SEC Follow Up Exhibits Part C SEC_OEA_FCIC_001760-2501

world. I enjoyed my time at the Journal. They let me live in Europe. I got to write mean things about socialists.
But with genuine respect, I say to my former colleagues –you are like the boy in the bubble. You live and breathe the “free
markets” paradigm. This is healthy, but it is limiting. Get dirty with the data. Behold the slop in our clearing and settlement
system. Consider how this slop is affecting our market, and tell me what is free or efficient about it.
Please, do it quickly.
The Wall Street Journal stated in a lead editorial last week that the SEC was “reasonable” to “clamp down” on naked
short selling. Well, that was progress of sorts, though one wonders how it could have taken all these years.
And now that this activity has been implicated in the Humpty Dumptying of our financial system, one grows wistful for the
golden age of journalism when editorialists (people working for famous newspapers, not just cyber weirdos) would
express a little outrage, demand that heads roll – muster something better than “reasonable” to describe the limp “clamp
down” of the SEC.
Alas, The Wall Street Journal is not angry about the scandal of naked short selling. To the contrary, it devotes most of its
editorial to tut-tutting the SEC for taking the mild step of requiring hedge funds to disclose their short positions. This, the
Journal laments, means the government wants to “slap a scarlet letter on short sellers.”
Might the SEC like to see which hedge funds are employing the strategy of illegal naked short selling – offloading huge
chunks of stock that they do not possess – phantom stock – in order to drive down prices? No, nothing to see there, says
the Journal. Having thoroughly investigated the matter, the editorialist reports that there is “no evidence of widespread
naked shorting of financial stocks in this panic.” Indeed, the Journal assures us that there is no evidence that short sellers
have engaged in any market manipulation whatsoever.
That is a mighty bold claim, because the data scream, “Investigate!”
Take the case of Washington Mutual, which met its demise on the same day that the Journal published its editorial. While
the SEC has not yet released data covering the last couple weeks of turmoil, the data through June show that at one point
that month “failures to deliver” of Washington Mutual’s stock reached an astounding 9 million shares. From June 5 to
June 19 there were, on any given day, at least 1 million WaMu shares that had “failed to deliver.”
In other words, hedge funds and brokers sold as many as 9 million shares that they did not possess (which is why they
“failed to deliver” them), and they kept the market saturated with at least 1 million phantom shares for more than two
weeks. WaMu’s stock price dropped by more than 30% during this period. Similar attacks, with similar effects, occurred
one after another in the months leading up to June.
That is very good evidence of a mismatch of supply and demand.
Aside from Washington Mutual, Bank of America, Fannie Mae, MBIA, Ambac, and close to 50 smaller financial firms – not
to mention a couple hundred non-financial companies – have appeared on the SEC-mandated “threshold” list of
companies whose stock has “failed to deliver” in excessive quantities.
That, too, is very good evidence of selling not matched with supply.
A number of the big banks never appeared on the SEC’s “threshold” list. Perhaps that explains the Journal’s claim that
there is “no evidence” that naked short selling contributed to our financial crisis. If so, the Journal does not understand the
methods that naked short sellers use to manipulate the markets. The Journal also does not understand how powerful
financial elites manipulate the government (and the media).
Peter Chepucavage, the former SEC official who authored Regulation SHO (the rules that governed short sales from
2005 until the SEC temporarily banned short-selling of financial stock last week) has told us that the rules were watered
down under fierce pressure from the hedge fund lobby.
One result is that Regulation SHO did not force short sellers to borrow real shares before they sold them. They were
given three days to produce stock before it was declared a “failure to deliver.” If they missed the three-day deadline, they
were given another ten days, after which they were supposed to buy (not borrow) real shares and deliver them, or face
penalties.
In practice, many hedge funds and brokers ignored the deadlines without repercussions. But even traders who met the
deadlines were able to churn the markets. Since they were not required to possess real shares before they hit the sell
button, they could offload a large block of phantom stock and let it dilute supply for three to 13 days. When the deadline
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