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Intro­duc­tion: Explor­ing rea­sons under­ly­ing the crash of 2008, inves­tiga­tive jour­nal­ist Lucy Komisar reveals that the rel­e­vant ques­tion is not so much “What went wrong?” but “What didn’t go wrong?” An invest­ment indus­try cor­rupt to its foun­da­tions, and col­lud­ing actively and rou­tinely with the offi­cials and insti­tu­tions charged with its reg­u­la­tion, engaged in fraud­u­lent com­merce mas­sive in scale and brazen in char­ac­ter. Lucy explores the use of devices and instru­ments such as short sell­ing, naked short sell­ing and credit default swaps in order to man­u­fac­ture vast amounts of wealth in the markets.

“Short sell­ing takes place when investors sell a stock they don’t own, in hopes it will fall and they will buy it more cheaply when they have to deliver it to the buyer. Under SEC rules they have to buy them and deliver them to their pur­chasers within three days. Except, they often don’t. They sell shares they don’t own and don’t intend to buy. That is called naked short sell­ing. And since these days investors don’t get share doc­u­ments on offi­cial paper, but sim­ply trust their bro­ker­ages that their shares are on file, they gen­er­ally don’t know that they’ve paid out money for nothing.”

Lucy defined credit default swaps:

” . . . the next cri­sis that will be pro­voked by short sell­ing. Mort­gage secu­ri­ties were bun­dled into large pack­ages which were then trans­ferred to large Wall Street firms. These firms cre­ated deriv­a­tive con­tracts from them which were resold. The con­tracts could be traded in the credit swap mar­ket. Its prospec­tive col­lapse dwarfs the prob­lem of mortgage-backed securities. . . .”

Another major ele­ment of dis­cus­sion con­cerned the neces­sity of the U.S. gov­ern­ment using its stew­ard­ship of AIG to inves­ti­gate the off­shore oper­a­tions through which it con­ducted busi­ness in the past. (Inter­ested lis­ten­ers can pur­sue the role of short-selling–probably exe­cuted by finan­cial enti­ties asso­ci­ated with the Under­ground Reich and its Bor­mann cap­i­tal network–in oper­a­tions asso­ci­ated with the assas­si­na­tion of JFK, the 9/11 attacks, and the col­lapse of invest­ment bank Bear Stearns.

Pro­gram High­lights Include: AIG’s use of “cap­tive” insur­ance com­pa­nies; review of AIG’s Coral Rein­sur­ance sub­sidiary; the man­ner in which naked short-selling and other invest­ment prac­tices cor­rupt cor­po­rate rep­re­sen­ta­tion and gov­er­nance; the man­ner in which naked short-selling and related prac­tices destroy the value of com­pa­nies that are tar­geted by the shorts; an overview of the cor­rup­tion of the equi­ties of the Taser company—in charge of man­u­fac­tur­ing Taser devices for law enforce­ment; the roles of the DTC and DTSCC in assist­ing the shady stock oper­a­tions that under­mined the finan­cial indus­try; RICO suits filed against SEC chair­man Christo­pher Cox; col­lu­sion of the SEC with the nefar­i­ous stock operations.

1. Intro­duc­ing one of the major focal points of dis­cus­sion, Lucy explains “short sell­ing” and “naked short sell­ing,” as well as the roles of the Depos­i­tory Trust Cor­po­ra­tion in the gam­bit. Note the restric­tions placed on short sell­ing in the wake of the stock mar­ket crash of 1929, ascribed by some ana­lysts to a “mas­sive con­spir­acy” involv­ing short selling.

“‘Naked short sell­ing,’ the trade in coun­ter­feit or non-existent shares, is a mas­sive fraud run by the country’s big bro­ker­ages and the stock clear­ing­house, the Depos­i­tory Trust Cor­po­ra­tion, with the col­lu­sion of the SEC.

Short sell­ing takes place when investors sell a stock they don’t own, in hopes it will fall and they will buy it more cheaply when they have to deliver it to the buyer. Under SEC rules they have to buy them and deliver them to their pur­chasers within three days. Except, they often don’t. They sell shares they don’t own and don’t intend to buy. That is called naked short selling.And since these days investors don’t get share doc­u­ments on offi­cial paper, but sim­ply trust their bro­ker­ages that their shares are on file, they gen­er­ally don’t know that they’ve paid out money for nothing.

Naked short sell­ing works is done through a device called stock lend­ing orga­nized by the Depos­i­tory Trust Cor­po­ra­tion (DTC) in New York. It is a sub­sidiary of the DTCC (Depos­i­tory Trust & Clear­ing Cor­po­ra­tion) a hold­ing com­pany charged with clear­ance and set­tle­ment of secu­ri­ties. It is owned by its mem­bers, the major bro­ker deal­ers. The Depos­i­tory Trust Cor­po­ra­tion (DTC) is the insti­tu­tion that trans­fers shares between buy­ers and sell­ers. When a DTC bro­ker mem­ber sells shares and can­not deliver them to the pur­chaser, the depos­i­tory makes arrange­ments to loan secu­ri­ties to the firm

It works like this. After the share trade occurs, it goes into the clear­ing sys­tem, if the seller does not have the secu­ri­ties avail­able, the depos­i­tory steps in with an auto­matic pro­gram that goes through all the avail­able shares on deposit where account hold­ers have said these shares can be loaned out if you need them. The DTC and the lender get commissions.

The DTC bor­rows the shares from its mem­bers –bro­ker­ages — to ‘deliver’ them to the buyer. But that’s just on paper; they are not really deliv­ered. Shares used to be rep­re­sented by paper cer­tifi­cates. Now that the DTC turned them into elec­tronic files and kept the cus­tody, it has made bil­lions of dol­lars lend­ing them out, over and over, get­ting a fee each time they ‘lend’ a share. The investor with an account at the lender has an account that says he owns those shares, and the buyer that has received shares also ‘owns’ the shares.

Through this stock lend­ing, you can mul­ti­ply the num­ber of shares in cir­cu­la­tion so the num­ber is greater than the num­ber of shares autho­rized and out­stand­ing. The ille­gal sys­tem affects stocks, bonds, cur­ren­cies, and strate­gic metals.

Restric­tions on short sell­ing were put into the Secu­ri­ties Acts of 1933 and 1934 because evi­dence that the ‘sheer scale of the crashes was a direct result of inten­tional manip­u­la­tion of US mar­kets through abu­sive short sell­ing by a mas­sive conspiracy.’”

2. Lessons from the Great Depres­sion went unlearned and the past has been repeated. The evo­lu­tion of elec­tronic records keep­ing exac­er­bated the prob­lem. For­mer Direc­tor of Trans­fer Agent Ser­vices for Depos­i­tory Trust Com­pany Susanne Trim­bath pro­vides much of the infor­ma­tion uti­lized by Lucy. Off­shore accounts are used in these trans­ac­tions, and one of the results of this is the cor­rup­tion of cor­po­rate securities—more shares are counted in proxy fights than are in exis­tence overall!

“But the prob­lem sur­faced again in 1971, when the DTC was set up to han­dle clear­ing elec­tron­i­cally, instead of have run­ners exchange checks and cer­tifi­cates between buy­ers and sell­ers. Ten years later the SEC approved a stock bor­row­ing pro­gram that set up a pool of shares from bro­kers mar­gin accounts (where the bro­ker had lent cash to the cus­tomer to buy the secu­ri­ties). Then gave an open­ing to those who wanted to manip­u­late shares by bor­row­ing them and never return­ing them to the pool. There was a sale but no deliv­ery of real shares to the buyer.

Susanne Trim­bath, Direc­tor of Trans­fer Agent Ser­vices for Depos­i­tory Trust Com­pany (1987 to 1993) first heard about the prob­lem from the peo­ple orga­niz­ing proxy vot­ing. Then in 2003 in New York, she had cof­fee with two lawyers at a mid town Man­hat­tan. She said, ‘They described sce­nar­ios of short sell­ing, stock lend­ing and off­shore accounts and how some small firms were being dri­ven out of busi­ness. They said what ten years ear­lier was a minor prob­lem which occa­sion­ally cre­ated dif­fi­cul­ties for cor­po­rate vot­ing had expanded tremen­dously and become an enor­mous problem.

‘It occurred to me that some­one out­side the sys­tem had real­ized this loop­hole existed and began to exploit it.’ She said the sce­nario they laid out was that DTC was being used for or was engaged in fraud­u­lent behav­ior. They said accounts in off­shore Bermuda were being used.’

She explains, ‘Let’s say there are shares that have been bor­rowed by the DTC from one bro­ker and loaned and deliv­ered to the investor cus­tomer of another bro­ker. That cus­tomer leaves the shares with the bro­ker. The buyer’s bro­ker can also say these shares are lend­able and they are lent again to cover set­tle­ment for another buyer.’ Then three investors think they own the shares — the orig­i­nal owner/lender, the first buyer, and the sec­ond buyer. Through this stock lend­ing, the num­ber of shares in cir­cu­la­tions can mul­ti­ply so it can be greater than the num­ber of shares autho­rized and out­stand­ing. That means that the same shares can be shorted repeat­edly and never deliv­ered, mak­ing it pos­si­ble to sell mul­ti­ples of the shares that really exist. She said, ‘I don’t think there’s a limit to how many shares you can dupli­cate this way. There’s noth­ing in the sys­tem that would pre­vent you from turn­ing ten shares into ten million.’

3. Like cur­rent Sec­re­tary of the Trea­sury Henry Paul­son, for­mer Trea­sury Sec­re­tary Robert Rubin worked for Gold­man Sachs, itself deeply impli­cated in many of these activ­i­ties. A 1996 change in reg­u­la­tion per­mit­ted the lend­ing of shares from pen­sion funds to short sellers.

“In fact, 1993 was the year that Clinton’s Trea­sury Sec­re­tary Robert Rubin, for­mer man­ag­ing part­ner of Gold­man Sachs where he was head of arbi­trage and trad­ing, issued an exemp­tion to the short-sale bor­row rule: if you were a mar­ket maker, arbi­trage or hedge fund, you didn’t have to locate stocks or bonds for short­ing. You could just sell them with­out hav­ing them or even know­ing where you could get them. SEC Chair­man Arthur Levitt, and FED Chair­man Alan Greenspan agreed. The rules would apply to those with the power to do the most damage.

Then, in 1996 there was a change in the mar­gin rules. From 1934 to 1996, it was ille­gal to lend any­thing except secu­ri­ties held in mar­gin accounts. Now for the first time secu­ri­ties in pen­sion funds could be loaned to short sell­ers. Under crit­i­cism, the SEC in 2004 adopted Reg­u­la­tion SHO which required short sell­ers to locate secu­ri­ties to bor­row before sell­ing, and also imposes deliv­ery require­ments on broker-dealers for secu­ri­ties that were suf­fer­ing sub­stan­tial naked shorts. But it exempted mar­ket mak­ers, and there were no penal­ties for violations.

Trim­bath says sell­ers’ fail­ure to deliver stocks to buy­ers went from $1.4 bil­lion in 1995 to $13 bil­lion in 2007. ‘The DTCC [the par­ent of the DTC) could throw out of sys­tem any­one who doesn’t deliver secu­ri­ties for set­tle­ment. But they are owned and con­trolled by peo­ple who fail to deliver secu­ri­ties for settlement.’

The win­ners are the short sell­ers and the DTC and bro­ker­ages. They all make a lot of money sell­ing shares that don’t exist. This cor­rupt sys­tem has destroyed dozens, maybe hun­dreds of com­pa­nies before it helped bring down Fan­nie Mae, Fred­die Mac, and prob­a­bly Bear Stearns and Lehman Broth­ers. The SEC has known this for years and, sid­ing with the bro­ker­ages, has cho­sen not to pro­tect com­pa­nies or investors. The result is that com­pa­nies are beaten into the ground, their share prices falling because of mas­sive sells. That hurts not only the com­pa­nies, that can’t bor­row because of bets against their future earn­ings and sta­bil­ity, but vic­tim­izes share­hold­ers, includ­ing pen­sion funds that hold the retire­ment money of Amer­i­can work­ers, and employ­ees of the com­pa­nies who lose their jobs.”

4. More about the mas­sive irreg­u­lar­i­ties caused by some of these devices, relat­ing the mis­ad­ven­tures of Zann Cor­po­ra­tion, a Michi­gan firm. Note the deep com­plic­ity in this activ­ity by the SEC and other agen­cies and insti­tu­tions designed to atten­u­ate this sort of behavior.

“In 2005, Robert Simp­son, CEO of Zann Corp, a Michi­gan tech­nol­ogy com­pany, saw its shares drop 98% in two years. To test the sys­tem, he paid about $5,000 for more than one mil­lion shares of a property-development com­pany called Global Links. He got deliv­ery of the shares, which turned out to be 126,986 more shares than the com­pany had issued. So he owned 100% plus. A day later, more than 37 mil­lion shares of the com­pany were traded. The day after that, over 22 mil­lion traded. None of them were his. All of them were counterfeit.

Both the US gov­ern­ment and munic­i­pal­i­ties who issue bonds also suf­fer. Trim­bath says that because more investors claim that their div­i­dends are from tax-free munic­i­pal bonds than there are bonds that exist, they are fail­ing to pay $1.54 bil­lion a year in fed­eral taxes. The investors are sim­ply get­ting cash from their bro­kers who tell them it is div­i­dends, but in fact it is not. And since there is a greater mar­ket for munic­i­pal bonds than the bonds that exist, the munic­i­pal­i­ties could be sell­ing more bonds and obtain­ing the cash. Instead, the bro­kers get their clients’ cash and use it for their own pur­poses, pay­ing out ‘div­i­dends’ at a lower per­cent­age than the inter­est they would have to pay if their bor­rowed that money legitimately.

Trim­bath, high­light­ing the short sell­ing prob­lem on sup­pos­edly safe, con­ser­v­a­tive secu­ri­ties: Fed­eral Reserve of NY data from the 22 pri­mary deal­ers who have to report trades and fail­ures to deliver show fails to deliver of $680 bil­lion a day over the last 3 weeks. The most recent report, for Octo­ber 8, 2008, show $2.5 tril­lion Trea­sury bill fails to deliver. It is the high­est it’s ever been. Since 2001, 15% of mort­gage backed secu­ri­ties trades failed to set­tle. There were no mort­gages under these bonds because they were phan­tom bonds. There was excess demand for these invest­ments. Rather than allow this to push prices up, the reg­u­la­tors allowed fail­ures to deliver to depress prices. If the 13% of extra out­stand­ing shares of Fan­nie and Fred­die had been trans­lated into buy­ers get­ting real shares, that would have dri­ven up the price.

The fail­ure of reg­u­la­tion by the SEC and the clear­ing agen­cies on naked short sell­ing is a mat­ter of record. The SEC has the infor­ma­tion show­ing more shares owned than issued, but has con­stantly allowed loop­holes in the sys­tem and car­ries out no real enforce­ment. Civil penal­ties are min­i­mal. One of the loop­holes allows traders to avoid the nor­mal set­tle­ment process of the National Secu­ri­ties Clear­ing Cor­po­ra­tion (NSCC) and thereby to avoid pub­lic and reg­u­la­tory scrutiny and to evade US secu­ri­ties laws.

The SEC rul­ing as a result of the finan­cial cri­sis tem­porar­ily banned short-selling for shares of some 900 com­pa­nies for a few weeks, But when the bailout was approved, it allowed short sell­ing to resume. But the prob­lem is not so much short sell­ing, as naked short selling.

Har­vey Pitt, who was Bush’s first SEC chair­man 2001 to 03, said in Novem­ber, ‘Phan­tom shares cre­ated by naked short­ing are anal­o­gous to coun­ter­feit money.’ Pitt, how­ever, ignored efforts by out­side crit­ics to get him to do some­thing about naked short sell­ing while he had the power to do so. C. Austin Bur­rell, a for­mer options trader for Shear­son Lehman and long­time critic of short sell­ing, has pointed out to Pitt and other SEC offi­cials over years that sell­ing coun­ter­feit and there­fore unreg­is­tered secu­ri­ties was a vio­la­tion of the Secu­ri­ties Act. But the SEC under Bush chairs Pitt, William Don­ald­son and Christo­pher Cox ignored him and other crit­ics, and did noth­ing to stop it. In fact, the rules of the SEC and other mar­ket insti­tu­tions facil­i­tate it.

A DTCC (Depos­i­tory Trust & Clear­ing Cor­po­ra­tion) sub­sidiary, the National Secu­ri­ties Clear­ing Cor­po­ra­tion (NSCC) is charged with clear­ing each trade. At the end of the day, the NSCC instructs the Depos­i­tory Trust Com­pany, also a DTCC sub­sidiary, to move shares between par­tic­i­pants. The DTCC writes the rules. And it pan­ders to the indus­try. One of its loop­holes allows traders to avoid the nor­mal set­tle­ment process of the NSCC and thereby avoid pub­lic and reg­u­la­tory scrutiny and evade US secu­ri­ties laws. The rule allows them to set­tle shares between mem­bers out­side the nor­mal sys­tem. They use the clear­ing sys­tem for money trans­fers but agree to set­tle trades off mar­ket. This is called ex-clearing, ie an agree­ment between mar­ket par­tic­i­pants to clear trades with each other rather than at the NSCC. The National Asso­ci­a­tion of Secu­ri­ties Deal­ers has the same rule.

The SEC decided that pro­vi­sions regard­ing naked short sell­ing do not apply to shares that don’t set­tle at NSCC. The SEC does not reg­u­late fails to deliver out­side of the National Secu­ri­ties Clear­ing Cor­po­ra­tion NSCC sys­tem, sup­pos­edly because they’re rare. But they are not rare. Do they know how fre­quent they are? They haven’t a clue. Fur­ther­more, SEC’s July emer­gency order, requir­ing pre-borrowing shares of 19 other finan­cial stocks to short them, exempted mar­ket mak­ers. The pri­mary mar­ket mak­ers are Gold­man Sachs (Fan­nie Mae) and LaBranche & Co. (Fred­die Mac). (A mar­ket maker is a bank or bro­ker­age com­pany that will pur­chase the stock from a seller, even if it doesn’t have a buyer lined up. In doing so, it is ‘mak­ing a mar­ket’ for the stock. The mar­ket maker makes money on the ‘spread’ (profit mar­gin) on the stock that it sells after it buys it.) Most mar­ket par­tic­i­pants were not allowed to short sell with­out pre-borrowing shares for set­tle­ment and in a 12 day period, this amount only accu­mu­lated to 5.5 mil­lion increased shorted shares. The major­ity of the 3.5 bil­lion shares sold were not sold by legit­i­mate investors who owned the shares. They must thus be shares coun­ter­feited by the mar­ket mak­ers, Gold­man Sachs and LaBranche & Co. who could avoid the nor­mal set­tle­ment process of the NSCC. The num­bers were known by the reg­u­la­tory and clear­ing institutions.

New York Stock Exchange (NYSE) col­lects trade-by-trade infor­ma­tion. It would know that shares were all owned by reg­is­tered insti­tu­tions and that mil­lions or even hun­dreds of mil­lions of shares should not be trad­ing. The National Secu­ri­ties Clear­ing Cor­po­ra­tion (NSCC) also has records that show bil­lions of shares could not have been legally set­tled through their set­tle­ment sys­tem. Why don’t the insti­tu­tional investors them­selves notice that more shares are traded than owned? Pri­vate invest­ment advi­sors to insti­tu­tions don’t care as long as the money keeps flow­ing, they buy stock, and get their fees.”

5. One of the most dev­as­tat­ing devices affect­ing the global finan­cial land­scape are credit default swaps.

“Credit Default Swaps: the next cri­sis that will be pro­voked by short sell­ing. Mort­gage secu­ri­ties were bun­dled into large pack­ages which were then trans­ferred to large Wall Street firms. These firms cre­ated deriv­a­tive con­tracts from them which were resold. The con­tracts could be traded in the credit swap mar­ket. Its prospec­tive col­lapse dwarfs the prob­lem of mortgage-backed secu­ri­ties. On Sep­tem­ber 23, 2008, in tes­ti­mony before the Sen­ate Bank­ing Com­mit­tee, SEC Chair Cox asked Con­gress to reg­u­late the mar­ket for credit default swaps, finan­cial instru­ments that insure the holder against losses from declines in bonds and other types of secu­ri­ties. He said, ‘I will con­clude, Mr. Chair­man, by warn­ing of another sim­i­lar reg­u­la­tory hole in statute that must imme­di­ately be addressed or we will have sim­i­lar con­se­quences. The $58 tril­lion notional mar­ket in credit default swaps to which sev­eral of you have referred in your open­ing com­ments that is dou­ble the amount that was out­stand­ing in 2006, is reg­u­lated by absolutely no one. Nei­ther the SEC nor any reg­u­la­tor has author­ity over the CDS mar­ket, even to require min­i­mum dis­clo­sure to the mar­ket. This mar­ket is ripe for fraud and manip­u­la­tion and indeed we are using the full extent of our anti-fraud author­ity, our law enforce­ment author­ity right now to inves­ti­gate this market.’

Credit default swaps are con­tracts between deal­ers on stocks, bonds, mort­gage backed secu­ri­ties or other finan­cial instru­ments (‘secu­ri­ties’) that can be hedged by sell­ing the secu­ri­ties at the cur­rent mar­ket value. Spec­u­la­tors may trade a swapped con­tract for a future deliv­ery of a secu­rity sev­eral years in the future. Then they hedge the con­tract by sell­ing the secu­ri­ties into the pub­lic mar­kets or to invest­ment funds, such as pen­sion funds, even though they don’t own them.

It works like this. You are Mer­rill Lynch and I am Lehman. You and I decide we’re going to short-sell a stock. I agree to write a con­tract to you that says in five years I will deliver to you 10 mil­lion shares of ‘xyz’ on Jan 1. You agree to write a con­tract to deliver to me 10 mil­lion shares on Jan 2. You and I never exchanged a dime, we just wrote a con­tract. We’re allowed to hedge that. I can sell 10 mil­lion shares of ‘xyz.’ So can you. Even though we don’t own them. 20 mil­lion coun­ter­feit shares just got sold. At the end, the con­tracts are shred­ded. The money is made from naked short sell­ing, from the price decline of the asset. The most profit is obtained if the secu­rity declines to zero.

Once they do their hedge, the bro­kers then can sell the con­tract to another party — to their favorite hedge fund client. Then that client is allowed tohedge again the risk of the ten mil­lion shares. It is legal­ized fraud.”

6. More about the SEC’s com­plic­ity in these gambit:

“They don’t set­tle. Cox said we have no statu­tory author­ity, the SEC doesn’t reg­u­late con­tracts. But when they sell the equity into the mar­ket as a hedge, the SEC has con­trol. It has turned a blind eye. Nei­ther the SEC nor any reg­u­la­tor accepts author­ity over credit default swap mar­ket even to require min­i­mum dis­clo­sure. Now they’re say­ing we have antifraud pro­vi­sions to go after these peo­ple. But they never used them.

US traders have issued credit default swap con­tracts far greater than hous­ing issues. The value of these con­tracts has been esti­mated to be $58 to 62 tril­lion. Com­pare that to the fact that the entire U.S. pub­lic retire­ment accounts amounted to $17.6 tril­lion at the end of 2007. Sixty tril­lion dol­lars is equal to the value of all pub­licly traded stocks listed on all major global stock exchanges. Cox said, ‘Because CDS buy­ers don’t have to own the bond or the debt instru­ment upon which the con­tract is based, they can effec­tively naked short [ie, sell and never deliver] the debt of com­pa­nies with­out any restric­tion, poten­tially caus­ing mar­ket dis­rup­tion and desta­bi­liz­ing the com­pa­nies them­selves.’ Because the com­pa­nies’ shares will plummet.

He said, ‘This is a prob­lem we have been deal­ing with, with our inter­na­tional reg­u­la­tory coun­ter­parts around the world with straight equi­ties and it’s a big prob­lem in a mar­ket that has no trans­parency and peo­ple don’t know where the risk lies.’ In fact, the SEC has not dealt with this. Cox asked Con­gress for the first time to reg­u­late the mar­ket for credit-default swaps, finan­cial instru­ments that insure the holder against losses from declines in bonds and other types of secu­ri­ties. Days later the SEC issued a new order indi­cat­ing it now real­izes that vol­un­tary sub­mis­sion of infor­ma­tion by the major bro­ker deal­ers does not work. So expect regulation.

The ana­lyst said, ‘Money in Wall Street does not vapor­ize in a finan­cial cri­sis; it is only trans­ferred from investors to those Wall Street par­tic­i­pants who ben­e­fit from mar­ket crashes. There have been very large credit default swap con­tracts and other meth­ods of naked short sell­ing used against U.S. secu­ri­ties. There is an incen­tive for the small num­ber of prof­i­teers in these large naked short posi­tions to crash the value of the under­ly­ing secu­ri­ties, but this will, as it already has begun to, crash the U.S. econ­omy. These prof­i­teers can then con­ceal the fact that they have pre­vi­ously stolen the money from the finan­cial sys­tem by sell­ing secu­ri­ties they cre­ated from sham con­tracts. There are vast pools of money gained from this activ­ity by a small num­ber of iden­ti­fi­able par­tic­i­pants and if the U.S. can­not coun­ter­act these pools, finan­cial dev­as­ta­tion is assured.

‘It’s col­lu­sion; it vio­lates fraud and anti-manipulation rules, but the SEC has never enforced the rules against these types of con­tract. As soon as they get to the large bro­ker deal­ers, they don’t deliver on promise to inves­ti­gate. Now they say they’re going to.”

7. When in Con­gress cur­rent SEC chair­man Christo­pher Cox helped to facil­i­tate the imple­men­ta­tion of these scams.

“In fact, Cox as a con­gress­man in 1995 spon­sored the pri­vate secu­ri­ties lit­i­ga­tion reform act to knock civil secu­ri­ties cases out of the RICO law. A num­ber of com­pa­nies had brought RICO actions in fed­eral court against prime bro­kers and hedge funds. Cox him­self was sued in a RICO case in 1992. So he pro­tected him­self, the bro­kers and the funds. The law gave the SEC sole author­ity to bring RICO actions related to stock fraud. Awards under the law can be sig­nif­i­cant — three times the amounts stolen. The SEC has never used it.

The ana­lyst said, ‘The exchanges, the clear­ing firms, the set­tle­ment firms have the data. It’s com­pletely ille­gal to sell some­thing long that you don’t own. The con­tracts are ille­gal because they mark the shares ‘long’ [mean­ing they own the shares they are sell­ing] so they never show up as ‘short.’ It’s the deal­ers’ respon­si­bil­ity. If they didn’t mark them as short, it’s fraud. And if they devel­oped very large sums of these, it’s mar­ket manip­u­la­tion by the fact of the num­ber of shares they devel­oped. This is theft on a major scale. They should do dis­gorge­ment of ill got­ten gains. Should peo­ple go to jail? Absolutely?

He said, ‘I would com­pletely revamp. They’ve taken a con­cept designed to be a risk hedge. It wasn’t a bad con­cept. But they changed it to hedge secu­ri­ties they don’t own. There’s no hedge. There’s no eco­nomic risk. That type of con­tract should be elim­i­nated. Any credit default swap based on no under­ly­ing assets should not be allowed to trade. He said, ‘The only answer I see is to go after the very large amount of money that has been stolen from the econ­omy. It’s not hard to track. Credit default swaps are ‘off bal­ance sheet trans­ac­tions’ in broker-dealers’ books, But they report them in foot­notes in 10K fil­ings and audi­tors are aware of them. Reg­u­la­tors don’t see them. It’s a non-reporting report. They use spe­cial accounts, trusts, spe­cial pur­pose enter­prises — that is the likely home for the money that was stolen through manip­u­la­tion of shares through fraud­u­lent methods.

It’s sit­ting off­shore, in the Cay­man Islands or the British Vir­gin Islands. Or it flowed through there. We know who exe­cuted the trades. Henry Paul­son as a Gold­man Sachs exec­u­tive and senior part­ner is very versed at how these types of mar­kets work and under­stands the com­plex­i­ties of credit default swaps and that the prime bro­ker deal­ers are car­ry­ing these trans­ac­tions off the books. But they always back off of the large prime brokers.”

8. Lucy dis­cussed the neces­sity of exam­in­ing AIG’s use of off­shore tax havens.

“The U.S. takeover of the world’s largest insur­ance con­glom­er­ate, AIG, puts it in a unique posi­tion to look into the inner deal­ings of a com­pany that is a prof­li­gate user of tax havens. AIG has employed off­shore shell com­pa­nies to cook its books and dodge taxes. The new U.S. man­agers should inves­ti­gate how they do it. AIG’s favorite off­shore juris­dic­tions are Bermuda, Bar­ba­dos, Switzer­land, and Lux­em­bourg, places immune from even the lax enforce­ment of America’s state insur­ance reg­u­la­tors and the Secu­ri­ties and Exchange Com­mis­sion (SEC). AIG’s off­shore sub­sidiaries include Amer­i­can Inter­na­tional Assur­ance Com­pany Lim­ited, Bermuda; Amer­i­can Inter­na­tional Rein­sur­ance Com­pany, Ltd., Bermuda; AIG Life Insur­ance Com­pany Ltd., Switzer­land; and AIG Finan­cial Advi­sor Ser­vices, S.A., Lux­em­bourg. AIG in the past has used tax havens to evade reg­u­la­tions and hide insider con­nec­tions in sup­pos­edly “arms-length” deals. This is espe­cially sig­nif­i­cant as the com­pany has moved into finan­cial ser­vices and asset man­age­ment. It has also used the off­shore sys­tem to evade U.S. taxes.

Here are two exam­ples, the first reported exclu­sively by this writer. AIG helped Vic­tor Pos­ner, a noto­ri­ously crooked investor, set up an off­shore rein­sur­ance com­pany so that Pos­ner could evade U.S. taxes. The pol­icy scam was dis­cov­ered in the early 1990s, after the SEC pros­e­cuted Pos­ner for a fraud­u­lent takeover scheme con­cocted with Wall Street thieves Michael Milken and Ivan Boesky, ordered him to pay $4 mil­lion to fraud vic­tims and banned him from serv­ing as offi­cer or direc­tor of any publicly-held com­pany. New man­agers took over Posner’s NVF Corp., which ran a Delaware vul­can­ized rub­ber plant. An insur­ance agent charged with exam­in­ing com­pany poli­cies dis­cov­ered that NVF was pay­ing AIG’s National Union Fire of Pitts­burgh sub­stan­tially over mar­ket for workmen’s com­pen­sa­tion insur­ance. AIG rein­sured the pol­icy through Chesa­peake Insur­ance, an off­shore rein­sur­ance com­pany Pos­ner owned in Bermuda. In essence, NVF, owned by Pos­ner, was buy­ing insur­ance from an AIG com­pany which was buy­ing rein­sur­ance for the pol­icy from an off­shore com­pany owned by Pos­ner. Bermuda pro­vided tax and cor­po­rate secrecy, so Chesapeake’s books were safe from the eyes of Amer­i­can reg­u­la­tors and tax author­i­ties. AIG and Pos­ner made out like ban­dits. AIG got a higher com­mis­sion from the inflated NVF pre­mium before send­ing the rest to Chesa­peake. Pos­ner wrote off the entire amount as a busi­ness expense and enjoyed the extra cash in Bermuda, tax free, stiff­ing the U.S. gov­ern­ment. Reduced prof­its also meant smaller div­i­dends and share prices for investors. The insur­ance agent can­celled the NVF pol­icy with AIG, but the Delaware Insur­ance Depart­ment did not make the scam pub­lic or take any action against AIG. A for­mer insur­ance depart­ment reg­u­la­tor told me, “This was not an iso­lated case with Vul­can [NVF]. AIG did that a lot. AIG helped com­pa­nies set up off­shore cap­tive rein­sur­ance com­pa­nies.” A “cap­tive” is owned by the com­pany it insures. AIG, he alleged, “would then over­charge on insur­ance and pay rein­sur­ance pre­mi­ums to the cap­tives, giv­ing the cap­tive own­ers tax-free off­shore income.”

AIG says that it “pio­neered the for­ma­tion of cap­tives” and offers man­age­ment facil­i­ties to run them in off­shore Bar­ba­dos, Bermuda, Cay­man Islands, Gibral­tar, Guernsey, Isle of Man, and Lux­em­bourg — all places where cor­po­rate and account­ing records are secret and taxes min­i­mal or nonex­is­tent. Another scam helped AIG dodge taxes and U.S. reg­u­la­tions. Insur­ance com­pa­nies nor­mally insure them­selves by lay­ing off part of their risk to rein­sur­ance com­pa­nies, so if a claim comes in above a cer­tain amount, the rein­sur­ance com­pany will pay it. State laws also require them to keep a cer­tain amount of cap­i­tal avail­able to pay out claims. If they have rein­sur­ance, that amount can drop. Com­pa­nies have to show losses — amounts they have paid out — on their books. If they have enough good rein­sur­ance, they get a credit for that against their losses. The rein­surer, of course, has to be an inde­pen­dent com­pany; the risk isn’t reduced if it’s just moved to another divi­sion of the same com­pany. In the mid-1980s, two of AIG’s rein­sur­ers failed. AIG would have had to cur­tail writ­ing new busi­ness, since rules require a cer­tain ratio of assets to risk. Find­ing new rein­sur­ers was going to be dif­fi­cult and expen­sive. CEO Mau­rice “Hank” Green­berg per­suaded sev­eral of his busi­ness friends to set up a com­pany into which he could “cede” AIG insur­ance. The com­pany was launched with a pri­vate sale of shares orga­nized by Gold­man Sachs, then headed by Robert Rubin. Greenberg’s front men were loaned the money to “buy” risk-free shares in the new Coral Re, an allegedly inde­pen­dent off­shore rein­sur­ance com­pany, to allow it to ille­gally move debt off AIG’s books and vio­late rules about main­tain­ing min­i­mum lev­els of reserves required to pay off claims. The com­pany was reg­is­tered in Bar­ba­dos, where cap­i­tal require­ments and reg­u­la­tion are min­i­mal, where Amer­i­can reg­u­la­tors couldn’t read­ily dis­cover AIG’s involve­ment and where, as an added incen­tive, it could evade U.S. taxes. If Coral Re was an AIG affil­i­ate, it would have to pay taxes on its income. . . .”

(“U.S. Should Exam­ine AIG’s Use of Tax Havens” by Lucy Komisar; 10/26/08.)