September 17, 2008
Dear Mr. Cox
I write to you today not as a Republican or Democrat but as an American.
I think yet again the SEC has lost an opportunity to bring forward meaningful market reforms. During the last 15 years the SEC sacrificed common sense for change. I warned this agency time and time again (in 1997, 2001, 2003 and 2004) that my research and experience predicted that many of the new rules that the agency has adopted would undermine the strength of the US equities markets. Regulations such as manning, SOX, Reg SHO, Reg NMS, FASB 157 and Decimalization have served to undermine free enterprise while buttressing corporatist interests.
These rules and many others have put small investment banks and brokerage firms out of business while fueling the rampant growth of totally unregulated hedge funds and goliath "bulge bracket" investment banks such as Lehman Brothers and Goldman Sacs. Prior to the NASDAQ settlement of 1996 hundreds of firms on Wall Street s distributed risk evenly across the whole industry at no cost to the taxpayer. In 1993, the top five firms on Wall Street had less than 20% of the industry trading market share, today they Goldman, Merrill and Lehman dominate markets clearly at the expense of America's economic security and taxpayer. In 1996 Arther Leviitt broke the system as he launched a witch hunt against Wall Street market makers. Today the SEC has regulated small brokerage firms and investment bank out of business hedge funds, the largely unregulated oversees investment funds run by the likes of George Soros have now more than $1 trillion in capital on their balance sheets and they are causing the economic collapse of America.
In my 2003 letter to the commission, I stated that the corporate governance crisis of 2001 has cost America $500 billion in capital losses and over 100,000 jobs. Also in New York alone the economic loss was roughly $9 billion. By all accounts the current crisis has resulted in losses of roughly $1.5 trillion (5x's our current budget deficit) which does not include the GSE's. Moreover as these risks became know to the board room the financial geniuses turned CEO's of Lehman Brothers, AIG, Bear Sterns, Goldman Sachs, Morgan Stanley and Citi Group paid themselves roughly $1 billion in 2007.
In 2003, Bill Donaldson and I discussed how the combination of electronic trading, decimalization and unregulated hedge funds undermined market liquidity, created the an asymmetrical risk to the financial system and limited the ability of small companies to raise equity capital. I told Mr. Donaldson that he was following the bankrupt path of ideologically driven reformers and that the SEC's new rules made no sense. At that time his predecessor Arthur Levitt and the now defrocked Elliot Spitzer were pushing a corporatist social agenda under the guise of popular reform. And as Spitzer began several witch hunts and pushed Dick Grasso out the NYSE as wel as Mr. Greenberg from AIG, Spitzer's policies just happened to support his cronies like Mr. Fuld (Lehman's CEO and Obama backer ) and liberal Hedge Fund operators like George Soros. As these firms grew they gave new meaning to "fixing the markets. While Mr. Spitzer's true self would on day be revealed, I encouraged Mr. Donaldson to change rule NMS and to his credit and with the encouragement of Dick Cheney he did, but Donalson's changes not go far enough. And while I sound like a partisan, I will say Charles Schumer is getting the message and I think enough Democrats and Republicans can come together and undo the path we are on.
So what does this have to do with short selling. Mr, Cox our markets are under fire from the hedge funds and until liquidity is restored, the trading of securities will be inefficient. Efficient markets are the seeds of capital formation thus we cannot expect any one to take risk in our markets or economy as long as the playing field is rigged. We cannot undo decimalization at this time, neither can be stop ATS's, Algorithmic trading or Darks pools of liquidity which has contributed to the dramatic collapse of equity shares in FNE and AIG and LEH but what we can stop the speculative short sellers.
Getting a hard locate or physical borrow is a fine start but does not go far enough.
I have a multi point plan:
1)Reserve requirements on short accounts must be raised to 100% (from 50%) of the short position so that it becomes much less profitable to enter to a speculative short trade. For example if I wanted to short $1 million of AIG stock under my proposal I would have to deposit $1 million into my prime brokerage account (as compared to $500,000) and I would also have to hold the $1 million in short sale proceeds in escrow. Once the markets stabilize then the reserve requirements can be lowered.
2) I would also encourage the SEC to suggest a special wind fall profits tax on short sale gains. This would offset the taxes lost on the uncovered short sale gain tax loophole, let us see if Move-on.org and George Soros likes that tax increase.
3) I would require short sellers to cover short sales if a company goes into bankruptcy and if a squeeze developes companies can issue special cover shares to short sellers and use the proceeds only to pay down debt or pay special dividends to shareholders under the supervision of the bankruptcy courts.
4) I also recommend a new uptick rule based on the percentage price change of a stock. If a stock traded below 5% short selling in that stock's shares must be suspended until the next trading day. This would give righ-of-way to long sellers and perhaps give the markets time to digest incremental datapoints.
5) Lastly, since securities dealers do play a positive role in the market by shorting stocks in the execution of legitimate buy orders I would also suggest preferred status for dealers executing bonfire customer buy orders. This would ensure stabile markets and limit the risk of a short squeeze due to order inbalances.
While these sound like extreme ideas I would like to point out that we do live in unusual times.
In God We Trust,
Richard Tullo
Should anyone want to discuss my letter I can be reached at (646) 201-2044.
(Attached File #1: s71907-1411a.pdf) (Attached File #2: s71907-1411b.pdf)