GameStop has been in the news cycle since January, with short squeeze talks, creating wealth transfers, and changing lives. But is this all under the pretense of a house of cards? In the process of learning what is causing the unique situation with GameStop and a few other stocks, including AMC, multiple very dedicated researchers have been compiling very compelling information about the status of the financial market today.
This post is a 3 part theory put together by /u/atobitt. Buckle up, grab a snack, or beverage, and be prepared to open up a lot of tabs to cross-reference what’s about to be explained. This post is over 8500 words long, which will be around an hour-long read in total. Headings have been placed so you can take breaks and keep your place.
This is not financial advice.
The DTC has been taken over by big money. They transitioned from a manual to a computerized ledger system in the 80s, and it played a significant role in the 1987 market crash. In 2003, several issuers with the DTC wanted to remove their securities from the DTC’s deposit account because the DTC’s participants were naked short-selling their securities. Turns out, they were right. The DTC and its participants have created a market-sized naked short-selling scheme. All of this is made possible by the DTC’s enrollee- Cede & Co.
Table of Contents
House of Cards – Part 1
The events we are living through RIGHT NOW are the 50-year ripple effects of stock market evolution. From the birth of the DTC to the cesspool we currently find ourselves in, this DD will illustrate just how fragile the House of Cards has become.
We’ve been warned so many times. We’ve made the same mistakes so. many. times.
And we never seem to learn from them.
DTCC’s New Rules
In case you’ve been living under a rock for the past few months, the DTCC has been proposing a boat load of rule changes to help better-monitor their participants’ exposure. If you don’t already know, the DTCC stands for Depository Trust & Clearing Corporation and is broken into the following (primary) subsidiaries:
- Depository Trust Company (DTC) – centralized clearing agency that makes sure grandma gets her stonks and the broker receives grandma’s tendies
- National Securities Clearing Corporation (NSCC) – provides clearing, settlement, risk management, and central counterparty (CCP) services to its members for broker-to-broker trades
- Fixed Income Clearing Corporation (FICC) – provides central counterparty (CCP) services to members that participate in the US government and mortgage-backed securities markets
A Brief History of the DTC
Brief history lesson: I promise it’s relevant (this link provides all the info that follows).
The DTC was created in 1973. It stemmed from the need for a centralized clearing company. Trading during the 60s went through the roof and resulted in many brokers having to quit before the day was finished so they could manually record their mountain of transactions. All of this was done on paper and each share certificate was physically delivered. This obviously resulted in many failures to deliver (FTD) due to the risk of human error in record keeping. In 1974, the Continuous Net Settlement system was launched to clear and settle trades using a rudimentary internet platform.
In 1982, the DTC started using a Book-Entry Only (BEO) system to underwrite bonds. For the first time, there were no physical certificates that actually traded hands. Everything was now performed virtually through computers. Although this was advantageous for many reasons, it made it MUCH easier to commit a certain type of securities fraud- naked shorting.
One year later they adopted NYSE Rule 387 which meant most securities transactions had to be completed using this new BEO computer system. Needless to say, explosive growth took place for the next 5 years. Pretty soon, other securities started utilizing the BEO system. It paved the way for growth in mutual funds and government securities, and even allowed for same-day settlement. At the time, the BEO system was a tremendous achievement. However, we were destined to hit a brick wall after that much growth in such a short time. By October 1987, that’s exactly what happened.
High Frequency Trading (HFT)
If you’re wondering where the birthplace of High Frequency Trading (HFT) came from, look no further. The same machines that automated the exhaustively manual reconciliation process were also to blame for amplifying the fire sale of 1987.
The last sentence indicates a much more pervasive issue was at play, here. The fact that we still have trouble explaining the calculus is even more alarming. The effects were so pervasive that it was dubbed the 1st global financial crisis.
Here’s another great summary published by the NY Times: *”..*to be fair to the computers.. [they were].. programmed by fallible people and trusted by people who did not understand the computer programs’ limitations. As computers came in, human judgement went out.” Damned if that didn’t give me goosebumps.
Notice the last sentence? A major factor behind the crash was a disconnect between the price of stock and their corresponding derivatives. The value of any given stock should determine the derivative value of that stock. It shouldn’t be the other way around. This is an important concept to remember as it will be referenced throughout the post.
A major disconnect occurred when these futures contracts were used to intentionally tank the value of the underlying stock. In a perfect world, organic growth would lead to an increase in value of the company (underlying stock). They could do this by selling more products, creating new technologies, breaking into new markets, etc. This would trigger an organic change in the derivative’s value because investors would be (hopefully) more optimistic about the longevity of the company. It could go either way, but the point is still the same. This is the type of investing that most of us are familiar with: investing for a better future.
I don’t want to spend too much time on the crash of 1987. I just want to identify the factors that contributed to the crash and the role of the DTC as they transitioned from a manual to an automatic ledger system. The connection I really want to focus on is the ENORMOUS risk appetite these investors had. Think of how overconfident and greedy they must have been to put that much faith in a computer script.. either way, same problems still exist today.
Finally, the comment by Bruce Bartlett regarding the mismatched investment strategies between stocks and options is crucial in painting the picture of today’s market.
Issuers, Participants, and Cede & Co.
Now, let’s do a super brief walkthrough of the main parties within the DTC before opening this can of worms.
I’m going to talk about three groups within the DTC- issuers, participants, and Cede & Co.
Issuers are companies that issue securities (stocks), while participants are the clearing houses, brokers, and other financial institutions that can utilize those securities. Cede & Co. is a subsidiary of the DTC which holds the share certificates.
Participants have MUCH more control over the securities that are deposited from the issuer. Even though the issuer created those shares, participants are in control when those shares hit the DTC’s doorstep. The DTC transfers those shares to a holding account (Cede & Co.) and the participant just has to ask “May I have some pwetty pwease wiff sugar on top?”
Now, where’s that can of worms?
Everything was relatively calm after the crash of 1987, until we hit 2003.
The DTC started receiving several requests from issuers to pull their securities from the DTC’s depository. I don’t think the DTC was prepared for this because they didn’t have a written policy to address it, let alone an official rule. Here’s the half-assed response from the DTC:
Realizing this situation was heating up, the DTC proposed SR-DTC-2003-02.
Honestly, they were better off WITHOUT the new proposal.
It became an even BIGGER deal when word got about the proposed rule change. Naturally, it triggered a TSUNAMI of comment letters against the DTC’s proposal. There was obviously something going on to cause that level of concern. Why did SO MANY issuers want their deposits back?
Issuers Demand Deposits Back
As outlined in the DTC’s opening remarks:
OK see footnote 4:
UHHHHHHH WHAT!??! Yeah! I’d be pretty pissed, too! Have my shares deposited in a clearing company to take advantage of their computerized trades just to get kicked to the curb with NO WAY of getting my securities back… AND THEN find out that the big-d*ck “participants” at your fancy DTC party are literally short selling my shares without me knowing….?!
This sound familiar, anyone??? IDK about y’all, but this “trust us with your shares” BS is starting to sound like a major con.
The DTC asked for feedback from all issuers and participants to gather a consensus before making a decision. All together, the DTC received 89 comment letters (a pretty big response). 47 of those letters opposed the rule change, while 35 were in favor.
To save space, I’m going to use smaller screenshots. Here are just a few of the opposition comments.
Here are a few in favor:
All the comments I checked were participants and classified as market makers and other major financial institutions. Go figure.
Here’s the full list if you wanna dig on your own.
I realize there are advantages to “paperless” securities transfers, however, it is EXACTLY what Michael Sondow said in his comment letter above.
We simply cannot trust the DTC to protect our interests when we don’t have physical control of our assets.
Several other participants, including Edward Jones, Ameritrade, Citibank, and Prudential overwhelmingly favored this proposal.. How can someone NOT acknowledge that the absence of physical shares only makes it easier for these people to manipulate the market?
This rule change would allow these ‘participants’ to continue doing this because it’s extremely profitable to sell shares that don’t exist, or have not been collateralized. Furthermore, it’s a win-win for them because it forces issuers to keep their deposits in the holding account of the DTC.
Fractional Reserve Banking System
Ever heard of the fractional reserve banking system?? Sounds A LOT like what the stock market has just become.
Want proof of market manipulation? Let’s fact-check the claims from the opposition letters above. I’m only reporting a few for the time period we discussed (2003ish). This is just to validate their claims that some sketchy sh*t is going on.
- UBS Securities(formerly UBS Warburg):
- pg 559; SHORT SALE VIOLATION; 3/30/1999
- pg 535; OVER REPORTING OF SHORT INTEREST POSITIONS; 5/1/1999 – 12/31/1999
- PG 533; FAILURE TO REPORT SHORT SALE INDICATORS;INCORRECTLY REPORTING LONG SALE TRANSACTIONS AS SHORT SALES; 7/2/2002
- Merrill Lynch(Professional Clearing Corp.):
- pg 158; VIOLATION OF SHORT INTEREST REPORTING; 12/17/2001
- RBC(Royal Bank of Canada):
- pg 550; FAILURE TO REPORT SHORT SALE TRANSACTIONS WITH INDICATOR; 9/28/1999
- pg 507; SHORT SALE VIOLATION; 11/21/1999
- pg 426; FAILURE TO REPORT SHORT SALE MODIFIER; 1/21/2003
Ironically, I picked these 3 because they were the first going down the line.. I’m not sure how to be any more objective about this.. Their entire FINRA report is littered with short sale violations. Before anyone asks “how do you know they aren’t ALL like that?” The answer is- I checked. If you get caught for a short sale violation, chances are you will ALWAYS get caught for short sale violations. Why? Because it’s more profitable to do it and get caught, than it is to fix the problem.
Wanna know the 2nd worst part?
Several comment letters asked the DTC to investigate the claims of naked shorting BEFORE coming to a decision on the proposal. I never saw a document where they followed up on those requests.
NOW, wanna know the WORST part?
The DTC passed that rule change.
They not only prevented the issuers from removing their deposits, they also turned a ‘blind-eye’ to their participants manipulative short selling, even when there’s public evidence of them doing so.
Those companies were being attacked with shares THEY put in the DTC, by institutions they can’t even identify.
..Let’s take a quick breath and recap:
The DTC started using a computerized ledger and was very successful through the 80’s. This evolved into trading systems that were also computerized, but not as sophisticated as they hoped.. They played a major part in the 1987 crash, along with severely desynchronized derivatives trading.
In 2003, the DTC denied issuers the right to withdraw their deposits because those securities were in the control of participants, instead. When issuer A deposits stock into the DTC and participant B shorts those shares into the market, that’s a form of rehypothecation. This is what so many issuers were trying to express in their comment letters. In addition, it hurts their company by driving down it’s value. They felt robbed because the DTC was blatantly allowing it’s participants to do this, and refused to give them back their shares..
It was critically important for me to paint that background.
DTC’s Cede & Co.
Remember when I mentioned the DTC’s enrollee – Cede & Co.?
I’ll admit it: I didn’t think they were that relevant. I focused so much on the DTC that I didn’t think to check into their enrollee.
Wish I did.
That’s right. Cede & Co. hold a “master certificate” in their vault, which NEVER leaves. Instead, they issue an IOU for that master certificate.
Didn’t we JUST finish talking about why this is such a major flaw in our system? And that was almost 20 years ago.
Here comes the doozy.
You wanna know the BEST part???
I found a list of all the DTC participants that are responsible for this mess.
House of Cards – Part 2
I wasn’t looking into GameStop when all of this began. Most of my time was spent researching the pandemic’s impact on the economy. I’m talking about the economic steam engine that employs people and puts food on their tables. Especially the small businesses that were executively steamrolled by COVID lockdowns. It was scary how fast they had to close their doors.
I spent a lot of time looking at companies like GameStop. Brick-n-mortar businesses were basically running out of bricks to sh*t. Frankly, GameStop looked a lot like the next Blockbuster and it just seemed like a matter of time before they went under. Had DFV not done his homework, it’s possible we wouldn’t have a rocket to HODL or a story to TODL.
Whoever has/had a short position with GameStop was probably thinking the same thing. The number of shares that can be freely traded on a daily basis is referred to as “the float”. GameStop has 70,000,000 shares outstanding, but 50,000,000 shares represented “the float”. With a small float like this, a short position of 20% becomes significant. Heck, Volkswagen got squozed with just a 12.8% short position. So let’s use little numbers to walk through an example of how this works.
Assume VW has 100 shares outstanding. If 12.8% of the company has been sold short, then 12.8 shares (let’s just say 13) must be available to purchase at a later date (assuming VW doesn’t go bankrupt). However, VW had a float of 45% which meant there was no real strain to cover that 12.8% short position at any moment. However, when Porsche announced they wanted to increase their position in VW, they invested HEAVILY.
“The kicker was that Porsche owned 43% of VW shares, 32% in options, and the government owned 20.2%…. In plain terms, it meant that the actual available float went from 45% down to 1% of outstanding shares” (bullishbears.com/vw-short-squeeze/).
Let’s revisit our scenario. With 100 shares outstanding and 13 shares sold short, what happens if only 1 share was available to cover instead of 45?
GameStop is/was the victim of price suppression through short selling. I discussed this topic with Dr. T and Carl Hagberg in our AMAs. Every transaction has two sides- a buy and a sell. Short selling artificially increases the supply of shares and causes the price to decline. When this happens, the price can only increase if demand exceeds the increase in supply.
I started looking closely at GameStop after confirming their reported short position of 140%. It’s important for me explain this why this is so much different than the VW example…
140% of GameStop’s FLOAT was sold short. There were 50,000,000 shares in that float, so 140% of this was equal to the 70,000,000 shares the company has outstanding. This means AT LEAST 100% of their outstanding shares has been sold short. Now compare that to VW where the short position was only 12.8%… Simply put, it is mathematically impossible to cover more than 100% of a company’s outstanding stock.
The peak of the VW squeeze was reached when the demand for shares became surpassed by the supply of those shares. Here, demand represents 12.8% of their stock which must be available to close the short position. With only 1% of shares available, this guaranteed a squeeze until the number of shares available to trade could satisfy the remaining short interest.
When a company has a short position with more than 100% of total shares outstanding, the preceding argument is thrown out the window. Supply cannot surpass demand because the company can only issue 100% of itself at any given time. Therefore, the additional 40% could only be explained by multiple people claiming ownership of the same share… Surely this is a mistake.. right? I thought this level of short selling was impossible..
..Until I saw the number of short selling violations issued by FINRA..
As we go through these FINRA reports, there are a few things to keep in mind:
- FINRA is not a part of the government. FINRA is a non-profit entity with regulatory powers set by Congress. This makes FINRA the largest self-regulatory organization (SRO) in the United States. The SEC is responsible for setting rules which protect individual investors; FINRA is responsible for overseeing most of the brokers (collectively referred to as members) in the US. As an SRO, FINRA sets the rules by which their members must comply- they are not directly regulated by the SEC
- FINRA investigates cases at their own pace. When looking at the “Date Initiated” on their reports, it is not synonymous with “date of occurrence”. Many times, FINRA will not say when a problem occurred, just resolved. It can be YEARS after the initial occurrence. The DTC participant report is littered with cases that were initiated in 2019 but occurred in 2015, etc. Many of the violations occurring today will take years to discover
- FINRA can issue a violation for each occurrence using a 1:1 format. When it comes to violations like short selling, however, these “occurrences” can last months or even years. When this happens, FINRA issues a violation for multiple occurrences using a 1:MANY format. I discussed this event in Citadel Has No Clothes where one violation represented FOUR YEARS of market f*ckery. What’s sh*tty is that FINRA doesn’t tell you which violations are which. You have to read each line and see if they mention a date range of occurrence within each record. If they don’t, you must assume it was for one event… BRUTAL
- FINRA’s investment portfolio is held by the same entities they are issuing violations to… Let that sink in for a minute
The Case of Short Positions
Can you think of a reason why short sellers would want to understate their short positions? Put yourself in their situation and imagine you’re running a hedge fund…
You operate in a self-regulated (SRO) environment and your records are basically private. If the SEC asks you to justify suspicious behavior, you really don’t have to provide it. The worst that could happen is a slap on the wrist. I wrote about this EXACT same thing in Citadel Has No Clothes. They received a cease-and-desist order from the SEC on 12/10/2018 for failing to submit complete and accurate records. This ‘occurred’ from November 2012 through April 2016 and contained deficient information for over 80,000,000 trades. Their punishment… $3,500,000… So why even bother keeping an honest ledger?
Now, suppose you short a bunch of shares into the market. When you report this to FINRA, they require you to mark the transaction with a short sale indicator. In doing so, FINRA builds a paper trail to your short-selling activity.
However… if you omit this indicator, FINRA can’t distinguish that transaction from a long sale. Who else would there be to hold you accountable for covering your position? This is especially true for self-clearing organizations like Citadel because there are fewer parties involved to hold you accountable with recordkeeping. If FINRA thinks you physically owned those shares and sold them (long sale), they have no reason to revisit that transaction in the future… You could literally pocket the cash and dump the commitment to cover.
Another very important advantage is that it allows short sellers to artificially increase the supply of shares while understating the outstanding short interest on that security. The supply of shares being sold will drive down the price, while the short interest on the stock remains the same.
So.. aside from paying a fine, how could you possibly lose by “forgetting” to mark that trade with a short sale indicator? It would seem the system almost incentivizes this type of behavior.
I combed through the DTC participant report and found enough dirt to fill the empty chasm that is Ken Griffin’s soul. Take a guess at what their most common short-selling violation is. I’m going to assume you said “FAILING TO PROPERLY MARK A SHORT SALE TRANSACTION”.
For the record, I just want to say I called this in March when I wrote Citadel Has No Clothes. Citadel has one of the highest concentrations of short-selling violations in their FINRA report. At the time, I didn’t fully understand the consequences of this violation… After seeing how many participants received the same penalty, it finally made sense.
There are roughly 240 participant account names on the DTC’s list. Sh*t you not, I looked at every short-selling violation that was published on Brokercheck.finra.org. To be fair, I eliminated participants with only 1 or 2 violations related to short selling. There were PLENTY of bigger fish to fry.
I literally picked the first participant at the top of the list and found three violations for short selling.
ABN AMRO Clearing Chicago LLC (AACC) is the 3rd largest bank in the Netherlands. They got popped for three short selling violations, one of which included a failure-to-deliver. In total, they have 78 violations from FINRA. Several of these are severe compared to their violations for short selling. However, the short selling violations revealed a MUCH bigger story:
So… ABN AMRO submitted an inaccurate short interest position to the NYSE and FINRA and lacked the proper supervisory systems to comply with… practically everything…
In 2014, AMRO forked over $95,000 to settle this and didn’t even say they were sorry.
In these situations, it’s easy to think “meh, could have been a fluke event”. So I took a closer look and found violations by the same participants which made it much harder to argue their case of sheer negligence. Here are a couple for AMRO:
ABN AMRO got slapped with a $1,000,000 fine for understating capital requirements, failing to maintain accurate books, and failing to supervise employees. If you mess up once or twice but end up fixing the problem- GREAT. When your primary business is to clear trades and you fail THIS bad, there is a much bigger problem going on. It gets hard to defend this as an accident when every stage of the trade recording process is fundamentally flawed. The following screenshot came from the same violation:
Warehouse receipts are like the receipts you get after buying lumber online. You can print these out and take them to Home-Depot, where you exchange them for the ACTUAL lumber in the store. Instead of trading the actual goods, you can trade a warehouse receipt instead… so yeah… since this ONE record allowed AMRO to meet their customer’s margin requirement, it seems EXTREMELY suspicious that they didn’t appropriately remove it once they were withdrawn.
Do I think this was an accident? No. Because FINRA reported them 8 years later for doing the SAME THING:
Once again, AMRO got caught understating their margin requirements. Last time, they used the value of withdrawn warehouse receipts to meet their margin requirements. Here, they’re using securities that weren’t eligible for margin to meet their margin requirements.
You can paint apple orange, but it’s still an apple.
The bullsh*t I read about in these reports doesn’t really shock me anymore. It’s actually the opposite. You begin to expect bigger fines as they set higher benchmarks for misconduct. When I find a case like AMRO, I’ll usually put more time into it because certain citations represent puzzle pieces. Once you find enough pieces, you can see the bigger picture. So believe me when I say I was genuinely shocked by the detailed report on this case.
This has been going on for 8 F*CKING YEARS!?
Without a doubt, this is a great example of a violation where the misconduct supposedly ended in 2015 but took another 4 years for FINRA to publish the d*mn report. If my math is correct, the 8-year “relevant period” plus the 4 years FINRA spent… I don’t know… reviewing?… yields a total of 12 years. In other words, from the time this problem started to the time it was publicized by FINRA, the kids in 1st grade had graduated high school…
Does anyone else think these self-regulatory organizations (SROs) are doing a terrible job self-regulating…? How we can trust these situations are appropriately monitored if it takes 12 years for a sh*t blossom to bloom?
…OH! I almost forgot… After understating their margin requirements in 22 accounts for over 8 years, ABN AMRO paid a $150,000 fine to settle the dust…
Marking a Short Sale as Long
One of the most common citations occurs when a firm “accidentally” marks a short sale as long, or misreports short interest positions to FINRA. When a short sale occurs, that transaction should be marked with a short sale indicator. Despite this, many participants do it to avoid the borrowing requirements set by Regulation SHO. If they mark a short sale as long, they are not required to locate a borrow because FINRA doesn’t know it’s a short sale.
This is why so many of these FINRA violations include a statement about the broker failing to locate a borrow along with the failure to mark a short sale indicator on the transaction. It literally means the broker was naked short-selling a stock and telling FINRA they physically owned that share.
Suddenly, a “small” violation had much bigger implications. The number of short shares that have been excluded from the short interest calculation is directly related to these violations… and there are HUNDREDS of them. Who knows how many companies have underreported short-interest positions.
To be clear, I did NOT choose them based on the amount of ‘dirt’ they had. AMRO’s violations were like grains of sand on a beach and It’s going to take A LOT of dirt to fill the bottomless pit that is Ken Griffin’s soul. Frankly, ABN AMRO wouldn’t get us there with 10,000 FINRA violations. So withot further ado, let’s get dirty.
FINRA Publishes Reports
When FINRA publishes one of their reports, the granular details like numbers and dates are often left out. This makes it impossible to determine how systematic a particular issue might be.
For example, if you know that “XYZ failed to comply with FINRA’s short interest reporting requirements” your only conclusion is that the violation occurred. However, if you know that “XYZ failed to comply with FINRA’s short interest reporting requirements on 15,000 transactions during 2020” you can start investigating the magnitude of that violation. If XYZ only completed 100,000 transactions in 2020, it means 15% of their transactions failed to meet requirements. This represents a major systematic risk to XYZ and the parties it conducts business with.
I spent some time analyzing Apex Clearing Corporation after I left ABN AMRO. Apex is 8th on the list and the 2nd participant I found with an evident short selling problem.
In 2019, FINRA initiated a case against Apex for doing the same sh*t as ABN AMRO. However, the magnitude of this violation really put things into perspective: I got a small taste of how f*cked this house of cards truly is.
This is practically a template of the first ABN AMRO violation we discussed. To see the difference, we need to look at their letter of Acceptance, Waiver, and Consent (AWC).
Let’s break this down step-by-step…
Apex had an issue for 47 months where certain customers recorded their short positions in an account that was NOT being sent to FINRA. It only takes a few wrinkles on the brain to realize this is a problem. The sample data tells us just how bad that problem is..
When you see the term “settlement days”, think “T+2”. Apex follows the T+2 settlement period for both cash accounts and margin accounts which means the trade should clear 2 days after the original trade date. When you buy stock on a Monday, it should settle by Wednesday.
Ok.. quick maff…
There are roughly 252 trading days in one year after removing weekends and holidays. Throughout the 47-month “review period”, we can safely assume that Apex had roughly 987 ((252/ 12) * 47) settlement dates…
In other words: 256 misstated reports over 47 months is more than 1 misstatement / week for nearly 4 years. Tell me again how this is trivial?
The wording of the “sample settlement” section is a bit ambiguous… It doesn’t clarify if those were the only 2 settlement dates they sampled, or if they were the only settlement dates with reportable issues. Honestly, I would be shocked if it was the latter because auditors don’t examine every record, but I can’t be certain…
Anyway… FINRA discovered 256 short interest positions, consisting of 481,195 shares, were incorrectly excluded from their short interest report. In addition, they understated the share count by 879,321 in 130 separate short interest positions. Together, this makes 1,360,516 shares that were excluded from the short interest calculation. When you realize nearly 1.5 million ‘excluded’ shares were discovered in just 2 settlement periods and there were almost 1,000 dates to choose from, it seriously dilates the imagination…
Once again… FINRA wiped the slate clean for just $140,000…
I want to talk about one last thing before we jump to the next section. Did you happen to notice the different account types that Apex discussed in their letter of Acceptance, Waiver and Consent ? They specifically instructed their customers to book short positions into a TYPE 1 (CASH) account, or TYPE 5 (SHORT MARGIN) account. A short margin account is just a margin account that holds short positions. The margin requirement for short positions are more strict than regular margin accounts, so I can see the advantage in separating them.
In the AMA with Wes Christian (starting at 7:30), he specifically discussed how a broker-dealer’s margin account is used to locate shares for short sellers. However, the margin account contains shares that were previously pledged to another party. Given the lack of oversight in securities lending, the problem keeps compounding each time a new borrower claims ownership of that share.
Now think back to the situation with Apex.
They asked their customers to book short positions to a short-margin account or a cash account. The user agreement with a margin account allows Apex to continue lending those securities at any time. As discussed with Dr. T and Carl Hagberg, the broker collects interest for lending your margin shares and doesn’t pay you anything in return. When multiple locates are authorized for the same share, the broker collects multiple lending fees on the same share.
In contrast, the cash account falls under the protection of SEA 15c3-3 and consists of shares that have not been leveraged- or lent- like the margin-short account. According to Wes (starting at 8:30), these shares are segregated and cannot be touched. The broker cannot encumber-or restrict- them in any way. However, according to Wes, this is currently happening. He also explained how Canada has legalized this and currently allows broker-dealers to short-sell your cash account shares against you.
Failure to Report Short Interest Positions
Alright…. I’ll stop beating the dead horse regarding short sale indicators & inaccurate submissions of short interest positions. Given the volume of citations we haven’t discussed, I’ll summarize some of my findings, below.
Keep in mind these are ONLY for “FAILURE TO REPORT SHORT INTEREST POSITIONS” or “FAILURE TO INDICATE A SHORT SALE MODIFIER”. If the violations contain additional information, it’s because that citation actually listed additional information. It does NOT represent an all-inclusive list of short-selling violations for these participants.
…You wanted to know how systematic this problem is, so here you go… (EACH BROKER-DEALER NAME IS HYPERLINKED TO THEIR FINRA REPORT)
- Barclays | Disclosure 36 – “SUBMITTED 86 SHORT INTEREST POSITIONS TOTALING 41,100,154 SHARES WHEN THE ACTUAL SHORT INTEREST POSITION WAS 44,535,151 SHARES.. FAILED TO REPORT 8 SHORT INTEREST POSITIONS TOTALING 1,110,420 SHARES”
a. $10,000 FINE
2. Barclays | Disclosure 54 – “SUBMITTED AN INACCURATE SHORT INTEREST POSITION TO FINRA AND FAILED TO REPORT ITS SHORT INTEREST POSITIONS IN 835 POSITIONS TOTALING 87,562,328 SHARES”
a. $155,000 FINE
3. BMO Capital Markets Corp | Disclosure 23 – “SUBMITTED SHORT INTEREST POSITIONS TO FINRA THAT WERE INCORRECT AND FAILED TO REPORT TO FINRA ITS SHORT INTEREST POSITIONS TOTALING OVER 72 MILLION SHARES FOR 11 MONTHS”
a. $90,000 FINE
4. BNP Paribas Securities Corp | Disclosure 53 – “FAILED TO REPORT TO FINRA ITS SHORT INTEREST IN 2,509 POSITIONS TOTALING 6,051,974 SHARES”
a. $30,000 FINE
5. BNP Paribas Securities Corp | Disclosure 9 – “ON 35 OCCASIONS OVER A FOUR-MONTH PERIOD, A HEDGE FUND SUBMITTED SALE ORDERS MARKED “LONG” TO BNP FOR CLEARING. FOR EACH OF THOSE “LONG” SALES, ON THE MORNING OF SETTLEMENT, THE HEDGE FUND DID NOT HAVE THE SHARES IN ITS BNP ACCOUNT TO COVER THE SALE ORDER. IN ADDITION, BNP WAS ROUTINELY NOTIFIED THAT THE HEDGE FUND WOULD NOT BE ABLE TO COVER. NEVERTHELESS, WHEN EACH SETTLEMENT DATE ARRIVED AND THE HEDGE FUND WAS UNABLE TO COVER, BNP LOANED THE SHARES TO THE HEDGE FUND. IN TOTAL, BNP LOANED MORE THAN 8,000,000 SHARES TO COVER THESE PURPORTED “LONG” SALES”
a. $250,000 FINE
6. Cantor Fitzgerald & Co | Disclosure 1 – (literally came out on 5/6/2021) – “THE FIRM SUBMITTED INACCURATE SHORT INTEREST POSITIONS TO FINRA. THE FIRM OVERREPORTED NEARLY 55,000,000 SHORT SHARES WHICH WERE CUSTODIED WITH AND ALREADY REPORTED BY ITS CLEARING FIRM, WITH WHICH CANTOR MAINTAINS A FULLY DISCLOSED CLEARING AGREEMENT”
a. $250,000 FINE
7. Cantor Fitzgerald & Co | Disclosure 31 – “…THE FIRM EXECUTED NUMEROUS SHORT SALE ORDERS AND FAILED TO PROPERLY MARK THE ORDERS AS SHORT… THE FIRM, ON NUMEROUS OCCASIONS, ACCEPTED SHORT SALE ORDERS IN AN EQUITY SECURITY FROM ANOTHER PERSON, OR EFFECTED A SHORT SALE FROM ITS OWN ACCOUNT WITHOUT BORROWING THE SECURITY…”
a. $53,500 FINE
8. Cantor Fitzgerald & Co | Disclosure 33 – “…EXECUTED SHORT SALE ORDERS AND FAILED TO PROPERLY MARK THE ORDERS AS SHORT. THE FIRM HAD FAIL-TO-DELIVER POSITIONS AT A REGISTERED CLEARING AGENCY IN THRESHOLD SECURITIES FOR 13 CONSECUTIVE SETTLEMENT DAYS… FAILED TO IMMEDIATELY CLOSE OUT FTD POSITIONS… ACCEPTED SHORT SALE ORDERS FROM ANOTHER PERSON, OR EFFECTED A SHORT SALE FROM ITS OWN ACCOUNT, WITHOUT BORROWING THE SECURITY OR HAVING REASONABLE GROUNDS TO BELIEVE THAT THE SECURITY COULD BE BORROWED…”
a. $125,000 FINE
9. Canaccord Genuity Corp | Disclosure 17 – “THE FIRM EXECUTED SALE TRANSACTIONS AND FAILED TO REPORT EACH OF THESE TRANSACTIONS TO THE FINRA/NASDAQ TRADE REPORTING FACILITY AS SHORT”
a. $57,500 FINE
10. Canaccord Genuity Corp | Disclosure 20 – “THE FIRM EXECUTED SHORT SALE ORDERS AND FAILED TO PROPERLY MARK THE ORDERS AS SHORT”
a. $27,500 FINE
11. Canaccord Genuity Corp | Disclosure 31 – “…SUBMITTED TO NASD MONTHLY SHORT INTEREST POSITION REPORTS THAT WERE INACCURATE”
a. $85,000 FINE
12. Citadel Securities LLC | Citadel Has No Clothes – LITERALLY ALL I TALK ABOUT IN THAT POST. GO READ IT
13. Citigroup Global Markets | Disclosure 10 – “THE FIRMS TRADING PLATFORM FAILED TO RECOGNIZE THAT THE FIRM WAS SELLING SHORT WHEN IT WAS ACTING AS THE CONTRA PARTY TO A CUSTOMER TRADE. AS A RESULT, THE FIRM ERRONEOUSLY REPORTED SHORT SALES TO A FINRA TRADE REPORTING FACILITY AS LONG SALES… EFFECTING SHORT SALES FROM ITS OWN ACCOUNT WITHOUT BORROWING THE SECURITY…”
a. $225,000 FINE
14. Citigroup Global Markets | Disclosure 59 – “…THE FIRM RECORDED 203,653 SHORT SALE EXECUTIONS ON ITS BOOKS AND RECORDS AS LONG SALES, SUBMITTED INACCURATE ORDER ORIGINATION CODES AND ACCOUNT TYPE CODES TO THE AUDIT TRAIL SYSTEM FOR APPROXIMATELY 2,775,338 ORDERS… “
a. $300,000 FINE
15. Citigroup Global Markets | Disclosure 76 – “…FAILED TO PROPERLY MARK APPROXIMATELY 9,717,875 SALE ORDERS AS SHORT SALES… FINDINGS ALSO ESTIMATED THAT THE FIRM ENTERED 55 MILLION ORDERS INTO THE NASDAQ MARKET CENTER THAT IT FAILED TO CORRECTLY INDICATE AS SHORT SALES…”
a. $2,250,000 FINE
16. Cowen and Company LLC | Several Disclosures – almost every other disclosure is for failing to mark a sale with the appropriate indicator, including short AND long sale indicators
17. Credit Suisse Securities LLC | Disclosure 34 – “NEW ORDER REPORTS WERE INACCURATELY ENTERED INTO ORDER AUDIT TRAIL SYSTEM (OATS) AS LONG SALES BUT WERE TRADE REPORTED WITH A SHORT SALE INDICATOR”
a. $50,000 FINE
18. Credit Suisse Securities LLC | Disclosure 95 – “BETWEEN SEPTEMBER 2006 AND JUNE 2008, CREDIT SUISSE FAILED TO SUBMIT ACCURATE PERIODIC REPORTS WITH RESPECT TO SHORT POSITIONS…”
a. $40,000 FINE
19. Deutsche Bank Securities INC. | Disclosure 50 – “THE FIRM FAILED TO REPORT SHORT INTEREST POSITIONS IN DUALLY-LISTED SECURITIES”
a. $200,000 FINE
20. Deutsche Bank Securities INC. | Disclosure 52 – “THE FIRM… EXPERIENCED MULTIPLE PROBLEMS WITH ITS BLUE SHEET SYSTEM THAT CAUSED IT TO SUBMIT INACCURATE BLUE SHEETS TO THE SEC AND FINRA… INCORRECTLY REPORTED LONG ON ITS BLUE SHEET TRANSACTIONS WHEN CERTAIN TRANSACTIONS SHOULD HAVE BEEN MARKED SHORT”
a. $6,000,000 FINE (SEVERAL OTHER ISSUES REPORTED IN ADDITION TO SHORTS)
21. Deutsche Bank Securities INC. | Disclosure 58 – “BETWEEN JANUARY 2005 AND CONTINUING THROUGH NOVEMBER 2015, THE FIRM IMPROPERLY INCLUDED THE AGGREGATION OF NET POSITIONS IN CERTAIN SECURITIES OF A NON-US BROKER AFFILIATE… IN ADDITION… DURING THE PERIOD BETWEEN APRIL 2004 AND SEPTEMBER 2012, THE FIRM INAPPROPRIATELY REPORTED CERTAIN SHORT INTEREST POSITIONS ON A NET, INSTEAD OF GROSS, BASIS..”
a. $1,400,000 FINE
22. Goldman Sachs & Co. LLC | Disclosure 32 – “THE FIRM REPORTED SHORT SALE TRANSACTIONS TO FINRA TRADE REPORTING FACILITY WITHOUT THE REQUIRED SHORT SALE MODIFIER”
a. $260,000 FINE (SEVERAL OTHER ISSUES REPORTED IN ADDITION TO SHORTS)
23. Goldman Sachs & Co. LLC | Disclosure 54 – “FAILED TO ACCURATELY APPEND THE SHORT SALE INDICATOR TO FINRA/NASDAQ TRADE REPORTING FACILITY REPORTS… INACCURATELY MARKED SELL TRANSACTIONS ON ITS TRADING LEDGER”
a. $55,000 FINE
24. Goldman Sachs & Co. LLC | Disclosure 63 – “…SUBMITTED TO FINRA AND THE SEC BLUE SHEETS THAT INACCURATELY REPORTED CERTAIN SHORT SALE TRANSACTIONS AS LONG SALE TRANSACTIONS WITH RESPECT TO THE FIRM SIDE OF CUSTOMER FACILITATION TRADES… THE FIRM REPORTED SHORT SALES AS LONG SALES ON ITS BLUE SHEETS WHEN THE TRADING DESK USED A PARTICULAR MIDDLE OFFICE SYSTEM…”
a. $1,000,000 FINE
25. Goldman Sachs & Co. LLC | Disclosure 150 – “GOLDMAN SACHS & CO. FAILED TO REPORT SHORT INTEREST POSITIONS FOR FOREIGN SECURITIES AND NUMEROUS SHARES ONE MONTH… THE FIRM REPORTED SHORT INTEREST POSITIONS IN SECURITIES TOTALING SEVERAL MILLION SHARES EACH TIME WHEN THE ACTUAL SHORT INTEREST POSITIONS IN THE SECURITIES WERE ZERO SHARES… ACCEPTING A SHORT SALE ORDER IN AN EQUITY SECURITY FROM ANOTHER PERSON, OR EFFECTED A SHORT SALE FROM ITS OWN ACCOUNT, WITHOUT BORROWING THE SECURITY OR BELIEVING THE SECURITY COULD BE BORROWED ON THE DATE OF DELIVERY…”
a. $120,000 FINE
26. Goldman Sachs & Co. LLC | Disclosure 167 – “…THE FIRM FAILED TO REPORT TO THE NMC THE CORRECT SYMBOL INDICATING THAT THE TRANSACTION WAS A SHORT SALE FOR TRANSACTIONS IN REPORTABLE SECURITIES…”
a. $600,000 FINE (SEVERAL OTHER ISSUES REPORTED IN ADDITION TO SHORTS)
27. HSBC Securities (USA) INC. | Disclosure 26 – “FIRM EXECUTED SHORT SALE TRANSACTIONS AND FAILED TO MARK THEM AS SHORT… HSBC SECURITIES HAD A FAIL-TO-DELIVER SECURITY FOR 13 CONSECUTIVE SETTLEMENT DAYS AND FAILED TO IMMEDIATELY CLOSE OUT THE FTD POSITION… THE FIRM CONTINUED TO HAVE A FTD IN THE SECURITY AT A CLEARING AGENCY ON 79 ADDITIONAL SETTLEMENT DAYS…”
a. $65,000 FINE
I’m going to stop at ‘H’ because I’m tired of writing. Hopefully, you all understand the point so far. We’re only 8 letters into the alphabet and have successfully buried Ken to his waist.
Fraud or Negligence?
The system that is used to mark the proper transaction type (sell, buy, short sell, short sell exempt, etc.) is obviously broken… There, I said it.. the system is INDUBITABLY, UNDOUBTEDLY, INEVITABLY F*CKED..
Regardless of the cause- fraud or negligence- there are too many firms failing to accomplish a seemingly simple task. The consequences of which are creating far more shares than we can imagine. It’s a gigantic domino effect. If you fail to properly mark 1,000,000 short shares and a year goes by without catching the problem, it’s already too late. They’re like the f*cking replicators from Stargate..
In each of the examples listed above, the short interest on the stock was understated by the number of shares excluded… and that was just a handful..
Knowing this, how can someone look at the evidence and say it’s trivial….?
No one really knows HOW systematic this issue is because it is so deeply incorporated in the market that it has BECOME the system itself. Therefore, there is obviously something much deeper going on, here.. How does one argue against the severity of these problems after reading this? There are FAR too many things that don’t make sense and FAR too many people turning a blind eye..
The only conclusion I keep coming back to is that the people with money know what’s going on and are desperately trying to keep it under wraps..
..So…. In an effort to prove this, I looked for violations that showed their desperation to protect this f*cked up system.
House of Cards – Part 3
Short Interest is Severely Understated
If you watched the AMA with Wes Christian, he talks about the number of occurrences where the actual short interest is severely understated based on the data his firm obtained for legal proceedings. According to his numbers, in most cases, the short interest is 50% – 150% MORE than what is reported by the SEC (starting at 14:30).
The objective isn’t to address the issue: it’s to keep the issue hidden. Firms that underreport their short interest are gaming the system by taking advantage of how the short interest calculation is done. When the SEC relies on reports that broker-dealers provide, and FINRA takes YEARS to reveal the lies within those reports, the broker-dealer can lie without immediately facing the consequences. It allows these firms to operate in a high-risk environment without exposing just HOW big their risk appetite is.
Another example that Wes mentioned was Merrill Lynch. Merrill was fined $415,000,000 (violation 3) in 2016 for using securities held in their customer’s accounts to cover their own trades. Check out this screenshot I took from that case:
Remember when we mentioned SEA 15c3-3 in the case with Apex? They were asking customers to book short positions to either a cash account or a short margin account. SEA 15c3-3 protects those customers from allowing brokers to lend out the securities within their cash accounts…
Well Merrill Lynch knocked that one right out of the park.
Merrill made it seem like the required deposit in their customer reserve account was much lower than it truly was. They wouldn’t have been able to use that cash if it reduced the amount below the minimum capital requirement, so they found a way to fudge the numbers. In doing so, they managed to prevent a CODE RED while reaping the benefits of a high-risk ‘opportunity’. Should Merrill have filed bankruptcy during that time, those customers would have been completely blindsided.
In the case of short selling, the true exposure of short interest is unknown… and I’m not just talking about the short sale indicator. When a firm fails to deliver securities that were sold short, there’s a pretty good indication that they’ve exposed themselves to a bit of a problem.. Now imagine a case where the FTDs start piling up and they STILL continue to short sell that same security. Think I’m joking?
Royal Bank of Canada
Check out the Royal Bank of Canada:
Again… I was pretty shocked at that one. However, nothing rang the bell quite like this one from Goldman Sachs:
Goldman had 68 occasions in 4 months where they didn’t close a failure-to-deliver… In 45 occasions, they CONTINUED to accept customer short sale orders in securities for which it had an active failure-to-deliver.
When a firm is really starting to sweat, they pull certain tricks out of their ass to quell the situation. Again, this is nothing but smoke and mirrors because that’s all they can really do. Just as Merrill Lynch artificially lowered their customer reserve deposit, other firms make it look like they cover their short positions.
One of the ways they do this is by short selling a SH*T load of shares right before a buy-in… Since we’re talking about Goldman Sachs, this seems like a great time to showcase their experience with this.
I promise, it really is as dumb as it sounds.
So the perception here is when Goldman’s client has a FTD and they find out a buy-in is coming, the required buy-in would obviously be too extreme for the client to handle. So they begin to buy those shares while simultaneously shorting AT LEAST the same amount they were required to purchase.
Have you ever failed to repay a loan so you went to another bank and got a loan to cover the first one? Well, that’s exactly what this is. I know what you’re probably thinking, “Didn’t that just kick the can down the road?”. The answer is YES: it didn’t actually solve anything.
There’s still one more citation that Goldman received which truly represents the pinnacle of no-sh*ts-given. After I cover this, I don’t know how anyone could argue the systematic risks that exist within the securities lending business. Check it out:
For 5 years, Goldman relied on a team of 10-12 individuals to locate shares to be used by its clients for short selling. This group was known as the “demand team”. Naturally, as the number of requests coming in the door started to increase, it became difficult for the team to properly document all of them. The volume peaked at 20,000 requests PER DAY, but the number of individuals that handled this job stayed the same.
Obviously, this became too much for them to handle so they opted out of the manual process and found another solution- the F3 key….
Yes- the F3 key… This button activated an autofill system that completed 98% of Goldman’s orders to locate shares
The problem with Goldman’s autofill system was that it used the number of shares available to borrow at the beginning of that day, which had already been accounted for. After using the auto-locate feature, the demand team didn’t even verify the accuracy of the autofill feature or document which method was used to locate the shares for each order… and this happened for 5 years.
Just goes to show how dedicated firms like Goldman Sachs truly are to the smallest of details, you know? Great f*cking work, guys.
By the way, I have to show one of Goldman’s short sale indicator violations… It’s too good to pass up.
At some point, you just have to laugh at these people… I mean seriously… one violation for a 4 year period involving over 380,000,000 short interest positions… they have plenty of other short interest violations, I just laughed at how the magnitude of this one was summarized by FINRA with 10 lines and roughly 4 minutes… whoever wrote that one must have been late for lunch.
The last thing I’d like to note here is the way in which short sellers use options to “cover” their positions. Wes gave a great overview of this in the AMA (starting at 6:25). Basically, one group will buy puts and another group buys calls. This creates a synthetic share that is only provided if the option is activated. Regardless, short sellers will use that synthetic share to cover their short position and the regulators actually accept it…
However, as Wes points out, most of those options expire without being activated which means the share is never delivered. This expiration can be set months down the road and allows the short seller to keep kicking the can.
I doubt I need to say this, but we all remember the wild options activity that was happening shortly after GameStop spiked in January. While a lot of that activity was on the retail front, I suspect a lot of it was done by short sellers to cover those positions.
Hedgies are Screwed
I’m officially +20 pages deep and there’s still so much I’d like to say. It’s best saved for another time and another post, I suppose. So I guess I’ll wrap all of this up with some of the best news I can possibly provide…
It all started with a 73-page PDF that was published in 2005 by a silverback named John D. Finnerty.
John was a Professor of Finance at Fordham University when he published “short selling, death spiral convertibles, and the profitability of stock manipulation”. The document is loaded with sh*t that’s incredibly relevant today, especially when it comes to naked short selling. He dives into the exact formula that short sellers use, which is far beyond what my wrinkled brain can interpret, alone.
However, when firms are naked shorting a company with the goal of bankrupting them, they leave footprints that are only explained by this event. The proof is in the pudding, so to speak.
Any of this sound familiar??
“The manipulator can not drive the share price close to zero unless he can naked short an extraordinary number of shares… this form of manipulation would result in… unusually heavy trading volume, and unusually large and persistent fails to deliver at the NSCC”.
Anyone else remember the volume in GME during the run-up in January? The total volume traded between 1/31/2021 and 2/5/2021 was 1,508,793,439 shares, or an average daily trade volume of 88,752,555 shares. On 1/22/2021, the volume reached 197,157,946… that’s roughly 3x the number of shares that exist..
If this doesn’t sound like unusual volume then I’m not sure what is. Furthermore, the FTD report on GameStop was through the roof during this time:
Notice the statement where the manipulator will be relieved of its obligation to cover IF the firm’s shares are canceled in bankruptcy? Did you happen to see footnotes 65 & 66 in the first screenshot of his PDF? It references a company that he used for his analysis.
Charter Communications had a whopping 241.8% short float in 2005… The ONLY way the manipulator could have escaped this was by bankrupting the company and relieving the obligation to repurchase those shares…
Guess what happened to Charter? They filed for bankruptcy in 2009…
However, unlike John’s example where naked short sellers were driving down the price without opposition, GameStop had extremely high demand from retail investors to counter this activity. As I have discussed with Dr. T and Carl Hagberg, the run-up in volume during January and February was largely conducted by naked short sellers in an attempt to suppress the share price. As I have shown in the example with Goldman Sachs, firms will short sell during a buy-in for the same exact reason. To stabilize the price, you must stabilize supply and demand.
In Summary of It All
The current short interest reported by FINRA from fund data on stocks is absolute bull, and always has been.
This is because funds have been found guilty of violating short interest report rules for decades, especially when their short positions were clearly illegal (i.e. naked shorting obvious).
We can also see through the ridiculous volatility and volume levels of GameStop that shorts indeed have not covered and that they’re still holding unspeakable levels of short positions on the stock.
And now because the vast majority of GameStop share owners and buying and holding their shares (and if they continue to do so), the true short interest will inevitably reveal itself and we’ll be in for the short squeeze of our lives.
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