Confessions of a Trader: The Short Selling Ban, Part II...

I am strongly opposed to the short sell ban enacted last week to protect financial stocks. This is not to say that I do not agree that there have been rampant abuses in the practices used by brokerage firms to manage short selling prior to this. I know of what I speak.

In an early phase of my career I was responsible for managing fail-to-deliver positions for OTC stocks in a major Wall Street bank’s back office. Back then we used paper ledgers and, when a position had not been resolved within 30 days, it would have to be placed into an error account and bought in. A lovely bipolar guy named Sam* who had liquor on his breath by 10AM every morning was responsible for the buy-ins. If a trade had been open long enough without properly settling Sam would come by my desk to let me know that he was going to move the position into an error accounts unless it was resolved by day’s end. That way, short sales that had never been properly borrowed would be flattened by buying shares in the open market keeping everything honest. That was the theory anyway; in practice the other broker’s identity in the ledger could be changed (say, switching the entry from Smith Barney to Merrill Lynch meaning that Merrill would DK the transaction and it would start life all over again as a brand new fail to deliver for 30 more days). In the little under a year I held that job before moving on to bigger things there was one particular position that never seemed to resolve itself, a sale of shares of a small cap stock predating my employment that had been on the books for so long that no one even knew which customer or prop desk had initiated it anymore –meaning that it would go into a departmental error account if it was bought in. It was still bouncing around when I left and I would not be surprised if it is still open and undelivered in the bowels of that bank to this day.

Later in my career, when I was a prop trader at a bank, I was once assured by a slick salesman that covered me that it would be no problem getting a synthetic short position for a hard to borrow stock –he had a buddy that would pick up market maker status on a foreign exchange that had an agreement to trade US stocks and then use his market maker exemption to short without borrow. Once he was short he would then would turn around and sell a total return swap to me (with a hefty commission for the salesman and a fat spread for his buddy of course). I turned him down. I am sure that many, many others did not. I heard later that that sales guy and others like him made a killing arranging short swaps for PIPE investors –essentially letting them take all market risk out at the point they bought into an offering. It was as a very sordid, very lucrative little corner of the business.

Yes, much as it pains me to say this, Pat Byrne was actually on to something in his own crazy way.

The problem is this, none of these abuses necessarily required new regulations –they merely required that the existing regulations be enforced. Since it took a market catastrophe and political witch hunt to cause this problem to be addressed –let’s hope that it does not inhibit legitimate shorting or overall market liquidity.

*(names have been changed to protect the guilty)

Andrew Barber
Research Edge LLC


By no means am I trying to imply that Beijing controls the government machinations of the Macau SAR. I’m actually stating it definitively. That is why I take note when Beijing summons the local Macau powers that be to the capital. I suspect there will be some more definitive action taken with regard to the visa situation. Leisure visits were recently pushed from once every month to once every two months. Effective September 1st, visa restrictions were tightened so that the circuitous route through Hong Kong to escape restrictions has effectively been closed. September gaming revenue looks like it could come in flat with last year vs. a 44% gain in August, so the visa situation is clearly making an impact.
  • What could happen at this meeting? I believe one of two scenarios. First, Beijing could maintain the visa status quo until the end of current Macau Chief Executive’s term next year. It’s no secret that Beijing is not happy with some of Edmund Ho’s public statements, especially regarding Beijing’s influence. A second plausible outcome could be a reversion to the previous visa environment; that is, back to the once a month visitation restriction and access for mainland Chinese arriving directly from Hong Kong.
  • Either of these scenarios takes a 6 month visa restriction off the table, which is big plus. You may recall, seemingly credible rumors of an even longer restriction contributed to a sharp sell-off in the Macau stocks. Investors now seem to anticipate either the current 2 month restriction continues in perpetuity or worse, so either scenario could be positive relative to expectations. On the margin, the probabilities are favorable for a near term spike in the Macau stocks. Las Vegas Sands, with 20% of the stock short, could have the most leveraged move higher.
Macau revenue growth is in Beijing's hands
Reversal of 9/1 visa restrictions would be a big positive

Debunking the Short Selling Ban, Part I

The SEC’s short sale ban created a rally by removing free market checks and balances. The long term impact on the markets will be less positive.

The SEC short selling ban covers 779 financial stocks until Oct. 2 and imposes new penalties for clearing brokers that fail to deliver on shares sold short after t+3. The FSA ban covers only 39 UK financial stocks but the window extends to January 16 of next year.

Overall the impact on market liquidity is expected to be significant. According to a report released last week by my friend Joe Gawronski at Rosenblatt Securities:

“Bans on shorting financial stocks, combined with the new disclosure and fail-to-deliver penalties, should exert considerable downward pressure on volumes. Short selling by hedge funds and other investment managers, as well as by many smaller and medium-sized high-frequency trading firms (but not their larger brethren), is likely to drop off significantly during the terms of the emergency orders.”

The options markets could be hit especially hard by this move. Options market makers have enjoyed an exemption from borrowing stocks before shorting intended to allow them flexibility as they offset their exposures. If they can’t borrow shares to deliver short then they can’t sell protection to the markets. On Friday it was reported that an SEC staff recommendation had been put forward to amend the order to allow options market makers to keep their exemption. The SEC’s waffling on this point is understandable since, with traders at bank desks sitting on their hands for want of capital, the locals are suddenly the only game in town. Without them, buyers and sellers will only be able to transact if they happen to meet in the same strike and maturity.

Decreased liquidity is obviously not the biggest negative aspect of this order. The natural checks and balances that legal short selling provide allows greater efficiency in the marketplace as short sellers are incentivized to police the market for poor performing management teams, corporate malfeasance and unrealistic valuations. By removing this force from the market we are sending a message to the world that our financial firms are too weak to stand on their own and that we will protect them despite by changing the rules of the game if need be. To some investors, this will look like the first step down a slippery slope of market manipulations that have chased foreign capital out of other markets in the past. Even if more banks failed without the short sale ban, there would remain faith in the integrity of the US market system. With this solution, we demonstrate that our market has no more integrity than our bad banks.

Andrew Barber

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Nike: Putting ROIC Before Ego

Nike but ego aside and made the right ROIC decision by getting out of the competitive swim business – but not without inflicting as much bodily harm as possible on its opponent.
I was initially shocked to see this one… After taking a blow during the summer Olympics by having to allow Nike swim athletes to wear Speedo suits, Nike s getting out of the competitive swim business.

Nike is finally seeing the light… After sustaining such a loss (in PR or in $$), the old Nike would have plowed capital into this business just for the sake of winning. That’s what they’ve always done. But an important point here is that Nike is getting out of ‘competitive’ swim – not ‘casual’ swim. For what it’s worth, 98% of swim-related sales come from the casual market. This is business that Nike licenses out to Perry Ellis. NKE brass asked themselves whether investing capital in this business would result in any boost in its casual business – and the answer is No. All in all, a wise move in my opinion. I’d rather see the capital go toward getting sport culture apparel right, or combating Under Armour in performance footwear. Apparently Nike Agrees.

One factor that really surprised me was that Nike was gunning for Michael Phelps. But something between the Olympics and now squashed chances of bringing him on. Could it be the sheer price, as nearly every endorser in the US has gunned for a piece of the MP enterprise?

To quote a sports agent representing most Nike swimmers (and most of his paycheck) "Nike getting out of the championship swimming market is the death of American elite swimming as we know it."

My view here is that Nike bid up Phelps just enough for Speedo (Warnaco) to keep him, but at a borderline painful price. In instances where Nike does not win, it inflicts as much bodily harm as possible.

Know When To Fold Em

“You got to know when to hold em, know when to fold em, Know when to walk away and know when to run.
You never count your money when you’re sittin’ at the table. There’ll be time enough for countin’ when the dealins done.”
-Kenny Rogers’, The Gambler

Feet on the floor and flush with cash - that’s where you need to be early this morning. This card game is over. Despite their fibbing to you for the past 9 months that “Investment Banking Inc.” is AOK, Goldman Sachs and Morgan Stanley faced the river card this weekend, and were finally forced to fold em’, turning over the keys to their leverage cycle castles.

You’ll read about yesterday’s Wall Street going away just about everywhere today, so I’ll save you the air time of the specifics. We hope we have been proactively preparing you for the inevitable. We now have more important things to do here this morning, like putting the client first. The bottom line is that the compromised, constrained, and conflicted “Investment Banking Inc” of 2007 is out of aces. Goldman Sachs and Morgan Stanley are now going to be regulated bank holding companies. They need commercial deposits to bail them out of this mess, so look forward to seeing Goldman ATM machines at a 7-Eleven near you.

Now to the markets and your money. Yes, that’s your money that tomorrow’s Wall Street will be managing, not the wealth associated with them levering up on it. Never mind the partisan bailout haggling of this weekend. Tomorrow is when both sides of the aisle are going to get at each other. Tomorrow is the Senate Banking session where Ben Bernanke, Hank Paulson, and Chris Cox will be on the hot seat, answering to the populist, conservative, and democrat cries of this fine nation. I am betting on black that Paulson doesn’t get his plan through the political process in the timeline he was pleading for yesterday on “Meet the Press” (see my note yesterday detailing Tom Brokaw’s intense interview).

During the short squeeze melt up on Friday, I moved to 96% cash, and that’s where I will likely stay until the dust clears on this mess on October 2nd, when free market capitalism’s rules come back to this game. That, of course, is the last day of the ban on short selling. While we can no longer rule out Paulson and Cox moving the goal posts on the fly, we can have confidence that this reckless government sponsored market volatility will continue into and out of that date.

Consider last week’s move in the Russell 2000 small cap index vs. the larger cap Dow Jones. The Russell was +4.6% on the week, and the Dow was down -0.30%. Why? Well, post the sandlot SEC rule change, all of the shorts had to cover, and the volumetric impact associated with small caps is much more powerful than in their big cap brethren. This is going to be a major problem on October 3rd, because illiquidity (no shorts) drives volatility – ask Dick Fuld what happens to a “Level 3” asset that doesn’t trade when it is forced to find a marked to market price. The US Government bailout team doesn’t get this.

Worse yet, John McCain is ranting and raving about replacing the SEC’s Chris Cox with the guy who suggested we ban short selling in the first place, Andrew Cuomo! People generally do not accuse McCain of being an economically intelligent man – this certainly is not going to get him any points from the free market capitalists today.

The “Trade” that you should be focused on this morning is the one that has been born out of the Paulson plan in the last 2 sessions of global trading – the devaluation of the US Dollar. The US$ is down a full percentage point so far this morning, taking its cumulative decline since John Mack’s “evil doer” short seller speech to -3%. If you follow the bouncing ball of interconnected global markets, you’ll notice that this has lit the fire underneath inflation related assets. Oil and Gold were +6% and 13% respectively last week. Food oriented commodity inflation remains sticky, and Dr Copper is hitting a 2 week high this morning as well.

Hank Paulson is a good and hard working man, but he himself noted on “Meet The Press” that he doesn’t know what the cost of bailing out his Wall Street investment banking cronies is going to be. He is also a smart enough man to not have answered Tom Brokaw as to whether he will be around at the US Treasury in 2009 to see his hurried decisions through.

Confusion in markets breeds contempt; crisis’ of confidence do not support recoveries; and governments do not mark bottoms in stock markets.

We’re rolling up our sleeves here. There is some heavy lifting to be done in re-building a Wall Street that we can all be proud of again. “There’ll be time enough for countin’, when the dealins done.”

Best of luck this week,


I thought this was an interesting turn of events. On Friday, MSD Capital (Michael Dell’s group) converted their friendly “G” filing into a not so friendly 13D filing. They own 14% of the common stock and a chunk of the preferred… As you read Item 4 of the filing, keeping mind that DIN is over 7x levered.

Item 4. Purpose of the Transaction.

"The Reporting Persons now intend to have further discussions and other communications with the Company’s management and members of its Board of Directors regarding debt repayment, changes in the Company’s capitalization and dividend policy, disposition of Company owned restaurants, composition of senior management including the hiring of a new Chief Financial Officer and the composition of its Board of Directors."

It goes on……

"The Reporting Persons may also have conversations with other stockholders. In the course of such conversations with members of management, the Board of Directors and other stockholders, the Reporting Persons may suggest actions that could result in, among other things: (a) the acquisition by the Reporting Persons of additional securities of the Company, or the disposition of securities of the Company; (b) an extraordinary corporate transaction, such as a merger, reorganization or liquidation, involving the Company or any of its subsidiaries; (c) a sale or transfer of a material amount of assets of the Company or any of its subsidiaries; (d) changes in the present board of directors or management of the Company; (e) a material change in the present capitalization or dividend policy of the Company; (f) any other material change in the Company’s business or corporate structure; (g) changes in the Company’s certificate of incorporation or bylaws or other actions which may impede the acquisition of control of the Company by any person;"

I have never met the people managing MSD Capital, but I’m sure their future plans will not include the current CEO of DIN.

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