The Pendulum Swings

Back in college, where the combination of free time and that university mojo so often lend themselves to this sort of thing, a friend and I challenged each other to cram the most undeniable truth into complete sentences of the fewest possible words.

In the end, we settled on the following:

“Entropy increases” and “The pendulum swings.”

The first sentence is a reference to the Second Law of Thermodynamics.

The second sentence is a reference to the fact that cultural trends will always increase in pervasiveness and acceptance until some limit is broached, at which time opposing forces will be applied that cause society to respond with increasing negativity toward that trend. And, as with an actual pendulum, the higher the upswing, the more forceful the push back will be.

How true both are.

I first encountered the market reform movement near the end of 2005. Over the months that followed, I witnessed the following:

1. An SEC staffer in San Francisco subpoenaed the communications of Jim Cramer, Herb Greenberg, Bethany McLean, Carol Remond and a handful of other “journalists” suspected of colluding with Gradient Analytics and short selling hedge fund Rocker Partners, only to have SEC Chairman Chris Cox personally sabotage the effort. This was followed up almost immediately by the SEC vindictively subpoenaing Patrick Byrne.
2. FOIA requests filed with the SEC intended to give some sense of the scope of the delivery failure problem were regularly denied or spitefully filled with minimal accompanying explanation.
3. Numerous brutal articles were published attacking opponents of naked short selling – Byrne primarily among them – under the bylines of (surprise) Jim Cramer, Herb Greenberg, Bethany McLean, Carol Remond, Joe Nocera, and Roddy Boyd.
4. Audio tape captured by a market reform operative who covertly accessed a panel discussion featuring Herb Greenberg, Joe Nocera and Dan Colarusso (then Roddy Boyd’s editor) hosted by the Society of American Business Editors and Writers. The theme of the discussion was essentially “How do we deal with these lying anti-naked short selling bloggers who are so critical of us?” Among other things, the tape caught Joe Nocera saying (to loud applause) he felt life was too short to bother understanding whether naked shorting is actually a problem, and Dan Colarusso saying he and his newspaper had the capacity to “crush” Patrick Byrne.
5. An all-out PR offensive launched by the Depository Trust & Clearing Corporation (DTCC) attacking opponents of naked short selling.
6. The emergence of Gary Weiss, an ostensibly credible former business journalist and blogger, bursting onto the scene, proclaiming naked short selling beneficial and its opponents crazy.
7. The hijacking and distortion of the Wikipedia article on naked short selling by whom we would soon learn was none other than Gary Weiss. Given journalists’ well-documented over-reliance on Wikipedia, this was undoubtedly a key factor in our difficulty getting them to provide more balanced coverage of the issue.
8. A special session of the Utah Legislature which, catching the banks flat-footed, resulted in passage of a law requiring brokerages with operations in Utah to promptly disclose stock delivery failures. But before it could go into effect, and after the prime brokers managed to rally their armies of lobbyists, the law was handily repealed.
9. Unprecedented growth of companies on the Reg SHO Threshold Securities list, indicating that, contrary to the intended aim of Regulation SHO, naked shorting was becoming increasingly prevalent.

On balance, it was a very dark time for the market reform movement, as every charge was followed by a blistering counter-charge, and every lunge answered by a quick parry. More than once, I recall hearing even the staunchest market reformers openly question the capacity of a rag-tag band of revolutionaries to counter the enormous influence and resources brought to bear by the hedge funds and prime brokers who were getting rich from the practice of manipulative naked short selling, and I couldn’t help but wonder whether I’d picked the wrong battle.

That’s not to say I ever doubted the correctness of the cause – only the correctness of my decision to join a fight that sometimes seemed impossible to win and certain to result in damage to my reputation as it had to Patrick Byrne’s and so many others’.

But in those moments of doubt, I’d remind myself of an eternal truth: the pendulum swings.

In other words, as dark as those days were, there would invariably be restraining forces applied to help slow – and eventually stall and even reverse – the momentum built up by decades of Wall Street villainy and the deep regulatory capture of the institutions intended to counter it.

What we could not have realized – as such perspective only comes with time – is that we (meaning, you, me, and everybody else who’s taken steps to do something about illegal naked short selling) were in fact the very restraining forces so many of us were expecting to arrive, cavalry-like, from some unknown quarter, and that as dark as those days seemed, they appeared quite bright to those who had endured the 1990s and early part of the current decade, when the practice persisted, without restraint, like a drunken orgy.

Of course, the event that finally brought the pendulum to a decisive halt and reversal was the current economic crisis, which saw the term “naked short selling” dragged into the popular lexicon (as determined by Yahoo! listing it as one of its five most popular search terms in September of 2008).

Since then, as the link between naked short selling and the beginning of the crisis itself has been solidly established, valiant members of Congress – most notably Delaware Senator Ted Kaufman – have dragged the issue of naked short selling into the political lexicon, as well.

Where are we today?

1. The SEC recently enacted permanent restrictions on illegal naked short selling, which include greatly enhanced disclosure of delivery failures and shorting activity.
2. Today, the SEC brought its first enforcement cases against illegal naked short selling.
3. Also today, FINRA expelled a member firm for engaging in illegal short selling.
4. Jim Cramer has been deeply and publicly shamed. Herb Greenberg is now a ‘consultant’. Bethany McLean has left business journalism. Dan Colarusso continues looking for steady employment. Roddy Boyd, Carol Remond and Joe Nocera all retain their former positions, but seem to steer clear of anything resembling the issue of naked shorting.
5. The DTCC is mum on the issue as well.
6. Gary Weiss – since abashed and banned from Wikipedia – sinks ever deeper into obscure irrelevance while the Wikipedia article on naked short selling that he once controlled has been liberated and made to read nearly as it should.
7. Substantive legislation with the capacity to end illegal naked short selling and other short-side market abuses once and for all is currently working its way through Congress.
8. As of today, the Reg SHO Threshold Securities list is 23% shorter than it was on the day I met Patrick Byrne (and 90% smaller than it was at its height in July of 2008), and is nearly devoid of the kinds of promising, well-capitalized companies whose inclusion used to be a sure sign of an impending bear raid.

These are all developments that seemed impossible in the dark days of 2006.

But here we are.

Yes, the pendulum is now unambiguously swinging in our direction, but the job is not done. Indeed, we can only be assured of progress to the extent that we each recognize our responsibility to continue pushing.