Wednesday, May 16, 2012

Goldman reveals its naked short selling practices

Matt Taibbi reports, in Rolling Stone, on Goldman's accidental release of legal documents that reveal confidential data on their short selling practices, ironically in a court filing meant to preserve confidentiality:
The lawyers for Goldman and Bank of America/Merrill Lynch have been involved in a legal battle for some time – primarily with the retail giant, but also with Rolling Stone, the Economist, Bloomberg, and the New York Times. The banks have been fighting us to keep sealed certain documents that surfaced in the discovery process of an ultimately unsuccessful lawsuit filed by Overstock against the banks. 
Last week, in response to an motion to unseal certain documents, the banks’ lawyers, apparently accidentally, filed an unredacted version of Overstock’s motion as an exhibit in their declaration of opposition to that motion. In doing so, they inadvertently entered into the public record a sort of greatest-hits selection of the very material they’ve been fighting for years to keep sealed. 
..the document is full of other interesting disclosures. Among the more compelling is the specter of executives from numerous companies admitting openly to engaging in naked short selling, a practice that, again, was often dismissed as mythical or unimportant.
 The article gives a brief explanation of naked short selling and shows Goldman's attitude toward regulation:
...naked short selling, in essence, is selling stock you do not have. If you don’t have to actually locate and borrow stock before you short it, you’re creating an artificial supply of stock shares. In this case, that resulted in absurdities like the following disclosure in this document, in which a Goldman executive admits in a 2006 email that just a little bit too much trading in Overstock was going on: “Two months ago 107% of the floating was short!” 
In other words, 107% of all Overstock shares available for trade were short – a physical impossibility, unless someone was somehow creating artificial supply in the stock. Goldman clearly knew there was a discrepancy between what it was telling regulators, and what it was actually doing. “We have to be careful not to link locates to fails [because] we have told the regulators we can’t,” one executive is quoted as saying, in the document. 
One of the companies Goldman used to facilitate these trades was called SBA Trading, whose chief, Scott Arenstein, was fined $3.6 million in 2007 by the former American Stock Exchange for naked short selling. The process of how banks circumvented federal clearing regulations is highly technical and incredibly difficult to follow. These companies were using obscure loopholes in regulations that allowed them to short companies by trading in shadows, or echoes, of real shares in their stock. They manipulated rules to avoid having to disclose these “failed” trades to regulators.
 Rolling Stone has a link to the motion, here. As the Economist, Bloomberg, and the New York Times were all interested in seeing these documents, we can expect a lot more analysis.

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