The SEC Shelters the Securities Industry in many ways, and perhaps the most graphic example involves the Eagletech case. Eagletech Communications was an emerging public company that developed patented wireless telephone technology. They traded on the over-the-counter market.
In order to raise capital, Eagletech entered into two PIPE (private investment, public exit) financings, not knowing that the loan transactions, one of which was arranged by Solomon Smith Barney, were a front for the Mafia. The company was shorted into a death spiral with a host of illegal activities that included counterfeiting stock, match trades, pump and dump, stock manipulation, money laundering, wire fraud and mail fraud. The scheme came to light as a result of a Department of Justice investigation into organized crime and the securities industry.
The D.O.J. “flipped” one of the mobsters, who told the whole story. An integral part of the scheme involved the active participation of Wall Street firms that included Citigroup, JP Morgan Chase, Solomon Smith Barney, Bank of New York (Pershing), Knight, Goldman, Prudential, Bear Stearns and others. The SEC was brought into the investigation to assist the D.O.J. The government contended the Wall Street firms knowingly and actively participated shoulder-to-shoulder with the mob. Not only did they profit from the death-spiral attack on Eagletech, they facilitated a tax evasion and money laundering scheme for the fraud participants.
At the end of the case, the mobsters went to jail and the Wall Street firms were not prosecuted by the D.O.J. or the SEC. On May 2, 2006, one of the participants, Knight Equities, made a blanket settlement with the SEC, without admitting or denying guilt for any and all stock manipulations from 1999 to 2004.
In addition to not prosecuting the Wall Street firms, the SEC did not notify the victim companies or their shareholders that they had been victimized. Eagletech only found out by happenstance later, and was able to file a civil suit against the Wall Street firms before the statute of limitations lapsed.
The fact that the SEC rarely takes a securities industry insider to judgment or criminal conviction means the deterrent value of being investigated by the SEC is that of a toothless tiger. This, coupled with laughable civil fines, actually serves to encourage bad behavior.
With great flair and media attention, the SEC in April 2008 announced the prosecution of a trader, Paul Berliner, for spreading untrue rumors about Alliance Data Systems (ADS). According to the SEC, Berliner was involved with a network of over 30 short traders, to whom he text-messaged an unfounded rumor on November 29, 2007. This mass text message apparently triggered an onslaught of shorting of ADS. The volume on November 29, 2007 was eleven times the average daily volume of about three million shares. The attack dropped the price of ADS from $78 to $63.65 in 30 minutes.
The SEC and Berliner settled for less than $150,000, with no admission of guilt. The SEC offered this case as proof positive they were actively prosecuting stock manipulation.
What wasn't in their press release was that ±30 million shares were shorted, resulting in a (short-lived) paper profit in excess of $200 million. The stock partially recovered that day, only to be crushed two months later.
The subprime mortgage crisis that boiled over in the spring and summer of 2008, witnessed actions by the industry and the SEC that illustrate how the prime brokers victimize companies with naked shorting, but when the game is turned on them, they run to the SEC for protection and get it.
The subprime crisis did not start as a result of wholesale defaults at the home owner level. While defaults were up somewhat from the prior year in absolute terms, they were not that bad. In addition, absent fraudulent underwriting, the recovery on a foreclosure historically has been a very high percentage of the loan amount. In most markets, the real losses were manageable.
Mortgages are pooled by Wall Street and those pools are rated by the credit rating agencies, usually as AAA, which means they are supposedly risk free. These pools usually borrow money that is secured by the mortgages in order to leverage up the return. Typically the assets are long term and the borrowings are short term.
The shorts started attacking the investment bankers with the large subprime pools, including Bear Stearns, Merrill and Lehman. The attackers were a consortium of large hedge funds and other investment banks, notably Goldman. It has been alleged that the shorts started spreading falsehoods that were picked up by the short media. Suddenly short term credit was denied to the target investment houses because of the perception that there were credit problems. The lack of available liquidity put them in dire straits. As a result, Bear was forced to the brink of bankruptcy.
The government jumped in and orchestrated a “shot gun marriage” with J P Morgan Chase, which was a confiscation of huge amounts of value from Bear's shareholders. The stated reason Bear was saved was to avoid turmoil in the financial markets. The unstated reason was that Bear was sitting on a massive amount of counterfeit shares that would have no backstop or way to be closed out if they went bankrupt. Allegedly the Bear situation was similar to Refco's estimated 400,000,000 counterfeit shares that are still floating around the system, long after Refco's demise. Bear was one of the big three counterfeiters and likely was many multiples of Refco. The government, by keeping Bear out of bankruptcy, avoided this day of reckoning. It is also obvious that the SEC and Congress are aware of the existence of this massive potential problem and as a result they are not going to allow any of the large Wall Street firms to go bankrupt.
The short attack on Bear was a wakeup call for Congress as they realized that the hedge funds and prime brokers, when acting collusively can destroy any size company. Despite the Bear bailout, the shorts continued to aggressively attack the investment banks, Fannie Mae/Freddy Mac and other lending institutions. The attacks included many of the tactics enumerated herein including massive counterfeiting. The week of July 14, 2008, saw unprecedented action by the SEC to protect Wall Street.
Christopher Cox, in a televised statement, said naked shorting (counterfeiting) was legal. Even Jim Cramer was flabbergasted as he quickly jumped in to correct Cox. The SEC was saying publicly the possible illegal activity by the shorts was the spreading of false rumors designed to manipulate stock. Little mention was made of the effect of flooding the board with massive numbers of counterfeit shares, none-the-less, Christopher Cox took the unprecedented action of invoking an emergency 30 day moratorium on naked shorting of 18 financial firms, including Goldman, Morgan, Merrill, Deutsch Bank, Bank of America, Credit Suisse, UBS, Freddy Mac, Fanny Mae and others. In short, all he was doing was affording the Wall Street firms some protection from counterfeiting of their stock. Counterfeiting continued, albeit at a slower pace, from naked shorting that utilized the option maker loophole. The results were stupendous. Once relieved of one of the millstone of manipulative counterfeiting, the stock prices of the protected Wall Street firms shot up 25 to 100% in two days. There was no change in the companies — only enforcement of rules regarding counterfeiting. In the meantime, the Wall Street firms continued their naked short attacks on other companies unabated.
This raises several questions: Why aren't all companies entitled to protection against having their shares counterfeited? Why are some of the most notorious counterfeiters protected by the SEC when their own game is turned on them? Why isn't the SEC protecting other companies and small investors with the same zeal that they are protecting those who have violated laws and rules on a scale that has decimated the U.S. economy?
This flagrant double standard is not unlike the police department protecting a gang of robbers from having their “loot” stolen by other bank robbers, thus assuring continued pillaging of the law abiding public.