Naked Short-Selling: Two Big Wall Street Firms Get Exposed

Naked Short-Selling: Two Big Wall Street Firms Get Exposed

Naked Short-Selling: Two Big Wall Street Firms Get Exposed

Normally, when you make a mistake, you choke down a slice of humble pie and life goes on. On rare occasion, however, there are mistakes so egregious that you just want to put a bag over your head and pretend that you don’t exist. This must be how the lawyers for Goldman Sachs feel after they inadvertently entered private company e-mails from both Goldman and Bank of America/Merrill Lynch into the public record.1 This revelation was detailed by Rolling Stone magazine reporter Matt Taibbi2 who took special note of the delicious irony stemming from the fact that the firms spent a fortune in legal fees to keep this material out of public view only to have one of their own attorneys accidentally dump it on the street.

The candid e-mails graphically detail how the named firms conducted naked short-selling transactions (selling a stock short without first borrowing the shares). The CFA Institute, a global association of investment professionals that sets the standard for professional excellence, articulates the following position regarding naked short selling.

Naked short selling – selling shares short without having a source of shares to cover the trade at settlement – amounts to a fraud by the seller and should be prosecuted under existing rules. This practice undermines investor confidence in a number of ways. First, naked short sellers deliver unauthorized shares to uninformed buyers, thus depriving the buyers of the basic benefits of ownership, such as voting and dividends. Such trading also may negatively affect an issuer’s reputation and subvert the appropriate workings of the market by avoiding certain restrictions applicable to those who deliver shorted shares on time.

Naked short selling can lead to failures in trade execution and to more absurd situations such as a number of shares owned exceeding the number of shares floated by the company. Irrespectively, it undermines the integrity of the financial markets. Lest one think that this was merely the aberrant behavior of a few rogue traders, the problem escalated to top-level management, including Peter Melz, the former president of Merrill Lynch Professional Clearing Corp. (Merrill Pro), whose own personal response to a subordinate’s concerns about the company’s failure to comply with regulations regarding short sales stated: “F*** the compliance area – procedures, schmecedures.”

Noted! While we at IFA have never thought of the big brokerage houses as genteel places, even we were surprised by the complete disregard for securities laws, which are ultimately in place for the protection of the clients of these firms. We feel a degree of pity for the Merrill compliance staff, who appear to suffer a low regard by their colleagues. However, this pity does not compare to the sort of concern we feel for the clients of these firms who, according to former Goldman vice president Greg Smith, have been characterized as “muppets” who are viewed purely as a source of profit, and the extraction of said profits is expressed in charming phrases like “ripping their eyeballs out.” 

Such statements reveal a corporate culture that is indeed naked of ethics and professional conduct.

As Alexander Pope said, "To err is human; to forgive, divine," and while Goldman CEO Lloyd Blankfein famously described Goldman as "doing God's work," we do not expect him to rise to the level of divinity and forgive that unwitting attorney. Regarding naked short-selling, while it may be many different things, God's work is definitely not one of them. Now that all of these documents are a matter of public record, we can truly say that the emperors of the financial world have no clothes. Our best advice to their clients is to stop exposing themselves to the shenanigans of these firms. Walk away, and don’t look back.