April 6, 2008
I believe that finally you are heading in the right direction. I don't believe however that you are going to solve the problem. Recognizing a "Naked Short Sale" as fraud is a solid move that should be applauded as it is a move in the right direction to recreate market confidence in the broader capital markets to the benefit of all vs what was going on that benefitted very few at the expense of those investors that actually create the markets in the first place. I would characterize those investors as the investing public. Without there collective capital, there would be no markets. My problem here is that the US market is primarily a "rules based" market, and simply creating a new rule governing a process simply leaves those most to benefit with the challenge of creating a new activity to circumvent the rule. As this is also a current issue under review in Canada and that up here we typically follow your lead when it comes to capital markets, I think we all need to get this one right. To successfully achieve the goals of your underlying principles, I believe you need to take the additional steps I have outlined below.
1) Naked Short selling should be illegal, period. I have witnessed many occasions where there is good natural buoyancy on a limited liquidity stock whereby the momentum driven naked short activity was conducted over one or two day periods which falls well within the three day settlement period. These strategies are routinely conducted by institutional traders, market makers or any savvy pro traders. This activity erodes market confidence no different than the failed trades "fraud" that exist beyond the three day settlement period and are far more common. A mandatory requirement to locate a stock to borrow for sale should be in place for any legitimate market short activity.
2) Now that at least there seems to be a willingness to call a naked short what it is, "fraud", the responsibility of enforcement of this fraud should be removed from the hands of any regulatory or market related body and placed squarely in the hands of those that do such, without prejudice, on a daily basis. Because these activities routinely happen across State, Provincial and our collective Federal/National boundaries, responsibilities for enforcement and prosecution should fall into the hands of Federal/National policing agencies like the FBI, US Secret Service and in Canada, the RCMP IMET teams. Comically, the markets in both the US and Canada are virtually devoid of enforcement prosecutions of these types of activities, yet our collective court rooms are jammed with penny anti sub $10,000.00 fraud cases from other types of criminal activity which are non capital markets related. Part of the reason for this seems to be the unwillingness and, for whatever reason, the inability for those currently responsible to act, as well as what appears to be an ongoing turf war between the policing agencies and the regulatory/enforcement agencies. Our policing agencies are very good at what they do. They simply need a clear mandate and the Federal/National financial support to augment their ranks to go after these crimes as it is clear that it would mean incremental activity load.
3) Now, if you can collectively buy into the notion that that our Federal/National policing agencies and prosecutors should be leading the charge here, then one must also consider the recourse that can be levied against such crimes. I firmly believe that because it is fraud, then it should fall under the commensurate criminal code of the offended jurisdiction and jail times and or fines levied against a successful prosecution should correspond with any like and similar activity without prejudice to the fact that it is a "White Collar Crime" vs a "Blue Collar Crime".
4) Finally, I believe that there is a significant lack of public disclosure on this issue as it relates to daily trading activities. Because at times these activities can place significant downward pricing pressure on a stock, all market participants should be aware of the activity as it is happening and who is conducting it. A comment made to me by a member of a policing agency is that even they have a difficult time following the trail because of lack of disclosure. When asked of the regulators what their reasoning for this is, they respond that is what is required to make an efficient market. I ask "efficient for who"? In my mind that simply translates to limited disclosure as only a few market participants are privy to that trade information and as such benefit from trading, or not trading because of a strong short strategy being played out that could erode the public value of the equity.
While an active CEO, I had two primary responsibilities to investors. One was to create real value in terms of growth in earnings, EBITDA and cash-flow, all on a per share basis and in a manner that reflected good solid ethical conduct related to all matters of the business and secondly to see that value reflected in market pricing so an investor could be rewarded for their patience through the ability to crystallize on their capital appreciation over time through good communication with analysts and solid IR work. The level of disclosure required for us to conduct our daily business activities was significant and in fact there was a recommendation at one point for daily disclosure of insider trading information on public companies. Disclosure issues related to public companies is now one of the largest single overhead costs within a companies overhead whether it be for financial reporting, prospectus issues or any other public documents. I have never been able to reconcile that with the limited.........or total lack of discloser relating to shorting in general, never mind naked shorting either of which can have a negative pricing impact especially on a limited liquidity stock no different than a substandard or neutral financial report. When presenting the argument to various market participants that one should be able to naked buy a stock (essentially removing any amount of stock for sale without paying for it, which is a direct offset), it was suggested to me that I would be thrown away in jail and somehow, the key would go missing. Go figure??
I thank you in advance for the time your group has invested in this matter as well as for the opportunity to provide my input.
Best Regards
Michael E Heier