STUDIO: Do you see now that they do not have to cover the shorts sales?UPDATED. You really MUST read ALL of it.
If you just read what you like to hear you are fooling yourself and THAT WILL COST YOU,IF PLAYING THE PINKS MATE.
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 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 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.
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. 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.
Some of the tricks are as follows:
Stock sales are either a long sale or a short sale. 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.
The prime brokers 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 lend 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 lend.
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, provides the broker dealers with a central clearing source, and operates 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 customer's 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 deals 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 a 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.
