July 7, 2008
To Whom It May Concern:
I would like to make a brief observation regarding Regulation SHO and abusive naked short selling.
Much is made about the facts that less than one percent of all trades fail, and a small proportion of all listed companies are on the threshold list at any given time.
What if 0.5% of all trades failed in only one company?
This is an exaggeration to make a point. While the number of failed trades is small relative to the number of successfully completed trades, this fact is meaningless if the failures are sufficiently concentrated to decimate the value of a small number of companies. In fact, the fewer companies are targeted, the more effective these techniques become both in making money for the criminals and destroying issuers (thereby making even more money for the criminals who never have to deliver).
If I have ten million shares outstanding and someone creates twenty million securities entitlements to drive down my stock price, my investors are going to get clobbered. However, if I have 100 million shares outstanding it would take an avalanche of fails to make a difference. Abusive short sellers know this, so they focus on a small number of small issuers.
When a pack of hyenas wants to eat a water buffalo, they don't individually choose targets and attack - they would probably come away with nothing. Instead, they single out a calf and work together to separate it from the herd. A huge herd doesn't change the calf's fate.
Please do not be distracted by the relatively small number of trades and companies involved in this abuse. Yes, we have a huge market. Yes, the perpetrators choose targets carefully and collaborate effectively to pile on. This does not diminish the harm to individual companies and their investors when these abuses occur, nor does it justify the massive illegal profits an abusive naked short seller can make by manufacturing as many securities entitlements as his co-conspirators will allow.
By the way, Rule 10b-21 will only force the criminals to seek additional conspirators. When a regulator starts asking questions about fails, today the broker dealer can blame the naked short seller who claimed to have access to shares - they still get their fees and DTCC gets their cut. Under Rule 10b-21, the naked short seller can simply convince someone to claim in advance to have the shares or simply refer to them as "easy to borrow". Conspiracies will continue. Enforcement should focus on forcing delivery rather than creating incentive for conspiracy. The folks on Wall Street are not going to police each other.