Post by jannikki on Nov 12, 2005 10:49:52 GMT -4
A Birds Eye View of Regulation SHO – September 2, 2005
David Patch
I must initiate this column with a caveat, I am biased, I never believed that Regulation SHO had any teeth so my perceptions may be skewed to that direction. With that being said I will attempt to present evidence for review regarding Regulation SHO.
Problem Statement:
Naked Short Selling (NSS), and the resultant increase in the level of trade settlement failures in the marketplace, has destroyed the growth of entrepreneurial companies and their investors and has left Wall Street with tremendous financial liability that, if called upon, could result in a breakdown of the overall stability of the markets.
Naked Short Selling has become so pervasive, according to one former SEC Attorney that it borders on a systemic breakdown in the Industry.
SEC Reaction to Naked Short Selling
In June 2004 the SEC approved a reform package called Regulation SHO with an effectivity date of January 3, 2005. In this reform the SEC has created a “threshold list” of securities, those companies with 10,000 shares and greater than 0.5% of the shares outstanding recorded as failures within the NSCC’s Continuous Net Settlement (CNS) system.
Within this reform the SEC also created what it called the “grandfather clause” which pardons all prior settlement failures from mandatory buy-in provisions prior to an issuer being published on the “threshold list”. The SEC’s rationalization for this was that there was concern over the liability of large pre-existing fails and the impact to the market of mandatory buy-ins for settlement.
SEC Published Statements on Naked Short Selling
The SEC has been extremely contradictory in their public statements regarding naked short selling. These contradictions, along with actual CNS Settlement data and other Industry professional comments tend to lead to a conclusion that the SEC is possibly downplaying this issue due to the out of control nature of what has taken place.
1. In the SEC proposal of Reg. SHO published for comment in October 2003:
“Naked short selling can have a negative number of negative effects on the market, particularly when the fails to deliver persist for an extended period of time and result in a significantly large unfulfilled delivery obligation at the clearing agency where trades are settled….More significantly, naked short sellers enjoy greater leverage than if they were required to borrow securities and deliver within a reasonable time period, and they use this additional leverage to engage in trading activities that deliberately depress the price of a security”
2. In a published SEC Q&A on Regulation SHO in April 2005
“The grandfathering provisions of Regulation SHO were adopted because the Commission was concerned about creating volatility where there were large pre-existing open positions. The Commission will continue to monitor whether grandfathered open fail positions are being cleaned up under existing delivery and settlement guidelines or whether further action is warranted.
It is important to note that the "grandfathering" clause of the Regulation does not affect the Commission's ability to prosecute violations of law that may involve such securities or violations that may have occurred before the adoption of Regulation SHO or that occurred before the security became a threshold security.”
The contradiction in these two public statements pertains to the issue of the impact that large pre-existing open positions have to the marketplace. On one point the SEC claims these have a negative effect on the markets and provide leverage used to engage in manipulative activities. And then on the other hand the SEC is “grandfathering” these fails because there is too many of them to deal with on certain “selected companies” as listed on the “threshold list”.
3. In a recorded Bear Stearns Conference Call on December 13, 2004 regarding Regulation SHO the General Counsel of Bear Stearns stated:
"To give you that brief introduction in Reg SHO the history how we got to where we are today. For the past few years we have been hearing from many different regulators regarding their concerns about the increase in the level of fails that they are seeing. They believe, and they have stated on numerous occasions, that one of the primary causes of the high level of fails was that various participants in the short sale process, prime brokers, executing brokers, clients were not following already established rules."
This statement, taken in the context of how the SEC released Regulation SHO with the “grandfather clause” challenges the true nature of the pre-existing fails now pardoned from mandatory buy-in closeouts. It appears that the regulators are identifying that the large pre-existing fails accumulated due to illegal trading taking place within the marketplace. If they are illegal, they have no rights to the protection of the grandfather clause. Future threats of regulatory enforcement pales to the destruction caused by the indefinite extension to closeout. In fact, the SEC has administered merely one enforcement action to date pertaining to naked shorting abuses yet the GC of Bear Stearns is admitting they have known of the abuses for years.
Analysis of System Fails
Several different attempts have been taken to box-in the magnitude of the problem faced with naked shorting.
1. Visiting Economic Scholar – Professor Leslie Boni.
In November 2004 a former visiting economic scholar to the SEC published her working paper on a study conducted for the SEC on the issue of settlement failures. The study “Strategic Delivery Failures in U.S. Equity Markets” by Professor Leslie Boni concludes that many failures in the system are conducted strategically due to the high cost of borrowing shares. The study also concluded that nearly 4% of all publicly eligible companies would qualify for the SEC’s proposed “threshold list” with accumulated fails greater than 0.5% of their shares outstanding. www.unm.edu/~boni/Fails_paper_Nov2004.doc
2. Continuous Net Settlement (CNS) Data Gathered under FOIA.
Recently, under Freedom of Information Act (FOIA) requests the SEC complied by providing CNS fail data on the NYSE/NASDAQ listed securities for the time period of April 2004 – April 2005. Additional data is being sought for the other markets. The data highlights that prior to the release of Regulation SHO the NYSE/NASDAQ listed securities were averaging approx. 160 Million shares daily as settlement failures in the CNS system. After June 2004 but before January 2005 the number of fails on the NYSE/NASDAQ rose steadily to a peak of nearly 200 Million fails daily on average for the month of December. This represents a 35% rise in system fails during a “period of opportunity” to slowly clean up the large pre-existing fails.
Since SHO was incorporated in January, the fails in the exchanges have begun to fall back from the December highs but have reductions have tapered off recently. Of note, the fails provided are only fails that take place at the NSCC. An analysis of Total Reported Trade Volume vs. DTCC Share Settlements for Overstock.com highlight that less than 50% of the total trade volume is presently being cleared through the DTCC. The remainder of clearance is taking place at the ex-clearing levels: in house settling. This percentage appears to be much higher than previously recorded data prior to Regulation SHO.
If this were in fact the case across the board on the issuers who are heavily oversold, overstock.com is a threshold-listed security; the Industry would have simply pulled a bait and switch on the market’s transparency. The SEC’s proposal to publish abused stocks would be hidden once again as the trades that became abusive were merely hidden from the database that tracks the failures.
3. NASDAQ SHO List Performance to Date
The first publication of Regulation SHO came out on January 7, 2005.
The NASDAQ and NASDAQ Small cap companies listed equalled a total of 101 Companies. Today, August 27, 2005, the list is comprised of 97 Companies representing a reduction of only 4 companies between these two snapshots in time [nearly 9 months apart].
Of the 97 companies on today’s list 18 companies were listed on January 7, 2005. Most but not all have been there the entire 8+ months.
Of the 18 companies defined above, 11 have Lost Market Value, 4 have gained in market value, and the rest have been flat over this period in time.
Of the 18 Companies, 8 of the 11 companies that lost Market Cap saw reductions in short positions between January and August.
Of the 18 Companies, 3 of the 4 companies that gained Market Cap saw reductions in short positions between January and August.
Of the 18 Companies, 4 companies had their minimum level to qualify for the threshold list [0.5% of Shares outstanding] represents greater than 10% of the reported short positions in the security. In two cases the minimum threshold level represented greater than 40% of the reported short position [69% and 45%].
Conclusions [my personal opinion]:
The very existence of a grandfather clause is evidence that the settlement failures are a concern to the marketplace. Under Securities Law [Section 17A, Rules 15c3-3, 15c6-1 of the Securities Exchange Act of 1934], failures are intended to be an exception and not the rule. As seen by the evidence now provided, that is in fact not the case.
The SEC has wilfully jeopardized many companies and investors to protect the liabilities presently resting within the Wall Street institutions. The existence of such destruction was never more clearly stated than in a recent theStreet.com article.
August 28, 2005 theStreet.com….The only clear-cut information on naked short-selling as an abusive practice has come from trials where such evidence was made public -- but often years after the fact. Ken Breen, an attorney in the Justice Department during the Anthony Elgindy case, says the prosecution presented evidence that naked short-selling was active in stocks between late 2000 and early 2002.
"There was a significant amount of naked short-selling in the Elgindy case," says Breen, now a partner at Fulbright and Jaworsky. "We presented evidence on nearly 40 stocks where there was manipulative short-selling, and in nearly all of those cases, there was naked short-selling."
Of the 40 Companies involved, most if not all are no longer in business. Forty separate companies, employees, technologies, and investors all lost to the abuses of naked shorting and settlement failures. When these companies closed the doors and ceased to trade in the public markets the profits from the illegal short sale became 100%. Investors paid for and lost their investment in shares they never actually owned. The SEC is fully aware of those past events and aware that present markets exist today with this type of abuse.
Remember, Elgindy did not work in isolation to manipulate these companies; he was a client to Wall Street who aided in the orchestration of the fraud. The SEC has never taken any regulatory enforcement on the firms representing Elgindy or the firms representing the buyers of the illegal shares Elgindy sold and never delivered on.
For more on this issue please visit the Host site at www.investigatethesec.com .
Copyright 2005
David Patch
I must initiate this column with a caveat, I am biased, I never believed that Regulation SHO had any teeth so my perceptions may be skewed to that direction. With that being said I will attempt to present evidence for review regarding Regulation SHO.
Problem Statement:
Naked Short Selling (NSS), and the resultant increase in the level of trade settlement failures in the marketplace, has destroyed the growth of entrepreneurial companies and their investors and has left Wall Street with tremendous financial liability that, if called upon, could result in a breakdown of the overall stability of the markets.
Naked Short Selling has become so pervasive, according to one former SEC Attorney that it borders on a systemic breakdown in the Industry.
SEC Reaction to Naked Short Selling
In June 2004 the SEC approved a reform package called Regulation SHO with an effectivity date of January 3, 2005. In this reform the SEC has created a “threshold list” of securities, those companies with 10,000 shares and greater than 0.5% of the shares outstanding recorded as failures within the NSCC’s Continuous Net Settlement (CNS) system.
Within this reform the SEC also created what it called the “grandfather clause” which pardons all prior settlement failures from mandatory buy-in provisions prior to an issuer being published on the “threshold list”. The SEC’s rationalization for this was that there was concern over the liability of large pre-existing fails and the impact to the market of mandatory buy-ins for settlement.
SEC Published Statements on Naked Short Selling
The SEC has been extremely contradictory in their public statements regarding naked short selling. These contradictions, along with actual CNS Settlement data and other Industry professional comments tend to lead to a conclusion that the SEC is possibly downplaying this issue due to the out of control nature of what has taken place.
1. In the SEC proposal of Reg. SHO published for comment in October 2003:
“Naked short selling can have a negative number of negative effects on the market, particularly when the fails to deliver persist for an extended period of time and result in a significantly large unfulfilled delivery obligation at the clearing agency where trades are settled….More significantly, naked short sellers enjoy greater leverage than if they were required to borrow securities and deliver within a reasonable time period, and they use this additional leverage to engage in trading activities that deliberately depress the price of a security”
2. In a published SEC Q&A on Regulation SHO in April 2005
“The grandfathering provisions of Regulation SHO were adopted because the Commission was concerned about creating volatility where there were large pre-existing open positions. The Commission will continue to monitor whether grandfathered open fail positions are being cleaned up under existing delivery and settlement guidelines or whether further action is warranted.
It is important to note that the "grandfathering" clause of the Regulation does not affect the Commission's ability to prosecute violations of law that may involve such securities or violations that may have occurred before the adoption of Regulation SHO or that occurred before the security became a threshold security.”
The contradiction in these two public statements pertains to the issue of the impact that large pre-existing open positions have to the marketplace. On one point the SEC claims these have a negative effect on the markets and provide leverage used to engage in manipulative activities. And then on the other hand the SEC is “grandfathering” these fails because there is too many of them to deal with on certain “selected companies” as listed on the “threshold list”.
3. In a recorded Bear Stearns Conference Call on December 13, 2004 regarding Regulation SHO the General Counsel of Bear Stearns stated:
"To give you that brief introduction in Reg SHO the history how we got to where we are today. For the past few years we have been hearing from many different regulators regarding their concerns about the increase in the level of fails that they are seeing. They believe, and they have stated on numerous occasions, that one of the primary causes of the high level of fails was that various participants in the short sale process, prime brokers, executing brokers, clients were not following already established rules."
This statement, taken in the context of how the SEC released Regulation SHO with the “grandfather clause” challenges the true nature of the pre-existing fails now pardoned from mandatory buy-in closeouts. It appears that the regulators are identifying that the large pre-existing fails accumulated due to illegal trading taking place within the marketplace. If they are illegal, they have no rights to the protection of the grandfather clause. Future threats of regulatory enforcement pales to the destruction caused by the indefinite extension to closeout. In fact, the SEC has administered merely one enforcement action to date pertaining to naked shorting abuses yet the GC of Bear Stearns is admitting they have known of the abuses for years.
Analysis of System Fails
Several different attempts have been taken to box-in the magnitude of the problem faced with naked shorting.
1. Visiting Economic Scholar – Professor Leslie Boni.
In November 2004 a former visiting economic scholar to the SEC published her working paper on a study conducted for the SEC on the issue of settlement failures. The study “Strategic Delivery Failures in U.S. Equity Markets” by Professor Leslie Boni concludes that many failures in the system are conducted strategically due to the high cost of borrowing shares. The study also concluded that nearly 4% of all publicly eligible companies would qualify for the SEC’s proposed “threshold list” with accumulated fails greater than 0.5% of their shares outstanding. www.unm.edu/~boni/Fails_paper_Nov2004.doc
2. Continuous Net Settlement (CNS) Data Gathered under FOIA.
Recently, under Freedom of Information Act (FOIA) requests the SEC complied by providing CNS fail data on the NYSE/NASDAQ listed securities for the time period of April 2004 – April 2005. Additional data is being sought for the other markets. The data highlights that prior to the release of Regulation SHO the NYSE/NASDAQ listed securities were averaging approx. 160 Million shares daily as settlement failures in the CNS system. After June 2004 but before January 2005 the number of fails on the NYSE/NASDAQ rose steadily to a peak of nearly 200 Million fails daily on average for the month of December. This represents a 35% rise in system fails during a “period of opportunity” to slowly clean up the large pre-existing fails.
Since SHO was incorporated in January, the fails in the exchanges have begun to fall back from the December highs but have reductions have tapered off recently. Of note, the fails provided are only fails that take place at the NSCC. An analysis of Total Reported Trade Volume vs. DTCC Share Settlements for Overstock.com highlight that less than 50% of the total trade volume is presently being cleared through the DTCC. The remainder of clearance is taking place at the ex-clearing levels: in house settling. This percentage appears to be much higher than previously recorded data prior to Regulation SHO.
If this were in fact the case across the board on the issuers who are heavily oversold, overstock.com is a threshold-listed security; the Industry would have simply pulled a bait and switch on the market’s transparency. The SEC’s proposal to publish abused stocks would be hidden once again as the trades that became abusive were merely hidden from the database that tracks the failures.
3. NASDAQ SHO List Performance to Date
The first publication of Regulation SHO came out on January 7, 2005.
The NASDAQ and NASDAQ Small cap companies listed equalled a total of 101 Companies. Today, August 27, 2005, the list is comprised of 97 Companies representing a reduction of only 4 companies between these two snapshots in time [nearly 9 months apart].
Of the 97 companies on today’s list 18 companies were listed on January 7, 2005. Most but not all have been there the entire 8+ months.
Of the 18 companies defined above, 11 have Lost Market Value, 4 have gained in market value, and the rest have been flat over this period in time.
Of the 18 Companies, 8 of the 11 companies that lost Market Cap saw reductions in short positions between January and August.
Of the 18 Companies, 3 of the 4 companies that gained Market Cap saw reductions in short positions between January and August.
Of the 18 Companies, 4 companies had their minimum level to qualify for the threshold list [0.5% of Shares outstanding] represents greater than 10% of the reported short positions in the security. In two cases the minimum threshold level represented greater than 40% of the reported short position [69% and 45%].
Conclusions [my personal opinion]:
The very existence of a grandfather clause is evidence that the settlement failures are a concern to the marketplace. Under Securities Law [Section 17A, Rules 15c3-3, 15c6-1 of the Securities Exchange Act of 1934], failures are intended to be an exception and not the rule. As seen by the evidence now provided, that is in fact not the case.
The SEC has wilfully jeopardized many companies and investors to protect the liabilities presently resting within the Wall Street institutions. The existence of such destruction was never more clearly stated than in a recent theStreet.com article.
August 28, 2005 theStreet.com….The only clear-cut information on naked short-selling as an abusive practice has come from trials where such evidence was made public -- but often years after the fact. Ken Breen, an attorney in the Justice Department during the Anthony Elgindy case, says the prosecution presented evidence that naked short-selling was active in stocks between late 2000 and early 2002.
"There was a significant amount of naked short-selling in the Elgindy case," says Breen, now a partner at Fulbright and Jaworsky. "We presented evidence on nearly 40 stocks where there was manipulative short-selling, and in nearly all of those cases, there was naked short-selling."
Of the 40 Companies involved, most if not all are no longer in business. Forty separate companies, employees, technologies, and investors all lost to the abuses of naked shorting and settlement failures. When these companies closed the doors and ceased to trade in the public markets the profits from the illegal short sale became 100%. Investors paid for and lost their investment in shares they never actually owned. The SEC is fully aware of those past events and aware that present markets exist today with this type of abuse.
Remember, Elgindy did not work in isolation to manipulate these companies; he was a client to Wall Street who aided in the orchestration of the fraud. The SEC has never taken any regulatory enforcement on the firms representing Elgindy or the firms representing the buyers of the illegal shares Elgindy sold and never delivered on.
For more on this issue please visit the Host site at www.investigatethesec.com .
Copyright 2005