September 12, 2007
Nancy M. Morris, Secretary
Securities and Exchange Commission
100 F Street, NE
Washington. D.C. 20549-1090
Re: Comments on Amendments to Regulation SHO
File No. S7-19-07
Dear Ms. Morris:
From page 63 of The Depository Trust Clearing Corporation Annual Report 2006 (www.dtcc.com/downloads/annuals/2006/2006_report.pdf):
"At the close of business on December 31, 2006, open positions due to NSCC aggregated $3,749,160,000 ($3,423,028,000 at December 31, 2005). When a participant does not deliver securities due to NSCC on the settlement date, NSCC, in accordance with its SEC-approved rules, utilizes the Stock Borrow Program (SBP) to complete its delivery obligations to the extent that participants have made available for loan to the system shares of that issue. As of December 31, 2006, NSCC completed delivery of $1,105,727,000 in securities through the SBP ($977,702,000 at December 31, 2005), leaving $2,643,433,000 in open delivery obligations due to participants ($2,445,326,000 at December 31, 2005). NSCC's borrowing from the SBP does not relieve a participant's obligation to deliver the securities to NSCC."
Thus, the total level of fails at the NSCC level at the end of 2006 was $7,498,320,000, summing fails to deliver and fails to receive when the amount of fails to receive covered by stock borrowing is included.
According to the combined balance sheet data of all NYSE member firms, published on the Securities Industries and Financial Markets Association (SIFMA) website www.sifma.org, at the end of 2006 fails to deliver for these firms totaled $37,732,600,000 and fails to receive totaled $44,614,100,000. Thus the total level of fails for NYSE member firms at the end of 2006 was $82,346,700,000.
This means there was a difference between fails at the NSCC and fails on NYSE member firms balance sheets of $74,848,380,000 as of December 31, 2006. While we do not necessarily expect these two values to be the same, such a large difference of $74.8 billion worth of settlement failures, in fact larger by a multiple ten, seems rather odd to say the least.
This difference is especially troubling in consideration of this statement from the DTCC found on page 19 its 2006 annual report (cited above):
"DTCCs clearing subsidiary, National Securities Clearing Corporation (NSCC) provides clearance and settlement services for virtually all trades done on the NYSE, Nasdaq, the American Stock Exchange and for all regional exchanges, electronic communications networks and alternative trading systems in the United States."
Perhaps this statement from DTCC, also found on page 19 of the DTCC 2006 annual report (cited above), provides some insight into the large difference:
"On a yearly basis in 2006, NSCCs Continuous Net Settlement system (CNS) reduced financial settlement from $174.9 trillion to $3.8 trillion, a netting factor of 98%."
Which brings the question if the NSCCs method of netting not only reduces transactions requiring settlement, but in doing so understates the level of settlement failures as well? It suggests that perhaps the NSCC is using a form of accounting that would not be permitted at a typical corporation, for example a NYSE member firm, thus accounting for a difference between the two totals due to common sources.
Another potential source of this difference in settlement failure totals is revealed in a letter dated September 6, 2006 to me from James A. Brigagliano, Acting Associate Director, SEC Division of Market Regulation, where Mr. Brigagliano wrote:
"We note, however, that there are no centralized databases or records to determine the number of securities transactions cleared and settled outside of a registered clearing agency or to determine the number of failures to deliver securities on these transactions. Because a registered clearing agency is not involved, neither DTC nor NSCC have any information relating to these transactions."
So if indeed the difference is due to settlement failures occurring outside the NSCC system, this brings the question if "virtually all" transactions pass through the NSCC as claimed by the DTCC, why is it that "virtually all" settlement failures are specifically being directed outside of this system through non-registered clearing agencies, and are investors being damaged by activity?
I have provided data which absolutely shows that by any metric the level of delivery failures is unacceptable. In examining this data we can only conclude that there is simply not enough transparency surrounding delivery failures in general. Whether the enormous $74.8 billion difference between NSCC level fails and NYSE member firm fails is due to accounting practices at NSCC, or settlement failures intentionally being pushed outside the system, a combination of the two, or for some other reason, this is definitely an area where the Commission must shine a lot more light.
Finally, please eliminate the options market maker exception immediately. There is simply no place in our capital markets for a rule which facilitates fraud.