Securities and Exchange Commission:
Re: File # S7-23-03
Dear Mr. Katz,
This is an addendum to my first comment letter re: Reg SHO. While strolling through the SEC.gov website this morning I noted some direct quotes from the introductory paragraph of the entire website. The introduction was entitled "THE INVESTOR'S ADVOCATE: HOW THE SEC PROTECTS INVESTORS AND MAINTAINS MARKET INTEGRITY". Boy, does this title ever hit home in our discussions on naked short selling abuses and the necessity of the SEC to address them. The very first line of this introduction to the entire SEC website is this, "The primary mission of the U.S. Securities and Exchange Commission (SEC) is to protect investors and maintain the integrity of the securities markets. Wow, considering the irrefutable fact that the naked short selling abuses currently in existence in our markets represent the single largest fraud, from a monetary point of view, being perpetrated on U.S. investors and the one fraud with the most deleterious effect on market integrity, then one might presuppose that the SEC would be all over this problem as hinted to in their mission statement quoted above. Yet only 1% of the cases brought by the SEC deal with issuers whose share price was crushed by the sale of nonexistent entities.
The article goes on to say, "The laws and rules that govern the securities industry in the United States derive from a simple and straightforward concept: all investors, whether large institutions or private individuals, should have access to certain basic facts about an investment prior to buying it. Can I go way out on a limb and infer that one "basic fact about an investment" that would be handy to know "prior to buying" shares would be that there are, let's say, three times as many "counterfeit electronic book entries" in existence at the DTCC and/or in "proprietary accounts" of unethical market makers and clearing firms, than are issued and outstanding in the share capitalization of the issuing firm?
This introductory article goes on to say, "The main purposes of these laws can be reduced to two common-sense notions:
"Putting investors interest first", is that what happens when a b/d "rents" out his client's retirement account shares or his childrens' college education fund shares to the NSCC in order to be used to allow the trade involving the sale of nonexistent shares by the mortal enemy of a client's investment, the naked short seller, to clear and settle and thus become a "counterfeit electronic book entry" at the DTCC? Is that also what happens when in the course of a dividend distribution, the DTCC allows these "counterfeit electronic book entries" to give birth to yet more "counterfeit electronic book entries" in order to cover up the initial fraudulent sale of nonexistent entities?
The article goes on to say that, "SROs, which are overseen by the SEC, are the front line in regulating broker-dealers. Well, what kind of job are the SROs like the DTCC and the NASD doing on this front?
The article continues, "Major pieces of legislation, such as the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Company Act of 1940, provide the framework for the SEC's oversight of the securities markets." The question arises as to why the SEC never seems to want to invoke the power or mandate given them by the '34 Exchange Act". In several different spots the "34 Act" instructs the SEC to "buy-in under a guaranteed delivery basis" shares which fall into the "open position" category. These include shares for which "good delivery" was either never made or in which "good delivery" was effected by a borrowed share that was not returned in a timely manner.
Later in the article can be found the following section:
Common violations that may lead to SEC investigations include:
Let's review these six most common violations that induce SEC investigations one by one and see their relevance to naked short selling. In regards to the first one, is not naked short selling by definition the selling of nonexistent entities masquerading as "securities" by Wall Street "professionals" and their coconspirators who do indeed possess nonpublic information, the visibility of the buy and sell orders, and use it to their advantage. This "insider" information has much more utility in defrauding investors than the CEO of a corporation will ever have. These market makers and clearing firm employees are the ULTIMATE INSIDERS with a superior visibility of, access to, and knowledge of "the system".
In regards to item #2, does not the DTCC's and SEC's failure to publish the number of "open positions" or existing naked short positions in a security tantamount to "omission of important information about securities". How about an "SPL" list (Securities Position Listing) sold by the DTCC to issuers qualifying as "misrepresentation of important information about securities".
In regards to item #3, the entire world is cognizant of the "manipulation of the market prices of securities" via market maker manipulative techniques as well as the oversupply of stock that can be sold at any instant in time caused by naked short selling.
In regards to item 4, naked short selling IS the "stealing of a customer's fund or securities", by definition.
Item 5 involves the violation of a broker/dealer's responsibility to treat customers fairly. This obviously occurs in naked short selling.
Item 6 involves the selling of securities without registration which is exactly what occurs in naked short selling. Those "counterfeit electronic book entries" are not registered nor do they qualify for any exemptions from registration.
So there you have it. Naked short selling fits very nicely into EACH of the 6 main categories of violations that typically lead to SEC investigations. Yet only 1% of the SEC's investigations are dedicated to these frauds. SOMETHING DOESN'T ADD UP!
THERE ARE TWO GIGANTIC FLAWS WITHIN THE PROPOSED REG SHO. THE FIRST INVOLVES HOW THE SEC HAS CLEVERLY NOT DIRECTLY ADDRESSED HOW THEY ARE GOING TO DEAL WITH THE MASSIVE PREEXISTING NAKED SHORT POSITIONS CURRENTLY IN EXISTENCE. ARE THEY GOING TO TAKE THE MORAL HIGH ROAD AND BUY IN THESE "OPEN POSITIONS" IMMEDIATELY OR ARE THEY GOING TO COWER TO THE WALL STREET FRATERNITY SYSTEM YET AGAIN AND NOT ADDRESS THESE PREEXISTING "OPEN POSITIONS"? THE SECOND MAJOR WEAKNESS IS THE LACK OF APPLICABILITY OF RULE 203'S INVOCATION OF RULE 11830'S PARAMETERS FOR QUALIFYING FOR THE "SAFE HARBOR" OF THE "RESTRICTED LISTS. AS IT IS CURRENTLY WRITTEN, THE SEC HAS CHOSEN ONCE AGAIN TO ABANDON THE U.S. INVESTORS OWNING SHARES OF NON-REPORTING COMPANIES. THE QUESTION BECOMES WHY ARE THE U.S. INVESTORS THAT FREELY CHOOSE TO INVEST IN NONREPORTING COMPANIES NOT AFFORDED THE SAME PROTECTION AS U.S. INVESTORS THAT INVEST IN REPORTING COMPANIES? IT IS NOT IN THE SEC'S PURVIEW TO INDIRECTLY DICTATE INVESTMENT CHOICES VIA "REGULATORY ARBITRAGE". THE INVESTORS IN NONREPORTING SECURITIES NEED THE PROTECTION PROMISED IN THE 1934 SECURITIES EXCHANGE ACT, PERIOD! THE '34 EXCHANGE ACT CLEARLY ALLOWS SMALL COMPANIES TO OPERATE UNDER A 12-g EXEMPTION FROM REGISTRATION AND FILING REQUIREMENTS FOR A REASON. THE SEC'S AS WELL AS WALL STREET'S IN GENERAL STEREOTYPICAL VISION OF ALL NONREPORTING PINK SHEETED COMPANIES AS BEING SCAMS HAS TO BE ENDED RIGHT NOW!
In this post-Sarbanes-Oxley era, many legitimate development stage companies simply cannot afford to be compliant with all of the Sarbanes-Oxley parameters that prove to be particularly usurious to small companies. This does not make them a "pump and dump"!
I have to relate to you a phone call I just had this morning with an attorney from the SEC. This gentleman is a very bright man and is very conscientious. He is one of the "good guys". We chatted for almost an hour about the securities laws, naked short selling and a host of other subjects related to Reg SHO. I saw where our philosophies were starting to drift away from each others so I asked him point blank why an investor that prefers investing in nonreporting pink sheeted stocks would be afforded less protection from manipulation in Reg SHO than an investor in General Motors. His answer, which came in the form of a question, was why would anybody buy stock in a nonreporting company? I had to ask my question again and I got the exact same "answer" again.
That 30-second question and answer period was, in effect, my last 21 years of researching naked short selling, in a microcosm. THE SEC JUST DOESN'T GET IT! THEIR JOB, AS RELATED IN THEIR MISSION STATEMENT, IS TO PROTECT INVESTORS, NO MATTER WHAT THEIR INVESTMENT PHILOSOPHY IS. "The primary mission of the U.S. Securities and Exchange Commission (SEC) is to protect investors and maintain the integrity of the securities markets". I don't see anything in that mission statement that addresses reporting or nonreporting securities. Every naked short selling fraudster on earth knows that this is the attitude of the SEC towards these smaller companies trading on the Pink Sheets and OTCBB. They make their livings based on this very consistent stereotypical attitude of the SEC. The knowledge of this stereotypical attitude in the SEC that all of these corporations are scams until proven otherwise allows these fraudsters to place gigantic "bets" against these corporations.
The fraudsters committing these crimes know, with 100% certainty, that the SEC will not be riding in on a white horse to save these "scammy" companies and their investors. This engrained stereotypical attitude won't permit it. It is a mindset. I don't want to be overly critical of you at the SEC but please open up your minds to entertain the thought that this engrained attitude IS THE PROBLEM. It provides the "lever" that these fraudsters need. It creates their niche. What complicates matters is that you at the SEC don't realize that this stereotypical attitude is the problem. This "stereotypical attitude" is a giant crowbar that provides the fraudsters with leverage. Naked short sellers rely on this attitude, they have made billions of dollars from U.S. micro cap investors because of the existence of this attitude. It is integral to their success. It provides the key to our wallets.
Where did this "attitude" come from? You guys are the cops, you deal on a daily basis with the worst of the worst and these smaller trading venues provide plenty of opportunity for the bad guys. It's only natural that stereotypes will develop. One thing you have to realize is that the OTCBB and Pink Sheets host nearly 7,500 companies and they are surely not all "bad apples".
THE ROLE OF THE GUARANTEED DELIVERY BUY-IN MANDATED BY THE 1934 SECURITIES EXCHANGE ACT (chapter 68)
The "Guaranteed delivery buy-in" as mandated by Congress, is an extremely well thought out solution to the fraudulent sales of nonexistent entities that only faintly resemble "shares". Some reasons for this include:
1) It provides a level of DETERRENCE to these fraudulent activities. U.S. micro cap investors are tired of watching the perhaps 1% of the naked short selling fraudsters that do get caught being fined $20,000 for stealing $5 million from naive investors and signing off on an Acceptance, Waiver, and Consent (AWC) form. This is not DETERRENCE, this is an ENGRAVED INVITATION TO COMMIT FRAUD.
2) The proceeds of the theft actually get returned to the victims of the theft. I realize that the SEC is not a court of equity. It is the giant pile of investors' money that is used to cover these naked short positions. In the Sedona case, the SEC fines Rhino advisors $1 million. The alleged fraudsters pay the fine with the pile of money allegedly taken from investors. Where does this leave the investors? Now the SEC has the investors' money, so what! Is the SEC going to take that money and only put 1% of it towards the fight against naked short sellers? I'd say the alleged naked short selling fraudsters made out like a bandit in this scenario.
3) Guaranteed delivery buy-ins are "DIAGNOSTIC", the bill for the bought in shares will with 100% certainty, land in the lap of the actual naked short sellers and their accomplices within the market making and clearing firms. This is unlike other legal mechanics wherein the cops work hard to try to find out the identity of the bad guys.
4) Guaranteed delivery buy-ins are also "CURATIVE" from an accounting point of view. Upon their completion there really is a legitimate "share"/"package of rights" in existence that corresponds to every monthly brokerage entry "IMPLYING" the ownership of a legitimate share. Imagine that, a "real" share certificate to back up every share implied as being owned on a monthly statement.
5) Guaranteed delivery buy-ins have PROPORTIONALITY. The financial penalty incurred by the fraudsters will be PROPORTIONATE to the crimes they previously committed. Fraudsters that have sold 100 million nonexistent entities and thus have accumulated a large pile of investors' money in front of them will have to spend a lot more than those that are naked short 1,000 shares.
6) Guaranteed delivery buy ins are FORENSICALLY DIAGNOSTIC. Many market makers and Wall Street "professionals" claim that naked short selling doesn't exist and it is only used as an excuse for inept corporate management. Fine! IF THIS IS TRUE THEN THERE WILL BE NO BUY-INS TO EFFECT AND THE TRUTH WILL BE KNOWN! That's the beauty of buy-ins, only the bad guys are afraid of them and the cloak of invisibility within which these people need to operate will be lifted. The light of day really is the best disinfectant!
7) Guaranteed delivery buy-ins are ECONOMIC FROM A REGULATORY POINT OF VIEW. They act like a thousand regulators without the matching payroll. If economics is part of the reason for the lack of regulatory attention, then this is a godsend.
8) Guaranteed delivery buy-ins act like BLIND JUSTICE. There is no wiggle room for would be extenuating circumstances. The message being sent will be to only sell that which really exists. As the old naked short selling aphorism goes, "He who sells what isn't his'n buys it back or goes to prison".
There are a dozen other benefits of guaranteed delivery buy-ins that I listed in my first book on naked short selling that I won't address now. They truly are an incredible vehicle with many beneficial side effects. Unfortunately, the guaranteed delivery buy-ins have no effect on the thousands of micro cap corporations that have already become insolvent and no longer trade due to naked short selling attacks or "bear raids". Perhaps the bad guys will have already won these battles due to the difficulty of exhuming these corporate remains and identifying the victim shareholders.
At first glance, it seems that there would be a long and tortuous journey for the SEC to go from being the problem to solving the problem. Not true. First address the preexisting "open positions" that have crushed all of these corporations and the lives of their shareholders and then level up the playing field for the future. The SROs underneath you have way too many conflicts of interest in place to address these issues. Please take the high road this time!