April 10, 2007
To The Commissioners:
I again urge you to act without further delay to eliminate every instance under your rules (including but not limited to Reg. SHO and the options market maker exception) by which brokerages or other market intermediaries may transmit (clear) funds of a buyer before the securities bought have been actually delivered by the seller.
Your agency has already delayed decisive action to eliminate these serious defects in U. S. markets transparency far too long. Experienced observers of trading practices in the U. S. can readily identify securities under attack by short sellers who fail to deliver shares, thereby creating counterfeit or phantom shares to dilute the public float and reduce the share price. This type of manipulation is very effective in creating fears in honest investors that something is wrong with the issuer company; otherwise the share price wouldn't be dropping. These honest investors then abandon their investments at losses, driving share prices down further.
You are informed, I'm sure, that a prominent television show host recently described how profits are made by astute short-side hedge funds by spreading false rumors with media outlets that readily cooperate in denigrating companies. The video of those insights into obviously illegal, fraudulent price manipulation has been viewed by thousands of American investors, as well as many others around the world. The perpetrator of that video recently appeared on a nationally syndicated radio show to deny his own veracity as a means of impeaching the evidence he had provided against Wall Street, the financial media and the hedge fund industry.
You must consider that market disinformation disseminated by short-side hedge funds has the superficial appearance of honesty because it criticizes companies rather than praising them. Many investors (and media reporters) do not readily understand that interested parties can make money when a stock price goes down. Thus, bad news about a company is viewed as if it must come from disinterested parties and is true. In reality, however, evidence is mounting of widespread false attacks on companies by parties who attack the stock price through failing to deliver shares sold short.
You should be aware, also, that three class action complaints filed in the U. S. District Court for the Southern District of New York during 2006 (Case Nos. 06 CV 2859, 06 CV 2933 and 06 CV 13676) allege conspiratorial actions by defendant prime brokerage firms consisting of deliberate failure to deliver shares sold short in all transactions by hedge fund clients. Each of the three complaints further alleges that the defendant prime brokers charged high fees for lending securities to be sold short, but in every transaction such securities were neither actually borrowed nor delivered to the buyer. By these alleged actions, the defendant prime brokers are said to have profited by keeping fees charged by them that ordinarily would have been expended to pay for borrowing the securities. These allegations indicate very widespread abuse of securities laws involving many millions of shares. That these allegations could be so long in the public arena of the federal courts without comment or investigation by the SEC severely undercuts the claim that U. S. securities markets are the most transparent in the world.
The options markets themselves have become regular demonstrations in securities price manipulation as each options expiration date arrives. However, the options market maker exception that permits that intermediary to sell non-existent shares to an unsuspecting buyer without delivering actual shares must be ended. The rationale that this exclusion provides desirable "liquidity" is entirely invalid. Liquidity is never more desirable in the markets than a fair price to buyer and seller. The existing rule permitting sale of non-existent and undelivered shares serves no purpose other than to enable sales at artificially low prices to the detriment of existing shareholders and for the profit of those engaging in the practice. Moreover, "put" options contracts are often bought by short-side hedge funds specifically with the arrangement that the options market maker will immediately sell short the number of shares covered by the "put" contract directly to the "put" contract buyer. This provides short-side hedge funds immediate access to newly created counterfeit shares to sell on the market, driving down share prices. The SEC must know this practice is occurring daily in the trading of many securities in U. S. markets, and it must be stopped without further delay. Throughout the term of the "put" contracts, the counterfeit shares dilute and drive down the share prices while creating artificially high volume and volatility of trading.
Half measures will not restore the credibility of the SEC, which is presently experiencing the most scandalous crisis of its history. You must act decisively and act now. No buyers funds should be permitted to be cleared to any seller without actual delivery of real securities; every failure-to-deliver should be bought in no later than T+10. My comments have been very direct, but the gravity of this crisis demands no less.