Evidence of massive naked short selling. Or not.

Today Matt Taibbi posted a “shocking” article and video purporting to show a day trader engaging in massive naked short selling of a stock. And the firm that clears his trades, Penson Financial Services, goes along with it all.

Taibbi says that day traders can have a huge impact on stocks when they engage in lots of naked short selling. For those not familiar with naked short selling of stocks, it’s something the Securities and Exchange commission prohibits. Normal short selling of stocks is accomplished by borrowing shares of stock in a company from someone who already owns them, selling those shares to someone else, and then repurchasing shares of the same stock from elsewhere to give back to the original owner who loaned out his shares. Traders profit when the share price of a stock goes down… they’ve borrowed and sold high, hoping to repurchase low, and pocket the difference.

Naked short selling is the pet project of whack-job CEO of Overstock.com (NASDAQ:OSTK) Patrick Byrne. I have yet to see any evidence of a massive conspiracy to destroy particular companies by engaging in massive naked short selling of their stock, but that doesn’t stop Byrne and his paid stalkers from prattling on about their conspiracy theories.

Of course, they take their tinfoil hat wearing to a whole new level by actively stalking anyone who points out that Overstock.com is a horrible company or that  massive naked short selling isn’t the problem the nutjobs claim it is.

But there are those determined to take anything and make it evidence of the naked short selling conspiracy.  A company’s stock price goes down? Evidence of the conspiracy! A company’s stock price rises? Evidence of the conspiracy!

Taibbi explains how short sellers can abuse the system by not actually borrowing shares of stock before they short them. The rules say the trader doesn’t actually have to have borrowed stock or a locate (shares available to borrow). The trader just needs to have reasonble grounds to believe that the stock can be borrowed.

Sure, that provision is ripe for abuse. But the fact that it can be abused and has been abused is not evidence of widespread abuse. It’s like anything in our world. There are a zillion chances for fraud to occur. That doesn’t mean it’s occurring.

But Taibbi has evidence!!!

He explains the video posted with his article. First a short sale of 100 shares of a stock referred to as BANK X is rejected because it is on the hard-to-borrow list. The trader is then prompted to go through the process of locating shares to borrow to see if the desired trade can proceed.

The trader then allegedly requests the broker to locate “tens of billions of shares.” (The actual number is supposedly blocked out in this video to protect the identity of the trader.) On this day, there were only 5.5 billion shares of BANK X in circulation, so a locate on tens of billions of shares couldn’t possibly be filled.

However, the video shows Penson “locating” tens of billions of shares and approving the trade.

If this was real, we’d seem to have evidence of a massive naked short sale. There weren’t tens of billions of shares available, yet the trader made the sale. Supposedly. And such a huge sale of stock would cause a company’s stock price to fall.

So is this video genuine? Did Penson participate in a massive naked short sale of BANK X?

Not according to John Carney at Clusterstock. He easily proved the video is a fake, and in short order Penson said the video isn’t even of their trading system.  And a closer look at the video shows the trade was actually rejected, not accepted as Tabbai claimed.

But even before these two tidbits were available, Carney had this whole thing nailed as a fake with some simple logic:

  • A trade for tens of billions of shares simply won’t happen this fast, no matter how good or efficient the clearinghouse is. Trades from Penson take minutes to clear (sometimes up to thirty minutes), not mere seconds as shown in the video fakery.
  • You can’t sell shares without buyers. This video purports to show tens of billions of shares sold. Where are the buyers? This much volume doesn’t happen on one day in the U.S. markets, much less in mere seconds.
  • The trader would have to have enough buying power at Penson to do this trade, which would have meant billions of dollars in his brokerage account. Traders with that much money won’t be using Penson.
  • A clearinghouse is not dumb enough to let a trade his size go through because they have risk in such a trade.
  • A trade this size would probably wipe out the company’s stock immediately. And trying to buy back tens of billions of shares to cover the short would not go well either.
  • The “OK” that shows in the video is not the execution of the trade, but and acknowledgment that the system is doing a locate.

So what’s Taibbi’s response? That Carney and Clusterstock misunderstood his original article:

Business Insider writer John Carney here seems to have read my recent post on Penson and taken from that that I was reporting that someone had executed a short sale of tens of billions of shares in a company whose float was only five and a half billion. This would, indeed, be ridiculous. Except that is not at all what I reported.

What I published was a tape of a trader asking for a locate of tens of billions of shares. It is the size of the locate, and the speed with which it is approved  that is the issue, not the trade. The actual trade, if Carney had bothered to read the text, was only for 100 shares.

Really? Well the video is called “Penson Approves Billion Share Naked Short” and Taibbi wrote the following in his original article:

:17 At seventeen seconds, at the bottom, you see that the firm Penson has now approved the trade and” located” the multibillion amount of shares. The trade goes through.

Was Taibbi really saying that a 100 share trade went through? Because that point wasn’t clear in the original article, and would essentially be a non-story. The real story, according to Taibbi, was the multi-billion shares that could be naked shorted. And the story was headlined with the words “naked swindle”… but now he’s saying there was no swindle?

So either way you interpret the original story, we still  end up with no evidence of massive naked short selling.

All that aside, what’s Taibbi’s response to the news from Penson that this video isn’t even of their trading system?

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2 Comments

  • Michael Goode says:
    5 October 2009

    Yes it looks like the order is canceled. The one key feature that proves to me that this is a hoax is that no matter how scummy a clearing firm is, none would be stupid enough to allow a trader to buy/sell way more than they actually have. Letting any trader buy/sell 10x or 100x more than what they have in their account would quickly lead the clearing firm to bankruptcy.

  • Kid Dynamite says:
    6 October 2009

    I addressed this in a post today:

    http://fridayinvegas.blogspot.com/2009/10/rampant-mis-information-and.html

    the video was completely misunderstood by a journalist who has no trading experience. The screen shown in the video is not a locate request – it’s an audit trail screen where locate information is entered – because the stock was not on the “Easy to borrow” list

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