October 4, 2005

Subject: File Number 265-23

Dear Sirs:

Thank you for this opportunity to 'sound off'. The following are my concerns related to the manipulation and ability to manipulate the share price of small cap companies as well as other related concerns and solutions.

I am retired and derive income primarily from a combination of SSI and stock dividends. The stock dividends are derived mostly from small cap companies that pay very substantial dividends. My largest holding is NovaStar Financial (NFI: NYSE), a mortgage REIT, which has had 18 consecutive quarters of equal or increasing dividends. At the end of Q2/2005, NFI had roughly $10.57/share cash and unpaid dividends based on taxable net income of $5.08. NFI is a very solidly run company but it's also a very heavily shorted with, apparently, a much manipulated share price and therein lies the problem. Share price instability, which flies in the face of the growth and stability of the dividend, is highly problematic.

NFI has been a 'hard to borrow' stock for more than a year. The visible short interest peaked in November, 2004, at 11.7 million shares, or 40% of the 27.7 million shares outstanding. Then, shortly thereafter, in January, 2005, the first month that regulation SHO went into effect, the short interest was reduced by 4 million shares. However, as a result there was not the price movement that one would expect if 4 million shares had been purchased to cover in such a short span of time. The suspicion is that most of these 4 million legitimate short shares were converted to quasi-legal FTD or naked shorted shares, grandfathered under regulation SHO. NFI has been on the regulation SHO threshold list since its inception and it's still on the regulation SHO threshold list At this time there remains, as of the last published short interest number, 8.6 million legitimate shares sold short--plus an unknown number of shares sold FTD/FTR that are not part of that number.

One of the biggest problems the SEC can address to help the small investor is the inability of the investor to know whether a stock is being sold off or shorted down, and if shorted whether it's borrowed share shorting or the selling of naked shares long or short (of course, all things being equal, there shouldn’t be any naked shares being sold—but that’s another problem altogether). The numbers are available. Let the small investor have access to them. A good first, a starting point, might be to add the FTD share count and possibly the short interest count to the regulation SHO list. I say it's a good starting point because this is an existing list of abusively traded stocks--so it's a logical first step in providing the information. The number of fails for each stock should be available to the public and the daily short interest would provide much information content to that number. Inasmuch as being on the SHO list has not stopped or even slowed the problem, stating the size of the fails could draw the necessary attention to those stocks being manipulated.

Just the fact that regulation SHO was started rather than enforcing the already existing rules against naked shorting and FTD being promulgated by the NASD created the impression that the problem is so immense that the SEC is afraid to enforce the rules for fear that it could bring down major brokers due to clients who have massive FTD positions. It also leaves the impression that the SEC is encouraging illegal activities by grandfathering the old fails. It looks like cronyism and corruption. It does not instill confidence in the investor. Add to this the problem that, apparently, many stock trades are held ex-clearing by the brokerages and don't go through the clearing process. Should this be true it would mean that the brokerages themselves could have large numbers of FTD/FTR on their books that don't show up in the counts held by the central clearing agencies. All this could mean that the entire industry requires a thorough cleansing; a cleaning job that only congress and a change in the governing law can cause to happen.

In conclusion; let me say that I think that most of the ills in the market place can be rectified by full disclosure. There should not be any secrets when it comes to the bulk numbers. I’m not asking to know who did what; all I want to know is what was done and to know it with the shortest possible time lag. This secrecy re the FTD/FTR counts is totally disgusting. It points to back rooms and conspiracies. There is absolutely no reason that everyone shouldn’t know the extent of the FTD problem as it relates to regulation SHO stocks. There’s absolutely no reason that everyone shouldn’t know the extent of the short interest daily, if not real-time. Give me full disclosure and, maybe, I'll go away happy ...

Thanking you in advance for your kind attention to these matter;


Glen Kelly


We all know that so-called naked shorting is legal in some instances, such as legitimate market making. But, such shorting is intended to be of limited duration; 3 days; 13 days; and up to 30 days. But, it also extends past 30 days (with permission). And, apparently, there are either additional or rather extensive numbers of illegal naked (FTD) shares in the float or market makers are being allowed to routinely exceed the 30 day limitation. The gross total number of FTD shares is also just a vague reference to the actual problem inasmuch as the FTD are highly concentrated in the stocks that appear on the regulation SHO list. This 'vagueness' is a very large part of the problem, and a solution is suggested later in this missive.

What has all this to do with small cap companies and the trading in their stock? I would think it would be obvious. Just using NFI as an example; when there is a small capitalization and a relatively small number of shares outstanding, add to that a short interest equal to 40% of the entire authorized shares outstanding, and an unknown and possibly virtually unlimited number of additional shares that can be shorted using the FTD (naked) route, the ability to manipulate the stock price must be uncontested. Add to this the reputed ability of well connected hedge fund managers to feed slanted and even untruthful stories to a compliant press; to have less than reputable research firms publish negative analysis on request; have ex-SEC investigators place phone calls and get an informal SEC inquiry started; then you have the environment for manipulation on a grand scale.

When the targets of such manipulation are small cap companies, it is all too easy to move the share price (in either direction) almost at will. It's apparent to me that manipulation of this sort was behind a bear raid on NFI, a raid that occurred in March and April of 2004, a time when NFI share price was reduced almost 50%. I might point out that this drop in share price occurred during a period of time when there was absolutely no change in the company's fundamentals and the dividend has continued to be paid since then without interruption. It's true that the entire market segment lost about 15% during this period--but NFI lost nearly 50% on all-time record volume--57 million shares traded in April when there were 28 million shares outstanding.

One can’t make an informed decision without full knowledge of the facts. Short sales should be published as part of the daily record, readily accessible to all investors, just as the total trade volume is reported. Then, by T+3, the extent of all FTD/FTR sales, long or short, should be available. In the longer term, the short interest that is published monthly should be available daily. After all, it’s now a requirement under regulation SHO to flag every trade as long, short or short-exempt, so the data is available 'somewhere'. And, finally, eventually, these figures should be available real time. It’s hardly fair that a large entity can manipulate the share price all over the park, with virtual immunity in this modern world wide electronic marketplace and full knowledge of their actions, while the investor sits on the sideline all a wonder at just that has happened.


The situation related to naked shares and dividends paid thereon raises an interesting question regarding what is possibly tax fraud on a rather grand scale. Companies pay dividends (DIV) on issued shares, short sellers make payment in lieu (PIL) of dividend on shares borrowed, and those who have sold shares naked pay what? They pay, effectively, DIV because there’s no borrowed share. This payment should really be PIL – because it’s not DIV. The tax fraud comes into play because DIV is taxed differently than PIL. There’s qualified DIV which is taxed at a lower rate than PIL, and if PIL is delivered to the shareholder as DIV then the tax may not be as high as it should otherwise be. Then there’s the case of dividends declared in December that are paid in January. The DIV is taxable in the prior year when declared, and the PIL is taxable in the year received. Therefore DIV received in January that should have been PIL is invalidly shifted from the year received to the prior year. This ‘tax shifting’ from one year to the prior can have significant effect on the tax owed. The only ways I see that this can be rectified is twofold; firstly, would be to stop the selling of shares naked and or require a timely (T+3) buy-in; or, secondly, to change the IRS rules and treat DIV and PIL identically. If we common folk knew the extent of the problem; ergo, the number of FTD shares by company; we could also calculate the effect on the tax system. My guess is that it’s a considerable number of dollars.