July 23, 2006
In its mission to protect individual investors from those who would abuse the system, the SEC should be commended for addressing the persistence of failures to deliver (FTDs) in a small number of stock issues. Given the SEC's decision to "grandfather" fails extant when Reg SHO went into effect, we can only presume there are massive numbers of FTDs in the market, otherwise the SEC would simply order them bought in.
Unfortunately, Reg SHO does nothing to curb naked selling of stocks, as it only requires the seller to "locate" rather than deliver shares, it does not require delivery -- ever, and it imposes no penalty on those who violate the regulation. It's toothless and meaningless.
I want to know when the SEC is going to do its job and clean up the FTDs. It must be done eventually. I don't mind if they give the prime brokers a year or 18 months to finish the job, but they must be forced to buy in naked sales, as the buyers of these shares are sitting on worthless "share entitlements" not backed by real stock. I believe hedge funds are taking advantage of the toothless Reg SHO by colluding with prime brokers to naked-sell large numbers of shares in a few targeted stocks, absorbing demand and driving the targets' share prices down. The only solution is to settle the trades, and waiting will only make the problem worse.
Reg SHO would be great if it outlawed naked selling and imposed penalties on the prime brokers who own the DTCC for failing to cover naked sales. Unfortunately, Reg SHO does neither. It is a meaningless regulation, serving only as a treasure map for stock manipulators.
If the SEC doesn't do something about this, hedge funds' lawsuits against prime brokers, lawsuits by NFI investors against prime brokers, and investigating state attorneys general will.
Chairman Cox, please do your job. Settle the trades.