Strange bedfellows: Gretchen Morgenson and Patrick Byrne

By Felix Salmon
March 26, 2012
Gretchen Morgenson, about Goldman Sachs and short selling, is notable for two things.

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Today’s story from Gretchen Morgenson, about Goldman Sachs and short selling, is notable for two things. One one front, it fails to deliver: Morgenson seems to be trying to make a case that Goldman might be guilty of naked shorting, but she doesn’t really come close. On a second front, however, it’s a great leap forwards for Morgenson.

The whole article is based on the transcript of a deposition given by a hedge-fund manager turned chicken farmer named Marc Cohodes. “His testimony, which has not been made public, was obtained by The New York Times,” writes Morgenson — and indeed “Mr. Cohodes declined to comment beyond his deposition”, which means that the deposition is the sole source for Morgenson’s story. Wonderfully, for the first time that I can remember when Morgenson was working off a non-public primary source document, she has actually posted it online.

As a result, it’s possible to read the full testimony of Cohodes, which turns out to be a very long way from a damning indictment of naked shorting on the part of Goldman Sachs. Here’s how the subject is initially broached:

Q. And did you ever come to believe that Goldman Sachs had not been borrowing stock when you were short selling stock?

MR. FLOREN: Objection, vague and ambiguous.

MR. SHAPIRO: Objection, lack of foundation.

THE WITNESS: That’s just speculation on my part at this point in time.

BY MR. SOMMER: Q. Well, I’m asking for your belief, so just tell me what your belief is one way or the other.

MR. FLOREN: Same objection.

MR. SHAPIRO: Don’t speculate; just say what you — answer the question about what you know. You’re here to testify, as a fact witness, what you know from seeing, hearing –

THE WITNESS: I don’t know. I just don’t know. I mean, I just — I don’t know.

This sets a pattern. Questioners representing Overstock — a company extremely hostile to short-sellers of any stripe — will try to ask Cohodes whether there was naked shorting going on; Cohodes will say, at best, that he talked about the possibility, but that he had no evidence of such activity at all. Or, to put it another way: Cohodes is angry at Goldman, and Overstock is trying to use that anger to get him to accuse Goldman of naked shorting. But he never actually does so.

Indeed, it turns out that the allegation that Goldman Sachs might have been engaging in naked shorting doesn’t really originate from Cohodes, or his deposition, at all. Instead, it’s contained on page 300 of a book by a former colleague of Cohodes, Richard Sauer, which was published in April 2010. Here’s the excerpt:


This is actually a vastly better explanation of the highly-circumstantial “evidence” of naked shorting than that provided by Morgenson. Here’s her attempt:

Failing to borrow shares on behalf of customers is illegal because of concerns about market manipulation. But it can also leave a brokerage firm’s client who is short a stock dangerously exposed to an escalating price in the shares. If a stock shorted by an investor began to trade higher and the shares were not borrowed, closing out the transaction would require the fund to buy them in the open market. That could propel the already rising price of the shares even higher, adding to the costs of the trade.

This doesn’t really make any sense. If a fund which is short a certain stock needs to cover that short, then it needs to buy those shares in the open market. That’s true whether the short is naked or not. And yes, when shorts are forced to cover, that can force the price up even further. That’s known as a short squeeze, and it’s exactly what caused the downfall of Cohodes’s fund. And again, you absolutely don’t need naked shorting to have a short squeeze.

Reading the deposition, it’s clear that while Cohodes is furious at Goldman Sachs, his fury has essentially nothing to do with naked shorting. This is absolutely not clear from Morgenson’s characterization of the deposition, which is why it’s so great that she uploaded the deposition so that we can see for ourselves. Cohodes is furious at Goldman for one main reason: that after Lehman Brothers went bust, there was some very crazy price action in the market. Most stocks were plunging, but a handful of stocks — the ones he was short — were going up, rather than down. It was a classic short squeeze.

In a short squeeze, the fight is simple. The fund which is short tries to stay solvent, while the market drives up the price of the stocks in question so much that the shorts are forced to sell at the top of the market. Once they capitulate in that way, the stock tends to plunge. A fund like that being run by Cohodes, which was massively short going into Lehman’s bankruptcy, should by rights have made a lot of money: Cohodes calculates it at a cool billion dollars. All he needed to do was wait for his stocks to plunge, and then cover his short positions.

But that’s not what happened. Instead, Goldman presented him with a huge and unprecedented margin call — not the kind of margin call required by federal regulations, mind, but rather a “house call” declared unilaterally by Goldman Sachs over and above what the regulations require. As a result of that call, his fund went bust, just days before it would have made a fortune. Here’s Cohodes’s deposition:

A. I can remember Goldman closing us out of American Capital Strategies at $33 on that Monday, and when they stopped doing whatever they had to do, when the smoke cleared, we finished covering the thing four weeks later at 2, something like that. We finished covering it at 2 but they took us out of eighty percent of our position in the thirties, and when they were done, we covered at 2. They took us out of Tempur-Pedic at 16, covered that, the rest of it four weeks later, at 3. I mean, it was insane.

So it’s kind of like I played the entire thing for a complete collapse, got the collapse and was closed out, closed out right before and during.

Q. If Goldman Sachs & Co. had not made these house calls and had extended you more credit during this time period –

A. We didn’t need more credit. All they had to do was not make the house calls.

Cohodes feels, then, with some reason, that Goldman Sachs did him in by foisting huge house calls on him during a point at which the stock market in general was going down rather than up. To make matters worse, when he tried to get out of the calls by moving his entire account to a different prime broker, UBS, Goldman wouldn’t let him do that. And when he tried to move his positions to a hedge fund with deeper pockets, Farallon Capital, he says that the CFO at Farallon got a phone call from Goldman warning him off.

So it’s easy to understand why Cohodes is very ill-disposed towards Goldman Sachs, and even suspects that Goldman’s prop desk might have been orchestrating the short squeeze. But there’s really nothing here at all to indicate that Goldman was engaging in any kind of naked shorting.

This testimony is mildly embarrassing for Goldman: no one likes seeing their former head of prime brokerage being described as “just a motherfucker”, as Cohodes describes Ravi Singh in this deposition. But Goldman’s argument for keeping the testimony sealed — “that their release would disclose trade secrets about the business” — is extremely weak. And Morgenson’s case that the deposition somehow indicates that Goldman might have been involved in naked shorting is even weaker.

Naked shorting is likely to become something of an issue in the news again soon, now that a documentary on the subject, called The Wall Street Consipracy, is being screened quite widely in finance and media circles. The documentary, like the deposition, is all part of a campaign by Overstock CEO Patrick Byrne against what he’s convinced is a massive conspiracy to bring down his company through illegal means.*

And that’s the main reason why I’m uncomfortable with Morgenson’s story: it seems to play far too neatly into the hands of Byrne, who’s really completely bonkers. But at least she posted the primary document, which is great, because it means that the rest of us can see much more clearly what the truth of the matter is.

*Update: Lewis Goldberg, the PR guy for The Wall Street Conspiracy, tells me that Patrick Byrne did not fund the movie, he just appears in it.


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Can’t Help but Wonder I – Is Mr. Cohodes familiar with the term “muppet”? Hey guy – at least you still have eyes.

Can’t Help but Wonder II – Is Morgenson somehow in GS’s pocket. I mean, if you want to state the case against GS, as Morgenson purports to do, you couldn’t do a worse job with the available facts than she did, could ya’?

Posted by MrRFox | Report as abusive

Patrick Byrne is not only bonkers. He cooked the books and fabricated profits too. The Securities and Exchange Commission made him restate’s financial reports and he is under investigation by the regulator. k_Accounting_Fraud.html

Posted by SamAntar | Report as abusive

I am a long time follower of securities lending vagaries and I read the whole deposition.
In addition to OSTK he mentions NFI and FFH.

I have some comments. Cohodes mentions being in compliance on Jewish holidays. Depending on his securities lending agreement–which it appears he would not have read–he does not have to be in compliance if the lender of securities agrees to a bespoke contract. Which leads to:

Q. What were the last two days that NFI broke (up) through the forty eight dollar barrier?
A. Sept 16, 2004 and Dec 7, 2004. Rosh Hashanah and the beginning of Hanukkah respectively.
They have all of the next day of trading to get the price down to their collateral.
The FFH borrow was actually a FFH/GRMN borrow–see  /A_-_Z_Guide_Documents/TestingScenarios _fulll_descriptions_FINAL.xls scroll down to Test Set 9.
From July 5th 2005 to July 5th 2006 the price of Fairfax at its close at 4pm plus the price of Garmin at its last trade of the day at about 7pm added up to $207 within two or three dollars.
If Fairfax closed up for the day at 4:00 pm on the NYSE where it then traded then GRMN would drop after hours on the NASDAQ by an amount equal FFH’s rise.
I took this to be because Fairfax and GRMN stock together comprised a single stock loan collateralized by something (like T-bills) which did not move much. Pushing Garmin down avoided collateral calls to Fairfax’s short sellers.
This is manipulation pure and simple.

Posted by bidrec | Report as abusive

MrRFox, their reach must be deep and wide given how much crap has been written about them.

Posted by Danny_Black | Report as abusive

“MrRFox, their reach must be deep and wide given how much crap has been written about them.” (The Hon. Danny Black)

Indeed it is, Mr. Black – they have a reach that an NBA power forward would envy, and seem to have their hands in damn near every pocket that contains anything more than lint.

Posted by MrRFox | Report as abusive

Sam Antar your parents must be so proud!!

Posted by oldepro | Report as abusive

Now when Gary Weiss shows up, ask him what he was doing inside the DTCC.

Posted by oldepro | Report as abusive

The idea that these stock all got caught in a short squeeze is very naive. GS had multiple chances to resolve this and at each turn chose the path that brought them most loss. Maybe they weren’t covering their naked short tracks but they can’t justify how they managed the situation. Mafia is an appropriate analogy.

Posted by cwdunlap | Report as abusive

This is getting good.
As United States Attorney for the Southern District of New York, Preet Bharara, working with the Federal Bureau of Investigation and the Securities and Exchange Commission to bring down insider trading rings, recently explained in a statement:

“The charges unsealed today allege a corrupt circle of friends who formed a criminal club whose purpose was profit and whose members regularly bartered lucrative inside information so their respective funds could illegally profit, ” Bharara explained in a statement Wednesday afternoon. dence-reveals-goldman-sachs-engaged-in-s ecret-re-titling-into-goldmans-name-alon e-of-over-20-million-shares-owned-by-mar vell-founders-2012-03-28

Posted by oldepro | Report as abusive

Wouldn’t these clowns have been lynched or shot by now in a different era (if not in a different country today? Even China executes financial criminals) ? It seems “rule of law” lacks meaning in the absence of morality.

Life is truly absurd.

Posted by longshorttrader | Report as abusive