"Sanity Check"A periodic editorial featuring Bob O'Brien.If you want to read the latest from Bob, or comment on Sanity Check, or just shoot the breeze, go to to www.The SanityCheck.com and blog away. Here are a few oldies but goodies, with newer revisions up at the aforementioned blog site. 3/24/05 3/20/05Heavy Lies The Head I was doing some light reading the other night, browsing through some of my favorite publicly traded brokerages' 10K's, when I was struck by an amazing omission. I couldn’t believe my eyes, so I called some of my accountant and attorney friends to verify that I was reading them correctly. I was. First, the ground rules: publicly traded companies are required to disclose to their shareholders all material risks they're aware of - it's pretty simple, actually. If you know it's a material risk, disclose it So my question was what's material? Turns out there’s a formula. If you have a trillion dollar contingent liability, and there is a 10% chance of someone suing you and winning damages that amount to 2% of the contingent liability, that would be material. 2% of a trillion is two billion dollars – real money by anyone’s metric. Or if there’s a 5% chance of that contingent liability being actualized, that’s material. So how, I asked myself, do these publicly traded companies not list the huge contingent liability from the fail to delivers and the margin shares loaned out to short sellers - both in terms of runaway prices if there's a squeeze that results in a liquidation of the customer account, or if there are large class action awards, as in the case of Worldcom or Cendant? Follow along on the squeeze part. If they sell shares and then fail to deliver, and then the DTCC lends the NSCC the shares to give to the buyer, technically that is an unsettled trade, which means that the liability rests with the broker who sold and failed, until such time as the trade is settled. So they have the liability for those shares, above and beyond whatever the buy-in is at today’s mark to market. Now to the lawsuit risk - what do I mean by that? Well, if it turns out that company ABC is a sham, or has been up to no good, and the shareholders sue for 5 billion dollars, everyone that is holding a “share” that is a fail to deliver or one that has been lent out as part of their margin agreement to a short doesn’t have the right to extract their share of the settlement from the company – it’s the broker who owes them their portion. That’s how the law's written. So that’s what I mean by liability. The brokers are legally on the hook for any shares they failed, or lent out from margin accounts. So where’s the disclosure as to how big that contingent liability is, and the description as to what reserves the broker's put into place to cover it? Simple question, really. Where is the mandated disclosure of that material risk, along with a description of the size and scope of the risk, so that investors in these brokerages understand what they are buying into? Wouldn’t you want to know if your bank had an off-balance sheet liability of hundreds of billions of dollars that wasn’t disclosed anywhere on their financials? Wouldn’t you expect that to show up in their filings? I would. And yet it doesn’t. So who is in violation of the fair disclosure rules? Certainly the brokers, in my opinion. But also the big accounting firms. They have to buy off on the audits, and they aren’t demanding that those contingent liabilities be accounted for appropriately. That puts them in the class action line of fire. Could it really be possible that our financial community has failed to disclose a trillion dollar contingent liability, placing them at risk for huge class action suits, regulatory action, etc.? And the big accounting firms as well? And with Sarbanes-Oxley, aren't the CEO's and such personally liable for this sort of a material omission? What kind of a financial reward has to be at stake to take this sort of a risk? Wouldn’t it be wild if I've just stumbled onto the biggest sham to take place in the financial sector in a hundred years, and one that is provable just by reading things like 17(a) and following the liability chain through the settlement phase? I think that it warrants everyone placing a call to the brokerages' and accounting firms' investor relations folks, and writing the SEC, and to Spitzer, and the like. Unless of course their position is that public companies on Wall Street don’t have to make full and complete disclosure of all material risks in their 10K’s and 10Q’s, in which case that is a fun bit of information to have as well. Is this the next scandal for the Class Action boys to go after? If
so, it could make Enron look like forgetting to give you a receipt
at Mickee Dee’s. 3/19/05The Greatest SHO On Earth Step right up, ladies and gentlemen. Move closer, there we go, little lady, there’s room for everyone. Welcome, welcome, to the greatest transfer of wealth from legitimate shareholders to the system set up for stock trading that's ever occurred. Inside the tent, you will see wondrous sleights of hand, miraculous examples of regulatory contortions, accounting trickery at a colossal scale, oddities you would expect to see from exotic lands – graft that would make a Central American police officer blush, corruption that would shock a Russian oligarch, dishonesty that would stop in his tracks the most inveterate used car salesman or rug merchant. In ring number one is the DTCC and their friendly captive subsidiary, the NSCC. Pay no mind to the fact that both are owned by the NYSE and the American Stock Exchange and such, who are in turn owned by the brokerage houses. The brokerage industry has your best interests at heart – the rumors that they are just there to suck money from you without providing any value are all untrue. You will see an amazing show in the DTCC/NSCC ring, wherein two sets of books are used to trick the eye and the audience into believing that all is well. The DTCC holds every share of stock in the US, pretty much, and has “dematerialized” them so they are electronic ledger entries. But that isn’t the trick. The trick is where the NSCC keeps a set of sub-accounts (C and D accounts) to keep track of the failure to delivers (naked shorts), keeping a bill for shares owed in account C, and netting it against cash on hand to collateralize the fails in account D. This enables the DTCC to hold, for instance, 100K shares of NFI for broker ML in their DTCC account. At the NSCC, ML may have a bill for 500K failed NFI shares, offset by the cash that represents the mark to market value of the shares, plus an overage for collateral. But they are netted against each other at the end of the day, so presto! The NSCC shows a zero sum, and the DTCC shows 100K in their account, even though that 100K may have been lent out 5 or 6 times, and “returned” in the form of cash from the borrower of the shares (the NSCC.) As far as the DTCC is concerned, cash or shares are the same thing at the end of the day – they net their accounts together, too. That’s how you could have 600K “shares” in buyers’ accounts with only 100K real authorized shares in existence – it’s a shell game at the DTCC/NSCC, and as long as nobody catches on, it’s a profitable one from all the fees collected. In ring number two are the brokers. They have trading desks that also keep sub accounts of their daily and weekly fails outside of the DTCC system, sort of an unofficial back office “pre-clearing system” where they try to work things out. ML’s back office may be holding SB’s NFI fails to the tune of 50K shares, but ML owes SB 60K shares of OSTK it can’t deliver – so what to do? Well, certainly not rock the boat – who wants to get bought-in, as the rules require? Especially if there are no innocent men in the system – everyone owes everyone else. So they will just keep a little ledger of IOU’s until that gets big enough to pose a problem, and THEN it will go to the DTCC for the aforementioned sleight of hand, On the trapeze high above ring number two are the upper echelons of the brokers, where for preferred customers a little “elasticity in the system” is available. They can arrange to have yet another set of books representing IOU’s from their big hedge fund clients, not really fails, so to speak, just shares they haven’t quite gotten around to delivering just yet. The only question is how they frame the story for their accountants – but there are a lot of bright lads on Wall Street, so they undoubtedly figure it out somehow. And in the center ring, we have the market makers and the financial institutions. The market makers aren’t subject to the rules against naked shorting – the SEC just decided to give them a little vacation from having to honor those regulations. So the market makers can naked short to maintain an efficient market – theoretically to be able to provide instantaneous availability of shares to buy or sell. Of course, given that very few of the rules have any teeth to them anyway, there’s little to stop an enterprising market maker or specialist from running the price into the ground to help their preferred customers out of a bind if they need some cheap shares – sure, technically it is manipulation and racketeering, but hey, nobody’s being prosecuted, so why not? Which brings us to the podium in the center ring, where we have the SEC. Decked out in the robes of the righteous, watch as they make loud noises and grandiose gestures, prosecuting famous people for trivial abuses, while ignoring the blatant systematic corruption at every level of the system. Wonder in awe as they pass rules with no consequences for violation, and see the miracle of effectively pardoning decades of illegal behavior with the wave of a hand! Don’t bother asking who gave them the right or authority to pardon, they’ll just laugh at your naiveté and respond in doublespeak. And on the side stage, see the gesticulations and acrobatics of the Exchanges, as they stand impassively watching millions of shares trade hands on issues that have little or no float, and pronounce to one and all that they see no evil, hear no evil, speak no evil. Of course given that the aforementioned brokers own them, what is their incentive to “catch” the system in its larceny? Kill the golden goose? Why, for God’s sake? The point, boys and girls, Madames et Monsieurs, Ladies and Gentlemen, is that a whole system has been set up to sell you shares of stock that don’t exist, take your money, and then insist that all is well. The brokers (who are owned by the banks) own the exchanges, which own the DTCC and the NSCC. It’s one big happy family. And their livelihood is in creating a transfer of wealth, in several ways. The first is to trick you into parting with your money in exchange for things they call “shares”, which in actuality are merely IOU’s in the system, and carry no actual rights. If they were honest and told you that your brokerage statement had a ton of IOU’s and very few actual shares, you would probably wonder why your actual dollars had been debited – why can’t you just buy the IOU’s using your own IOU for the dollars? So they don’t tell you. If they can get you to give them real dollars in exchange for vapor, IOU’s that were created with close to zero investment, then that’s a great business – the raw product costs them virtually nothing. As long as there isn’t a run on the bank, so to speak, they can keep the con going, and everyone makes a fortune – except the shareholders who are being secretly diluted, and the companies whose stock is being counterfeited in the system. The second trick is to keep the grift hidden from view, claiming that all is well. All good cons require an endless stream of rubes, and you can’t get people to put their money into the system unless they believe that they won’t be cheated at will. So the DTCC/NSCC fight tooth and nail to keep their records secret, and the trading desks and brokers aren’t even asked what they are doing – don’t ask, don’t tell is the rule. So that’s the show, my fine lads and lassies, and it requires your ongoing participation in terms of money to act as grist for the mill. Whatever happens they can’t have you demand that the system be made fair and transparent, or ask for an accounting from the regulators for their behavior, or require the DTCC and the NSCC to be open to scrutiny. Why, if that were the case, they would simply publish a list of the number of fails for every company on the SHO list, daily, and automatically buy in everyone on day T+4. So straightforward, and yet nobody is enacting rules to do so. This isn't rocket science, and yet we have regulations that run for dozens of pages - instead of publish the fails, and automatically buy in on T+4. Doesn’t it make you wonder why it isn’t done that way? Now you know. There’s another show after the matinee today, and the evening performance has the flying hedge fund brothers putting in a special appearance, direct from the Caribbean island where they've developed their amazing juggling and balancing act. Don’t miss it. It’s a stunner. 3/2/2005Mamma Juju Say… When predicting the future, my crystal ball is usually too opaque to be useful. Not so when trying to assess what will happen in a stock manipulation, however. I thought it would be useful to go back and look at my predictions for one of my old favorites and see what the accuracy has been – and it’s been astoundingly accurate, if I do say so myself. So let's see what has transpired at OSTK, and how on the mark I have actually been. When I first communicated with Dr. Byrne, there were a number of predictions offered up as likely scenarios that would play out if Overstock was in fact going to follow the path of other manipulations I’d observed. I predicted that there would be unusual interest from the lapdog and his gang of quisling kindreds. I predicted that there would be unusual volatility, and an increase in volume. I mentioned some other names, specifically Liz and the C section editor of the Journal. Fast forward to the Q4 CC, and I am on record describing the anatomy of the manipulation in a more robust way. I pointed out that in addition to the usual lapdog screeds, we would see analysts in the pockets of the hedge fund issue specious negative reports, and see an increase in negative coverage from the co-opted press cronies. All of that I will lump into prediction number one. It has all come to pass, and more. I also described that he would see the borrow dry up, and naked shorting become a real issue. When we got off the call, I was informed that OSTK had just appeared on the Reg SHO list. So prediction number two came to pass. I described that an essential part of the game was that they would be listed on a series of foreign exchanges, to facilitate the fail to delivers here – waiting on Berlin time, so to speak. Bingo, they are on 5 different German exchanges. I described that we could expect to see a bogus regulatory probe, and a huge slam from a “credible” mainstream publication, coupled with some bogus class action suits. Well, we saw the FTC probe, so I could take that as a hit. In fact, I will. It counts. But I don’t get the sense that did the requisite damage. So we still have another phase of the manipulation to look forward to – the last predictions. For those that haven’t read the transcript of the Q1 call, here it is again: 1) I think we can expect an SEC investigation into the company or Dr. Byrne – probably an informal inquiry, as those are easy to initiate – all it takes is a staffer to write a letter. It will be purely for headline value, or to build a case, as the SEC tends to dislike folks who draw attention to their failings, which Dr. Byrne has been doing of late. 2) I think we will see a nasty C section of the Journal or Barron’s or whatnot article filled with alarming predictions and half truths, which may or may not mention the investigation – the sequence I’ve seen is either the investigation is driven by the article, or the article by the investigation – it can work either way. 3) The class action squeegee boys will file suits based on the premise of either wrongdoing, or a precipitous drop in price. Again, doesn’t matter if there is no merit – it’s all designed to get the price tunneled and to let the shorts get out with their skin. It will be interesting to see this play out. I have never, ever not seen the above take place when the hedge fund in question runs into trouble, or gets it wrong. It’s a standard part of their playbook. Consider this notice that the tactics are well understood, and that we are all watching and waiting for these next shoes to drop – perhaps some emails to the SEC and the FBI and the DOJ to alert them to the likelihood of this being next would be in order. Feel free to send them this article, as well as the transcript from the call, and warn them that this is part and parcel of an illegal stock manipulation tactic, and to be on the alert for it. Who knows, maybe it will stop this crap from happening over and over and over, with our regulators breathlessly expressing surprise that anything like it could be contrived, much less used as part of an orchestrated manipulation. At some point someone has to put a stop to this. Maybe this time
it will be you. Stranger things have happened. 2/24/2005As a follow-up, I've had outraged emails suggesting that by telling the story of a woman who lost almost everything (that isn't the part everyone's outraged about) I'm doing NCANS a disservice. The reasoning is that because the company involved was NanoPierce Technologies [NPCT.OB] (who some feel is less than sterling in their dealings), NCANS is somehow endorsing that company, or aligning ourselves with them, or sullying our reputation by "laying down with dogs." Wrong. Couldn't be further from the truth, and they miss the point. I have no idea if NanoPierce is the best thing since sliced bread or a complete sham. And I don't really care. I'm of the quaint and naive opinion that everyone is entitled to the protections that the law affords. Even companies that some dislike, for whatever reason. If their complaint is that they were naked shorted out of existence, my question is why aren't they entitled to have their case heard - and why is the DTCC so hell bent on keeping their books from the public eye? If everything is on the up and up, wouldn't it be simple - throw open the books, demonstrate that it's "all a dirty lie", and end of story. But that's not the way it is playing. So my story stands - the true story of a woman known to me who is now having a different life than she should have, and is convinced that naked shorting is responsible. That story is: Not So Bad.
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