June 7, 2004
Mr. Chairman, Commissioners,
This most recent proposal placed in front of the public for comment is one of the more egregious efforts undertaken by the SEC to date to cover-up the real issue at hand. The SEC, in this proposal, is ultimately shooting the messenger for a fault they are unwilling to recognize and correct.
From this proposal:
In Section 17Aa, Congress made findings that 1 the prompt and accurate clearance and settlement of securities transactions, including the transfer of registered ownership and safeguarding of securities and funds related to clearance and settlement activities, are necessary for the protection of investors and those acting on behalf of investors,13 and 2 inefficient clearance and settlement procedures impose unnecessary costs on investors and those acting on their behalf.14
But what of the allegations made, and SEC and NASD affirmations, that the settlement of certain small cap, illiquid, securities are far from prompt or accurate? In Regulation SHO the SEC has admitted that Settlement failures exceed the entire public float of companies in certain cases. The NASD, in their own reforms, admits the same allegations with both the SEC and NASD stating the abusive nature of those failures to the investor. I believe that is the message to take away from the issues. Instead, this proposal is shooting the small companies that are using their own Self-Help measures to protect against the abuses the SEC and NASD recognize.
It is my opinion that before the SEC can decide upon a reform package that restricts self preservation, the SEC must first and foremost address the present flaws in the settlement process. The settlement of the trade itself.
Todays system relies on the process of Book Entry to define share ownership. The investor, upon executing the purchase of a share, is provided an electronic book entry into their account regardless of whether that trade meets the criteria for settlement or not. To the Industry, that book entry allows the shareholder the option of selling that same share at any time regardless of whether the trade has properly settled. I can sell what I do not yet own. These book entries, when added with the millions of others that are entered under the umbrella of settlement failure become dilutive to the Investor and/or Issuer and have a negative affect on the stock price. The accumulation of the Book Entry failures are in direct violation of section 17Aa as defined in your own proposal.
The value of Issuers in moving to custody only trading must then be weighed with the value of the Investors right to know whether their trade has properly settled or not. After all, the stock values represented in the market not only affect the investment made by shareholders, stock values also present opportunities or roadblocks to future business opportunities and financing.
Under custody only trading, shareholders can directly communicate with the company on the settlement of their investments. As their trades are being executed, they will either receive a physical certificate in the mail which validates settlement or they will see an account statement that contains a balance of shares held in Type 4 safe keeping. Type 4 safe keeping representing physical ownership of shares. Shareholders can then audit the accuracy of such settlements by calling in delivery of the type 4 Certificates or by calling the transfer agent for verification of physical ownership. Ultimately, this process, while possibly cumbersome in nature, will yield better transparency of the safety of the trade executed. Significant failures can then be addressed quickly such that present levels are mitigated.
When the SEC makes claims that it has the investors best interests in question here, the SEC must do a cost analysis of what those best interests are. Is it better to pay an additional 75 for Certificate trading if it can control the dilution affects that result in more than 100 of the float failing settlement? Has the SEC reviewed the affects that the present process of Book Entry settlement, with failures, has had on those securities that have been oversold by more than 100 of the float? Is that cost greater than or less than the additional cost of 75/trade to acquire physical shares? I would contend that the investor economic losses associated with settlement failure dilution far outweighs the cost of physical share trading.
I would more vehemently claim that the present move by the SEC to restrict issuers from moving to placing restrictions on their stock is actually a move to create a beneficial settlement policy for the Broker Dealers at the very expense of those few firms seeking relief from abuse.
What did the SEC expect to get from Investor comments based on language in the proposal that highlight broker dealer disregard for present laws?
Again from the proposal:
In situations where broker-dealers refused to comply with the issuer demands to disclose the name of customers so that new restricted shares may be issued, the new securities remain unissued.
To this statement, I ask, where is SEC enforcement? Is there present law that allows our Broker-Dealers to refuse compliance with the bylaws of the issuer or the notifications presented by the Nasdaq/NASD in UPC notifications? This statement presents an impression of the inmates running the asylum as the broker-dealers are selectively deciding how they will operate. Is the Congressional mandate about investors safety or broker dealer conveniences?
Finally, I would like to address the present problem of the Broker-Dealers placing restrictions on the securities that have settlement failure abuses.
The SEC has apparently taken acceptance to Broker Dealers who place sell only restrictions on securities with settlement failures in their own self help measures to prevent net capital reserve liabilities. With the industry, and the present book entry process creating this settlement issue, it seems out of context to allow the investor to be placed in harms way as the security is placed under Sell Only restrictions. How would an investor be allowed to protect his/her investment if he cannot purchase shares to offset a seller choosing to sell shares?
The fact that Settlement failures create a capital reserve liability on the books of our firms is due solely to their failure to enforce delivery for settlement. These firms, and the industry, chose to take on the revenues of the trading Commissions with a total disregard for settlement. Once the industry itself was found with a potential costly liability, self help measures are accepted at the detriment of the investing public. One author of this presentation highlighted that it was in my best interest to have sell only restrictions on a stock if that stock was not going to settle. I disagree as that seller will always be a seller but limited access to buyers will force a reduced value in the security.
Has the SEC considered the reason for the Settlement failures and the overselling of these securities? Has the SEC calculated the resultant affects that these settlement failures have had on the investing public? Has the SEC evaluated the affects that Sell Only restrictions will have on the holding shareholders of a fully diluted and devalued stock? Finally, has the Sec considered who, if not investors, would be buying up shares with significant Sell Only restrictions on a particular security?
It is my contention that the SEC, in eliminating the Self-Help measures of the issuers to protect their ability to operate without abuse has been biased in their actions as they allow similar Self-Help measures by the Industry in order to cover up their actions. When major firms like Merrill lynch, Charles Schwab, Morgan Stanley, AG Edwards, Ameritrade, First southwest, and others all place Sell Only restrictions on a single security due to settlement problems, how is that a fair market? Where is this wonderfully efficient clearance and settlement system that the SEC has referenced so frequently in this proposal? Where is the system that Congress mandated that they create to protect the investor?
The SEC has delayed regulation SHO for nearly 5 years as they have watched the settlement system grow into the present failure we see today. This proposal is yet another attempt at hiding the real issue by shooting the messenger. The messenger in this case being small issuers and retail investors fed up with the abuse and manipulation the SEC and NASD recognize but fail to act upon.
The SEC would be negligent in approving any proposal of this nature until they can come up with that system that they keep telling Congress they have. A efficient and accurate settlement system.