STOCKGATE TODAY
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Little Honor in Reg. SHO ‘Honor System’ – December 20, 2005

David Patch

Earlier this week General Electric’s (NYSE: GE) affiliate station CNBC held a live interview with Overstock.com (NASDAQ: OSTK) CEO Patrick Byrne and again discussed the Byrne Jihad against naked shorting abuses. Once again the CEO was left to defend himself to anchors willing to accept the abuse.

CNBC analyst Joe Kernen initially applauded Overstock.com calling it the envy of many companies due to its growth potential before attacking the efforts of Byrne to fight Wall Street corruption. Kernen’s attack challenged Byrne on his fight against short sellers by identifying that short sellers can go after any company they want in the entire country so why not “leave them alone” and focus on the business model. Kernen alludes to the fact that eventually the evil that short sellers bring to a company, legal and otherwise, can be exorcised through a solid business model. What happens in between is for the markets to bear and should not be the worry of the CEO.

Kernen’s statements are rather hypocritical in an Industry where CEO’s are required to continually add to shareholder value. Allowing shareholder value to be manipulated by illegal acts should be the fiduciary responsibility of the CEO yet Kernen wants the abuses ignored.

The response from Patrick Byrne to Joe Kernen left the anchor literally speechless. Kernen suddenly was left with nothing he could say to rebut the CEO. And when that happens all CNBC can do is move on to another subject, which is exactly what they did.

According to Byrne, for the second time since August he has gone into the open market and purchased stock in his own company. The result of his near $4 Million in stock purchases since August is an indicator of what is wrong with this marketplace and what is wrong with the SEC’s rendition of Regulatory Swiss Cheese.

For the second time the seller of Overstock securities, to the tune of nearly $2 Million, failed to meet obligations of delivery on shares sold. This on limited trades that were followed through and audited.

In the latest e-mail exchange between Byrne and his broker, his broker has identified that the trades have failed settlement due to the fact that there are no shares available in the system to settle with. Some of the e-mail excerpts between Byrne and his broker, which were provided to CNBC prior to the morning interview, included;

Byrne’s Broker: Your Shares “originally confirmed to have settled on Dec 5th and in the process of being converted from DTC shares to paper, have in actuality not settled and no shares have been received.”

Byrne: Can you buy-in the fails?

Brokers Response: “Talking with my traders they feel that we will run into the same problem [Settlement Failure], no one seems to have enough of the shares to deliver.”

Brokers Response: “Since Overstock is a "hot" stock they [Wall Street] are finding it just about impossible to find shares to borrow or buy.”

While CNBC had access to these transcripts, and is aware of the firms involved, Joe Kernen asked Patrick why he didn’t just walk away. What is the concern over $1.8 Million worth of trades that were recently executed by Wall Street without the shares existing to sell? Who cares that you were notified that a trade settled only to have you conduct your own follow up and prove that that notification was in fact false? Walk away, leave these guys alone was Kernen’s opinion.

Why not ask the shorts and Wall Street to stop abusing Companies Joe?

Patrick Byrne, earlier in the interview described with courage that he is not fighting about Overstock.com but instead is fighting to resolve a systemic economic collapse “of Enron like proportions.” If left unattended. Byrne further identifying that the problem exists mainly due to an “intellectually corrupt SEC”.

Byrne’s allegations regarding the SEC were never challenged by CNBC and here is probably why.

Under the guidelines of Regulation SHO, all trades in a threshold listed security must settle within a window of Trade plus 13-days. If such trades do not settle within the 13-days, the seller must cease all future short sales without first executing a pre-borrow. The seller must also initiate an immediate closeout of the failed trades. The Seller, under these guidelines, refers to the originating broker-dealer, prime broker, or executing broker depending on the circumstance.

In the case of Market Makers, as was the case here, the Market Maker is required by law to ‘give up the book’ on the security until the trade has actually met settlement. The SEC identifying in a Securities Industry Association (SIA) forum that a Market Maker cannot fulfill their obligations of Bona-Fide Market Making should they be required to pre-borrow prior to making a short sale thus must step aside.

Under both of these guidelines cast above, the enforcement of these higher market restrictions falls upon the ‘Honor System’ of the firms according to a source at the NASD. Imagine that, an ‘Honor System’ amongst crooks and criminals?

In this case the ‘Honor System’ failed. The firm responsible for the delivery of shares to Mr. Byrne missed the deadline yet remains dominant as a sell-side Market Maker in the box. The regulators have yet to pick up on this and most likely by the time they do the damage will be done. As shown in the chart below, the trading in Overstock has been a complete sell off as fails continue to persist and the members continue to work the stock in attempt to cover these fails at a profit.

Review of Byrne’s Form 4 Filed with the SEC, the stock purchase of 50,000 shares was executed in a price range of $37.21 - $38.20. The selling market maker would only honor those trades with delivery [settlement] when their cover price fell below this pricing window. There has been insufficient activity and shares available below this price, which subsequently led to extended fails. The Bona-Fide Market Making of this firm became a trading strategy in the house account and the house never loses.

With today’s heavy early morning volume and the stock now trading with lows at $33.54, the originating seller now has the opportunity to cover for profit. Acquiring shares at $34 - $35.00/share will yield the firm a hefty $150-$200K profit.

And CNBC analyst Joe Kernen, expert to the industry, wants to know why you can’t leave the shorts alone.

The ‘Honor System’ of Wall Street is a joke. The firms responsible for defrauding the investing public out of hundreds of billions in investments is once again expected to police itself under an ‘Honor System’. The goal being, don’t get caught right away and your profits can outweigh your penalties when the police catch up with you. The Securities and Exchange Commission set it up this way.

If you ever wondered how Wall Street Executives earn their pay look to this as the perfect example. Patrick Byrne paid $1.8 million for stock that doesn’t exist and by the time he receives it the stock will have de-valued by near $200,000 or more. Byrne’s loss being diverted to the Wall Street firms bottom line profit. In this case, the profit came on a mere 50,000 shares traded. With tens of billions of shares trading daily in these markets imagine the revenue stream created selling what does not exist.

Of record, in the 11 months since Regulation SHO has been in place not a single enforcement action has come to play regarding illegal shorting or failure to ‘give up the book’ due to extended fails in threshold securities. The SEC has qualified this a success. The investors see this as more of the same as market raiders continue to manipulate the markets for profit.

SEC Asst. Director of Market Regulation James Brigagliano stated in a recent NASAA Public Forum on Naked Shorting, bring us the evidence and we will rigorously enforce the laws. Sorry James this is yet another example that the SEC is aware of but has ignored.

Yes there is Dishonor in this Honor System and it starts at the front door to the SEC. How the SEC can ignore this blatant abuse is reprehensible – “intellectually corrupt” to steal a phrase.

For more on this issue please visit the Host site at www.investigatethesec.com .

Copyright 2005