April 12, 2008
Dear Mr. Chairman and Commissioners:
Please give this petition your prompt and favorable attention. In my opinion, the petitioners correctly argue that every registered security involved in trading transactions under the federal securities laws must at all times remain a registered security as defined by federal law and cannot be converted to a security of a completely different nature and value (a security "entitlement" in the nature of a claim against the buyer's broker) for the benefit and convenience of a short seller who chooses never to deliver the shares sold. Unfortunately, this convoluted state of affairs is the present opaque trading environment of U. S. equity markets due to the ill-advised regulatory and enforcement practices of your agency.
Your director of market regulation, Eric Sirri, confirmed this is the case in remarks made to a New York audience on October 16, 2007, as follows:
“The vast majority of US investors hold their securities position as beneficial owners at a traded securities are held by these intermediaries on behalf themselves and their customers. Most of these securities are deposited with the Depository Trust Company, the DTC, a Commission registered clearing agency that acts as a securities depository. And those securities are held in fungible bulk for the benefit of DTC participants. Broker participants in DTC own a pro rata interest in the aggregate number of shares of an issue held by DTC. And their beneficial owners, the end customer, owns an interest in the shares in which the brokers, themselves, have an interest. Consequently, there are no specific shares directly owned by either broker participants, DTC, or the underlying beneficial owner. As a result, the beneficial owner's ownership cannot be tracked to a specific share, but rather, his ownership interest is represented as a securities entitlement at his or her own broker dealer. Each of these beneficial owners don't own the actual shares that have been credited to their account, but rather, they own a bundle of rights defined by Federal and State law and by their contract with the broker. Consequently, a beneficial owner may not have the right to vote the securities credited to his or her own account, but ends up with what the beneficial owner's contract says. That's news to a lot of people.”
Mr. Sirri's remarks candidly concede that investors in U. S. markets do not actually get the shares they think they are buying when they pay their money, even when the share are delivered by the seller. He admits buyers are defrauded by saying: "That's news to a lot of people." It is also news to a lot of people that in many transactions the shares bought are not even delivered by the seller, and the seller actually gets the investor's money without delivering anything for it. This leaves the buyer's broker exposed to the risk of being unable to respond to the buyer's claim for the shares, which is considerably higher risk exposure to the buyer than if the buyer's broker actually receives shares on the buyer's behalf.
This deplorable, untenable regulatory environment must be rectified at the earliest possible date. This petition is the best vehicle for accomplishing the reform and clean-up necessary. However, I respectfully suggest a modification of the proposed rule set forth in the petition. I believe the buyer in any transaction in which the shares are undelivered at T+3 should have the right to demand that the shares purchased be "bought in" from the seller's account and delivered to the buyer. If the seller who fails to deliver shares is exposed only to the prospect that the transaction will be canceled and the seller will keep his money, then sellers will be able to "paint the tape" with impunity, failing to deliver and affecting market prices with sham transactions, and the only thing that will happen will be cancellation of the sham transactions. A "wash sale" should not be the outcome of any trade entered into by a seller and a buyer. The buyer should be entitled to close the trade on the shares at the agreed price at the time of the transaction, regardless of the price at which the seller is bought in to obtain the shares he sold and committed to deliver.
The types of illicit trading practices under discussion here strongly resemble those discovered in the Pecora hearings of 1933-1934. Your agency was established under law intended to prohibit and prevent those practices. I encourage you to fulfill that historic and statutory role.
Managing Principal and Chief Economist
Classical Capital LLC
San Marino, CA