August 10, 2008
Regarding the proposed amendment to Regulation SHO, SEC Release No. 34-58107, I suggest that Reg. SHO, as written, falls short of achieving its purpose. Having eliminated one of two exceptions to Reg. SHO, the grandfather provision, I believe it is urgent for the SEC to close the second loophole permitting primary dealers—or any other short-sellers—to avoid closing out their positions.
Requiring nothing more than the assurances of hedge funds on this matter is ineffectual and almost nave. Responsibility must be placed on the broker dealer to assure delivery by borrowing shorted shares.
Allowing a primary dealer more than 21 days to deliver before buy is an implicit sanction of the practice of naked shorting. Naked shorting violates regulations prior to Reg. SHO. Failure to eliminate this practice violates your authority and responsibility to protect and regulate capital markets. It violates the fundamental purpose of capital markets, which is to provide companies access to capital and not, as has become all too common, to allow financial entities to profit at the expense of those very companies, especially early-stage companies, which have historically made our economy vital and strong.
More specifically, a primary dealer is—by definition—a trader who makes both bids and offers on a continuous basis. Because of this, a primary dealer will be short but not for investment. The short in the primary dealer's position will rotate between short and even, possibly short on balance. A primary dealer will then be able to make delivery on the short without borrowing because when bids are hit (and they will be) he moves either to flat (even) or turns the short by purchasing voluntarily or involuntary. If this entity does not maintain a constant two way bid and ask then this entity is NOT a primary dealer.
The recent decision by the SEC to selectively enforce on-the-books laws regarding naked shorting underscores the harm which naked shorting can inflict even on mature companies. It also brings attention to the failure of Reg. SHO as a tool in assisting the SEC to regulate markets, and to do so based on accepted principles of dealing fairly and equally with all those it regulates.