Remarkably, or perhaps not so remarkably, literally hours after issuing an emergency order requiring short sellers to actually borrow the stock they sell - but only in the large financial companies largely complicit in causing hundreds of billions of dollars of damage to the financial markets via naked short selling - several interesting things happened. If you read my last blog, you'll see I saw it coming. Loopholes, poor craftsmanship, silliness, dishonesty, all baked into the SEC cake so that the proclamation has little real world effect.
First, the market makers, including the options market makers, were granted an exemption from the rule.
These would be the same market makers which the SEC's research published last week clearly shows are abusing the exemption, to create massive fails for their clients. The short simply buys a gazillion put options, the options market maker "hedges" that position by naked short selling, and presto, net effect is the same - massive creation of phantom stock. Only difference is that the options MM gets paid to do it - another middle man collects for facilitating market manipulation. Nice. No manipulator left behind...
The SEC of course ignored this, and grants these crooks the license to hedge their activity using naked short sales. Now, understand two things immediately about this: First, the only reason to grant this exemption is so that OPTIONS speculators can have artificially cheap option pricing in hard to borrow stock - at a direct cost to STOCK investors. This is antipodal to the SEC's mandate to only grant exemptions where they are necessary for investor protection. There is no reason to have this exemption except to reward options speculators and market makers, and have stock investors pay the price for the subsidy. No investors are protected - they are harmed. But why sweat those niggling details?
Second, understand that the SEC does not have the authority to allow anyone to violate a host of federal securities laws, and create phantom stock out of the securities entitlements that are credited to investor accounts (for the period up until the stock is supposed to be delivered at T+3). This glaring unlawful and harmful behavior by the SEC is clearly explained in the NIPC petition - which nobody has refuted or been able to counter. The SEC just ignores the factual arguments against its behavior, hoping that you are all too stupid to figure it out.
If you haven't read the petition, you need to. It is airtight, ironclad, and perfectly explains what laws are being broken.
Which brings me to the next point. Cox did an interview, and repeated the extremely misleading canard that naked short selling isn't illegal, and that legitimate short selling is vital and good for the markets.
Let's take the latter claim first. No study has ever been done to support this assertion about legal shorting. There is no data to back it up. It is just a piece of fiction that is very popular, made so by the short sellers and their friends in the media, and their bought and paid for academic cronies. In point of fact, there is zero data to suggest that markets need short selling, even the legal variety, for liquidity. There are no studies that show that to be true. It is just pronounced, over and over, in a politically correct fashion, as it is JUST TOO CONTROVERSIAL TO SUGGEST THAT IT IS A LIE, AND TO DEMAND PROOF FOR THE ASSERTION. When you do, you get folksy stories about how short sellers spot flawed valuations, and provide an important counter to pump schemes, and introduce valuable info into the marketplace. The only problem is that is all opinion, wholly lacking any basis in verifiable, objective fact. But I digress.
The real problem I have is that Cox keeps repeating that naked short selling is not illegal. That is a technical sleight of hand. It is also largely a lie. It is a very clever one, and a very lawyerly lie, and can take a bit of grappling with to understand. Here's the lie.
Failing to deliver is not necessarily illegal. You could have lost the stock certificate. In that case, you weren't selling a share with no intent to deliver. It is a legit oops. Now that there are basically no physical shares, it is also a theoretical, which almost NEVER happens. So that argument when discussing massive bear raids on financial companies is BS. Which he knows.
Selling short, and having never gotten a decent locate or pre-borrow, is in fact illegal. But the SEC doesn't enforce the law here. Telling the trading desk that Mickey Mouse is going to lend you the 1 million shares in Bear Stearns you want to short today may well work if you are a big hedge fund and your prime broker loves you, but it isn't a legit locate, and everyone knows it. But the SEC looks the other way. And selling short without delivering, in order to drive down the price of a stock, is a manipulative device, which is also illegal. Market manipulation is illegal. 10B5.
"Naked Short Selling" is not illegal - technically true, as the SEC has studiously avoided creating a formal definition for it in the Federal securities laws, thus THE TERM doesn't exist in those laws. What I mean is that, even though they mention it in FAQs, and in discussions and explanations, it has no LEGAL definition of the term, as terms like "security" and "unregistered security" and "issuer" have, in Federal securities law. But the behavior does, and it does in fact violate a ton of securities laws. But because there is no formal definition of the term (a la 1933 Act, Section 5) in Federal securities law, Cox can correctly say that "the term" isn't illegal. This is part of the sleight of hand.
Before we cover why the SEC hasn't defined Naked Short Selling in a formal manner so that it becomes recognized and defined in Federal securities law, we need to go deeper into the processing of a trade, and see the consequences of failing to deliver deliberately. Then it will be pretty obvious how badly out of whack everything has gotten, and why Cox's statement is particularly noxious.
The bad guy places a sell on non-existent stock. The sale transaction is processed and posted. Three business days go by, and the hedge fund doesn't deliver the stock. Why isn't the trade broken, and the stock bought in? That's the real gotcha - if they were bought in, nobody would do it, as they would lose money. But they aren't bought in, and that is what you need to know when you consider all this.
It's when the buying broker of the bogus failed shares gets to T+3 that the really ugly part starts, and the systemic meltdown potential is created. The SEC takes the position that the buying broker can create a securities entitlement while it is waiting for the share to show up for the three days the law allows. That is basically an IOU for a share. Fine. Allowed by the rules. But when the share fails to materialize on day three, FEDERAL SECURITIES LAW is violated by the SEC's behavior, which is to replace federal law, with state UCC rules, and just ignore the dozen or so federal securities laws outlined as being violated AT THAT POINT (all categorized in the NIPC petition).
The problem is that there is no rule allowing the SEC to make that swap of rules, and to declare the federal laws of the land requiring delivery to be immaterial. That is proved in detail by the NIPC document, and you really need to get clear on it to understand that it is that behavior by the SEC that allows this whole mess to get really big and really ugly.
Again, there is no rule that allows the SEC to enable brokers to convert securities entitlements into freely trading surrogates (phantom shares) for real securities, after T+3. None. Doing so violates the gamut of established Federal Securities laws. And yet they allow it.
Now, we can argue that philosophically, the law doesn't mean what the law says in writing, it means whatever the enforcer of the law says it means. That is not a system that is the rule of law - it is a system wherein the law means nothing other than what those in power feel it should mean whenever they want to skirt it. As it is, Federal Securities Law says one thing, and the SEC behaves in another. Absent any formal rule allowing them to.
The worst part about all of this is that, as mentioned before, the SEC has very deliberately avoided a formal definition of "naked short selling". The reason is simple. If they did, the definition would clearly violate a host of federal laws, and they would THEN be forced to then enforce those laws. So instead, they leave it undefined in Federal securities law, and allude to it, talk about it, refer to it, but NEVER DEFINE IT FORMALLY, as it would be plainly completely illegal. For a list of laws it violates, again, read the NIPC document, where they are all listed.
So the SEC can say that Naked Short Selling isn't illegal, because to the Federal securities laws, THE TERM doesn't exist in any formal sense. Something that doesn't exist in the lexicon of the code can't be illegal, right?
It's clever, just as when the SEC declared SHO to be working it was a lawyerly lie, using selective reasoning, data sorting, etc. This regulator has been caught in so many half truths and distortions, one reasonably should ask why anything it says is worthy of anything but the most callous skepticism?
So what we are seeing is basically more of the same. We are seeing the SEC pretend to take a strong position, of course favoring special interests responsible for the whole train-wreck in the first place, and then backslide and put the same massive loopholes into the new, strong position that rendered the old strong position a travesty. Precisely as predicted. We are seeing them take a very narrow description of naked short selling, which again, is commonly intended to mean selling shares short that you haven't seriously located or borrowed, and go through rhetorical contortions to try to confound that meaning with some other, more benign meaning. And then make statements that are true when applied to THE TERM, but not the behavior. We have seen a near constant intellectual dishonesty from the SEC, that to me is entirely consistent with only one thing - a group that wants to seem to be trying to do something (so that when the system collapses, they can argue that they were trying) instead of just doing something meaningful.
What do I mean by meaningful? How about, any trade failing, long or short, to be delivered at T+3 is broken and bought in. Period. No exceptions. The financial devastation then belongs to the manipulator, not the buyer of the bogus non-share.
But they don't do that. No, instead they do a 4 hour opera, filled with bluster, and noise, and bright lights, and bombast. But wholly lacking the simple solutions that would end this, now.
There is nothing new going on here, folks.
As an aside, Cramer had me in tears with his socio-pathology the other night. Declaring that he has been on a crusade to end naked short selling and market manipulation. God, if his stance is representative of the whole beast, they really do believe we are all complete, blithering idiots. Maybe they are right. It seems that few actually understand the gang raping they are getting by these thieves.
And the media continues to propagate it's dishonesty and half truth, while the nation continues to see its retirement savings, and now its very real net worth, evaporate.
Move along. Nothing to see here.