Most of the examinations of stock manipulation published here on deepcapture.com take place after the fact, the damage being done. However, we’ve became aware of instances of apparently illegal, manipulative trading in several companies’ stocks, happening right now, which we have the ability to monitor and report on in nearly real time.

I’ll starting with Sears Holdings Corporation (NASDAQ:SHLD).

A few months ago, an unusual trading pattern in shares of Sears emerged, in which large blocks of shares change hands within minutes of deep in-the-money call options equivalent to precisely the same numbers of shares in these blocks. This behavior is consistent with the illegal “reset” transaction described in the enforcement case brought by the SEC against naked short seller Steven M. Hazan:

“…a market participant who has a “fail-to-deliver” position in a threshold security buys shares of that security while simultaneously selling short-term, deep in-the-money call options to – or buying short-term, deep in-the-money put options from – the counterparty to the share purchase. The purchase of shares creates the illusion that the market participant has satisfied the close out obligation of Reg SHO. However, the shares that are apparently purchased in the reset transactions are never actually delivered to the purchaser because on the day after executing the reset, the option is either exercised (if a call) or assigned (if a put), transferring the shares back to the party that apparently sold them the previous day. This paired transaction allows the market participant with the fail-to-deliver position to effectively borrow the stock for a day, in order to appear to have satisfied the close out requirement of Rule 203(b)(3).”

If you want to see the each of these reset transactions in detail, you can do so here. But if you’re content with the bottom lines, take a look at this table, keeping in mind each call option contract gives the buyer the right to purchase 100 shares of the underlying stock (meaning, these trades were undeniably “matched” to one another).

Take a look at how these blocks trades appear when charted.

SHLD matched block trades: click to enlarge

Looking at the relationship between these matched blocks and the delivery failure data currently available suggests the blocks are a pretty reliable predictor of delivery failures reported two days later.

SHLD matched block trades and delivery failures: click to enlarge

Moving fails back two trading days we see just how reliable a predictor these matched block trades really are.

SHLD matched blocks and failed trades, offest -2 days: click to enlarge.

On average, SHLD fails are roughly 102% of these matched blocks. Given that relationship, I feel quite confident predicting how the as-yet-unreleased SHLD delivery failures will appear (note the dashed line).

SHLD matched block trades and offset delivery failures with prediction: click to enlarge

Now for the good and bad news inherent to this situation.

The good news is: this unusual market activity is fairly easy to spot.

The bad news is: despite being easy to spot, in recent months multiple companies have come under identical attack, suggesting whoever  is responsible is not too concerned about the consequences of overtly violating the securities laws…a familiar situation for anybody who’s followed deepcapture.com for any length of time.

I’ll have more on this subject as soon as the SEC fails data are released, so stay tuned.

 

UPDATE:

Last week I dared to predict the number of then unreleased delivery failures in shares of Sears Holdings (NASDAQ:SHLD). The figures I ultimately settled upon (after two minor tweaks in the days to follow) were:

1/29/2010 879,444
1/28/2010 873,222
1/27/2010 870,570
1/26/2010 851,904
1/25/2010 848,742
1/22/2010 865,266
1/21/2010 857,106
1/20/2010 1,535,508
1/19/2010 1,540,914

This morning, the SEC having yet to release the numbers, I explained the basis for my prediction, which is in simple terms, based on a pattern of apparently manipulative naked short “reset” transactions the Deep Capture team has observed in SHLD, and how those trades consistently predict how many shares of SHLD will fail to deliver after two days.

Well, literally moments after I published my explanation, the SEC released the numbers.

I asserted that my prediction would be accurate to within +/-2.5%. I’m embarrassed to reveal that in the end, my predictions were on average accurate to within 2.55%.

Sorry. I’ll try harder next time .

At this point, the  most relevant question is: will the SEC do anything about this obvious violation of the law?

Sadly, I predict that no, the SEC will not.

The next most relevant question is: will the manipulator continue manipulating, knowing he or she has been spotted?

Because I suspect the manipulator is operating without much concern over being held accountable, I must also predict that no, this pattern is unlikely to change.

However I can confidently predict that Deep Capture will continue identifying and reporting on these sorts of abuses, in the trading of SHLD and several other companies, in the very near future.

Mostly inconsequential postscript: Deep Capture team member Patrick Byrne, who possesses a doctorate degree in mathematical logic, points out to me that instead of average error, I should have used weighted error, in which case my prediction was off by just 2.51%.

Judd Bagley is a reporter for Deep Capture