August 8, 2008
In 2002 the SEC invited comments on the subject of naked short selling activity. I submitted my comments on August 1, 2002 and it may be accessed on the following link
http://www.sec.gov/rules/concept/s72499/waurilio080102.htm
How could a naked short sale be created without a concomitant delivery-in or, in the absence thereof, the generation of the requisite notice of FAIL.
Below, excerpted from my submission, is my explanation.
MY EXPLANATION
Operating under the assumption that the participants would normally follow the standard procedures concomitant with the short transaction, I can see only one explanation for the facts as outlined above and that is as follows:
When the brokerage house receives a buy order they do not go to the market to satisfy the trade but, instead, merely report to the customer that he has bought the security, when in fact there was no actual trade.
This leaves the customer with a phantom position and the brokerage house with an off book liability with no opposing broker to whom they must give an accounting. It also gives the brokerage house an interest free loan that, should the company go belly up, will require no closing transaction. Should this happen the interest free loan would, as a consequence, ripen into a windfall for the brokerage house and could conceivably inure to their benefit without incurring a tax. (No taxable event having been involved in the process.)
There are procedures in the SEC playbook that can control and virtually eliminate this fraudulent practice and restore confidence in the market. Those procedures should be implemented without delay.