It might be illegal. But... I'm trying to see if there are any technical differences at all between the two practices. If there are no such technical differences, then the law has no reason to be and it's mere government interfering in the proper function of the market. If there are differences we could find an interesting econometric relation between the two, that could be very useful when creating a legislation around the subject; you see, we cannot legislate economic laws, we can merely observe them and legislate around them. I've have found a difference between the two, they are not paying short interests. This is no small matter. Over a very large sum of money, that is a scam since it's allowing firms to expand the stock multiplier into infinity. This scam can be penalized with the existing legislation. Let me explain; My econometrics are a bit rusty, but the relation I'm seeing here is that in a perfectly shortable market [without restraints] where interests are paid in full and all stock is electronic, the float will expand to equal a stock supply of: float/(short interest rate)= stock supply. if we have a float of 10,000 shares and an short interest on 5% we'll have 200,000 shares supplying the market. The problem with naked shorts is that no short interests are being paid so you get a case where 10,000/0= infinite. With an infinite supply the only possible price for a stock is 0. If courts create regulation further restricting shorts, and putting fines over naked shorts [be it jail, or plain money] and perhaps even creating a regulating body; you'll have yourselves a terrible waste of resources. All you need to do is make those firms pay short interest to the one lending the stock and the problem is solved. Once you have no way around short interests, the equation balances itself out. In the case of naked shorts the stock is lent by the buyer, so applying such a method will actually make the market more efficient as the short interest will be gained by the owner of the stock not his clearing firm, and you would remove the whole stock lending process. When fail to deliver happens, start charging interests, you can enforce this with the current regulatory bodies and without a need for large changes in legislation.
short interest and rebates are being paid - to the Prime Brokers, who are usurping said revenues from the rightful owners of shares. A vodiagroup piece estimated the cost, just, w/o considering neg rebates, at 200 mm a year to the Nation's pension funds. This is why, in the Bloomberg telecast of Mar 13, you see Chanos say it's not hedgies that are doing it, and also, the reason why hedgies sued the Prime Brokers. They fully know what is happening, the Hedgies, that is. They participate because they have to. Read a 10K on GS or any of them, and see how much Prime Brokerage, and particularly stock loan, brings in.
eusdaiki, Could you explain this further? "if we have a float of 10,000 shares and an short interest on 5% we'll have 200,000 shares supplying the market." This is legitimate short interest? Assuming so, one would have to conclude the "float" reported is inaccurate or not adjusted for the "synthetic" shares created by short interest. Thanks
What I describe is a multiplier. The place where you usually find multipliers is in monetary systems. Lets asume a mandatory reserve of 10% Central bank gives $100 to bank1, they reserve $10 and lend 90 to person A, he puts his money in bank B, they reserve $9 and lend 81 to person B... you do this to exhaustion you end up with a monetary supply = monetary emision / mandatory reserve. My hypotesis is that the same process might be happening with stocks, thanks to shorts. However Im not 100% sure as to how interest rates can limit such a process, or even if the limitant factor are the interest rates, I could be missing a variable here. The company issues 100 shares, bank 1 buys them. they lend 100 to bank b who shorts 100 shares bought by bank C. Bank C can then go and lend 100 shares to bank D to short, they sell them to bank E. After settlement Bank A has 100 Long Bank b has 100 short bank C has 100 long, bank D 100 short and bank E 100 long. By this time there is 300 longs and 200 shorts... even thought the float is only 100. So the float is equal to the difference between long and shorts not the total liquidity in the market.
eusdaiki, Thanks for the update. Sounds very reasonable. Although I'm gnawing away at the info to see if it presents any value from the technical aspect. Ya know, like now that I have the information what do I do with it syndrome.
I just read the nature of the case... naked shorts are the least of their problems... these guys are getting charged on RICO statutes, wash trading, reporting false information to the street, bribing, counterfeit, money laundry... they're worse than the freakin mob! Question is, why is this a civil case? Shouldn't there be penal responsibilities here?
it is about naked short selling. That's where the profits come from. However, this particular case is mismarked longs. Semantics. Remember the saying, "are you going to make a Federal Case out of it?" Long road. What needs to happen is, a Special Prosecutor needs to be appointed to clean up the SEC, or we'll have no markets. If you're counting on the Hedgies and Wall St. to do the right thing for you, you are sadly mistaken. They 'll just take it all. And I believe you now know that. The idea GS was fined 2mm for naked shorting is an absolute joke. You can see who is involved and what they do. Here the Administration passes the Patriot act, and look at the money laundering here that the SEC is ignoring, sitting on the documents. Cox is the Administration. It's a travesty.
Yeah but this guys are doing much more than not delivering securities they short, they're washing trades, given out bribes... the whole tamale!!