Solution To Naked Short Selling

Naked short selling is a widespread problem on Wall Street, as illustrated in Bloomberg's Emmy nominated exposé:




My reaction: As soon as I watched this video, I realized there is an easy and insanely profitable way of destroying the practice of naked short selling on Wall Street. There is one key fact to note from the Bloomberg's special report:


Robert C. Simpson (former CEO, Zann Corp) aquired 111% of the issued and outstanding shares of Global Links (GLKCE).


The possibly of acquiring more than 100% of the outstanding shares allows for the exploitation of a fatal flaw involved in the practice of naked short selling (short sellers must pay the dividends on the 'phantom shares' they sell).


Plan for destroying naked short selling on Wall Street


Step one:
Find the stock of a solid company which is under attack by naked short selling.

Step two: As Robert Simpson did with Global Links, buy more of the stock than is available in the market, except take it one step further. Keep buying the stock until 200% to 300% of all outstanding shares are owned. Importantly, these purchases should not be made through only one stock broker, but should be divided up among all the brokers responsible for enabling naked short selling.

Step three: Encourage widespread ownership of the stock:

A) Tell friends and family to buy stock
B)
Tell anyone who has ever been hurt by naked short selling to buy stock.
C) Make sure than all major financial news organizations have a small position in stock (important!). This can be accomplished through donations if necessary.
D) Donate or fund the purchase of stock by NGOs, political organization, charities, etc...

Step four: Enter into an agreement with the company to fund a dividend payment. A good starting dividend would be twice the stock's current trading price.

Step five: As soon as dividend is paid, agree to fund a new dividend, twice the size of the previous one. The money to fund this new dividend should come from the old dividend, which has been double or tripled (thanks to 200% to 300% ownership of all outstanding shares).

Step six: Keep repeating the process of funding new dividends which are twice the size of the previous ones until corrupt naked short sellers and Wall Street brokers are brought to their knees. Only stop dividend payments once broker/dealers have made major concessions (especially greater transparency) about naked short selling.


Notes about this solution to naked short selling:

1) It's perfectly legal. Best part about the plan outlined above is that no illegal activity is involved in its implementation. It simply takes advantage of the illegal actively on the part of naked short sellers.

2) Once step four is reached, the plan is inescapable. Even if Wall Street brokers/naked short sellers realize what is going on, they won't be able to do anything to stop it. They can't turn to the authorities for help, without admitting to illegally selling millions of shares.

3) It will be incredibly satisfying. Can you imagine the panic on the part of naked short sellers once they realize they are trapped into paying ever increasing? Their desperation as the stock price soars to insane levels? If you can't imagine it, then watch "the producers" (see Bloomberg video above).

4) One time is enough. Implementing this plan a single time will permanently eliminate most naked short selling, because Broker/dealers will take reign in naked short selling themselves to make sure they are never caught in the trap again.

5) The plan bypasses incompetent/corrupt regulators, politictians, and financial media. Waiting for someone, especially regulators, to solve the problem is a losing proposition.

6) Finally, What better way to end illegal short selling than to turn the practice against itself? Forcing 'phantom shares' to pay massive 'phantom dividends' is poetic justice.

-----

So, how about it? Can anyone see a flaw in this plan to end naked short selling?

(PS. If anyone does decide to adopt the plan outlined here, I would appreciate a donation from the profits that are generated.)

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27 Responses to Solution To Naked Short Selling

  1. stibot says:

    Hmss, but where is the video? No idea what to play.. Could you provide links in cases like this?

  2. Martijn says:

    Eric,

    I already thought of that solution, but immediately wondered why it has not been done already. There have been enough players with sufficient deep pockets around I suppose.

    But it still is the solution

  3. Bowtie says:

    I'm down, I just don't have the money to single handedly acquire 100% of a company let alone 200 or 300 percent.

  4. dashxdr says:

    Eric you speak of paying out the dividend. Where does the money to pay the dividend come from? The company itself must make profit that must then be distributed to shareholders. Due to naked short selling there are supposedly 100% or 200% more shareholders than there is real stock. Only the holders of the real stock can claim a dividend payment. That can never be more than 100%.

    The brokerage houses don't fund the dividend payments, do they?

    Seems to me the whole scenario is fundamentally flawed wishful thinking.

  5. Bowtie says:

    Since you would own 300% of the company, you would get 300 % of whatever the dividend is.

  6. dashxdr says:

    "Since you own 300% of the company, you get 300% of whatever the dividend is."

    OK, by what mechanism is this excess money produced? The company itself? The brokerage houses that sold short?

    The way it would play out is the brokerage houses that sold short would simply void the transaction, refunding the original purchase price of the share that was never delivered. And the government "regulators" would simply say, "Shame on you" but would impose no penalties of any significance.

    I love Eric but man, why do people have to slip into being ditto heads? Either they blindly follow The Establishment, or they blindly follow Anti-Establishment. Can't people think for themselves?

    Eric's not incapable of making mistakes. I just want to understand the logic of his premise. Either he's wrong or I'm wrong, I'd like to settle the issue.

  7. Bowtie says:

    I don't know much about naked short selling and i haven't really read Eric's articles on it, i was just assuming that's how it would work.

  8. Martijn says:

    Dividend payments can be a problem indeed. I wonder how that's taken care of when FDTs are around.

  9. Hugo says:

    I have to agree with dashxdr in this one. The idea sounds great, but if you are playing in their casino they make the rules, so they would find some solution that would not hurt the important players, something among the lines of what dashxdr said:

    The way it would play out is the brokerage houses that sold short would simply void the transaction, refunding the original purchase price of the share that was never delivered. And the government "regulators" would simply say, "Shame on you" but would impose no penalties of any significance.At least the naked selling brokerage houses would go bankrupt.

  10. Anonymous says:

    You would need major deep pockets for this to actually happen.

    You see it even in the penny markets and it can't be stopped and we're talking companies with market caps of like what? A few hundred thousand?

    Try this on a bigger board stock with high shares outstanding trading at $10 for example.....that's a lot of money to try and harness in and also not have anyone sell in the process. My 2 cents...

    All the more reason why I don't even touch the stock markets these days. Money better off in the FOREX exchange IMO....

    ed in CA

  11. Martijn says:

    Startup companies hardly pay any dividends.

  12. stibot said...
    Hmss, but where is the video? No idea what to play.. Could you provide links in cases like this?

    I added the link above, and I will remember to add them in the future.

    -----

    Bowtie said...
    I'm down, I just don't have the money to single handedly acquire 100% of a company let alone 200 to 300 percent.

    In the video above, Robert Simpson acquired all outstanding shares of Global Links for $5,000.

    -----

    dashxdr said...
    Eric you speak of paying out the dividend. Where does the money to pay the dividend come from?

    It would come from the short seller:

    Where shares are shorted and the company which issues the shares distributes a dividend, the question arises as to who receives the dividend. The new buyer of the shares, who is the "holder of record" and holds the shares outright, will receive the dividend from the company. However, the lender, who may hold its shares in a margin account with a prime broker and is unlikely to be aware that these particular shares are being lent out for shorting, also expects to receive a dividend. The short seller will therefore pay to the lender an amount equal to the dividend in order to compensate, though as this payment does not come from the company it is not technically a dividend as such. The short seller is therefore said to be "short the dividend".
    From the Wikipedia's entry on short sellingLast year I was short citigroup (legitimate short selling of an overpriced stock) and I paid their dividend (it was worth it).

    The company itself must make profit that must then be distributed to shareholders. Due to naked short selling there are supposedly 100% or 200% more shareholders than there is real stock. Only the holders of the real stock can claim a dividend payment. That can never be more than 100%.

    Actually, there can be more than 100% thanks to Manufactured Dividends:

    MANUFACTURED DIVIDENDS
    When securities that have been lent to pay a dividend, the borrower of the securities is required to pass the dividend on to the lender of securities.

    This payment is know as a manufactured dividend (as opposed to the normal dividend paid by the issuer of the securities) and will be an amount equal to the gross coupon. Manufactured dividends cause tax problems in some markets.

    The brokerage houses don't fund the dividend payments, do they?

    Not normally. The short seller pays the dividend, but if the short seller goes under, then brokerage houses are on the hook.

    In the plan outlined above, the short seller would be driven out of business within a few dividend payments, and then it would brokerage house would need to take over payments.

    Seems to me the whole scenario is fundamentally flawed wishful thinking.

    Not wishful thinking at all. The real point of the plan is to force naked short sellers to pay out these "manufactured dividends" creating enormous loses for them and scaring them away from future naked short selling.

    -----

    Bowtie said...
    Since you would own 300% of the company, you would get 300 % of whatever the dividend is.

    Correct.

    -----

    dashxdr said...
    OK, by what mechanism is this excess money produced?

    manufactured dividends paid by short seller.

    The way it would play out is the brokerage houses that sold short would simply void the transaction, refunding the original purchase price of the share that was never delivered. And the government "regulators" would simply say, "Shame on you" but would impose no penalties of any significance.'

    That would be excellent. Remember, while profiting would be nice, the real purpose of this exercise is to destroy short selling. What you are suggesting would be by far the damaging thing to ever happen to the short selling industry. Consider your the full implications of what you are suggesting:

    "the brokerage houses that sold short would simply void the transaction, refunding the original purchase price of the share that was never delivered."

    What do you think would happen if some brokerage houses "void the transaction" while others don't? Would you do business with a brokerage house that voids your trades when you make a profit? Furthermore, any brokerage houses canceling trades would be immediately singled out as the rogue operations in league with naked short selling, badly damaging their reputation at a time short sellers are intensely hated. Finally, naked short selling is ILLEGAL! Do you really think brokerage houses would offer the world uncontroversial proof of illegally selling millions of 'Phantom shares'? It would create a legal nightmare for those firms: The traders who involved in would end up in jail, the firms would be fined millions, and settling all the class actions lawsuits would cost even more.

    Eric's not incapable of making mistakes.

    What?

    I just want to understand the logic of his premise. Either he's wrong or I'm wrong, I'd like to settle the issue.

    I am fairly sure I am right on this one (As stated above, I have paid these imaginary dividend when I was short citigroup last year).

    -----

    Hugo said...
    I have to agree with dashxdr in this one. The idea sounds great, but if you are playing in their casino they make the rules, so they would find some solution that would not hurt the important players

    I would love to hear how brokerages escape the trap outlined above without surffering horrible damage.

  13. Mark says:

    My quick guess is that this is illegal. :-))))

  14. dashxdr says:

    Eric -- thanks for the detailed response to my question about how the dividend is paid. I had not known the information you shared about the manufactured dividend vs the real thing.

    As such your scheme sounds perfectly viable.

    Can you partner with the fellow that owns the company outright for $5,000 and get him to do the squeeze?

  15. Anonymous says:

    wouldn't it be easier to rob a rich old lady. Not much difference from what I see.

    As soon as you get it all figured out, let us all know. I for one, could give a crap. Its amazing how many circus acts are at the casino now.

  16. Numonic says:

    Weird timing. We're in a time shorts are getting squeezed because of the credit crisis. I just feel like doing this would be beating the naked shorters while they are down. You're trying to stop something that's on the verge of stopping itself as credit and naked short selling are inherently self destructive and inevitably default without any extra help such as a multitude of forced demand of delivery. If you want to squeeze a short and benefit at the same time, just buy some physical gold or silver but regaurdless if you do or don't the massive defaults/credit collapse that is coming will end the shorts, when that happens what would you rather be holding: nothing(which is what you'll get in a credit collapse as there isn't even enough Fed Notes available for the shorts to settle in cash and even if you're lucky enough to receive a fraction of your money in the settlement, it won't be worth anything as massive defaults would destroy the value of the dollar) or some physical gold/silver which in relation to the Fed Notes will be worth allot more? I choose the latter.

    There's no need for a plan like this, the credit market is already damaged and it's end is near, if you're looking to benefit get physical gold and silver now and keep it in your possession where you are the only person in the world that knows where it is.

    If you want to help those who lost money in stocks or naked shortselling tell them to do the same and buy physical gold and silver.

  17. Bowtie says:

    Numonic, are funds like CEF and GTU safe, or am i better off taking delivery?

  18. Numonic says:

    I don't know much about those funds but I'd stay away from all funds.

  19. Robert says:

    While I agree that the possibility of someone acquiring 300% of the company should be an important control on short selling - perversely it is currently considered market abuse!

    You are required to disclose how many shares you own above some trivial percentage. Failing to do so is market abuse. When Porsche bought 70% of VWs shares using options - causing a massive short squeeze - they managed to build up this position while avoiding disclosing this to the market (option didnt have these disclosure rules) but this has now been changed (disclosure is now required on options too) to protect the short sellers!

  20. Robert said...
    While I agree that the possibility of someone acquiring 300% of the company should be an important control on short selling - perversely it is currently considered market abuse!

    Not sure it would be considered market abuse in this case. I believe acquiring 300% of a company's share would only be considered "market abuse" if it was done with the intent of "taking up the supply of securities available for borrowing". This would be an "abusive squeeze". However, as long as no attempt to reduce "the supply of securities available for borrowing" are made, there should not be a problem in terms of market abuse. (furthermore, it would be impossible to make a claim of "market abuse" against those owning 300% without also making a claim of "market abuse" against those who sold short 200%)

    SqueezesWe have also had some questions concerning the obligation on market participants to lend securities, for example during a period of market tightness. It must be stressed that the Code does not impose any obligation to lend beyond those which might already exist under any other obligation. The Code discusses abusive squeezes, which may occur when a person holds a significant percentage of the stock available for supply, and also holds a position, say in a derivative contract, that requires the delivery of that stock. We have made clear in the Code's discussion of abusive squeezes that:

    'The regular user is likely to expect other market users to settle their obligations and not to put themselves in a position where, to do so, they have to rely on holders of long positions lending when they may not be inclined to do so and may be under no obligation to do so'. (MAR 1.6.17) and;

    one of the factors we would take into account would be 'the extent to which a person is willing to relax his control or other influence in order to help maintain an orderly market and the price at which he is willing to do so.' (MAR 1.6.16 (1))

    Therefore, a firm's willingness to lend at normal market rates may suggest it has not engaged in market abuse. However, if a firm squeezes short position holders by taking up the available supply of securities available for borrowing, this may amount to an abusive squeeze and therefore, market abuse.
    Current Code of Market ConductYou are required to disclose how many shares you own above some trivial percentage.

    Disclose requirements could be circomvented by breaking up ownership of 300%. For example, 100 investors take small positions in stock and then pool money to pay dividends.

    When Porsche bought 70% of VWs shares using options - causing a massive short squeeze - they managed to build up this position while avoiding disclosing this to the market (option didnt have these disclosure rules) but this has now been changed (disclosure is now required on options too) to protect the short sellers!

    I remember when Porsche bought 70% of VWs shares, and it was a very diferent situation for a number of reasons:

    1) There was only 15% short interest in VWs shares, which means these were legitimate short positions. VWs shares were not under attack by naked short sellers.
    2) Porsche restricted the supply of VWs shares by not lending out its shares.
    3) Porsche also held a position via options that required delivery of the VWs shares.

    In other words, Porsche was clearly trying to "corner the market".

  21. Robert says:

    Eric,

    Cornering the market is EXACTLY WHAT YOU ARE PROPOSING!

    If you could build up a 300% position in a company while still disclosing everything in a timely manner that might not be market abuse - but realistically this is unlikely to happen.

    Once you disclose you have acquired a large enough stake - shorters will become increasingly reluctant to short.

    You don't really need to buy a 300% stake either.. the second you have 1 share more than the issued shares you effectively own your counterparty and they are insolvent.

    Just take the company private for $1 billion per share. That extra share is now worth $1 billion to you. Adjust the buyout price so that your extra share is worth whatever the total assets of the counterparty and their insurers are worth.

    I don't understand how you can differentiate between naked and non-naked short selling. There is no practical difference between the two activities.

    If you like think of 'naked' short selling as just regular short selling where you immediately borrow the share back from the client you sold the share to instead of someone else.

  22. Robert said...
    Cornering the market is EXACTLY WHAT YOU ARE PROPOSING!

    No, it is not. Cornering the market involves taking control of the underlying asset. For example, Porsche bought 70% of VWs shares (and 25% were owned by pensions who didn't loan shares), effectively 95% of all outstanding shares were not available to borrow. With 15% short interest in the stock, the numbers didn't add up. Shorts were screwed.

    The plan outlined above makes no effort to control the underlying shares. The 300% of shares aquired will be available to borrow at all times. Furthermore, in a market where an unlimited amount of naked short selling is possible, IT IS IMPOSSIBLE TO CORNER THE MARKET!

    Once you disclose you have acquired a large enough stake - shorters will become increasingly reluctant to short.

    In the video, Robert Simpson aquired over 100% of Global Links, and this did nothing to stop the naked short selling of the stock. News of someone aquiring 300% would be no differant. Think about it, there are probably already dozens of investers who own more than 100% of penny stocks, and this hasn't stopped naked short selling in the least.

    You don't really need to buy a 300% stake either.. the second you have 1 share more than the issued shares you effectively own your counterparty and they are insolvent.

    If this was true, then naked short selling wouldn't be a problem. Theoretically speaking, you are right, assuming that trades get settled. However, the reality is naked shorts aren't required to settle their trades (thanks to Regulation SHO, there are millions of naked short positions that have been "grandfather" and which will NEVER be required to settle). If you acquire 101% of a companies stocks, naked shorts will lauch at you and then sell 10000% of outstanding shares driving the value of your 101% down to zero. This means the insolvent one is you with your worthless 101%.

    I don't understand how you can differentiate between naked and non-naked short selling. There is no practical difference between the two activities.

    Are you kidding? Their is a HUGE differance. Are aware that to borrow a stock, a 102% cash deposit is necessary?

    Here is an example: an investor has 102 dollars and he desides to short sell a stock trading at 100.

    If he uses normal short selling: he borrows stock for $102 and sells it. He now has 100 cash in his account, on which he earns interest.
    If he uses naked short selling: he sells stock short for $100. He now has 202 cash in his account, on which he earns interest.

    If you like think of 'naked' short selling as just regular short selling where you immediately borrow the share back from the client you sold the share to instead of someone else.

    Again, this is ignoring the 102% deposit required for borrowing a stock.

  23. Robert says:

    Eric,

    I don't see that it makes much difference whether you use options or shares.

    Shares (when bought through a retail brokerage anyhow) are really just paper contracts that may or may not exist.

    While I am quite sure that almost every share is oversold to some degree I'm not sure how many instances there have ever been when one person has amassed more than 100% of the company.

    If you do find yourself in that position and try to execute either my buyout strategy or your dividend paying one I'm pretty much certain you'd end up in court. I have no idea what the end result would be.

    Am I kidding? I'm really not. I really liked your response though as it provides a basis for defining what naked short selling actually is.

    (What you said is...) naked short selling is when you short without any reserves set asside and 'safe' short selling is when you do it with a 102% set asside.

    At the moment with interest rates near zero, borrowing 102% cash costs the shorter basically nothing.

    But even in more normal times I suspect there are many MANY fun accounting tricks that can be played (although I don't know what they are) to double count (triple? 1000x?) the reserves and otherwise reduce their significance.

    After your great articles about banks using sub-savings accounts to get around keeping current account reserves I'm sure you're well aware how devious banks can be when it comes to avoiding keeping reserves.

    If you're shorting properly and playing the right tricks it shouldn't really cost you much more than naked short selling.

  24. pebird says:

    There is nothing "short" in naked short selling. It is creating phantom stock - counterfeiting.

    Why?

    To short you have to have the stock in your possession in order to sell it.

    If you don't own it, you borrow it, but you have to have it in your possession - legally.

    Naked "shorting" is basically an option without having to pay the overhead on an option - it's a free ride.

    The idea of buying up a multiple percentages of a company and having the company issue dividends (the company would only have to pay 100%, since they issue against known holders), the counterfeiters have to pay the dividend in order to hide their identity.

    My guess is that there is lot of phantom stock "buffer" the big boys hold to net out positions between players in the event something like this happens - call it grandfathered.

  25. Robert says:

    There is very little practical difference between "legally having the stock in your posession" for 30 miliseconds while a couple of database entries get updated and not having it at all.

    There's no reason you couldn't keep an inventory of 1 of every share and just process every transaction one share at a time.

    Eric's point about rules regarding the amount of cash you're supposed to pay the lender are much more relevant.

    There are several problems though;

    a) shorting carries infinite risk. having 102% cash coverage for your short isn't much better than 0%.

    b) you can borrow the cash at nearly 0% interest for your 'coverage'

    c) the people you pay the cash too will probably deposit it into an account with you so you still have it and can re-use it over and over.

    d) probably many other things as well..

  26. Hi Robert,

    Have a look at the graphics I made about short selling and naked short selling.

    The real issue with (naked) short selling ISN'T the price manipulation of stocks, but the risk of critical cash shortages in financial system. Look at the graphics above and imagine what massive withdrawls of by hedge funds (what happened last september) would do to cash flow of Wall Street broker-dealers.

    There is very little practical difference between "legally having the stock in your posession" for 30 miliseconds while a couple of database entries get updated and not having it at all.

    I hate to disagree, there is a huge diferance. Both normal and naked short selling create a "stock IOU", but who gets this "IOUs" The key is in who end IOU. If you look at graphics, you should understand:

    In a normal short sale, a securities lender (401k plan, pension fund, etc...) loans the stock (stock IOU). This securities lender is aware of the loan and the risk involved. This securities lender also gets cash equal to 102% of stock as collateral in case of default.

    In a naked short sale, the retail investor buying a stock ends up making an involuntary stock loan when the seller fails to deliver. This retail investor is unaware of the loan (it doesn't show on his statements) and has no idea his investment has counterparty risks. Additionally, This retail investor receives no cash as colleteral and will be left with nothing in the case of default.

    "legally having the stock in your posession" for even "30 miliseconds" is the differance between the buyer getting a real stock VS getting unknowingly screwed with a stock IOU.

  27. hmp49 says:

    "Only the holders of the real stock can claim a dividend payment. That can never be more than 100%."

    When you buy a stock, do you ask the seller "are you long the stock or are you a short seller?" You have no way of knowing, nor most likely does your broker.

    Every long gets the dividend. The short sellers get the tab for the dividend if they are short the stock, this funds the "additional" dividend beyond what you are thinking of as the "real" stock (i.e. the number of issued shares).

    As for this scheme being "legal," it's purpose is to manipulate the price of the stock, it's hard to see that NOT running afoul of the SEC (or at least the pre-Bush SEC).

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