This is one of the most comprehensive breakdowns of all Wall Street crime and manipulation. There seems to be so much back and forth about what really takes place in the markets and because of how complex it all is it makes sense the utter confusion. This breakdown is sure to teach you a lot!
This was created by “petepetit” FULL LINK – SOURCE: https://www.petepetit.com/mimedx/downloads/Counterfeiting-Stock.pdf
illegal naked shorting are two of Wall Street’s dirty little secrets.These techniques, which have been in use for many years, have led to Wall Street swindling the American public out of trillions of dollars. In the process, numerous new businesses were forced out of business. This report will describe the scope of the issue, how it manifests itself, How short sellers attack a corporation, why it has been hidden, etc. It’ll also demonstrate how each of the participants, including the prime brokers, short hedge funds, and the Depository Trust Clearing Corp. (DTCC) make scandalous profits while defrauding American small-time investors’ proceeds unabated.
Why is this Important?
This problem affects the investing public. Whether invested directly in the stock market or in mutual funds, IRAs, retirement or pension plans that hold stock – it touches the majority of Americans. The participants in this fraud, which, when fully exposed, will make Enron look like child’s play, have been very successful in maintaining a veil of secrecy and impenetrability. Congress and the SEC have unknowingly (?) helped keep the closet door closed. The public rarely knows when its pocket is being picked as unexplained drops in stock price get chalked up to “market forces” when they are often market manipulations. The stocks most frequently targeted are those of emerging companies that went to the stock market to raise start-up capital. Small business brings the vast majority of innovative new ideas and products to market and creates the majority of new jobs in the United States. It is estimated that over 1000 of these emerging companies have been put into bankruptcy or had their stock driven to pennies by predatory short sellers. It is important to understand that selling a stock short is not an investment in an American enterprise. A short seller makes money when the stock price goes down and that money comes solely from investors who have purchased the company’s stock. A successful short manipulation takes money from investment in American enterprise and diverts it to feed Wall Street’s insatiable greed – the company that was attacked is worse off and the investing public has lost money. Frequently this profit is diverted to off-shore tax havens and no taxes are paid. This national disgrace is a parasite on the greatest capital market in the world.
A Glossary of Illogical Terms- The securities industry has its own jargon, laws, and practices that may require explaining. Most of these concepts are the creation of the industry, and, while they are promoted as practices that ensure an orderly market, they are also exploited as manipulative tools. This glossary is limited to naked short abuse or counterfeiting stock as it is more correctly referred to.
- 1. Broker Dealer or Prime Broker – The big stockbrokers who clear their own transactions, which is to say they move transacted shares between their customers directly, or with the DTC. Small brokers will clear through a clearing house – also known as a broker’s broker.
- Hedge Funds – Hedge funds are really unregulated investment pools for rich investors. They have grown exponentially in the past decade and now number over 10,000 and manage over one trillion dollars. They don’t register with the SEC, are virtually unregulated, and are frequently foreign domiciled, yet they are allowed to be market makers with access to all of the naked shorting loopholes. Frequently they operate secretively and 1 collusively. The prime brokers cater to the hedge funds and allegedly receive eight to ten billion dollars annually in fees and charges relating to stock lend to the short hedge funds.
- Market Maker – A broker, broker-dealer, or hedge fund who makes a market in a stock. In order to be a market maker, they must always have shares available to buy and sell. Market makers get certain sweeping exemptions from SEC rules involving naked shorting.
- Short Seller – An individual, hedge fund, broker, or institution who sells stock short. The group of short sellers is referred to as “the shorts.”
- The Securities and Exchange Commission – The SEC is the federal enforcement agency that oversees the securities markets. The top-level management is a five-person Board of Governors who are Presidential appointees. Three of the governors are usually from the securities industry, including the chairman. The SEC adopted Regulation SHO in January 2005 in an attempt to curb naked short abuse.
- Depository Trust Clearing Corp – Usually known as the DTCC, this privately held company is owned by the prime brokers and it clears, transacts, and holds most stock in this country. It has four subsidiaries, which include the DTC and the NCSS. The operation of this company is described in detail later.
- Short Sale – Selling a stock short is a way to make a profit while the stock price declines. For example: If investor S wishes to sell short, he borrows a share from the account of investor L. Investor S immediately sells that share on the open market, so investor S now has the cash from the sale in his account, and investor L has an IOU for the share from investor S. When the stock price drops, investor S takes some of the money from his account and buys a share, called “covering”, which he returns to investor L’s account. Investor S books a profit and investor L has his share back. This relatively simple process is perfectly legal – so far. The investor lending the share most likely doesn’t even know the share left his account, since it is all electronic and occurs at the prime broker or DTC level. If shares are in a margin account, they may be loaned to a short without the consent or knowledge of the account owner. If the shares are in a cash account, IRA account, or restricted shares they are not supposed to be borrowed unless there is express consent by the account owner. 8. Disclosed Short – When the share has been borrowed or a suitable share has been located that can be borrowed, it is a disclosed short. Shorts are either naked or disclosed, but, in reality, some disclosed shorts are really naked shorts as a result of fraudulent stock borrowing.
- Naked Short – This is an invention of the securities industry that is a license to create counterfeit shares. In the context of this document, a share created that has the effect of increasing the number of shares that are in the marketplace beyond the number issued by the company is considered counterfeit. This is not a legal conclusion, since some shares we consider counterfeit are legal based on today’s rules. The alleged justification for naked shorting is to ensure an orderly and smooth market, but all too often it is used to create a virtually unlimited supply of counterfeit shares, which leads to widespread stock manipulation – the lynchpin of this massive fraud. Returning to our example, everything is the same except the part about borrowing the share from someone else’s account: There is no borrowed share – instead, a new one is created by either the broker-dealer or the DTC. Without a borrowed share behind the short sale, a naked short is really a counterfeit share. 2
- Fails-to-Deliver – The process of creating shares via naked shorting creates an obvious imbalance in the market as the sell side is artificially increased with naked short shares or more accurately, counterfeit shares. Time limits are imposed that dictate how long the sold share can be naked. For a stock market investor or trader, that time limit is three days. According to SEC rules, if the broker-dealer has not located a share to borrow, they are supposed to take cash in the short account and purchase a share in the open market. This is called a “buy-in,” and it is supposed to maintain the total number of shares in the marketplace equal to the number of shares the company has issued. Market makers have special exemptions from the rules: they are allowed to carry a naked short for up to twenty-one trading days before they have to borrow a share. When the share is not borrowed in the allotted time and a buy-in does not occur, and they rarely do, the naked short becomes a fail-to-deliver (of the borrowed share).
- Options – The stock market also has separate, but related markets that sell options to purchase shares (a “call”) and options to sell shares (a “put”). Options are an integral part of short manipulations, the result of SEC promulgated loopholes in Reg SHO. A call works as follows: Assume investor L has a share in his account that is worth $25. He may sell an option to purchase that share to a third party. That option will be at a specific price, say $30, and expires at a specific future date. Investor L will get some cash from selling this option. If at the expiration date, the market value of the stock is below $30 (the “strike price”), the option expires as worthless and investor L keeps the option payment. This is called “out of the money.” If the market value of the stock is above the strike price, then the buyer of the option “calls” the stock. Assume the stock has risen to $40. The option buyer tenders $30 to investor L and demands delivery of the share, which he may keep or immediately sell for a $10 profit.
- Naked call – The same as above except that investor L, who sells the call, has no shares in his account. In other words, he is selling an option on something he does not own. The SEC allows this. SEC rules also allow the seller of a naked short to treat the purchase of a naked call as a borrowed share, thereby keeping their naked short off the SEC’s fails-to-deliver list. A share of stock that has a naked call as its borrowed shares is marked as a disclosed short when it is sold, even though nobody in the transaction actually owns a share
How The System Transacts Stocks – This explanation has been greatly simplified in the interest of brevity.
- Customers – These can be individuals, institutions, hedge funds, and prime broker’s house accounts.
- Prime Brokers – They both transact and clear stocks for their customers. Examples of prime brokers include Goldman Sachs; Merrill Lynch; Citigroup; Morgan Stanley; Bear Stearns, etc.
- The DTCC – This is the holding company that owns four companies that clear and keep track of most stock transactions. This is where brokerage accounts are actually lodged. The DTC division clears over a billion shares daily. The DTCC is owned by the prime brokers, and, as a closely held private enterprise, it is impenetrable. It actively and aggressively fights all efforts to obtain information regarding naked shorting, with or without a subpoena. When the prime brokers sell directly to one another, circumventing the DTC, it is called ex-clearing.
Stocks clear as follows:If Customer A-1 purchases ten shares of XYZ Corp and Customer A-2 sells ten shares,then the shares are transferred electronically, all within prime broker A. Record of thetransaction is sent to the DTC. Likewise, if Investor A-1 shorts ten shares of XYZ Corp andInvestor A-2 has ten shares in a margin account, prime broker A borrows the shares fromaccount A-2 and for a fee lends them to A-1.If Customer A-1 sells shares to Customer B-2, in order to get the shares to B-2 and themoney to A-1, the transaction gets completed in the DTC. The same occurs for shares thatare borrowed on a short sale between prime brokers.As a practical matter, what happens is prime broker A, at the end of the day, totals all ofhis shares of XYZ owned and all of the XYZ shares bought and sold, and clears thedifference through the DTC. In theory, at the end of each day when all of the prime brokershave put their net positions in XYZ stock through the system, they should all cancel out andthe number of shares in the DTC should equal the number of shares that XYZ has sold intothe market. This almost never happens, because of the DTC stock borrow program which isdiscussed later.
Who are the Participants in the Fraud?
The participants subscribe to the theory that it is much easier to make money tearing companies down than making money building them up, and they fall into two general categories: 1) They participate in the process of producing the counterfeit shares that are the currency of the fraud and/or 2) they actively short and tear companies down. The counterfeiting of shares is done by participating prime brokers or the DTC, which is owned by the prime brokers. A number of lawsuits that involve naked shorting have named about ten of the prime brokers as defendants, including Goldman Sachs, Bear Stearns, Citigroup, Merrill Lynch; UBS; Morgan Stanley, and others. The DTCC has also been named in a number of lawsuits that allege stock counterfeiting. The identity of the shorts is somewhat elusive as the shorts obscure their true identity by hiding behind the prime brokers and/or hiding behind layers of offshore domiciled shell corporations. Frequently the money is laundered through banks in a number of tax haven countries before it finally reaches its ultimate beneficiary in New York, New Jersey, San Francisco, etc. Some of the hedge fund managers who are notorious shorters,are very public about their shorting, although they frequently utilize offshore holding companies to avoid taxes and scrutiny.
Most of the prime brokers have multiple offshore subsidiaries or captive companies that actively participate in shorting. The prime brokers also front the shorting of some pretty notorious investors. According to court documents or sworn testimony, if one followed some of the short money trails at Solomon, Smith Barney, they led to accounts owned by the Gambino crime family in New York. A similar exercise with other prime brokers, who cannot be named at this time, leads to the Russian mafia, the Cali drug cartel, other New York crime families, and the Hell’s Angels. One short hedge fund that was particularly destructive was a shell company domiciled in Bermuda. Subpoenas revealed the Bermuda company was wholly owned by another shell company that was domiciled in another tax haven country. This process was five layers deep, and at the end of the subterfuge was a very well-known American insurance company that cannot be disclosed because of court-ordered sealing of testimony. Most of the large securities firms, insurance companies, and multi-national companies have layers of offshore captives that avoid taxes, engage in activities that the company would not want to be publicly associated with, like stock manipulation; avoid U.S. regulatory and legal scrutiny; and become the closet for deals gone sour, like Enron.
The Creation of Counterfeit Shares
There are a variety of names that the securities industry has dreamed up that are euphemisms for counterfeit shares. Don’t be fooled: Unless the short seller has actually borrowed a real share from the account of a long investor, the short sale is counterfeit. It doesn’t matter what you call it and it may become non-counterfeit if a share is later borrowed, but until then, there are more shares in the system than the company has sold. The magnitude of the counterfeiting is hundreds of millions of shares every day, and it may be in the billions. The real answer is locked within the prime brokers and the DTC. Incidentally, counterfeiting of securities is as illegal as counterfeiting currency, but because it is all done electronically and has other identifiers and industry rules and practices, i.e. naked shorts, fails-to deliver, SHO exempt, etc. the industry and the regulators pretend it isn’t counterfeiting. Also, because of the regulations that govern the securities, certain counterfeiting falls within the letter of the rules. The rules, by design, are fraught with loopholes and decidedly short on allowing companies and investors access to information about manipulations of their stock. The creation of counterfeit shares falls into three general categories. Each category has a plethora of devices that are used to create counterfeit shares.
- Fails-to-Deliver – If a short seller cannot borrow a share and deliver that share to the person who purchased the (short) share within the three days allowed for the settlement of the trade, it becomes a fail-to-deliver and hence a counterfeit share; however the share is transacted by the exchanges and the DTC as if it were real. Regulation SHO, implemented in January 2005 by the SEC, was supposed to end wholesale fails-to deliver, but all it really did was cause the industry to exploit other loopholes, of which there are plenty (see 2 and 3 below). Since forced buy-ins rarely occur, the other consequences of having a fail-to-deliver are inconsequential, so it is frequently ignored. Enough fails-to-deliver in a given stock will get that stock on the SHO list, (the SEC’s list of stocks that have excessive fails-to deliver) – which should (but rarely does) see increased enforcement. Penalties amount to a slap on the wrist, so large fails-to-deliver positions for victim companies have remained for months and years.
A major loophole that was intentionally left in Reg SHO was the grandfathering in of all pre-SHO naked shorting. This rule is akin to telling bank robbers, “If you make it to the front door of the bank before the cops arrive, the theft is okay.” Only the DTC knows for certain how many short shares are perpetual fails-to-deliver, but it is most likely in the billions. In 1998, REFCO, a large short hedge fund, filed bankruptcy and was unable to meet margin calls on their naked short shares. Under this scenario, the broker-dealers are the next line of financial responsibility. The number of shares that allegedly should have been bought in was 400,000,000, but that probably never happened. The DTC – owned by the broker-dealers – just buried 400,000,000 6 counterfeit shares in their system, where they allegedly remain – grandfathered into “legitimacy” by the SEC. Because they are grandfathered into “legitimacy”, the SEC, DTC, and prime brokers pretend they are no longer fails-to-deliver, even though the victim companies have permanently suffered a 400 million share dilution in their stock. (See Appendix A for more on The Grandfather Clause). A significant amount of counterfeiting is the result of the options market exemptions. The rule allows certain options contracts to serve as borrowed shares for short sales even though there is no company-issued share behind the options contract. The loophole is easily abused, helped in part by SEC’s apparent inability to globally monitor compliance. There has been considerable pressure on the SEC to close the Options Maker Exemption, but through January 2008, they have refused to act. (See Appendix B for more on The Options Maker Exemption).
A significant amount of counterfeiting is the result of the options market exemptions. The rule allows certain options contracts to serve as borrowed shares for short sales even though there is no company-issued share behind the options contract. The loophole is easily abused, helped in part by SEC’s apparent inability to globally monitor compliance. There has been considerable pressure on the SEC to close the Options Maker Exemption, but through January 2008, they have refused to act. (See Appendix B for more on The Options Maker Exemption).
Three months prior to SHO, the aggregate fails-to-deliver on the NASDAQ and the NYSE averaged about 150 million shares a day. Three months after SHO it dropped by about 20 million, as counterfeit shares found new hiding places (see 2 and 3 below). It is noteworthy that aggregate fails-to-deliver are the only indices of counterfeit shares that the DTC and the prime brokers report to the SEC. The bulk of the counterfeiting remains undisclosed, so don’t be deceived when the SEC and the industry minimize the fails-to deliver information. It is akin to the lookout on the Titanic reporting an ice cube ahead.
- Ex-clearing counterfeiting – The second tier of counterfeiting occurs at the broker-dealer level. This is called ex-clearing. These are trades that occur from dealer to dealer and don’t clear through the DTC. Multiple tricks are utilized for the purpose of disguising naked shorts that are fails-to-deliver as disclosed shorts, which means that a share has been borrowed. They also make naked shorts “invisible” to the system so they don’t become fails-to-deliver, which is the only thing the SEC tracks. The SEC does not examine exclearing transactions as they don’t believe that Reg SHO applies to short shares held in ex-clearing.
Some of the tricks are as follows:
- Stock sales are either long sales or short sales. When a stock is transacted the broker checks the appropriate box. By mismarking the trading ticket -checking the long box when it is actually a short sale the short never shows up, unless they get caught, which doesn’t happen often. The position usually gets reconciled when the short covers.
- Settlement of stock transactions is supposed to occur within three days, at which time a naked short should become a fail-to-deliver, however, the SEC routinely and automatically grants a number of extensions before the naked short gets reported as a fail-to-deliver. Most of the short hedge funds and broker-dealers have multiple entities, many offshore, so they sell large naked short positions from entity to entity. Position rolls, as they are called, are frequently done broker to broker, or hedge fund to hedge fund, in block trades that never appear on an exchange. Each movement resets the time clock for the naked position becoming a fail-to-deliver and is a means of quickly getting a company off of the SHO threshold list. (See Appendix C for more on Short Squeezes).
- The prime brokers or others may do a buy-in of a naked short position. If they tell the short hedge fund that we are going to buy in at 3:59 EST on Friday, the hedge fund naked shorts into their own buy-in (or has a co-conspirator do it) and rolls their position, hence circumventing Reg SHO.
- Most of the large broker-dealers operate internationally, so when regulators come in (they almost always “call ahead”) or compliance people come in (ditto), large naked positions are moved out of the country and returned at a later date.
- The stock loan is enormously profitable for the broker-dealers who charge the short sellers large fees for the “borrowed” shares, whether they are real or counterfeit. When shares are loaned to a short, they are supposed to remain with the short until he covers his position by purchasing real shares. The broker-dealers do one-day lends, which enables the short to identify to the SEC the account that shares were borrowed from. As soon as the report is sent in, the shares are returned to the broker-dealer to be loaned to the next short. This allows eight to ten shorts to borrow the same shares, resetting the SHO-fail-to-deliver clock each time, which makes all of the counterfeit shares look like legitimate shares. The broker-dealers charge each short for the stock loan.
- Margin account buyers, because of loopholes in the rules, inadvertently aid the shorts. If short A sells a naked short he has three days to deliver a borrowed share. If the counterfeit share is purchased in a margin account, it is immediately put into the stock lend and, for a fee, is available as a borrowed share to the short who counterfeited it in the first place. This process is perpetually fluid with multiple parties, but it serves to create more counterfeit shares and is an example of how a counterfeit share gets “laundered” into a legitimate borrowed share.
- Margin account agreements give the broker-dealers the right to lend those shares without notifying the account owner. Shares held in cash accounts, IRA accounts, and any restricted shares are not supposed to be loaned without express consent from the account owner. Broker-dealers have been known to change cash accounts to margin accounts without telling the owner, take shares from IRA accounts, take shares from cash accounts and lend restricted shares. One of the prime brokers recently took a million shares from cash accounts of the company’s founding investors without telling the owners or the stockbroker who represented ownership. The shares were put into the stock lend, which got the company off the SHO threshold list and opened the door for more manipulative shorting.
This is a sample of tactics used. For a company that is under attack, the counterfeit shares that exist at this ex-clearing tier can be ten or twenty times the number of fails-to-deliver, which is the only category tracked and policed by the SEC.
- Continuous Net Settlement – The third tier of counterfeiting occurs at the DTC level. The Depository Trust and Clearing Corporation (DTCC) is a holding company owned by the major broker-dealers and has four subsidiaries. The subsidiaries that are of interest are the Depository Trust Company (DTC) and the National Securities Clearing Corporation (NSCC). The DTC has an account for each broker-dealer, which is further broken down to each customer of that broker-dealer. These accounts are electronic entries. Ninety-seven percent of the actual stock certificates are in the vault at the DTC with the DTC nominee’s name on them. The NSCC processes transactions provide the broker-dealers with a central clearing source and operate the stock borrow program.
When a broker-dealer processes the sale of a short share, the broker-dealer has three days to deliver a borrowed share to the purchaser and the purchaser has three days to deliver the money. In the old days, if the buyer did not receive his shares by settlement day, three days after the trade, he took his money back and undid the transaction. When the stock borrow program and electronic transfers were put in place in 1981, this all changed. At that point, the NSCC guaranteed the performance of the buyers and sellers and would settle the transaction even though the seller was now a fail-to-deliver on the shares he sold. The buyer has a counterfeit share in his account, but the NSCC transacts it as if it were real.
At the end of each day, if a broker-dealer has sold more shares of a given stock than he has in his account with the DTC, he borrows shares from the NSCC, who borrows them from the broker-dealers who have a surplus of shares. So far it sounds like the whole system is in balance, and for any given stock the net number of shares in the DTC is equal to the number of shares issued by the company.
The short seller who has sold naked – he had no borrowed shares – can cure his fail-to-deliver position and avoid the required forced buy-in by borrowing the share through the NSCC stock borrow program.
Here is the hocus pocus that creates millions of counterfeit shares.
When a broker-dealer has a net surplus of shares of any given company in his account with the DTC, only the net amount is deducted from his surplus position and put in the stock borrow program. However, the broker-dealer does not take a like number of shares from his customer’s individual accounts. The net surplus position is loaned to a second broker-dealer to cover his net deficit position.
Let’s say a customer at the second broker-dealer purchased shares from a naked short seller – counterfeit shares. His broker-dealer “delivers” those shares to his account from the shares borrowed from the DTC. The lending broker-dealer did not take the shares from any specific customers’ account, but the borrowing broker-dealer put the borrowed shares in specific customers’ accounts. Now the customer at the second prime broker has “real” shares in his account. The problem is it’s the same “real” shares that are in the customer’s account at the first prime broker.
The customer account at the second prime broker now has a “real” share, which the prime broker can lend to a short who makes a short sale and delivers that share to a third party. Now there are three investors with the same counterfeit shares in their accounts.
Because the DTC stock borrow program, and the debits and credits that go back and forth between the broker-dealers, only deal with the net difference, it never gets reconciled to the actual number of shares issued by the company. As long as the broker-dealers don’t repay the total stock borrowed and only settle their net differences, they can “grow” a company’s issued stock.
This process is called Continuous Net Settlement (CNS) and it hides billions of counterfeit shares that never make it to the Reg. SHO radar screen, as the shares “borrowed” from the DTC are treated as legitimate borrowed shares.
For companies that are under attack, the counterfeit shares that are created by the CNS program are thought to be ten or twenty times the disclosed fails-to-deliver, and the true CNS totals are only obtained by successfully serving the DTC with a subpoena. The SEC doesn’t even get this information. The actual process is more complex and arcane than this, but the end result is accurately depicted.
Ex-clearing and CNS counterfeiting are used to create an enormous reserve of counterfeit shares. The industry refers to these as “strategic fails-to-deliver.” Most people would refer to these as a stockpile of counterfeit shares that can be used for market manipulation. One emerging company for which we have been able to get or make reasonable estimates of the total short interest, the disclosed short interest, the available stock lend, and the fails-to-deliver has fifty “buried” counterfeit shares for every fail-to-deliver share, which is the only thing that the SEC tracks, consequently the SEC has not acted on shareholder complaints that the stock is being manipulated.
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