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Dear Bill,

If it please the Court, I would like to respond to your post on Feb. 9 (“Re: Guest Appearance: A Brief Reply to Bill Mann”). My apologies for not getting back to you sooner; I have been busy selling toasters.

I would agree that the SEC's decision to grandfather old fails is curious, and contemptible. It's also extremely predictable. One must ask one's self "qui benes?"

As one who has let many an unedited typo slide through, I should avoid saying, “You mean, 'qui bono.'” But I am too much the schoolmarm, I fear.

The people who are being screwed the hardest for heavily shorted companies are not the shareholders -- these are largely static short positions. The people who really get screwed are the short sellers who hold legitimate positions.

A) Are not shareholders who suffer capital losses also getting screwed?

Let me break that down into two questions:

B) If a shareholder suffers a large capital loss due to naked shorting, has he been screwed?

C) Do you think there are any shareholders anywhere who have suffered such losses?

If your answers to B and C are, "yes," then so must be your answer to A. If you would answer "no" to either B or C or both, I would love to know which one(s) and why.

Why would the brokers cover, or clear? They've got those shares short in a heavily shorted position for free.

Another point of agreement—it's the broker/dealers who are carrying out the naked short selling. I don't recall explicitly alleging that hedge funds were the ones naked shorting, though I believe they play a key role and benefit through collusion. Did you watch my presentations on

Let me walk you through an example:

1) The Broker dealer sells Hedge Fund XYZ puts on 1 share for $2.

2) The BD naked shorts 1 share.

a) If the stock goes down, the BD's gains on the short are offset by his loss on the puts, but he comes out $2 ahead.

b) What if the stock goes up?

i) If it goes up $1.50, then the BD loses $1.50 on the short, but makes the $2 on the put, for a net of 50 cents made.

ii) If it goes up $2.50, then the BD loses $2.50 on the short, makes $2 on the put, for a ($.50) loss. And of course, anything beyond $2.50 is just additional loss to XYZ.

3) The broker dealer says, what if the stock goes up, XYZ? XYZ says, "I'll sell you a call at today's price for $1."

a) Now, if the stock goes up $10, the BD makes $10 on the call and $2 for selling the puts, loses $10 on the short and a cost of $1 for the call. He comes out $1 ahead.

b) Now, if the stock goes down $10, the BD makes $10 on the short and $2 for selling the puts, loses $10 on the put and a cost of $1 for the call. He comes out $1 ahead.

i) Lemma A: In sum, the BD comes out $1 ahead.

c) Note that if the stock goes up $10, XYZ loses $10 on the call and $2 for buying the puts, but makes $1 for selling the call. He loses ($1 plus the gain in the stock).

d) Note that if the stock goes down $10, XYZ makes $10 on the put and $1 for selling the call, but the put cost him $2. He makes the amount the stock dropped minus $1.

ii) Lemma B: Note that the last two sentences would also precisely describe the economics of this situation, "XYZ pays $1 to short one share."

e) Lemma A + Lemma B = The BD rented for $1 his market maker exemption to XYZ so he could naked short 1 share.

There are other variations, of course. Imagine that when the BD naked shorts its shares, the buyer is XYZ. Now XYZ has matched puts and shares. (What does he care that they were naked shorted to him? His brokerage statement says he has them). Now he can sell them, loan them to a friend who shorts them, etc. etc.

This reminds me philosophically of Hannah Arendt's book, Eichmann in Jerusalem: A Report on the Banality of Evil. Of course, that book concerns a much graver matter. But among the brilliant ideas developed in that book was her analysis of the moral responsibility for the Holocaust got distributed by a system across a bunch of civil servants: was the guy who created the train schedules culpable? Yes, somewhat. Was the guy who worked in the chemical factory making precursors to the gas culpable? Yes, somewhat. The system spread the culpability around so that a lot of Germans played tiny contributory roles, while relatively few where completely monstrous. It was genocide conducted not by so much by monsters as by civil servants: hence, the "banality" of the evil.

Imagine a system such as the matched-put, broker-dealer exemption loopholing system described above. Take it a step further, adn imagine that it is one crooked broker-dealer in BVI doing a piece of it, then a white shoe firm taking the shares thus created and loaning them out again, etc. etc. The system would have no one in it with really unclean hands, but a lot of people in it with an unclean thumb or finger or palm.

I'll make a deal with you, Patrick. The next time you are in Washington, I will be more than happy to go with you to the SEC and we can ask them this question together.

What question? It sounds to me like the SEC has already taken an interest: subpoenas, investigations, etc. I suggest all read about it at the website run by the dangerous blowhard, . His information about the DTCC, the formal investigation, and the subpoenas going out to certian hedge funds, is true.

The volatility issue is garbage.

I disagree (do you know this via divine revelation, or is there an argument?) In fact, it may be the one honest statement the SEC has made. If just a fraction of the suspected naked short selling does occur, then we are headed for a market-wide game of musical chairs. That is not me saying that, it is the SEC saying it. The SEC may not want to be the one to stop the music.

This, by the way, is why I think that the impact of naked shorting is relatively minor, as compared to the vast number of pump and dump scams that take place in the microcap universe of the public markets. Why the SEC allows these capital-destroying cesspools to operate without real oversight is something that is beyond my comprehension. Let's take the 500,000 number presented in the FOIA request. Obviously, now that we know Rocker & Associates are the 9th largest shareholders, at 590,000 shares. I use that particular item because we are reasonably certain that Rocker is short shares as well. So we thus know some details of the short and failed positions as of Aug 1 (which preceded the Rocker disclosure of an increased stake, but the numbers aren't the issue here -- the scale is.)

Remember, the 550,000 was the number of failed short sales. It was not the number of failed long sales. Read the SEC FOIA letter closely: they make that distinction. Why might that be important? Because on November 30 I bought 50,000 shares in 150 transactions. None settled for a month. I have the trading data on 144 of those trades. Every single one was marked a long sale. Not a single one was marked as a short sale, though it turned out in retrospect that they were (that is, they were short sales which could not settle, hence no good locate had been made, hence they were naked short sales).

Takeaway #1: 97% of the sales that day were naked short.
Takeaway #2: None of those unsettled trades would have shown up in that SEC FOIA response.

For the record, I believe the unsettled trades in our stock now number in the millions, easily.

1. This short interest number is gross, not net. It doesn't build in the amount of shares that people are long in contra accounts.

2. It also counts all of the clearinghouse shares -- the ones that the big wirehouses will naked short in order to keep an orderly market -- which is both legal and what they are supposed to do. It additionally counts the shares that these clearing houses have in order to clear any options positions of their customers.

Bill – Respectfully, this is all words words words. The market maker exemption is a good faith, keep-liquidity-in-the-market exemption, not a sell-and-don't-deliver-for-a-year exemption. Come on.

3. And in Overstock's, and many other companies' cases, the short interest will be pumped up as a result of a hedge against other financial instruments issued by the companies themselves. With an $86 million convertible, Overstock has, if you believe that the amount is fully delta-hedged, some 2 million shares shorted that aren't really shorted. But each one of these shorted shares increases the float, regardless of the rationale for their origin.

Respectfully, this is just more hand-waving. First, the right number is $77 million and about 400,000 shares delta hedged. Second, that gives a reason why someone would short shares: it does not speak to the issue of unsettled trades. I am sure there are all kinds of reasons people might short our shares, including buying our converts and hedging them, as you suggest: this is unrelated to the question of the existence and magnitude of unsettled trades in our stock.

So that's it in a nutshell -- the system is corrupt, but the protected parties are the brokers, who have a license to hold onto securities they have no intention of clearing -- because they're the equivalent of options without expiry.

Agree—it's the brokers. You got it.

But then there are other elements that simply don't make sense to me about the short conspiracy, beyond the lack of a barking dog for past transactions where there were large short interests.

1. Capital is lazy. Overstock (specifically) to my mind is a hardened target. It's also huge, with a fairly liquid security. (My shares, btw, cleared in 2 days.) Why would a conspiracy target THIS company. It makes no sense.

First, “conspiracy” is your word, not mine. For one who has objected to others exaggerating Seth's positions then attacking them as straw men, I would hope you would be more careful.

Second, folks tell me that the miscreants came after when we were a smaller company, just before a big push in revenue. Perhaps they thought we would require more secondaries to sustain such growth, guaranteeing an egress. Perhaps the plan was to leverage the dot-com stigma and tank this with an SEC investigation or Class Action suit and barrage of Herb articles, as has been done so many times in the past. I upped the ante so that they can't get out, thus the only option is to throw the kitchen sink at me and this company. But it wasn't a hardened target when Herb first started hitting it and the SI climbed significantly, so there's your first clue.

2. Why, if there are a list of thousands of companies that have been destroyed by naked shorting, is the list confined by name to Sedona, which, once again, took on death spiral financing? That's not exactly the stuff of a large scale conspiracy. Oh, sure, there's JAG Media, Nanopierce, and others that point to naked shorts. The fact that these companies were penniless capital destroyers has to be relevant. Those are the kinds of companies I'd like to short.

We just watched DAL get crushed. They had a lousy economic issue, but they also were a huge company on the SHO list until they dropped off and went bankrupt. I imagine that many of the companies that are destroyed by the practice have other issues; the miscreants are clever and there is generally plausible deniability. If your agenda is to maintain it is NEVER naked short selling that contributed to a company's destruction, then you can ALWAYS find other reasons for the destruction. The miscreants would be insane to pick companies that were not already vulnerable--it's one thing to not be a strong swimmer when your boat goes down, quite another to throw the victim an anvil rather than a life vest, quite another to shoot him as he swims for shore and say, “He would not have made it anyway.”

Nothing is ever black and white. There are lists of companies that have been badly damaged and have been on the SHO list for months if not a year (recall that there was no way of even proving any naked short selling until the last 12 months or so). A year and a half ago, the mantra was still that it didn't exist. Hard to prove that something for which all evidence is kept secret, caused the destruction of a company, isn't it? Perhaps if all the data were made available then we wouldn't have to engage in these angels on the head of a pin discussion--we could just pull up the total FTDs for a given company and end the discussion. By design we cannot, and that is problem. And we cannot because the SEC says that if they made the information public it would cause too much “volatility.” Hard to square that with your sense that this must be minor.

3. In many countries, naked shorting is quite legal -- most notably Canada. Why is there not a vast swath of destroyed Canadian companies? If the conspiracy works in a market with trillions of invested capital, it would work much better in less liquid markets. Again, capital is lazy, and it is fungible. If naked shorting companies to death in Germany were profitable, there would be tons of pools of money doing this very thing.

Again, there you go with your “conspiracy” again.

I am not aware of anyone claiming that naked short selling companies in Germany is profitable. Using Germany as an international arbitrage pretence for not delivering your shares in the US is, on the other hand, quite profitable. Did you know that one broker listed all the companies in Berlin, and paid $12K per company for the privilege? And yet most never trade more than a handful of shares every couple of months. What do YOU think the financial incentive was?

By the way, the broker that did that used to own 10% of Ladenburg Thalman, who was big in toxic convertibles. Isn't that a coincidence. Ha.

Incidentally, there is another big name from teh Den of Thieves days with a significant tie to Ladenburg: any guesses?

As to why doesn't it happen more in Canada, I do not know, but I can guess. One explanation is that the grass is much greener here in the US; there are far more companies to savage and, as the case of Elgindy proved, there are highly organized networks that do it here. Why bother with some illiquid Vancouver penny stock when you can take down a $100 million dollar biotech here? There is way more cash to be had doing that than taking down some $3 million mining company.

Another, more subtle, explanation made by an economist I know has to do with a form of moral hazard. My friend argues that the pretense of effective institutions is more dangerous than no institutions at all. In the case of naked short selling, the public assumes the SEC/DTCC are doing their job of regulating securities markets and few question participation in those markets, at least not for reasons connected to clearing and settlement. As a result, capital is circulated blindly. Perhaps in Canada, if one knows no cop is on the beat then one avoids dark alleys.

Incidentally, Canadian companies are not immune if they trade on US markets. I know Fairfax Financial Holdings' Prem Watsa. FFH has been on the SHO list for over 100 days and attacked by the usual miscreants in the public sphere (including Two weeks ago he let me know that a suburban with black windows had pulled up in front of his office, four men came out and harassed people, etc.

So sure, I think that the SEC is hiding something. I suspect that they're protecting someone. But I don't think it's what is being contemplated by those who believe that this is a massive, massive scandal that is destroying millions of lives.

Operation Bermuda Short gave us a glimpse of how it works, Elgindy gave us more info, RYCO gave us some more. So is your position that this goes on but can't be that big a problem? I'd like for you to be right. But we—myself included-- don't have enough data to know one way or another. I've simply noticed that this giant pink elephant has wandered into the room and certain people are doing everything they can to convince others that it is anything but a pink elephant. It has reached a rather insane degree, in my view.

So in sum, my answer is, You might be right, or…. you might NOT be right. Usually the best way to handle such forks in the road is to get data. That is, after all, the whole Western tradition. We ned not take things on faith: we can get facts. So let me ask you two simple questions, sir:

1) What would you consider to be convincing proof of massive unsettled trades in the system?

2) How do you propose we get that proof?

If you answer to #1 is a hurdle so high that your answer to #2 is, "We cannot," then you are tacitly admitting that yours is a position not open to evidence or argument: it becomes merely, "To know this we'd have to know X, we cannot get X so no discussion or argument can sway me." The position is not without its merits: like solipsim, it is internally consistent, for example, but you cannot go anywhere with it.

Your humble servant,
Patrick Byrne

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