Hedge Funds, Naked Short
Selling, Phantom Stocks and Stock Market Collapse
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Nobody in the media seems bothered by this. To the contrary, the
Media Mob rises to Cramer and Herb’s defense. For example, Joe Nocera of
The New York Times, who is an old friend of Herb,
writes a column attributing the SEC investigation to Patrick
Meanwhile, these journalists continue to use Gradient and Rocker as sources in negative articles. MSN Money’s stock rating feature, which gives “buy” and “sell” recommendations to the website’s readers, is based entirely on Gradient’s analysis. CNBC’s stock picking tool also comes from Gradient.
This is pretty appalling given that the journalists have good reason to believe that Gradient produces bogus research. They know that its supposedly “independent” financial researchers are kids who take dictation for Rocker. And they know that Herb and Gradient have been accused of committing serious crimes. They know because they have the affidavits from Gradient’s former employees.
A few other key facts, known to many journalists, but so far unreported:
- Cramer claims never to have heard of Gradient, but a former Gradient employee says that Cramer’s colleague, Becky Quick, has confirmed in emails and on the phone that “Cramer loves Gradient’s research,” and that he has requested their research on specific stocks.
- Herb claims to have no special relationship with Gradient, but he had access to its computer system and regularly logged in.
- Herb’s research assistant, Brian Harris, spent a significant amount of time working out of Gradient’s office. (Herb claims that Harris was trying out for a job there).
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A guy named Jon Markman was for some time running a hedge fund out
of Gradient’s back office. So-called “independent” research shops
aren’t supposed to run hedge funds. If Markman was trading in advance
of Gradient’s research and Herb’s stories, as the firm’s former
employees claim he was, this is yet another jailable offense.
- Markman is one of Herb’s close friends. He was, along with Herb, a top editor of TheStreet.com. After that, and prior to starting a dodgy hedge fund in Gradient’s back office, Markman was the managing editor of MSNMoney.com (which explains why MSN Money continues to use Gradient’s research).
And maybe Herb, Markman, Eisinger, Nocera, Cramer and all the other journalists who think Gradient is a credible source–and who call Patrick Byrne a wacko, a Waldo and a menace–can tell us why at least one Gradient manager has used multiple aliases and IDs to hide his activities.
* * * * * * * *
There was a time, before Rocker and Gradient came along, that Patrick Byrne was a darling of the financial press. In 2002, Fortune magazine called him “The Renaissance Man of E-commerce“. The article noted that Patrick is an admired protégé of celebrity investor Warren Buffett. It added that Patrick has a black belt in tae kwon do, “has bicycled across the U.S. three times, studied moral philosophy at Cambridge as a Marshall fellow, and briefly pursued a career in boxing. Byrne also speaks Mandarin-not to mention four other foreign languages-and translated Lao Tse’s Way of Virtue…He has a nearly photographic memory [and can study] a deck of cards for a couple of minutes [and] recite them back, one by one…six months later.” Byrne also survived a three-year “bout with seminoma, a cancer that reduced his 6-foot-5-inch frame from 240 pounds to 164…[and left] his body scarred with the marks of 20 surgeries.”
There were no short-sellers behind the Fortune story, but short-sellers do often pump stocks up before they trash them. If they take their short positions at a peak price, they make more money on the way down. This might explain why, in December 2003, Cramer couldn’t say enough good things about Patrick and Overstock. “We really like this guy,” Cramer said on Kudlow & Cramer, the CNBC show he was then hosting. Yes, Cramer was very impressed by Overstock’s growth. He said it was a really great company. He said he was gonna go to Overstock.com and buy Mrs. Cramer a Christmas present.
Soon after, David Rocker took his initial short position in Overstock. The first sign that this might affect the media coverage of the company came in January 2004, when Patrick was invited to appear again on Kudlow & Cramer. Only a few weeks had passed since Cramer’s initial extolments, but now the mood was entirely different. Now Cramer and his co-host, Larry Kudlow, seemed to be casting aspersions on Patrick’s character.
In his quarterly earnings statement Patrick had cited Overstock’s gross profits, which had increased nicely. There was nothing at all unusual about this - Patrick also cited net profits and many other figures - but Kudlow and Cramer hinted that it was somehow suspicious, that maybe mentioning gross profits was a slippery thing to do, and maybe Patrick was trying to overstate his success.
“You talk about something called gross profits,” said Kudlow, “Why are you - is this a confusion thing, an ambiguity thing, or what point were you trying to make?”
Yeah, said Cramer, “You don’t need to….You don’t need to - I know that you don’t regard that as spin. But…”
Patrick was visibly baffled. “Gross profit is an accounting term,” he said. “It’s an accounting term…on an income statement…I described each line on the income statement…”
* * * * * * * *
“You saw what just happened, didn’t you? It was a set-up. This is what these guys do - they try to make CEOs look like they’re cooking the books. It’s pure smear. They take their cues from short-sellers. Watch out, these people don’t mess around. They’re dirty players.”
It’s a Wall Street broker on the phone, and Patrick has just left the studio where he was blindsided by Kudlow and Cramer. He still doesn’t know anything about the Wall Street cabal, but it was a strange interview, and he’s had some other warnings.
Like just recently, he got two calls, from two different hedge fund managers. The hedge fund managers told Patrick that one of their brokers, a guy who handles short-sellers’ orders for Bear Stearns, a major investment bank, had sold 300,000 shares in Overstock that he didn’t have - phantom shares. The broker registered the sale on his computer - which created a sort of I.O.U. - but he had no intention of finding real shares to buy or borrow and then deliver to the purchaser. To justify this action - and perhaps to put some additional downward pressure on the stock - the broker circulated a rumor that Patrick was using some kind of offshore synthetic instrument to sell his stock while hiding this from the public. This was completely false.
In January 2004, Patrick doesn’t know it yet, but short-sellers are preparing to take down Overstock. Soon, the company will come under attack from multiple directions. Millions of phantom Overstock shares will be sold into the market. And the media - led by Cramer, Herb and affiliated journalists, will orchestrate an unprecedented smear, all the while insisting that phantom stock is not a problem.
* * * * * * * *
On January 23, 2004, just a few days after Patrick hears about the sale of 300,000 non-existent Overstock shares, Carol Remond, a reporter for Dow Jones Newswires, publishes a story about a recent decision of the National Association of Securities Dealers (NASD). Members of the self-regulating body (later renamed the Financial Industry Regulatory Association) have long had to abide by the requirement that they deliver the stock they have sold within three days. It is not just a NASD rule - it’s U.S. law. But some brokers have bypassed this rule by selling, and never delivering, phantom stock through foreign brokerages that do not belong to the NASD. Now the NASD has announced that it will try to close this loophole.
Preventing traders from breaking the law seems hardly controversial, but Remond, the French-Canadian reporter who will later try to establish that Patrick is running a criminal enterprise out of a gay bathhouse (she will also later get a government subpoena along with Herb and Cramer) apparently thinks the NASD should keep out of the way. “Taking most market participants by surprise,” she writes, “the National Association of Securities Dealers has drastically tightened its rules governing short-selling” by closing the loophole allowing sales of phantom stock. The “market participants” think - and Remond agrees - that this is no good because “it’s impossible to borrow the shares of…overvalued development stage companies.”
So Remond - siding with her sources - thinks that if it is impossible to borrow shares of a company, hedge funds should nonetheless be able to sell, sell, sell. Create unlimited amounts of illegal phantom stock to drive down prices and never deliver it. This is Remond’s standard position: if a company is deemed “overvalued” by short-sellers, then the short-sellers should be allowed to destroy it. This position is shared by every journalist affiliated with Cramer, David Rocker, and a crew of dirty players.
How dirty? Well, the only “market participant” named in Carol’s story is Pacific International, a brokerage in Canada. As Remond surely knows, more than 15 American criminal indictments have targeted Pacific International clients. It is widely suspected as a favored broker for sellers of phantom shares. Five of the indictments mention Pacific International as a conduit for money laundering and stock fraud.
In one court case, Sasha Angus, the director of enforcement for the
British Columbia Securities Commission,
describes
this scene: “Jean Claude Hauchecorne, one of the top revenue
producers at Pacific International, was summoned to New York…Phil Abramo
and Phil Gurian, entered the room with two other men. These men were
armed… ….Abramo and Gurian were apparently high-ranking members of the
Mafia.”
On that day, Abramo and Gurian, of the Gambino crime family, threatened to kill Hauchecorne because he had funneled money to a stock promoter linked to the rival Bonanno and Genovese Mafia clans.
According to Carol, Pacific International is a credible source - just your average “market participant.”
Most of the Cramer crowd of journalists would agree.
* * * * * * * *
Fortunately, there is a wild-eyed guy in Massachusetts named Dave Patch. Dave is an engineer. He spends his days building parts for jet airplanes. At night, though, he is a revolutionary firebrand, churning out searing entries on his blog, which is called InvestigateTheSec.com, and firing off cantankerous letters to government officials and mainstream journalists about the problem of phantom stock.
In September 2006, SEC Director of Trading and Markets James Brigagliano referred to Dave Patch and his fellow crusaders as “bozos.” For years prior, the SEC said that there was very little phantom stock in the system. Then, one day, it said there was so much phantom stock in the system that it couldn’t force the sellers to deliver real stock because it would cause “excessive volatility” - a euphemism for “total market chaos.”
A couple of years ago, Dave began invoking the Freedom of Information Act to compile reams of trading data. This data, combined with research published by the securities industry itself, suggests that there is now around $12 billion of phantom stock in just one corner of the system. There is an unknown amount - perhaps $100 - $150 billion - in a part of the system that is not monitored by any regulatory body. Just as a spill of $1,000 of radioactive waste costs much more than $1,000 to clean up, a certain dynamic of the stock market (named, “short squeezes”) means that to clean up $100 billion of phantom shares would cost much more than $100 billion: it could easily cost over $1 trillion.
Dave puts this information on his blog. He receives back-up from a crew of anti-phantom stock fanatics who live on the internet. Meanwhile, the Easter Bunny takes on the role of chief PR man, publishing his own fiery - and often hilarious - blog, which he calls TheSanityCheck.com. One day, the Easter Bunny calls Patrick Byrne, who launches an unprecedented public campaign against phantom stock sellers and the journalists who support them.
Then, on March 26, 2008, as the markets are melting down, the SEC invites Dave Patch to brief the agency on the phantom stock problem. The Counsel to the Inspector General of the SEC writes a letter to investors who have complained about naked short-selling.
It says that the SEC Inspector General has “met with Mr. David Patch…at which time he gave us an extensive briefing on this topic. We understand the seriousness of the concerns about naked short selling and have begun looking into potential audit issues related to this matter.”
Says a former SEC attorney: “It wasn’t until Dave Patch started firing off FOIA requests that anyone started taking this seriously.”
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