Re: 2/26/05 - [NCANS.net] Mark Cuban: "Bob [O'Brien, of NCANS.net], you are confused and use all the terminology of a scam artist."
Blog Maverick - The Mark Cuban Weblog
I feel so dirty….Naked Shorts
I short stocks. I make money shorting stocks. Some of my best friends are the stocks that became worthless over the years and I never had to cover.
I short stocks because Im a firm believer that in a universe of more than 10k public companies, not all of them are well operated. I also believe that since short selling is rarely if ever offered as an option by traditional brokers to their customers, there is always going to be a bias towards demand trying to push the price of a stock up. That in turn creates an opportunity for short sellers who get to take advantage of that upside bias.
Of course there are risks to short selling. If you dont fully understand what you are doing, you can lose more on the short side since a stock can only fall to zero, but it can go up to any price. To me, that just gives me reason to do more homework, not to shy away.
I thought this blog entry would be timely because the SEC has recently taken steps to stop abuse of the rules of shorting. One of which is that you have to actually borrow shares before you can sell them (if you dont know what this means, just ask your broker). Some short sellers abused the process by giving sell orders to their brokers for stocks they dont own, or have not borrowed. The SEC decided to finally enforce the rule and make brokers confirm that the shares have been borrowed and delivered. Some short sellers dont like that this rule is being enforced. I actually like it.
I like it because it balances the playing field. Sometimes when I, or anyone borrow a stock in order to short it, we have to pay a fee to borrow that stock. If a stock is heavily shorted, and as a result, difficult to borrow, the owners of the shares will only lend them to you if you pay them some percentage of the stocks value. It may be 2 pct, or go as high as 15 pct on an annual basis. The “vig” becomes part of the cost of doing business. If Im paying the VIG because I think the companies prospects are so poor its worth it, then I want everyone playing by the rules.
Why ? In case Im wrong about the stock. If by chance Im wrong (and honestly, it doesnt happy very often), naked shorts increase the demand for shares of stock in the company beyond what it legally should be. How can that be ? Because even naked shorts have to cover sometime. Particularly if the stock is moving up. Even though they didnt play by the rules, their brokers will still apply the margin rules against the short sellers accounts. If a stock moves hard against them, they will cover. THeir covering stock, moves the stock price higher, which in turn hurts my short position.
I also want them playing by the rules in case I own a stock that is heavily shorted. Sometimes the shorts are wrong. If the demand to short the stock is high, and I think the shorts are wrong, forcing the shorts to borrow the stock first , can increase the demand to borrow the stock I own and push the VIG higher. Nothing better than owning a stock that other shorts have wrong. I can be the one charging 10 pct or more VIG , and make money on the long side.
So mark me down as a short seller who thinks naked short selling is wrong.
That said, let me also say that when we had broadcast.com, and this would be my position if I ran a public company today, other than making oodles of money and having lots of demand for your stock, there was and is nothing better for the price of a stock than having it shorted. It doesnt matter if the shares are shorted naked, or fully borrowed. Doesnt matter a bit.
The more shorts, the more shares shorted, the more pent up demand there is for the stock. For a company that is well run and operationally successful, short shares are like an insurance policy to protect the downside for the price of your stock and more likely push the stock price ever higher. When we had broadcast.com I used to beg people to short our stock. If they didnt like what we were doing I would actively suggest to them that they short the stock. Sure, it might have slowed the rise of the stock in the short term but who cared. I knew we were going to be able to hit our numbers, so why not. If we did our jobs, it just meant they would have to cover the stock and in a down market, that helped keep the price up and in an up market, that could cause the stock to run. Both very good things.
Which leads to one of the things I look for when I short a stock.
The louder a company complains about the shorts, the worse the company. Companies bitching and moaning about shorts trying to hit their stocks are companies that are far too worried about their short term stock price and are looking for an excuse to give their shareholders.
A smart CEO is out there telling shareholders that the numbers will speak for themselves, that the company is doing what we set out to do, and if you believe in what we are doing , buy the stock. If you dont, you probably shouldnt.
A company with problems finds a reason to talk about anything but the company as a reason for the stock not doing well. It reminds me of the music industry. They didnt want to address what really was causing sales to fall, so they blamed it all on the internet and piracy. Piraphobia in their case, Shortophobia in the case of public companies. Rule of thumb, ITS NEVER THE SHORT SELLERS, ITS ALWAYS THE COMPANY
Short sellers also provide a 2nd set of eyes looking from a completely different perspective. When a short seller called, I would always talk to them. Its possible they know something you dont. Maybe there is a problem with your product or service that they have heard from one of your customers that hasnt filtered to you. The short sellers give you a heads up about that problem and the chance to go fix it. In essence, they are giving you a challenge and saying “if you can correct what we think is wrong, or explain to your shareholders that we are wrong on a certain subject , (doesnt matter if its real or made up) we are going to have to buy shares of your stock to cover our shorts”. How in the world can that be a bad thing ? If they are wrong, you tell them why. If they make something up, you tell the truth. That simple. Then they buy your stock to cover.
So if you own a stock, and the company or other shareholders are blaming the share price on shortsellers, run away. Quickly. You are in the wrong stock. If you are short that stock, keep on digging. There is probably alot of shit buried in the company books waiting to be discovered if you havent already.
Short Selling is an important part of the market. If you manage your own stock portfolio, not understanding how it works is the equivalent of playing basketball and having one hand tied behind your back. You are going to be at a huge disadvantage
*************Part 2********************** Posted Feb 26, 11:30 pm *****************************************
I want to add a part 2 in response to a post from Bob OBrien. - Bob, you are confused and use all the terminology of a scam artist.
Let me tell you how it really would work.
Lets say I run a public, thinly traded company, and i think my stock is being pushed down by dirty boys using naked shorting. Lets also say I have a very real need for capital.
If its my company, and I know its a good company, be it REIT, Widget company or any other… I take avail of my options, which are plenty.
1. If my stock price is pushed down far enough, and again , we are talking thinly traded companies that you refer to, it will take far less money to do a buy out, interest rates are cheap. I just go to the bank, show them how wonderful my company is, that the stock is incredibly undervalued and we take it private. The fact that there are naked shorts make it even more attractive. You announce the deal, you watch the stock price go through the roof as your shareholders are handsomely rewarded as the shares go north as the naked little beasts try to cover their shorts.
2. If i dont want to take it private, and where your argument turns into total bullshit is that there are private equity firms all over the country looking for deals. Undervalued stocks. They arent capital constrained. They are opportunity constrained. Its not like all the little naked short funds are the only ones that scan the universe for thinly traded, highly shorted companies where the shorts are wrong. Me, anyone with sense, their uncles , brothers and the funds down the street all look for these situations and salivate over them. I bring them in and ask them to buy up the stock. They do, they make a boatload of money and so do my other shareholders
3. If i dont want to do a secondary because my stock is low, rightfully or wrongfully, i go to the bank and borrow money. Banks give lines of credits based on operating performance of the company. Sure a higher stock price can let you get a little lower interest rate, but it wont make the difference as to whether you qualify for the loan or not. The capital is out there for companies with strong performance.
I know you are active with NFI. It has a market cap (according to Yahoo) of 907mm dollars before debt. With all that cash they supposedly generate why havent they gone to their local bank and or private equity fund and borrowed the money to take the company private ?
Just what they pay in dividends could easily cover principle and interest on a Billion Dollars or 1.5B or more in a buyout price. PLUS, if there as many naked shorts as you say, in addition to the real shorts, that price would run so high, so fast, you guys would make a killing. The only problem with this approach, is that a bank cares about real operating earnings. If they are there, its an easy deal. if they arent…. And if the company doesnt do it, some Warren Buffet wannabe will.If its a real company, with real value.
Wasnt Kmart a heavily shorted stock ? The value was there, a smart buyer recognized it and the stock went to the moon, rewarding all those who believed, and crushing those that didnt. Thats what happens when real companies have depressed stock prices.
Like I said, if there is value in NFI or any company to the degree that you and others say, then where are the funds with billions, or those with a couple hundred million and good credit, coming in and buying the company outright ? With all the naked shorts and legit short positions out there, everyone and their brother who believed in the company would make far more than they would if the naked shorts just disappeared.
I wanted a reason to buy shares in NFI. I could get a dividend, I could lend the shares to a shortseller and make more than 10 pct. Between the two, you would think its easy money. I even looked at buying puts, to protect my long position, but the puts were SOOOOO expensive, it wasnt worth it. When I did my homework, everything about this company scared the shit out of me. There were red flags every step, the biggest of which was your NFI website and all the talk about how the shorts are hurting the company.
Now, I wish I could short the stock, but its impossible to borrow.
So Bob O’Brien, I just gave you several ways that your friends at NFI can protect the interests of their shareholders….. let see what they do. ....
For anyone else out there reading. When a company complains about shorts, run as fast as you can to sell the stock.
blogmaverick.com
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Posted Feb 26, 2005, 7:37 PM ET by Bob O'Brien
Well, we agree and disagree. First to the agreement part. Naked shorting, or failing to deliver, is wrong, a violation of the rules, and is potentially damaging in the extreme to a thinly traded stock's market value - if there is no limit to the number of shares that can be sold (which by definition there isn't in naked shorting as the only limitation is money, and there's hundreds of billions in hedge funds looking for a place to park) then there will inevitably be a supply side pressure to the downside.
Always.
Especially when the companies are smaller, less visible, thinly traded. Supply and demand. Under a billion market cap means little real institutional support (generally) and virtually no analyst coverage. So if you can just sell without having to locate and deliver (in violation of rule 15(c)6-1, 10(a)2, rule 203, and a few others) there is no obstacle to putting a company into the toilet - and if that company is dependent upon raising capital in the market to fund its growth, there's no barrier to putting them out of business, period.
So we agree that naked shorting is bad, and represents a violation of the rules and laws designed to protect investors and companies alike.
Where we have a cognitive disconnect is that it is a good thing to have a huge short interest, legitimate or not. You lose me there. I don't have a problem with legitimate shorting - it is a fine and acceptable way to bet against a company's prospects. But last time I checked, it's illegal to create shares and sell them in excess of the authorized and registered shares available from the company. Naked shorting does precisely that - and results in a hidden float of indeterminate size, with no limitation on growth beyond that of the naked shorters' ability to fund the trades. Now, why would it be bad for something like a REIT that needs to have access to the capital markets with regularity to have an ever-decreasing stock price, regardless of the fundamentals? Easy - it constricts its ability to fund its growth, and increases dilution as more shares have to be issued to raise the same dollars. And it hurts investors who use margin, or have an expectation that the rules designed to protect them are being enforced. Those rules, incidentally, were put in place after the Crash of '29, due to the naked short selling abuses that were rampant, and were significant contributing factors in that crash. It's one of the primary reasons the SEC was formed.
The presence of a Reg SHO list, which memorializes the companies that are abusively naked shorted, is a testament to the lack of the SEC's enforcing the rules and laws on the books. If they were enforcing them, there wouldn't be a list. And yet there is, and further, the problem is so egregious that the SEC "grandfathered" in all pre-existing fail to delivers (the euphemism for naked shorting used by the SEC) prior to January 7, 2005. The reason? There isn't one. It's been illegal for 71 years, but the SEC gave the rule violators a hall pass on all activity prior to that arbitrary date, well, just cause. That stinks. It also leaves a lot of companies with unauthorized floats of who knows how large a size. And it leaves a lot of bad guys that profited from violating the rules with fat pockets and no penalties.
Nice.
I wish I could find a business where I could sell unauthorized and unregistered instruments that I created out of thin air (maybe car titles, or deeds of trust, or corporate bonds, or currency) and then be allowed to keep all the proceeds of my little business, and further not be punished. That would be pretty neat. A guy could get rich doing that. Really rich.
The other disagreement is that companies that are being systematically violated should just lay back and think of England, and let the numbers do the talking - the theory being, evidently, that eventually the marauders will get tired of raping and just go away, or somesuch.
I don't disagree with that strategy with legally shorted companies, as there are a natural set of checks and balances in place - like the size of the float of lendable shares. Just run the business and eventually if you are legit the numbers will carry the day, and the shorts will depart.
The problem is that if the company is naked shorted, those checks and balances don't exist. That’s why it’s illegal. It can destroy a company over time. So saying nothing will only result in further predation.
I don't have a problem with a company who is being naked shorted in significant amounts calling attention to the fact that the law is being systematically violated by market manipulators out to hurt the company. Basically, they are saying enforce the law.
That seems reasonable to me.
Enforce the law. I don't have a problem with that, nor with them pointing out they are getting screwed, and nobody is doing anything to stop it - especially the regulators chartered with protecting the company, and their investors. If there is something illegal going on, stop the violations, and THEN it becomes about the company and the fundamentals – otherwise it’s only about the effectiveness of illegal activity to harm those targeted.
I do agree that if a company is blaming their misfortunes on legal shorting it is a warning sign. But if it is illegal naked shorting (the Reg SHO list being the litmus test), it is a legitimate cry for help to the agencies that are supposed to stop that crap immediately. If they haven't or don't, then it's not a company problem, it's a criminal manipulation problem - that's what it is when you break laws to depress a company's share price, deliberately, as part of a strategy. And I think if there's a manipulation going on, then the company should say something - the "blame the victim" mentality that the rule violators have attempted to make the norm sucks, and is offensive to anyone with a business ethic.
I think that there is a deliberate campaign underway to blur the distinction between legitimate shorting and illegal naked shorting, and I’m pleased that you are making the distinction, except towards the end of your piece when you discuss strategic responses. The more the line can be blurred between legal shorting and illegal naked shorting, the better the odds are that those that are violating the rules can get away with their behavior. If they can convert the argument from one of illegal vs. legal into one of valuation, or folksy wisdom heuristics, or whether the victim of the rape somehow "deserves it", then they have succeeded in making it about something besides what it really is all about: Do you enforce the laws, and is everyone entitled to be protected by them, or not? At the end of the day, that seems simple to me.
But what do I know?
Bob O'Brien - NCANSinfo@gmail.com
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