Counterfeiting Stock – Explaining illegal naked shorting and stock manipulation
counterfeitingstock.com
counterfeitingstock.com
Person A has 1 share of company Y. Person B borrows 1 share of company Y from person A, and then sells it into the market. This is called a short sale. But person B just sold their borrowed share. Now that share is owned by person C. Person C can now lend it back out to person D, or to person B again, and the process can repeat infinitely. The idea that short interest is constrained by shares outstanding is just a fundamental misunderstanding of how the short market works.
Shorting behaves the same way that fractional reserve banking does, and there is a 'money multiplier' like leverage effect in the process. There is nothing nefarious about this, and it certainly isn't 'countfeiting'. Short sellers provide an important service to capital markets, maybe the most important service: they help to identify mismanaged or fraudulent companies. The idea that attacking short sellers is attacking wall street is completely backwards. Most of Wall Street hates short sellers, because they drive down the prices of companies and confidence in markets (in the short run, in the long run, they increase it).
Yes. Except that the fractional reserve banking system has a lender of last resort.
Historically, systems without lender of last resort have done quite well. See eg the Canadian system of the 19th century, with no lender of last resort, and that often ended up as an emergency lender to the mis-regulated and crisis-prone American system to the south.
You can lend the whole share you bought.
But the bank cannot lend the whole dollar you deposited, they have to keep a fraction of it as reserve.
That automatically implies something more complicated than lending. At the very least, money was borrowed (on a promise) from a third party in order to provide the money they loaned.
You and I can do the same, I can promise you whatever I like. And if I manage to convince you, or a third party, that my promise is good, I can even borrow money from them. And loan out that money, despite not owing it; Unless there is something fraudulent in doing that wrt my agreements with the borrower - but the bank has the same, nationally regulated, restrictions too.
They can lend only $0.9 because they need to keep $0.1 as reserve (for example).
From there different things could happen:
a) if the borrower takes the $0.9 and takes it elsewhere the bank cannot lend a single additional cent until they get more deposits.
The fractional reserve means they could only lend a fraction of the dollar.
Maybe the money will be deposited in another bank who will then lend to someone else, but for the original bank who got $1 it stops there.
b) if that money remains in the bank as a new deposit, they have now $1.9 in deposits.
They can lend a fraction of the additional $0.90, and make an additional loan of $0.81 (keeping $0.19 in reserves in total).
If the second loan also ends in the bank as a deposit they will have $2.71 in deposits, they can make a new loan etc. but the multiplier is limited.
For shares there is no limit at all.
If Alice has a share she can lend it to Bob who sells it to Carol. Carol can lend it to Daniel who sells it to Elaine. Elaine can lend it to Felix who sells it to Gloria. Gloria can lend it to Hector who sells it to Ingrid. They can go on for as long as they want and all the ladies will be long one share.
The price of anything is a result of its some intrinsic value and the volume of supply. So a precious stone is valuable because of its beauty, but also because it's rare. If someone mines a billion such stones, it won't affect their individual beauty, but it will certainly reduce the price someone is willing to pay for one.
Now, you seem to be saying that short selling is a signal about intrinsic value, but the process you describe, whether you want to call it counterfeit shares or fractional reserve shareholding or whatever also messes with the valuation by inflating the supply. If there are more shares of a given company available, those individual shares will be worth less.
The result would seem to be that naked short selling at volume will create a self-fulfilling prophecy. You can drive the price down simply by inflating the supply, regardless of whether the company is well managed or not. Maybe you start with badly-managed companies, but there's always going to be a perverse incentive to target any company so long as you can manipulate the supply enough to force a price drop. If you care about the market as a measure of company health, that doesn't sound like a good idea.
To be super clear, naked short selling is banned for everyone but market makers [1]. A market maker goes naked short when there is a buying frenzy. Their economic incentive is to then cover the short given they are in a buying frenzy.
The NYSE explicitly markets its specialist system to issuers as a stabiliser mechanism. It’s a selling point to long-term investors and Boards. The only people who get upset about this are hedge funds and day traders who get ahead of their skis.
[1] By Wall Street tradition, every long losing money must allege naked shorting. That doesn’t substitute for evidence of it. Large amounts of short interest do not indicate naked shorting. (Lots of FTDs do, but this figure has to be scaled to leverage and volatility.)
After all, we allow something similar to naked short selling when people write options or trade futures. And those markets work just fine.
My comment was meant to say that I think it would be fine to allow everyone to do naked short selling like that. Of course, subject to margin requirements etc.
The actual share gets delivered 2 days later, and it doesn't matter whether who you bought from, short-seller or otherwise.
Your voting rights are exactly the same.
You are right that replicated shares with options and other derivatives usually does not come with voting rights. That's true.
The market price for voting rights on individual shares is usually miniscule. But non-zero.
I wonder what the value of short term naked short selling would even be? In that timeframe borrowing should not be very costly anyway? The GME shorts have been short way longer than 2 days.
First, to put everyone on the same footing as the market makers.
Second, just to make short selling easier in general. Short sellers are massively important to spots bubbles and other asset mispricings, but they never get any love.
When someone buys a stock very often the purpose is to "physically" have it as soon as possible.
Though funny enough, stocks are already a virtual thing and exist in computers only. Whereas oil or onions are physical goods, and there are real consumer who absolutely need real physical onions.
What you are saying is like saying that lending money to your friend creates inflation by expanding the money supply, because you still have $10 (that he's holding for you), plus he also has $10. In fact, since he knows he owes you $10, he's going to have to cut back on his spending at some point in the future, to pay you back. (Your mileage may vary with actual friends.)
The key difference in your estimates of supply is that you include the future repayments of current lending, but ignore future lending. The general assumption in macroecomics is that we don't treat such lending as isolated one-off events, but as a sum of ongoing activity by many people, continuing forever at a stable level unless some event affects it.
Assuming that the principles governing lending don't change, the future repayments are balanced by payouts of new loans at that point of time, and the current payouts (if they are greater than current repayments of past debt, i.e. there's a net increase) are not balanced and thus increase the supply. If at some point the fundamentals change so that the lending decreases or stops then that event would decrease supply back to where it was.
I.e. if you often lend money to your friends so that usually someone or someone else owes you $10, then this lending is not a change and does not affect supply, but if you did not loan money and now you start lending, then that $10 is an increase in money supply.
You are talking about lending by banks, and/or the central bank, which is quite clearly money creation.
New lending of your money to your friend does not create additional money.
There's also a word game going on here. What you are describing is a situation where I lend money to my friend, and for the purpose of your analysis, you assume that I will always have lent out a similar amount of money forever starting now.
That's fine if that's what you want to analyse. But that isn't the situation I described.
Not if the company goes bankrupt though, right?
Seems like a potential strategy hedge funds can use (and maybe are using) is to short a company a ton and collect a lot of money from that. They can short more than the float, so even collecting more cash then the market cap of the company. This drives the price down, because there is more supply. The more they short, the more the price goes down. Then they just wait for the company to go bankrupt, which is more likely since the company's share price is in the dumpster.
See, eg, https://www.bloomberg.com/opinion/articles/2018-04-11/-go-to...
> Seems like a potential strategy hedge funds can use (and maybe are using)
Anyhow, no, doesn't work. Even apart from getting burnt when the fraud is finally exposed and the company goes bust before your short position is closed or whatever (which is thankfully pretty unusual), stock borrow costs will eat you alive. Also, you can't short more than the float (short interest can be over 100%, but that's confusing net versus gross), you can't collect more cash than the market cap of the company, and you can't really bankrupt healthy companies by shorting the stock.
(The way short sellers (like Muddy Waters work is they find a company doing a bunch of fraud, they take out a large short position, then they publicise their research. If the market agrees with them, the uncovered fraud tanks the stock price, and they make a healthy profit. Sometimes the company ends up bankrupt and/or with their executives in prison, but the cause is the fraud, not the short selling. Short selling an otherwise healthy company into bankruptcy doesn't make a lot of sense in theory, and doesn't seem to happen in practice.)
This is giving the market a lot of credit for being a rational and well-informed actor. The market is not full of people who calmly evaluate a short seller's argument and make a logical decision. It's full of people who lack the time, experience, and confidence to question the "financial expert" making dire predictions on the morning news and think "I should get out of this stock just to be safe".
In practice you just don't see examples of productive companies driven into insolvency by short sellers.
But it's a question of scale. The fact that any one investor may make mistakes doesn't mean that the market as a whole, in the medium or long term, also makes these sorts of mistakes.
"Some hedge fund guy released a report saying stock X is bad and the stock tanked 30% from small investors panicking before recovering when people realised it actually wasn't bad" is pretty silly, yes. And it's a bit rough on the small investors selling at a loss into the large investors who are able to correctly analyse the report, absolutely. But does any company actually go bankrupt in cases like this? The answer seems to be no; there's no evidence for it happening, and it's hard to see how it even could. Confused retail investors can lead to price volatility, but they don't make or break a new share offering.
There's no such reality check with things going up on the long side as we see from Gamestop. Someone can't step in and cash out on the company at a ridiculously high price compared to fundamentals. It is only driven by the market. In general short sellers are vilified more than warranted. If you are long on a good company you should applaud them because after all, they now have to buy back at some point. People view it as if you are some villain going against what is right (shares just going up and everyone gets rich). Stocks that go down with high short interest are almost always going down because they are bad companies, not due to short sales.
No. The price of a stock is the value of its discounted cash flows.
Shorting creates synthetic shares, that guarantee the new longs an exactly replicated stream of cash flows. This doesn’t make the original shares any less valuable, because they still have the same cash flows.
Imagine someone conjured a new company, called Tesla-2, out of thin air. It’s future profits and dividends exactly match Tesla. Why should this make TSLA any less valuable?
If people are investing in TSLA for the company’s long term viability, the existence of TSLA-2 should be a good thing for holders of TSLA. Now they can buy even more. It’s only bad if people are buying TSLA as a speculative asset to flip to a greater fool. Which is why short selling is such an important mechanism to prevent speculative bubbles.[1]
[1] https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1540-6261....
Nearly. There ARE a few other reasons to own a stock, such as the right to influence the governance of a company.
(I agree that shorting is an important market mechanism that protects against frauds and bubbles. I am much less sure that naked shorting provides value. In fact, I'm not sure I have ever heard an argument for why naked shorting is valuable... they always turn out to be arguments for why shorting is useful.)
Once the IOU comes due, B will need to acquire a share from D to give back to A, at which point both A and C own a share - but D no longer does.
At no point are there any magic duplicated shareholding rights.
And you don't get extra voting rights for shorting (borrowing) a share.
https://www.investopedia.com/ask/answers/05/shortsalevotingr...
In my naïve view, TSLA's future cash flows have value because the company is expected to sell a lot of cars that:
1. No one else makes (or practically no one, such that TSLA has a majority of market share)
2. Many people want to buy.
Now, supposing TSLA would be able to service all the demand for its cars, how would a competing TSLA-2, presumably offering identical cars (or of identical value at least) not affect TSLA's future cash flows?
All things equal, if two companies sell products that are basically the same (same quality, price, etc), wouldn't that split the market in two? I wouldn't expect to see people buying twice as many cars because there are now two companies producing them.
Short term trading has nothing to do with fundamental.
The market can be irrational.
The price of something is just what someone else will pay. Period.
Intrinsic value factors into what people are willing to pay but only indirectly.
See: beanie babies, trading cards, status items, old land rovers.
No, it's the result of supply and demand not supply and “intrinsic value”. Demand is driven by subjective value, not “intrinsic value” which is a nonsense concept that misunderstands fundamentally how value and human action relate.
Tautologically so, in the sense that the market’s notional consensus of the expected future cash flow is inferred by those who are convinced of it's simplistic financial rationality from the stock price and assumptions of the proper discounting mechanism. Factually...that's a bit harder to argue.
There's some a-step-more distant proxies that people hold up as touchstones for that like P/E ratio, but those aren't consistent across stocks or, marketwide, over time.
short selling does not increase the number of shares. if i borrow a share from you and sell it, you cannot also sell that share. the number of shares is constant regardless of how many shares are sold short (except for naked short selling).
short selling increases the number of people that can sell, but that only increases symmetry in an otherwise asymmetrical system. anyone can bet that the price goes up, but without short selling, only people that already bought can bet that the price will go down.
> there's always going to be a perverse incentive to target any company so long as you can manipulate the supply enough to force a price drop
what is "manipulative" about selling a stock? if i buy a bunch of stock (to make the price go up), is that also "manipulation"?
I think some of the confusion is people talking past each other.
I think some people latch onto the whole concept of "borrowing" as the supply inflation. In the housing market, when I buy a house it is OFF the market. There is no "borrow someone's house & reintroduce it into the supply and gamble on the direction of the market".
Can you comment on how that interpretation is wrong?
The case outlined in the whitepaper is not just regular short-selling (e.g. you borrow a share and sell it, with a promise to buy it back). Short selling has actual uses in a market and they are not claiming that shorting in itself is "manipulative" or "fraud".
Their claims of counterfeiting stock involve the use of naked shorts(a.k.a where a share is sold, but never borrowed) Naked shorts must be attached to a real share within 3 - 21 days, not doing so is illegal. They outline a series of loopholes which are used to sell shorts w/o ever borrowing a real share, effectively diluting the actual stock issued by the company with extra counterfeits to drive the price down. The goal is to drive the price to 0 and bankrupt the company, so that the shorts don't have to be covered anymore, netting a large (tax-free) profit.
> if i buy a bunch of stock (to make the price go up), is that also "manipulation"?
No, lets talk about the details of how actual manipulation works. Below is not an exhaustive list of manipulation tactics, just a selection of examples:
1. SEC rules left a loophole allowing naked shorts to be covered with naked calls. No actual instance of stock has to actually be borrowed in this case, but it's not marked as a fail-to-deliver in SEC reporting. The naked call option is not tied to any stock issued by the company, it's just an option to buy at a future date, but it can now be repeatedly borrowed out for shorts as if it were a stock.
2. The SEC keeps track of fail-to-deliver in the SHO list and has requirements of 3 days for brokers and 21 days for market makers to borrow an actual stock. Another fraud claim is that brokers/hedge funds collude to pass around naked shorts between offshore shell companies in order to indefinitely reset the 3 day SEC requirement to keep naked shorts indefinitely and keep it off of the SECs fail-to-deliver list. They also use a similar technique to allow 8 - 10 shorts to borrow the same shares and then just move them around in time to meet SEC reporting deadlines. During any audit by the SEC, the SEC calls ahead and they move all naked shorts to offshore accounts where they can't be seen and then move them back once the investigation is over.
This means for every fail-to-deliver marked on the SECs books, there will be several times (10 - 20 according to the whitepaper) more counterfeit shares being sold by shorts that are not tied to any real shares.
3. The third fraud claim involves the clearing house (a.k.a a broker for brokers) the DTCC (we care about two of its subsidiaries DTC and NSCC). When a broker sells a short and fails to deliver an actual share in 3 days, before 1981 they would be forced to buy it back. After 1981, they can borrow one from the NSCC Stock borrow program. The NSCC will then go to the DTC which holds all the stock certificates and find a broker with a surplus of shares and borrow the necessary amount of shares.
Now here's the fraudulent part. When the shares are borrowed only the net amount is deducted from the surplus, but no actual shares are actually removed from the individual accounts of the broker. Now both the lending broker and the borrowing broker have real shares in their account, but they're the same real shares. Since the borrowing broker has real shares now, these same shares can again be lent out by NSCC to another borrowing broker and again no shares are removed. Now 3 investors have the same shares in their account. Since transactions are done as net transactions (instead of individual stocks) between brokers, the fact that 3 investors have the same share never has to be reconciled and two counterfeit shares have been created.
In regards to the GME short, even though only 71 million shares were issued by the company, currently institutions have reported to the SEC (13F filings https://fintel.io/so/us/gme) that they own more than 113 million shares (including 13% owned by gamestop ceo).
Additionally according to the SEC's fails-to-deliver list for December, Gamestop has nearly 1.8 million shares failed-to-deliver. Most companies have anywhere from 0 to a few thousand. Going by the whitepapers estimates the number of counterfeit shares would be 10-20 times that amount, indicating that ~ 40 million shares of Gamestop would be counterfeit.
In order to verify these accusations with concrete data, we would need access to the books/transactions of the DTCC. They are a private organization that is collectively owned by brokers and they are very secretive and have few disclosure requirements due to regulatory capture at the SEC.
An undervalued share price is also a great opportunity for the company (or anyone really) to buy back some of their stock. In that sense, by manipulating the price too low, the short sellers are basically giving the company an opportunity for easy money.
Also, why wouldn't you have to pay tax on gains from a short if the company goes bankrupt?
If a casino allows you to make play as long as you want, i.e. unlimited bets, does that de-value the bet?
If the shorted stock doesn't go down, people need to pony up the difference to buy it back; it is that capital risk that represents the "skin in the game", and why shorts aren't really unlimited, any less than an insurance company is limited in how much insurance it sells, by the capitol it holds to pay out on claims.
This website seems to mainly be talking about naked short selling, which is selling a stock without first owning or borrowing it. This not necessarily illegal, although can be under some conditions, including aggressive short selling. Wikipedia has a fair amount of info on the practice, https://en.wikipedia.org/wiki/Naked_short_selling
The practice of a selling a share that one does not own is supposed to be used by market neutral market makers to ensure their is always liquidity. They must then at some point in the future buy a share from the market to replace the phantom (i.e., counterfeit) share that they sold.
This practice is useful when there are suddenly more buyers than sellers and the market maker exhausts their standard supply of shares. Otherwise there may not be any bids on the stock at any price for sometime. Other argue that this is no longer necessary with many participants beyond market makers that also employ algo trading and can quickly adjust to increasing demand. Further, if lack of supply becomes a regular occurrence, investors may start regularly setting high, possibly even ridiculously high, standing sell limit orders such that there will always be bids at some price points.
I call up Dominos and order a pepperoni pizza. They take my order and process my credit card. They’ve just sold me a pizza that doesn’t exist. Is this fraud?
There's nothing special about shorting in your imaginary scenario either. You could change your scam to "I own Dominos stock and don't order any pizzas, but I put out articles claiming I ordered a million. People will buy up the stock expecting the profits from the million-pizza-order and I will pocket the money. These long holders are a scam"
No because they have the raw materials and labour to make a new pizza and have entered into a contract to do so.
Short sellers don't have raw materials to make new shares.
If I sell you an August-settled coffee future, that's a promise to deliver you coffee in August. Is it fraudulent if I don't have the coffee right now? After all, I've sold you something I don't own.
Of course it isn't. What matters is that the contract is fulfilled, and for equity sales in the US, the contract states that a share will be delivered to the buyer 2 days after the transaction.
How about if you sell a share that you bought within the last two days. I mean, your buy trade hasn't settled yet so you technically don't own it yet. Is that fraud?
From the other end, someone is accepting payment in advance i.e. selling a product that doesn't exist.
If you intend to purchase that product (or constituents of it) from third parties, then that becomes selling a product that you don't own (the third parties you intend to buy it from currently own it).
Now you can say it doesn't yet exist, or isn't yet bought, in order to fulfill the order - but the argument for selling stocks you don't own, is that you don't yet own them. I see no reason to say a genuine intent exist when fulfilling a purchase order, but not when returning a stock; kick-starter provides enough evidence against that..
It's not fraudulent if you don't have the coffee, as long as you make public that you don't, "I do not own any coffee, but will sell you a delivery of coffee for August".
Now, if you're selling share in ownership of a company, IMO it's right to disallow - by law - representations of ownership of companies that are not backed by numbered shares. It's not coffee, you can only own shares in the company itself, you can't get those shares from other origins it's not a commodity.
You make a post-harvest offer to sell me coffee from a particular plantation, then you arrange for the media to report that plantation's coffee is really inferior, maybe not even drinkable - something you had arranged in advance, of course. Tell me, why is this good for society? Now, you advertise, with your friends, lots of coffee available at low prices (after all the media said it's inferior coffee), only thing is you're offering more coffee for sale at low prices than there is coffee from that plantation ... that's driving the price down, there being lots of coffee noone wants ... only it's a lie, a trick, a fraud, just so you can manipulate the price. And now, oh look that plantation has gone out of business and you managed to buy them coffee I ordered for essentially nothing. Wow, you added so much value to the World by destroying the livelihood of that coffee plantation's workers.
Furthermore, that agreement doesn't in any way apply/affect to the stock you sold (or the person you sold it to), the obligations to return is yours alone.
In the end there’s a chain and if the person who lent you the share wants it back then the person you loaned it to will need to produce it for you, etc.
This is why we have margin accounts (and limits to how much margin we get/can support).
The analogies hold though - people sell things they don’t own all the time. The important thing to understand is it is based on promises to deliver an asset/money by a certain date.
Likewise people buy assets on margin all the time. This means people can buy things they don’t have money for based on a promise they will pay that money back. Credit cards, mortgages, auto loans, bonds, etc.
This is how our finance system works and for whatever problems it has, the future promise concept isn’t one. Especially with the regulations and limits on it.
Agreed. People should be able to take the pessimistic side of a trade.
The one problem I could see with short selling is not the technical act of selling short, but the (dis)information campaign around a company that appears to follow. But, this happens both ways good and bad so it's probably a wash.
> Most of Wall Street hates short sellers, because they drive down the prices of companies and confidence in markets
There's also an emotional dislike of the person who wins when you lose. Short sellers are like the person playing 'don't pass' in craps.
Absolutely. A real problem in things that aren't publicly traded on open markets is hype asymmetry. Somebody who wants the share price to go up can put enormous amounts of time and money into creating the appearance that the stock is worth more than it is. But there's no corresponding incentive to puncture the hype.
I suspect every one of us can name a privately held startup with a valuation we think is absurdly high. But there's no practical way to bet against them until they're publicly traded and we can short them or buy options (which may get hedged by buying or (short) selling stock).
Only if you ignore reality. Huge hedge funds are called market movers for a reason. These hedge funds decide to short your company's stock and they have a direct impact on your stock value regardless of whether the hedge fund has any basis for actually shorting. Their "reason" can be 100% bullshit. Doesn't matter. They put a large short position on your company and it has an immediate direct impact.
Not only that, like you said about disinformation, it also allows them to get other parts of the market to also jump on board.
The way shorting works with hedge funds is that it is a self fulfilling prophecy a huge majority of the time
And people talk about how capitalism has driven companies to only care about the next quarter. Everyone realizes this is overall a bad thing. Short sellers are one of the reasons you have to do that.
I don't believe shorts have any intrinsic value they are actually bringing to the market. People choosing not to buy stock at existing prices does the same thing people claim shorting does. You don't need to borrow stock and sell it back making a profit to have a functioning trading system.
This is obviously related to the stock price and has an operational impact.
In the widely reported Gamestop case, they write that over 140% of all shares were naked shorted - aka created from thin air.
This is very different to normal shorting, that is ok.
Well, the FDIC insures up to 250k of bank accounts, but what happens when there’s a run on your 401k?
Of course if many Alices do that, that will push down the price of GME, because it's market-relevant information that many people think GME will go down.
The real problem is counterparty risk. What happens if Alice runs out of money and can't pay up, or there's a run on all Alices at once? So a system of guarantors is needed. But this is far from the simple argument that "selling a borrowed car is stealing".
What happens to Person A in this scenario?
Person B thinks that it will cost less to buy that share in the future than the money they make from selling the share today, which is why they asked A to lend them the share in the first place. They plan to buy a cheaper share and give that back to A.
A doesn’t care if they get back their original share, they just want to get a share back.
Options are contracts which expire. A short position is not that, it doesn't have any expiration date.
It can be untenable to maintain that short position forever due to costs, but that's a different discussion.
If it is possible to 'create' and sell an infinite amount of shares, wouldn't this automatically and artificially dilute the stock price, making these short attacks self-fulfilling prophecies?
This makes me think, that the theory that retail traders own more than 100% of GME might actually be true and that this is the reason why the situation is still not resolved.
But it's a same concerns longs have. If people borrow non-stock (money) and buy too much stock the price goes up, self fulfilling prophecy.
It works the way lending in general works. “Fractional reserve banking” is a very specific, restricted mechanism of lending, and I'm not sure what the equivalent of “depository institutions” with centrally-mandated common “reserve requirements” based on their “deposit liabilities” are in shorting.
At least there the shares move from one hand to another. Pure option/derivative contracts allow parties make bets on a stock without ever touching actual shares. That's the original dark market I fear is pushing these prices.
The author does not complain about short sellers per se or about the fact that more than 100% of a stock's float can be shorted. That is all nice and fine. Instead what the author does complain about is that fact that the (supposedly regulated) mechanisms for shorting a stock are fraught with loopholes and exceptions that make it possible for brokers and the DTC to create stocks "out of thin air" for the short sellers and never neutralize. This dilutes the company's stock in the process and thereby damages the company's shareholders.
It is an issue that, if true, should absolutely be brought to public and regulator's attention.
While this doesn't mean a price of infinity, since price is also constrained by the available money for the purchase, in reality this then becomes a liquidity trap which is guaranteed to bankrupt the least liquid short sellers until enough positions have gone under to bring the short position down under the float size. So whilst some flexibility may make sense to resolve some of the buffering issues with settling, if that is being deliberately exploited as claimed in the article, that is a huge regulatory problem.
The point of a naked short system is that short sellers never need to cover their positions.
Naked shorting allows any credit worthy institution to create synthetic shares as long as they continue to pay the dividends. That’s what makes it IMO a superior system. It eliminates the disruptive problem of short squeezes. Shorts can never get recalled, because they’re simply synthetic cash flow streams.
Overall we want more short selling in the market, and therefore want to remove as many constraints to short selling as possible. Short selling improves price efficiency[1], increases liquidity[2], reduces corporate fraud[3], and helps protect against speculative bubbles[4]
[1] https://academic.oup.com/rfs/article-abstract/24/3/821/15904... [2] https://img.iex.nl/iexprofs/images/2008-12-01ResearchEvidenc... [3] https://onlinelibrary.wiley.com/doi/abs/10.1111/jofi.12369 [4] https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1540-6261....
Wouldn't you want to know if what you bought are actually, say, AAPL shares or "synthetic shares"?
An AAPL share will always be worth an AAPL share. What can you say about those "synthetic shares"?
The biggest asterisk is hand waving away the credit worthiness of the synthetic issuer. But this is a solved problem. We have plenty of derivative markets, where a counterparty guarantees some cash flow related to an underlying security. You just use central clearing houses and set reasonable margin. Nobody worries about whether their options will actually payoff or if their futures contract will default.
No, the stream of dividends doesn't have identical value.
There are other relevant corporate actions.
Shares can vote, your stream of dividends cannot vote.
If the company spins-off a segment it may distribute shares of the new company to shareholders while the owners of that third-party stream of dividends won't get anything.
If someone wants to acquire the company they will make an offer to buy outstanding shares, they won't care at all about those syntethic streams of dividends.
In general, if you want to sell a delta-one derivative that's fine. But you cannot sell that to someone who wants to buy a stock!
Would you want to be delivered a derivative when you bought a share in the market?
That wouldn't be shorting the stock, it would be selling something else. Related but far from identical.
> If the company spins-off a segment
A spinoff is just a divided in the form of stock in the new segment. This is easy to handle. The short is now simply short both one share of the original and one share of the spinoff. The long now owns synthetic shares in both.
> If someone wants to acquire the company
An acquisition is just a one-time terminal dividend to the company. In a cash acquisition the short owes the long the value paid for the stock. In a stock acquisition the short is now short the equivalent shares of the acquiring company.
> Shares can vote, your stream of dividends cannot vote.
This is the biggest wrinkle. But it basically still exists even in the current system. If a stock has short interest of 50%, then there's 150 shares held long for every 100 shares of float. In practice it's not really that big a deal because 99% of investors just vote the proxy.
At voting time, some investors will find they own synthetics and some will find they own originals. Just the same as today some will find their stocks on loan, and they can't vote. It doesn't really seem to make a difference.
IMO I think a requirement for public listing should be letting all beneficial owners, including those who own synthetic shares/have shares on loan. I think if anything it strengthens corporate governance, by avoiding voting rights shenanigans. The two classes have equal interest in setting the company perform well.
In the "current system" there is no problem at all. Those who lent out their shares cannot vote.
Sure, you can write a contract detailing all the possibilities. Maybe even get those derivatives listed.
But you could be doing that already!
I'm not sure what are you proposing that should replace "the current system".
Do you suggest that when you buy a share of J&J or whatever, and pay the price of a share of J&J, you may find later that what you got is a derivative product issued by "I can't believe it's not stock! Ltd"?
This is simply not true at all. Like anything that can be bought and sold shares derive their value from supply and demand.
[1]https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1540-6261.... [2]https://onlinelibrary.wiley.com/doi/abs/10.1111/jofi.12369 [3]https://academic.oup.com/rfs/article-abstract/26/2/287/15819...
If irrational investors are being driven out why is there an evident trend of increasingly irrational stock prices over time?
Naked short system is potentially very disruptive (like we are currently experiencing with GME), is essentially a tool for entities with large capital to synthetically induce bankruptcy earlier than necessary, and poses systemic risks. There is a reason there are regulations that attempt to guard against it.
See: Dark Side of the Looking Glass, a 9-part lecture on the same. Part 1: https://www.youtube.com/watch?v=gpWzOjB8qtU
All short sellers can do is reveal pre-existing flaws In the company. Which is why the presence of short sellers reduces corporate fraud
So can negative press coverage. And yes, either can prevent a company that is on the brink from staving off bankruptcy. It's questionable whether you ought to call the press coverage the cause of the problems, though, and the same objection applies to the shorting.
Would the previous majority shareholder group lose their majority even if they had sold no shares?
Or would the new majority shareholders have no decision making power even though they have more "shares"?
This can be used to get more votes by borrowing stocks just to hold and vote.
But I'm asking in the case of naked short, which is what is being defended as "superior system" in this thread.
Whether a long is synthetic/borrowed or primary, their interests are aligned. They both want the company to do as well as possible. It also avoids voting rights shenanigans that exist, even with the current borrow-to-short system. At the very least it seems extending voting rights to synthetic longs won't ipso facto make corporate governance worse. I see no obvious downsides. And the academic evidence shows that removing constraints to short sales makes corporate governance significantly better.
The real world is not a special case.
If naked short selling is restricted to short term trades in special circumstances (as it is now), the system still functions and market makers have a little more freedom to create liquidity (whether the liquidity is worth the other issues is a question I won't try to answer here). Allow unrestricted naked shorting though, and the next time you buy shares in msft, it could turn out that your investment depends on msft dividends paid by a hedge fund betting on cattle futures more than it depends on microsoft's financial performance.
The tone of this is just short of complaining about "the international Communist conspiracy to sap and impurify all of our precious bodily fluids". But what they say is all exactly true of all speculation, short and long. The only thing that's actually an "investment in American enterprise" is buying new shares in a public offering. The rest is just gambling on the outcome to "feed Wall Street's insatiable greed".
Indeed, one could argue, as short-sellers do, that unchecked positive hype is more damaging to market participants, because it obscures the underlying value of a instrument causing people to overpay. When people buy something overvalued, they've already lost money; they just don't know it yet. Shorting helps keep those dastardly long-sellers in check, keeping them from stealing the hard-earned money of retail investors everywhere. If shorts manage to momentarily drive a price down below the intrinsic value, why they've just created a bargain for savvy investors. They are in fact doing a public service that otherwise would have to be performed by intrusive regulators. Etc, etc.
I think the truth lies between. Speculation, short and long, is economically valuable because it aids in price discovery, creating a liquid market so that actual investors in a company can exit, freeing up capital for further new investment. One could argue (and I often do) that we have way more speculation than we need to fill that economic purpose. But complaining bitterly about just the skeptical side of that speculation is like arguing that Hacker News should only allow positive comments about startups.
Who cares about the tone? It's f**ing dumb.
But the reason to care is the same in both cases: people with good points generally don't need to cover them up in a lot of bonkers language.
Even during the heights of the last few financial crises, clearinghouses did not fail.
(Option writers and people trading futures are in a very similar situation to short sellers. They also have clearing houses.)
They're mine.
If there are naked shorts floating around (or shorts covered by my stock without permission), someone else is making money off of risk I am taking on, but didn't agree to. There can be a cascading set of failures which lands with me not having my shares.
It's the difference between taking out a $300,000 mortgage on a $500,000 house, versus borrowing $300,000 with no collateral. You'll get a different interest rate, if you can get a loan at all. And this resembles someone taking a $300,000 mortgage, only missing the house.
Yes, there's always a risk, but that risk profile is very, very different (esp. in the case of catastrophic events, like a stock market collapse or similar, when many institutions might be going down at the same time).
If you don't want that, don't. It's in your control.
First scenario, B sells the share they have to X.
Second scenario, B sells the share they don't currently have to X.
And there's a third scenario where B has not even ordered a share, but still sells a share they don't have to X.
All the shareholders will get dividends, for example. The same as if there were no shorts. The only thing that those who lend their shares will lose is the voting rights - and those who don't lend their shares will vote normally.
This creates the illusion that there's a LOT of people who believe the stock will go down in price, which can affect market sentiment and actually cause real movement when in reality that wouldn't be possible if every short was in fact backed by a real share (which they're trying to do via rules making Naked Shorts illegal).
It's kind of weird to distinguish "naked" shorting from this when they're functionally the same.
Initial conditions: Alice has a share of XYZ
Proper shorting: Alice lends her share to Bob, Bob sells the share to Carol
=> Alice has a share (lent to Bob, who will have to pay her the eventual dividends), Bob owes a share to Alice, Carol has a share (which has full rights including voting and dividend)
Naked shorting: Bob sells an imaginary share to Carol
=> Alice sill has her share (with full rights)
What does Carol have?
Would you rather be the Carol who bought the XYZ stock that Alice lent to Bob or the other one?
Proper-shorting-scenario Carol owns a perfectly good XYZ share.
What does naked-shorting-scenario Carol have?
In the naked short scenario you don't immediately have the share, though I'm unsure how important this is for someone shorting the stock.
In saying that, brokers can still fail to deliver the share with non-naked shorting in which case it is effectively a naked short.
In the case of $GME, there were a lot of shares that failed to deliver in December as shown in this /r/wallstreetbets post: https://www.reddit.com/r/wallstreetbets/comments/l97ykd/the_...
Short-selling is forbidden to reduce the risk that when you want to buy a share and buy the share you find a few days later that in fact you didn't quite buy a share because whoever sold the share to you didn't have one to sell.
But it's fine, I concede the point.
As far as I care, you can find weird to distinguish "naked" shorting from "borrow-and-sell" shorting because if the short-seller who didn't borrow the stock before selling it does borrow the stock afterwards to be able to settle the trade the end result is the same.
The person who's most affected by naked shorting is the unsuspecting person who buys the borrowed share from the shorter because nobody actually has that share yet.
From the buyers perspective I can understand the importance of this, I just didn't see how the distinction made a difference to the short interest.
You have issued 10 million shares; but the market is trading with 15 million because of counterfeit stocks.
The bankers and the hedge funds have got to dilute you; actively hurting your fundraising ability, and of course; your stock price (which you may own as a founder).
It’s because I believe in ownership of what you make. If you founded a company, sold 10% on public markets for float, and magically 20% of your cap table now exists on the NYSE; something is horrifically wrong.
And yes, you would have suffered negative financial outcomes because of the counterfeiting.
If you can't it is because you are making mental gymnastics as soon as the word is some magical word Wall Street made up. Sure it is correct that you can but it shouldn't be and can't be fixed fast enough.
But thank you to everyone who gave me GME money with their mental gymnastics <3
Does this mean that I've found an infinite supply of free burgers and should go into competition with McDonald's? No. Because I'm going to have to buy the burgers from McDonald's to supply to my children. They own two new paper burgers, but I'm short two burgers. So the net total world supply of burgers is unchanged.
So you're saying it's okay to promise burgers as long as it's an amount that actually exists and McDonald's can fulfil it. So what you're saying is that you shouldn't sell things you can't possibly fulfil? Hence the argument against this kind of trading.
A regulated entity might have capital requirements which would limit the no of burgers promised to money held. Another might be a contract with mcdonalds for N burgers, or a warehouse full of burgers - shorted stocks require the lender to actually sell a stock, and the shorter to actually sell it (and buy it back later) but there will need to be security/"deposit" on the returning of the stock - there exist a risk that the lender will not get their stock back, which is part of the reason for the premium.
Since you/I are not regulated financial institutions, not may would trust us to deliver 1 trillion burgers on paper; so the flaw exists in "What if they take their future 1 trillion burgers and sell half" - sell to whom? They'd have to find someone willing to buy. "What if you walk into McDonalds to claim the 1 trillion burgers" - the "paper burger" is an agreement between you and some third-party, not mcdonalds. You couldn't pre-order items from one shop, and go to another store with you invoice and demand they fulfil it - your contract is not some general/official currency, there is no obligation to accept it.
> So you're saying it's okay to promise burgers as long as it's an amount that actually exists and McDonald's can fulfil it.
It's a promise that you will supply N burgers, so the criteria for ok-ness is that you can supply N burgers, that McDs can provide that many is necessary-but-not-sufficient alongside:
- you can pay for N burgers - you can transport N burgers (on time)
but when I say "ok", I mean from a "morality of making personal promises" perspective, not "financial promises/obligations made by a regulated financial institution" perspective. Individuals are not financial institutions, and financial institutions are regulated as such.
Person D borrows Person C’s burger and sells it to Person E.
Still seems to work? Then, tomorrow Person B and Person D owe burgers to Person A and Person C.
If there is only one burger in existence, this will create demand pulling prices up I’d think.
What can happen in real life is Person A and Person C are given a digital receipt confirming delivery of the burgers they were owed and that is the end of the transaction. To shield themselves from revealing potential fraud, the brokerage will charge a $500 fee if either of them ask for proof of their burger.
Now, while there may only be one burger in existence, it appears as though there are two, keeping demand artificially flat.
So how could you do this? Well you could create a burger delivery service that sells other peoples burgers. But you sell them for a bit more than what you pay for them and you can begin you’re offering “all the burgers” and connecting the sellers with the buyers. Now you’re creating burgers out of thin air to people buying them from you and you’re delivering the burger they ordered even though you don’t even own a grill. Congrats, you just created a burger exchange that sells promises of future burgers on margin out of thin air.
If you’re even smarter you’d use other people’s money (which is key) to capitalize this venture instead of your own and keep an outsized share of the profits. This is what investment banks and hedge funds do. Other people’s money is key to winning and not really losing.
You never look at the value of a dollar as the % of total dollars in circulation. The value of a dollar is rather defined by how many goods/services/other currencies you can get in exchange for it.
With stock it matters a lot more how many % of a company is represented by a single share.
Similar, each short seller not only adds a _virtual_ share to the market, but also has an obligation to later on buy a share back.
Again, to be super clear: for everyone but market makers, the law is you have to locate the borrowed share before selling short. Market makers can naked short to provide liquidity in a buying frenzy. Given they're shorting into a buying frenzy, they tend to be quite motivated to immediately cover themselves.
We have lots of people shorting GameStop. We have zero evidence anyone is improperly naked shorting.
I think naked shorting would be a perfectly valid thing to allow every investor to do, you clearing house would just want to ask for pretty high margin requirements.
Very similar to how there are covered call options, but also naked call options. And the economy hasn't collapsed either.
Horrifically wrong! Heavens to Betsy!
What went horrifically wrong is the company went public with a clueless CFO. For all corporate actions—reporting, dividends and buybacks—that additional float is meaningless. It’s only relevant for short-term holders and short-term metrics.
My understanding is that naked shorting can be used to artificially lower the stock price by increasing the supply with the ultimate goal of driving the company into bankruptcy.
So on one side you have illegal(?) market manipulation benefiting sophisticated traders and on the other you have companies that are presumably creating jobs and generating something of value being destroyed as a result of financial engineering.
You can decide if that's upsetting or not.
Why?
A owns a share, loans it to short seller B. B sells the loaned share back to A. Then A loans the share again to B, B sells it back to A. Now repeat the process a million times.
You can get arbitrarily high amounts of shorting without any naked shorts. (And usually, A and B don't know each other. It's all done via exchanges and clearing houses etc.)
In the “A loans to B who sells to C” scenario, C is the one who gets to vote.
That's why I said "Interestingly, in both cases the short interest can be greater than 100%"
But in the situation you're describing the total number of shares on the market is still equal to float.
If we altered your example to have naked shorting it would be: B sells a share it hasn't borrowed to C, A sells a share it hasn't borrowed to D. The total number of shares that can now be traded is equal to the float + 2. Hence the claims of 'counterfeit shares' which is not a great description.
Naked shorting can only be done by market makers. The argument is that it helps to create liquidity and that these actors will have the ability to later borrow the shares without issue. The problem is that, as I understand it, there are not strict rules dictating when they must actually borrow the shares to back the shares that they sold short.
There are some indications that this has happened with GME. For example Michael Burry said in a now deleted tweet[0]:
"May 2020, relatively sane times for $GME, I called in my lent-out GME shares. It took my brokers WEEKS to find my shares. I cannot even imagine the sh*tstorm in settlement now. They may have to extend delivery timelines. #pigsgetslaughtered #nakedshorts"
[0] https://web.archive.org/web/20210130030954/https://twitter.c...
Why? Imagine there exists one share of GME, owned by Alice. Bob borrows it from Alice and sells it to Charlie. Now both Alice and Charlie own one share, and no naked short sale ever happened, as far as I understand that term.
In the only-one-share-exists situation, there's no real way out of that. In a situation where more than one share exists, Bob could, say, obtain a call option so that he at least has a plausible way to acquire a share in the future to make Alice whole.
In your example Alice doesn't own the share at this point, she owns an agreement that says she will be returned a share in the future and is paid interest on it in the meantime.
Same if you buy an apple, I'm sure you'd only do it in the belief that you will actually get something edible. If I got nothing, I'd want my money back! But then when you buy an apple, you can see and touch it before you commit. Not so with stocks. And so you buy it while trusting the broker that your order will actually be met.
If instead my money is “borrowed” without my concent for some nefarious activity—in order to create more “liquidity”—that has a name: It's fraud. It's fraud of the customer whose money is being stolen. It's fraud of the customer who's being fooled into thinking that he's buying a real stock. That these shares do not exist, isn't some slip-up. It's an intentional effort, done with the motive of earning money by exploiting the trust of their customers. Such action should thus clearly be illegal.
Same if you bought a stock, and your broker suddenly decides to steal it without your knowledge, and loan it out in order to sell it in the hopes of earning money if its value drops (i.e. short the stock). Clearly you'd want to know if your property is being loanded out, because it means that you're incurring risk, no matter if you're compensated for it through interest or not.
The other thing to consider here: if some entity needs to provide the put option, how does one hedge (risk manage) a put option ? They need to consider what would happen if the price drops, and as the price drops their hedge needs to increase in price. There's undoubtedly more to this, but that relationship sounds awfully like a short.
Any experts want to wade in here?
A short sale is something very particular: it's selling something you're borrowing. The counterparty has actually bought a stock. Not an option, he can hold that stock for sixty years. This is fucking weird.
(If you write a put and a call for the same strike, you are basically in the same position as a short seller. If you buy a put and a call for the same strike, you are economically in the same position as an owner of the stock.)
Hence, you can't separate options from stocks.
To replicate the stock, you'd buy the call and sell the put. The risk exactly balances out in the sense that a total portfolio of 1 stock short, 1 call long and 1 put short would have zero risk and behave like a risk-free bond.
(If the risk premia of the long call and the short put would not exactly balance, you could make money with very simple arbitrage trades.)
When we talk about naked shorts, they would still have to be covered before delivery (usually two days after the trade).
And when buying a normal stock, not from a short seller, you also can only vote once you take delivery. So everything is the same.
Selling cash secured puts is risk equivalent to covered calls, but doesn't require stock. If anything it's a neutral/bullish strategy since max profit is above the strike.
It's one thing to argue for making sure shorts are well-regulated, but this something entirely different that has the risk of fundamentally breaking our society.
Eg it's common in some tech companies to give the founders super-voting stock that reverts to normal stock on sale.
When you buy a share from the open market, they are not going to guarantee a particular share with a particular serial number you specify, they will only provide a number of that particular class of share of the company.
Most companies decide to make their shares fungible, because they want them to be readily tradable.
But there's no one forcing anyone here. Companies and investors could agree to shares with particular serial numbers.
It's just so much more convenient to have fungible shares, that this is where all the capital goes.
I think he is arguing against the idea of applying fractional reserves to brokers.
> Same if you bought a stock, and your broker suddenly decides to steal it without your knowledge, and loan it out in order to sell it in the hopes of earning money if its value drops (i.e. short the stock). Clearly you'd want to know if your property is being loanded out, because it means that you're incurring risk, no matter if you're compensated for it through interest or not.
I can't find any other interpretation for this logic and terminology other than a rally against fungibility.
No, fungibility is whether an asset (ie. individual assets within a particular class of asset) is interchangeable with one another.
It means when you deposit banknotes into your bank, whether the bank has to give you the same banknotes with the same serial number, or whether they can give you equivalent instruments to satisfy their obligation to you. What they owe you aren't the banknotes, but instead the money.
Also note when you deposit money into a bank, it's not treated the same way as if you put banknotes in a safe deposit box. The way you made your argument on stock brokers is as if it is, and fundamentally misrepresents this relationship. They don't owe you 'your' shares, they owe you a number of shares. Your shares become their asset, in exchange for their liability to you. You don't get to control what they do with their assets.
That's also the reason you don't get to control what the bank does with 'your' money you hold with them, because legally, it's their money with an obligation to pay you when requested. Hence the central bank steps in to regulate and guarantee fractional reserve banking in order to prevent bank runs.
Of course. This is synonymous with my own explanation. However your take is that it means that after you've made it interchangeable, then the bank or exchange somehow automatically gets more rights over it. That just isn't the case. Unless there's an express prior agreement, it's also morally wrong.
You have agreed to it at some point. If your broker doesn't give you a choice you may go to another broker.
This is an explanation of how it does actually work.
The brokers I have experience with either propose you to participate in a share-lending program with profit sharing (opt-in) or propose two different kinds of accounts and you can disallow lending but then the conditions are slightly worse (some fees are waived if you let them loan your shares).
The shares are not "stolen without your knowledge". If you're using margin it may be part of the conditions attached to that. Would you say that a broker liquidating part of your positions to satisfy margin requirements is also the broker deciding to steal your shares without your knowledge?
However, this argument does not apply to regulations that lower barriers to entry, because low barriers to market entry are exactly what enables competition.
(Most regulations, alas, raise barriers to entry. Even if that's not their intended purpose.)
https://en.wikipedia.org/wiki/Cede_and_Company
All you own are assignments of that stock
What DTC trades are assignments of stock held by Cede corp, what you own are assignments of assignments held by brokers - it's how you take physical stock certificates and start trading them electronically (back in the 60s)
You give stock borrow consent when you sign up for a brokerage account. It’s also trivial to turn off, though there isn’t an informed reason for non-activist investors to do this. Some brokers share stock loan income with the account holder, though most keep it from retail accounts.
'a physical share' No. There's no such thing. Even a physical share certificate is not a physical share. It's a physical piece of paper which documents a nebulous thing - the set of rights you have, and terms between you, the company, its management and other shareholders.
'slippage and volatility'. No. You bought the share at the price you were filled on. No slippage. One share gets lent out, one share gets returned. You are not affected by volatility in any way, because the share your get back is exactly the same as the one you lent, and the price change would have affected you anyway.
'A substantial loss' When a share your broker lent out fails to deliver (which you would never know about), the broker doesn't write to you and say 'oops, your share didn't make it back, your loss'. First of all they didn't write your name on the same before they lent it. They have a bunch of shares which they lend out. Secondly, someone will have to produce either the share or the exact amount of money required to buy an identical share at some point. Thirdly, even if they didn't, the broker would make good any loss, whether inadvertent or due to some mysterious malfeasance. That's literally the reason your broker holds capital and is regulated.
A share is not like an apple. You buy a share with the clear intention of selling it to someone else one day. It's a speculative activity par excellence. People who buy apples in order to trade them are generally quite comfortable with the fact that 'their apples' are in reality just a binding contract on someone else to produce those apples when asked. In the same way, the bank does not have 'your money' in a pot somewhere. They just promise to produce it under certain conditions, and there are regulations making sure they keep this promise. I get that some people think this in itself is suspect, but if so, you are opposed to most aspects of modern finance, why pick on short sales?
If you buy a share, your order to buy one will most definitely be met. They can't lend out something that hasn't been bought. You might be confusing short selling with another bugbear, order internalisation and PFOF.
> If instead my money is “borrowed” without my concent for some nefarious activity
What activity? Who is borrowing your money?
> whose money is being stolen Your money was used to buy the share.
Want to sell the share? It's there. Want to vote the share? It's there provided that you actually paid for it with cash. Oh, you bought the share on margin? Well, the same as a car which you borrowed money to buy, the share does not fully belong to you in those circs. So depending on the rules, you might not be able to vote it.
> That these shares do not exist, isn't some slip-up. The share definitely exists. Allowing retail investors to bet on shares going up and down without any actual shares trading hands is illegal, since the 1930s.
'without your knowledge'. Everyone knows about this. That's literally why we're taking about it.
>loan it out in order to sell it in the hopes of earning money if its value drops The broker doesn't earn money if its value drops. They lend out a share, they get back an identical share.
>Clearly you'd want to know if your property is being loanded out, because it means that you're incurring risk
No more risk than the general risk that your broker (or bank) will fail, that the regulator got it wrong and they don't have enough money to pay everyone back, and that the govt won't step in if this happens.
And you do know.
And you are allowed to ask them not to do it. If you paid cash for the share.
Oh, you bought the share on margin? So the broker stole someone else's money from their pot at the bank where they thought it would be taken care of, lent it to you for nefarious activity, and you spent their money on a share you couldn't afford yourself, with the express intent of making the price go up? Shouldn't that be illegal? No, margin investing is conceptually very similar to short selling and is also an accepted part of modern finance. The broker lends you money, you buy a share, you hope it goes up, when you sell the share you pay back the money. The broker lends a short seller a share, they sell it, hold onto the money, hope it goes down, when they buy back the share they give it back to the broker.
There are tons of problems with finance and financialization in modern society. This isn't one of them.
In some cases they’ll pay you to allow them to loan it out. You can reject this if you want.
When you put money in a bank, acquiring interest, you no longer control that money, the bank is free to invest it, though obligated to return it. This is part of your agreement with the bank.
When a broker buys stock on you behalf, there are often similar arrangements in the T&Cs. Your stocks therefor, cannot be borrowed, or sold, without your consent; but you need to read the terms to see what you are consenting to.
While the mechanics are more-or-less equivalent, the settlement assets in the two scenarios are not which can make a big difference depending on the circumstances of the trade. Neither is generally a problem in a high volume, liquid system though.
The DTCC provides extensive reporting to market participants, including issuers [1].
[1] https://www.dtcc.com/settlement-and-asset-services/issuer-se...
https://www.dtcc.com/settlement-and-asset-services/issuer-se...
Also, it's DTC, not DTCC. The inter-company loopholes still apply, not to mention all the international shenanigans.
Have you actually thought this through?
If Bob has one of the five bananas but sells Alice a contract for delivery of 500 bananas and then can't make good on his promise, then Bob has screwed only himself, because now people know that Bob's bananas are only worth 0.002 of other people's bananas. Even if Bob finds another rare banana he won't be able to sell it for anywhere near it's true value.
Critically, Bob has only devalued his own banana contracts.
In the meantime, Alice has only the one banana she bought from Bob, and she spent all her savings on that banana, thinking she'd get 500 of them.
But Alice is clever. She has a plan for making back her savings. Alice sells 10 bananas for future delivery to Cecil. Alice plants the one banana she bought from Bob. And sure enough, come delivery time, Alice picks the bananas from her tree and delivers them to Cecil. Cecil, in turn, sold 20 fruit salads for future delivery to other people -- that's how she afforded the banana contract from Alice.
Two observations I want you to make:
1. The one bad actor screwed himself out of the market in no time at all.
2. The 22 good actors managed to allocate capital effectively where it would do the most good for everyone, and allowed entrepreneurs of very little means to start profitable businesses.
Derivatives trading is very resource efficient and has made modern society possible. It has a few drawbacks but they are self-correcting.
There are problems, but they are not with derivatives trading.
Edit: And keep in mind that Bob's banana contracts are not worth anything compared to other people's bananas, but they are still not completely worthless. If Dave owes Erica 50 of Bob's banana contracts, Dave will find it easy to repay them: you can trade almost anything for a Bob banana contract.
You can't have 500 net buys (i.e. someone is 'long 500 bananas', or 500 people 'long' 1, etc.), but sales, fine!
But that is not the point. The point is you had 5 bananas to sell and 500 people who bought 1 banana each. Now all 500 monkeys wants its dinner so please deliver. If you can't it is fraud.
The mental gymnastics in the stock market are insane. More shares have been sold than exists. That has nothing to do with the amount of times they were sold.
If it's supposed to be a different banana, that's the 'net buys' scenario I described and is not fine, that would indicate naked (which is illegal other than by MMs) short banana selling.
That only becomes a problem if at settlement time there are not 500 bananas. Since you can plant them that's not much of an issue.
Shares are worth the present value of their future dividend cash flow. Shorting doesn't change no dividend payment at all ever.
A loans a share to B. Now A owns an iou, which doesn't have any voting rights. B agrees to pay A an amount of money equal to a dividend payment if a dividend is paid by the company.
B goes short by selling the share to C.
C owns a share of stock.
When the company pays dividends, C is paid and B pays A.
You shouldn't. When the economy collapses because of the aforementioned practices and you family loses their jobs, housing etc, you should not be upset either.
If anything, it's very good to have short sellers, because they are the only market participants who have an incentive to expose bubbles. And expose them early.
"At any given point in time more than 100 emerging companies are under attack as described above.... The success rate for short attacks is over ninety percent—a success being defined as putting the company into bankruptcy or driving the stock price to pennies. It is estimated that 1000 small companies have been put out of business by the shorts. Admittedly, not every small company deserves to succeed, but they do deserve a level playing field...."
I IPO for 20 million, giving me 18 months of runway. My stock instantly gets shorted a ton, then what? How does that impact me? How does that put someone out of business? If someone thinks that a company is profitable, they can always invest AND that investment is cheaper because of the 'excess' selling of the shorts.
I don't follow how shorts kill companies.
New variant: https://prospect.org/power/wall-street-gambling-from-inside-...
It sure does to me though:
First of all, there's the whole self-fulfilling prophecy thing. On a technical level, everything borrowed is eventually given back, so the effects should cancel out in the end.
The problem starts when the borrowing and selling of stocks happens at a scale where it influences the stock price. At that point, you're a) actively hurting the company b) expecting to profit from it c) sometimes without even expecting the stock price to fall if it weren't for your intervention.
Like, I don't see how financially hurting others for personal gain is not a bad thing, but what makes it even worse is that these might be companies producing actual goods, driving humanity forward, and this is being hindered by economic parasites that are only throwing sticks in peoples way.
It's easy to understand why many believe this should definitely be illegal, and why people without much knowledge of stock markets would expect it to actually be illegal in the first place.
This is the equivalent to shouting "fire" in a crowded theatre... intending to loot whatever people leave behind.
Also:
> In compiling the information contained in this website, the author relied on sources — both public and private — and, for the most part, accepted the information from the source as reliable.
This only works when the piece is written or published by someone willing to stake their reputation on its veracity.
Doesn't sound like it was properly made illegal. Should probably fix those rules.
The “loopholes” are intentional carve outs for market makers [1]. Something you want unless you like market makers disconnecting every time the market hiccups.
We have fast settlement for Treasuries. They’re T + 1 and heading towards real-time settlement.
For equities, however, there really aren’t many downsides to T + 2. At the same time, there are many advantages. On the balance, most people who have an idea about clearing are fine with T + 2, though it’s heading towards # T + 1.
As for market makers, we have similar evidence for market made markets being more stable in crisis than order book markets. Cryptos don’t need this. They have never marketed themselves as being stable, and don’t do anything that requires price stability.
Surely anything traded on a central limit order book requires outstanding limit orders to provide liquidity and therefore all order book markets are "market made"?
Or are you working with some specific technical definitions here?
No. Some markets, e.g. the NYSE, have specialists [1]. They support the market even when there is nobody else on one side of the order book. When companies list on the NYSE, they are explicitly asking for a group of market makers to be able to naked short their shares as a stabiliser. Many longer-term investors, similarly, explicitly express preference for these protections.
Other markets, like dark pools, are completely counterparty to counterparty. Still others operate around dealers (who are similar to but distinct from specialists).
There is a lot of variation in and competition around market structure.
But I see that you're making a comparison about bitcoin markets where that kind of structure is mostly not there.
That reminds me. For anyone interested, there's an interview with a HFT market-making guy here who set up the LXDX exchange for crypto derivatives and who talks a bit about the differences in market microstructure: https://www.youtube.com/watch?v=xkhLZXLb8mU
> Failing to deliver shares is legal under certain circumstances, and naked short selling is not per se illegal.
There are arguments for why phantom (i.e., counterfeit) shares benefit the market. E.g., providing liquidity. Others contend that this practice is used in the aggressive short selling of companies, which is illegal, and there is insufficient transparency and accountability of this practice.
There's a great story of supposed illegal naked short selling in the Global Links fiasco. [1] In this case, one investor was able to purchase 100% of outstanding shares while trading continued unaffected. This post's website also cover's that story and I don't recall how this mess was ever resolved. Briefly searching through sec.gov that didn't turn up anything relevant.
[0] https://en.wikipedia.org/wiki/Naked_short_selling [1] https://www.forbes.com/2006/08/25/naked-shorts-global-links-...
It's interesting in much the way the Timecube site is interesting...and is informative about financial markets in much the same way the Timecube site is as well.
Briefly, if you're familiar with a field, you can (generally) tell if an argument is at least trying to engage with the field, or if it exists in some disconnected parallel universe. This happens a lot more than you might think. It's a real issue in physics (see, eg, https://theness.com/neurologicablog/index.php/cranks-and-phy... or https://blogs.scientificamerican.com/cross-check/in-physics-...), but it pops up everywhere.
I believe I am familiar enough with this area to say this is the work of a crank. Some key problems:
1. There's a huge body of scholarship out there about markets, how they work, how to think about them, how they may fail, how you can measure how they're failing, etc. This doesn't engage with any of that. It's not "Prof X said Y is true, but my data suggests he was wrong, see table 2", it's just "everything you think you know about Y is wrong".
2. Also, the paper is making up its own terms. That's actually a pretty good rule: Any paper that tries to discuss a topic and starts with a bunch of idiosyncratic definitions of basic terms is a huge red flag, because anyone in the field knows what those words mean already. So again, you're clearly not writing for an audience of people who could critique your argument. But if you're not looking for a critique, why are you writing at all? How can you know you're right unless the top experts in the field have tried to tear you apart and failed? Which they won't do if you don't engage with them.
3. There's no data anywhere, just assertions which (again, as someone a bit familiar with the field) seem wildly implausible. Eg:
> At any given point in time more than 100 emerging companies are under attack as described above. [...] The success rate for short attacks is over ninety percent—a success being defined as putting the company into bankruptcy or driving the stock price to pennies. It is estimated that 1000 small companies have been put out of business by the shorts.
So more than 100 companies are being attacked every moment of the day. There's no real definition of what an attack might be, or how you might count this, nor is there any evidence given of where the author came up with this number, or how long an attack lasts, or a list of companies under attack at the time of writing. Then we're told that these attacks succeed 90%(!) of the time, bankrupting the company(!). Again, no information why we might think such attacks succeed at all, much less 90% of the time, nor any acknowledgement of the huge body of research suggesting shorting does no such thing. Then we say "it is estimated" (by whom? when?) that 1000 companies have been so bankrupted. ...if 100+ companies are being attacked, and this has been going on for many years, and the success rate is 90%, and the result is bankruptcy, how come only 1000 companies have been bankrupted? Also, again, how come we can't seem to name any of these companies?
Also, I elided a passage of the quote above, which is:
> This is not to be confused with the day–to—day shorting that occurs in virtually every stock, which is purportedly about thirty percent of the daily volume.
That probably sounds pretty wild too. But actually, last I heard, the actual number was more like 49%, because that's how stock markets work. You ask your broker to buy 100 shares of Apple, and he'll sell you 100 shares (short), then go buy the rest on the market. As a general rule, whenever you buy shares it shows up as a short order, and whenever you sell shares it shows up as a long order. Since any time someone buys someone else is selling, about half the order volume is short orders. Simple.
But consider: The author got the number wrong (it's ~50%, not ~30%), which is a bit embarrassing. Worse, it's a number which exists. "Purportedly about thirty percent"? You don't need to use anonymous rumours. Why not "according to the SEC it's 49%"? (Some slightly old numbers here: https://www.sec.gov/files/short-sale-position-and-transactio..., I believe newer ones are reported regularly, although I'm not quite sure where to look, because I'm not an expert on finance writing about fundamental market structure questions. But I do know the numbers exist, and anyone qualified to write the paper the author is wring would have them at the tips of their fingertips. And of course, the bigger issue is that number has nothing to do with what he's actually talking about. Unless of course he's talking about some other number entirely, but how would we know, because he doesn't actually explain it or cite it!
That's a lot of errors to pack into such a short passage! And then consider his rant about the grandfather clause (linked from the main article, or available here: http://counterfeitingstock.com/CS2.0/CS1TheGrandfatherClause...) Read what's being said carefully; I would paraphrase it as: "The initial regulation grandfathered a group of transactions. Authorities claimed the size of this group was small, but I (and unnamed others) believed they were wrong. This exception was later closed; if I was correct and it covered a large number of transactions, this would have had a large impact, but it actually had a very small impact, in line with what the SEC had stated all long. Since the data suggests I was wrong, this proves the conspiracy goes much deeper than I had realised!" This is not falsifiable; if reality agrees with his predictions it means he's right, if it disagrees with his predictions it means he was even more right. If everything that happens or does not happen proves the SEC is lying then....what now?
And so forth. Note that nothing says this guy (or any other "crank") is wrong; by chance if nothing else they'll occasionally be right! The problem is that science, finance, economics, software engineering, etc. are all disciplines that require many people to work together, building on the work of those that came before. If you come up with your own arguments using your own terminology and your own data, nobody will ever understand what you're trying to say, nobody will ever engage with or vet your arguments, nobody will ever have any reason to trust your arguments, etc.
You are assuming that the only point of writing anything is to either create new knowledge (for experts) or to distill existing knowledge (among experts). This is simply not true.
An off–shore hedge fund devised a remarkably effective incentive program to motivate the traders at certain broker dealers. Each trader was given a debit card to a bank account that only he could access. The trader's performance was tallied, and, based upon the number of shares moved and the other “success” parameters; the hedge fund would wire money into the bank account daily. At the end of each day, the traders went to an ATM and drew out their bribe. Instant gratification.
I don't understand how the stock market actually works. I also don't need my Economics degree to understand that the way people over the past week have suggested it works doesn't make a lick of sense.
Look at the Soviet Union for an example of what happens when no companies ever go bankrupt.
Short activists expose shitty companies and as such, they play an important role in the economy.
Maybe Wirecard's fraud scheme would still be going on if it wasn't for short sellers.
Maybe shorting, in particular naked shorting, is not ideal. But there needs to be a way to reward people for taking shitty companies down.
https://www.economist.com/finance-and-economics/2020/09/24/w...
True
>Look at the Soviet Union for an example of what happens when no companies ever go bankrupt.
The Soviet Union was not a free market economy.
>Short activists expose shitty companies and as such, they play an important role in the economy.
In free market economies, shitty companies fail by themselves because their competitors offer better good or services. Short activists don't help make better competitors.
Companies in the Soviet Union needed more competition than short selling.
>Maybe Wirecard's fraud scheme would still be going on if it wasn't for short sellers.
Who knows? Tesla wouldn't exist if short sellers had their way either.
If you want the market to encourage people to investigate fraud and bad news, then they need to be able to profit off of announcing it.
When people don't figure out fraud, the company still suffers eventually but it does so much harder and hurts more people. For example, if Enron's cheating had been exposed a lot earlier it could have been stopped.
Shorting has real and important benefits. And real downsides too, when shorters try to tank companies that had perfectly acceptable fundamentals. But it's definitely a tradeoff, not shorters being parasites.
and some companies do, that is the point.
Why do you feel you need to help it to go down?
Why let people make money on someone's fail?
Why let people have incentives to ruin other people lives?
We should build safety cushions for people, not companies.
> Why do you feel you need to help it to go down?
Do you think it is a good idea to help Intel go bankrupt because it's shitty right now in comparison to AMD?
Of course not. But if either one of them has secret bad information, it's good for everyone to have it revealed to the public so the stock price can be more accurate.
Fraud may be rare but companies have negative info all the time.
I would say that short sellers are even more important around primary transactions because then share price matters more. Good prices prevent new investors being left holding the bag and inefficient allocation of capital which could have gone to a different business with better investment opportunities.
This is the crux. "Shitty" as in obsolete business model: Yes. Shitty as in fraudulent company behaviour: No.
In fact, fraudulent behaviour creates a competitive advantage. And there is only an incentive for the regulator to intervene in the most extreme cases.
Wirecard employed thousands of employees, paid taxes, contributed to social security, and created wealth for investors. Tesla has accelerated the spread of EVs and similarly created enormous wealth for investors. These are real, significant positive effects.
Are you thinking of Melvin Capital, GameStop, or both?
That's what disclosed shorting is for. Why is naked shorting needed?
What about shitty hedge funds overusing illegal[1] financial mechanisms to their advantage?
And there's already a less risky mechanism for that: put options.
1- The stock market should not kill a healthy company. Sure, it can affect its money raising capabilities (and maybe hiring) but it should not drive it out of business.
2- Naked Short-sellers still have to pay interest and dividend on their sold shares. This would create a certain equilibrium. If you nake-shorted a company at x2 its value, you suddenly doubled its profit; and that's being paid by the short-sellers. Profit (dividend) gives a reason to investor to hold on that stock; which brings us to point
3- Naked short-selling is probably done on very short time frames that doesn't extend between quarterly dividend payments. The company is probably going under anyway.
It doesn't only cover the stock market, it covers the whole operation, which goes way beyond only the stock market.
Shorts can't drive companies in the ground if that's not where they're headed anyway. First of all most short sellers are not activists. The perception that shorts causing companies to tank is because activist short sellers are right a high percentage of the time so often their reports result in a quick price adjustment. Being an activist short seller is a very high risk activity so they tend only to pull the trigger when they have high conviction. For example I'm not sure Muddy Waters has ever been wrong in calling out an accounting fraud. I have a really hard time buying the line that short sellers bring down good companies (examples?) and the fact that people do think that seems to me more of an indication of the power of corporations and their management than anything else.
This article isn't about the stock market, it's about short sellers and the activity of those isn't contained to the stock market.
These are not really counterfeit shares, because they do not pay dividends or have any voting ability, the companies do not recognize them. More like "synthetic assets" that have the price pegged to the asset they mimic.
It's more like if I started lending you some rocks, and told you that each rock is always 1 Tesla share. You can always come to me and cash in that rock for whatever a Tesla share is. I'm not lending you counterfeit Tesla shares, but rocks. There's no counterfeiting going on.
If I place a bet on the direction of the price pegged to a given type of rock, then borrow millions of those rocks from you, then trade those rocks back and forth with my buddies to create the illusion of demand momentum (linked to an artificial price pattern going down or up)...I can swing the price pegged to that rock. So the rock could still be cashed in for whatever price it's pegged to, but that doesn't mean I didn't mess with that price. (would take massive amounts of capital obviously)
I'm also not sure if there's any way to tell if it's only being lent out once. Since futures contracts are even more abstract than stock ownership (i.e. have the option to possibly purchase blocks of shares in the future or just scrap the contract altogether), there's probably ways to create value by taking on risk in the form of overextending the appearance that you have access to a security at a certain price.
This video explains everything going on: https://www.youtube.com/watch?v=gMShFx5rThI
edit: I just realized this is exactly what USDT is, but I still feel like it will all come burning down at some point. Maybe it will take 30 years though.
This describes like half of finance. Treasuries, bank deposits and credit cards all represent to varying degrees “synthetic dollars.”
I highly recommend this Coursera course to shed light on this: https://www.coursera.org/learn/money-banking
There are also real world examples of currency pegs, for example the Hong Kong Dollar, which is pegged to the USD since the 70's.
To add to the confusion we're still within the 45-day filing window for the end of the last quarter, so some investors may not have filed yet either.
>"At any given point in time more than 100 emerging companies are under attack as described above. [...] The success rate for short attacks is over ninety percent"
he/she can only find two examples (Global Link and TASER), which is a bit odd.
In any case, there is a connection to the current narrative of "short sellers are evil". But "the shorts" or "they" is one of these "us vs them" constructs that does not exist in any meaningful way.
Even worse, there is a common notion on r/WSB that "the shorts" are also "the suits" and there will be some rough awakening when folks find out that Wall St made more money on $GME than Main St, and that is on the long side, before any dip in share price!
By the way, this awakening might never happen and there is a scenario where we will never find out who traded what on $GME, because transparent transaction data is not publicly available. Thinking back about the 2010 flash crash [1] we still don't know with certainty what exactly happened.
Grant Williams did a podcast about the current events [2] and I can only recommend it (also check out his Endgame series).
There certainly are unethical sellers of stock (see e.g. Jim Cramer video where he talks about manipulation) but I have yet to see convincing evidence that unethical or fraudulent behaviour is more common on the short than long side.
There was a recent poll on Fintwit to name examples where "short attacks" hurt companies, and the paucity of meaningful examples further confirmed the above point (can't find reference due to crappy Twitter search).
> Question 7.1: Do naked short sale transactions create "counterfeit shares?"
> Answer: Some believe that naked short sale transactions cause the number of shares trading to exceed the number of shares outstanding, which in turn allows broker-dealers to trade shares that don't exist. Others believe that the U.S. clearance and settlement system, and specifically the NSCC’s CNS, produces "phantom" or "counterfeit" securities by accounting for fails to deliver.
> Naked short selling has no effect on an issuer's total shares outstanding. There is significant confusion relating to the fact that the aggregate number of positions reflected in customer accounts at broker-dealers may in fact be greater than the number of securities issued and outstanding. This is due in part to the fact that securities intermediaries, such as broker-dealers and banks, credit customer accounts prior to delivery of the securities. For most securities trading in the U.S. market, delivery subsequently occurs as expected. However, fails to deliver can occur for a variety of legitimate reasons, and flexibility is necessary in order to ensure an orderly market and to facilitate liquidity. Regulation SHO is intended to address the limited situations where fails are a potential problem.
> Similarly, CNS has no effect on an issuer's total shares outstanding. With regards to the contention that the U.S. clearance and settlement system, and specifically NSCC's CNS system, creates counterfeit shares, this is not the case. CNS is essentially an accounting system that indicates delivery and receive obligations among its members (i.e., broker-dealers and banks). These obligations do not reflect ownership positions until such time as delivery of shares are actually made. Ownership positions are reflected on the records of The Depository Trust Company ("DTC").
[1] https://www.sec.gov/divisions/marketreg/mrfaqregsho1204.htm
An overspecific dementi: Surely, it has no effect on issuer's total shares outstanding but on shares outstanding.
GME had 140% short interest, issuance was 100%, so there was -40% float. So there was less float than for a non-publicly traded company (which would be 0)
How would you like it if I sell more than 100% of your company? Should I be allowed to in the first place?
"significant confusion" indeed
He barely gave a single example 'TASER' and frankly didn't really specifically indicate how that worked.
With 100 companies at any time under the squeeze it should be relatively easy for him to give a lot of examples and to specifically list the trades themselves, but also point at the 'media barrage' and highlight the asymmetrical effect those 'shadow shares' have.
It's a neat idea and maybe there's some truthiness to it, but there's no evidence.
The site claims that a single article which was corrected 3 days later did damage to the stock price, but I'm not seeing it in the price history.
http://counterfeitingstock.com/CS2.0/CS8PullingMargin.html
Sounds a lot like Thursday and Friday, no?
https://seekingalpha.com/instablog/11442671-gerald-klein/309...
Although it's not clear to me if Gerald Klein is the author, or is reposting a document someone else wrote.
On the one hand you have returns available to anyone prepared to invest consistently in the stock market across the last 30 years that are both well documented and very substantial. People like Warren Buffet & boggleheads make data-backed arguments about how well you could have done if you put money in even just broad index-tracking funds.
And yet on the other hand there are two massively powerful groups with materially more leverage and informational "edge" within the system compared to all the people with a 401K. These are the executives who actually run the public corporations (and can choose their own compensation as a class via board/exec rotation & internal influence) and the financial firms that are embedded both in the firms' operation and also essentially setting/playing the rules of the meta-game as evidenced by articles like this.
It feels like the fact that there are any returns left for a retail investor in public stock market investing speaks more to the quantities of wealth creation taking place than the absence of this sort of outrageous market rule capture.
Two disclaimers: 1.) the slider for wealth "creation" on the public markets in the US seems fairly obviously to be being dragged from innovation to ZIRP... whole separate matter. 2.) at a whole-society level obviously the availability of public market returns is limited to a tiny sliver of the population with the means to invest, so when I say "bounty of capitalism" above I'm more referring just to the sum of financial profits as a result of the system.
This is why lots of retail on forums like wsb treat the market as gambling. There is almost no edge you can get when compared to big players. And even if you make correct assumptions you can get losses out of them either by them being already priced in or via short manipulation.
One example I remember last January's fake tesla brake issues the week a huge volume or calls expired.
In the author's case because DTC is a blackhole system, these naked shorts can continue to exist. They also can continue to exist in self-contained as well as loop-holed systems.
No it wouldn’t. You would be delivered shares within two days as is required. Lots of institutions don’t hold their shares “in street name,” i.e. they hold them in their own. And some people still demand physical certification. (Not every issuer supports this, largely due to exchange rules.)
When a stock has 140% short interest, there are net 40% of the float of holders who have loaned out their shares. They wouldn’t have the right to certificate until they called back their shares. If literally everyone asked for delivery, you’d wind up with the naked shorts needing to pay up to some of those taking delivery to settle their positions. If everyone refuses to sell, those naked shorts would FTD, and the appropriate processes would take over.
Long story short, nothing intrinsic to the DTCC creates net over or under allotment. Companies go private all the time, which is a functional case of all of a company’s shares being taken out of the DTCC.
For all EU-countries there is an official list here: https://www.esma.europa.eu/sites/default/files/library/ssr_w... (and most of the links work ;- )
Is there something similar for NYSE?
GME was trading below net cash last year, which is insane. E-commerce is growing 300% YoY and Ryan Cohen, former founder and CEO of Chew, just made a major move as an activist investor. If GME was valued by VC measures, it would be trading at $420. Most of the people on WSB believe in the value of the company and have faith in a successful turnaround.
Short-selling helps to correct market prices of capital, which is good. It even directly helps the average retail investor because when you buy an index, you want the prices to be as close as possible to the "actual value".
This is not what elasticity means here. In fact, the demand shown in the picture is not infinitely elastic.
Who does this actually benefit?
The paper is NOT just claiming that regular shorts are stock manipulation. It outlines a series of tactics and loopholes in detail that involve the use of shorts among other market tools to sell people stocks that don't exist, but were counterfeited through book-keeping tricks.
Their claims of counterfeiting stock involve the use of naked shorts(a.k.a where a share is sold, but never borrowed) Naked shorts must be attached to a real share within 3 - 21 days, not doing so is illegal. They outline a series of loopholes which are used to sell shorts w/o ever borrowing a real share, effectively diluting the actual stock issued by the company with extra counterfeits to drive the price down. The goal is to drive the price to 0 and bankrupt the company, so that the shorts don't have to be covered anymore, netting a large (tax-free) profit.
Below is not an exhaustive list of manipulation tactics, just a selection of examples:
1. SEC rules left a loophole allowing naked shorts to be covered with naked calls. No actual instance of stock has to actually be borrowed in this case, but it's not marked as a fail-to-deliver in SEC reporting. The naked call option is not tied to any stock issued by the company, it's just an option to buy at a future date, but it can now be repeatedly borrowed out for shorts as if it were a stock.
2. The SEC keeps track of fail-to-deliver in the SHO list and has requirements of 3 days for brokers and 21 days for market makers to borrow an actual stock. Another fraud claim is that brokers/hedge funds collude to pass around naked shorts between offshore shell companies in order to indefinitely reset the 3 day SEC requirement to keep naked shorts indefinitely and keep it off of the SECs fail-to-deliver list. They also use a similar technique to allow 8 - 10 shorts to borrow the same shares and then just move them around in time to meet SEC reporting deadlines. During any audit by the SEC, the SEC calls ahead and they move all naked shorts to offshore accounts where they can't be seen and then move them back once the investigation is over.
This means for every fail-to-deliver marked on the SECs books, there will be several times (10 - 20 according to the whitepaper) more counterfeit shares being sold by shorts that are not tied to any real shares.
3. The third fraud claim involves the clearing house (a.k.a a broker for brokers) the DTCC (we care about two of its subsidiaries DTC and NSCC). When a broker sells a short and fails to deliver an actual share in 3 days, before 1981 they would be forced to buy it back. After 1981, they can borrow one from the NSCC Stock borrow program. The NSCC will then go to the DTC which holds all the stock certificates and find a broker with a surplus of shares and borrow the necessary amount of shares.
Now here's the fraudulent part. When the shares are borrowed only the net amount is deducted from the surplus, but no actual shares are actually removed from the individual accounts of the broker. Now both the lending broker and the borrowing broker have real shares in their account, but they're the same real shares. Since the borrowing broker has real shares now, these same shares can again be lent out by NSCC to another borrowing broker and again no shares are removed. Now 3 investors have the same shares in their account. Since transactions are done as net transactions (instead of individual stocks) between brokers, the fact that 3 investors have the same share never has to be reconciled and two counterfeit shares have been created.
In regards to the GME short, even though only 71 million shares were issued by the company, currently institutions have reported to the SEC (13F filings https://fintel.io/so/us/gme) that they own more than 113 million shares (including 13% owned by gamestop ceo).
Additionally according to the SEC's fails-to-deliver list for December, Gamestop has nearly 1.8 million shares failed-to-deliver. Most companies have anywhere from 0 to a few thousand. Going by the whitepapers estimates the number of counterfeit shares would be 10-20 times that amount, indicating that ~ 40 million shares of Gamestop would be counterfeit.
In order to verify these accusations with concrete data, we would need access to the books/transactions of the DTCC. They are a private organization that is collectively owned by brokers and they are very secretive and have few disclosure requirements due to regulatory capture at the SEC.
a) Take my word for it. I am a former VC now working as a professional short seller (for the past eight years; my first really great short idea I found from a comment on HN). When I instruct our prime broker to short a stock, I must provide a matching locate id that corresponds to a specific block of borrowed stock. No locate id, no trade. Can't locate the stock to borrow to obtain a locate id? No trade.
Get a margin account and try it yourself.
b) Borrow costs. If I could short sell anything I wanted without having to borrow the stock, there wouldn't be such a thing as a borrow cost. I could short anything in as much size as I wanted for free. (And retail traders wouldn't get paid for lending their shares, which happens all the time.)
c) Recalls. If naked shorting were a thing, there would be no such thing as stock borrows getting recalled. Again, take my word for it, they happen.
d) Margin. Would I have to post cash collateral to our prime broker to borrow a stock if I could naked short? There's no stock I need to return, as I wouldn't have borrowed it from anyone. I mean, I guess I could still lose money short a stock and they'd want some protection against that, but I doubt we'd have Reg T margin rules if naked short selling were a thing.
And nobody could make me close the short, unless the company got sold. I could just stay short forever, as I haven't borrowed anything that ever needs to be returned.
So if interest rates were >0%, I could just naked short at no fee, let the cash from the short sale sit in my account collecting interest, and never have to cover the short. I'd also pay no dividends on the borrowed stock, as I presently must, as I hadn't actually borrowed it.
In other words, riskless profit for everybody. Let me know if you find one of those.
e) There are dozens of stocks out there that I (and lots of other people) believe will likely be worth zero one day, but it's uneconomic to make that bet as the borrow cost is 90%+. If I could naked short, I'd make a huge fortune shorting them to zero. Other people would make huge fortunes. Neither I nor other short sellers have such fortunes. If short sellers made fortunes, there'd be hundreds of short-only funds. There are barely a handful remaining.
More broadly, I've worked on hundreds of shorts over the past eight years. In some cases, the company was perfectly legitimate, just overvalued by an enthusiastic market. I've also helped expose companies that were screwing people and lying to investors, in several cases resulting in SEC investigations and criminal indictments. And I've lost money when companies got bought by other companies that later wrote off the entire investment. I've also been straight up wrong on plenty of them, and exited the position when that became clear.
An important function of the market is price discovery, and my job--like that of a long-oriented analyst--is to express the reasoned view that the current price is wrong. It's not a market if there's no way to express a contrary view.
Nothing I say or do can keep a company from raising capital or succeeding if the bull case is more convincing than the bear case. (Again, if I could destroy companies based on shorting them--even if I had to borrow the stock--I'd never lose money. So everyone would do it.) Netflix has had short interest forever and ever, and proved all the doubters wrong.
And if you don't believe that overly high prices lead to misallocated investment in nonsense projects, take a good look at the amount of money sloshign around Silicon Valley these days.
The fact is, it's a lot more fun and profitable to be a venture capitalist than it is to be a short seller, and there's a lot more VCs as a result.
I kind of doubt it considering all the regulation scrutiny recently.
I find it much easier to consume information via headphones while I do the dishes then to sit down and read it through.
It is also a good opportunities to give the eyes some reast from monitor work.
Any tips if one wants to learn this via listening?
It never occurred to me the majority of the “lending” did not actually happen.
This is similar to how the bank may lend out your current balance and not actually hold ALL of the money that its customers has in their accounts.