Uncovering the Tactics:
How Market Makers,
such as Virtu Financial,
Hide Short Positions
Using International Entities
Introduction
The world of finance is filled with complex mechanisms and strategies that market makers employ to maintain market stability and liquidity. However, some tactics have come under scrutiny for their potential to manipulate markets. One such strategy involves hiding short positions using international entities. In this article, we delve into the methods market makers use to obscure their short positions and the implications of these practices.
The Offshore ETF Strategy:
Market makers have been known to create offshore Exchange Traded Funds (ETFs) as a means to hide short positions. These ETFs can be composed of a basket of stocks, including meme stocks, which can be shorted without the need to report to regulatory bodies like FINRA (Financial Industry Regulatory Authority). This practice enables market makers to bypass certain reporting requirements, making it difficult for regulators and investors to track the true extent of short positions.
Utilizing Foreign Affiliates::
Another tactic employed by market makers involves using positions in overseas affiliates to net out short positions. This approach allows them to balance their short positions in the domestic market with long positions in foreign markets, effectively masking the actual short interest. This practice is particularly concerning as it can lead to misleading information about the true level of short interest in a stock.
Shorting in Foreign Markets:
Market makers have been known to short stocks in foreign markets to avoid scrutiny in their home markets. By shorting stocks in countries with less stringent regulations or reporting requirements, they can circumvent the rules and regulations of their domestic market. This practice can result in discrepancies between reported short interest in different markets, making it challenging for investors to accurately assess the true level of short interest in a stock.
The Role of Dark Pools and Over-the-Counter (OTC) Trading:
Dark pools and OTC trading provide market makers with additional avenues to hide short positions. These trading venues are less transparent than traditional exchanges, allowing market makers to execute trades without revealing their true intentions. This lack of transparency can make it difficult for investors and regulators to monitor the extent of short selling activities.
Implications and Concerns:
The use of international entities to hide short positions raises several concerns. Firstly, it undermines the integrity of the financial markets by making it difficult for investors to make informed decisions based on accurate information. This can lead to market distortions and potentially harm retail investors. Secondly, the lack of transparency and oversight can create systemic risks, as regulators may be unable to identify and address potential market abuses. Finally, the practice can lead to a lack of trust in the financial system, as investors may question the fairness and reliability of market information.
Conclusion:
Payment for order flow is a system where shares are immediately sold to a customer at what the market maker deems to be “fair value,” and then within 2 days they are supposed to locate those shares, and actually settle the trade. They are only able to do this when they have reasonable belief that they can locate the shares. This “reasonable believe” is where there is a lot of room for market manipulation because if they claim to be able to locate a share, then after 2 days can’t find it, they are given 35 days to try and locate it again. If the price of the stock goes down over that 35 days, then they were essentially able to short the stock without paying the borrowing fee, and without affecting any buying pressure that would have held the stock up. This is strategic naked short selling. It is a predatory tactic, which can be very powerful, especially if multiple large financial institutions coordinate to attack a company from all sides.
You can tell that naked short selling is strategic not accidental by looking at the rates of “failures-to-deliver.” Naked short selling is only profitable when the share price goes down, and you can see the rate of “failures-to-deliver” on a company that is being attacked like First Republic Bank or Gamestop to be 9000 times more likely. Is that coincidence? Or is that evidence of collusion and fraud?
There are many ways to not report short positions, and many ways to borrow more shares than even exist for a company. Virtu Financial for instance seems to be the connecting point between international “liquidity providers” which are completely unregulated like FTX(through Pyth network on Solana and other various connections) or traditional finance with convenient loopholes like Instinet or Credit Suisse to traditional finance to give it legitimacy like JP Morgan Chase or Citigroup. The regulators that are meant to prevent collusion like this are either unaware of the complexity of the transactions or paid off to look the other way. Similar to how alarm bells in the Mortgage-backed securities and total return swaps market were going off as early as 2005 but no one did anything, a bigger systemic risk is looming.
Market making through payment for order flow is not essential, anyone who would rather have an instant settlement of a counterfeit share rather than place a limit order and wait for a counterparty to accept it shouldn’t be trading. There is no money to be made through payment for order flow without corruption, and therefore creates a large conflict of interests for them. Their business model has not worked since its inception. The reason the balance sheet doesn’t show that, is because they mark down the assets sold not yet repurchased at whatever fair value they want. Let’s say for instance they are short on gamestop, they could write down the fair value of what they owe as $1 per share even though the price is much higher and might go much higher still.
Why has no one caught this? In the case of Virtu Financial their Chief Financial Officer, the one who curated the samples for the auditors to sign off on, worked for the same company that audits them. There are several individuals that either came from PWC accounting firm and now work at Virtu Financial or vice-versa. Coincidentally PWC audits all of the other players in this scheme with Virtu such as JP Morgan or FTX.
The systemic risk that Virtu has created must be addressed soon and the risk unwound! They need a full audit by a firm that is not deeply connected to the company.