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Naked shorting: The curious incident of the shares that didn't exist (2005)

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Re: Naked shorting: The curious incident of the shares that didn't exist (2005)

#111

Post by YZF »

brockwhittaker wrote: post #62
koolba wrote: post #55

Earlier quoted context omitted.

If you own all the shares then you can control the company via voting control. That’d generally allow you to prevent the issuance of new shares and you could hand pick the board as their terms expire. It’s not immediate, but you’d eventually be in control of everything.

Not all shares have voting power, and even so the voting power of those shares (if they were 2% of the company for example) may be proportionally tiny compared to the founders/board/execs. For example shareholders don't have any control at FB, since Mark controls 51% of the voting power.

It's fairly unusual to have companies with this sort of structure. Why would you ever buy shares in a company that doesn't pay dividends and where you can get infinitely diluted and have no control? (other than for speculative reasons)

Re: Naked shorting: The curious incident of the shares that didn't exist (2005)

#112

Post by Lazare »

Tokelin wrote: post #47
Lazare wrote: post #40

Summary: Every so often, someone gets very steamed about short selling, often with no real reason. Back in 2005, someone got very steamed about short selling, and then got a journalist to write a somewhat confused article about it. It's not clear anything was actually wrong then, but in any case, the rules have been changed a few times since then, so there doesn't seem to be any obvious relevance to current times. It…

What would be a better model for how the stock market works?

I don't have a good general answer; it's complex. But some specific things relevant to this story:

Market makers are allowed and expected to run naked shorts in order to ensure liquidity. We want a system where you can just buy or sell an item "into the market", and then everything will get sorted out eventually. We optimise for the case where shares can be found because it's overwhelmingly common.

Stock borrowing is routine and transparent. People often have no idea if their stock has been lent out or if they own a borrowed stock; the reason for this is because the system has been designed so it doesn't matter. Shorting is common and accepted.

The volume of transactions is enormous, and the system began to freeze up under the weight of its own paperwork in the 60s and 70s. To work around this, a policy of stock immobilization was implemented to ensure that stocks don't need to physically change hands. As a result, almost all stocks in the US are actually owned by a small, obscure partnership called Cede & Co. As the excellent writer Matt Levine wrote a while back:

> Nobody owns stock. What you own is an entitlement to stock held for you by your broker. But your broker doesn't own the stock either. What your broker owns is an entitlement to stock held for it by Cede & Co., which is a nominee of the Depository Trust Company, which is a company that is in the business of owning everyone's stock for them. This system sounds convoluted but actually makes it easy to keep track of things: If I sell stock to you, I don't have to courier over a paper share certificate, or call up the company and have it change its shareholder register. Our brokers just change some electronic entries at their DTC accounts and everything is cool.

Dematerialization has been extremely helpful, but at scale, it moves us even further away from a system that deals with concrete items. Hence, eg, Levine's hilarious story "Banks Forgot Who Was Supposed to Own Dell Shares", from which my earlier excert comes from: https://www.bloomberg.com/opinion/articles/2015-07-14/banks-...

Or for another even more hilarious story (also by Levine), "Dole Food Had Too Many Shares": https://www.bloomberg.com/opinion/articles/2017-02-17/dole-f...

And so forth, and so on. The system, at every level, is not one where it makes any real sense to say "the company has issued five hundred thousand shares, I own twenty of them, I keep them in a drawer in my office, look, here are the serial numbers". It's more probabilistic than that, very much by design.

Re: Naked shorting: The curious incident of the shares that didn't exist (2005)

#113

Post by rags2riches »

Swenrekcah wrote: post #102
jaycroft wrote: post #67

Earlier quoted context omitted.

And just for completeness on your comment, a naked short is the same as a regular short, but in the opposite order. First sold short, then borrowed after the fact.

I can’t quite wrap my head around how this is possible. Are stock brokers allowed to just generate shares in their computer systems and then find a way later to actually obtain them? And when they do so, that might actually be from another broker who magicked them into existence?

Trades aren't settled immediately. Finance runs on various forms of promises, basically.

Re: Naked shorting: The curious incident of the shares that didn't exist (2005)

#114

Post by ralph84 »

nabla9 wrote: post #26

Note: Shorting more than 100% of shares outstanding does not imply that there is naked shorting happening. You can re-borrowing the shares someone shorted and it happens.

Correct, but consistent fails to deliver over a period of many months certainly does.

Re: Naked shorting: The curious incident of the shares that didn't exist (2005)

#115

Post by esrauch »

LatteLazy wrote: post #78
ketamine__ wrote: post #65

Earlier quoted context omitted.

So what would have happened if he sold them all at the same time?

His broker can recall the lent stock, so they'd recall it and have it sent to whoever bought it on their/his behalf. I worked on a computer system to handle all this for a while. It was front office so as well as buy/sell transactions we had to process lend/return and borrow/return actions to actually understand the company position. Within each of those are lend request messages with approval/declines etc.

I don't understand how this can work. The broker loans the share to person B. Person B sells the share to person C (as B wants to short the stock). How can the Broker recall the share: they have no relationship with the current owner of the stock. Even if the broker demanded B rebuy a share to return the stock, since the original guy owner all liquid shares, it would only take one other share holder to holdout to make the share return impossible.

Re: Naked shorting: The curious incident of the shares that didn't exist (2005)

#116

Post by twic »

gridder wrote: post #89
PragmaticPulp wrote: post #42

Recent events have a lot of people confusing high short interest with naked shorting. A stock can have short interest greater than 100% without any naked shorting. How is this possible? The textbook definition of a "short sale" is that someone borrows stock and then, literally, sells it short. The buyer of the stock is free and clear to do whatever they want with the stock, including re-lend it for another short sale…

http://counterfeitingstock.com/CS2.0/CounterfeitingStock.htm...

I read this, but it's not clear to me there's anything to it. It has a strong aroma of crank, and not a lot of quantitative detail. Has anyone written a useful response to this?

EDIT: Specifically, I think the idea that failures to deliver create counterfeit shares is wrong. I'd love to hear from someone with intimate operational knowledge of this process. FYI, SEC SHO FAQ:

https://www.sec.gov/divisions/marketreg/mrfaqregsho1204.htm

Re: Naked shorting: The curious incident of the shares that didn't exist (2005)

#117

Post by FabHK »

rwmj wrote: post #16
slashdev wrote: post #7

Wow, how has nobody noticed this before? This looks seriously rotten: > Michigan-based entrepreneur Robert Simpson decided to see what would happen if he bought the entire stock of one company. Using a single broker, within a couple of days Simpson had paid a little over $5,000 for 1,285,050 shares in OTC bulletin board property-development company Global Links. According to Simpson, these shares were delivered into…

I think the more interesting part of the story (if I'm reading it right) is he paid $5000 to completely own a company with millions in assets.

He owned the equity, and therefore theoretically had control over its management. The firm might still have a lot of debt, so be owned largely by banks (or bond holders).

Firm value = equity ("market cap") + debt + various, see

https://en.wikipedia.org/wiki/Enterprise_value

Re: Naked shorting: The curious incident of the shares that didn't exist (2005)

#118

Post by oblio »

dleslie wrote: post #66
Tokelin wrote: post #47

Earlier quoted context omitted.

What would be a better model for how the stock market works?

When it's not the purchase-a-thing model it's otherwise-disinterested third parties making large bets on possible future outcomes. It has more in common with a bookie's ledger than a warehouse of goods. Why this is often harmful and dangerous is that the financial viability of businesses and individuals are often backing these bets. A person or company expecting financing to be predictable and stable may suddenly fin…

I still don't understand why these kinds of derivatives are not banned. They're, as you described, basically betting.

Except for a handful of folks, everybody loses money on them. The ones that do make money are rigging the game (à la casinos) or are just lucky. Some of the lucky ones have been lucky for decades, some even went bankrupt after being lucky for so long.

Re: Naked shorting: The curious incident of the shares that didn't exist (2005)

#119

Post by twic »

tempestn wrote: post #91
Lazare wrote: post #40

Summary: Every so often, someone gets very steamed about short selling, often with no real reason. Back in 2005, someone got very steamed about short selling, and then got a journalist to write a somewhat confused article about it. It's not clear anything was actually wrong then, but in any case, the rules have been changed a few times since then, so there doesn't seem to be any obvious relevance to current times. It…

I think you could make an argument that allowing naked shorting could in fact be beneficial. Part of what's allowing gamestop stock to explode recently is that it's next to impossible to find shares to borrow for shorting. If everyone who wanted to short the stock could do so without having to borrow shares, price discovery might work significantly better. (I assume the counter-argument would be that short squeezes c…

This is a reason why cash settled single-stock futures are useful. They have the same economic value as a long or short share of stock, but because they're just a bet on the price, they don't have any of the awkward features that come with needing to deliver an actual share.

Re: Naked shorting: The curious incident of the shares that didn't exist (2005)

#120

Post by Swenrekcah »

koolba wrote: post #106
Swenrekcah wrote: post #102

Earlier quoted context omitted.

I can’t quite wrap my head around how this is possible. Are stock brokers allowed to just generate shares in their computer systems and then find a way later to actually obtain them? And when they do so, that might actually be from another broker who magicked them into existence?

Because actual delivery does not happen until settlement time three days later. The seller has until then to acquire the shares. Naked shorting is illegal. To short the shares the seller only has to perform a “locate” first. That involves contacting someone that has the shares and is willing to lend them. Skipping the locate step is illegal. They just don’t have to actually borrow them until delivery. Additionally, i…

Thanks, that’s a bit clearer now.
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