Forcing a Crash: Inside a Wall Street Scheme (Court Documents Revealed) transcript

Today's episode is an important public service announcement to warn you of an illegal naked shortselling scheme that a lot of beginner and even experienced traders are getting caught up in. All of this has come to light thanks to a lawsuit that was recently filed. In that lawsuit, allegations are put forth in court documents that walk us through the inner workings of how this scheme functions. And it is mindblowing. It's so much bigger than I would have guessed.

And I'm going to tell you, if you've been trading for the last 6 months, you have seen this scheme happening right on the level two and right on the charts, right before our eyes. We've been talking about it. We've been asking, how is it possible that a stock could come out with good news, squeeze up, and then there's an infinite wall of selling, what feels like an algo pushing the price right back down. That has been naked shortselling.

Okay, that makes sense. all of a sudden. Yeah, cuz we've been seeing that and we were trying to figure it out. So, thanks to this lawsuit, we now have an understanding of how it works and that's what I'm going to be sharing with you here today. Now, I wish I could say this is brand new, but it's not. This has been going on for a long time and even if this current shortselling scheme gets shut down, another one will pop right back up.

Now, to be clear, shortselling is not illegal, but naked shortselling is. If you don't know the difference, you will by the end of today's episode. So, let's begin by playing a clip from the HBO documentary Gaming Wall Street. This is a former Morgan Stanley Banker talking about his experience naked shortselling. Let's hear what he has to say. This is going to set the tone for today's episode. You know, I would illegally naked short sale stocks every day.

Every day, as long as I was collecting commissions. There it is. He would illegally naked short sell stocks every day. Every day as long as he was getting commissions, he goes on to say, "And the bank did not care." The bank did not care. Now, in today's episode, we have a special guest. He is a former attorney at the SEC. His name is Nick Morgan and he is also the founder of a nonprofit law firm, Ian, Investors Choice Advocates Network.

So, Nick, are you ready to jump in and pull back the curtains on everything that's been going on here with naked shortselling? I'm ready, Ross. Let's pull back the curtain. This is a theme that was that it's a theme that's been true for years. This is true before the GameStop short squeeze, and it's still true today. Now, we're in a current regulatory environment where I fear that there's not as much attention on reigning in these big institutional players and these big brokers.

Now, I could be wrong. The rules are the same. They've been the same. Nothing has changed with the rules, but the enforcement of the rules seems to vary a bit, partly from administration to administration, the political climate, and the whim of the regulators. And for whatever reason, naked shortselling has been unable to be fully reigned in. So, as I walk you through this scheme, we're going to begin part one with the bait.

How are people getting involved in it? Are you involved in it without knowing? Well, this is how it starts. Posts on social media of people showing a chart like this with a bunch of red arrows going up. So, as the price goes up, what they're doing is they're shorting, shorting, shorting, shorting, shorting, and they're adding as it goes up. And they say this is easy. It's emotionless. You just add every x percent that the price goes up.

And then look, nothing goes up forever. The statistics tell us that even the biggest moves like GameStop eventually come back down. So as long as you leave yourself room to keep adding, you'll be fine. And then you cover as it comes back down. And the best part of this is that you can automate it. It's a systemized short selling strategy. You can turn it into your own trading bot, your own algorithm, and it will trade the market for you while you're at work.

What could be better than that? But you've got to use our special broker because you can't automate this type of trading using a Schwab or Robin Hood or Weeble account. Of course, you've got to use one of these special boutique brokers. So, what they tell you is that you don't need scanners. You don't need charts. You don't even really need to know how to trade. You'll have a high win rate. You can automate your trading and you can just use the statistics to create an algo.

What could be better than that? But there's a catch. You can't trade with the trend like I do. You may know that I'm a momentum trader. So, I look for something that's already moving and I look to jump on that momentum and continue to ride it as long as I can. Now, this system of algo trading doesn't work for trend trading because it's it's just not something that it's able to do at this point just due to the complexity of knowing the discretion of do I jump in this stock right here that's already up, you know, 100 plus%.

Or is this too extended? Now, those are the discretionary decisions that I'm making as a long biased trader. Now, I'll tell you that historically long biased traders are kind of have kind of been thought of as being the dumb money. They jump into anything that's moving during the dotcom bubble. You know, the OTC pink sheet penny stocks and it was the short sellers who were a little bit more sophisticated that would bring the price back down.

But then shortselling became so popular that the shortselling sector became quite crowded. And as it became quite crowded, there were a couple issues that you're going to learn about today, including availability of shares to borrow. Now, trading to the long side, you don't really have to worry as much about it being crowded because the shares that you buy are all part of the float. And as people buy shares, the price goes higher.

But when you trade to the short side, you need to have the shares available to trade first. So if you're going to trade a system short selling strategy, number one, you're not trend trading, you're counter trend trading. So what that means is that as a stock goes higher, you're shorting or as a stock goes lower, you're buying. Now, a simple algo for retail traders is just not sophisticated enough to know that you could buy in the middle of a trend like this right here at $8.

This stock just went from 550 to 8 and you know reasonably is very extended, right? That's a very extended stock. Probably anyone typically looking at that on paper would say this is not a good place to buy right where my white arrow is. However, what we knew at that moment was that that stock had a very specific catalyst. That the theme in the market was that these stocks with these catalysts are making huge moves. And so for all of those reasons, we were able to make the discretionary decision to take the trade and I lock up $156,000 of profit.

As you can see right here on the previous slide, I had $169,000 of profit doing something very similar, making the discretionary decision to buy in the middle of a trend. That discretionary decision cannot currently be automated to an algorithm, not in a successful way because there's too many variables. However, counter trend trading is a little bit different. So trading bots only trade reversals. And what they do is they add fixed shares at fixed intervals.

They could do it either long or short. So as a stock is going up, they add, they add, they add, and they add at these fixed intervals. And then as it comes back down, they're covering and covering and covering. And this makes it feel very simple and very easy. So certainly the algo could work on buying weak stocks, but we're not talking about this. We're talking about naked shortselling. So why is that? Well, when a stock is weak, especially a small cap stock like this, often there's panic, there's fear, and it takes a long time for people to become greedy and want to buy a stock that's down 50% or more.

For that reason, it's very difficult to trade bottom reversals and expect a big rally back up, especially on small cap stocks. Usually, when they're dropping, it's for a good reason. And so, the bounces are very small. So if you start adding adding adding adding adding adding, you never really get the relief bounce to give you profit. But with trading to the short side, because the market is fundamentally long biased, companies want their stock price to increase.

They're constantly putting out good news. And in a hot market, investors and traders experiencing FOMO and greed, stocks are more likely to trade at overbought levels versus oversold levels. So this means there are more opportunities to trade reversals short versus trading reversals long off the low, especially in the small cap market, which naturally is more appealing to beginner and intermediate traders with smaller accounts.

So this leads us right into naked shortselling. Well, it doesn't have to be naked, but in this case, it is. So the idea with a short system, a short selling system, is that you use statistics to create your strategy. And so the idea here is that nothing goes up forever. We know that. And so as long as you leave yourself room to continue to add, then you'll be fine. And this in theory is true. You take a starter here.

And if it immediately reverses, you have a winner with 1x position. If you add to your second starter, your second ad position, then it reverses here before the third. You have a profit with 2x of position or 3x or 4x. And at a certain point, you get that reversal. So the idea is that you add 100 shares when the stock is up 50%. For instance, you add another 200 shares when the stock's up 75%. You add another 400 shares when the stock's up 100%.

And by increasing your share size as the price moves higher, you're also increasing your cost basis. So when it rolls over, you'll be at profit sooner. And so you see how you keep doubling up. You go 100 to 200 to 400 to 800 to 1600 to 3200 to 6,400. So, in this scenario right here, this works as long as the stock doesn't go up more than 500% and you have the buying power to have a full position here, which is the culmination of all of these shares added together plus your final ad.

So, in theory, it works great. You remove emotions, you systemize trading, you systemize shorting. You're essentially trading against the very low probability of a 600% move. This, however, is a martingale strategy. So this strategy, it's Achilles heel is a black swan event because if a stock does go up a,000% or more, you end up taking that loss. But for every other time that it only the stock only goes up 300% or 400%, you may not get to your final ad before it rolls over and then that's fine.

So this is a strategy unfortunately where traders can do really well for a long time until the black swan comes along and wipes them out. And so that actually creates an illusion during the period that things are going well that this system is awesome and I want to trade it with more and more size until you get that black swan where you give back a lot of profit. Now whether you give back all your gains or you give back, you know, just a portion of your gains ultimately depends on how quickly you're able to exit the position once you hit your max loss.

What we know about trading these types of stocks is that they can move extremely quickly. We've seen times where stocks have gone up a,000% in as little as five minutes. So, if your algorithm was not fast enough to exit that position, then suddenly, you know, you're down substantially and you could even have a margin call to your broker. We'll talk more about that in a minute. So, in the past year, we've seen a lot of these moves where a stock will come out with news, it'll start to squeeze up, and then it just gets hammered right back down.

And it's been very confusing why a stock with seemingly good news would be unable to hold these levels. And we've called them round trips. the stock pops up is not able to hold and it comes right back down. So a Martingale strategy is high risk but by itself it's not a scam. You you know you could use it. It's just it's high risk. That's all it is. So the idea of doubling each time you add that you'll eventually make back everything you lose is correct except that you have limits of scalability and a certain point you run out of equity in your account.

So, the reason that it's being used as the basis for these trading bots is because it can be automated. You just add as a stock goes higher, it feels easy and it has high accuracy. Now, it feels easy. It's not actually easy when you factor in the black swan events, right? But this is this is the way it's marketed. And so, can you trade this strategy and automate it with Schwab, Robin Hood, or Weeble? And the answer, of course, is no, you can't.

You cannot do it. They don't have good access of shares to borrow. So now to trade this strategy that feels so alluring. This is the bait. You have to use a broker that allows API for trading bots, has large availability of shares to borrow, has reasonably priced borrowing fees because anytime you borrow a stock, you have to pay a fee on it, and has flexible margin requirements because if they make you, you know, have a lot of equity in your account to take these trades and that's not going to work either.

And so now you've got thousands of affiliates all pushing leads into these special brokers that are allowing naked shortselling. This is a problem. So Nick, can you give us a little bit of context around when people make these posts on social media um when there's an affiliate relationship because most of these posts don't make any disclosure about that at all. Right. Well, there's a real concern at the SEC about manipulative conduct by traders. uh and that uh manifests itself in a number of rules and and enforcement actions by the SEC.

But when someone is talking about a stock and unbeknownst to the people reading the posts or the articles or whatever, they actually are being paid by an issuer or a broker, the SEC wants that to be disclosed so that people who are receiving the information know about possible conflicts of interest. So, I think it's pretty widespread that that the disclosures are not always as robust as they could be. So, part two, now we've got to talk about these brokers that all these affiliates are sending leads to.

So, the broker makes money every single day, rain or shine. They make money on platform fees. They make money on the API fees for system trading and trading bots. They make money on commissions. And they make money on short borrowing fees. Now, these brokers are not commission free. So, every time you trade, you're going to pay a fee. Now, these fees typically are based on a per share basis or or charged on a per share basis.

So, $1,000 shares times 0.005 is a $5 commission. So, $5 to trade a,000 shares to buy it. It's another $5 to sell it. So, if you end up doing 10,000 share positions because you're scaling up, you're paying $50 total to buy and $50 to sell. That's a $100 round trip for the broker. That's the commission that you're paying. So now you can see how the broker is making hundreds of dollars per day per customer. You multiply this by thousands of customers and you add on the additional fees and you know everything else, they're making a lot of money.

So with that profit, they're paying affiliates to keep driving fresh leads. But there were two problems. Now again, all of this is perfectly legal until you introduce naked shortselling. a Martingale strategy. It's high risk. Eventually, you could have a blowup, but it's legal. You could trade it if you want. Training the short side, that's legal, but the way it works when you're trading the short side is you have to borrow shares from someone who owns them.

Too many short sellers meant the brokers were running out of shares to borrow. And the result was that it was increasing the cost to borrow for everyone. And so a lot of the big money traders were going to the broker and saying, "Hey, I've got a $5 million account with you. I want to short, you know, whatever 100,000 shares of this stock and the cost is outrageous or I don't even have shares to borrow. I can't find any.

So, you know what? I'm going to close my account. I'm going to go somewhere else." And the broker's like, "No, no, no, no, no. Don't do that. Don't do that. We're going to figure this out. We're going to figure this out." So, for their top, you know, heavyweight traders, they don't want to lose all the commission they're making on them. So, they have to figure it out. And for all these new leads that are coming in that are doing the system short selling, they don't want to lose out on that profit either.

So, they got to figure something out. Now, if you actually look at the charts, um I have I use this software called Ortex and it shows you the cost to borrow. And on this particular stock, PL ag borrow was up 315% just in the last 3 months. And most of that was in the last 14 days. A 350% increase in the cost to borrow. So, the cost to borrow was going up. Why was it going up? Because everyone wanted to short it. Because it made a big move.

But what's worse is that there was only uh 3% less than 3% shares available to short, the remaining 97% of the shares that were totally available for shorting are already spoken for. So, not only are you paying an elevated cost, there's hardly any shares left to borrow. So, now this is a problem. You try to borrow and it says symbol not eligible. Nope, no shares available. So my broker does this. It says no shares available.

Now fortunately the broker that I'm using does not involve itself in naked short selling. So they just say no. Sorry, no shares available. That is what it is. Whatever. Now if there are no borrowers, if there's no borrows on shorts, the system short sellers will close accounts. The heavyweight traders close accounts and the brokers lose business. And so all of a sudden the pressure is on. And this is where we come back to when the pressure is on, what are we gonna do?

I would illegally naked short sell stocks every day. That's the quote from the banker. And so this is this is a Morgan's former Morgan Stanley employee saying that. And what they would do uh is they would press an F3 button on the keyboard, the broker would to autolocate shares. In 2016, Goldman Sachs pays $15 million settlement on allegations made by the SEC that they were using an F3 button to autolocate shares. They're not alone.

Maril Lynch, Goldman Sachs, UBS, uh, you know, Morgan Stanley, Interactive Brokers, all of these, all of these have had abusive, illegal, naked shortselling fines. This is widespread. This is not a small thing. This is happening across the market. It's happening on large cap stocks. It's happening on small cap stocks. it's happening on, you know, these random sort of Chinese stocks are popping up. It's it's across the board.

So then if we take these relatively small penalties sort of as that that these were administrative bookkeeping issues, they paid a penalty, which in the scheme of the size of these companies is very minuscule. Um, have there been more well-known instances of actual naked shortselling schemes that the SEC has prosecuted or that have been alleged and that something has come of it or is this just something that continues to kind of happen without much action?

Yeah. Well, kind of both. In other words, the SEC has brought a number of actions. Certainly from the perspective of shareholders in a company or management of a company being the subject of a persistent naked shortselling campaign is devastating. And so there have been some historical examples where companies got really incensed and tried to do something about it. The one that comes to mind immediately for anyone who's kind of been in the space for a long time is the famous case of Patrick Burn and the company he was CEO of, Overstock.com, which was the subject of a persistent shortselling campaign.

He [clears throat] became so insensed by that that he went very public, filed a number of lawsuits, complained loudly to the SEC. Um, and ultimately, I think he was so frustrated by what was going on, he attributed the conduct to what he called a Sith Lord. Um, who he viewed as sort of a puppet master behind the scenes, coordinating the efforts of naked shellers and the press and the regulators. And ultimately, I I don't think he was right that there was a Sith Lord conspiracy because frankly, it's a lot more boring and mundane than that.

It doesn't require a conspiracy. All it requires is sort of knowledgeable exploitation of the way the system is set up by people kind of doing ordinary kinds of things. That's very interesting. And so with naked shortselling, now you get a broker that gives you quote guaranteed borrows, automatic locates, which means you don't even have to locate. You just press the sell button and immediately you're short. Like magic.

Yeah, it's magic. It's not real. In fact, what you're doing is you're selling shares that don't exist. So let's just think about how this works for a second. So if you want to go short, this is legal shortselling. So legal shortselling is you've got someone who owns shares. You've got an owner of the stock. They bought 10,000 shares of Robin Hood, whatever it is, and they own it. Now, what Robin Hood does as a broker is the broker lends out the shares from one customer to another customer.

So, this is the borrower. And now, the borrower can now sell the 10,000 shares on the open market. The stock goes down. And this is all while this person is still holding the shares. They still have a position in their account that they're long 10,000 shares. If they sell the 10,000 shares, then immediately the broker needs to get back these shares from this person or replace that borrow with with another borrow. So this person's holding the shares, this person sells it.

The price declines, they buy back the shares, 10,000. They make, let's say, whatever amount of money, doesn't matter. And they then have those shares given back to the original owner. Now, the owner earns a tiny little fraction of interest. And the broker also charged this person interest to be borrowing those shares. So every time you short, you're shorting shares and borrowing them from someone out there who's an owner of the share.

And the broker sits as an intermediary that makes a profit from loaning out shares. Now, during the GameStop short squeeze, there's a lot of discussion about restricting the ability to of your broker to let uh people borrow your shares. And so you can actually go into your settings on some platforms and say, "Don't lend out my shares. I don't want that." So you could do that, but most people don't do that. And so the results is that your shares are are lent out.

All right, that's fine. But there are instances where stocks have a very low float uh and there's simply not a lot of shares at brokers that are available to borrow. And so this person wants to borrow and they can't. But the broker could say, "Well, you know what? I'm just going to give you the 10,000 shares. I'm going to press that F3 button on my keyboard. I'm just going to give you the shares and I'm going to figure it out later.

I have reason to believe I will be able to get the shares." That was what the F3 said. I have reason to believe, but they didn't have any reason to believe. They just that was the button they pushed. If I'm a broker and somebody comes and sends me a bunch of short sale orders, the regulations require that I have a reasonable basis that I can go out and borrow shares to match against those short orders. Well, they they do it by a various various means.

Um, but the the the reasonable basis can be created by just looking at what's the inventory of shares out there. Um, and that that can give me a reasonable basis to think I can borrow, but at the same time, the broker next to me is doing the same thing and looking at the same pool and the broker next to him is doing the same thing, looking at the same pool. So, it's as though you were a travel agent booking seats on an airplane that has a 100 seats.

Everyone's looking at the same 100 seats. If you've got 50 brokers all, you know, thinking they had a reasonable basis of 10 seats per broker, you can see how you could easily exceed the number of seats on the airplane because we're all looking at this same pool. So, that's the it's the ambiguous nature of who owns which shares at which point in time that allow the brokers to have a reasonable basis and basically overpromise shares to short sellers that are coming in.

And the brokers, you know, they want to satisfy their customers who are putting in short sale orders. And so, um, there is an incentive to be less fidious about how how reasonable is your belief that you could go borrow these shares if you wanted to. So, that's the real problem. It comes from a good thing, a good innovation um that has created some problems and traders and brokers know about this and can sort of take advantage of it.

So then to expand on the F3 button that Goldman Sachs was using, on the one hand, if you've got all of these um brokers checking an inventory, the inventory may not be updating in real time, second by second, when people are actively buying and selling so rapidly, which we know, even if those of you who have tuned in and watched me trade, how within seconds I could be an owner and then I'm not an owner and then I'm an owner again, then I'm not an owner.

So if there's so essentially if there's shares available they would uh or or if they had the reason to believe they would press the F3 button or how exactly did that work? You you know by well it's I mean anyone can go read the SEC's allegations against Goldman in that case and so Goldman like all brokers had this problem of short sale orders are coming in and they need to establish that they have a reasonable basis that they can borrow.

So what they did was they at the beginning of every day they had and this is all automated computerized they would have an inventory list for each ticker. How many shares do we know that we have in inventory that can be borrowed against for short sale. So fine you've got 10,000 shares of whatever ticker. But then when during over the course of the day if short sales came in that exceeded that then they had to go to a manual process to determine whether oh we need to maybe call a customer to see if we have additional shares we can borrow beyond what was on the beginning of day list.

And over time that was really cumbersome and and at least the way the SEC alleged it against Goldman. They eventually created this F3 key solution where traders who had short sales coming in could hit the F3 key which sort of shortcircuited the inventory issue and gave the brokers the answer that they wanted which was yes. I have a reasonable basis to believe we have shares that they can borrow. And the SEC said no you really don't. the F3 key was an illusion that gave the brokers uh the belief that they could borrow shares when in fact uh in many cases they did not have sufficient inventory.

So the F3 key is just a reference to Goldman's solution to the same problem that every broker has which is how do you satisfy customers who want to do short sales and satisfy your regulatory obligation to identify or have a reasonable basis that you can borrow shares to satisfy those short sales. Interesting. And so then if you had a dozen or so brokers all working on that same beginning of day inventory and also just sort of going on the assumption that maybe they could get more shares somewhere, right?

Then all of those brokers could sell short in theory. Yes. And if they all did that, you would have many multiples of the total shares outstanding now short. That's right. On the open market. That's right. Yeah. That's right. And so that's the problem. That's the sort of overbooking the seats on the airplane because you're all looking you're all booking against the same you know hundred seats on the airplane and and by the end of the day you've exceeded it.

So you know that would result in a fail to deliver and uh and that would get resolved in other ways but uh that is the problem. So then what is the what is the real impact then in the market when you have 10x number of shares being sold? you've you've got artificial selling essentially like phantom shares. Yeah, that's exactly right. These these are now shares that have been sold by the short seller uh that don't exist.

Uh and so particularly in micro cap stocks that are thinly traded, this can have a big impact on the share price just like normal selling can and just like regular non- naked short selling can. But this adds sort of accelerant to that where you're you're selling shares that don't exist. So these these are in fact like phantom shares. Now they short, they buy back the shares inside of a day as day trade. It's all covered and you know all is kind of well and done.

Uh they didn't get squeezed whatever whatever except that the broker you know yes they make their commission and they're happy about that but they've now engaged in naked shortselling. So, a lot of these brokers that offer guaranteed borrows, automatic locates, or offer discounted or free borrowing rates for big money traders and/or big affiliates, to me, that's a red flag. It doesn't mean necessarily that they're naked shortselling, but that's a red flag because you have to ask yourself, where are they getting those shares to borrow?

And how are they offering free borrowing or discounted borrowing when you still have to pay interest to whoever you borrow the shares from. So all of this whole scheme with naked shortselling has resulted in more affiliate marketing. All right. So we shouldn't be surprised about that. More affiliates promoting promoting system shortselling. And again it's it's short selling because that's there are more opportunities to trade these to the short side in the market because the market is fundamentally long biased.

The big P&L screenshots making it look easy. The links to the affiliates at the brokers. There's more system short sellers. broker makes more money and more uh selling suppresses the price of the stock. So now we're seeing bigger rejections and bigger profits for shorts. So now let's do another scenario. Let's pretend we've got a stock with a 1 million share float. So that means there's a total of only 1 million shares available in the entire market.

And then you have the broker here and then you have system short sellers. And let's just say the system short sellers cumulatively have asked to borrow 2 million shares across, you know, 10,000 accounts or whatever it is, and they sell 2 million shares. Well, wait a second. You're selling more shares than actually exist in the float. So, of course, you're going to suppress the price of the stock. There's not enough shares in the float of people that own it to buy and and and to hold it up.

So, what happens to the price? It goes down. Perhaps in spite even of a good news catalyst, the price declines. This should not be possible. It should not be possible to be able to take a short position in excess of the float except when naked shortselling is involved, which again is illegal. So this is the feedback loop where naked shortelling has become more and more popular. But as I said, there were two problems.

The first was too many short sellers meant the broker was running out of shares to borrow and was increasing the cost to borrow for everyone. They solved that when they could short selling. But the second is the short squeeze. Because what happens if you do get a stock that just keeps going higher and higher and higher? Then all of these system short sellers with 2 million shares to the short side and the stock goes up a,000%.

Who's in trouble? Well, sure. The system short sellers, their accounts are gone and now it's on the broker. You know that that's the expression. If if you owe the if you owe the bank $1,000, that's your problem. If you owe the bank, you know, $10 billion, that's the bank's problem. So, when you got this big of a position and they're deep in the red, now the broker is the one who's getting scared because they could be stuck holding the bag.

So, big short squeezes, blowups, and margin calls are bad for traders. Sure, they're bad for brokers, though, and they're bad for business. But how do you stop short squeezes from happening? And that gives us this brand new short ALGO that we saw launch earlier this year, selling a seemingly unlimited number of shares run at an institutional broker level. And this is where we saw it right on the level two. MX, we would see this big seller.

Now, this one right here is for um it shows 114 shares, but there's two zeros. So, it's 11,400 shares. And what we would see is that this this ALGO would pop up as soon as the stock was up more than 50%, we would see the ALGO come out and it would suppress the price and it's it's like it was allowing the system short sellers to have an easy layup because it was just selling and selling and selling. At a certain point, you create enough weakness just through all of that selling, the chart is ruined.

Everyone gives up on it. And at a certain point, sentiment becomes so poor because people just say, "This is ridiculous. What are we doing here?" You know, I'm not going to keep I'm not going to keep uh trading this type of stock because every time I try, I just end up getting smoked. And so the result was that this MEMX MEX ALGO created such bearish sentiment in the market. Every time something would pop up, it would reverse.

People stopped trusting it. They weren't feeling safe trading these. And so what you ultimately had was a period where the market got very cold. Stocks, even with seemingly good news, were popping up and failing dramatically. Nothing was able to go up 500%. The system shorts were winning. Now, I actually have a video that I'm going to share with you. I'm going to put it up on my screen and I'm going to walk you through what it actually looked like to see this algorithm in real time.

All right. So, we've got a live archive here where you're going to see this MEMX algo at work. Now, this is an interesting one because the stock is not up more than 50% here. However, versus the previous uh two days, it's holding right at a very critical level, and $5 is the breakout spot. So, now we're coming up to 8:15 in the morning, 8:20 in the morning, and we see MEMX is sitting there at $5 with 50,000 shares. That's a big sell order.

So, let's keep an eye on that sell order. Let's watch how it moves. Okay. So, currently stock's up 181 19%. The order starts to get bought up a little bit. It's It was 50, now it's 49,300400. The order disappears. It gets cancelled and moved up to 526. You see that? Now it's at 27. Now the order is at 40. Do you see how it moves? The fluidity of how it moves is indicative of an algo. It's not like cancel and slowly replace.

It's instantaneously moving. So, let's just back that up. What we of we saw two there were two behaviors that we saw with this algo. One behavior that we saw with this algo was that um the it it would keep sell orders just slightly above the current market to almost put a ceiling on how much the stock could go up. almost it like just it was always like 10 15 20 cents just slightly above the current market to create this impression of upside resistance and so when you constantly have a big sell order hanging right over the ask people get nervous to buy and so that creates an impression of weakness.

Now, this order was moving up and then moving down and then it was very fluid as you could see right there. And so that was the first um form of order spoofing and manipulation that we saw from this short algo where they would put out this order to what feels like create the impression of weakness but not with the intention of the order executing because soon as the order starts to execute they pull it back up. So that feels like order spoofing which is also illegal.

So then we have um the second uh instance which is so in that first instance they're not really selling that many shares. They're just using big order size to scare other traders and to create this kind of area of resistance. And then in the second instance we're actually seeing it um executing and selling shares. So let's watch this again. So we're at 50 here. Someone buys like 700 shares. All right. So, a little bit gets bought and if they're trying to create the impression of weakness, but they don't actually want to short that position, then they cancel the order and they move it.

Cancelled order, move to 526. Now, someone who genuinely wanted to sell the stock doesn't cancel the order. You you sell the stock anyway. So, it goes to 27 in an instant. Then it goes to 40 and then it comes back down to 16. Do you see that? So they took the ceiling off giving the impression that okay maybe we can go for a second and then they come right back down. Now it's up at 21 22 21. This is now it's at 37 and it's gone up to 39,000 shares.

Now it's gone. So where is it? Is it gone? This ALGO is now are we clear? you know, could I take a trade on this now for a a squeeze up to six or seven? I mean, what's going on here? And you can't really tell. So, it to me, the amount of times that we saw this unfold, I I couldn't possibly count them. And so, you guys who are uh tuning in, watching this, who have been, you know, trading for the last 6 months, you've seen this price action.

And what I kept saying was, look, this will end in one of two ways. One way is whoever's doing this is gonna get in trouble. Sadly, you know, because of all the I mean, look, it just the current state of the government and all the staff layoffs and everything that's happened in the past couple years, I don't know that someone doing this is going to get picked up. You know, I really don't know. And if they're being enabled by an institution, uh, you know, a big broker, their their clearing firm, whatever, then yeah, we might not see it go anywhere for a while.

So then the second scenario is this will go away when you get a big squeeze. If you get a big squeeze where this where someone puts out that 50,000 share order and they get filled because traders realize well this stock actually has a really good catalyst. It's got a really good catalyst and this thing is going to go higher. Then suddenly uh uh oh they're short 50,000 shares. And I'll just give you an example of a stock today.

Um, we had a stock just today, and I'm not kidding, this is unbelievable. Um, where the stock in 10 seconds went, you could see right here, from $1 to a high of 18. You do a move like that with 50,000 shares, you're losing $50,000 each point. So you're down 5 10 15 20 25 30 35 40 4550 55 60 65 70 75 80 85 90 nearly a million dollars gone in 10 seconds. Now the price came back down. But if you you know what if it kept going higher, you know, then all of a sudden you know you're really smoked.

You're you're in a real pickle. So as you as you see that type of behavior of the way that order moves around, what what does that make you think in sort of putting on your regulator hat? So my regulator hat requires me to be cynical and assume there's a a bad motive going on there. But so um one thing that it could be is an instance of spoofing. Um which is where someone places an order they never intend to fill. uh which is intended to send a signal to the market that that there is interest in uh purchasing or or selling in another context at a certain level that doesn't actually exist.

Um so that happens a lot and with automated trading it can happen on an automated basis. I mean with an algorithm for example. So we know this occurs every once in a while the SEC brings a spoofing case there. I will say from the SEC's perspective, very hard to prove because you need to prove that there's something deceptive or manipulative about the order you placed. So, an innocent trader could say, "Yeah, I'll put an order out there, X number of shares at such and such a price, and then I change my mind for for perfectly innocuous reasons, right?

That's the that's the defense explanation for why that happens." So the SEC has to prove that if they're going to bring a manipulation case around spoofing that the person did not have the intent that was expressed by the order that was placed and then rescended. That's hard to do unless you have like contemporaneous emails or chats or something where the person saying, "I don't really intend to fill this order." So So that's one possible explanation for this is that this is spoofing intended to manipulate the price of the stock. we know that happens.

That that could be um what's going on here. Um you know, alternatively, it could be someone or a number of people who are putting in orders and and changing their minds, but uh the pattern you just described, that doesn't look like that to me. So, this behavior um was very prevalent earlier in the year. And what was very interesting was that suddenly it um suddenly it stopped and we were we were like what what just happened?

Uh and it was crazy because even stocks was seemingly good news you know because of this algo we're going red on the day and it was beyond frustrating you know I mean we were sitting here trading and it was like man I I don't even know what to trust right now and so naturally I was trading less during those um couple of months. I wasn't trading to the short side. I wasn't, you know, I wasn't that depressed, but I was trading less and I was just like, well, it's we're in a slow period, but when this thing blows up, and eventually it will.

I mean, think, look, GameStop blew up, $7 billion loss from Melvin Capital. The Volkswagen short squeeze of 2008, $30 billion losses for hedge funds short selling. So, it's only a matter of time before you get a black swan that really squeezes this thing. Um, and and you know, when that happens, then all of a sudden, sentiment and momentum is going to shift really quickly. But in in the meantime, I've just got to wait.

So, you know, they were winning. The affiliate marketers were winning. They were getting paid. The brokers were getting paid. You know, the big short sellers were making money. So, everyone was winning. But at whose expense? Well, of course, from my perspective, uh I mean it was at my expense, right? Long biased traders like me, we certainly were making less money because of this short ALGO. So, uh, day traders, but also active traders, certainly, uh, even if you're not a day trader, we we it was at our expense without a doubt.

Uh, we were accustomed to stocks with news increasing in value, not with news and declining. Uh, but take it a step higher. What about longbiased investors? Imagine for a second, um, you know, that you're not in the stock market, but, um, you know, you're whatever. You're, let's just say you're a doctor. You're a doctor and you know, you you work with patients all the time. you're a GI doctor and you've been um you know as part of the work you do you learn about these new medicines and you find out that there's this company developing a new medication for you know Crohn's disease or something like that and you're like you know what man if this if this thing works it's going to be a really big deal um you know what I'm going to buy 5,000 shares of this company and and let's see you know maybe I'm wrong but but I think it's probably going to work and then uh you know few months later whatever it is they come out with news of positive clinical clinical trials and so as a physician you're like this is exactly This is awesome.

This is so great. Soon this is going to really help patients and yet the stock declines. So you've got clinical trials, maybe it's phase one, maybe it's phase two, and they're positive. They're good results and yet the price declines. Now, you would be probably quite confused if you were a physician or, you know, a novice investor. You're not a sophisticated investor. You're not a Wall Street professional, but you're investing what you know, which is, of course, what Warren Buffett and many others have always said you should do. and you're following that rule and yet the price is declining because of an artificial level of selling created by naked shortselling.

That's not fair. That hurts the integrity of the market. That means that investor, that physician is probably going to say, you know what, this is just I'm I'm done. I'm never putting my money in the market again because, you know, I just had this bad experience. And and I wouldn't blame them for feeling that way. And so, of course, there's no question that I was very frustrated dealing with this naked shortselling. I mean, it's been going on.

And so it's it's frustrating when I see it. I am still left with the belief that eventually they get squeezed and we have seen a number of squeezes. So I just have to stay tuned for those and then trade them when they happen. Um but then for an investor who's only in the market periodically, it's extremely disappointing. But imagine a step further. Um what about the actual companies, right? Can you imagine how frustrating it must be to be sitting at the conference table, you're the CEO of a company and you're like, "All right, guys.

This is this is a great week for us. we just put out, you know, the the Q Q1 earnings. They were 500% year-over-year increase. This is phenomenal. And you know, your junior guy intern is like, "Um, sir, [clears throat and cough] so have you looked at our stock price?" And the CEO is like, "Yeah, what is it up like 3 400%." I mean, you would figure it would be because if earnings are up three 400%, you know, then that would that would track.

Uh, well, no, the price is down 33% today. And the CEO is like, "What? What's happening, Phyllis? Where's Phyllis? Can someone get Phyllis in here now?" Phyllis is sharp as attack. You get her in there because she's the one you need when things are getting tough and she's smoking a cereal. What's going on? And you explain the whole thing to her. So, here's here's the reality. Jokes aside, here's the reality for these companies.

If you sell enough shares, any stock will break. What happens if you're selling more shares on any particular day than there are buyers? It's going to suppress the stock. What if you sell more shares than the entire float? Well, that's what happened with GameStop. And it would have worked except in that one instance enough, you know, retail traders caught on. But for that one instance that retail traders caught on, how many other companies do you think got forced into delisting, forced into bankruptcy because their stock price kept going lower and lower and lower?

So here's the deal. When you list on the NASDAQ, you have to maintain a minimum stock price of a dollar a share even after you've become listed. So if you can keep short selling to push a stock below a dollar a share and keep it below a dollar a share, they're out of compliance with NASDAQ. Now um Historically, NASDAQ will give about 188 day grace period uh time to regain compliance and there's an appeals process and it can drag on for a while.

So, realistically through this long process and through reverse splits, most companies don't end up actually getting delisted because they're below the minimum price. NASDAQ has been, you know, pretty accommodating in that regard. But, you know what's interesting is um NASDAQ proposed a rule change and this is brand new. They proposed a rule change that if the company has a market cap less than $5 million for 30 consecutive trading days that the company's automatically delisted and there is no um there's no cure for it.

There's no, you know, pausing while we do an appeal. It's you're automatically delisted. And uh their reason for it was that they said if if a stock has a market cap of less than $5 million, it's just not going to recover. it it's not possible. It's going to go to the OTC market anyways. So, we're just going to kind of speed up this process because when you have a stock with a one, two, three, four million dollar market cap, these are companies that are very desperate.

Those stocks might be more prone to manipulation. They might be more subject to fraud and then that we're we're going to protect investors by just saying if it's below 5 million for 30 days, just get it out of here. So, so Nick, what do you think about the general approach that regulators and maybe even the exchanges take um when it comes to protecting investors, retail traders and investors? Well, I do think there's a tendency for regulators to be paternalistic and so regulators sometimes do things that in their view protect investors from themselves for example and it's a phenomenon we call protection through prohibition.

So um for example, you might see a trading halt in a situation where there's unexplained activity in the market and the trading halt is designed either by uh one of the exchanges or by the SEC itself. The trading halt is designed to protect investors from this uh inexplicable information conduct in in the marketplace. um that is a I think good sentiment, a good idea, but in fact a trading halt can have the opposite effect on the people who are holding those shares and be extremely harmful.

Um so I do think it's important to uh be on the lookout for regulators who want to protect you either from yourself or from a situation that may do more harm. In other words, the cure may do more harm than the thing that's the regulator is trying to cure. And they submitted that rule change to the SEC and a division of the SEC approved it. And so in July it went into effect that any stock with a market cap of less than $5 million for 30 days would automatically be delisted.

Now, um the small public company coalition, the SPCC, filed a um filed a uh what was it? Um let me just pull up the article here. Um uh they filed a petition um with the SEC requesting a full review. And so now, as of July 22nd, uh this rule change has been paused. So, it's no longer in effect pending a full review by the commission. And so, this full review is is now going to take uh months, certainly six months, nine months, might maybe a year longer.

And and we don't know what the result will be. But I think it's very interesting uh that this would happen because it this again feels like I I know when you know when Robin Hood took away the buy button, people felt like, wow, they're capitulating to short sellers. you know, those big hedge funds must have cried to daddy and daddy told Robin Hood to, you know, take away the buy button. And while we know now that it was actually an issue related to collateral obligations with the clearing firms, um, it it it didn't feel good.

It felt yucky. And to be honest, the SEC just sort of rubber stamping or greenlighting this $5 million market cap rule feels a bit yucky because it feels like now these naked short sellers that are running rampant and have for a long time now have this extra um sort of u weapon that they can hold a stock hostage. if they can just keep it below that $5 million market cap for 30 days, then it'll force the company to be delisted to the OTC market.

And when stocks trade on the OTC market, they trade for fractions of a penny versus the NASDAQ or the NY or the MX exchanges because investors, real investors, don't really want to buy OTC companies. They they just don't. And so uh so what what I found really interesting was that as part of the petition um the small public company coalition uh did some research on this to question the belief that NASDAQ had that companies that are below a $5 million market cap um you know inherently don't recover.

And so they actually found that um over the past 20 years there were 816 companies that would have been delisted to the OTC market. Dell listed it because of this rule change. And of that 640 of those companies actually later went on to regain a $5 million market cap. That's over the past 20 years. And of those, 212 companies were still above a $5 million market cap as of the end of last year. And of those, several have become multibillion market cap companies.

And of these, you're talking about tens of thousands of employees. These are real employees. Now, with this $5 million market cap rule, they're basically the exchange was saying, "You know what? Just get rid of all of these companies and forget about the ones that might have survived and all their employees because in the eyes of the exchange, some of these companies were destined to get delisted to the OTC market anyways.

That was already going to happen. And the moment that happens, investors are harmed. And NASDAQ doesn't want harm to come to investors on their exchange whenever it's avoidable. And that's commendable. I understand that and I think that that makes a lot of sense, but I would ask how many of the companies they look at as being examples of companies that declined in value, you know, month over month and eventually all the way to getting delisted to the OTC market that ultimately caused harm to investors.

How many of those companies were subject and victim to a campaign of naked shortselling? And I don't know the answer to that, but it can be found out because if they were victims of naked shortselling, then the company's share price was artificially suppressed in order for the shortselling brokers and the shortelling firms and even the hedge funds or the big traders to profit from that company's demise. And that should that is not allowed.

And yet because naked shortselling doesn't seem to be enforced uh adequately, it happens. It was happening in 2001 with GameStop. Now GameStop was just the black swan. It was working really, really well. And these funds were making billions of dollars suppressing and burying stocks until they just capitulated and were gone. They made billions of dollars with that business practice until finally some of them got squeezed on GameStop.

But then that was just the one black swan and then they regain control for many other companies and these are not just small cap companies by the way that be can become a victim of naked shortselling. So this report on the 816 companies was prepared by uh the small public company coalition and also Craig Lewis. Craig Lewis is a professor at Vanderbilt. More interestingly he was the chief economist at the SEC. He was also the director of the SEC's division of economic and risk analysis.

This is someone who knows a lot about the public markets. And my view from reading and listening to what they've talked about with this proposed rule change is that this proposed rule change would be an absolute slam dunk for the market participants certainly engaging in naked shortselling and even legal shortelling because if they could just hold the stock below a $5 million market cap for 30 days, it's a slam dunk win.

So, if you had a group of hedge funds that all said, "We're all short bias on this. You're short. We're short, too. Hey, that's great. Keep it below five million for 30 days. Dellisted. It's an instant win." So, can you just describe where reggg show came from, what it is, and and where what in what environment was it? So, regow is an SEC regulation. It applies to brokers. So, for example, it does not prohibit traders from shorting or even naked shorting.

If you're a trader, you probably don't even know if you're naked shorting. Um, but it comes from the concern that we've just been talking about, the practice by brokers of putting through their customer short sales without having a corresponding long position they can borrow against. And so really, it was a a regulation created by the SEC in 2004, 2005 that was meant to address that underlying problem. Interesting. Okay.

And then the failure to deliver list, um, which was discussed quite a bit during the GameStop short squeeze, keeps a record of the companies that exceed a certain threshold of trades that did not settle, indicating perhaps that there was a short, right? Yeah. [clears throat] Massive failures to deliver suggests that the brokers may not have had their their belief that they could borrow the shares may not have been reasonable.

Um, so certainly massive failures to deliver are good evidence of a problem in the system. There's a big mismatch between the short orders that went through and the actual shares that were available to cover those uh short sales. So this this is all of the context around this naked shortselling scheme. The naked shortselling scheme is sort of separate from this $5 million market cap rule. It just so happened that this came up right at like the perfect time for it to be topical because it came up just after a lawsuit was filed against allegedly firms and traders engaging in naked shortselling.

So now let's talk about that lawsuit. The lawsuit was filed by one company. One company decided to defend itself. LN AI. They said they said they were frustrated. And I've seen this before. I've seen other companies that have tried to file lawsuits against naked shortselling against brokers, against individual traders, and they accuse them of naked shortselling, but they're I've never seen, and I could be wrong, but I've never actually seen one of these cases succeed.

Ultimately, the company just spends a lot of money on litigation. They don't get anywhere. Nothing happens. and they're just, you know, they're just they're doing what they feel they have to do and to, you know, represent shareholders and defend themselves, but nothing happens. So, um, LNAI, um, alleges that naked shortselling artificially suppressed the price of the stock. And they were able to identify naked shortselling from elevated failure to deliver rates.

Now, every time a short closes, that's fine. But if a short fails to clear because there was not an original match from a borrower, then it's considered a failure to deliver. And failure to delivers are reported on reggg show 203. They're reported because the regulators are trying to monitor for potential naked shortselling. And stocks can go onto a threshold list if there's been enough failure to delivers. Stocks on threshold list you cannot short.

They also name in their allegations, they're naming um John Doe's one through 100 and individual brokers and uh traders that they think were responsible for naked short selling. Interestingly, they even named a trader who is only short 17,000 shares, a 17,000 share position, which is obviously negligible, but this is a a probably a regular trader who just may not have even known. They may not have even known that the broker that they were using was enabling them to short naked.

I mean, if you short 17,000 shares, you have no idea, right? I don't know. And I think that's a fair argument that when I'm trading, I have no idea if my how my broker is getting the shares. So, I don't know why I would be liable as the trader if my broker was allowing or enabled naked shortselling. But if you knew it was happening and then there was like an email chain and you know whatever text chain between you and the broker being like, "I don't care how you got the shares.

Just get them." And the broker's like, "Well, they're definitely naked." And you're like, "I don't care if they're naked." Then they introduce that as evidence. Then that's obviously going to be a little bit of a different situation. So in their lawsuit, they allege that on March 18th, 6.6 million shares failed to deliver. The following day, another 2.7 million shares failed to deliver. And then on March 27th, an additional 5.6 million shares failed to deliver.

So these are millions and millions of shares. Think about those big sell orders, that 100,000 share sell order. This is like a hundred of those sell orders just sitting there pushing the price down, suppressing the price. It has a real effect. If you've got 10 million extra shares that are sold on the market that weren't borrowed from an actual shareholder, you're creating an artificial level of supply, additional supply affects the supply, demand, and balance.

And so you can have a company in theory that's putting out great news and yet there's people just dumping shares. Now, this is obviously why naked short selling is illegal um because it does have a negative effect on the integrity of the market. You know, look, the market is fundamentally long biased. Companies IPO, they sell shares on the open market to raise money to fund the work that the company's doing. If it's McDonald's, it's to buy more buy more real estate, build more McDonald's stores and expand.

And they need all that money to do that. Now, you're an investor in McDonald's, and you benefit as the price goes up as their profitability improves over time. everyone's 401ks and IRA and you know all these pension funds are invested in the market. We need integrity in the market where you don't have naked shortselling. Some would argue that shortselling, you know, by itself is quite opposed to kind of this American dream of working for 30 years and putting your money in the market and then being able to retire.

On the other hand, um you know, economists like um Alan Greenspan would say that it the market is self-correcting. You don't need prices will go high and then short sellers will bring it back down. The prices will go low, buyers will bring it back up and at the end of the day it will all equal out to the exact pricing to perfection. And so you don't need to overregulate it. You don't need to, you know, restrict short selling whatever.

But naked short selling clearly is um a function of an electronic market. I don't think you could have done naked shortselling on the floor of the exchange in, you know, 1950. But in today's electronic market, there's a lot of different ways that uh unfortunately we've seen these schemes operate that put companies at a disadvantage and this is certainly one of them. And you wouldn't normally have like pull the victim card on, you know, a company.

It's a publicly traded company. And yet in this case, they're one of um what have been many companies that have alleged this. Millions of shares being borrowed and sold into the market but failed to deliver. meaning they were not properly borrowed in the first place is a sure sign of naked shortselling. So, we're in a position now where we heard all about naked shortselling during GameStop. We've heard about it after the dot bubble.

I mean, it's not new. It continues to come up today with this most recent lawsuit. Why do you think it's been so difficult to rein in this problem? Well, it goes back to the the DTCC shares and the the ambiguity around who owns what share at what point in time, that's that's the problem that needs to be solved. So, unless [clears throat] you're going to ban shortselling outright, which I don't think there's any regulatory appetite for that to happen, uh, or you're going to require actual locates to borrow, not just a reasonable belief, um, then that you're always going to be stuck with these two things.

A requirement that you have a reasonable belief to borrow against an ambiguous pool of shares that may or may not be available to borrow. [snorts] Um, so our view at I can is that this probably needs to be solved on a more structural level. There will continue to be private lawsuits like the one that you described. Those occur, you know, with some regularity and that seems to stop the behavior at least temporarily. The SEC, the most egregious, the most egregious ones.

Yeah. And the SEC will continue to bring reggg show cases against brokers whose bookkeeping whose uh tracking of reasonable basis to borrow um is not what the SEC thinks it should be. So you'll continue to see those. But it's really this dynamic of brokers wanting to give their customers what they've asked for, which is a short sale, and some uh short sellers who are motivated by um uh a desire to drive a stock price in a certain direction.

So until you solve for that underlying structural problem, I think you're just going to continue to see what's been happening for the more than 20 years that ra has been in place. Um this dynamic just continues to to occur. So this is filed on May 11th. That's interesting. May 11th. And now they named all the um the defendants as like John Doe, you know, one through whatever um and corporations, whatever. But suddenly the shortselling algo disappeared.

You guys noticed that, right? All of a sudden it was gone. Without naked shortselling, stocks began going up 500% a,000% on breaking news. This was ASTC. This one ended up continuing higher. This one this one went uh let's see, it started at like $45 a share, went all the way up to a high of $26 a share, which is unbelievable that I mean, we we weren't accustomed to seeing something like that. Even today, it's still holding up over $9 a share.

STI. This one squeezed from about $89 a share to $56 a share. The cost to borrow began going up, making short selling more expensive or even impossible. Trading bots lost money. They had to stop trading. They that further reduces selling pressure. Here's a stock that went from a dollar up to $6.50 in, you know, one day. This one went from $4 to $18 in one day. This one went from $3 to $24 in one day. These are huge moves.

And you might argue these moves are overdone. These this is too far. Well, again, a self-correcting market, these will come back down and through organic short selling, that's fine. If you want to take a short position on this and you want to use a Martin Gale strategy on it and add ad, that's fine. And you might catch the one that goes to $75 or $100 a share, and we've seen several of them now since uh after May 11th essentially.

Uh, and that's that's the risk that you play or you take when you're trading a counter trend strategy. So, one of two things always happens with naked shortselling. Number one, they get caught and shut down. Number two, they blow up. Number two is more common because unfortunately the regulators have been slow to I've I you know yes there have been fines and stuff like that but it feels like giving you know one of these giant institutions a $15 million fine is the equivalent of putting a parking ticket on the FedEx truck.

They're going to keep delivering in New York City. They're not going to stop delivering. They're just going to pay the parking ticket and go on with business. Right. So unfortunately our better bet is probably the blowup. But in this case it is an interesting maybe it's a coincidence that just shortly after that May lawsuit was filed that we saw um that algo disappear. Maybe that's a coincidence. Maybe that just happened to happen at the same time.

I guess I don't really know. But for right now balance has been restored. System short sellers are giving up because stocks with news are holding their gains. They don't have this algo that's creating this artificial level of supply that's holding everything back. Long bias traders are feeling safe trading again. The companies and existing shareholders are benefiting from the increased value. Beginning in June on June 7th, um I had no idea about the lawsuit.

I did notice that the market had improved. I decided to start a small account challenge June 8th with a goal of making donations to 50 children's hospitals in the United States. I grew the account from two grand to $65,000 over the course of 30 days. And I wouldn't have been able to do that, grow that account that quickly if the naked shortselling scheme had continued. So now I've donated to 42 children's hospitals. Out of the 50, donate a total of $435,000 um as part of these small account challenges.

So here's the deal. Naked shortselling will come back. There will continue to be affiliate marketing on social media, you know, Reddit, Twitter, Facebook, whatever. And you'll continue to see people saying, "This is the broker to use. zero autolocates, no borrowing, super cheap borrowing. Some of them may be legitimate. Some of them maybe they've just got a great deal on borrowing, but inevitably they become popular enough.

What's going to happen? Same thing. Cost to borrow goes up, availability declines, so now people just can't get shares. People get frustrated and they either leave to go to the next broker or, you know, that broker decides, well, we don't want to lose business, so what are we going to do? H just give them the shares. Give them the shares. Whatever. What's the worst? What are we going to do? Pay a penalty? Maybe in a few years?

We'll just let's do the business now. And uh unfortunately, we're going to continue to see that happen. So, you know, every few months there'll be new brokers that open. There'll be other brokers that close because that's the cycle of these illegal naked shortselling schemes, but they always blow up for one of two reasons. Number one, they get shut down by regulators, the broker or the hedge fund or the traders engaging in naked shortselling.

Or number two, we have an epic short squeeze where we have a stock that suddenly goes up and just in spite of all of that selling, it doesn't stop rising. The circumstances that create an epic short squeeze like this, obviously GameStop was very unique. What seems to happen more commonly is that shorts will underestimate a particular stock and the fact that the company is closely held by insiders. And this is especially true with foreign listed securities that those insiders really are capable of controlling the price even more than the naked short sellers can.

And that's when they get squeezed. And when they start buying back those shares, the move is epic. And although you may not have heard of all of those short squeezes on, you know, the news, they might not make it to the news the way GameStop did. Some of them are actually even far bigger in terms of percentage gains. In fact, just since May, I can't even count the number of stocks that have gone up over a,000% in one day.

And I think it's because at least temporarily, the degree of naked shortselling has been reduced as a result of this lawsuit, which is a good thing uh for now. But again, it's only a matter of time most likely before it comes back and then until the next short squeeze and the cycle repeats. Now, I have this clip up from uh Gaming Wall Street, the HBO documentary, and I want to play it again. Um I'm going to play a little bit longer this time so you can hear a little bit more of the insight from someone on, you know, the other side of the desk from an actual institutional trader.

So, let's hear what he has to say again, uh about naked shortselling. And he's going to give us a little more detail. You know, I would, you know, I would illegally naked short sell stocks every day, every day, as long as I was collecting commissions. So, that was what we heard before, that he would illegally naked short sell stocks every day. But did the bank care and the bank did not care? In fact, they did not care.

The client will send you an order electronically. All you do is you click on the order, you go to execute, it'll pull up a little box, you type in anything you want, and you just hit okay. That's to me just what's totally crazy about this. You don't ask questions. [music] You appreciate the order. And if that involves shorting a stock naked, you do it anyway [music] because management essentially tells you just create the business.

So now you can see this motivation that we talked about before. You've got a good client who wants to short a stock or in the case of these brokers enabling system short sellers. You've got an army of traders that all want to short the stock. They want to pay you, you know, the fee, the borrowing fee, which is like the commission. They want to pay you to borrow these shares. And so now the broker is like in in this situation where if if there's no shares available, they can't make money.

So now they're motivated to create the shares. Anything on the backside we will deal with. And I think this speaks to what we saw earlier also from the GameStop documentary about how these, you know, multi-billion dollar investment banks are paying penalties that are a couple million dollars. So that's not at all demotivating them to stop doing what they're doing. So you're collecting money on the front. You collect money on the back and you actually have zero risk.

That's pretty insane. So, it's a system that's set up so the individual employees have zero risk. If something happens, then management says, "Oh, we didn't know what was happening." They get a slap on the wrist, they move on, and then it just starts all over again. Clients never see that. all the prime lenders, they all do it consistently. What would you propose if if you were going to come up with a possible solution?

What structural change would you make? Would it be that you require a locate in order to borrow like a confirmed actual share and then that share gets taken or would you do something else? Well, I I think some of the responsibility probably sits with uh retail uh traders. So, when you sign up with a broker, um, you may not know this until you go because who reads the terms of service in the agreement with the brokerage firm, but every every brokerage agreement allows the broker to loan your shares.

Um and so one possible solution and we're actually working with a particular company on this is to uh the require shareholders to opt into a program where they say yes you broker you may loan my shares. Um I don't know that it's a panacea but I it's we're trying to get at the underlying problem which is the ambiguity around who owns what when and who can loan which shares at what point in time. So, um, it would be like if you had, to continue the airline air airplane analogy, if you had a seat on an airplane, the airplane would have to get your consent before it agreed to give that seat to someone else.

Um, a possible objection to what we're trying to do is that um, it could slow down settlement. uh because remember this pool of shares at the DTCC exists to allow very quick settlement. So if brokers need to get consent from the owners of the shares that may slow down settlement. Um some of that problem may be addressed technologically uh because we live in a much more digital world than we did when the DCC was uh DTCC was created.

Um yeah so but I do think that's where the solution lies. It's in the structural um uh makeup of the markets that allow quick settlement. Um but if we can identify who owns what shares at what time, we won't the brokers will not be able to loan shares that they don't have permission to loan. Interesting. So there's really no question about it that naked shortselling is fundamentally bad for the market. It erodess public trust in the market, reduces um the integrity of our markets.

It subjects stocks to potential bear raids where naked short sellers can artificially suppress the price either so someone can acquire the stock at a particular price that they want for the purpose of options expirations or in the case of midcap and small cap stocks potentially to drive the companies all the way into delisting which then causes further harm to investors, shareholders, insiders and employees of the company. you know, in this particular naked shortselling scheme, um, you know, the strategy of using affiliate marketing to bring in retail traders to participate in this scheme potentially, you know, without even exactly knowing that they're naked shortselling, you know, because they funded one of these accounts, they set up their trading bot or their system short strategy.

And even if they're doing it in a discretionary way, if the broker that they're using is allowing the naked shorts, then suddenly, you know, they're they're part of the scheme without even realizing it, you know, which so and this is the thing where you you guys we have to look out for each other and make sure when we see this stuff that we steer clear of it and warn other people of it because, you know, we don't want to be the one who falls for the bait, funds an account, account then gets our money tied up with a broker that ends up getting shut down or the account gets frozen because they're participating in this naked shortselling scheme.

That's the last thing that you would want. And so it's important that you know I put out this type of content to make sure you guys are aware of these schemes. And to the extent that you say, well geez, you know, maybe I shouldn't even trade small caps at all. You know, maybe I should trade large cap stocks or something like that. You know, my issue with large caps has always been that, you know, you got a large cap stock that's $150 a share.

You know, you jump in um you know, to profit on a move from 100 to $151. Let's just say you buy a 100 shares to make a profit of $100. Well, the thing is you're putting $15,000 of capital on the line for that $100 profit. And so the way I'm typically trading is I'm looking for stocks that are priced around, you know, three or four or $5 a share. And geez, you know, I could buy 3,000 shares, 3,000 shares for $15,000 worth.

And if this thing goes up just 20 cents a share, I'm up 600 bucks. So the return on my investment I've always felt and this just as a matter of fact is higher in small cap stocks even in spite of uh the risks that they face. Now you know even this year this year has been a little bit tough because of the extent of uh naked shortselling that we had certainly at the beginning of the year the first whole half of the year really.

Um but if you look at my metrics um for this uh calendar year, let's see, we'll go to this is my audit of my small account challenge which gets updated at the end of each year. But if we look at uh just my 2026 earnings, I funded my account at the beginning of the year with uh $96,000 only trading small caps. Well, with the exception of like SpaceX and a couple big IPOs, things like that. And as of the end of July, my account was at uh just under $2 million.

I didn't make any contributions. That was just from actively day trading small cap stocks. And I wouldn't have been able to achieve that type of growth certainly if I was trading day trading large caps unless I started getting into trading options which you know presents a whole additional layer of complexity and risk because it's derivative and you know they can expire worthless and so on and so forth. And not to mention the fact that I don't actually know that you would really escape naked shortselling uh with large caps.

I know you would certainly have more highfrequency trading algorithms which are predatory in their own right. Uh although those are um legal uh that creates a whole different challenge with large caps. But to the extent that naked short selling is used to suppress the price around options expiration because there's always a battle around the the expirations, especially the big ones like quadruple witching and things like that, then you know you're still going to deal with it there.

Or some big, you know, firm out there wants to push the price down for whatever reason, try to get someone else to capitulate. You know, then you're just playing the tugof-war. And it's almost like in that in that market, you're trading against forces that are so big that you're almost like trying to play chess against the computer. I mean, so that doesn't feel like it's a good solution to me. So, you know, my conclusion is that even in spite of naked shortselling, I keep showing up every single day.

I keep trading volatility where we find it. Whether it's a SpaceX IPO, which happens to be large cap, or more traditionally, it's looking at the leading gainers each day that are moving up. And typically, these leading gainers are small cap stocks. In order for a stock to be up 75, 80%, 100% in the day, you know, for the most part, these are small cap stocks. So, I'm going to log into the chat room here um just real quickly and I'll show you I'm going to put in my username, password, and I'll just show you the u leading gainers just from today just so you can get a sense of the type of percentage gains that we see in the small cap world.

But it's exactly these big percentage gains um that also attract the interest of naked short sellers because let's just look um here at Wetto, which just happened to be today's biggest move. It was the stock I also made the most money on today. Well, you know, this stock went uh literally from uh $3.78 a share to a high of 13 bucks. That's a 240% gain. Now, I didn't see any of the naked shortselling algos on it. Uh the ones that we were obviously seeing earlier in the year.

Um so, that's a that's obviously a good thing. Uh but, you know, this is no doubt the type of stock that I want to trade. And even if those algos come back, and eventually they probably will, um, you know, then it's only so it's only going to be how long before we end up having one of those stocks that just does something absolutely unbelievable and all those naked shorts get smoked. A a great example of this is actually um the stock ticker uh ZJ L.

So I'm going to search for this ticker here in my um classes. So, this was ZJY LL. Um, this stock um sold off and we don't know if this was a victim of naked short selling, but it dropped from $27 a share down to about 10 bucks. It's a Chinese stock and it ends up squeezing up and halting. It then opens at 25 and halts a second time in a row and then it remained halted. And you want to know what price it opened at? It opened at $500 a share right there.

If you were doing a system short strategy and just shorting because it hit your volatility scanner is squeezing up there. Holy smokes, you could have lost, you know, in this case, uh, an unbelievable amount of money, $2.5 million on even a position as small as 5,000 shares. So, you know, the and then so of course this is a great reminder of why I don't engage in short selling. Not just because of naked shortselling and I don't want anything to do with that, but because of the fact that these stocks can be completely irrational.

And if I'm in a position and it goes to zero, then yes, I lose what I put in it. But if I'm short a stock at $5 and it goes to 500, I am losing far more than I ever stood to gain, which is the inherent flaw with shortselling. Which is why, in my opinion, this naked shortselling algo was deployed to essentially put a cap on how much these stocks could go up. Except for cases like this where you have a small company closely held not a not many shares are in the float and so all of a sudden you know shorts get squeezed and that's what happens and that's I mean we that that one was particularly impressive this one same thing went from $20 a share and spiked all the way up to $220 a share and then we had socket uh last no it was earlier this week we had socket this one in one candle if you were shorting and averaging into every candle that popped up.

It went from 50 cents to over $4 a share right there. So, you know, again, right now we're not seeing as much of the naked short selling suppressing uh the price action on these stocks. We're not seeing that algo aggressively holding them down, but eventually it'll come back and then all of a sudden you'll get something like this that just absolutely explodes and that can begin a whole cycle of momentum. as now suddenly uh shorts either shut off their algo their uh trading bots andor naked shorts get completely smoked their accounts are blown and now long biased traders feel confident stepping up to the plate.

But it's a real shame when you have a market due to that due to illegal naked shortselling has long biased traders that are on the sidelines because they're afraid to put their money in these stocks. You know, the whole idea of the public markets is that these companies list, they put out their shares, they try to produce good earnings, they try to generate profitability, and they want their share price to increase. obviously all the shareholders and investors do too.

I want to buy into these stocks that on this day are moving that they're obvious. They're the leading gainer. They've got a catalyst, ideally a strong catalyst. And so when we're in a position where even stocks with good news are getting buried, that's a broken market. That's not a good thing. It's not healthy for the market. So this now puts you certainly on notice. If you see any of those affiliate marketers, just ignore them completely. take it all with a grain of salt because as good as that system looks, that martingale strategy, it has an Achilles heel and when you get bit, it hurts really badly.

And I've seen, I can't tell you the number of traders I've seen who grew accounts and then boom, grew accounts and then boom, and they keep going back because every time they have a nice stretch like this, they think they've got it. This time will be different. But then this always happens. You always get that day. Now, in my trading, you know, full disclosure, I have red days, in case you didn't know. So, I make profit, I give back some.

I make more profit, I give back some. So, from $96,000 on the year to at this point in August over $2 million, yeah, I'm I'm doing pretty well. Do I have some red days here and there? I certainly do. Are some periods a little slower because of naked shortselling, regular short selling, bearish market sentiment? Sure. It's not a straight equity curve. It never will be. But the discretionary strategy that I trade involving buying pullbacks on stocks already exhibiting momentum is the only consistent way that I've found to make money in the market.

And I funded my first account in 2001. That's 25 years ago. So I put my money where my mouth is. I trade this strategy every day. And look, I'm not going to say it's the only way to make money. And I'm not going to say that there aren't short sellers out there that are able to make money and do it legally and avoid by not naked shortselling and avoid getting caught in huge draw downs because they manage their risk. However, they are the exception, not the norm.

So, please manage your risk. And I'll end this episode with my disclaimer. That's as always trading in the market is risky. My results are not typical. And there's no guarantee you'll find success whether you trade on your own or you learn from me. So, your best bet as a beginner trader is to practice in a simulator and prove you can make money in a simulator before you ever put real money on the line. If I had done that, it would have saved me years of frustration and disappointment as I was losing hardearned money through trial and error.

There is a better way. So, please take it slow. And hey, if you enjoyed this episode, I hope you hit the thumbs up or consider subscribing to the channel.