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`Phantom Shares,' Failed Trades and Naked Shorts: (Transcript)

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March 14 (Bloomberg) -- Bloomberg's Michael Schneider reports on the practice of naked short selling,
its impact on companies such as Overstock.com Inc. and efforts by the Securities and Exchange
Commission to combat abuses. Naked short selling involves selling stocks short without borrowing the
shares first, meaning sellers theoretically can place unlimited orders to drive down a company's stock.
Patrick Byrne, chief executive officer of Overstock.com, and others speak. (Source: Bloomberg)

(This is not a legal transcript. Bloomberg LP cannot guarantee its accuracy.)

HATCH: Well how can we allow $6 billion a day not to be reported? It ought to be stopped.

COX: And intentionally failing to deliver that stock within the standard three-day settlement period can
be market manipulation that is clearly violative of the Federal Securities laws.

O'QUINN: Which is just stealing is all it is. This is all an example of stealing.

CHANOS: It sounds ominous. It sounds nefarious. And by and large it's a non-issue in the marketplace.

ANGEL: Is somebody manipulating the shares? What is going on here? It certainly smells bad.

SCHNEIDER: Welcome to this Bloomberg News Special Report. I'm Mike Schneider.

Stock manipulation. It's a problem that dates back to a time when Wall Street was just a wall. Built by
the Dutch back in 1653, stood 12 feet high, it ran pretty much beneath where I'm standing right now.

Over the centuries, investors have learned many tricks to drive stocks both up and down. One of the
newest ways to drive them down - and you can make lots of money doing that - is with an obscure Wall
Street trading tactic called naked short selling.

In a normal short sale, an investor borrows shares and sells them. If the price falls, he profits by
replacing those borrowed shares with cheaper ones. But in a naked short sale, an investor fails to
deliver the shares because he doesn't borrow them.

In extreme cases, he even sells phantom shares, shares that don't even exist.

While naked short selling is legal, manipulating markets is not, and regardless of intent, the effect of
naked short selling can be the same - driving share prices lower.

Our story now begins with a man who has done more to call attention to this problem than anyone else.

BYRNE: There is in place a system. There is an Al-Qaeda, so to speak, a loosely organized group of
people who are destroying small companies and looting the savings of America.

Gather round. We're doing our morning meeting this afternoon. Come on in.

SCHNEIDER: Meet Patrick Byrne, the outspoken CEO of Overstock.com, an Internet retailer based in
Salt Lake City that went public in May 2002.

For the past two years, Byrne has been complaining that naked shorting has driven down share prices in
thousands of small public companies, including his own, by permitting the sale of stock that, in some
cases, doesn't exist.

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From January 2005 to January 2007, Overstock share prices dropped nearly 70 percent.

BYRNE: It's a really simple concept, and when you get to it, you think, what's all the hullabaloo about?
It's really basic. There are people selling things and not delivering.

SCHNEIDER: The 43-year-old Byrne, who counts Warren Buffett among his friends, says his troubles
began after Overstock reported a profit for the second time in its history, in the fourth quarter of 2004.

UNIDENTIFIED: It is my privilege to welcome Overstock.com to NASDAQ this morning as we honor their

accomplishment as one of the most innovative and successful Internet companies in recent history.

SCHNEIDER: In 2004, Overstock's sales had more than doubled, to nearly $500 million. Its stock had
tripled.

But the high fives and champagne soon gave way to disbelief. From a high of $77.18 in December 2004,
Overstock shares began tumbling. By December 2005, they collapsed to a low of $28.02.

Byrne become convinced his shares were being manipulated, a conclusion also reached by Tom Ronk,
the President of Buyins.net. Ronk sells data on short sales to companies and investors.

RONK: Overstock is a - is the poster boy of naked short selling. What's interesting is that, from January
1st, 2005, Overstock.com has been on the naked short list for 91 percent of the trading days. In that
exact same period of time, over 86 million shares have been shorted in Overstock.

How is that possible? It shouldn't be.

SCHNEIDER: Ronk says naked short selling explains the huge decline in Overstock shares that January,
when the stock fell 20 percent in just one month.

RONK: We have found very large drops in U.S. stocks in one- month trading periods. So, we're seeing
that, when they first come in and attack, they hit it hard. They really hit it hard, because they can get
away with it. And they cause the largest damage to the stock usually in the first wave of selling.

SCHNEIDER: Overstock is just one of hundreds of companies considered at risk for manipulation by
naked short sellers. They appear on stock exchange lists mandated by the Securities and Exchange
Commission's Regulation Short Sales, or Reg SHO. These threshold lists consist of companies with too
many trades that can't be settled because stock is not delivered to the buyer, so- called failures to
deliver.

ANGEL: I mean, some people use the phrase counterfeit stock to describe the phenomenon, that if you
can sell stock and you never have to deliver, it's going to have the same impact as selling, selling and
selling. It's going to push the price down.

What is naked short sell?

SCHNEIDER: Angel says not all failures are the result of traders trying to manipulate stock prices. Some
may be caused by clerical errors.

Overstock was on the list of failed deliveries that U.S. Exchanges released in January 2005. Along with
Overstock were more than 240 other companies on NASDAQ's list, among them some familiar names -
Trump Hotels and Casino Resorts, Global Crossing, Netflix, TASER and, U.S. Airways.

The New York Stock Exchange had nearly 60 companies on its list, including Delta Airlines, Martha
Stewart Living Omnimedia, Krispy Kreme Doughnuts, and Winn-Dixie Stores.

And the problem is not going away. Since Reg SHO took effect, more than 4,500 companies have been
affected by stock delivery failures severe enough to qualify them as threshold securities. That's roughly
one in three companies traded on U.S. exchanges, the majority of them with small or very small market
caps.

BYRNE: I don't opposed hedge funds. I don't oppose short selling. I object to the accumulation of
unsettled trades in our financial system.

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SCHNEIDER: Reg SHO is supposed to restrict short selling in threshold securities. Once a company is on
an exchange's threshold list, Reg SHO requires prime brokers to settle any new trade failures after 13
consecutive trading days.

But Byrne and other CEOs say the SEC's own data prove that Reg SHO is failing to stop naked short
selling. Companies including Overstock, Krispy Kreme, and Martha Stewart each have been on threshold
lists for more than 400 trading days.

ANGEL: I can see no reason why sellers should be able to fail to deliver shares for years in name-brand
companies. It just doesn't make sense. It raises the question, what is going on here?

SCHNEIDER: Patrick Byrne was convinced that illegal activity was responsible for the failures in
Overstock trades.

BYRNE (?): There's people going to go to prison. There's nothing they can do to make me stop.

SCHNEIDER: When we return, Byrne's fight would take him to a place that is one of Wall Street's best-
kept secrets.

But first - what naked short selling has in common with the Producers.

UNIDENTIFIED: There, how much percentage of a play can there be altogether?

UNIDENTIFIED: Max, you can only sell 100 percent of anything.

UNIDENTIFIED: And how much of Springtime for Hitler have we sold?

UNIDENTIFIED: Twenty-five thousand percent.

SCHNEIDER: In the Producers, down on his luck Broadway impresario Max Bialystock and his hapless
accountant, Leo Bloom, sell more shares in a play than is mathematically possible.

CEOs like Frank Dobrucki have complained for years that the same Producers style accounting is at work
when abusive naked short sellers target small companies.

DOBRUCKI: Twenty thousand, eight hundred percent of our company was traded in a single month. The
shares weren't available. They weren't there. There was no way they could be trading.

SCHNEIDER: In March 2005, the Senate Banking Committee confronted then-SEC Chairman William
Donaldson with a story about Frank Dobrucki's company, the Nevada-based real estate holding
company, Global Links. An investor named Robert Simpson had set out to prove that small companies
were indeed frequent targets of abusive naked short sellers.

Simpson placed an order for $5,000 worth of stock in Global Links. That got Simpson ownership of all
1.1 million Global Link shares in the market. Not some of them, all of them.

UNIDENTIFIED: There were no shares available to be borrowed, and yet in two days, there were over 50
million shares traded. That's clearly something that needs work.

SIMPSON: I was absolutely blown away when I bought 1,282,050 shares, which equated to 111 percent
of the issued and outstanding. I just couldn't even fathom that. So, it wasn't just crooked, it was Wild
West times 10.

SCHNEIDER: The day all this started, trading in Global Links opened at 10 cents a share. Within a
second, the price dropped to a penny. An hour and 16 minutes later, Global Links stock was trading at
eight one-hundredths of a penny. Prices dropped 99 percent in less than two hours.

Global Links CEO Frank Dobrucki wrote shareholders telling them the selling of Global Links shares was
evidence of illegal trading, and when that occurs, he said ?

DOBRUCKI: The company cannot meet its goals, and shareholder equity is diluted so that brokers can
line their pockets with illegal cash.

SCHNEIDER: The same conviction motivated Patrick Byrne to hire six-foot six-inch John O'Quinn, one of

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the few attorneys in the country tall enough to look him in the eye, and by reputation, a giant killer.

In Texas, they call O'Quinn the billion-dollar man because he won billion dollar judgments against
makers of silicone breast implants and Fen-Phen, and against big tobacco.

O'QUINN: The deal is rigged so bad, I can make this statement safely - you have more chance to be
treated fairly in a casino in Vegas than you do in the stock market. The Securities industry has things
rigged where they can deal from the bottom of the deck regarding your stock and your money.

SCHNEIDER: O'Quinn's co-council is another Houston-based attorney, Wes Christian. Together they
represent some 20 U.S. companies that all claim damage from naked short selling, including Overstock,
Sedona Corporation, and TASER. They represent Overstock in a lawsuit seeking $3.5 billion in damages
from Wall Street's biggest prime brokers, accusing them of executing short sales with no intention of
delivering stock, causing Overstock's share price to drop.

All the accused have declined comment on pending litigation.

BYRNE: If you're a short seller and you abide by all the rules governing short sales, then fine. It's
legitimate, it's legal, it's proper. That's not what is going on on Wall Street. What's going on on Wall
Street in our cases, and we're now seeing in many other companies is a rigged system.

SCHNEIDER: But where Byrne and his lawyers see naked short sellers driving down stocks and
destroying companies, many on Wall Street see something far less threatening.

CHANOS: Well, I think the phrase I would use would be red herring. It sounds ominous. It sounds
nefarious, and by and large it's a non-issue in the marketplace.

SCHNEIDER: Jim Chanos runs Kynikos Associates, a New York Hedge Fund known for short selling. He
says he's never naked shorted a stock. Chanos is among those on Wall Street who say CEOs who
complain about short sellers are usually trying to divert attention from fundamental problems.

CHANOS: And they often find the short sellers convenient excuse as opposed to perhaps their own
failings in execution to blame for share price disappointment. And that's where I think we see a lot of
the sterm and drung , if you will, of this issue.

SCHNEIDER: Byrne's critics have dismissed him as a conspiracy theorist and have criticized his
company's performance. In 2006, Overstock revenues fell one percent. The company lost $97 million.
Share prices fell 46 percent.

BYRNE: I knew as soon as I put them on, it was going to be spun as, oh, this is a CEO who is just mad
about his stock price, and it was just, you know, if you only ran a better liquor store, maybe people
would stop robbing it.

SCHNEIDER: Byrne's battle against naked short sellers led him to one of Wall Street's best-kept secrets,
the Depository Trust and Clearing Corporation or DTCC. It's just a few blocks from here.

On average, the DTCC says it processes more than $1.4 quadrillion worth of trades a year. That's more
than 20 times the economic output of the entire planet. The DTCC also keeps track of the trades that
can fail due to naked shorting.

Speaking at a conference just a few blocks from DTCC headquarters, Suzanne Trimbath, who worked for
a subsidiary of the DTCC, explained the corporation's role in U.S. capital markets by comparing Wall
Street to Broadway.

TRIMBATH: Imagine that all of Wall Street is a stage. The DTCC is like backstage. These are the guys
that run the lights and the cameras, the grips and the gaffers, the people that moviegoers really don't
need to know what they do, and you don't need to care about it. But we all do need to care about what's
happening backstage at the capital markets.

SCHNEIDER: Meantime, Patrick Byrne says he received data from the DTCC that stunned him.

On January 12th, 2006, Byrne says the DTCC data indicated that there were seven million more

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Overstock shares in circulation than there should have been, a discrepancy coinciding with the steep
decline in the company's share price.

BYRNE: If it's only seven million shares, it's 35 percent of our company has been counterfeited. I think I
have a fiduciary duty to the shareholders, or the people who think they are shareholders, to clean this
up.

SCHNEIDER: DTCC data obtained from the SEC through the Freedom of Information Act also revealed
the scope of the failed trade problem. On an average day last March, failed trades amounted to more
than 750 million shares in almost 2,700 stocks, exchange traded funds, and other securities.

In all, the DTCC says about $6 billion in trades can't be cleared every day, 1.5 percent of the total dollar
value.

In this letter to the SEC, Wall Street's Trade Association, the Securities Industry and Financial Markets
Associations, or SIFMA, says trade settlement failures are only a problem for an extremely small
universe of securities.

Peter Chepucavage is a former SEC attorney who helped write Reg SHO.

CHEPUCAVAGE: To say it's trivial in the context of the entire universe is a meaningless statement. We
all want to know more about how many fails there are with respect to short sales and who exactly is
failing.

SCHNEIDER: Because trades can fail for innocent reasons, like clerical errors, the DTCC says it doesn't
know how many failed trades can be blamed on abusive naked short selling. A statement on its Web site
reads, ?While we have data on the volume of fails, we have no information on the underlying causes of
those fails.?

DTCC officials declined our request for interviews. DTCC members include the prime brokerage firms
that control the $10 billion annual stock lending market and are responsible for many of the failed
trades. Officials at SIFMA declined to be interviewed too.

Up next, is the SEC doing enough to crack down on abusive naked short sellers?

COX: The next item on our agenda is the serious problem of abusive naked short sales, which can be
used as a tool to drive down a company's stock price to the detriment of all of its investors.

SCHNEIDER: In July 2006, SEC Chairman Christopher Cox admitted there were loopholes in Reg SHO
that permitted naked shorting to continue.

COX: There continues to be a number of threshold securities with substantial and persistent fail to
deliver positions that aren't been closed out under existing delivery and settlement guidelines.

SCHNEIDER: One problem, trades that fail before a company lands on a threshold list can remain
unsettled forever. The SEC wants to close that loophole by setting deadlines for settling failed trades,
but some say this still isn't enough. Reg SHO, they say, will still fail to prevent abusive naked short
selling, that's because the rule only forces naked short sellers to settle trades after they've failed, and
by then it's too late. The alleged damage inflicted by naked shorting can occur before a company shows
up on a threshold list.

Example - January 2006, shares of Audible, the company that sells audio newspapers and books, fell
nearly 15 percent. The drop coincided with a jump in undelivered shares, which occurred before Audible
was placed on the NASDAQ's threshold list.

RONK: Our data is showing anywhere from 15 to 35 percent drops in stock prices in the first month that
this is happening. And we've seen stocks go from 26 down to three, you know, 90 percent drops in the
stock price over six, seven or eight-month periods. But it's usually the first month where the most
damage is done.

SCHNEIDER: In 2003, the SEC filed suit against Rhino Advisors for naked short selling shares of
software company Sedona Corporation two years earlier. Rhino settled the case in 2003 for $1 million

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without admitting or denying wrongdoing.

According to SEC records, Rhino instructed brokers at the now-defunct brokerage Revco to clobber
Sedona's stock until its share prices collapsed. The shares fell 50 percent in three weeks.

UNIDENTIFIED: Yes. Did you get anything good there for me?

EMRICH: They were congratulated for clobbering Sedona's stock. Go after, make sure you go all the
way, run them out of business. I have now 15 employees when, at one time, I had over 70.

SCHNEIDER: Traders have committed federal crimes using naked short selling. This document contains
e-mails written by a convicted naked short seller serving 11 years in prison for racketeering, conspiracy,
securities fraud, wire fraud, and extortion.

Anthony Elgindy directed members of his Internet-based investing cartel to sell their stock in a certain
company at the same time, carpet bombing, he called it. Ken Breen was lead federal prosecutor in the
case.

BREEN: There was testimony at trial with regard to volume, pounding, volume trading. They were able
to overwhelm the stock by just flooding the market with short sell orders. And their short sell orders
would eat up all the buy orders, and it would just drive the price down.

SHAPIRO: The bottom line is that the one ?

SCHNEIDER: Former Under Secretary of Commerce Robert Shapiro works as a consulting for lawyers
representing alleged victims of naked short sellers. He says as many as 1,000 public companies were
damaged by naked shorting in the decade it took to get Reg SHO into the rule books.

SHAPIRO: A lot of those companies are gone. A lot of them died. This was a fatal attack.

Now, some of them were weak when they were attacked. Some of them would have failed anyway.
Others wouldn't have. Again, it's not up to the naked short sellers to decide. It's up to the investors that
play by the rules.

SCHNEIDER: Well if you believe the $6 billion in failed trades every day could endanger a market the
size of America's, some argue the dollar value isn't the real threat. The danger, they say, is in what
those trade failures represent.

CHEPUCAVAGE: And why should a group of overzealous short sellers, and frankly, they are mostly
hedge funds, why should they be allowed to destroy the American dream? It's a matter of fairness. I
think what you hear among all the critics is, let's just be fair. There's no need for this.

SCHNEIDER: Right now, affected companies blame hedge funds, and hedge funds are blaming the prime
brokers, the firms that process trades for institutional investors.

CHANOS: If we're going to find out that there are fails in the system due to widespread naked short
selling, it's going to be due to the brokerage houses, and some of my best friends are prime brokers,
don't get me wrong, but it's going to be due to the back office problems at the brokerage houses, not
the hedge funds.

SCHNEIDER: Patrick Byrne, who once personified the NASDAQ's hopes for a dot-com recovery, is now
the poster child for all that's wrong with Reg SHO.

The day Overstock became a threshold security, in January 2005, the NASDAQ reported that more than
280,000 Overstock shares had failed to deliver. After becoming a threshold security, prime brokers were
supposed to guarantee delivery of Overstock shares in any new short sales.

Instead, the number of undelivered shares skyrocketed. By March 20th, 2006, they topped 3.8 million,
an increase of more than 1,200 percent.

Across the Rockies in Utah, Overstock's CEO slips his Jeep Scrambler into second gear near his
company's headquarters in the foothills of the Losach Mountains. It is his place to escape. Like these
roads, his battle still seems uphill, but Byrne says he won't quit.

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BYRNE: So, it becomes like a game of chicken, and I'm putting a brick on the accelerator and taking my
hands off the wheel. And if they do the same thing and we crash, we crash.

SCHNEIDER: Of all the numbers that we've reported here, there is one that everyone can agree on - the
number one. Using the most conservative estimate, about one percent of all trades in U.S. exchanges
will fail on days the market is open. State security regulators say that's one percent too much. They
want the SEC and brokers and stock exchanges to take the necessary steps to ensure a 100 percent
success rate.

Finally, based on data from the SEC, in the half-hour it took to watch this program on a typical trading
day, about four million shares failed to deliver.

I'm Mike Schneider for Bloomberg News. Thank you for watching.

***END OF TRANSCRIPT***

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