such that the level of culpability reaches a level where the information and data we seek will speak for itself.  It is time for the public to step up and we, along with others look to be one of their many voices of action.

Comments

[Renowned Expert]

Welcome to the battle. Looking forward to your findings.

[dzimmer@aaronmorgangroup.com]

Renowned Expert,

Thanks for the comment and the good wishes. As I tracked the trading in today's marketplace, the blatant use of all of the illegal trading practices stated above, and more, were apparent.

These people think they are above the law which makes sense. They are fully aware that the guard in place to monitor and prevent their trading practices is on their team.

It is going to take time but the more publicly traded companies that come to us for our securities forensic services the more evidence we will be able to present when Congress finally opens up its doors to change. Referrals are appreciated and will be treated confidentially. Simply send us an email at info@aaronmorgangroup.com with the contact information of who we should speak with.

To recite a phrase from this year's elections, "Change is coming" and with respect to naked shorting and the many and varied tools of capital destruction, it's about time.

AMG

[Ginger]

Mission Statement transcribed from the SEC website:

http://www.sec.gov/about/whatwedo.shtml

"The mission of the Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation."

With support from certain corrupt “journalists” the SEC kept the story of naked shorting untold thereby denying the existence of a root cause of the financial crisis. The SEC was more focused on covering up Wall Street’s gigantic fraud than on its dishonest ‘what we do” Mission Statement.

The SEC, with its co-conspirators in crime, covered up the truth so Wall Street’s pinstripe gangsters could take possession of peoples’ investment accounts and retirees’ pension plans.

The SEC is a miserable failure – a den of thieves!

[dzimmer@aaronmorgangroup.com]

Ginger,

Thanks for the comment. From the SEC down to the hedge fnd clients of the prime brokers and right back up the chain through the DTCC / NSCC there is little exterior independent oversight.

Keep watchint the site as we embark on a campaign to make one large voice out of several little ones.

It is people like you who speak up and take the time to write than truly make a difference.

AMG