Cramer's Disingenuous Tirade on Naked Short Selling

One of the most interesting issues/debates going on in the financial markets the last couple of years that has really caught my attention is the issue of naked short selling. One of the most interesting aspects of it is how misunderstood it really is by a vast majority of savvy investors, including brokers and financial advisors. It's also a prime example of how market regulations and oversight have gotten way off track in recent years, much to the detriment of the average investor (you and your clients).

First of all, naked short selling is NOT defined by selling shares you don't own, which is perfectly legal. It's about selling shares that you don't own, and haven't arranged to borrow from a "long" investor, with no intention of delivering shares to your counterparty, at least until you cover your short position (which in many cases can be months). This is a violation of SEC Regulation SHO, and is, in essence, counterfeiting shares which don't exist. In an environment of coordinated hedge fund naked short selling, supply of counterfeit shares increases dramatically, without a corresponding increase in demand, thereby driving share price down (basic Econ 101 stuff), much to the benefit of the shorts.

Jim Cramer has passionately joined the debate, albeit in a misleading way, as exhibited by his recent interview with Senator Ted Kaufman of Delaware, which you can see right here (8 minute video clip):

Although Cramer is showing some passion about what is an extremely important and underappreciated issue, he is being very misleading in addressing the issue and confusing the real solution with the reinstatement of the uptick rule. The uptick rule really has NOTHING TO DO with the crux of the naked short selling issue, i.e., counterfeiting shares. The uptick rule applies to legal short selling (inclusive of selling borrowed shares). Requiring naked short sellers to wait for an uptick to sell counterfeited shares is still allowing counterfeit shares to hit the market. When Cramer sounds like he's passionately on board with fixing naked short selling now that it has gotten to be a hot issue, but advocates the wrong solution (even though he's stepping gingerly around it), it's hard to tell whether he's being disingenuous, deliberately misleading, or he doesn't really understand the issue.

Just to be clear, there is no doubt in my mind that the uptick rule should be reinstated, but to imply that that is the solution to the naked short selling problem is to be either uninformed or deliberately misleading. Again, check out the text caption in the video: "Anatomy of a Naked Short: Shorts Used To Have To Wait Until There Were Buyers Willing To Pay More On The Uptick". This is NOT the issue of naked short selling. Senator Kaufman at least tries to separate the issues of the uptick rule and what he refers to as "abusive short selling". No such distinction from Cramer (it's all about the uptick, not enforcement of Reg. SHO).

Patrick Byrne, Overstock.com's CEO, has taken the lead in researching and exposing the naked short selling issue and is undoubtedly the most in-depth source of information on the topic. If you want to understand the issues and why opponents believe it could be a foundational threat to the markets, I highly recommend the following two presentations by Patrick and team:

http://www.businessjive.com

http://www.deepcapturethemovie.com

There is also a wealth of information on the www.deepcapture.com web site, and, of course, you can follow deepcapture on twitter at www.twitter.com/deepcapture. Perhaps the most important aspect of Patrick Byrne's collective analysis is how badly the regulatory authorities have let the average investor down by, at best, looking the other way, and at worst, conspiring against them. I'll let you be the judge. As for Cramer, since you can't say he's uninformed, it all comes back to how lame the financial media has become, who they are an advocate for, and a question of integrity. 

Comments

[Gary Kinghorn]

Follow-up: Here's an excellent article by Senators Ed Kaufman and Johnny Isakson, who authored a bill directing the SEC to fix naked short selling: http://ow.ly/59ps This article has a very accurate description of the nature of the problem and the best path to remediation.

[Patrick Byrne]

Thanks for the kind words. Right on.