[thegranderson]

Very helpful explanation from a thread about this on reddit (narrated from the first person perspective of the scammer):

It's pretty beautiful in an illegal sort of way: So the clever short sellers borrow and sell 100,000 shares of stock at $2 each, hoping to profit when it crashes to zero.

By hypothesis, there are no buyers. But we buy. We buy those 100,000 shares for $2 each, laying out $200,000. Now we own 300.1 million shares, out of 300 million outstanding.

On Thursday we go to our brokers and say "you know what, we changed our minds, we want our stock back from whoever you loaned it to."

So the brokers call in the short sales.

The short sellers can't borrow the stock anywhere else. We own it all. So they have to close out their short sales by buying in the stock.

But they can't buy the stock anywhere else either. We own it all. So they have to buy it from us. How much do we charge?

Yeah, $15. Or $20 or whatever, I don't know. We can charge whatever we want. If the short sellers don't buy the stock, they're breaking the law. So they'll pay whatever we ask.

They pay $20 to buy back the shares they sold us at $2, making us a $1.8 million profit.

source: https://www.reddit.com/r/investing/comments/4wvlkv/a_scam_wi...

[edit: formatting]

[brownbat]

If you follow that link all the way back to the original source, you're back at Bloomberg, and the writing of Matt Levine.[0]

It provides additional context, some entertaining footnotes, and is generally just very much worth the trip.

[0] https://www.bloomberg.com/view/articles/2014-07-11/cynk-make...

[MichaelGG]

That's so damn cool. So does the SEC regularly just raid places or wiretap them or ...? Seems like more sophisticated financial scams can just go undetected or impossible to prosecute if you split it up enough.

[heroprotagonist]

From that article, it sounds like the SEC wait until they hit television news..

[ChuckMcM]

This sounds pretty amazing but I can't figure out bindings for all the pronouns.

Who are the short sellers? Who are the brokers? are they complicit? Is one of them acting as the market maker for the stock? When the con is exploded and the money gets paid back, where did it come from? The short sellers? the brokers? thin air?

[kevinpet]

Eve finds NeuroMama, a worthless stack of nothing but shady documents, and importantly, without a significant number of shares available to borrow. She knows how to manipulate markets and doesn't care much for legality. Eve buys a significant position in NeuroMama over a period of time. She can do this cheaply, but slightly drives up the price.

Alice sees that the stock price has increased and this puts it on her radar of companies to investigate. She sees that NeuroMama is a worthless stack of nothing but shady incorporation papers. Alice thinks the stock value will decline. She goes to her broker, Bob, to borrow shares so that she can short sell. Bob calls around Long Island and locates some shares belonging to Eve for Alice to borrow.

Alice offers these shares for sale. Eve buys up a significant portion of them and puts them back on the market for sale at a massive markup.

Eve calls back her shares. Alice is required to return the shares to Eve. But Alice has sold those shares, so she must buy them back. She tries to find anyone to buy them from. Unfortunately, Eve is the only one selling, so Alice must pay Eve's price.

The only money that has changed hands is between Alice and Eve. There was no $34B, only a small fraction of the shares changing hands at highly inflated prices. If Eve is caught she'll need to disgorge her earnings to Alice.

[infinite8s]

Why would Eve worry about being caught? Everything you've outlined is perfectly legal, and in fact was executed brilliantly by Porsche (http://www.reuters.com/article/us-volkswagen-idUSTRE49R3I920...) in 2008.

[conistonwater]

> Although some short squeezes may occur naturally in the market, a scheme to manipulate the price or availability of stock in order to cause a short squeeze is illegal.

https://www.sec.gov/investor/pubs/regsho.htm

[kirubakaran]

executed brilliantly by Porsche

Didn't really work out for them in the end. They executed the short squeeze to acquire VW but they're owned by VW now.

http://www.automobilemag.com/news/porsche-and-volkswagen-wha...

[jschulenklopper]

There are two Porsche companies. Porsche AG (the car company) is controlled/owned by Volkswagen AG, but there's also Porsche SE (holding company). The latter controls a 50.7% majority of voting rights of Volkswagen AG, for 31% of share ownership. The families of Porsche-Piech own 50% of Porsche SE, but 100% of the voting rights.

[colechristensen]

TL;DR Banks stopped lending to Porsche before it could seal the deal because 2008 happened.

[kirubakaran]

And Angela Merkel herself dissuaded the sheikh from lending Porsche money!

[rtpg]

My understanding of securities law is that intent is 95%. If you're doing market manipulation "just to make money" (instead of, say, to buy a company? Not really sure) then it's illegal.

[digler999]

> to borrow shares so that she can short sell.

why would she do this instead of just buying a bunch of put options on the stock ?

[akg_67]

There need to be someone who is selling/writing put option before you can buy put option.

[elevensies]

This is a typical short squeeze. ( https://en.wikipedia.org/wiki/Short_squeeze ) [ With the caveat that I'm far from an expert on this, I just have a collection of documents of many failed corners and very few successful corners. ]

The short sellers are anyone with a negative outlook on the stock. For example, some hedge funds do 50% buying, 50% short selling, so in theory they are neutral to overall market conditions.

The brokers in this case have been permitted to lend out the stock to earn extra money, the short sellers are ordinary customers of the brokers, the short sellers don't necessarily have any special relationship with the brokers.

The market maker would be buying as much as selling, and not holding any position over extended time, so they don't influence this event.

In theory, the short sellers have to pay up to meet their obligations.

[delecti]

Side note unrelated to your question itself, the name for the reference that a pronoun points to is an antecedent.

Not trying to correct you, I just think grammar is nifty.

[monochromatic]

Same here. Reading the original makes things clearer though.

https://www.bloomberg.com/view/articles/2014-07-11/cynk-make...

[thegranderson]

Haha yeah the pronouns are not the clearest in this. Let me try:

Let's set up three parties to this scam: 1. The Scammers - these people start the company 2. The Short Sellers - these are the "smart money" who uncover some fictitious/sketchy company and want to profit 3. Brokers - these are the intermediaries through which both The Scammers and The Short Sellers trade

First, The Scammers set up the company and take it public on some sort of lightly regulated exchange (look up pink sheets, over-the-counter trading, etc.). These are not the NY Stock Exchange where an IPO has to be somewhat legitimate.

Second, The Scammers lightly trade the stock up among themselves over time until it looks overvalued enough for The Short Sellers to notice it in their quantitative screens and get interested.

Then, expecting the price to drop, The Short Sellers decide they want to sell short the stock. This would generally mean that they borrow the shares from someone that has them (e.g., borrow 100 shares at $10 a share), sell them to someone else (e.g., all 100 shares at $10 a share), and buy shares again when the price goes down (e.g., buy 100 shares at $2 a share) to repay the person they bought them from (to whom they owe 100 shares, regardless of share price).

So, in order for the Short Sellers to orchestrate this, they turn to Brokers, who match buyers and sellers. Since this company is a scam, only The Scammers have any shares. So the Brokers go find The Scammers (hopefully not realizing they are scammers), and ask them to lend their shares to The Short Sellers. The Scammers gladly do this.

Next, the Short Sellers want to sell their borrowed shares back to someone, so they are set up for when the price drops. Again, The Scammers are glad to buy these shares (putting up some cash to do so).

When enough Short Sellers get involved, or when The Scammers feel like it, they will call up their Brokers and ask for the shares they loaned back. There are some rules around this, but they can generally call them back. Now begins an epic short squeeze - the Short Sellers don't have any shares, but they owe them to someone, not realizing that the person they borrowed from is the same as the person they sold to (The Scammer in both cases).

So, the Short Sellers go out looking for shares to buy to repay their loan (again, denominated in shares, not cash). But since only The Scammers have shares, they can demand any price, and they do. They demand higher and higher prices, until the Short Sellers finally have to pay up exorbitantly for shares to pay back their loan. The Short Sellers buy shares from The Scammers at wildly high prices, and return them (through a Broker) to The Scammers, who are very pleased with themselves, having both sold their shares for 100s of times what they bought them for, and having gotten the shares returned to them.

[ChuckMcM]

Ok, that is helpful. I'm still a bit confused though. (where's collida when you need him?)

So I get the point where the scammer is selling options amongst themselves to get the stock price to rise. I put out an "ask" and then later come back with another shell company/identity and buy that stock with my "bid". Brokers are handling these transactions by connecting the buyers to the sellers (which happen to be the same people so they can buy an sell at an arbitrary price and only the brokers are making any money on the transaction fees.)

Now you stipulate this causes the stock to show up as "over valued" based on pretty standard technical analysis. Sort of "look no revenue but people are buying this stock for $2? WTF?"

So our short seller (who isn't a scammer right? they are being scammed?) goes to their broker and says we think this price is too high and its going down, so we want to sell a put option (that is the promise of a sale) of these shares at $2 a share, 6 months from now. Since they are an options trader and they know how these things go, they also buy a call option, to buy shares at $2.25 6 months from now. This is known as a "butterfly" if the shares go up you will be able to cover your put options with shares from the call option and "lose" only 25 cents per share, if the shares go down, the person on the other side of your put buys your shares for $2 and you sell them for less than $2 and pocket the difference.

What I don't understand is what broker is going to play the other side of the short seller's order book?

If our scammers agree to sell a call option at $2 to counter balance the short seller's put option, they are forced to sell at $2, they can't decide to sell at $20.

How does the scammer get the short seller's broker to take a bath here? They aren't some dupe in an investment club who things "its going to the moon!" and so buying what ever comes out, they are trading options on high risk securities over the counter (in many ways the highest risk securities).

So the only way I see this working is if the broker in this melodrama is corrupt and telling someone to short a stock which the broker does not ever get control over (essentially con them into a naked short).

[rdtsc]

But there are no options involved here. Short selling is a separate strategy that doesn't involve options at all (as far as I understand).

Your point still stands and in respect to broker(s), I wonder if they:

* knew, but could ignore it, because it is legal and they wanted to collect the fees

* didn't know

* knew, and should have done something, but didn't, and thus broke some law.

[peternilson]

Ah makes sense now, thanks for illustrating it so clearly.

[codedokode]

And why is this scheme illegal? Isn't it Short Sellers' fault that they have borrowed shares without reading the conditions properly? They could just buy them.

It looks like a casino where you are allowed only to lose, not a free market where you can trade however you like. Once you find a profitable scheme you go to jail.

[downandout]

This is called a short squeeze. It's done all the time and is not illegal. Pumping the stock up at first through manipulative transactions is illegal, but not all overvalued stocks get that way through illegal means. If you have an overvalued stock and short sellers move in, conducting a short squeeze against those sellers is not by itself illegal and can be an effective way to encourage short sellers to stay away from the stock.

[theyoungestgun]

Famous example with Porsche: http://www.nytimes.com/2008/10/30/business/worldbusiness/30i...

[kirubakaran]

As I mentioned elsewhere, it didn't really work out for them in the end. They executed the short squeeze to acquire VW but they're owned by VW now.

http://www.automobilemag.com/news/porsche-and-volkswagen-wha...

[celias]

Sounds like the plot of the "Ties That Bind Us" episode of the BBC show Hustle from 2006

[rhizome]

Sounds like what SCOX was speculated to be doing on their way down the chute during the IBM suit.