January 26, 2007
The Honorable Christopher Cox
Securities and Exchange Commission
100 F Street, NE
Washington, D.C. 20549
Dear Chairman Cox:
I entirely support the proposed amendments to Regulation SHO (Release No. 34-54154; File No. S7-12-06). Furthermore, if the SEC is truly dedicated to enforcement of Section 17A of the Securities Exchange Act of 1934, then I believe that eliminating illegal "grandfathering" and eliminating the criminally abused options market maker exception are only first steps that need to be taken to stop delivery failures. Many other comment letters wisely suggest the actions the Commission must take, which include complete transparency, serializing securities, requiring a pre-borrow, and meaningful criminal penalties for individuals guilty of violating the rules.
The purpose of this letter, however, is to comment specifically on the Commission's proposal to require previously grandfathered fails to be closed out within a 35 settlement day phase in period from the effective date of the amendment. Interestingly, if the Commission had shown any sense of urgency in solving this problem which plagues our markets and acted in a timely manner by implementing the amendment long ago, debate over this time period would be moot by now.
First of all, the Commission's stated rational behind creating the grandfather clause was to prevent volatility and allow those pre-existing failed positions to be "cleaned up" on their own. Clearly, this did not occur as the current amendment is proposed to deal with these same failed deliveries. Thus these positions have had ample opportunity already to "clean themselves up". Having squandered over two years and counting to close these positions out do they deserve 35 more settlement days?
Furthermore, the simple law of supply and demand shows a long phase in period to be inconsequential. Here, you have a fixed supply of legitimate shares from which the failed deliveries must be purchased, of course assuming that the options market maker loophole is closed at this time. Given the relatively short time frame for these buy ins to occur, we can assume that external factors which affect the price of this supply will be net neutral, removing incentive for delay. Thus as each failed share is bought into a legitimate share, the price of the remaining pool of legitimate shares may be expected to rise. Therefore the "smart" fail will be first in line to buy in and pay the lowest price. Indeed, the "smart" fail will theoretically anticipate the Commission's action in approving the amendment and buy in immediately. So a one-day phase in period is all that is required for the "smart" positions.
However, there are bound to be fails which should not be considered "smart". These fails will delay buy in for a variety of reasons: hope that some other rule change may occur before the 35 settlement days pass which will then not require buy in, hope that some bad news may befall the supply of legitimate shares during the 35 day period which lowers the price of this supply, or perhaps pure procrastination. These fails will likely wait until the last day of the phase in period to buy in, however many days or months this period lasts.
Therefore, I propose that the Commission adopt a two settlement day phase in period for previously grandfathered fails to be closed out; one day for the "smart" fails which will probably be already closed out by then, and a second or last day for the remaining fails. Further I suggest that the amendment is adopted immediately. Either it is a problem and thus must be dealt with now, or it is not a problem and the issue should be dropped. Every shred of credible evidence points to the former.
The investing public and this nation's industry are counting on the Commission to enforce the law without further delay. If the Commission is not up to the task, she should strike her colors and retire from the field of battle in order to make way for the people of strength and integrity that we both need and deserve.