Post by jannikki on Nov 12, 2005 10:38:15 GMT -4
DTCC Responds to Accusations of Naked Shorting Abuses – March 25, 2005
Dave Patch
On March 5, 2005 the DTCC published an interview style report on their website discussing the naked shorting issue that haunts them today. The interviewee was Chief General Council Larry Thompson. For all practical purposes the DTCC interview was nothing short of self-serving fiction intended to muddy the waters of the issue at hand.
Lets start with cold facts. Settlement failures do exist and exist to levels that have placed as many as 600 eligible publicly traded companies on the SEC’s new threshold security list for excessive and extended failures. This is fact that cannot be disputed by Mr. Thompson or any other as the list is posted daily on all major market web sites. Mr. Thomson alleges that settlement fails represent approximately one tenth of one percent of all daily trade volumes but when isolating those fails to individual companies it can be extremely damaging – manipulative damaging.
Below are some of the questions asked, excerpts of Mr. Thomson’s responses, and my breakdown of his statements.
Question: Just how big is the fail to delivers, and how much of those fails does the Stock Borrow program address?
LT: In dollar terms, fails to deliver and receive amount to about $6 billion daily, again including both new fails and aged fails, out of just under $400 billion in trades processed daily by NSCC, or about 1.5% of the dollar volume. The Stock Borrow program is able to resolve about $1.1 billion of the “fails to receive,” or about 20% of the total fail obligation.
The Stock Borrow program was created in 1981 with the approval of the SEC to help reduce potential problems caused by fails, by enabling NSCC to make deliveries of shares to brokers who bought them when there is a “fail to deliver” by the delivering broker.
Reality: In 1981 the DTCC submitted, and the SEC approved, a stock borrow program that clearly stated that its intentions were to address the temporary settlement failures that occurred. Today 20% of all fails, nearly $1.1 Billion in stock transactions daily, utilize the stock borrow system to settle trades. The DTCC stock loan program is being used to mask the fraud not settle temporary hiccups in the system. The exception [fail] has become a standard part of the industry.
The DTCC system is an electronic system with far greater technologies than what was available in 1981. The value of fails is increasing while the technological ability to settle is becoming easier. The DTCC is ignoring that simple fact.
Question Does DTCC have a regulatory role in naked short selling? What authority does it have to force companies to settle a fail?
LT: Naked short selling, or short selling, is a trading activity. We don’t have any power or legal authority to regulate or stop short selling, naked or otherwise. We also have no power to force member firms to close out or resolve fails to deliver. That power is reserved for the SEC and the markets, be it the NYSE, Nasdaq, Amex, or any of the other markets. The fact is, we don’t even see whether a sale is short or not. That’s something only the markets see. NSCC just gets “buys” and “sells,” and it’s our job to try and clear and settle those trades.
Reality: The DTCC has every right to close out that fail they simply ignore their responsibility. In fact the main charter of the near monopoly we call the DTCC is to clear and settle trades. The added feature of the stock loan program created in 1981 was not intended to be used as the DTCC uses it today. The intention in 1981 was that when the paper finally arrived several days later the loaned share was returned. What we see today is that it is not a paper delay that has created the fail but instead systematic fails intended to defraud. The fails last for extended periods in time without any supportive justification and the DTCC allows the fail to extend itself.
The DTCC is supposed to call in the loan when the loan goes beyond temporary. They are the bank and as is the case with any bank there is a plan for payback. It is a right the DTCC has but an option they chose not to exercise.
Question: Another allegation is that the Stock Borrow program has become “a reliable source of income” for NSCC? Some articles have said we make almost $1 billion from it.
LT: The fact is that there are NO separate fees for transactions processed through the Stock Borrow program. There is just the normal fee for delivery of the shares, which is 30 cents per delivery. If you assume we make an average of 22,000 deliveries through Stock Borrow a day, there would be about $6,600 extra a day in revenue over 253 trading days, or about $1.67 million a year in additional revenue, out of $1 billion.
All of our members know that DTCC and all its subsidiaries operate on a “not for profit” basis. What that means is that we aim to price our services so that our revenues cover our expenses.
Reality: The DTCC is a non-profit operation managed by a large percentage of Wall Street firms. When the DTCC comes to excess in funds, the members receive rebates for the services. Those rebates become beneficial to the members without any of those rebates being returned to the investors. Investors pay fees for each trade executed but those fees never change when rebates are given back to members.
As a non-profit operation the executive staff of the DTCC are certainly well compensated for their efforts and members are part of the compensation committee. It benefits the executives to keep peace with members.
Secondly, if the DTCC is not charging a loan fee, a margin, to the firm borrowing the shares to cover the settlement failure, they exacerbate the neglect as the failing firm is spared the required cost to borrow as is the case in a normal short sale transaction. Mr. Thompson is alluding above to there being no interest paid on the shares borrowed to settle. That is either a conflict of the agency or a mis-statement by the General Council. There needs to be a time based fee on loaned shares used to settle fails and that time based fee is profit to somebody.
Question: If the volume in the Stock Borrow program is so small, why are these companies suggesting it is a major issue?
LT: Frankly, we believe that the allegations are attempting to purposely mislead those who are not familiar with this program. A number of small OTCBB and so-called “pink sheet” companies have contended that this practice is driving down the price of their shares and driving them out of business.
According to their own 10K and 10Q reports financial auditor’s disclosure statements, many of these firms have admitted that “factors raise substantial doubt about the company’s ability to continue as a going concern.” They have had little or no revenue, according to their financial reports, and substantial losses, for periods of seven or eight years. One of these companies has been cited for failing to file financial statements since 2001. Another has been cited by the SEC for press releases that misled investors on expanding business contracts that didn’t exist. They will do anything they can do that takes people’s attention off that kind of record, especially if they can convince a law firm to take the case on a contingency basis, which is what has happened.
Reality: Lets start with the 10K and 10Q Comments. By law companies are required to submit a Safe Harbor Agreement that provides investors with the possibility of failed operations. The quote Mr. Thompson uses is standard in hundreds of company filings. To use that as an example of why this problem exists is clearly intent to mislead. But that is really about fundamentals and the stock borrow program and naked shorting is not about fundamentals. Fundamentals are based on supply and demand and naked shorting abuses the economics of supply and demand.
Investors invest. That is the general premise of the market. The fact that Regulation SHO has created a list of 600 companies with settlement abuses above a significant level is documented. The fact that the DTCC provided a visiting economic scholar to the SEC, Professor Leslie Boni with data that supports claims of settlement abuses is a fact. The DTCC’s own data alleges that of 3500 OTCBB and Pink Sheet Companies they presented 1790 had excessive fails with the average number of fails across these companies equaling 1.59% of the shares outstanding and the average age of the fail being greater than 56 days. In an era of electronic trading this is not a set of figures Mr. Thompson should hang his hat on being a non-issue. It should be an embarrassment.
Today the list of companies complaining has expanded to brand name companies listed on the NYSE and NASDAQ. Are they too simply misunderstood? What will Mr. Thompson have to say when a NYSE or NASDAQ company enters into a lawsuit against the agency?
Question: What causes a fail to deliver in a trade? Is it all naked short selling?
LT: There can be any number of reasons for a “fail to deliver,” many of them the result of investor actions. An investor can get a physical certificate to his broker too late for settlement. An investor might not have signed the certificate, or signed in the wrong place. There may have been human error, in that the wrong stock (or CUSIP) was sold, so the delivery can’t be made. Last year, 1.7 million physical certificates were lost, and sometimes that isn’t discovered until after an investor puts in an order to sell the security. There are literally dozens of reasons for a “fail to deliver,” and most of them are legal. Reg SHO also allows market makers to legally “naked short” shares in the course of their market making responsibilities, and those obviously result in fails. We can’t do anything about them but what we are doing: that is, report all fails of more than 10,000 shares in any issue to the marketplaces and the SEC for their action.
Reality: Again Mr. Thompson attempts to work the numbers to diffuse the truth.
Last year 1.7 million certificates were lost. Earlier we heard that there were 22,000 transaction failures executed daily through the stock borrow program. Over 5.5 Million trades. The use of lost certificates (not necessarily representing one trade per certificate) as justification of an extended fail is that needle in the haystack. By the SEC and DTCC’s own charter the entire industry is moving to totally electronic and we are close to getting there today. Paper being lost is a ruse.
Wrong stock or CUSIP etc… again those are the “temporary fails” that the stock borrow program was intended to cover. Today we have household names like Martha Stewart Living, TASER, and Overstock.com with extended and excessive fails that have persisted for months. The NASDAQ reported listing of threshold securities has 40 NASDAQ NMS and small cap companies that have qualified for excessive fails for nearly 90 days. Human errors do not last 90 days. Fact is, even exemptions provided to market makers were not intended to allow a market maker to carry an indefinite naked short.
In December 2004 the NASD took action against Hilary Shane for the sale of unregistered securities. Ms. Shane executed 975 transactions representing 475,000 shares of CompuDyne stock that she did not own nor borrow. The NASD claimed she was selling unregistered securities, securities not issued by the company. The DTCC executed settlement on these transactions through their stock borrow program. They aided and abetted the fraud as they did not question the nature of the fails but instead simply settled the trades through the stock loan program.
Question: Do you think there is illegal naked shorting going on?
LT: Certainly there have been cases in the past where it has, and those cases have been prosecuted by the SEC and other appropriate enforcement agencies. I suppose there will be cases where someone else will try to break the law in the future. But I also don’t believe that there is the huge, systemic, illegal naked shorting that some have charged is going on. To say that there are trillions of dollars involved in this is ridiculous. The fact is that fails, as a percentage of total trading, hasn’t changed in the last 10 years.
Reality: Regulation SHO provides the evidence of naked shorting abuses. Worse, however, is that as stated above the SEC and NASD have taken enforcement actions against naked shorting. A sum total of three enforcement actions have been taken to date. Each action was taken years after the trading events were initiated and in each case the illegal trading went undetected for extended periods because the DTCC was settling the trades. In all cases the investors who were manipulated lost everything before the enforcement actions came through.
As for the magnitude of the losses, Mr. Thompson clearly identifies that the trading fails has not changed in 10 years. The SEC created Regulation SHO identifying the potential abusive nature of fails and the greater leverage these fails have on the sell side. Do the math, review the magnitude of fails generated each year and then equate a fail to sell side pressures on the market and you can easily achieve a $1 Trillion aggregate market cap loss over a 10 year span. Wall Street is a multi trillion industry.
Example: The SEC action against Rhino Advisors regarding the naked shorting of Sedona took nearly $5.00/share off the stock price. With 100 Million shares outstanding that is $500 Million on one event alone. Today we have 600 companies listed with abusive fails.
Do the math.
In closing. It is disappointing to see someone such as Mr. Thompson come out and mislead a circumstance such as this. Wall Street and the credibility of all those involved in the regulatory guidance of Wall Street are at all time lows. Nobody trusts the people or the integrity of the business operations. Now, Larry Thompson comes out and tries to fool more while belittling others.
If the DTCC has nothing to hide, why have they fought so hard to block discovery by these companies to see the actual trading volumes in their stock? What is there to hide? Why has the DTCC never questioned the reasons behind the settlement failure but instead simply covered it up with a loan that has no time limits to it?
In February of this year Mr. Thompson was in Reno, Nevada fighting yet another company looking for discovery of the DTCC records. This time, however, NBC’s Dateline was there to film the hearing. Mr. Thompson and his legal team argued with the judge to have the camera’s removed but the Judge allowed them to stay. While I hear the rest of the day was quite interesting we shall have to wait until Dateline airs before we really see the story. The DTCC must not have felt it went too well as they printed this PR right after the hearing. This story is a decade old, the DTCC admits to 12 lawsuits filed against them and their first real open response come 2.5 weeks after Dateline films them in Reno.
Coincidence or just a little pre-emptive damage control.
For the Full DTCC Release follow the link… www.dtcc.com/Publications/dtcc/mar05/naked_short_selling.html
For more on this issue please visit the Host site at www.investigatethesec.com .
Copyright 2005
Dave Patch
On March 5, 2005 the DTCC published an interview style report on their website discussing the naked shorting issue that haunts them today. The interviewee was Chief General Council Larry Thompson. For all practical purposes the DTCC interview was nothing short of self-serving fiction intended to muddy the waters of the issue at hand.
Lets start with cold facts. Settlement failures do exist and exist to levels that have placed as many as 600 eligible publicly traded companies on the SEC’s new threshold security list for excessive and extended failures. This is fact that cannot be disputed by Mr. Thompson or any other as the list is posted daily on all major market web sites. Mr. Thomson alleges that settlement fails represent approximately one tenth of one percent of all daily trade volumes but when isolating those fails to individual companies it can be extremely damaging – manipulative damaging.
Below are some of the questions asked, excerpts of Mr. Thomson’s responses, and my breakdown of his statements.
Question: Just how big is the fail to delivers, and how much of those fails does the Stock Borrow program address?
LT: In dollar terms, fails to deliver and receive amount to about $6 billion daily, again including both new fails and aged fails, out of just under $400 billion in trades processed daily by NSCC, or about 1.5% of the dollar volume. The Stock Borrow program is able to resolve about $1.1 billion of the “fails to receive,” or about 20% of the total fail obligation.
The Stock Borrow program was created in 1981 with the approval of the SEC to help reduce potential problems caused by fails, by enabling NSCC to make deliveries of shares to brokers who bought them when there is a “fail to deliver” by the delivering broker.
Reality: In 1981 the DTCC submitted, and the SEC approved, a stock borrow program that clearly stated that its intentions were to address the temporary settlement failures that occurred. Today 20% of all fails, nearly $1.1 Billion in stock transactions daily, utilize the stock borrow system to settle trades. The DTCC stock loan program is being used to mask the fraud not settle temporary hiccups in the system. The exception [fail] has become a standard part of the industry.
The DTCC system is an electronic system with far greater technologies than what was available in 1981. The value of fails is increasing while the technological ability to settle is becoming easier. The DTCC is ignoring that simple fact.
Question Does DTCC have a regulatory role in naked short selling? What authority does it have to force companies to settle a fail?
LT: Naked short selling, or short selling, is a trading activity. We don’t have any power or legal authority to regulate or stop short selling, naked or otherwise. We also have no power to force member firms to close out or resolve fails to deliver. That power is reserved for the SEC and the markets, be it the NYSE, Nasdaq, Amex, or any of the other markets. The fact is, we don’t even see whether a sale is short or not. That’s something only the markets see. NSCC just gets “buys” and “sells,” and it’s our job to try and clear and settle those trades.
Reality: The DTCC has every right to close out that fail they simply ignore their responsibility. In fact the main charter of the near monopoly we call the DTCC is to clear and settle trades. The added feature of the stock loan program created in 1981 was not intended to be used as the DTCC uses it today. The intention in 1981 was that when the paper finally arrived several days later the loaned share was returned. What we see today is that it is not a paper delay that has created the fail but instead systematic fails intended to defraud. The fails last for extended periods in time without any supportive justification and the DTCC allows the fail to extend itself.
The DTCC is supposed to call in the loan when the loan goes beyond temporary. They are the bank and as is the case with any bank there is a plan for payback. It is a right the DTCC has but an option they chose not to exercise.
Question: Another allegation is that the Stock Borrow program has become “a reliable source of income” for NSCC? Some articles have said we make almost $1 billion from it.
LT: The fact is that there are NO separate fees for transactions processed through the Stock Borrow program. There is just the normal fee for delivery of the shares, which is 30 cents per delivery. If you assume we make an average of 22,000 deliveries through Stock Borrow a day, there would be about $6,600 extra a day in revenue over 253 trading days, or about $1.67 million a year in additional revenue, out of $1 billion.
All of our members know that DTCC and all its subsidiaries operate on a “not for profit” basis. What that means is that we aim to price our services so that our revenues cover our expenses.
Reality: The DTCC is a non-profit operation managed by a large percentage of Wall Street firms. When the DTCC comes to excess in funds, the members receive rebates for the services. Those rebates become beneficial to the members without any of those rebates being returned to the investors. Investors pay fees for each trade executed but those fees never change when rebates are given back to members.
As a non-profit operation the executive staff of the DTCC are certainly well compensated for their efforts and members are part of the compensation committee. It benefits the executives to keep peace with members.
Secondly, if the DTCC is not charging a loan fee, a margin, to the firm borrowing the shares to cover the settlement failure, they exacerbate the neglect as the failing firm is spared the required cost to borrow as is the case in a normal short sale transaction. Mr. Thompson is alluding above to there being no interest paid on the shares borrowed to settle. That is either a conflict of the agency or a mis-statement by the General Council. There needs to be a time based fee on loaned shares used to settle fails and that time based fee is profit to somebody.
Question: If the volume in the Stock Borrow program is so small, why are these companies suggesting it is a major issue?
LT: Frankly, we believe that the allegations are attempting to purposely mislead those who are not familiar with this program. A number of small OTCBB and so-called “pink sheet” companies have contended that this practice is driving down the price of their shares and driving them out of business.
According to their own 10K and 10Q reports financial auditor’s disclosure statements, many of these firms have admitted that “factors raise substantial doubt about the company’s ability to continue as a going concern.” They have had little or no revenue, according to their financial reports, and substantial losses, for periods of seven or eight years. One of these companies has been cited for failing to file financial statements since 2001. Another has been cited by the SEC for press releases that misled investors on expanding business contracts that didn’t exist. They will do anything they can do that takes people’s attention off that kind of record, especially if they can convince a law firm to take the case on a contingency basis, which is what has happened.
Reality: Lets start with the 10K and 10Q Comments. By law companies are required to submit a Safe Harbor Agreement that provides investors with the possibility of failed operations. The quote Mr. Thompson uses is standard in hundreds of company filings. To use that as an example of why this problem exists is clearly intent to mislead. But that is really about fundamentals and the stock borrow program and naked shorting is not about fundamentals. Fundamentals are based on supply and demand and naked shorting abuses the economics of supply and demand.
Investors invest. That is the general premise of the market. The fact that Regulation SHO has created a list of 600 companies with settlement abuses above a significant level is documented. The fact that the DTCC provided a visiting economic scholar to the SEC, Professor Leslie Boni with data that supports claims of settlement abuses is a fact. The DTCC’s own data alleges that of 3500 OTCBB and Pink Sheet Companies they presented 1790 had excessive fails with the average number of fails across these companies equaling 1.59% of the shares outstanding and the average age of the fail being greater than 56 days. In an era of electronic trading this is not a set of figures Mr. Thompson should hang his hat on being a non-issue. It should be an embarrassment.
Today the list of companies complaining has expanded to brand name companies listed on the NYSE and NASDAQ. Are they too simply misunderstood? What will Mr. Thompson have to say when a NYSE or NASDAQ company enters into a lawsuit against the agency?
Question: What causes a fail to deliver in a trade? Is it all naked short selling?
LT: There can be any number of reasons for a “fail to deliver,” many of them the result of investor actions. An investor can get a physical certificate to his broker too late for settlement. An investor might not have signed the certificate, or signed in the wrong place. There may have been human error, in that the wrong stock (or CUSIP) was sold, so the delivery can’t be made. Last year, 1.7 million physical certificates were lost, and sometimes that isn’t discovered until after an investor puts in an order to sell the security. There are literally dozens of reasons for a “fail to deliver,” and most of them are legal. Reg SHO also allows market makers to legally “naked short” shares in the course of their market making responsibilities, and those obviously result in fails. We can’t do anything about them but what we are doing: that is, report all fails of more than 10,000 shares in any issue to the marketplaces and the SEC for their action.
Reality: Again Mr. Thompson attempts to work the numbers to diffuse the truth.
Last year 1.7 million certificates were lost. Earlier we heard that there were 22,000 transaction failures executed daily through the stock borrow program. Over 5.5 Million trades. The use of lost certificates (not necessarily representing one trade per certificate) as justification of an extended fail is that needle in the haystack. By the SEC and DTCC’s own charter the entire industry is moving to totally electronic and we are close to getting there today. Paper being lost is a ruse.
Wrong stock or CUSIP etc… again those are the “temporary fails” that the stock borrow program was intended to cover. Today we have household names like Martha Stewart Living, TASER, and Overstock.com with extended and excessive fails that have persisted for months. The NASDAQ reported listing of threshold securities has 40 NASDAQ NMS and small cap companies that have qualified for excessive fails for nearly 90 days. Human errors do not last 90 days. Fact is, even exemptions provided to market makers were not intended to allow a market maker to carry an indefinite naked short.
In December 2004 the NASD took action against Hilary Shane for the sale of unregistered securities. Ms. Shane executed 975 transactions representing 475,000 shares of CompuDyne stock that she did not own nor borrow. The NASD claimed she was selling unregistered securities, securities not issued by the company. The DTCC executed settlement on these transactions through their stock borrow program. They aided and abetted the fraud as they did not question the nature of the fails but instead simply settled the trades through the stock loan program.
Question: Do you think there is illegal naked shorting going on?
LT: Certainly there have been cases in the past where it has, and those cases have been prosecuted by the SEC and other appropriate enforcement agencies. I suppose there will be cases where someone else will try to break the law in the future. But I also don’t believe that there is the huge, systemic, illegal naked shorting that some have charged is going on. To say that there are trillions of dollars involved in this is ridiculous. The fact is that fails, as a percentage of total trading, hasn’t changed in the last 10 years.
Reality: Regulation SHO provides the evidence of naked shorting abuses. Worse, however, is that as stated above the SEC and NASD have taken enforcement actions against naked shorting. A sum total of three enforcement actions have been taken to date. Each action was taken years after the trading events were initiated and in each case the illegal trading went undetected for extended periods because the DTCC was settling the trades. In all cases the investors who were manipulated lost everything before the enforcement actions came through.
As for the magnitude of the losses, Mr. Thompson clearly identifies that the trading fails has not changed in 10 years. The SEC created Regulation SHO identifying the potential abusive nature of fails and the greater leverage these fails have on the sell side. Do the math, review the magnitude of fails generated each year and then equate a fail to sell side pressures on the market and you can easily achieve a $1 Trillion aggregate market cap loss over a 10 year span. Wall Street is a multi trillion industry.
Example: The SEC action against Rhino Advisors regarding the naked shorting of Sedona took nearly $5.00/share off the stock price. With 100 Million shares outstanding that is $500 Million on one event alone. Today we have 600 companies listed with abusive fails.
Do the math.
In closing. It is disappointing to see someone such as Mr. Thompson come out and mislead a circumstance such as this. Wall Street and the credibility of all those involved in the regulatory guidance of Wall Street are at all time lows. Nobody trusts the people or the integrity of the business operations. Now, Larry Thompson comes out and tries to fool more while belittling others.
If the DTCC has nothing to hide, why have they fought so hard to block discovery by these companies to see the actual trading volumes in their stock? What is there to hide? Why has the DTCC never questioned the reasons behind the settlement failure but instead simply covered it up with a loan that has no time limits to it?
In February of this year Mr. Thompson was in Reno, Nevada fighting yet another company looking for discovery of the DTCC records. This time, however, NBC’s Dateline was there to film the hearing. Mr. Thompson and his legal team argued with the judge to have the camera’s removed but the Judge allowed them to stay. While I hear the rest of the day was quite interesting we shall have to wait until Dateline airs before we really see the story. The DTCC must not have felt it went too well as they printed this PR right after the hearing. This story is a decade old, the DTCC admits to 12 lawsuits filed against them and their first real open response come 2.5 weeks after Dateline films them in Reno.
Coincidence or just a little pre-emptive damage control.
For the Full DTCC Release follow the link… www.dtcc.com/Publications/dtcc/mar05/naked_short_selling.html
For more on this issue please visit the Host site at www.investigatethesec.com .
Copyright 2005