Subject: Petition - File No. 4-842
From: A Concerned Retail Investor
Dear Ms. Countryman,
As a retail investor, I respectfully submit this petition for rulemaking pursuant to Rule 192 of the Securities and Exchange Commission’s (SEC) Rules of Practice [1]. I am requesting that the SEC amend Rules 18 and 22 of the National Securities Clearing Corporation’s (NSCC) Rules & Procedures [2] to provide investors with clarity and certainty regarding the settlement of guaranteed transactions, strengthen the resilience of a registered clearing agency (e.g., the NSCC) in their role as a central counterparty (CCP), and support the stability of our financial markets and financial system by incentivizing appropriate risk management practices by market participants.
I submit this petition consistent with the SEC’s guidance on Petitions for Rulemaking Submitted to the SEC [3], which states, “any person may request that the Commission issue, amend or repeal a rule of general application” and specifies that petitions may be submitted via email to Secretarys-Office@SEC.GOV. This petition also meets the requirements that “petitions must contain the text or substance of any proposed rule or amendment or specify the rule or portion of a rule requested to be repealed” and “petitions must also include a statement of the petitioner’s interest and/or reasons for requesting Commission action.”
Background
It has come to the attention of retail investors, like myself, that NSCC Rules and Procedures do not codify strict procedures for closing out positions (e.g., in the event of failed settlements). Current rules allow significant discretion, and this petition seeks to provide transparency and protect investors by requesting amendments that ensure timely settlement and closure of failed transactions.
Concerns with Current NSCC Rule 22
The following issues exist under the current rules:
•
Rule 22 grants NSCC officials the power to ignore the rules whenever they deem it necessary.
•
Officials can waive requirements, such as immediate liquidation of failing positions, allowing for discretion in cases where this might “disrupt the market.”
•
Changes are only partially disclosed to the public, lacking transparency.
•
These deviations can last up to 60 days without further approval.
This flexibility means that market participants like brokerage firms, investment banks, hedge funds, and asset managers can take excessive risks, knowing the NSCC may cover costs if they fail. This leads to “Too Big To Fail” scenarios, effectively incentivizing risky behavior in financial markets.
1. What is the underlying root cause of the disorderly market?
The root cause of a disorderly market often lies in Members building up positions that, if closed out, would cause significant market disruption. When Members take on increasingly disruptive positions, they become “Too Big To Fail,” as their failure would create systemic risks. Ironically, this incentivizes Members to increase their risk exposure to ensure they are bailed out in times of trouble. As Members increase their risk, the burden falls on CCPs like the NSCC, which may be forced to cover or mitigate these risks, often to the detriment of retail investors.
2. How can this lead to market distortions and market manipulation?
Members may exploit incentives to build positions that would create a disorderly market if closed, as these are profitable for them but costly for others. For example, a naked short position in a security held by a Member that is not closed out due to the fear of market disruption artificially increases the security’s supply, distorting its market value. This loophole effectively perpetuates market distortions and manipulation.
3. Who is responsible for the costs of closing out a position?
Currently, Members who engage in risky behavior are not held accountable for the costs of closing out their positions. Instead, CCPs and, by extension, retail investors and taxpayers bear these costs. This leads to an unfair situation where profits are privatized while losses are socialized.
4. How do we fix this?
By identifying these misaligned incentives and changing the regulatory framework, we can ensure that financial market participants are responsible for the costs of their positions. This petition proposes amending NSCC rules to include clawback provisions, which would hold executives accountable for losses incurred by their firms. Additionally, codifying strict procedures for closing out failing positions will ensure consistent application of rules, fostering a level playing field for all market participants.
Proposed Amendments to NSCC Rules
NSCC Rule 4 Proposed Change
SEC. 4. Loss Allocation Waterfall, Off-the-Market Transactions.
Each Member, including its executives, shall be obligated to the Corporation for the entire amount of any loss or liability incurred by the Corporation arising out of or relating to any Defaulting Member Event with respect to such Member. To the extent that such loss or liability is not satisfied by the Member, all executives of the Member (past or present) shall be obligated to the Corporation for an amount equivalent to the preceding 5 years of compensation from the Member. To the extent that such loss or liability is not satisfied pursuant to Section 3 of this Rule 4, the Corporation shall apply a Corporate Contribution thereto and charge the remaining amount of such loss or liability ratably to other Members, as further provided below.
NSCC Rule 18 Proposed Change
SEC. 6. (a) Promptly after the Corporation has given notice that it has ceased to act for the Member, and in a manner consistent with the provisions of Section 3, the Net Close Out Position with respect to each CNS Security shall be closed out (whether it be by buying in, selling out, or otherwise liquidating the position) by the Corporation; provided, however, if, in the opinion of the Corporation, the close out of a position in a specific security would create a disorderly market in that security, then the completion of such close-out shall be at the discretion of the Corporation.
NSCC Rule 22 Proposed Change (Option A – Public Notice)
A written report of any such extension, waiver, or suspension shall be promptly made and published on the Corporation’s website for access by the general public within 1 business day and filed with the Corporation’s records, available for inspection by any person, Member, during regular business hours on Business Days. Any such extension or waiver may continue in effect after the event giving rise thereto but shall not extend beyond 60 calendar days without Board of Directors’ approval.
NSCC Rule 22 Proposed Change (Option B – No Exceptions)
The time fixed by these Rules, the Procedures, or any regulations issued by the Corporation for the doing of any act or acts may not be extended, waived, or suspended. Any deviation shall be promptly made and published on the Corporation’s website for public access within 1 business day.
Final Remarks
These amendments will protect investors, maintain fair and efficient markets, and facilitate capital formation. They foster an environment where costs for closing out positions, including disruptive ones, are borne by the responsible Members and executives, rather than being socialized. Including clawbacks for executive compensation in the loss allocation waterfall adds another layer of accountability, incentivizing proactive risk management and discouraging privatized profits with socialized losses.
This petition represents a significant step toward market stability and transparency. I urge the SEC to act promptly on it and consider similar changes for other clearing agencies.
Sincerely,
A Concerned Retail Investor