The SEC’s Sins of Omission

Cramer has for a long time been crusading against naked short selling. But that kicked up on notch on Thursday when he found out the Securities and Exchange Commission investigated just 2.5% of complaints about the practice.

As if he didn’t have enough reasons to dislike former SEC Chairman Christopher Cox. Now he can virtually blame Cox for the collapse of both Bear Stearns and Lehman Brothers. After all, naked short selling is what brought them down.

Just to recap, short selling is the practice of borrowing stock to sell at high price and then buying the shares back at a lower price so as to return what was borrowed. The short seller keeps the profits. When the stock isn’t first borrowed, that’s called naked short selling.

Market manipulators use this tactic because more shares can be sold short than actually exist, and that can overwhelm the target company. Illegal or not – and naked shorting is against the rules – these manipulators do it anyway because they can make big money in the process.

Here’s what the short selling in Lehman looked like just before the company went under: 32.8 million shares were sold short but never delivered, as is required, which is called fails-to-deliver. That means the seller never borrowed stock in the first place. And the 32.8 million is 57 times as many failed trades as there were on the prior year’s peak. Cramer says that can mean only one thing: Lehman was being manipulated down to scare off its shareholders.

At the same time, rumors were circulating that Lehman would be taken out at a discount just as Bear was, and that the investment bank was losing two trading partners. This was more market manipulation, Cramer said. But with the stock price already down, Lehman couldn’t issue more shares in order to raise money and save itself. Instead, the ratings agencies jumped on the bandwagon and downgraded Lehman, making the situation even worse. In the end, Cramer said the failed trades caused between 30% and 70% of both Bear and Lehman’s declines.

Of course, Cramer wants heads to roll. But more than that he wants the SEC to do its job and enforce the rules. Christopher Cox, he fell short. But Cramer’s hoping Mary Schapiro, President Obama’s handpicked replacement, will institute much-needed changes at the regulatory body.

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