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For The Record  

FTR #650 Analyzing the Causes of the Crash –-Interview with Lucy Komisar

MP3: Side 1 | Side 2

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.)


13 comments for “FTR #650 Analyzing the Causes of the Crash –-Interview with Lucy Komisar”

  1. I’m impressed with the clear­est analy­sis read to date on this sub­ject. This lev­el of know­ing and delib­er­ate theft by decep­tion deserves the most direct appli­ca­tion of the law of fraud.
    Of course Boobus Amer­i­canus just elect­ed a new over­seer, but the fox will keep the hen­house secu­ri­ty con­tract in per­pe­tu­ity, or so it seems.

    It needs to be pro­duced as a “Scrooge McDuck” car­toon with the bad guys in bur­glar’s masks, or black hats to make the point where in the trans­ac­tion the con­flict of inter­est aris­es. That’s if we want to pen­e­trate the gov­ern­ment trained minds of our fel­lows. And we must. There is pow­er in num­bers. Those with­out pow­er can­not defend lib­er­ty, read hon­est courts.
    Please keep on writ­ing. Sol­id, clear style. Lucid.

    Posted by Jim Lorenz | November 27, 2008, 10:09 pm
  2. I’m impressed that you broke Lucy’s sto­ry about 5 months ago and only now peo­ple and the main­stream press are start­ing to get out­raged at AIG, and not even at the out­rages that mat­ter about AIG...

    Posted by rk | March 19, 2009, 8:30 am
  3. I only heard about short sell­ing and naked short sell­ing a short while ago. It astounds and mys­ti­fies me. This seems to be a com­plete­ly dis­hon­est prac­tice and I won­der why there aren’t law pro­hibit­ing it. All these investors are going to be broke because of the dis­hon­esty of a few and there isn’t enough sur­face pro­tec­tion in the world to coun­ter­act it.

    Posted by Ginny Crandall | January 6, 2011, 1:28 pm
  4. [...] FTR #650 [...]

    Posted by Lucy Komisar on Naked Short Selling and other Wall Steet gambits | lys-dor.com | April 19, 2011, 10:12 pm
  5. With the Euro­zone cri­sis still going strong, it’s worth keep­ing in mind that the EU only banned naked short­ing of EU sov­er­eign bonds a cou­ple of weeks ago:

    Asset man­agers decry ‘pure­ly polit­i­cal’ short-sell­ing ban

    William Hutch­ings
    19 Oct 2011

    Asset man­agers and bro­kers have react­ed against the “pure­ly polit­i­cal” impo­si­tion of a ban on naked short­ing of Euro­pean Union sov­er­eign gov­ern­ment bonds and stocks, which is expect­ed to come into law fol­low­ing a late-night agree­ment between the Euro­pean Par­lia­ment and rep­re­sen­ta­tives of EU mem­ber states.

    Naked short-sell­ing is car­ried out when an investor uses a cred­it default swap to make a bet against a finan­cial prod­uct, such as sov­er­eign bond, with­out hold­ing the under­ly­ing asset itself.

    Andrew Bak­er, chief exec­u­tive of Alter­na­tive Invest­ment Man­age­ment Asso­ci­a­tion, which rep­re­sents the glob­al hedge fund indus­try, said: “We have pre­vi­ous­ly expressed our con­cerns about the impact of a ban on uncov­ered sov­er­eign CDS.

    “It could not only reduce liq­uid­i­ty and increase volatil­i­ty in debt mar­kets, but also increase gov­ern­ment bor­row­ing costs and reduce real econ­o­my invest­ments in EU mem­ber states.”


    Proxy hedg­ing and mar­ket-mak­ers are exempt­ed from ban, the observ­er said.

    Andrew Shrimp­ton, a part­ner of finan­cial advi­so­ry firm Kinet­ic Part­ners and a for­mer exec­u­tive of the Finan­cial Ser­vices Author­i­ty, also said the pro­posed ban will reduce liq­uid­i­ty in the CDS mar­ket, “lead­ing to increased volatil­i­ty of CDS prices, under­mine con­fi­dence in mem­ber state sov­er­eign bonds and make it more expen­sive for mem­ber states to finance bud­gets”.

    He said: “This has been demon­strat­ed by sim­i­lar­ly ill-timed reg­u­la­to­ry tight­en­ing such as the ban­ning by France, Italy, Bel­gium and Spain of the short sell­ing of finan­cial stocks ear­li­er this year, which under­mined con­fi­dence in bank stocks, reduced liq­uid­i­ty in the bank­ing sys­tem and even­tu­al­ly led to a tax­pay­er-fund­ed bailout of Dex­ia.

    I love this ratio­nal: Ban­ning naked short sell­ing under­mines con­fi­dence in stock, send­ing them plung­ing. Giv­en how often mar­ket’s “con­fi­dence” is used to jus­ti­fy insane poli­cies, I’m start­ing to think that it isn’t just reg­u­la­to­ry reform we need. The “mar­ket” clear­ly needs a life coach to deal with this scary scary world. Fear not Mr. Mar­ket, there is hope!

    Posted by Pterrafractyl | November 4, 2011, 10:12 am
  6. Anoth­er price­less gem, this time by SEC chief enforcer Robert Khuza­mi:

    Promis­es Made, and Remade, by Firms in S.E.C. Fraud Cas­es
    Pub­lished: Novem­ber 7, 2011

    WASHINGTON — When Cit­i­group agreed last month to pay $285 mil­lion to set­tle civ­il charges that it had defraud­ed cus­tomers dur­ing the hous­ing bub­ble, the Secu­ri­ties and Exchange Com­mis­sion wrest­ed a typ­i­cal pledge from the com­pa­ny: Cit­i­group would nev­er vio­late one of the main antifraud pro­vi­sions of the nation’s secu­ri­ties laws.

    To an out­sider, the vow may seem unusu­al. Cit­i­group, after all, was mere­ly promis­ing not to do some­thing that the law already for­bids. But that is the way the com­mis­sion usu­al­ly does busi­ness. It also was not the first time the firm was mak­ing that promise.

    Bar­bara Rop­er, direc­tor of investor pro­tec­tion for the Con­sumer Fed­er­a­tion of Amer­i­ca, said, “You can look at the record and see that it clear­ly sug­gests this is not deter­ring repeat offens­es. You have to at least raise the ques­tion if oth­er alter­na­tives might be more effec­tive.

    S.E.C. offi­cials say they allow these kinds of set­tle­ments because it is far less cost­ly than tak­ing deep-pock­et­ed Wall Street firms to court and risk­ing los­ing the case. By law, the com­mis­sion can bring only civ­il cas­es. It has to turn to the Jus­tice Depart­ment for crim­i­nal pros­e­cu­tions.

    Robert Khuza­mi, the S.E.C.’s enforce­ment direc­tor, said nev­er-do-it again promis­es were a deter­rent espe­cial­ly when there were repeat­ed prob­lems. In their pri­vate dis­cus­sions, com­mis­sion­ers weigh a firm’s his­to­ry with the S.E.C. before they set­tle on the amount of fines and penal­ties. “It’s a thumb on the scale,” Mr. Khuza­mi said. “No one here is dis­re­gard­ing the fact that there were pri­or vio­la­tions or pri­or mis­con­duct,” he said.

    So pre­cious: “nev­er-do-it again promis­es were a deter­rent espe­cial­ly when there were repeat­ed prob­lems”

    I guess Mr. Khuza­mi would be in a posi­tion to know how these things work...

    Cir­cle Jerk 101: The SEC’s Robert Khuza­mi Over­saw Deutsche Bank’s CDO, Has Recused Him­self Of DB-Relat­ed Mat­ters

    Sub­mit­ted by Tyler Dur­den on 04/24/2010 13:08 ‑0400

    The incest con­tin­ues: the WSJ has informed that the SEC’s chief inves­ti­ga­tor, Robert Khuza­mi, used to be gen­er­al coun­sel for Deutsche Bank, and pre­sum­ably reviewed numer­ous CDO-relat­ed trans­ac­tion, while on the “oth­er side” of the wall. “As part of that job, he worked with lawyers who advised on the CDOs
    issued by the Ger­man bank and how details about them should be dis­closed to investors. The group includ­ed more than 100 lawyers who also defend­ed the bank against law­suits and vet­ted oth­er finan­cial prod­ucts, these peo­ple said.” The good: he prob­a­bly knows more about CDOs than any oth­er per­son in gov­ern­ment admin­is­tra­tion his­to­ry, and thus would not have brought on the Gold­man case with­out being aware of all the poten­tial trip­wire nuances (and yes, if the Gold­man case gets to the dis­cov­ery stage, which it will, it is game over for Gold­man’s defense strat­e­gy, which means set­tle­ment and/or much worse). The bad: who knows how many Deustche Bank CDO’s of com­pa­ra­ble or worse nature he allowed to see the light of day. The most inter­est­ing: “Because of Mr. Khuza­mi’s old job and his finan­cial inter­est in the
    com­pa­ny, he has recused him­self from any mat­ters relat­ed to Deutsche Bank, accord­ing to an SEC spokesman.”
    With Greg Lipp­man­n’s (leg­endary head of CDO trad­ing at the Ger­man firm whose assets are greater than all of Ger­many’s GDP) recent sud­den depar­ture, and the SEC being pre­vent­ed from bring­ing CDO-relat­ed charges against the bank (for the time being), is DB cur­rent­ly active­ly clean­ing up its tracks? After all the firm was one of the top 3 CDO issuers in the peri­od under con­sid­er­a­tion.

    Posted by Pterrafractyl | November 8, 2011, 8:18 am
  7. More pre­cious nuggets from the SEC:

    On Wednes­day, the judge homed in on the issue of banks who set­tle with the S.E.C. and pledge to not vio­late the secu­ri­ties laws, yet repeat­ed­ly do so. Why then, Judge Rakoff asked, had the com­mis­sion not brought any con­tempt charges against large finan­cial firms in the past 10 years?

    Mr. Martens, the S.E.C. lawyer, said that the agency felt that there were bet­ter and more appro­pri­ate ways to deal with chron­ic mis­con­duct. The S.E.C. has said that strik­ing set­tle­ments is often prefer­able to a cost­ly and pro­tract­ed law­suit that it might lose.

    Judge Rakoff called the con­tempt pow­er — a judge’s abil­i­ty to pun­ish a par­ty for dis­obey­ing a court order — “the back­bone of the judi­cia­ry.” He ques­tioned whether the S.E.C. was real­ly seri­ous about ever seek­ing an injunc­tion against repeat offend­ers.

    “It’s just for show,” Judge Rakoff said.

    “We’re not say­ing that we will nev­er use injunc­tive relief,” said the S.E.C. lawyer.

    “Hope springs eter­nal,” the judge replied.

    Aha, I see, this must all part of some sort of “dumb cop/dumber cop” rou­tine designed to lull Wall Street into a false sense of secu­ri­ty. Like they said...

    “We’re not say­ing that we will nev­er use injunc­tive relief”

    Springeth Hope! Springeth!

    Posted by Pterrafractyl | November 10, 2011, 8:12 am
  8. [...] I rec­om­mend that you lis­ten to the one-hour inter­view that she gave to radio host Dave Emory in For The Record #650. Free­man also touch­es on some com­ple­men­tary ele­ments to try to sum up the ques­tion of finan­cial [...]

    Posted by Kevin Freeman on economic and financial terrorism: The Chinese threat and Unrestricted Warfare | Lys-d'Or | January 27, 2012, 6:31 pm
  9. [...] FTR #650 [...]

    Posted by Lucy Komisar on Naked Short Selling and other Wall Steet gambits | Lys-d'Or | April 27, 2012, 11:41 am
  10. Well isn’t that nice....new EU reg­u­la­tions are in place to ban naked short sell­ing. But fear not intre­pid investors that still desire the abil­i­ty to engage in the naked short­ing of gov­ern­ment bonds! While the new reg­u­la­tions do indeed clamp down of the direct naked short­ing of sov­er­eign debt it appears that deriv­a­tives and exchange trad­ed funds (ETFs) will still do the trick:

    Europe’s naked short sell­ing ban leaves investors with skin in the game
    By Guest Con­trib­u­tor
    Decem­ber 4, 2012

    By Christo­pher Elias

    LONDON/NEW YORK, Dec. 4 (Busi­ness Law Cur­rents) – New Euro­pean short sell­ing reg­u­la­tions are dress­ing naked short sell­ers in a reg­u­la­to­ry straight­jack­et, but ill-fit­ting pro­vi­sions may leave investors with skin in the game.

    In force since 1 Novem­ber 2012, the reg­u­la­tions were sup­posed to curb naked short sell­ing and to pro­vide trans­paren­cy on those trad­ing against Euro­pean sov­er­eign debt. How­ev­er, with gaps between short sell­ing meth­ods and alter­na­tives pop­ping up in exchange trad­ed futures and syn­thet­ic forms, the holes are already becom­ing appar­ent.

    Part dis­clo­sure regime, part (naked) sov­er­eign short­ing ban, the Euro­pean reg­u­la­tions impact a wide vari­ety of trades and there are signs that the mar­kets are already adjust­ing.

    Broad­ly speak­ing, the rules ban the short­ing of Euro­pean sov­er­eign debt oth­er than as a hedge, and require the dis­clo­sure of sub­stan­tial short posi­tions in list­ed Euro­pean com­pa­nies.


    Uncov­ered “naked” shorts

    Per­haps most con­tro­ver­sial are the new rules on uncov­ered and naked short posi­tions. “Naked” shorts are posi­tions where­by a firm sells shares that they do not own or have not bor­rowed.

    Unlike a “nor­mal” short sell­ing sce­nario, a naked short sell­er will not buy or bor­row the shares before sell­ing them on. Instead the sell­er will hope to pur­chase the shares pri­or to deliv­er­ing on its sale or in some cas­es will just fail to deliv­er those shares.

    By way of illus­tra­tion, sup­pose a naked short sell­er sells shares in Com­pa­ny A at $50 each for deliv­ery in three days time. The sell­er will then hope that the val­ue of Com­pa­ny A’s shares fall in the inter­im peri­od so that he or she can pur­chase those shares at less than $50 before deliv­er­ing them to the buy­er whilst pock­et­ing the dif­fer­ence.

    The process of naked short sell­ing can lead to what are known as “failed to deliv­er” notices – instances where­by the short sell­er is unable to obtain the secu­ri­ties and there­fore fails to deliv­er them to the buy­er. Although far from con­clu­sive, such fail to deliv­ers have been charged with cre­at­ing mar­ket volatil­i­ty and poten­tial­ly sharp decreas­es in a company’s share val­ue.

    The new reg­u­la­tions seek to large­ly do away with naked short sell­ing by requir­ing firms to have either bor­rowed or be able to bor­row shares to cov­er their short posi­tions or in the case of sov­er­eign bor­row­ing to have some cor­re­spond­ing hedge.


    Naked sov­er­eigns

    Curi­ous­ly, the reg­u­la­tions are rather more relaxed in rela­tion to naked sov­er­eign or cred­it default swap (CDS) posi­tions than in rela­tion to com­pa­ny shares. Even more per­plex­ing are that the rules are sub­tly dif­fer­ent for CDS posi­tions and for uncov­ered short posi­tions- a dif­fer­ence that may have ram­i­fi­ca­tions for mar­ket par­tic­i­pants.

    Both CDS and uncov­ered short posi­tions do not require a firm to have bor­rowed or be able to bor­row secu­ri­ties, pro­vid­ed that the posi­tion is being used for the pur­pos­es of a per­mit­ted hedge.

    Per­plex­ing­ly, what con­sti­tutes a per­mit­ted hedge, how­ev­er, dif­fers between cred­it default swap posi­tions and more straight for­ward short­ing. For uncov­ered short posi­tions, a sov­er­eign debt short will be per­mit­ted if it is being used to hedge a long posi­tion in the debt instru­ments of an issuer, the pric­ing of which has a “high cor­re­la­tion” (80 per­cent accord­ing to ESMA FAQs) with the pric­ing of the sov­er­eign debt.

    By con­trast a naked CDS is required to hedge against the risk of default of the issuer where the short sell­er has a long posi­tion in the sov­er­eign debt or oth­er finan­cial con­tract that is cor­re­lat­ed (but not “high­ly”) with the risk of decline of the sov­er­eign debt.

    The cor­re­la­tion between CDS and sov­er­eign debt may be judged quan­ti­ta­tive­ly (with a co-effi­cient of at least 70 per­cent) or qual­i­ta­tive­ly using his­tor­i­cal infor­ma­tion from the pre­vi­ous 12 months and includes indi­rect expo­sures obtained through funds, indices or spe­cial pur­pose vehi­cles.

    The dis­tinc­tion seems to sug­gest that CDSs may offer more flex­i­bil­i­ty to short sell­ers than short sov­er­eign bond posi­tions. The CDS 70 per­cent cor­re­la­tion is low­er than the sov­er­eign bond 80 per­cent cor­re­la­tion and includes more types of finan­cial instru­ments. Where­as bond short sell­ers must have a cor­re­lat­ing debt instru­ment, a CDS could match sov­er­eign debt to a more diverse uni­verse of finan­cial con­tracts.

    Despite the fact that the reg­u­la­tions are bare­ly in force, there are signs, how­ev­er, that some investors have already found a way around the reg­u­la­tions.

    Back to the future(s)?

    As Europe clamps down on CDSs and sov­er­eign short­ing, there has been a sharp uptick in the num­ber of investors using exchange trad­ed futures. Capa­ble of per­form­ing in an eco­nom­i­cal­ly sim­i­lar way to CDSs or short posi­tions, investors may be plow­ing into these more light­ly reg­u­lat­ed instru­ments.

    IFR, a Thom­son Reuters pub­li­ca­tion, not­ed recent­ly that on the eve of the short sell­ing rules com­ing into force, flows into futures had increased dra­mat­i­cal­ly. Not includ­ed with­in Europe’s short sell­ing reg­u­la­tions, exchange-trad­ed gov­ern­ment bond futures may be being used by some to evade the ESMA restric­tions.

    Open inter­est in Eurex-list­ed Ital­ian BTP futures has almost dou­bled since the announce­ment of the ban back in March, from 32,271 to a new peak of 62,489 accord­ing to IFR.

    Vol­umes in OAT futures have rock­et­ed even more sharply with open inter­est reach­ing a high of 146,923 on Octo­ber 24 despite the con­tracts only launch­ing in April.

    The futures pro­vide sim­i­lar eco­nom­ic expo­sures to CDSs or short sell­ing of Euro­pean sov­er­eign debt but with­out the restric­tions imposed by the reg­u­la­tions. The impact of which may be to move naked or oth­er short sell­ing from over-the-counter world to exchange trad­ed futures.

    As well as futures, exchange trad­ed funds (ETFs) have begun offer­ing investors a syn­thet­ic alter­na­tive to buy­ing or sell­ing sov­er­eign debt. Short­ly after the reg­u­la­tions were announced, Deutsche Bank launched DB X‑trackers that offer dai­ly lever­aged expo­sure to U.S. and UK sov­er­eign debt.

    Funds of this type allow investors to go long or short against the sov­er­eign bond mar­ket with­out hav­ing to buy bond futures con­tracts, which in some cas­es can prove cost­ly.


    Posted by Pterrafractyl | December 5, 2012, 8:12 pm
  11. Huh:

    SEC enforce­ment chief Khuza­mi is leav­ing

    By Sarah N. Lynch

    WASHINGTON | Wed Jan 9, 2013 5:46pm EST

    (Reuters) — Robert Khuza­mi, the enforce­ment direc­tor at the U.S. Secu­ri­ties and Exchange Com­mis­sion who worked to rebuild its tar­nished image after the Bernard Mad­off scan­dal and the finan­cial cri­sis, said on Wednes­day he is leav­ing the agency.

    Khuza­mi fol­lows SEC chair­man Mary Schapiro and sev­er­al oth­er high-pro­file SEC offi­cials who have stepped down since Pres­i­dent Barack Oba­ma’s re-elec­tion in Novem­ber.

    The SEC did not name a replace­ment for Khuza­mi, who is expect­ed to leave at the end of the month.

    Agency insid­ers say can­di­dates for the job could include the SEC’s deputy enforce­ment direc­tor, George Canel­los, and the region­al direc­tor of the SEC’s Boston office, David Berg­ers.

    The new enforce­ment chief will have to address a still-large pipeline of cas­es stem­ming from the 2007–2009 finan­cial cri­sis.

    While the SEC brought a record 735 enforce­ment actions in fis­cal 2011 and a near-record in fis­cal 2012, that end­ed Sep­tem­ber 30, the agency also faces crit­i­cism that it has not been tough enough in hold­ing top exec­u­tives account­able for their roles in the cri­sis.


    Some crit­ics of the agency have ques­tioned why the SEC has not brought any cas­es against Deutsche Bank, where Khuza­mi worked as the top lawyer for the U.S. unit dur­ing a peri­od when it was heav­i­ly involved in pack­ag­ing sub­prime mort­gages into secu­ri­ties, a prac­tice that has been linked to investor law­suits and reg­u­la­to­ry scruti­ny at oth­er banks.

    In response, Khuza­mi said he had already spent 12 years as a pros­e­cu­tor before ever work­ing on Wall Street.

    “If I had some inap­pro­pri­ate sym­pa­thy for my for­mer employ­er, I would­n’t have come in and in six weeks torn the place up and cre­at­ed spe­cial­ized units to focus on exact­ly the kinds of things that they and oth­er banks were doing,” he said.


    Posted by Pterrafractyl | January 9, 2013, 3:33 pm
  12. It could have been worse, although not much worse:

    Flaws Seen in ‘Almost Every’ Mort­gage-Bond as Crash Began
    By Jody Shenn May 21, 2014 11:50 AM CT

    Inves­ti­ga­tors prob­ing mort­gage-bond sales in the run-up to the finan­cial cri­sis are find­ing improp­er actions occurred “not only occa­sion­al­ly, but in the end, with almost every” deal exam­ined, a U.S. offi­cial said.

    Author­i­ties have uncov­ered evi­dence of lenders and bond issuers obscur­ing risk even more as the mar­ket began to crash to lim­it their own loss­es, with employ­ees “laugh­ing” about the envi­ron­ment, Michael P. Stephens, the Fed­er­al Hous­ing Finance Agency’s act­ing inspec­tor gen­er­al, said.

    “They were more con­cerned about their bonus­es than what was going in these pools,” Stephens said today at a Mort­gage Bankers Asso­ci­a­tion con­fer­ence in New York. “At the core of it is greed.”

    A task force of state and fed­er­al author­i­ties set up in 2012 to probe the prac­tices still has “more than a dozen ongo­ing inves­ti­ga­tions,” includ­ing some that may be pur­sued crim­i­nal­ly, accord­ing to Stephens. While the gov­ern­ment “lock­ing every­body up” is not “the long-term answer for the tax­pay­er being put in the tar­get zone for all these bailouts,” enforce­ment is need­ed to address issues that “destroyed investor trust,” he said.

    Stephens leads the Office of Inspec­tor Gen­er­al sec­tion of the Res­i­den­tial Mort­gage-Backed Secu­ri­ties Work­ing Group, whose oth­er mem­bers include the Depart­ment of Jus­tice and state attor­neys gen­er­al. The group coor­di­nat­ed a $13 bil­lion set­tle­ment between JPMor­gan Chase & Co. and the gov­ern­ment last year, among oth­er actions. His own agency is the watch­dog for the over­seer of tax­pay­er-backed Fan­nie Mae and Fred­die Mac.

    ‘Fifth Inning’

    Banks are prob­a­bly in the “fifth inning” of mort­gage inves­ti­ga­tions, he said in response to a ques­tion, based on the reg­u­la­tion nine innings of a base­ball game. That’s part­ly because the com­pa­nies have been slow in nego­ti­a­tions and seek­ing broad set­tle­ments, he said.

    “They may be anx­ious to get it behind them, but obvi­ous­ly not too anx­ious to write a check,” he said. “I don’t see any­thing in the near future that’s going to wipe the slate clean with all of the inves­ti­ga­tions.”

    Amer­i­cans should be aware that “hun­dreds and hun­dreds of peo­ple have been indict­ed and con­vict­ed of some form of mort­gage fraud,” such as bankers and fore­clo­sure firms, he said. His orga­ni­za­tion has indict­ed about 82 peo­ple in the past six months, includ­ing three who com­mit­ted sui­cide, he said.


    Huh. So were all the low-income home buy­ers the right wing rou­tine­ly blames for the hous­ing cri­sis also employ­ees at the banks sell­ing those mort­gage backed secu­ri­ties? Because that might explain how the finan­cial cri­sis was all the fault of poor peo­ple, although it still would­n’t explain why fur­ther dereg­u­la­tions are the answer.

    Posted by Pterrafractyl | May 22, 2014, 1:42 pm
  13. I don’t know, but per­haps the recent Ini­tial Pub­lic Offer­ing of the Aliba­ba Goup, could be shady. I don’t quite get why reg­u­la­tors allowed the odd cor­po­rate struc­ture.


    “5. What’s real­ly for sale: When investors buy Aliba­ba, they are actu­al­ly pur­chas­ing shares in a Cay­man Islands enti­ty called Aliba­ba Group Hold­ing Lim­it­ed.

    But that com­pa­ny — sur­prise! — does­n’t actu­al­ly own Aliba­ba. Instead, Ma and anoth­er co-founder, Simon Xie, own most of Alibaba’s biggest busi­ness­es accord­ing to Chi­nese law. Ma and Xie are then under con­tract to turn prof­its over to the Cay­man enti­ty.

    The arrange­ment is called a vari­able inter­est enti­ty (VIE), and is nec­es­sary to get around Chi­na’s strict for­eign invest­ment rules. But investors should be aware of the struc­ture — espe­cial­ly since Chi­nese courts have not clar­i­fied the legal­i­ty of the arrange­ment.

    A recent research report by the U.S.-China Eco­nom­ic and Secu­ri­ty Review Com­mis­sion took a dim view, argu­ing that “risks could mount for unsus­pect­ing U.S. investors who buy into ... pre­car­i­ous VIE struc­tures.” ”
    When the biggest IPO in U.S. his­to­ry could be a unde­mo­c­ra­t­ic, shady off­shore Cay­man Islands
    Trans-nation­al deal where, most investors and reg­u­la­tors are ignor­ing risks that seem pret­ty appar­ent, this whole deal might not bode well for the future.


    Posted by GK | October 5, 2014, 8:50 am

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