Subject: File No. S7-08-08
From: Nicholas Stavriotis, Mr

March 22, 2008

Naked short selling opens the door to a question everyone at the SEC must be asking now:
What kind of trading results in losses or debts which don't get collateralization on a marked-to-market basis, thus protecting the broker every evening?
The most obvious one I can think of is naked short selling, wherein the miscreant manipulators naked short sell (NSS) a company from $10 to $1, and due to the marked-to-market nature of the collateral they are required to keep to collateralize their position, their profits on the short from $10 - $1 are withdrawn and spent on jets and such. No problem, as long as the stock stays depressed - but if it rises, the broker (remember Refco) could well be in a situation where the collateral is woefully inadequate to cover the new obligation. A friend of mine described the math this way:
"Assume I am your broker, and you are short 10 million shares of some stock that today is at $10. That is 10 million X $10 = $100 million dollar short position. I insist you keep 102% (in this case, $102 million) in cash with me as collateral.

Thus your incentive is to keep shorting it: as the price collapses, you can suck more and more cash out of the sold shares and your collateral with me.

If another 10 million shares were able to drop the price to $4, then you now have to have collateral of 20 million X $4 X 102% = $81.6 million.

You have thus pulled out however much you sold those 10 million shares for (say, at an average price of $7, you would have gotten 10 million X $7 = $70 million) plus the $102 million - $81.6 million = $20.4 million, for a total of $70 million + $21.4 million = $91.4 million.

Now if the stock spikes to $15 some day. You are short 20 million shares, and should have $15 X 20 million X 102% = $306 million in collateral with me. So now, you have to pony up $306 million - $81.6 million = $224.4 million.
Ouch.

You cannot come up with $224.4 million. I might buy shares to cover as much of your short as I can, but I run through your $81.6 million pretty quickly and only get (assuming the price does not move) $81.6/$15 = 5+ million shares.

You crash and are gone. But there are still people out there who think
they own the 20 million - 5 million = 15 million shares that now become my obligation.
BTW, by "trading losses" I'll bet they mean "trading positions."
This is a pretty good description of the math, as well as the nature of the systemic risk dollar hit - never mind the NSS, which could be many multiples of that.
Now imagine that multiplied out over hundreds and hundreds of stocks.
That's the systemic risk issue. And it also should tell the SEC why the brokers work with their large hedge fund customers to make sure that any stock that has come down 50-70%, and is on the SHO list, stays depressed. The brokers' survival is on the line, right along with their hedge fund customers. Last year's big bonus was made allowing and aiding them in beating the stocks down - this year's survival of the brokerage could well be tied to ensuring the stocks don't go back up.
How many more Refcos are percolating on Wall Street? Quite a few, is my guess. And I bet the SEC, in its darkest and most frightened moments, understands precisely how out of control this is and why File No. S7-08-08 is a no brainer –end naked short selling now.
Like many other retail investors, we urge the SEC to end all market maker exceptions mandate that all trades settle within 3-days and put teeth into all the regs now on the books.
The SEC doesnt need seeing eye dogs to locate all the FTDs they just need some guts.

Respectfully,

NMS