Pickard and Djinis LLP
Attorneys at Law
1990 M Street, N.W.
Washington, D.C. 20036
Telephone           Telecopier
(202) 223-4418           (202) 331-3813

January 5, 2004

By Electronic Mail

Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Mail Stop 6-9
Washington, D.C. 20549

Re: Commission File No. S7-23-03
Comments on Behalf of a Canadian Investment Dealer

Dear Mr. Katz:

Pickard and Djinis LLP submits this letter on behalf of a client of our firm1 who wishes to comment on certain aspects of Regulation SHO, recently proposed by the U.S. Securities and Exchange Commission ("SEC" or the "Commission").2 Among other things, Regulation SHO would impose a uniform rule across all securities markets which would require short sellers of equity securities, or the broker or dealer executing a short sale on behalf of a seller, to have borrowed the security, entered into an arrangement to borrow the security or have reasonable grounds to believe that the security could be borrowed. For the reasons explained herein, our client respectfully submits that imposing such a requirement with respect to thinly traded issues, such as those that trade on the over-the-counter bulletin board ("OTCBB") or the Pink Sheets, will remove an important market constraint on pricing inefficiencies and upward manipulations attempted or occurring with respect to such securities. Our client further submits that improvements to the buy-in system and a centralized securities lending post would address most, if not all, of the concerns expressed by the Commission with respect to "naked short selling" while not imposing too substantial a burden on the pricing mechanism with respect to such securities.

Regulation SHO Would Create Additional Opportunities for Manipulation by Restricting Short Selling on the OTCBB and Pink Sheet Markets

The economic role of short-selling is that it assists in adjusting securities prices to their underlying fundamental values. While short-selling provides benefits in any type of market, it is particularly important in less liquid markets such as the OTCBB and the Pink Sheets, which are more susceptible to pricing inefficiencies and to manipulative activity on the part of some market participants.3 Regulation SHO would reduce the effectiveness of this important control and actually assist the efforts of persons seeking to artificially inflate or maintain the price of securities trading on these thinly-capitalized markets.

While the Proposing Release refers to "bear raids" and other alleged uses of short sales to manipulate securities prices downward, studies have shown that the vast majority of manipulations involve the inflation of stock prices or the attempt to stabilize a price at a level above fundamental market value, not downward manipulations.4 One technique used by upward manipulators and stabilizers is to restrict the supply of stock available to the market.5 Unfortunately, Regulation SHO's proposal to restrict short sales of OTCBB and Pink Sheet securities to situations where stock is available for borrowing plays directly into the hands of such manipulators. Indeed, the regulation actually would have the effect of encouraging manipulative tactics that involve restricting the supply of securities.

Restricting the supply of securities (or any product) typically increases prices because buyers must pay more to access the limited supply. Under Regulation SHO, if stock is not available for borrowing, it cannot be sold short. Accordingly, an upward manipulator who restricts the available supply of securities will benefit not only from increased buying pressure, but also by eliminating the ability of short sellers to act as a control on this upward pressure.

As the Proposing Release notes, there has been a recent trend among some issuers and other market participants to remove securities from the clearance and settlement system. Although the Proposing Release attributes this activity to a "defensive action . . . designed to combat the potentially negative effects [of naked short selling] on shareholders, broker-dealers, and the clearance and settlement system," our client believes there is a much simpler explanation for such activity. The existing securities lending market is dependent upon the book-entry settlement system. It is simply not practical to arrange for the borrowing of securities from securities owners who hold shares individually in certificated form. By encouraging the removal of securities from the clearance and settlement system, an upside (or stabilizing) manipulator can restrict the supply of securities available for borrowing without the economic and legal risks inherent with other techniques. By restricting short sales to circumstances where securities are available to be borrowed, Regulation SHO would actually encourage the removal of securities from the clearance and settlement system and assist these manipulative activities. Our client submits that alternatively, the Commission should consider actions that would restrict the ability of issuers and others to interfere with the book-entry settlement of securities transaction. 6

Our client respectfully submits that the major regulatory concern facing trading on the OTCBB and Pink Sheet markets is the upward manipulation of securities prices of certain issues trading on those markets. Regulation SHO not only fails to address this concern, it actually exacerbates it by restricting the ability of short sellers to act as a check on such trading. Furthermore, the regulation will have the effect of encouraging the removal of securities from the clearance and settlement system, a problem it purports to remedy. For these reasons, the aspect of Regulation SHO which would under all circumstances mandate that short sellers must borrow, arrange to borrow or have reasonable grounds to believe that the security may be borrowed is not in the public interest and should not be adopted by the Commission.

Improvements to the Buy-In Process and a Centralized Securities Loan Post Would Ameliorate the Concerns Identified by the Commission Without Inhibiting the Constructive Effect of Short Sales on the OTCBB and Pink Sheet Markets

The Proposing Release attributes several negative market effects to naked short selling, including: 1) allowing short sellers to deliberately depress the price of securities through greater leverage; 2) adversely effecting certain rights of the purchaser, such as the right to vote, in cases of a failure to deliver; and 3) unilaterally converting a securities contract (which should be settled T+3) into an undated futures-type contract, again in cases of failures to deliver. As discussed above, our client believes that the Commission's concerns regarding manipulative short selling on the OTCBB and Pink Sheet markets are overstated, as upward and stabilizing manipulations are far more rampant. While our client does not suggest that downward manipulations can not and do not occur, it believes that they can be and have been dealt with effectively by means of the SEC's existing enforcement tools.7 With respect to the Commission's other stated concerns, which are consequences of failures to deliver, not short selling per se, it is our client's view that these concerns can be addressed without negatively impacting the legitimate role short selling plays in the securities pricing function by improving the existing buy-in system and encouraging a vibrant and centralized securities lending market.

Our client believes that many of the problems attributed in the Proposing Release to naked short selling are actually the result of a cumbersome, inefficient and ineffective close-out/buy-in process in the U.S. over-the-counter markets. The U.S. OTC markets lack a means to broadcast cash bids for buy-ins. Furthermore, the lack of regulation of the price at which buy-ins are effected leaves the system open to abuse.

The Canadian securities markets do not have a "locate" or "affirmative determination" rule, but do have a well-defined buy-in process and have avoided major problems with extended failures to deliver. In Canada, notice of an impending buy-in is provided through the clearing system to the short broker. If delivery is not made within the prescribed time period, the long broker can post a cash bid that is widely distributed through the quotation system. This wide dissemination typically results in an efficient auction-style market. Finally, the system discourages buy-ins executed at abusive prices unrelated to the market, establishing a procedure whereby buy-ins executed at a price more than 15% above the current market must be justified through an affidavit.8

Our client also believes that an improved securities lending market would assist in reducing the amount of failures to deliver in the U.S. markets. Lack of a central loan post has made it difficult for investors to borrow stock for delivery, especially with respect to smaller investors and thinly traded securities, such as OTCBB and Pink Sheet issues. While a centralized loan post would not address situations where the available stock for lending has been artificially restricted, it would mitigate circumstances where there is stock available for delivery, but potential lenders and borrowers can not find each other.


Our client respectfully submits that the provisions of Regulation SHO which would require a short seller in all circumstances to borrow, arrange to borrow or have reasonable grounds to believe that the security may be borrowed prior to effecting a short sale will have a deleterious effect on the trading of securities, particularly with respect to thinly traded issues such as those trading on the OTCBB and Pink Sheet markets. As an alternative, our client suggests that the Commission consider streamlining the buy-in/close-out process for such securities, and encourage the development of a centralized securities lending post.

Please contact Lee A. Pickard or William D. Edick of Pickard and Djinis LLP at 202-223-4418 if you have any questions regarding this comment letter.

1 Our client is a full service Investment Dealer headquartered in Canada and is a member of the Toronto Stock Exchange, the Montreal Exchange and the Investment Dealers Association of Canada.
2 SEC Release No. 34-48709 (October 28, 2003) (hereinafter the "Proposing Release")
3 See Rajesh K. Aggarwal and Goujun Wu, Stock Market Manipulations, University of Virginia and University of Michigan Business School, December 3, 2003 at 2, available at http://webuser.bus.umich.edu/gjwu/Papers/aw.pdf [hereinafter Aggarwal and Wu] (study of 142 identified cases of stock manipulation between 1990 and 2001 indicated "that most manipulation cases happen in relatively inefficient markets such as the OTC Bulletin Board and Pink Sheets that are small and illiquid.")
4 See, Aggarwal and Wu at 22 (84.1% of manipulation cases involve the inflation of stock prices, 2% involve stabilization, 13% were not classifiable based on available information and less than 1% were identified as involving the deflation of securities prices.)
5 See, Aggarwal and Wu at 22 (noting that 13% of manipulations in a sample from January 1990 through October 2001 involved attempts by the manipulator to corner the supply of stock to inflate prices).
6 At minimum, the Commission should establish a base-level percentage of shares that are available for shorting to address "liquidity squeezes" such as those described above and to prevent upward market trading abuses.
7 If the Commission does believe that further action is necessary with respect to potential downward manipulations, which our client does not, the Commission may wish to consider extending the application of the "bid test" proposed in Regulation SHO to the broader markets.
8 See Canadian Depositor for Securities, SSS Bulletin #2502 "New Procedures for Filing Disputes on ACCESS Buy-In Executions between CDS Participants" (June 15, 1999).