VirnetX: Naked Shorting And Dark Pools

| About: VirnetX Holding (VHC)

It just doesn't seem logical that a 30% of float short position against VirnetX (NYSEMKT:VHC) has been maintained for months on end. How could the short sellers maintain their positions without being forced to cover? Wouldn't short covering be obvious given the short covering rules, an average daily volume of about 1.5 mil shares with 14 mil of 43 mil float shares listed as short? A Google (NASDAQ:GOOG) search on "dark pools and short selling" may provide one answer.

Dark Pools were purportedly designed to "manage" large trades outside the public arena by matching buyers and sellers and executing the trades 'within the pool' before the market became aware of the trades and perhaps tried to move against them. In the search, Goldman Sachs comes up repeatedly since they manage a Dark Pool and clearly are heavily involved in short selling. , Joan E. Solsman quoted from a report by Goldman Sachs (NYSE:GS) "recent rule changes (in short selling) have been effective, but that additional measures on 'naked' short selling - selling shares before they have been borrowed - are not necessary" and " While it reiterated its support for regulation of abusive, or "naked" short selling, Goldman said further regulation isn't necessary and could actually hurt the market. Goldman reiterated the important role legal short selling plays in trading activities and said pre-borrow requirements would hurt liquidity and market efficiency".

So, what is "abusive short selling"? Apparently it isn't defined by selling shares that you don't own or shares that are not available to borrow. Then it would not be abusive to execute a bear raid on a stock by naked short selling in the open market and then covering the short within a dark pool where large volumes can be traded without driving the price back up and without the general market being aware of the players?

Under current SEC rules, the buy to cover would only be reported on the exchanges national consolidated tape as an over-the-counter transaction. Information on the volume or type of transaction may be reported by the crossing network to clients if they desire and are contractually obligated. Is it any wonder that Goldman and certainly others will fight tooth and nail to prevent a rule that you must own or borrow the stock before you can sell it and against any rule which would expose short covering activity in a dark pool? Short covering in a dark pool with high speed trading maximizes their profits since there is little impact on the share price of the equity on the open market and their anonymity is maintained. Trent may well be correct "dark pools are the get away vehicle for short sellers".

It looks like easy money:

  1. buy puts
  2. naked sell the stock short
  3. sell the puts
  4. buy stock back in the dark pool

So what about that VirnetX 30% of float short position that's always reported? The percent of float short would artificially grow over time if the short selling is recorded for open market but the buy to cover takes place in a dark pool and is only reported as an 'over the counter transaction' on the national consolidated tape. As a result, the actual percent of float short position for VirnetX and other highly shorted equities could be dramatically lower than reported.

Disclosure: I am long VHC.