NEW YORK (TheStreet) -- One of the more curious legal battles under way in Corporate America involves two companies, Goldman Sachs and Overstock.com, which score close to 10 on the Enron-Halliburton Generally Obnoxious Scale.The suit concerns one of my favorite Wall Street conspiracy theories: that naked short-selling has destroyed untold thousands of innocent, sweet little companies. This suit was filed back in 2007 against a dozen Wall Street prime brokers (now just Goldman and Bank of America's Merrill Lynch subsidiary), and in the past I've viewed it with disgust. I mean, if you're going to sue bankers, how about suing them over something they actually do, and not to shift blame for your share price being in the commode? Well, folks, I'm here to tell you that I've changed my mind. I like this lawsuit, and even though it's been dismissed -- surely no obstacle to continued publicity -- I'd like to see it continue to make waves. The reason is that discovery in the suit is beginning to emerge, and I think we may actually get to the truth behind naked shorting. And from what I've seen, it's not going to make either Goldman or Overstock (or any other naked shorting crybaby) look very good. Mind you, the facts certainly won't put an end to the conspiracy theories that have swirled around naked shorting -- the truth is useless against paranoia -- but perhaps it will have some effect on the regulators who have wasted untold resources dealing with crackpots and charlatans over this issue. What changed my mind was a column by Gretchen Morgenson that appeared Monday in the New York Times, which was swiftly followed by an informative rejoinder by Reuters blogger Felix Salmon later in the day. With all due respect to these two fine journalists, I suggest that both of them are missing the point. I'll be coming to that in a moment. Morgenson's column focuses on a deposition in the case from Marc Cohodes, who was manager of the now-defunct Copper River Partners hedge fund. Copper River, formerly known as Rocker Partners, had been short Overstock shares, and had previously been sued by Overstock for supposed "stock manipulation," in a case that struck me and quite a few other observers as an effort by Overstock's CEO, Patrick Byrne, to intimidate critics of his famously erratic management of the company. What's interesting about his deposition, the full text of which is appended to the online version of Morgenson's column, is that Cohodes was considerably harder on Goldman than he was on Overstock.
For one thing, he alleges that Goldman effectively put his hedge fund out of business. Cohodes maintains that at the time of the 2008 stock market meltdown, Goldman crushed his hedge fund by imposing "house calls" -- margin calls not required by federal rules. The reason is that some of the shares that he was shorting (none of which were Overstock) had inexplicably climbed in value despite the general stock market disaster. Cohodes testified that "someone was running in front of the shares." He then goes on to muse that Goldman was engaged in the front-running, saying that "the guys at Goldman are common criminals, just common criminals." (A Goldman spokesman has said that the front-running allegations were investigated and found to be not true.) But the real dynamite pertains to naked shorting. And this is where neither naked shorting conspiracists nor Goldman are likely to be very happy. In an ordinary short sale, a stock has to be borrowed before it can be sold. In a naked short sale, the stock is not borrowed. Although stock market conspiracy theorists have long pointed the finger at hedge funds for engaging in that practice, in fact that's pretty much impossible unless the broker that makes a market in the stock is in cahoots with the firm. And that's where the stock market conspiracy theories fall apart. Why would a Goldman or a Merrill give a hoot about the share price of a company like Overstock or any of the other grimy companies targeted by short-sellers? 10 Stocks Boosting Little Funds to Big Returns Nothing in Cohodes' deposition supports the conspiracy theory. He maintains that he not only borrowed the stock of every company he shorted, but paid hundreds of millions of dollars to Goldman for the privilege of doing so. Indeed, in the Overstock suit, Overstock never alleged that he naked-shorted the stock. But his deposition raises an intriguing question: Did Goldman naked-short the shares, not to screw Overstock but to rip off Copper River -- collecting fees for stock borrowing that never actually happened? Cohodes testified that when he first began shorting Overstock's shares in early 2004, the stock was easy to borrow. But later, as the company attracted shorts like bees to an open honey jar, the stock became harder and harder to borrow, making it more costly for Copper River to short. Cohodes never comes out and says so -- he refers to it as just "speculation" -- but he raises the possibility that Goldman naked-shorted the stock while charging unjustified fees, which, in turn, was amplified in the Times column on Monday.
Cohodes says in his deposition testimony that partners of the firm discussed that possibility at the time Goldman imposed its "house call" on the firm in 2008. Why had Goldman been so heavy-handed with them? "So we assumed -- assumed, didn't know -- that this could have been an issue with them." (By "this," he testified, he meant naked short positions.) In other words, Copper River was crushed in order to cover up for the naked short positions. Goldman vigorously denies that it engaged in naked shorting. 18 Dividend Stocks That Will Outlive the Hype In his Reuters blog on Monday, Salmon was unimpressed. That scenario is not new, he points out, as it had first been made in the book "Selling America Short"by a former Copper River partner, Richard Sauer, a couple of years ago. The evidence of naked shorting by Goldman is "highly circumstantial," he argues. Pointing to a documentary on naked shorting that Byrne is promoting, Salmon says "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." Personally, I think that both Salmon and Morgenson are missing the point. I agree that the actual evidence of naked shorting by Goldman is a stretch. But the Cohodes deposition, and Sauer's book, raise an intriguing hypothesis: that naked shorting, to the extent that it exists at all, is not what the conspiracy theorists like Byrne say it is, but a simple case of brokerage firms taking fees from their customers -- in this case for loaning hard-to-borrow securities -- and not delivering. That would mean that Overstock, which is in dire financial straits -- and whose shares are trading at close to a nine-year low -- has been throwing money down the toilet by pursuing a lawsuit in which the true victims, if there were any, were not Overstock or "thousands" of nonexistent companies but rather the short-sellers that it despises. How's that for ironic? 7 Health Care Stocks to Weather Supreme Court Challenges Goldman and Merrill have fought against public disclosure of the massive amounts of documents that have emerged from the Overstock lawsuit, and are expected to appeal a court ruling that the documents must be released. If they are released -- and I hope they are -- I have every expectation that Overstock will put its PR machinery into high gear and spin the results to support its tired conspiracy theories.
But I suspect that the most we'll see is the replay of an old story: banks screwing customers. Gary Weiss's most recent book, AYN RAND NATION: The Hidden Struggle for America's Soul, was published by St. Martin's Press in February.