Subject: File No. S7-12-06
From: Thomas Reilly, Part 4

September 14, 2006

Thank you for the opportunity to comment on Proposed Rule - Short Sale.

Convertible Arbitrage is not dynamic hedging..or is it? (cont)

I don't know when "current practices" began to precede the rulemaking process but it must stop. The letter from the MFA is reminscent of a scene from a movie wherein a thief tells the police he is going to steal something and says "catch me if you can".

Academic studies on the performance of equities after the issuance of convertible debt have consistently found the stocks of the companies issuing convertible debt underperform. Here are some examples:

1. A Working Paper by Ilia Dichev and Joseph Piotroski entitled "The performance of long run stock returns following issues of public and private debt." published
Journal of Business Finance Accounting found that the market does not react negatively to issues of straight debt. The reaction is much more serious when convertible debt is issued, depressing equity values anywhere from 50 to 70 percent relative to the market. Importantly, the reaction is such not only in the short, but also in the long run. Therefore even those sceptical of the hypothesis that markets are efficient should be convinced that there is a difference between issuing straight and convertible debt.

2. A study by Spiess and Affleck-Graves (1999) entitled "The Long-run Performance of Stock Returns Following Debt Offerings" , Journal of Financial Economics found substantial long-run post issue underperformance in smaller,
younger firms that had made convertible debt offerings.

3. Bae, Jeong, Sun, and Tang. (2002) show that convertible debt issuers experience a significant decline in operating performance from the pre- to post-issue period, but
that straight debt issuers do not.

4. Loughran and Lee "Performance Following Convertible Bond Issuance," Journal of Corporate Finance 1998 implemented a buy and hold abnormal return method to examine convertible debt offerings. Thet report that the buy and hold returns
significantly underperformed their matched counterparts in the long run.

The academic studies have determined that equities
underperfom after they issue convertible debt and the underperformance is more pronounced in smaller firms. The academic studies however do not necessarily agree as to the reasons for this underperformance. It is time the the SEC and the Academics start looking into the "current practices" of dynamic convertible arbitrage. While the classic convertible arbitrage is a very important aspect of the market, the dynamic convertible arbitrage is not. The dynamic convertible arbitraguers ("current practice"), with their subjective pricing models designed to maximize hedge fund returns and armed with short sale exemptions can become judge, jury and executioner of a companys prospects, especially in the case of small, illiquid companies.

"Current practices" should never precede the rulemaking process and strict enforcement measures should be taken to ensure they do not.

Short Sale reporting and "worthless" -

The recent release of the first short interest report pertaining to OTCBB, Pink and other OTC securities opens the door to some questions. The list:,2006.txt

contains many securities that should be deemed "worthless" both for tax reasons and to protect investors from predatorial practices that pump worthless securities. The SEC, the IRS and State taxation departments need to address this issue. It is depriving the government of tax revenue and opening the door to the sale (pumping) of worthless securities.

For example, there is absolutely no reason why a security like ACAR, trading on the Pink Sheets for .005 cents, should not be deemed worthless. The company ceased to exist over six years ago. The above list contains hundreds of similar companies. A consistent system of evaluation should be in place to deem securities "worthless" and remove them from trading on any exchange.

Related topic - Securies Lending - Mutual Funds-

Don't let the States beat you to next Mutual Fund Scandal. As Lori Richards, Director, Office of Compliance Inspections and Examinations at the SEC confirmed the SEC was looking into securities lending by mutual funds. In a speech on October 13,2004 she said the SEC was examining:

undisclosed payments - off-the-books, side letter-type payments that appear not to be disclosed to the ultimate stakeholder, the investor. In these examinations, we're following the old adage "follow the money." Some situations involve the inappropriate use of fund's money. For example, we're looking mutual funds' securities lending - to see if the proceeds of the loan go back into the fund.

To date there STILL is absolutely no transparency in Mutual Fund securities lending and shareholders currently have no idea where the money is going from the securities
lending operations ie. whether it is going back to the fund shareholders or to the firm? Investors also do not know how many shares are lent or the return garnered from the lending operations. It is essentially a non-transparent black hole and it is unacceptable when so much of America's retirement wealth is in Mutual Funds.

Closing -

Thank you again for the opportunity to comment. I hope the SEC realizes the importance of acting to protect individual investors. Transparency is essential.