September 13, 2007
To the Commission:
Thank you for the opportunity to comment on the latest proposed amendments to Regulation SHO. I will provide initial comments on Regulation SHO and related matters then comment on the proposed amendments themselves. I am an attorney duly licensed to practice law in the State of North Carolina. My practice has allowed me to work with public companies, private companies that have considered (some which have undertaken) public listings, private investment funds including hedge funds, PIPE funds and similar sophisticated investors, as well as sophisticated individual investors in the United States securities markets.
As the Commission knows, the refusal of many in the securities industry to honor settlement obligations continues to have serious negative effects on Americas public markets. The selling of unregistered securities (absent an available registration exemption, e.g., the safe harbor provisions provided in Rule 144) is against the law. A good though not exhaustive list of the laws and regulations being violated by the perpetrators is contained in the September 12, 2007, letter to the Commission from the National Coalition Against Naked Short Selling, which may be viewed here: http://www.sec.gov/comments/s7-19-07/s71907-216.pdf.
The Commission notes in its comments to the Proposed Rule that where a seller of securities fails to deliver securities on settlement date, in effect the seller unilaterally converts a securities contract (which should settle within the standard 3-day settlement period) into an undated futures-type contract, to which the buyer might not have agreed, or that might have been priced differently. (Federal Register Vol. 72, No. 156, Proposed Rules, Page 45559).
The Commission does not actually use the word counterfeit, but in effect a seller who sells a security without a reasonable belief that such seller will be able to timely settle the trade in accordance with applicable law is electronically counterfeiting a corporate security, which is a felony. In effect the seller is defrauding the purchaser. In effect, other direct victims include the public companies whose capital structures are compromised or destroyed, the employees thereof as their employers are injured and often destroyed, and all legitimate shareholders of the victim companies whose ownership is diluted and whose investments are fraudulently devalued by the counterfeit supply.
The Commission to this day is not willing to take the necessary steps to protect the investing public, but continues to shuck and jive the investing public and the companies we would invest in. The Commission passed a toothless and, despite Commission assurances to the contrary, largely ineffective Regulation SHO. An examination of the Threshold List and the time lengths victim companies remain thereon provides simple yet unassailable confirmation of the previous statement. The Commission inserted the reprehensible grandfather clause to ensure that none of the serial securities manipulators (e.g., the OTC market makers) that infest the U.S. markets—or their complicit enablers such as the clearing firms, prime brokers and the utterly corrupt Depository Trust and Clearing Corporation—were negatively affected in any way by Regulation SHO. The Commission then at the instruction of the industry removed one of the few minimal protections against bear raids (the uptick and similar rules) justified by dubious economic analysis.
The Commission gives lip service but by its actions demonstrates no concern about down-side volatility caused by bear raids, abusive market making (options and otherwise) and other stock counterfeiting but the Commission is determined not to allow its rulemaking to trigger any upside volatility, which the Commission views as a stock manipulator being required to purchase securities at prices higher than the artificially lowered levels achieved by the manipulation. Sure they drove the price to artificially low levels, but according to the Commission it is just not fair to make them buy to cover if doing so would drive the price back toward its pre-manipulation levels, or if their profits on the illegal trades would be diminished.
Though the Commission has finally decided to dump the grandfather clause—after extending the time to cover 35 more days—and appears ready to modify or eliminate the options market maker exception, it is deplorable that the Commission has had to be figuratively dragged kicking and screaming even to this point. Even now the Commission delays implementation of these minimal reforms by drawn out and extended/reopened comment periods and analyses of the comments. Further, there is still no substantive deterrent for improper behavior contained in Regulation SHO. The securities industry violates the Regulation at will and makes a mockery of the Commission in the process, knowing that there is no substantive enforcement of Regulation SHO or any of the other short sale regulations. The Commission plays catch and release with the miscreants, fining them pennies on the dollars they steal from the investing public then politely asking them not to do it again, so long as its not too much trouble.
There are a lot of good people working at the Commission. With all the recent departures at senior levels (hopefully a few more will move on over to Wall Street soon), it is hoped that replacement leadership will have a more open mind to the idea of protecting issuers and investors against securities industry fraud in the settlement process. It is a simple matter to require, as securities markets in most civilized countries require and as the NASD sought to require in 2004 but was blocked by the Commission, that all trades not settled in 10 days or some reasonable period of time be bought in immediately at the market.
Ladies and gentlemen, it is a simple matter to prohibit brokers from charging commissions on trades until the trades clear and settle (if the buy side broker could not charge a commission until his client received good delivery of securities, we would see far better participant enforcement of the rules). It is a simple matter to require clearing firms to withhold the mark until trades settle. It is a simple matter to allow a buyer who can not get settlement on a trade to unwind the defective trade after a reasonable period of time (though you would have to require that brokers inform their clients when they are being cheated in this way and of their rights as a result).
It is a simple matter to require market makers to settle trades in a timely manner, rather than letting them sit on settlement failures until it suits them to cover. If the Commission wants to let market makers counterfeit securities to ensure orderly markets, then at least require them to correct this wrong by delivering good shares by the settlement date, after whatever legitimate extensions are available. It won't stop the bear raids by market makers, but might shorten the duration.
If the Commission ever does get serious about its Congressional mandate to ensure prompt and accurate clearance and settlement of securities trades, the above are simple market driven solutions to the problem, and could be quickly added to Regulation SHO.
In short reply to your request for comment, the options market maker exception is unfair to the investing public, an obvious and effective tool for downside stock manipulation, is fatally flawed and must be removed immediately. There is simply no justification for giving these market professionals such an unfair and overwhelming advantage over the investing public. If you need an example of how the privilege the Commission has afforded the options market makers is abused, please review the case of Scott H. Arenstein and his firm SBA Trading, which can be found at http://www.amex.com/?href=/atamex/regulation/ discipline/at_regdiscipline.html. By the way, when may we see SEC enforcement action against and federal prosecution of these and similar criminals? Do the SROs not inform the Commission and the Department of Justice about the actions of corrupt members?
Regarding the proposal to require broker-dealers marking orders as long sales document the present location of the securities, while it is a shame that such a proposal is required, in the current industry environment where concern for investor protection is minimal at best, this proposal is a good one. Certain brokers like to mask naked short sales as long sales, to avoid affirmative determination and delivery requirements. If the securities are already in the account from which they are being sold, this requirement will not be any more work for the broker. If the securities are not in the custody of the selling firm, it is entirely reasonable for the selling firm to at least be required to determine where they are and whether they will be available for timely settlement. Why would they not do so in any event, if prompt settlement were a priority for them?
I close with a quote from King Solomon: "Food gained by fraud tastes sweet to a man, but he ends up with a mouth full of gravel." (Proverbs 20: 17, NIV). Perhaps the securities industry should start buying dentures futures.
H. Glenn Bagwell, Jr., Esq.
Raleigh, North Carolina USA