Matt Levine: Target of naked short sellers is confused

(Bloomberg) — Here is a lawsuit that I pass on to you mainly because it is adorable. There’s a little company called Life Partners Holdings that is “engaged in the secondary market for life insurance known generally as ‘life settlements.’” 

Life Partners has an equity market cap of about $53 million based on yesterday’s closing stock price of $2.83 a share, but traded at almost 10 times that price in early 2009. So it seems to have fallen on hard times.

I know very little about the company so I will not speculate on the reasons for that, though I will throw out there that the Securities and Exchange Commission’s long-running case against Life Partners and its executives for fraud probably didn’t help. However, Life Partners won that case last month, and is perhaps understandably aggrieved about having had to litigate it.

The other thing that Life Partners is aggrieved about is naked short selling, and I must say, there seems to be an uncanny correlation between (1) being accused of securities fraud and (2) accusing your enemies of naked short selling. But Life Partners is pretty sure that naked short selling brought it down, and now it’s suing optionsXpress, a brokerage subsidiary of Charles Schwab Corp., for helping those naughty naked shorts.

From its complaint: Plaintiffs are informed and believe and thereon allege that Defendants, and each of them, have engaged in the unlawful creation and sale of millions of shares of counterfeit-phantom stock which said Defendants have mischaracterized to be the genuine stock of Life Partners and 24 other public companies.

Once the counterfeit-phantom stock trade is placed into circulation, it continues in circulation in the securities markets much like counterfeit bank notes continue in circulation after they are introduced into the monetary system. It thus has the effect of increasing the supply of stock available on the market for sale.

The increased supply of stock, albeit counterfeit-phantom stock, generally has a depressing effect on the price of the genuine stock of the public company whose name the counterfeit-phantom stock bares. As alleged below, naked short sales of counterfeit-phantom stock harm investors holding genuine stock, investors who receive the phantom stock, and the public company whose stock is diluted with counterfeit-phantom stock. It goes on irresistibly in that vein.

None of this is even a little bit true, but, like I said, it’s adorable. I mean, wait, no, one important part of it is true: OptionsXpress really did facilitate illegal naked short selling in Life Partners stock! I guess that’s a big one.

Here is the SEC’s case against optionsXpress, and here is the administrative law judge’s decision (referred to by Life Partners). OptionsXpress totally helped its clients do a lot of naked short selling, in Life Partners and other stocks, and was fined millions of dollars for it.

Otherwise, though, nope. We’ve talked about naked short selling before (and about optionsXpress’s naked short selling before that). The key thing to remember about naked short selling is that it’s a way to make money off of stock borrow costs without taking stock price risk; it’s not usually a way to make money by manipulating stock prices.