August 19, 2008
To the Honorable Christofer Cox, and
Commissioners of the SEC
19 aug 2008
Runors that the SEC intends to reform the rules on short selling to require a firm pre-borrow, as was imposed temporarily on 19 financial stocks, and not just a fictitious "locate", are welcome news, and such would be a better solution to market abuse than regulation SHO. However, the market maker exception should still be eliminated,
The letter from the CBOE claiming that OMM hedging is "market neutral" is wrong. Manipulators who cannot find a way to naked-short a stock directly do so indirectly by buying a slew of Puts, which the OMM then hedges by naked shorting the stock, using his exception. Since anybody can become an OMM, this exception must be eliminated.
I also wish to point out yet again that the rules on even legal short selling are faulty, giving a downside bias to the market.
Brokers are currently permitted to lend to short sellers shares of any security in market value up to 140% of TOTAL margin debit in an account, even when the loaned security is only providing a tiny fraction of the margin collateral for that debit.
Firstly, the 140% number is an arithmetic error, and it should be 100%. Please do your own research to confirm this.
Secondly, brokers should only be allowed to lend shares of any security from a margin account in debit, up to a market value not greater than the collateral value that security is provding against that margin debit.
For example, suppose a margin account is $500000 in debit, and suppose the account contains shares in one particular security with market value of $100000, and the margin requirement on those shares is 70% then those shares are providing $30000 of collateral against that total $500000 of debit.
Then shares of that security should only be permitted to be lent to short sellers up to $30000 in market value.
Today, the rules permit shares in that or any security in such an account to be lent up to a market value of $700000
(140% of the $500000 debit). The latter is clearly absurd and inconsistent with the requirement to maintain in the account all shares that have been fully paid for.
The change I recommend would prevent broker abuse typified by raising margin requirements on an already abused stock to 100%, so that it is not accorded any collateral value against margin debit, and leading to margin calls against the investor, while continuing to lend all of that stock to short sellers. The change I recommend would not permit any lending of a stock that has been already so abused that its margin requirement is 100%. The broker would then have to make his own choice whether to raise the margin requirement on the stock while reducing his lending of it to short sellers, or else to maintain a low margin requirement in order to continue the lending. This would have the stabilizing effect that was the original intent behind linking the amount of short selling of stock not actually owned to the amount of stock bought on margin and not actually paid for. A balance between these sell-side and buy-side pressures is required by making this link 1:1 and not 1.4:1 in favor of the short side, as at present.
If the SEC wishes the regulations to be market neutral instead of providing a downside bias in favor of short selling, the above changes are necessary.
Paul W. Dent