Winston Churchill said, "A fanatic is one who can't change his mind and won't change the subject." So at the risk of sounding like a fanatic... I thought you might be interested in a reproducible experiment. I took from the current, ridiculously slanted article on naked short selling the section on the media treatment of the controversy. I left what was there, but I added some fresher facts from the other side. The result is rather funny. I only posted it on the NSS article's Talk Page. - Patrick Byrne
Controversy Over the Pervasiveness of Naked Shorting - Patrick's Respectful Proposal
There is debate about the extent of this manipulation within US capital markets. For many years the consensus was that this was a non-issue. Recently, however, this conventional wisdom has been dissolving.
Naked short selling critics
The SEC estimates about 1% of shares that change hands daily, or about $1 billion, are subject to delivery failures. The SEC views this $1 billion/day number as a serious enough matter to have made two separate efforts to restrict the practice.[1]
The SEC hired an economist, Leslie Boni, to investigate this issue. In 2006 she wrote a seminal paper, "Strategic Delivery Failures in US Equity Markets", showing that delivery failures were much more prevalent than had previsoly been thought, that the mechanisms that were supposed to stop them were triggered in .12% of the relevant cases, and that the distribution of delivery failures showed purpose and could not be explained as random human error. As her paper's summary put it: "Sellers of U.S. equities who have not provided shares by the third day after the transaction are said to have 'failed-to-deliver' shares. Using a unique data set of the entire cross-section of U.S. equities, we document the pervasiveness of delivery failures and evidence consistent with the hypothesis that market makers strategically fail to deliver shares when borrowing costs are high. We then show that many firms that allow others to fail to deliver to them are themselves responsible for fails-to-deliver in other stocks."
Robert J. Shapiro, former undersecretary of commerce for economic affairs, has claimed that naked short selling has cost investors $100 billion and driven 1,000 companies into the ground.[2]
The North American Securities Administrators Association, representing state stock regulators, filed a brief saying that if these claims were correct, its shareholders "have been the victims of fraud and manipulation at the hands of the very entities that should be serving their interest."[3][6][7]
Ralph Lambiase, head of the Connecticut Securities Agency and the NASAA, declared his disappointment at how the industry was handling the issue as a whole.[citation needed]
In early 2006, Bloomberg Magazine's Bob Drummond wrote "The Corporate Voting Charade", claiming that naked shorting was creating so much phantom stock it was ruining corporate democracy. As the article's subtitle put it: "One share does not always equal one vote in the crazy math of proxy contests. When short sellers borrow stock, investor democracy can be a sham."
In September, 2006, Bloomberg Magazine's Bob Drummond wrote "Games Short Sellers Play", alleging that "Traders who sell shares they don’t own—and haven’t even borrowed—are driving down prices. More than 425 companies a month may be the victims of these schemes."
In February, 2007 Forbes Magazine published two stories supporting the view that naked shorting is a serious problem in US capital markets. One article, "Naked and Confused", described the naked shorting attack on Sedona, a Pennsylvania software firm. Another article, "Sewer Pipes", explored the apparent involvement of the Russian Mafia in this issue: "Hedge funds are posting nice returns from deals that may involve ex-cons, stock scammers--even the Mob."
In March 2007, Bloomberg Television featured a special on naked short selling, "Phantom Shares" that presented a sharp criticism of naked short selling in the US capital markets. Phantom Shares' was nominated for an Emmmy for Long Form Investigative Journalism. [4] [5]
In May 2007, Max Keiser reported on naked short selling as part of a report on Al Jazeera's People and Power show. [6]
In July 2007, United States Senator Bob Bennett suggested on the U.S. Senate floor that the allegations involving DTCC and naked short selling are "serious enough" that there should be a hearing on them with DTCC officials by the Senate Banking Committee. The committee's Chairman, Senator Christopher Dodd, indicated he was willing to hold such a hearing.[7]
Also in July, 2007, Forbes published another article, "Naked Shorting Case Gains Traction" concerning the failure of the prime brokerage industry to get a judge to dismiss litigation by Overstock.com against them.
According to The Guardian, Bear Stearns CEO Alan Schwartz has maintained naked short selling played a role in the March, 2008 collapse of Bear Stearns.
Lehman Brothers CEO Dick Fuld has gone on CNBC to make this claim as well: "Lehman Brothers CEO Richard Fuld has instructed his legal staff to tell regulators that he has information suggesting that short-selling hedge funds colluded to help cause the demise of Wall Street investment bank giant Bear Stearns, sources told CNBC."
On April 3, 2008, SEC Chairman Chris Cox, testified to the United States Senate that the SEC is investigating whether or not Bear Stearns was brought down by "illegal naked short selling".
In May, 2008, The US Chamber of commerce made public [a letter] in which they said, "We are pleased that the SEC... recognizes the serious problems with naked short selling and is taking additional steps to curb this abusive practice. We agree with Chairman Cox that naked short selling is a serious fraud that needs to be eliminated. However, we remain concerned that the current proposal does not address critical aspects of this disruptive practice."
On July 15, 2008, "The Securities and Exchange Commission today issued an emergency order to enhance investor protections against "naked" short selling in the securities of Fannie Mae, Freddie Mac, and primary dealers at commercial and investment banks," as their press release stated.
On July 21, 2008, Reuters ran the story a headline about former SEC Chairman Harvey Pitt, "Harvey Pitt to SEC: Expand ban on naked short-selling". It opened, "Emergency action by regulators to rein in abusive short-selling in some large financial firms should be expanded to include the stocks of all public companies, a former top markets watchdog said on Monday."
On July 22, Reuters reported that "Debate rages over naked short-selling as SEC mulls extending ban". The Reuters story described the situation succinctly: "The SEC’s emergency rule rattled the trading community, which scrambled to understand how the rule would be enforced. The unprecedented rule came after the SEC announced plans to crackdown on rumormongering and has started examining whether broker dealers and investment advisers have controls in place to prevent market manipulation."
On August 7, 2008, the American Bankers Association released a letter requesting that the SEC extend the protections afforded some in its July 15 Emergency Order be extended throughout the market. "At a time, when the economy is clearly under stress, the commission has a responsibility to assure that destructive practices such as abusive naked short selling are stopped," said the letter dated August 7.
Here is a Reuters story on this.
Naked short selling apologetics
Regulators, hedge fund managers, and financial journalists downplay the extent of naked shorting in the US.
On its Regulation SHO website ("Does Naked Shorting Drive Prices Down?" section), the SEC cites the prevalence of false claims of naked short selling in Pump and Dump fraud. The SEC downplays naked shorting as a factor in declining stock prices, stating that stock values ideally should be determined by "the quality of the company itself," "supply and demand" of the company's shares, and the company's ability to generate positive income. The SEC's short selling FAQ criticizes what it claims are common misconceptions about the practice. For example, the SEC website denies that naked shorting causes "phantom" shares to enter the market: Naked short selling, the SEC said, would not increase a company's shares outstanding shares nor result in "counterfeit shares."[8]
Statistics on failures to deliver securities are sometimes used as evidence of naked short selling in specific stocks. However, the U.S. Securities and Exchange Commission stated in January 2008 that "fails-to-deliver can occur for a number of reasons on both long and short sales. Therefore, fails-to-deliver are not necessarily the result of short selling, and are not evidence of abusive short selling or 'naked' short selling." [9]
At a North American Securities Administrators Association (NASAA) conference on naked short selling in November 2005, an official of the New York Stock Exchange stated that NYSE had found no evidence of widespread naked short selling, and alleged "fear mongering that there's this rampant naked shorting that's gone unregulated." At that conference, Cameron Funkhouser, NASD senior vice president of market regulations, noted that although companies have alleged stock manipulation through the Berlin stock exchange, the NASD has seen "not one instance of naked short selling [on the Berlin stock exchange]". An official of the SEC said that "While there may be instances of abusive short slling, 99% of all trades in dollar value settle on time without incident." [10]
Short seller David Rocker has contended that failure to deliver securities "can be done for manipulative purposes to create the impression that the stock is a tight borrow." In such a situation, the failure to deliver would be on the part of "longs," not "shorts.""Naked Truth Dressed to Baffle". www.thestreet.com. Retrieved on 2008-04-03. </ref>
There is a debate regarding the extent to which DTCC is involved. [11] DTCC says naked shorting is not widespread enough to be a major concern. "We're not saying there is no problem, but to suggest the sky is falling might be a bit overdone," DTCC's chief spokesman Stuart Goldstein said.[12][13] DTCC General Counsel Larry Thompson calls the claims "pure invention."[13]
A study of trading in initial public offerings by two SEC staff economists, published in April 2007, found that excessive numbers of fails to deliver in IPO's were not correlated with naked short selling. The authors of the study said that while the findings in the paper specifically concern IPO trading, "The results presented in this paper also inform a public debate surrounding the role of short selling and fails to deliver in price formation." [14]
Even though fails to deliver are viewed by some as a way of measuring the degree of naked short sales, the SEC economists said the delivery failures seen in the IPO market "cannot be explained by short selling in general or 'naked' short selling specifically."[15]
An April 2007 study conducted for Canadian market regulators by Market Regulation Services Inc. found that fails to deliver securities were not a significant problem on the Canadian market, that "less than 6% of fails resulting from the sale of a security involved short sales" and that "fails involving short sales are projected to account for only 0.07% of total short sales." [16][17]
Until at least 2007, most Wall Street financial journalists took the position that naked short selling is not harmful and its prevalence has been exaggerated by corporate officials seeking to blame external forces for their own shortcomings.
Wall Street Journal columnist Holman W. Jenkins, Jr., has derided naked shorting allegations, and claimed that "fails were more like an acceptable kludge, helping the market work better, than a cesspot of corruption liable to bring down the financial system." [18]
In the New York Times, several columnists have criticized the campaign against naked short selling. Chief financial correspondent Floyd Norris contended that investors of stocks that are being shorted "might do better to try to understand why some think the shares are overvalued, rather than simply rail about unfair short selling."[19].
New York Times financial columnist Joseph Nocera has criticized naked shorting allegations as diversionary complaints, and said that "most people who understand the issue or have looked into it think it's pretty bogus."[20]
Author, columnist and former Business Week investigative reporter Gary Weiss maintains that the SEC enacted Regulation SHO in part due to pressure from a handful of small and microcap companies.[21] He also cites economic justifications for naked short selling and downplays its significance as a problem for the market. [21][22]