This is Chapter 2 of a 15 chapter series. The entire series is listed here
In January 2007, some 15 months after CNBC’s Jim Cramer announced that the FDA had rejected
Provenge (even though the agency had not yet reviewed Provenge), the FDA assigned “priority review
status” to Dendreon’s application to have the drug approved. Such status is typically granted to drugs
whose trials suggest that they can significantly improve the safety or effectiveness of treating a serious or
life-threatening disease. Some weeks after receiving “priority review status,” Dendreon announced that an
FDA advisory panel would meet on March 29 to vote on whether its treatment for prostate cancer should
FDA advisory panels are made up of doctors and scientists who are employed on a one-time basis to
review a new drug. Their decisions are not binding, but in 97 percent of all cases, the FDA follows the
advisory panel’s recommendations. Given that Dendreon’s data results had been strong enough to cause
the FDA to fast-track things by granting “priority review status”, it was widely expected that the advisory
panel would vote in favor of Provenge, and that the drug would get FDA approval soon after. This was
very good news.
Normally, this would be a time for short sellers to close out their trades. Companies receiving priority
status (moving them down the road to FDA approval) generally see their stocks soar in value, and
typically the prices stay at peak levels, at least until the companies present plans for how they are going
to bring their drugs to market.
But in the middle of that March, there was a strange occurrence: short selling in Dendreon began to
increase at an unprecedented rate. Illegal naked short selling increased as well.
SEC data shows that on March 16, 2007, over 1 million Dendreon shares “failed to deliver” – because
they were sold short by people who did not possess any shares. That is, these naked short sellers took
investors’ money but delivered…nothing.
The numbers rose steadily, so by March 28, the day before the advisory panel vote, more than 9 million
phantom shares were circulating in the market. And consider that the SEC data might understate “failures
to deliver” by factors of ten or more. So by that point the market may actually have been flooded with
about 90 million phantom shares – in a company that had only 100 million shares outstanding.
On the night of March 28, 2007, Cramer commented on Dendreon again. He did not mention the phantom
stock (in May, 2008, he began a “crusade” against naked short selling, but he started this “crusade” just
one day after he was exposed by Deep Capture as a central player in a media cover-up of the naked
short selling scandal). Instead, Cramer offered the long-shot prediction that the FDA advisory panel would
not approve Provenge. He advised Dendreon’s shareholders to “SELL, SELL, SELL!!!”
This was the “battleground.” And Dendreon was under attack.
The next day—March 29, 2007–the FDA’s advisory panel decided overwhelmingly in Dendreon’s favor.
Every one of the 17 scientists and doctors on the panel voted that Provenge was safe, and 13 of the 17
panelists voted that there was substantial evidence that the treatment lengthened the lives of prostate
As you will recall, the FDA had followed the recommendations of advisory panels in 97 percent of all
cases. So at this point it seemed extremely likely that Provenge was on the fast track to approval. Most
experts expected that Dendreon could begin delivering its treatment to prostate cancer patients within six
months. The company’s stock price, which the short sellers had depressed to $4 before the panel vote,
By the first week of April, Dendreon was worth more than $20 a share.
But the short sellers did not relent. The more the stock rose in value, the more they piled on, flooding the
market with still more phantom stock. On the day after the advisory panel meeting, at least 9 million
phantom shares were sold, according to the SEC’s unforgivably incomplete data. During the following two
weeks, between 9 and 10 million shares were “failing to deliver” on any given day. And on one day, April
5, the total number of shares sold short more than quadrupled.
This was unprecedented, and by any reckoning, it was sheer insanity. Given Dendreon’s prospects for
FDA approval, it seemed like the short sellers were flushing money down the toilet. Some observers
racked it up to psychology – the short sellers had grown emotionally tied to their positions, and simply
could not give them up.
But I offer several other possible hypotheses, which are all mutually compatible. The first is that the short
sellers believed that they could generate enough phantom shares to drive the stock price back down,
despite Dendreon’s fantastic news. The second is that the short sellers were aware that there was about
to be released a wave of lopsided negative financial research and media reports (including more from
Cramer) that they expected would crack the stock.
And the third hypothesis is that the short sellers who made this long-shot bet knew something that the
rest of the world did not. They knew that some strange occurrences were imminent, and that these would
diminish Dendreon’s prospects. And given the especially sharp increase in short selling on April 5, they
might have expected that the strange occurrences would begin on that particular day, or soon after.
Alas, something strange would indeed occur on the next day, April 6. And after that, there was another
strange occurrence – then still more strange occurrences, one after the other until it seemed that
Dendreon and its treatment for prostate cancer would no longer exist.
I will describe these strange occurrences, but first we must understand a bit more about a network of
smooth market operators and a “prominent philanthropist” named Michael Milken.
As mentioned, we do not know who was responsible for the illegal naked short selling of Dendreon. The
SEC keeps that a secret.
But while the SEC is of no help, most any Wall Street broker can describe several “proprietary” strategies
that are popular with unscrupulous hedge funds.
One such strategy is known as a “married put.” Normally, a hedge fund buys from a market maker a
certain number of put options—the right to sell a stock at a specified price at a specified date. If on that
date the stock has lost value to the point it is below that specified price, the buyer of the put option (the
hedge fund) makes money, and the seller (the market maker) loses money. To hedge the risk that he
might lose money, the market maker, at the same moment that he sells the put option, also short sells the
stock. This is perfectly legal.
But some market markers conspire with hedge funds to drive the stock price down. Instead of merely
shorting the shares into the market, the market maker naked short sells the shares, and, importantly, sells
those phantom shares to the same hedge fund that bought the puts. As a result, the hedge fund manager
winds up with the puts and a matching number of shares (actually phantom shares that are never
delivered to him, but about which he never complains, or forces delivery, as that would create upward
pressure on the stock, the precise opposite of what he wants). Because the puts and the phantom shares
are equal in number and arrive together at the hedge fund, they are known as “married puts”.
Once in possession of the phantom shares, the hedge fund manager proceeds to fire them into the
marketplace. But he is able to say that he never naked shorted because all he has done is sold the
shares that he bought (wink wink) from the market maker.
Either way, the effect is to flood the marketplace with phantom stock. The hedge fund makes money. And
the market maker is rewarded with more business selling married puts.
Incidentally, the fee charged for such puts do not follow any normal option model pricing (in fact, the
exchanges search for married puts by looking for options that are mispriced in relation to Black-Scholes,
the standard formula that prices options). That is because their pricing is not really a function of any math
or statistics, but is a function of the willingness of the hedge fund to pay the option market maker to help
him break the rules against naked short selling. And that willingness is a function of how difficult it is for
the hedge fund to use other loopholes to break those rules.
In the slang of Wall Street, these married puts are known as “bullets.” Through their maneuverings, the
option market maker and hedge fund manager synthesize a naked short position that puts “bullets” into
the hands of the hedge fund. The hedge fund fires those “bullets” at the stock to make it collapse, timing
the last “bullet” to fire as the hedge fund’s put option expires profitably. If the option position nears
expiration and looks like it will expire at a loss (“out of the money”), the hedge fund manager goes back to
the option market maker, and together they reload by synthesizing more “bullets.”
Until recently, this behavior flourished owing to the “Madoff Exemption” – a rule that the SEC named after
a “prominent” market maker and investor named Bernard Madoff. Mr. Madoff had considerable influence
at the SEC, and helped the commission write the rule that carried his name. This was before Mr. Madoff
became famous for orchestrating a $50 billion Ponzi scheme with help from the Mafia (CNBC’s Charles
Gasparino has reported that Madoff might be tied to the Russian Mafia; whistleblower Harry Markopolis
stated in Congressional hearings that Madoff appeared to have ties to the Russian Mafia and Latin
American drug gangs; and Deep Capture’s own investigations suggest that Madoff did business with
multiple people with ties to both Russian and Italian organized crime).
The “Madoff Exemption” permitted market makers (e.g. Madoff) to sell stock that they did not possess, so
long as they were doing so temporarily to “maintain liquidity.” Abusing that exemption in order to facilitate
naked short selling in cahoots with hedge funds looking to drive down stock prices was blatantly illegal,
but the SEC looked the other way, even as market makers failed to deliver shares for weeks, months, and
even years at a time. If anyone raised a fuss, the hedge funds would say that the phantom shares didn’t
originate with them, the SEC would say that stock manipulation is hard to prove, and the market makers
would say that they weren’t breaking any rules.
After all, they had a “Madoff Exemption.”
At any rate, in March 2007, with Dendreon seemingly on the fast track to FDA approval, most traders
were rushing to buy the company’s shares. A specific set of hedge funds, however, purchased large
numbers of put options in Dendreon. Without a subpoena, we cannot say for sure whether the put options
they bought were married to naked short sales, but simply from their put activity it is clear that these
hedge funds were placing quite large bets against Dendreon, and they maintained these positions even
after the FDA advisory panel voted in favor of Provenge on March 29.
To understand how completely anomalous these bets were, consider that in the entire universe of 11,500
hedge funds, only ten held put options on large numbers (more than 150,000) of Dendreon shares at the
end of March 2007. Two of those ten funds held put options on relatively few (200,000 each) Dendreon
shares and cashed out soon after the FDA advisory panel meeting. They do not appear to have otherwise
been major traders in Dendreon, so I will not mention their names.
The third of those ten hedge funds is Apollo Medical Fund Management, which is managed by a man
named Brandon Fradd. Fradd was once accused of burning documents relevant to a civil court case.
Fradd was also once the limited partner of a criminal named Reed Slatkin, who was indicted for
orchestrating the third largest Ponzi scheme in history. But Slatkin seems to have had minimal
involvement in Apollo’s trading, and I have yet to uncover any evidence proving that Apollo is tied to
naked short sellers or others in the network that this story intends to document. So let us give Fradd the
benefit of the doubt.
Let us focus instead on the remaining seven of the ten hedge funds that held large numbers of put
options immediately after the FDA’s advisory panel handed Dendreon its fantastic news, which was right
at the time that Dendreon was bombarded by illegal naked short selling (phantom stock), and just before
Dendreon was to experience some strange occurrences.
The managers of these seven hedge funds all know each other well. They have all worked with Michael
Milken or Milken’s close associates. They include the following:
- a fraudster and naked short seller who is believed to have stolen billions of dollars with help from
Russian and Italian organized crime;
- a trader working for a man who once managed, along with his father-in-law, the dirtiest, Mafialinked brokerage on Wall Street.
- a trader who co-founded his fund with a man who was jailed for plotting to murder Michael
Milken’s famous co-conspirator, Ivan Boesky;
- a man who became the “most powerful trader on the Street” after working for one of the most
notorious, Mafia-linked brokerages on the Street;
- an accused naked short seller who was at the center of the greatest scandal in SEC history, and
is now under criminal investigation;
- a fellow who once owned a fund that was charged in a massive naked short selling fraud and was
later mixed up in a Mafia-connected, criminal naked short seller’s scheme to bribe agents of the
- a Russian “whiz kid” who was the top trader for a man who once worked at a notorious Mafialinked brokerage—the same brokerage that once employed the criminal naked short seller who
bribed those agents of the FBI.
Again, judging from SEC disclosures of put option holdings, these seven colorful traders (plus Fradd,
whom I have yet to definitively tie to this network) were the only hedge fund managers on the planet who
were placing serious bets against Dendreon after the FDA’s advisory panel voted in support of Provenge.
So let’s get to know more about these seven colorful traders–and then let’s try to surmise whether they
knew about the strange events that were about to occur in the Spring of 2007, and whether those strange
occurrences had anything to do with a “prominent philanthropist” named Michael Milken.