Equity Market Integrity Initiative - "Short Sales"

Preamble: The intention of this article is to encourage thought about what we have come to know about “Short Sales”. Although I have endeavored to validate my understanding, I am not representing the contents as fact, but as just my understanding and deductions. It is my hope that even when assertions are forcibly made, the reader will be critical, validate and form his/her own opinion. In fact, one of the main points I want to convey is that we need to critically challenge the current status quo and terminology bandied about, not mindlessly take it as “gospel”, which I believe is what brought us to the point we are. I could expound on the devastating effect and enormity of the problem, rightly so. I allude to it, perhaps another time. Please excuse any duplication, sometimes something is expounded upon further down in a separate paragraph. This was originally written to be conveyed in separate posts.

Introduction

Most criminal enterprises are eventually brought down because their scam(s) have been taken to the extreme. Perhaps one of the most notable in recent times is the infamous Madoff ponzi scheme; which continued to be exploited for many years, several after whistle blowers had gone to great lengths, even risking their lives, to alert the SEC and others. In most cases there are significant red flags, even early on, like the “it's too good to be true” adage. In each and every case, it begins with rationalizing the unusual, the exception or the irrational.

“Short Sales” is exactly that, a huge rationalization of the irrational. We have said the words “short sale” so frequently, institutionalized them, and have continued down a path of rationalizing and making exceptions, and exceptions to the exceptions. Even now, when the effects are plain to see, and devastating, FINRA is attempting to come up with ways to improve reporting on the “exceptions”. We try to distinguish between naked short sales and others, between illegal naked short sales vs legal, between some institutions that are allowed and other persons who are not. We try to define and categorize “Failures” to deliver, then rationalize some FTDs that are okay, and others that are not, with different time frames to remedy. The fact is that no system will ever be efficient and effective in the timely reporting and management of the exceptions, and even if we were to get it 90%, the effects and the devastation will not change.

Rationally speaking, the word “short” infers that you don't have it. The word “sales” means taking proceeds in exchange for conveying “OWNERSHIP”. Right there we have an indictment, a process of “TAKING PROCEEDS FOR CONVEYING OWNERSHIP THAT YOU DO NOT HAVE”. If that does not sound irrational, why does theft in broad daylight? Is it only because the latter could possibly get you arrested or shot? The truth is that “short sales” are irrational, a misnomer, and would be illegal, but for it being rationalized and done anyway, by institutions with Hundreds of Billions of Dollars, profiteering Hundreds of Billions of Dollars.

The Illusion – Share Borrowing

Proponents of “short sales” argue that the share has been “loaned” to the short seller. Rationally, that should already leave you astonished, a red flag! Since when does borrowing something entitle you to sell it?

Firstly, rights inferred from borrowing is typically the right to use something, NOT to alienate the lender's ownership! Specifically, in a legal sense, borrowing should definitively not to cause value to be diminished and, when formalized, there is usually a tenure specified. Title and right of disposal are expected to be retained by the lender. With “short sales”, value is diminished, to put it mildly. In fact, the short seller's goal is to bankrupt the company and reduce the value to zero, profiting the full proceeds. And no tenure is specified, to the extent that it may be, it's just extended.

Proponents will have us believe that the very share's ownership, that the borrower is taking proceeds for conveying the to its buyer, is ALSO is retained by the lender. That is beyond being a red flag, it must surely be an impossibility?

In other words, in the unlikely event that it is not a crime to take proceeds for conveying ownership belonging to someone else, does it still, once conveyed, exist in custody for account of the original owner, available for disposal? If yes, as brokers would allege and report to clients in their statements, what was conveyed by the borrower? A counterfeit, fake or fictitious share? If no, is it not subterfuge to still account to the rightful owner as if the share is still in his/her custody, unfettered for their account and benefit?

Short sales result in fictitious, counterfeit or fake shares in the accounts of shareholders. Ordinarily, when party A sells a share to party B, party A's balance of the shareholding is reduced and party B's balance of the shareholding is increased. In theory, all shareholders' account balances should balance or reconcile to the Company's total shares in issue. Shares are not called shares by accident, they are called “shares” because they represent a “SHARE” in the company, which have to add up to 100%. Anything in excess of 100% has to be fake, fictitious or counterfeit.

The indisputable fact is that the new owner to whom the borrower has sold the share, and the owner who ostensibly loaned it, are both at equal liberty at any time to sell that same share. Supply in reality has been duplicated and will soon be triplicated.

Secondly, in many instances brokers lend their clients' shares (it's in the fine print) without their express knowledge, sometimes clients are unaware that their share could be loaned out. Sometimes Brokers share the interest with owners, sometimes not. However, one has to ask, what investor in their right mind, is going to willingly lend out their shares, knowing that this would significantly undermine their investment's value? (Are we beyond the red flags yet?)

Thirdly, clients entrust brokers with their hard earned savings; investments for life events, for retirement, hoping and believing that their investments will go UP in value. Brokers return this trust by lending out their clients' shares, fully knowing that these shares are being to be “sold”, creating Supply. What does increasing supply do to price, in our “fair” market? It drops the price and the value of their client's investment. Their client is NOT a willing seller, but their share has been pimped to a Willing NON-Owner, who's going to purport to sell it and collect proceeds. (Enraged yet?)

Fouthly, short sellers, in the process of “selling short”, contract an obligation to purchase the share at a later time; but that time is conveniently not defined or just extended. What they are “selling” and being paid for, is not the obligation to purchase, it is purported to be ownership of a real share. The one is a derivative; the other is purported to be real, but it is fake, because no real share has left either the short seller or any other rightful shareholder's account.

If ownership is what is being conveyed, should it not belong to the conveyor? The truth is that ownership is integral to its supply, and we can only have “supply” per the supply and demand equation if OWNERSHIP is what you are collecting the proceeds for!

Fifthly, “short sales” of “borrowed” shares do not stop at duplicating the share “loaned” just once, when that share is credited to the buyer's account, it becomes “available” to be loaned out as well, it is after all purported to be real. Again and again, resulting in so called “short interest” in large proportions to the total issued shares, often more than 100%. (Let's be clear, 100% short interest duplicates the entire potential supply of the shares to 200%, sometimes 250% or even more.)

How can we expect that the market will return a fair market price based on supply and demand, if we fictitiously double or treble the supply, or allow it to be infinite? Proponents, in fact the industry, call these fictitious shares “synthetic”. That they would even name them anything, as if there's no problem in the world to have in excess of a 100% shares on account, is already an indictment! But “synthetic”? What a misnomer! I can understand that it is difficult to come up with a name for something that is the result of “short sales” without making it sound incriminating; like fake, or fictitious, or counterfeit would sound. But one thing it is NOT, is “synthetic”! It's digits on a computer system that represent shares with equal rights to any other real shares, which now total more than 100%! That is beyond disingenuous, beyond red flags, it is racketeering!

The Illusion (Part Two) – Distinctions and Terminology

The term “Illegal naked short sale” is used to define the sale of a share that is not owned and not borrowed. As implied, it is illegal (well mostly, because for every rule of law there has to be an exception.) But let's accept that for most people, most of the time, “naked” short sales are illegal. We also hear about “Failures to Deliver” or FTDs, again as implied, failing to deliver what you've sold. Again, there are of course exceptions, but FTDs are a serious offense (depending on who fails) and have to be remedied to avoid serious sanctions. However, naked short sales do happen, as do FTDs (they even get categorized and reported by the SEC).

What distinguishes a naked short sale from an “un-naked” short sale? The answer, when you consider the net effect and the truth, is NOTHING! Just like a naked short sale, the short sale of a borrowed share is in effect NAKED, which is why it only becomes “covered” when the short seller meets their obligation to buy a real share, to replace the fictitious one credited to his/her buyer's account.

Put another way, if the “un-naked” short sale was not naked to start with, why does it have to be covered? The answer is because, just like the use of the word “synthetic” to describe fictitious shares is a deceitful distraction, so is the distinction between naked short sales and all other short sales. In truth they're all naked and they all entail failing to deliver the ownership that has been purported to have been conveyed.

Proponents would argue that the short seller has to borrow the share, which restricts the availability. That's also not true. Restricts it from what, 1000%, or a free for all supply, but 250% say is justified? Where in the definition of a free and fair market does it say that supply should be allowed to be multiplied at all? Furthermore, with the fabrication of “synthetic” (fictitious) shares to the n'th degree, and the total lack of control over naked shorts and FTDs, in many cases what we end up with is a free for all.

FINRA, the SEC and the brokerages, even if they had the will, don't have and never will have a system that tells them on a timely basis, how much the short position is; not naked, not un-naked, not with or without FTDs. (Currently relies heavily on “self reporting”). Whatever data is produced is uselessly inaccurate, incomplete, and even if it was at some time approximate, it's outdated by the time it's reported. It is antiquated by the time it's made available to retail investors, fundamentally flouting the “Market” stipulation that all information must be available to market participants equally.

The Effects: Part 1

“Short sales” result in a fictitious Market and price manipulation.

Market price is the price at which two willing parties transact, one demanding and the other supplying, with equal access to information that may affect the value, and without compulsion* to trade. What makes the market work, is that both supply and demand are constrained; supply because it is by implication limited to as many shares as Holders Of The Shares In Issue want to sell; and demand, because price will by market forces increase to the point where buyers are no longer available or willing to buy because the price is deemed too expensive. These constraints are integral to market pricing dynamics. The higher the demand and the lower the supply, the higher the price will be, and vice versa. As soon as the quantum of either supply or demand is distorted, the system is broken.

The moment we include parties who are not holders of the shares in issue, we remove the restriction, amplify the supply and make the system fictitious, effectively manipulating the price. Manipulating share prices down has a cascading effect, investors are alarmed and may become sellers or refrain from buying, again more supply and less demand equals lower prices. The fact is that short sales do not merely anticipate prices going down as proponents would allege; short sales force prices down by creating both fictitious and cascading supply, and reducing demand. This is before considering the effects of Payment for Order Flow, Dark Pool trading and high frequency high volume algorithmic trading, that we know takes place and we know factors in a trend, including a trend resulting from “short sales”. (Heaven forbid that we suspect that short sellers' financial interests in driving down prices become ancillary or primary in such trading practices. Shall we be really naive and assume there is zero connection or influence?).

“Without Compulsion” - The proponents of short sale have a real dilemma, and they're quick to cry foul and throw stones at every- and anybody else, except their greedy selves. The problem with collecting proceeds for “selling” something that you do not own, is that you may become compelled to buy it to cover up your greedy act (because you're NAKED); unless you can make the share worth zero, bankrupt the company and hope everyone forgets about your contracted obligation to buy it. It's like blackmailing yourself, it is a pretty strong compulsion; your own bankruptcy or buy the share! Remember that stipulation “without compulsion” in the “Market” definition, it's stipulated for a reason. Because, if you're “compelled” there is no longer a reasonable restriction on the price; if no seller wants to sell, and you can't bribe the company to issue more shares, and the price is just going up and up, you own the self-inflicted compulsion to pay, regardless of price, whatever it takes, deservedly! If the increasing prices resulting from short squeezes; stemming directly from nothing else but your boundless greed, blackmailing yourself with a self-inflicted compulsion to buy, does not provide some encouragement to consider the possibility that short sales have no rightful existence, are you being open-minded?

The Effects: Part 2 – The Assault on Market Integrity - AMC

Make no mistake; “Short Sales” are an assault on our Market's integrity, motivated by extreme greed and carried out by means of creating a false supply. AMC is by no means the only company attacked, maybe not even the worst. BUT, what makes it the vilest of vile acts of attempted destruction, is that it exploited the pandemic to profiteer from the extreme effects it had on the industry, its people, its customers and its investors. Proponents of short sales will tell us that short sellers are the canaries in the mine shaft, alerting us of dangers. No, they are not, they are the hyenas who want to kill, destroy and prey, in AMC's case, on their weakness caused by the pandemic. Here are the facts:

FACT 1. Nobody needed any canaries to tell us about the devastating effects of the pandemic on AMC or Hertz or the economy as a whole. To suggest that short sellers exploited the pandemic because of noble intentions just adds to the insult and to the severity of the deprivation. They stood to make hundreds of millions if not billions. That's not only a conflict of interest, that is their interest!

FACT 2. Short sellers create and exploit fictitious supply. They do not convey ownership of the shares that they collect proceeds for; not their ownership, nor anyone's ownership. Selling a borrowed share is their ruse to create fictitious supply. Possession from borrowing something does NOT entitle one to convey ownership. That ownership remains in the custody of the broker for the account of the owner who is the only one “ENTITLED” to sell it, and who retains that right. Collecting proceeds for the purported sale of a borrowed share is no different to a naked short sale and no different to a “failure to deliver”. What gets delivered is a duplication of a share, a counterfeit of the share, which stays in existence and remains available to the real owners for sale.

FACT 3. The volume of short selling; whether un-naked, naked and failures to deliver; is not quantified accurately or timely by any stretch of the imagination. The market has in several instances been so completely broken that there is no telling what supply is real and what is fictitious, whose shares are real, or whose shares are counterfeit (“synthetic”). We no longer have prices determined by supply and demand. We have prices determined by what hedge funds want the supply to be, with little regard for the actual and truthful supply represented by the actual and truthful shares validly issued by companies.