1. Equity Securities Fraud
“Naked” Short Selling
Equity Securities Fraud
Julie Cardoza & Arlie Rogers
Craig School of Business
Copyright 2010 Julie Cardoza & Arlie Rogers

2. Why “Naked” Short Selling?
Arlie – here are some clip art options… if you are interested.

3. “Naked” Short Selling Agenda
History of managing equity securities
What is Short Selling?
What is “Naked” Short Selling?
“Naked” Short Selling Cases
SEC Regulations
Regulation Recommendations

4. Management of Equities Securities
The Background

5. History of Equity Securities
Loop-holes
Internet  Removed the Middleman
Depository Trust Company
Caveat Emptor
Source: “Wall Street’s Naked Swindle”

6. Short Selling
The Legal Version

7. Legal Short Selling Legal Requirements
The sale of a stock that a seller does not own at the time, hedging that the stock will fall.
If the price of the stock drops, short sellers buy the stock at the lower price and make a profit.
Legal Requirements
Seller has borrowed the security or made a good faith arrangement to borrow the security, or
Seller reasonably believes it can locate and borrow the security by the settlement day, and
Seller has documented compliance with either of the above two requirements.
Source: “Naked shorting is little different from permissible shorting.” and “Division of Market Regulation”

8. An Illustration Legal Short Selling 100 100 100 @ $10/share
COMPANY
BROKER
TRADER
An Illustration
Hold
Borrow
100
100
100
@ $10/share
100 x $10 = $1000
Source: Matt Taibbi on Short Selling

9. Legal Short Selling $1000 $1000 100 100 @ $10/share @ $10/share BUYER
TRADER
Shares
$1000
$1000
100
100
@ $10/share
@ $10/share
Money
Source: Matt Taibbi on Short Selling

10. Legal Short Selling $10 $8 $1000 100 Time Passes 100 x $10 = $1000
TRADER
Time
Passes
$1000
100
Source: Matt Taibbi on Short Selling

11. Legal Short Selling 100 $800 $1000 100 @ $8/share (still has $200)
TRADER
100
SELLER
Money
$800
$1000
100
@ $8/share
Shares
(still has $200)
Source: Matt Taibbi on Short Selling

12. Legal Short Selling $200 100 $2000 100 @ $8/share @ $8/share Profit of
TRADER
BROKER
Profit of
$200
Return
100
$2000
100
@ $8/share
@ $8/share
Source: Matt Taibbi on Short Selling

13. “Naked” Short Selling
The Illegal Version

14. “Naked” Short Selling
Similar to legal short selling, but with a willful intent to defraud the system. The seller knowingly allows buyers to purchase more shares than are available.
Results of “Naked” Short Selling
The seller profits financially
Manipulates the market
Company stocks are devalued
Source: Division of Market Regulation

15. An Illustration “Naked” Short Selling Borrow 100 BROKER TRADER
Source: Matt Taibbi on Short Selling

16. “Naked” Short Selling 100 IOU $$$ @ $10/share TRADER BUYER BUYER BUYER
Source: Matt Taibbi on Short Selling

17. “Naked” Short Selling IOU Failure to Deliver TRADER BUYER BUYER BUYER
Source: Matt Taibbi on Short Selling

18. “Naked” Short Selling TRADER GOSSIP GIRL Bad Rumors
Source: Matt Taibbi on Short Selling

19. What happens to the company stock?
“Naked” Short Selling
What happens to the company stock?
100 x $10 = $1000
$10 $2
100 x $2 = $200
Source: Matt Taibbi on Short Selling

20. “Naked” Short Selling 100 $200 $1000 100 @ $2/share (still has $800)
TRADER
100
SELLER
Money
$200
$1000
100
@ $2/share
Shares
(still has $800)
Source: Matt Taibbi on Short Selling

21. “Naked” Short Selling 100 $7,200 Profit TRADER BUYER BUYER BUYER BUYER
Source: Matt Taibbi on Short Selling

22. “Naked” Short Selling
Recent Cases

23. Overstock.com/ Copper River
Background
Copper River (formerly Rocker Partners), a hedge fund, was charged with profiting from “naked” short selling Overstock stocks.
Overstock sold over 19 million shares, but 35 to 40 million shares existed. Resulting in shares held by legitimate owners of Overstock are potentially worth half their true value.
Fine/Settlement
Copper River paid Overstock $5 Million
Sources: Overstock.com website &
“Overstock's Byrne claims $5m scalp over short selling”

24. Hazan Capital Management LLC
Background
Engaged in “naked” short selling (‘05-’07)
“Failure to Deliver” list by Clearing Firm
Ultimatum lead to more shams
At least $3 million in profit
Fine/Settlement
$1 million fine to SEC
$1.5 million each to NYSE AMEX & NYSE Arca
Steven Hazan barred for 5 years
Sources: “SEC Charges Options Traders and Broker-Dealers for "Naked" Short Sale Rule Violations” and “SEC takes enforcement action against naked shorts charges lodged against 2 option traders and their broker dealers.”

25. Bear Sterns Background (provide additional info here) Results
Source: “Wall Street’s Naked Swindle”

26. Regulations
For Equity Securities Fraud

27. Regulatory Actions Regulation SHO “Locate” Requirement
"Close-out" Requirement
Daily list of threshold securities
Rule 204
(provide details here)
Source: “Wall Street’s Naked Swindle”

28. Recommendations
To Improve Regulations

29. Recommendations
TBD

30. Thank You
TBD

31. Sources
Naked shorting is little different from permissible shorting. The Economics of Naked Short Selling by C. Culp and J.B. Heaton. Regulation. Spring 2008)
Division of Market Regulation: Key Points About Regulation SHO. April
Wall Street’s Naked Swindle: A scheme to flood the market with counterfeit stocks helped kill bear Sterns and Lehman Brothers – and the feds have yet to bust the culprits. By Matt Taibbi. October 14, Rolling Stone.
Matt Taibbi on Short Selling
Overstock's Byrne claims $5m scalp over short selling. Financial News. By Cade Metz. December 9, 2009.
SEC Charges Options Traders and Broker-Dealers for "Naked" Short Sale Rule Violations. Aug. 5, 2009.
SEC takes enforcement action against naked shorts charges lodged against 2 option traders and their broker dealers.