How is Naked Short Selling Fraud?
Location: BlogsBob O'Brien's Sanity Check Blog
Posted by: bobo 1/29/2006 1:05 PM
I got involved in a discussion on the Yahoo message boards which questioned my assertion that naked short selling is fraud – specifically, the other party indicated that there couldn’t be fraud, absent damages.
Which got me thinking – what are the damages?
And here’s what I came up with: The damage is the entire value of the FTD. Why?
Because it is un-sellable once you know that it is an FTD, from a moral and ethical standpoint, not to mention a legal one. Why? Because an FTD is a counterfeit.
Why is it a counterfeit?
Well, simple, really. It is represented to the buyer, by the seller, as the genuine article – that is why it commands full price.
And yet it is no such thing – it has none of the rights associated with a genuine share – voting, the right to legal redress, etc. Just doesn’t – because it isn’t a share. It is something else.
The industry calls this non-share a share, in the interests of keeping everyone believing that as long as the same name is used, that it is the same thing, and you can keep right on trading, no harm done.
Only it isn’t the same thing. It is a counterfeit, a facsimile that is represented as genuine, but in point of fact isn’t.
Because this occurs electronically, the average person’s eyes glaze over at this point – because there is no easy way to tell what an electronic counterfeit is, much less visualize it. However, if you imagine it in the real world with paper stock, it is easy.
The seller offers for sale a “share”, and the buyer agrees to buy it. His account is debited the funds, and the seller promises to deliver the share in 3 days, and then doesn’t.
So no share delivered. Nothing in the box marked “account” with the buyer’s name on it, if you lift the lid and look inside.
That is the fraud part. But in order for there to be fraud, there needs to be damages. Where are they? Let’s keep on following the trail.
The buyer is told that he now has his “share” in the account – and nobody ever really goes and looks at the share – they just take the broker’s word for it. But it isn’t just the broker’s word. The broker actually sends a statement through the mail, and over the internet, which shows a share in the buyer’s account. Which is a claim on a share in the vault at the DTC. Eliminate that claim and collapse it, and it is a share. Fine. But no share was deposited with the DTC to back up that claim. THERE IS NO SHARE CERTIFICATE IN THE BUYER’S ACCOUNT “BOX”.
So what is that “claim on a share that doesn’t exist”, but is represented as a “share” to the next person, when the seller wants to sell the “share”? Is there a market where claims on shares that don’t exist trade with full disclosure that no share exists to back them up? No. There isn’t. There is only the market where genuine shares are bought and sold.
So the system needs to treat those facsimiles as genuine in order to affect trades, or you couldn’t sell the facsimiles.
But wait. The facsimiles weren’t authorized by the company as shares. They don’t have any rights attached to them. They aren’t genuine shares.
And yet they are represented as such when you buy them from the holder of the FTD. Nobody tells you that you aren’t getting a legit share – it is represented as genuine, in order to separate you from your money – because otherwise you wouldn’t pay anything for it, as it has none of the qualities of a legit share.
Huh.
So, is there a word for a facsimile, which is not genuine, being used as a surrogate for a genuine article? Specific to securities, for instance?
Yes.
It is, “Counterfeit.”
Here is the code section. 18 USC, section 514. Says that trading in these “counterfeits” is a Class B felony, and which describes how to identify a counterfeit – what the characteristics are:
“Section 514. Fictitious obligations
(a) Whoever, with the intent to defraud -
(1) draws, prints, processes, produces, publishes, or otherwise makes, or attempts or causes the same, within the United States;
(2) passes, utters, presents, offers, brokers, issues, sells, or attempts or causes the same, or with like intent possesses, within the United States; or
(3) utilizes interstate or foreign commerce, including the use of the mails or wire, radio, or other electronic communication, to transmit, transport, ship, move, transfer, or attempts or causes the same, to, from, or through the United States, any false or fictitious instrument, document, or other item appearing, representing, purporting, or contriving through scheme or artifice, to be an actual security or other financial instrument issued under the authority of the United States, a foreign government, a State or other political subdivision of the United States, or an organization, shall be guilty of a class B felony.
(b) For purposes of this section, any term used in this section that is defined in section 513(c) has the same meaning given such term in section 513(c).
(c) The United States Secret Service, in addition to any other agency having such authority, shall have authority to investigate offenses under this section.”
The bold sections are my emphasis.
I’m sure the legal-minded will argue that there is no intent to defraud. Huh. Really. Then why represent it as genuine to the buyer, other than to get their money for the article you know isn’t genuine?
That is the fraud part.
And the aiding and abetting counterfeiting, or rather the trafficking of counterfeits, would be the selling the facsimile once you are aware it isn’t the genuine article.
Now, a lot of folks address this by saying, “but everyone is doing it.”
I am reading the code, printed above, and I don’t see language that says “unless everyone is doing it, or Wall Street decides to do this on a large scale.”
Because it doesn’t say that.
So where is the damage that constitutes fraud? The purchase price, for which you received a facsimile, and which once you understand it is a facsimile, I would argue makes you a party to counterfeiting if you try to resell it.
Now, there are certainly greater legal minds than mine out there – what am I missing? I’m not a lawyer, but how is an FTD, in your account, represented to you as a genuine share, not a counterfeit in every aspect of the above description?
Anyone? Have I gone off the reservation here, or does the code say what it appears to?
In which case, wouldn’t the trafficking of FTDs, represented as real shares, be simple counterfeiting, albeit electronic? Just as if you could figure out a way to credit your bank account with a hundred thousand dollars of electronic dollar representations, which you just created on your computer?
Help me out here. Gary Weiss and the gang that say this is all silly are busy mocking this line of reasoning, with no clarity or rebuttal afforded. But here, where adults are in attendance, I’d like to hear from informed folks who know the law. Their arguments come down to: "everyone's doing it", or "Wall street doesn't call them counterfeits, so they aren't, even if they 100% match the code's description of counterfeits", or "nobody is enforcing that law W/R/T securities, so it is OK to violate the law whole cloth."
Does anyone have a problem with all this? Doesn't it start to seem like if you have enough money and power you can simply violate the law, constantly, and pay to have your violations ingnored or grandfathered, and then cite the lack of prosecution of the violations as proof that the rules don't apply to you?
And of course, I’m always interested in everyone else’s comments, as well. But I would LOVE to hear from attorneys who can disabuse me of my reasoning, or confirm it.
Copyright ©2006 Bob O'Brien
