Important News - New Rules may change things - - but the proof of the pudding is in the eating

New Rules Will Cause Panic For Shorts

Posted: Feb 25 2011 By: Jim Sinclair

Dear Friends,

http://jsmineset.com/

The following is information from Dr. Jim Decosta:

Here is the URL:

http://www.finra.org/Industry/Regulation/RuleFilings/2010/P121892?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+FINRARuleFilings+(FINRA+Rule+Filings)

Quote: There�s 3 new laws gaining attention in the NSS market reform arena:

FINRA 4320 goes into effect on 2/28/11.

It mandates 13 day buy-ins for open delivery failures FINALLY applying to shares of non-reporting corporations. FINRA 2010-043, also starting on 2/28/11 reinstates the �short sale exempt� (SSE) marking requirements for trade reporting and the OATS system. Those MMs accessing the bona fide MM exemption from executing pre-borrows or �locates� before admittedly naked short sales must now FORMALLY acknowledge the accessing of that universally-abused exemption.

Being that these trades are theoretically being made to �inject liquidity� then the excuse to hide the related trade data from the public�s eyes goes out the window. You can�t have it both ways and claim the bona fide MM exemption and later claim that the related trade data needs to be kept secret because it might reveal a �proprietary trading strategy�.

Truly bona fide MMs that are able to legally access that universally-abused exemption cover their naked short position on the next downtick after their short sale when buy side liquidity is in need of being ejected as share prices fall.

The 3rd new rule which is in effect now states that the offers and bids that MMs post must be of approximately the same size. No longer can the offers be of 1 million shares and the offsetting bid good for the minimum 5,000 shares.

The verbiage in 4320 is especially well done as it FINALLY puts the clearing firms that aid and abet this crime wave on the spot.

With the FFETF, which is made up of 25 different agencies, now on the scene the transparency has increased markedly. You can imagine how critical the lack of transparency is to a crime involving selling nonexistent securities and then refusing to ever deliver that which you sold AFTER being allowed access to the funds of the investor being defrauded.

Here are the links to the rules SR-FINRA-2010-028 and SR-FINRA-2010-043:

http//www.finra.org/Industry/Regulation/RuleFilings/2010/P121522

Notice the part I marked in bold in the quote above:

"FINRA 4320 goes into effect on 2/28/11.

It mandates 13 day buy-ins for open delivery failures FINALLY applying to shares of non-reporting corporations."

I'm going to take a wait and see approach. For one thing, a rule that is not enforced is no rule at all. Enforcement has been a real problem. Here is some further commentary from taskforceviking.

What this means for investors and traders is that many of the games large brokers and market makers use to manipulate a stock by holding down investor interest through short selling, or by using a small sell to offset a large buy to keep a stock from moving in a particular direction, will be illegal, and open to investigation.

Examples of this type of manipulation occur when investors put in bids to purchase say, $100,000 shares of XYZ stock at the current market price of say 10.00 per share. The market maker will purchase those shares in the open market in blocks as they can accumulate shares until the purchase is completed. Then, a market maker will bring down the price through manipulation, by selling short a block of say 5000 shares at $9.95. The ratio of strong buying to selling was 20:1, but after both transactions took place, the stock actually fell $.05.

Thus the market maker controls the market of stock through manipulation, instead of simply allowing for the equity to move according to natural market forces.

Horror stories abound of market maker manipulation and naked short selling. There was even a proven case where an investor owned 150% of the shares that a company legally had in the market. This means, 50% of the investors shares were invisible and were created out of thin air, established through naked short selling by a broker, or market maker.

Tomorrow begins a new day for the US markets, and new rules that could prove interesting for investors. If the SEC and FINRA follow through with enforcing these new rules, then we could see the markets skyrocket upwards as short sellers desperately battle to purchase their necessary stock back at any price.

This new rule seems to be rather equivalent to the uptick rule - yes, it slows down shorting and naked shorting, but it does not address the fundamental problems as I have described (duplication, transparency, misleading stats, etc.) Since it is entirely dependent on effective enforcement, rather than outright ban, it is subject to the kind of systemic failure, biased reporting, jaundiced oversight, money manipulation, captured regulators as Taibbi notes in his latest article. So while its better than nothing, and longs on message boards may see some respite for awhile, I suspect the comfort will be short lived.

Updates, Comments, Notes

• 2009, 2010 Having difficulty designating account as 'cash' instead of 'margin' a protective measure that is supposed to make shares unborrowable. Bank of Nova Scotia, TD Waterhouse and Questrade refuse.

Oct, Nov 2010. Stories emerging about price manipulation in the Comex silver market. Big players implicated. I'll get a link up asap.

• Nov 30, 2010. As an update, folks should be wary of the new bubble forming in bonds, especially gummerment bonds and the consequent skyrocketing short interest. This is too new and so I'm going to have to leave you to Google the subject for now. Here is one link to start you off. Given the situation in PIIIG countries, cutbacks in England, France and the US, one wonders why anyone would buy any public sector bonds but that seems to be the case. The safe investment people call it - and it has been for a long time, about 30 years. Pundit Prechter and others have written about ever lower interest rates as far as the eye can see which would be good for the holders of bonds. How this jives with Quantitative Easing is beyond me but perhaps for little old ladies, bonds are safe?

It does take mental effort to adapt to what is going on these days and I believe that the entire financial industry is, at some level, a stupendous (and stupid) diversion of human effort from what matters (making stuff) into what does not matter (counting). With all the shorting activity going on in this sector, one has to wonder if one (or one's pension or advisor) is buying a real bond or a virtual duplicate or just a pure counterfeit (naked shorted bond). If nobody was shorting, then presumably the price of bonds would be rising even more than charts show. We shall see. Good luck. Dec, 2010.

• Dec 8, 2010. Thanks to shorter HW for sending the following information about current practice [my clarifications is square brackets] He writes:

  Here is a document about shorting from a person that obviously believes that any lack of shorting does create a bad market.

  But it does not address the BIG problem.

  It used to be, when you called up a broker to short a stock, they would short the stock before they would find a 'borrow'.

  Usually they could find a borrow in 3 days (the settlement day) otherwise you had to cover it [by buying it back].

  That has been stopped, now you have to FIRST borrow the stock.

  The big problem is with the companies that created this recession: Goldman Sacks, Bear Stearns, Lehman, JP Morgan and other market makers [big entities charged with maintaining a liquid market by always providing shares for sale or purchase].

  But the shortselling rules do not affect those big boys as they have big conflict of interests that go unpunished.

  They will still be able to "borrow" stock without anybody knowing it as they were the ones that made the IPO or PP and the market makers will remain untouchable. And they still can and will manipulate the market.

  It is a joke that on the moment the banks are rich and the governments are broke because they spend billions to bail out these criminals. And this has little to do with any side you may be on as libertarian, democrat or republican - all agree on that. Except of course the bankers and government officials who created the mess. Most of the influential government persons had their "training" at GS or the RAND Corporation and are paid nicely for their efforts to fill their wallets.

  Do you recall Blotchet with his Commerce One recommendation and several others?

  After recommending it to the public he told his colleagues that it was a POS [piece of shit] and all of these "recommendations" went bankrupt!

  So if you want to fight problems caused by shorting, you have to address the big cause, but as has been proven in the past, it is a lost cause. Maybe WikiLeaks will shed a little light on the conflict of interest problems among banks and brokerage firms, as they said that they will have some info on the banks.

  As to phantom shares, this is "supposed to be" covered by the new rules in Regulation SHO which became effective on September 7, 2004

  Rule 200 – Definitions and Marking Requirements. It defines ownership for short sale purposes, and clarifies the requirement to determine a short seller’s net aggregate position. It also incorporates requirements to mark sales in all equity securities “long,” “short,” or “short exempt.”

  Question 2.3: May a seller mark an order “long” if the seller owns the security pursuant to Rule 200(b) but is not “net long” in the security?

  Answer: Rule 200(c) provides that a person shall be deemed to “own” securities only to the extent that the person has a “net long” position in such securities. Therefore, a seller must be net long in a security in order to mark “long” an order for that security. Rule 200(c) does not change the “net long” requirement of former Rule 3b-3.

  (NEW! 08/28/09) (HW: is this a modification or a clarification of a loophole? I thought the text is quite clear that you cannot sell long more than you own long!)

  Question 2.4: How should a broker-dealer mark an order where the seller is net long for only part of the order?

  Answer: A seller may be net long a security but wish to sell additional shares of that security in excess of the seller's net long position. For example, a seller may be net long 500 shares of a security but may wish to sell a total of 600 shares of that security. Under such circumstances, only 500 shares can be sold long, and the remaining 100 shares must be sold short.

  RI Comment: HW's notation aside, Rule 200 does not appear to address the phantom share issue, just clarifies that long is long and short is short. HWs comments about how big banks can easily flout regulations illustrates why this entire practice should be abolished. One might argue that the very act of making markets (providing shares for transatlantic) necessitates shorting, ipso facto. My response would be twofold. One might certainly accept the notion of making markets, but in a manner constrained in such a way that shorters like HW would not have cause for complaint. Second though, I have to wonder why, aside from ensuring that a few thousand shares can transact in seconds, when quantities rise to millions of shares, that the expectation of requiring market makers having to provide excessive quantities on immediate notice is simply a spoiled brat privilege, not a fundamental right that we must respect. Why would a large order not have a limit anyway? Who cares if it takes a little while? The fact that even shorters are complaining is indication that the shorting cure is worse than the disease of selfish impatience.

---

HW responds:I have not read it enough to have a good opinion: I am not a trained broker, but your concern about phantom shares seems wrong. If an company has a balance sheet with: Accounts receivable: $1000 Accounts payable: $1000 they break even. The next year they have a big order, and both accounts are $2000. Are you saying that now their debt has doubled? (yes, it has!) Are you going to criticize people that indicate that their account receivable has doubled?

With small start-up companies shorting can create problems, but not by you or me as we do not have a chance to borrow shares, but the big boys can and will. And when the law allows they will lend them to you and me at an outrageous daily rate! It used to be that they would just get the interest off the money that came into your short account by selling these borrowed shares. That is why you had a short account and a long account, On the credit money in your short account [that results from a short sale] you would not get any interest (the lender or his brokerage firm got that) but you still had to pay interest on your debit money in your long account.

But than interest rates went low, and the greedy brokerage houses needed more money to pay their exec bonuses, so they came up with a compromise to keep the SEC happy (to keep the people happy) and started charging interest on borrows and everybody was happy! The SEC had made a new rule (no naked shorting) brokerage houses were happy (they could charge outrageous fees) and the US got even with Canada as it did not have stupid rules like the US. And the people are worse off than before (but that they will not realize because of the hype the SEC's PR contains on how great a job they did by listening to the people!)

When naked shorting was allowed, it could create more phantom shares than the float, if the clearing house was asleep and never declared a buy-in. But it also created IOU's, which could cause a stock to squeeze [upwards in price] in totally unrealistic terms.

I got to know many of the traders I used-to-know during the squeeze of ADSP, a company that had their false press release covered on CNBC. ADSP shares kept on soaring to astronomical heights even though there were shorters early in the process that realized the PR was false and they did not expect CNBC to be stupid enough to see some value in the PR. CNBC must have been desperate for a story and according to the PR this had to do with wireless, a hot topic! So when it went from $1 to $5 many [other] people started shorting as the PR was false, however since CNBC did not realize that and [since] their audience is much greater than the financial chat-rooms, it kept soaring to over $50, because nobody was interested in selling their shares and the shorter were required to cover due to margin requirements. Of course when the stock hit $50, the insiders had shares they could sell as they knew that this rally was totally unjustified and they were laughing as they were instant millionaires. ADSP consequently went bankrupt, not because they had no product, but the motivation of these new millionaires was not the same as it was before. Needless to say, the smart folks that knew how to analyze the PR in a truthful way, had to declare bankruptcy - a short position of $10k is not bad [position size] for a scam, but when it goes from $1 to $50, [due to margin requirements] they [would] need [to supply to the broker an additional] .5 million and more than 1 million if they added to their initial position.

Many of the short-bashers are people that benefit from scams. I never heard [large legitimate companies like] Intel, Google, etc. be against shorts. There was one company or fund whose shares were based on BCE to go up and NT to go down, I think it did not survive the NT hype. And when NT lost their glory after BCE sold their interest, people that had NT did not loose their money overnight. That would have happened if their would be no buyers, and who would buy NT? Yes BCE was buying shares, but only to cover their options because before they divested from NT they had bought a shitload of puts. The same thing could have happened as with ADSP, but in reverse: no buyers? .... Shares drop from $50 to $1. But it was a very gradual process, because many people knew NT was over-hyped (me too as you know and of course BCE!) and they were short, so when some granny wanted to cut her losses, she could get $25 for some shares as there were shorters that did not mind to double their profits and close their position. As it turned out NT died a slow death the same (almost identical) like ADSP (because the run-up it was also and unbelievable, given options!) which also took years to go below $1 again. The similarity is large, the (insinuated) PR from NT that their 50% growth-rate was going to last for many years was also hype! ADSP also made a product (probably OK for a $1 company) but their PR was blatant hype. On whom do we rely to properly analyse this material? CNBC???? BCE (who were shorting NT before the split)? Or the brokerage firms with their commissions?

RI Comment: HW has some interesting insights and great stories. Shorters always have swashbuckling tales which naturally flow from such a risky and cutthroat environment. We can all be thankful we didn't try to short ADSP at $5. He doesn't really address any of the deleterious aspects, although I highlighted where he does acknowledge that there can a problem. A shorter acknowledging a problem is cause for celebration, even if it's on a limited basis! Whether problems are caused by a few of da big boyz, or lots of little ones is immaterial, at least to the main argument. Whether grannies get to sell out to shorters (or to new longs looking for a bargain), is immaterial. Whether they get a better price is immaterial. Whether ADSP or Nortel was overrun by criminals (or by greed) is immaterial. They are both gone, in large part (of course not the only part) because shorters slammed them down so hard they couldn't get up. So if anything, HWs response strengthens my understanding that shorting is bad.

Further, as I contemplate the story of ADSP and Nortel, it seems that there is a feedback mechanism between the press and the company officers. Hype begets hype. The media benefits as much as the company. Officers, it seems, succumb not so much to greed as to their own hype, writ large on a national stage. Boosted by positive feedback, flashing lights, excited commentary, egos inflate and the expansion begins. Be that as it may, whether MSM is culpable or not, it is the availability of the mechanism of shorting that enables the cynics and destroyers to profit. Abolish short selling and these folks will have to resort to creating something of value to the rest of us in order to make a living

PS. I'm wondering how my new formatting is going do differentiate my comments from others'. Let me know if there are problems with your browser as colors can be problematic.

HW responds - well he doesn't actually respond to what i wrote just keeps nattering on as if constant repetition will prove the case. So here it is without any further comment from me.

have a look at HHWW.

It is a blatant scam, and people tried to short it in the mid 1.50's. But their were no shares available, so it squeezed Al's the way above $3 when the insiders started selling. That made shares available for shorting, and look at what it did a drop from $3 to $1 in a single day. You think that private investors watched this stock on a daily basis so they could have sold? Most of them are probably not aware of it yet, as many of them have recently bought it as it has had an avalanche of PR's.

Oh yes the Securities Act of 1933 has two basic objectives:

• 1) to require that investors receive significant (or “material”) information regarding securities being offered for public sale.
• 2) to prohibit deceit, misrepresentations, and other fraud in the sale of securities to the public.

Nobody would dare to break those rules now would they?

I suppose if i post comments like this, I have to declare hereby, that I take no responsibility for comments made by others, having no personal knowledge of particular companies mentioned and have no short or long position in any company mentioned and that any persons reading this should consult their own financial advisor or do their own due diligence. Blah, blah, blah. On my other site (click my name at top) I complain about having to make self evident statements such as this just because lawyers have taken over and common sense has fled the scene. Somehow, I also have to come up with a better format so folks can navigate more easily & figure out where comments begin and end. Let me know what you think.

RI Comment from XYZ who seems to know something about the situation. Sorry for taking so long to post the comment. He says:

Date: Thursday, 10 February 2011, 1:49 PM

Subject: ADSP

|Hi,

|Just stumbled onto your web page, trying to find an old stock chart from ADSP to entertain some folks here at work. I was working at ADSP when the craziness happened. My recollection of events differs from yours, however.

|First off, it was the day after Thanksgiving in the US, normally a light trading trading day. The company was closed. So we all got to watch this transpire (if we were paying attention) from our homes.

|At the time, the market was gaga over anything related to Linux. Red Hat was shooting through the roof, VALinux IPOed to an absolutely insane valuation. While Ariel certainly was putting out PR, I don't recall anything out of the ordinary for the time. Rather, there was an announcement on that day (or maybe the day before) from another company named Aerial that tied them to Linux somehow (don't remember the exact details). Confusion between the two companies then led to Ariel exploding. I don't recall anyone in the company (at least none that I spoke to) having any other explanation. We all knew it was a big crazy mistake, and watched in amazement.

|Because the company was closed, there was no opportunity for anyone to exercise vested options. In fact, I was not at the time aware of a single individual at the company who made a killing that day. Not saying that it definitely didn't happen (if you have definite knowledge about this I'd be interested to hear about it), but most folks' company stakes were in options, and again it was not possible for anyone to exercise them that day.

|The next Monday, when we all returned to work, the primary aftereffect of that crazy day was that we had a good story to tell.

|The company's eventual bankruptcy had absolutely nothing to do with that day; rather, it was a general casualty of the telecom bubble. The company went chasing (unsuccessfully) after high-growth markets in the telecom industry, while letting its original core business wither away. That whole process started way before the stock craziness, and continued apace afterwards.

|If you have any particular knowledge that contradicts any of this account, I'd be interested to hear it. None of this, of course, has any bearing on the relative evilness of stock shorting. Just thought I'd try to clear up the account of this particular incident.

Thanks XYZ for the insight on ADSP. While the failure of this particular company may not be related to short activity, that in no way invalidates the argument that deliberately making companies wobble (or worse) is simply not a good idea. It is easy to show that some wobbles do lead to eventual failures, and that is all the argument needs in order to be valid. Do I have to argue that failure itself is not a desirable outcome?