August 12, 2008
August 12, 2008
Securities and Exchange Commission
100F Street NE
Washington, DC.
Release No. 34-58190 File No. S7-20-08
Mr. Chairman,
Clearly the Commission must be frustrated at the high level of assault against the agencies more recent actions and more recent failures. Members of the Congress, the Media, State Regulators, Hedge Fund Lobbyists, Banking Lobbyists, Public Issuers, and private investors have all spoken out against how poorly the SEC has handled investor and market protections.
I am now to understand based on recent media reports that the SEC remains disjointed on whether naked shorting is a real problem and thus how the SEC will handle this growing issue. I guess from my perspective it is quite simple but then again, I am not conflicted over who deserves and who does not deserve regulatory protections. My emphasis is on the majority of the 97 Million investors and the 14,000 public companies that comprise the US Capital Markets – who has the SECs emphasis of attention?
In the NY Post and Reuters it is being reported that the SEC is planning on potentially proposing a new short sale rule for public comment as early as next month but may appear uncertain as to whether to extend the short sale rule to all public issuers as was recently subjected to a select few or, whether to simply create a fine for any who fail to deliver a security within 3-trade days from execution.
My response to such indecisiveness more of the same.
The evidence before the SEC, and the little analysis conducted by the OEA to date, both illustrate the disparity between the rapid trading short seller whos intentions are to settle within the 3-day settlement window and the invested short seller who acts like a long shareholder but from the different side of the equation.
The question before the SEC is a simple one a hard borrow or a hard closeout.
HARD BORROW:
If the SEC imposes a hard borrow it will force all short sellers to engage in a short sale with the intent of 3-day settlement. If the short seller closes out the trade before the 3-day settlement they can return the borrowed share and carry the cost for the duration of how long that share was used in their short sale exercise.
The reason such an imposition is required is to insure that the abuses identified in 10b-21 do not manifest themselves as a loophole that requires significant SEC resource to unwind and discover.
Presently the SEC has evidence that short sellers will use the same locate multiple times and that multiple parties will use the same located shares. Such activity violates the general principles behind short sale policies that being that every trade executed must be done with the intent of 3-day settlement (Rule 15c3-3 15c6-1).
Presently rapid trading short sellers and the firms that execute on behalf of short sellers are aware that the same located shares are being used to execute trades on behalf of multiple investors and by a single investor multiple times. Such is in violation of securities rules not presently being enforced. The rapid trading short seller has no guarantee that a trade will be covered by T+3 and thus must enter into such a contract to trade with the sole intent of on-time settlement.
Reference: CIPC and MFA Comment Memo to SEC in which the memo states "Under the Emergency Order, before undertaking a short selling strategy, a market participant must consider in advance teh costs and risks of ensuring with 100% certainty that enough shares will be available to cover the maximum number of shares that may be sold short throughout the duration of the strategy."
I believe the response is yes, every short sale executed must be executed with intent to settle. To do otherwise is decalring that there was intent to naked short which is illegal for this market participant.
The hard to borrow allows for stabilized short selling that prevents the intra-day bear raids associated with a pack mentality of sellers. With short selling now accounting for nearly 30% of the daily NYSE trade volume, how many of these trades being executed are being done so without the intent of actual settlement (i.e. Short seller acting as a Market Maker utilizing the market making exemption)?
To maintain the integrity of the markets, and to address the flaws of the Continuous Net settlement system and T+3 settlement delays, the SEC would be best served to initiate the hard borrow mandate into all short sale activities engaged in.
HARD SETTLEMENT:
To consider a hard settlement or fine policy requires more than simply honesty amongst thieves, it requires regulatory intervention. Who will impose these fines? Where would these fines accrue and who would benefit from the fine itself?
If a market is being manipulated by a short seller looking to drive down a stock does the SEC really believe that a compliance level fine will deter them from their intentions? The cost of the fine can be factored in to the level of manipulation needed to cover the penalties.
When a market is under attack, $10s of millions to $Billions in market capitalization can be lost. The short seller(s) who orchestrated this attack would not realize such profit but only a fraction of what can be lost by all the long shareholders holding the security long. No fine would ever recover the monies lost to these investors and certainly not to those who bailed on their investment under this vicious attack.
NOTE: Because of the short sale itself, additional long investors take ownership in the market intended to be manipulation.
This hard settlement policy with fines imposed does not have visibility to control the predatory day trading short seller who engages in the 10b-21 type activities the SEC has identified to exist. These short sellers would function on the pre-existing locate policies that are presently being abused by some of this countries largest and wealthiest of funds.
I believe that had the SECs Division of Trading and Markets and Office of Economic Analysis pulled the trade tickets of targeted companies they would find that short sellers have used order splitting to circumvent the trade policies relative to a full locate and at times have found that they could not cover all of the trades executed on a daily basis which is cause for the volatility in the fail to deliver data. I also believe that had the SECs Division of trading and Markets and office of Economic Analysis pulled not only the executed trade tickets but all trade tickets they would begin to understand how a short sale raid will pulls investor away from the collapsing bids seeking a more profitable trade based on the selling they witness taking place.
Again, the hard settle would not address this area of abuse.
CONCLUSION:
The SEC has a responsibility to all investors to protect their interests. When it is reported that Stevie Cohen and SAC Capital can individually account for as much as 3% of the total NYSE volume and 1% of the total NASDAQ Volume the SEC must insure that such rapid trading is not being done to serve the best interests of Stevie Cohen but is done to best serve the integrity of the US Capital markets as a whole and the 97 million investors who benefit from such a marketplace.
What Mr. Cohen brings to these markets carrying such volume is not efficiency in pricing discovery because clearly many such positions are not being executed for long enough duration to create such discovery. Such trading is instead being executed to create a shift in momentum that can derive profit.
In a short sale raid comes emotion, panic, fear. Allowing rapid traders such as SAC Capital to enter into a fragile market and use the pre-existing loopholes to turbo charge the markets into a freefall are neither healthy nor responsible. Forcing SAC Capital to identify a share to be used for each short sale executed, whether for a day position or long term investment, insures that the intent of each and every trade is to meet the obligation of a settlement. The hard borrow is the only alternative to this end.
The SEC enforcement staff is limited in numbers and faces an endless list of fraudulent activities to investigate. Increasing this list by creating soft rules will only sign off acceptance of a large percentage of unenforced fraud. History has proven that to be the case and thus, it is time the Commission acts on those lessons learned.
Force the Hard Borrow and be done with this issue. Hasnt the SEC spent enough resource already in taking these baby steps to nowhere? Doesn't the investing public deserve better? Is the SEC willing to continue to allow investors such as James Chanos and the funds represented by the MFA to execute their 'strategies' for personal profit in violation of present securities laws requiring full intent on settlement?
Dave Patch
BTWWhen you address this issue in your proposed rule making please make sure that you address the loophole regarding the market maker exemption. It is well known that hedge funds will bribe market makers to execute a naked short on their behalf. If there is nothing in the rule proposal to address this I will provide better clarification then.