April 5, 2008
Dear Mr. Chairman and Commissioners:
After ten pages of technical hair-splitting, you offer for public comment a new rule defining as fraud under Rule 10(b) if a person offers and security for sale and deceives the broker (or purchaser) about his ability or intention to deliver the security. You specify that scienter is an element of the violation, so evidence must prove the seller intended to deceive as well as deceived in fact. Since the seller never communicates with the purchaser, the seller's broker is the only party who can affirm deception. The seller's broker cannot prove what was in the seller's mind when the order was placed.
All the seller has to prove under your existing Reg SHO is reasonable basis for thinking the shares sold can be borrowed and delivered. The seller would have an easier evidentiary burden than the SEC, in that the seller could testify to a genuine belief that the shares could be borrowed, while the SEC would have to prove that belief was unreasonable and that the seller intended to deceive and actually deceived the seller's broker in placing the sell order.
In context, this proposed rule provides additional technical assistance to naked short sellers in perpetrating their fraud on the investing public. Reg SHO itself is the mainstay of that technical assistance put in place by the SEC and its staff at the behest of hedge funds and prime brokers who foist counterfeit shares onto retail investors through the medium of naked short selling. The SEC is mandated by the 1933 Act and the 1934 Act to protect the investing public from fraudulent practices such as watered stock, which is another name for counterfeit shares. Yet Reg SHO has gone a great distance to construct a pretext permitting sale of non-existent shares by sellers who own no shares, and to allow such sellers unlimited time to deliver the shares sold to unsuspecting investors.
Your commentary on the proposed rule is careful to refer repeatedly to "abusive" naked short selling, apparently to distinguish the abusive practice from the naked short selling that Reg SHO treats as legal. For example, Reg SHO permits dealers in options to sell unlimited numbers of shares without delivering them to buyers - and without informing the buyers of non-delivery - so long as the naked short selling is for the purpose of hedging the options dealer's position. That "gift" options dealers of license to naked short sell is unconscionable and illegal, and ought to be rescinded without more dilatory delay.
When the SEC and its staff had Reg SHO under consideration, you represented to the public that undelivered shares amounted to a small problem involving no more than about $6 billion on any given day. Since adopting Reg SHO, you have represented that Reg SHO has improved the situation and reduced the problem of undelivered shares. If that is the case, then please explain the attached consolidated balance sheet for member firms of the New York Stock Exchange as of July 30, 2007, showing total failed-to-receive and failed-to-deliver shares as valued at approximately $192 billion. That consolidated balance sheet was obtained from the public website of the Securities Industry and Financial Management Association. Also from the SIFMA site, please see the attached graph showing failed-to-deliver and failed-to-receive shares for past years, all at levels much higher than $6 billion.
This evidence, plus the evidence obtained in your own audits of Pequot Capital during 2005 showing hundreds of "short to buy" wash sale transactions designed to create "synthetic" long positions (i.e., counterfeit shares) prove the naked shorting and failure-to-deliver problem is a major issue that overhangs public trust in U. S. markets. Recent concern shown for possible illegal shorting of Bear Stearns and other Wall Street firms rings very hollow when many firms are subjected to rabid attacks on NYSE, NASDAQ and other U. S. markets every day. The time is late for SEC and its staff to salvage any degree of integrity at all.