Naked shorting's early critic starts to see some vindication

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Naked shorting's early critic starts to see some vindication


Submitted by cpowell on 08:56PM ET Sunday, August 3, 2008. Section: Daily Dispatches

Byrne's Battle Helps Bring Curbs on Naked Short-Selling Practices

By Steven Oberbeck
The Salt Lake Tribune
Saturday, August 2, 2008

http://www.sltrib.com/ci_10079510

Over the past several years, Patrick Byrne's campaign to clean up Wall Street and end a practice that has destroyed companies and cost unwary investors billions of dollars generated plenty of publicity for him, mostly the wrong kind.

Critics labeled him nuts, a conspiracy theorist, a complete wack job.

Byrne, the chief executive of the Utah-based discount online retailer Overstock.com, even found himself tagged a member of the "tin-foil hat" brigade, a reference to the flying saucer fanatics of the 1950s who adorned their heads with aluminium to ward off, or enhance, thoughts from aliens in outer space.

These days, when people talk of Byrne, the word "vindication" comes up a lot.

"You can always tell who the pioneers are -- they're the ones with all the arrows sticking out of their backs," said James Angel, a finance professor at Georgetown University. "You really can't understate what Byrne has accomplished."

Three years ago Byrne, believing Overstock.com's shares were under pressure from an illegal trading tactic known as "naked short-selling," launched a campaign to end the practice. He termed it his own personal "jihad," or holy war.

Short-selling is a legal practice in which brokerages allow investors to borrow and then sell a company's stock on the hope its price will drop. If that happens, investors then can buy back the stock at a lower price, pocket the profit and return the shares to the brokerages.

Naked short-selling takes place when investors sell stock without first borrowing it. In market parlance, the seller is "naked" those shares. The usual outcome is that it creates an artificially high volume of shares for sale, which can drive down a company's stock price.

In a naked short sale, the transaction is never truly completed because the short-seller doesn't really possess the stock that was sold. That means the seller cannot deliver the shares to buyers, which in market jargon is called a "failure to deliver."

... Big Victory

Byrne's biggest victory in his jihad came July 15 when the U.S. Securities and Exchange Commission issued an emergency order that prohibited naked short-selling in the shares of Fannie Mae, Freddie Mac and 17 large investment banks.

The fear was that aggressive short-selling could exacerbate the plunge in those company's share prices. The SEC goal was to stem the downward pressure on the shares by requiring short-sellers to actually borrow shares before selling them.

"Even though they [the SEC] would never admit it, Patrick Byrne helped instruct them in the danger. When the time came, they understood the threat," said Peter Chepucavage, a former attorney in the SEC's Division of Market Regulation now with the Plexus Consulting Group in Washington, D.C.

Byrne said he supports the SEC's emergency rule, which on Thursday was extended through mid-August. "What I don't understand is why the SEC is only addressing Fannie Mae, Freddie Mac and the large investment banks. Why should those companies be the only ones protected?"

Others want to know the same thing.

The American Bankers Association said it was "disappointed and deeply concerned" the SEC extended its order without including all publicly traded banks.

"We know it has been going on and that it's been harmful to share prices," said Carol Kaplan, a spokeswoman for the ABA, which indicated in an earlier statement that the failure to include bank stock in the ban could backfire and disrupt an industry that is essential to the function of the nation's economy.

"One of the big concerns we have is that depositors often can not distinguish the difference between a stock price dropping and the safety of their deposits and soundness of their bank," Kaplan said.

... Extend Ban

Byrne said he wants the ban on naked short-selling extended to all publicly held companies. He may be successful.

SEC Chairman Christopher Cox told Congress last week that a proposal expanding the order to cover all public companies will be introduced soon.

"Hundreds are clamoring for protection," Byrne said.

Still, not everyone is convinced that naked short-selling is a problem. In Barron's last week, editorial page editor Thomas G. Dolan wrote that "rather than fixing any of the real problems with the agency and its mission, Cox and his fellow commissioners waved a newspaper and swatted the imaginary fly of naked short-selling. It made a big noise, but there's no dead bug."

The editorial led Gary Weiss, a veteran New York-based financial journalist and author of Wall Street Versus America: The Rampant Greed and Dishonesty That Imperil Your Investments, to post a scathing comment about Byrne on his blog.

"Byrne has said that the SEC's politically motivated pandering means that he has won the 'intellectual argument' on naked short-selling," Weiss wrote. "But there hasn't been an intellectual argument. There has been a campaign of intimidation and personal attacks against critics of his poor management of his company and his naked-shorting jihad."

... Nothing New

The criticism linking Overstock.com's often-disappointing earnings performance and Byrne's campaign against naked short-selling isn't new. It has been around since he started criticizing the growing number of "failures to deliver" that resulted from rampant naked short-selling.

"What they're saying is that if he only ran a better liquor store he wouldn't get robbed as much," said Byrne, whose campaign against naked shorting is detailed at www.deepcapture.com.

Throughout his campaign, Byrne said there really was only one moment when the criticism personally got to him. And that was when an old friend from high school sent him an e-mail stating that she remembered Byrne as a really nice guy.

"Then she mentioned about how she'd read about all the horrible things I was doing and how it appeared like I'd gone completely off the deep end," Byrne said. "It bothered me a little."

Byrne went on to speak about a trip he made to New York City in 2006 to see a well-known hedge fund manager, someone he had known for a decade.

"As we sat down he said, 'Patrick, I want you to know that you have become the most hated man I've ever known in all my life here in New York. Wall Street used to think so highly of you. You were kind of a golden boy. Now, you are despised more intensely than anyone I have ever known. You could kill people, and not be hated like they hate you in this town.'"

Byrne understands the ill will. He believes correcting the problem would cost billions and likely lead to the demise of many of the hedge funds he believes are actively engaged in naked shorting.

"When I think of what might happen to the financial system as a result of all of this, it just makes me sick. There is no joy in being right," he said. "It's going to be ugly."

But then there have been those who offered him encouragement when he needed it the most, he said.

Byrne said one man jumped onto an empty elevator as he was entering. "He said, 'Mr. Byrne, you don't know me, but I just want to tell you I support your fight. What you are talking about goes on every day around me. Don't quit. I can't be seen with you. Goodbye.'"

And he hopped off the elevator, Byrne said.

[Dr.3D]

This is what makes me start to think anything can be manipulated. Especially if it is being manipulated by the government.