From: Nicholas Stavriotis
Sent: January 20, 2007
Subject: File No. S7-12-06

Would like to add a further note to clearing up the REG SHO mess: How is it that fails to deliver continue to increase in a security listed on the threshold list while under the restrictive guidelines of SHO?

According to Regulation SHO:

Rule 203 (b)(3) States: If a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in a threshold security for thirteen consecutive settlement days, the participant shall immediately thereafter close out the fail to deliver position by purchasing securities of like kind and quantity.

The key to this text is the contradiction between “immediately thereafter close out the fail” and the condition of “purchasing securities of like kind and quantity”.

Why not stop at “immediately thereafter close out the fail”?

Because the loophole is in the second half of the equation “like kind and quantity” Has anybody figured out what “like kind” means? I mean I have a fail to deliver of 1000 shares of XYZ, does anybody really think I can go out and buy 1500 shares of ABC and consider that a close out? Could I even fathom using ABC shares to deliver to the buyer of XYZ and think they would buy that off as a close out?

Nope. The SEC created a loophole to protect the interests and the liabilities of the industry who took the sell order, took the buy side and sell side commissions, and was paid a premium to borrow securities that were never borrowed. I say liabilities because, if you have ever spoken to a regulator they will tell you the liability of the close out expenses is that of the industry member.

Consider that if I sell short 1000 shares of XYZ at $10.00/share and my broker dealer fails to deliver, they are liable for the cost of the close out if one takes place. If the stock goes to $11.00/share it would have cost them $1000 to settle the trade. If the stock goes to $9.00/share they not only delayed settlement and took a fee (borrow rate) to do so, they also made $1000 in the deal. My baseline remained at $10.00 and my short was not closed out.

In 2004 the NASD recognized this “like kind and quantity” as being a potential loophole in the laws and tried to clarify the law further by proposing better language in defining a close out.

Although the proposed rule change provides that a clearing firm may not be in violation of the rule if it has taken “affirmative steps” to make delivery, NASD expects that a failure to deliver the shares within the 10-day period will only be acceptable in very limited cases. For example, the fact that a buy-in for guaranteed delivery is available only at a price above the current market price for a security or that a member can borrow securities only at a “negative rate” (interest paid on cash collateral for securities that are borrowed to effect delivery) would not be considered acceptable bases for non-delivery by the 10th day.

Like Kind and Quantity had limitations applied to it and those limitations specifically identified that you can’t use the fact that you went into a negative liability as an excuse to not settle a trade.

If Wall Street can take risks to make Hundreds of Billions in profits and hand out tens of billions in bonuses, they can pay the penalties for taking that risk as well. If Wall Street wants to receive the Commission and Borrow Fees on a sale they commit to settle they can pay the penalty for not securing the necessary shares to settle. Or at least that is what the Investors believe.

The Securities and Exchange Commission rejected this definition and clarification because as a captured regulator the SEC does not accept liability as being a potentially negative possibility to Wall Street. The Industry must be fully protected from any and all potential looses due to their trading strategies and risks associated with client and proprietary accounts.


Until the SEC understands this concept, no changes to SHO will ever solve this problem. The SEC will always have a loophole imbedded deep enough into the law to allow Institutions to escape from enforcement and from financial liability.

I hope the SEC will do the right thing and protect American investors from Wall Street's predators and create a level playing field.

Looking forward to your support to fix the naked shorting issues,

Nicholas Stavriotis