April 28, 2008
The number of shares issued by a company should equal the number of shares held in brokerage accounts and those accounted for by the tranfer agent when the investor holds certificates.
Because the SEC has not been enforcing the Securities Act, brokers have been crediting something other than company-issued shares to investor accounts. A security entitlement is good for the settlement period. A security entitlement is not a share. Allowing security entitlements to masquerade as real shares past the settlement period is fraud. A share should only be identified as a share in a customer's account after it has been delivered and is actually in that account.
When shares are lent from an account, these shares should be removed and a designation of them having been removed should be made. If the shares are not in the account, then it is fraud for a broker to state that they are in the account. When brokers borrow customer shares from a margin account, the customer should know that the shares have been removed. When a customer receives a payment in lieu of dividend because the shares have been lent out, the only clue a customer has is a substitute for the dividend.
The recent debacle of CMKM Diamonds is an example of how fraud on the market was possible because the SEC is doing nothing, when the technology is readily available to monitor companies. CMKM claimed that they didn't have to report because they had fewer than 600 shareholders, when there were 40,000 shareholders defrauded. The SRO's are incapable of monitoring the number of shares, but the SEC could easily compile the number of shares and the number of shareholders daily from the brokerages and transfer agents.
1. How many customers hold ABC shares?
2. How many shares of ABC are credited to customer accounts?
3. What is the number of issued shares reported by the company?
4. Is the company reporting?
If the number of people holding shares is greater than the threshold for reporting, and the company is not reporting, the trading should be halted.
If the brokers and transfer agents report more shares credited to customers than the number of shares reported by the company, trading should be halted.
If a scam like CMKM Diamonds was issuing shares, while claiming that the price was going down because of naked shorting, investors would have known almost immediately that the company was a fraud when there were more shares in customer accounts than the company reported and from the collected data if it had been published daily.
Both shares and security entitlements (fails) should be compiled. This combined number less the number of legitimately issued shares would show the "liquidity" that the SEC insists that the market maker exemption needs. When this liquidity becomes too large or lasts for too long, then the SEC could look to see if the fails to deliver are intentional.
The technology is readily available to compile this information and to put transparency into the market. Investors should know at all times how many real shares and share entitlements are in the market.
All you need to monitor is the shares and share entitlements credited to investors. If there are more shares credited to customer accounts than the company has issued, the SEC should investigate the brokers who are abusing the market maker exemption or the company who is dumping shares into the market. Shares that are on loan would only be accounted for in the account of those who bought the shares from the short as the lent shares are removed from the lender. Long-standing naked short positions that are being kited around ex-clearing would show up as share entitlements(fails).
Since the security industry insists that the market maker exemption is necessary and this is the root of fraudulent shares and abuses by some of the market makers, investors should at least be aware of how much fraud there is in the market. When share entitlements exceed a reasonable amount, perhaps a half percent of the outstanding shares or 10,000 shares, a red flag should alert regulators to potential fraud. When shares credited to customers' accounts exceed the registered number of securities and these are not share entitlements, both the public and Enforcement would be alerted to a scam company.
Since these numbers are in aggregate, no trading strategy would be revealed except for those who are trying to manipulate the market. Legitimate shorts who borrow shares would not reveal their positions, but these would be accounted for as real shares in the purchasers account. Only the illegal activities of criminals would be revealed with excessive shares from a scam company or naked shorting and abuse by market makers.
We don't need another statement about something that is illegal being illegal. The SEC needs to monitor the market as it is obvious that the SRO's aren't capable or motivated enough. Pubishing the numbers would motivate the brokers to play by the rules.
The transparency that would come from this would stop the fraud. Brokerages who persistently fail to deliver and create share entitlements beyond the settlement period should lose their exemption. "Abuse it, you lose it"
This is such a simple concept, one has to wonder why the SEC hasn't published the numbers before. It is probably because the SEC is protecting the criminals who are making a mockery of our market. This is no exaggeration. Why else would a regulator slip in "grandfathering"?
Publishing the numbers does not need to be discussed. Hiding the number of fails and the mindset of the Commissioners that foisted grandfathering and the options market maker exemption on the market to benefit the criminals... that is the problem.
If an accounting firm had to balance the books for the market, they would refuse to sign off knowing that there is wholesale fraud with the way brokers are redefining securities and pretending that a share entitlement is as good as a real share.
Account for the shares. publish it daily, and stop the fraud.