Go to the following website and read the report there on the ramifications of the latest anti-naked short selling suit against the brokers:
http://www.vodiagroup.com/pdfs/seclending1.pdf
It lays out the mechanics of how broker-level naked short selling can occur, and more importantly articulates the money motivation for the brokerage industry.
It does not cover the profit to the hedge fund industry to be had from the resultant destruction in shareholder value.
It does articulate the size of the next big lawsuit to come down the pike, which is mind-boggling, and yet still peanuts compared to the largest ones, which will be against the brokers for actual damages resulting in their allowing rampant naked short selling in certain securities - i.e. if they allow millions and millions of FTDs on a basket of securities, thereby expanding supply far greater than the market demand can accommodate, thus destroying billions in market cap, then obviously they as the causal force will be culpable, as will the hedge funds that benefited.
I do want to qualify one statement, which is that the hedge funds can't naked short illegally unless their prime broker allows them to - true in a theoretical, strictly domestic sense, but false if one considers the international scope of the markets, and the many jurisdictions where there are no rules against naked short selling, or where they aren't enforced strictly - like Canada, the Caribbean, Malaysia, Thailand, etc. Further, the ECNs allow brokers in these jurisdictions to play fast and loose, acting as well-paid enablers for the funds.
I would argue that this is a chicken/egg scenario. If miscreant hedge fund A wants to employ a stock manipulation scheme to drive down the price of a stock, using a combination of doctored research, hatchet jobs in the press, class action suits, related party trading, collusive Internet message board posting, etc., then NSS is only a means to an end - a tactical mechanism to introduce massive volume and sell-side pressure to achieve the desired result - a depressed stock price. If the prime brokers are colluding for special customers and facilitating naked short selling by failing to borrow the shares, that is a different issue, although associated.
I think what will be discovered is that it is worse than this report presents - that the prime broker trading desks add fuel to the fire in destroying shareholder value by playing alongside the hedge funds on targeted stocks, thereby even further benefiting from the radically increased supply of bogus shares, and resultant drop in price.
I think that we will also see that there are complex international strategies wherein domestic prime brokers are used in conjunction with a myriad number of international clearing systems and brokers to further leverage the unfair advantage.
In my mind there are going to be interpenetrated offenses - 10b5 violations with RICO likelihood on the hedge fund side, and the bevy of broken rules from the prime broker side. In terms of liability, I think that the author is trying to articulate a contingent liability of epic proportions for an industry that has collectively stolen (that would be the word) hundreds of billions from American shareholders over the last 5 years.
And he is correctly predicting that smart attorneys are going to go after both the funds and the brokers for damages - I think he stays away from the obviously largest damages - the measurable loss in market cap to investors - because it sounds wild to consider hundred-billion dollar suits with a good chance of success due to direct and measurable malfeasance by brokers and hedge funds with deep pockets.
He does not touch upon what will happen when all those gamed shares have to be bought back in.
My feeling is that there is a lot of jockeying behind the scenes at the moment to reclassify FTDs into something else, thus removing them from the harsh glare of the public's scrutiny. I believe that a lot have been moved ex-clearing, and are now being called "open positions", and are being passed around in offshore venues to obfuscate the true nature of the obligations. Think Refco. Times a thousand.
Anyway, this is a great piece, and it qualifies why this is a sh#tstorm that will not be blowing over - the participants and the hedge funds will be fighting to point fingers and protest innocence - exactly as the S&L crooks did in that crisis.
And exactly as I have been predicting for the last year and a half.