Continuing on our last post, we are going to look at the threat of Naked Short Selling and what it means for us all.

The editor at Oilprice.com wrote up an exceptionally good article on this threat and I’ll be just extracting some highlights.  To read the full article go here:

Hordes of new retail investors are banding together to take on Wall Street.  They are not willing to sit back and watch naked short sellers, funded by big banks, manipulate stocks, harm companies, and fleece shareholders.

In order to [legally] sell a stock short, traders must first locate and secure a borrow against the shares they intend to sell. A broker who enters such a trade must have assurance that his client will make settlement.

While “long” sales mean the seller owns the stock, short sales can be either “covered” or “naked”. A covered short means that the short seller has already “borrowed” or has located or arranged to borrow the shares when the short sale is made. Whereas, a naked short means the short seller is selling shares it doesn’t own and has made no arrangements to buy. The seller cannot cover or “settle” in this instance, which means they are selling “ghost” or “phantom” shares that simply do not exist without their action.

When you have the ability to sell an unlimited number of non-existent phantom shares in a publicly-traded company, you then have the power to destroy and manipulate the share price at your own will.

And big banks and financial institutions are turning a blind eye to some of the accounts that routinely participate in these illegal transactions because of the large fees they collect from them. These institutions are actively facilitating the destruction of shareholder value in return for short term windfalls in the form of trading fees. They are a major part of the problem and are complicit in aiding these accounts to create counterfeit shares.

The funds behind this are hyper sophisticated and know all the rules and tricks needed to exploit the regulators to buy themselves time to cover their short positions. According to multiple accounts from traders, lawyers, and businesses who have become victims of the worst of the worst in this game, short-sellers sometimes manage to stay naked for months on end, in clear violation of even the most relaxed securities laws.

The short-sellers and funds who participate in this manipulation almost always finance undisclosed “short reports” which they research & prepare in advance, before paying well-known short-selling groups to publish and market their reports (often without any form of disclosure) to broad audiences in order to further push the stock down artificially. There’s no doubt that these reports are intended to create maximum fear amongst retail investors and to push them to sell their shares as quickly as possible.

That is market manipulation. Plain and simple.

Their MO is to short weak, vulnerable companies by putting out negative reports that drive down their share price as much as possible. This ensures that the shorted company in question no longer has the ability to obtain financing, putting them at the mercy of the same funds that were just shorting them. After cratering the shorted company’s share price, the funds then start offering these companies financing usually through convertibles with a warrant attachment as a hedge (or potential future cover) against their short; and the companies take the offers because they have no choice left. Rinse and Repeat.

Naked short selling was officially labeled illegal in the U.S. and Europe after the 2008/2009 financial crisis.

Still, it gets even more sinister.

“Global working groups” coordinate their attacks on specifically targeted companies in a “Mafia-like” strategy.

Journalists are paid off, along with social media influencers and third-party research houses that are funded by what amounts to a conspiracy. Together, they collaborate to spread lies and negative narratives to destroy a stock.

At its most illegal, there is an insider-trading element that should enrage regulators. The MO is to infiltrate a company through disgruntled insiders or lawyers close to the company. These sources are used to obtain insider information that is then leaked to damage the company.

Often, these illegal transactions involve paying off “informants”, journalists, influencers, and “researchers” are difficult to trace because they are made from offshore accounts that are shut down once the deed is done.

Likewise, the “shorts” disguised as longs can be difficult to trace when the perpetrators have direct market access to trading systems. These trades are usually undetected until the trades fail or miss settlement.  At that point, the account will move the position to another broker-dealer and start the process all over again.

The collusion widens when brokers and financial institutions become complicit in purposefully mislabeling “shorts” as “longs”, sweeping the illegal transactions under the rug and off of regulatory radar.

“Spoofing” and “layering” have also become pervasive techniques to avoid regulator attention. Spoofing, as the name suggests, involves short sellers creating fake selling pressure on their targeted stocks to drive prices lower. They accomplish this by submitting fake offerings in “layers” at different prices to create a mirage.

Finally, these bad actors manage to skirt the settlement system, which is supposed to “clear” on what is called a T+2 basis. That means that any failed trades must be bought or dealt with within 3 days. In other words, if you buy on Monday (your “T” or transaction day), it has to be settled by Wednesday.

The naked truth is this: Investors stand no chance in the face of naked short sellers. It’s a game rigged in the favor of a sophisticated short cartel and Wall Street giants.

Now, with online trading making it easier to democratize trading, there are calls for regulators to make moves against these bad actors to ensure that North America’s capital markets remain protected, and retail investors are treated fairly.

The recent GameStop saga is retail fighting back against the shorting powers, and it’s a wonderful thing to see – but is it a futile punch or the start of something bigger? The positive take away from the events the past week is that the term “short selling” has been introduced to the public and will surely gather more scrutiny.

What happens with GameStop next could end up dictating a new form of capital markets democracy that levels the playing field and punishes the Mafia-like elements of Wall Street that have been fleecing investors and destroying companies for years.

Retail investors want to clean up capital markets, and they just might be powerful enough to do it now. That’s a serious wake-up call for both naked short sellers and the investing public.

Viva la Revolucion.

This is the threat of naked short selling.