Naked short sales hint fraud in bringing down Lehman

As many as 32.8 mn shares were sold and not delivered on time.

The biggest bankruptcy in history might have been avoided if Wall Street had been prevented from practicing one of its darkest arts.

As Lehman Brothers Holdings Inc struggled to survive last year, as many as 32.8 million shares in the company were sold and not delivered to buyers on time as of September 11, according to data compiled by the Securities and Exchange Commission and Bloomberg. That was a more than 57-fold increase over the prior year’s peak of 567,518 failed trades on July 30.

The SEC has linked such so-called fails-to-deliver to naked short selling, a strategy that can be used to manipulate markets. A fail-to-deliver is a trade that doesn’t settle within three days.

“We had another word for this in Brooklyn,” said Harvey Pitt, a former SEC chairman. “The word was ‘fraud.’”

While the commission’s Enforcement Complaint Center received about 5,000 complaints about naked short-selling from January 2007 to June 2008, none led to enforcement actions, according to a report filed yesterday by David Kotz, the agency’s inspector general.

The way the SEC processes complaints hinders its ability to respond, the report said.

Twice last year, hundreds of thousands of failed trades coincided with widespread rumours about Lehman Brothers. Speculation that the company was being acquired at a discount and later that it was losing two trading partners both proved untrue.

After the 158-year-old investment bank collapsed in bankruptcy on September 15, listing $613 billion in debt, former Chief Executive Officer Richard Fuld told a congressional panel on October 6 that naked short sellers had midwifed his firm’s demise.

Gasoline on fire
Members of the House Committee on Government Oversight and Reform weren’t buying that explanation.

“If you haven’t discovered your role, you’re the villain today,” US Representative John Mica, a Florida Republican, told Fuld.

Yet the trading pattern that emerges from 2008 SEC data shows naked shorts contributed to the fall of both Lehman Brothers and Bear Stearns Cos, which was acquired by JPMorgan Chase & Co in May.