Post by jannikki on Jun 15, 2007 0:02:11 GMT -4
Chairman Cox, A Lesson in Securities Law - June 14, 2007
David Patch
Mr. Chairman and SEC Commissioners, as the leadership staff of the Securities and Exchange Commission I find it imperative that you understand our securities laws if it is you who are to decide the future regulatory environments for which these capital markets will operate in the future.
Yesterday, in an open SEC hearing on short sale reforms, I listened to the SEC staff and Market Regulation staff butcher the language pertaining to a short squeeze. On several occasions the Commission staff equated abusive with a short squeeze in the same sentence while at other times simply downplayed the short squeeze as a volatility problem. For these reasons, the SEC created laws to prevent such market events from taking place. In response The SEC instituted illegal pricing controls.
Well folks, let me give you a lesson in simple securities law.
First and foremost; Under Section 9 of the Exchange Act of 1934 It shall be unlawful for any person, directly or indirectly to effect either alone or with one or more other persons any series of transactions for the purchase and/or sale of any security registered on a national securities exchange for the purpose of pegging, fixing, or stabilizing the price of such security in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.
This law, while addressing the purchase and sale of securities also applies to the SEC when it relates to pricing controls. Congress did not interject such language because Congress never anticipated the SEC violating their laws.
Congress never authorized the SEC to fix or stabilize the price of a security in contravention of rules and regulations that presently exist.
Section 11A and rules 15c3-3 and 15c6-1 promulgated thereafter require the prompt settlement of trades and further identify that prompt is defined as 3-business days. Yesterday, when the SEC admitted on several occasions that the grandfather clause was put in place to restrict and/or eliminate the possibility of a short squeeze due to the forced settlement of a failed trade the SEC subjected itself to a possible investigation into stock manipulation.
The admittance of pricing controls, in contravention to Section 11 and Rules 15c3-3 and 15c6-1, is the very definition of stock manipulation. The fact that a Federal authority engaged in the act is criminal.
Okay, so now that we are all in agreement that the SEC staff was most likely involved in stock manipulation, lets talk about the feared short squeeze. The short squeeze is that dirty word amongst wealthy short interest hedge funds and betting market members.
There are not many definitions of a short squeeze out there but Investopedia seems to have a solid definition as they describe a short squeeze as a situation in which a lack of supply and an excess demand for a traded stock forces the price upward. Further identifying that if a stock starts to rise rapidly, the trend may continue to escalate because the short sellers will likely want out. For example, say a stock rises 15% in one day, those with short positions may be forced to liquidate and cover their position by purchasing the stock. If enough short sellers buy back the stock, the price is pushed even higher.
Now forgive my ignorance here but I am missing the adjectives of "abusive" and "illegal" in this definition. In fact, it appears to be a standard market driven event based on the economics of supply and demand. Who caused the short squeeze? By the definition above, the short sellers caused the squeeze by bringing demand into a market. Is that against the law? If there is a short there can be a short squeeze in the same tone as if there is a long there can be a crash. Both create profit for one side of the market and a loss on the other. Neither is illegal!
Now how would a volatile short squeeze transpire in the regulatory enforcement of trade settlement?
Since trading volumes vary from day to day the relationship of supply and demand would equally vary and depending on the variations between the two a stock will either appreciate in value or depreciate in value. Under normal market conditions, the supply and demand is based on natural buyers and sellers in a particular market.
To create volume and liquidity, the Commission set forth exemptions to market members to allow them to create sells side liquidity without the ownership of shares. Such liquidity, naked shorting, is legal by all definitions if used as a temporary means to offset unusual buy side volumes, the operative word being temporary. Nothing states however that a market maker must engage in sell side liquidity or that when no liquidity exists between buyer and seller the market maker must engage in the sell side of the market to create the liquidity. It is an option afforded the firm but not a requirement.
What the SEC has learned over the last decade is that temporary became persistent as members of Wall Street were betting against companies and using the market making exemption as the trade vehicle for the bet. When they brought liquidity into the markets it was easier and cheaper to create sell side liquidity than buy side and thus the bets were negative bets.
The members were no longer stabilizing markets but instead manipulating markets under pricing controls. The result was massive levels of persistent failed trades. Trade settlement failures began to exceed the critical 0.5% of the total shares issued and outstanding and a far greater percentage of the general public float. The markets in these stocks took the brunt of the dilutions created and the imbalance created between supply and demand.
While these trades were in violation of the letter and the spirit of the securities laws the SEC allowed the trade liabilities to escalate to levels now determined to be out of control. Temporary became persistent in the dictionary of the SEC and in the dictionary of the member firms.
The SEC's solution to such pricing manipulation was to create a grandfather clause that would prevent any kind of upward pricing mobility should these failed trades be forced to settle. The SEC determined that the upward mobility, coined a "short squeeze" would be abusive and volatile to the marketplace. The SEC placed blame on the investors for a situation the investor had no control over.
The level of volatility in an "abusive" short squeeze would be directly correlated to the level of abusive settlement failures the industry engaged in when price fixing a security. The difference in the abuse is both are self-induced by the member firms. There can be no "abusive" squeeze had the persistent and excessive fails not existed in the first place. Thus, holding investors hostage to the pre-existing abuses of member firms is an act of aiding and abetting fraud.
In fact, a history lesson for you.
In 1997/98 the stock market began the dot.com crash. In that crash the sell side market [supply] far exceeded the demand side market and stocks plummeted 40, 50, 60% on any given day. The plummets would be volatile but crash they did.
During this period in our markets, investor portfolios witnessed the damage of these conditions as our retirement savings, education savings for our children, or our spending monies all but disappeared. There were no SEC laws put in place that forced market makers to buy in to this massive supply side markets. Instead there was sell side volatility that resulted in considerable losses to the investing public and lost financial opportunities to the public issuers who would have otherwise benefited from the higher market values.
The dot.com crash was a short sellers haven and a bona fide market making boon and nowhere along the trail was the SEC found protecting the investment liabilities of long investors.
When the volatility of a short squeeze enters into a marketplace the same liabilities of loss exists as what took place in 1998/99 but exists to the short sellers and the market members who took out a calculated short position against the market. It is all part of fair market risks. The fact that the squeeze is precipitated by an event, and a forced cover event, differs not from any forced sale executed by a broker dealer on the behalf on an investor who purchased a long security but failed to make the payment as required.
With the exemptions made for market members comes an equal liability and the fails in the system are not the liability of the investing public they are 100% the liability of the firm who carries the failed delivery. It is for that reason that the SEC does not have the authority to restrict the rights of the investing public against the abuses of members taking calculated bets. Members must be held to the same standards of accountability as an investor and with such accountability comes opportunity for profit and loss.
If the price of market making liquidity is a failure to protect the rights of the investing public than the SEC's mission has ventured off course.
I would urge the Commission to better study up on the Commission's authority to control market conditions and pricing. I am sure that Congress has not authorized the Commission to decide who will take a risk of financial loss and who will be free of all burdens. Our markets are a place of investment and with each comes the possibility of a loss.
To put a conclusion on my point, consider this:
One senior executive of a market making operation that is now out of business once identified how they viewed bona fide market making naked shorts. This executive stated, during the period in which SHO was up for public comment, that there was no way his firm would ever close out a bona fide naked short at a loss. His firm would carry the fail until such time as the fail came in-the-money before a closeout transpired.
If you consider such a business model, these firms making a bad bet on the temporary influx of volume could create a substantial allotment of fails that were out-of-money. If they have no intent on settling these trades at a loss then the accumulation becomes substantial and damaging to the market. Unless the firms engage in further manipulation of the security by driving investors out any upside appreciation to their "liabilities" could become crippling.
The SEC has protected against such financial liabilities to member firms by creating the grandfather clause in 2004 in what has been presented as direct contradiction to Congressional authorities.
The investor advocate would have the intuition to investigate how bona fide market making naked shorts are being covered in a marketplace. Should such investigations take place the SEC would most likely see that through the net settlement system, market makers engage in sell side market activities to drive investors out during a covering period.
While this is activity is clearly illegal, it is a venue the SEC has and will continue to protect.
With all this talk of short squeezes, the SEC has always stereotyped investor efforts as one where the mission has been to create nothing but a short squeeze across the marketplace. This bias without investigation is harmful and damaging. The efforts of the investor are simply to obtain fair and equal markets. We cannot induce a short squeeze because we do not hold the power to do so. A short squeeze is an event that is precipitated by an activity and in this case can only be precipitated by the covering of an excess and crippling level of fails in the system. Long investors did not create the fails they only purchased into a company they believed and from a seller who never had anything to sell.
In many cases the fails could easily be covered without a squeeze due to the volume trading in the stocks. The fails however would be covered at a loss to the member firm and that is precisely what prevented the members from covering. It was not about a squeeze, it was about pure profits. Investors have no such protection like what the SEC provided the members. The squeeze would only take place on those companies most abused by settlement failures to levels far exceeding normal daily volumes. That in itself should be a red flag.
I would urge that the next time the SEC elects to stereotype the investing public as greed infested dolts, the Commission look squarely across the table at those that aide them in coming to such conclusions and drafting such laws against the public interests. Certainly those lawyers and executives of Wall Street, each making tens of millions in annual compensation, have much more to lose in profit and loss than we ever had to gain.
The investors want a level playing field and that is all. Wall Street wants a captured regulator who will protect the revenues and compensation packages of an industry capable of handing out near $30 Billion in bonuses in 2006 alone. To date the investing public has witnessed a very compliant agency who has done everything it can to protect just that income.
As a sign of investor sentiment towards the recent SEC actions, the web site www.investigatethesec.com witnessed a spike in hits and signatures the day following the SEC's open public hearing. The investing public continues to sound off that trust in this federal agency is lacking and that a formal investigation into the legalities of their actions is being requested. Will members of Congress finally see the light and begin this long overdue investigation?
For more on this issue please visit the Host site at www.investigatethesec.com (posted with permission)
Copyright 2007
David Patch
Mr. Chairman and SEC Commissioners, as the leadership staff of the Securities and Exchange Commission I find it imperative that you understand our securities laws if it is you who are to decide the future regulatory environments for which these capital markets will operate in the future.
Yesterday, in an open SEC hearing on short sale reforms, I listened to the SEC staff and Market Regulation staff butcher the language pertaining to a short squeeze. On several occasions the Commission staff equated abusive with a short squeeze in the same sentence while at other times simply downplayed the short squeeze as a volatility problem. For these reasons, the SEC created laws to prevent such market events from taking place. In response The SEC instituted illegal pricing controls.
Well folks, let me give you a lesson in simple securities law.
First and foremost; Under Section 9 of the Exchange Act of 1934 It shall be unlawful for any person, directly or indirectly to effect either alone or with one or more other persons any series of transactions for the purchase and/or sale of any security registered on a national securities exchange for the purpose of pegging, fixing, or stabilizing the price of such security in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.
This law, while addressing the purchase and sale of securities also applies to the SEC when it relates to pricing controls. Congress did not interject such language because Congress never anticipated the SEC violating their laws.
Congress never authorized the SEC to fix or stabilize the price of a security in contravention of rules and regulations that presently exist.
Section 11A and rules 15c3-3 and 15c6-1 promulgated thereafter require the prompt settlement of trades and further identify that prompt is defined as 3-business days. Yesterday, when the SEC admitted on several occasions that the grandfather clause was put in place to restrict and/or eliminate the possibility of a short squeeze due to the forced settlement of a failed trade the SEC subjected itself to a possible investigation into stock manipulation.
The admittance of pricing controls, in contravention to Section 11 and Rules 15c3-3 and 15c6-1, is the very definition of stock manipulation. The fact that a Federal authority engaged in the act is criminal.
Okay, so now that we are all in agreement that the SEC staff was most likely involved in stock manipulation, lets talk about the feared short squeeze. The short squeeze is that dirty word amongst wealthy short interest hedge funds and betting market members.
There are not many definitions of a short squeeze out there but Investopedia seems to have a solid definition as they describe a short squeeze as a situation in which a lack of supply and an excess demand for a traded stock forces the price upward. Further identifying that if a stock starts to rise rapidly, the trend may continue to escalate because the short sellers will likely want out. For example, say a stock rises 15% in one day, those with short positions may be forced to liquidate and cover their position by purchasing the stock. If enough short sellers buy back the stock, the price is pushed even higher.
Now forgive my ignorance here but I am missing the adjectives of "abusive" and "illegal" in this definition. In fact, it appears to be a standard market driven event based on the economics of supply and demand. Who caused the short squeeze? By the definition above, the short sellers caused the squeeze by bringing demand into a market. Is that against the law? If there is a short there can be a short squeeze in the same tone as if there is a long there can be a crash. Both create profit for one side of the market and a loss on the other. Neither is illegal!
Now how would a volatile short squeeze transpire in the regulatory enforcement of trade settlement?
Since trading volumes vary from day to day the relationship of supply and demand would equally vary and depending on the variations between the two a stock will either appreciate in value or depreciate in value. Under normal market conditions, the supply and demand is based on natural buyers and sellers in a particular market.
To create volume and liquidity, the Commission set forth exemptions to market members to allow them to create sells side liquidity without the ownership of shares. Such liquidity, naked shorting, is legal by all definitions if used as a temporary means to offset unusual buy side volumes, the operative word being temporary. Nothing states however that a market maker must engage in sell side liquidity or that when no liquidity exists between buyer and seller the market maker must engage in the sell side of the market to create the liquidity. It is an option afforded the firm but not a requirement.
What the SEC has learned over the last decade is that temporary became persistent as members of Wall Street were betting against companies and using the market making exemption as the trade vehicle for the bet. When they brought liquidity into the markets it was easier and cheaper to create sell side liquidity than buy side and thus the bets were negative bets.
The members were no longer stabilizing markets but instead manipulating markets under pricing controls. The result was massive levels of persistent failed trades. Trade settlement failures began to exceed the critical 0.5% of the total shares issued and outstanding and a far greater percentage of the general public float. The markets in these stocks took the brunt of the dilutions created and the imbalance created between supply and demand.
While these trades were in violation of the letter and the spirit of the securities laws the SEC allowed the trade liabilities to escalate to levels now determined to be out of control. Temporary became persistent in the dictionary of the SEC and in the dictionary of the member firms.
The SEC's solution to such pricing manipulation was to create a grandfather clause that would prevent any kind of upward pricing mobility should these failed trades be forced to settle. The SEC determined that the upward mobility, coined a "short squeeze" would be abusive and volatile to the marketplace. The SEC placed blame on the investors for a situation the investor had no control over.
The level of volatility in an "abusive" short squeeze would be directly correlated to the level of abusive settlement failures the industry engaged in when price fixing a security. The difference in the abuse is both are self-induced by the member firms. There can be no "abusive" squeeze had the persistent and excessive fails not existed in the first place. Thus, holding investors hostage to the pre-existing abuses of member firms is an act of aiding and abetting fraud.
In fact, a history lesson for you.
In 1997/98 the stock market began the dot.com crash. In that crash the sell side market [supply] far exceeded the demand side market and stocks plummeted 40, 50, 60% on any given day. The plummets would be volatile but crash they did.
During this period in our markets, investor portfolios witnessed the damage of these conditions as our retirement savings, education savings for our children, or our spending monies all but disappeared. There were no SEC laws put in place that forced market makers to buy in to this massive supply side markets. Instead there was sell side volatility that resulted in considerable losses to the investing public and lost financial opportunities to the public issuers who would have otherwise benefited from the higher market values.
The dot.com crash was a short sellers haven and a bona fide market making boon and nowhere along the trail was the SEC found protecting the investment liabilities of long investors.
When the volatility of a short squeeze enters into a marketplace the same liabilities of loss exists as what took place in 1998/99 but exists to the short sellers and the market members who took out a calculated short position against the market. It is all part of fair market risks. The fact that the squeeze is precipitated by an event, and a forced cover event, differs not from any forced sale executed by a broker dealer on the behalf on an investor who purchased a long security but failed to make the payment as required.
With the exemptions made for market members comes an equal liability and the fails in the system are not the liability of the investing public they are 100% the liability of the firm who carries the failed delivery. It is for that reason that the SEC does not have the authority to restrict the rights of the investing public against the abuses of members taking calculated bets. Members must be held to the same standards of accountability as an investor and with such accountability comes opportunity for profit and loss.
If the price of market making liquidity is a failure to protect the rights of the investing public than the SEC's mission has ventured off course.
I would urge the Commission to better study up on the Commission's authority to control market conditions and pricing. I am sure that Congress has not authorized the Commission to decide who will take a risk of financial loss and who will be free of all burdens. Our markets are a place of investment and with each comes the possibility of a loss.
To put a conclusion on my point, consider this:
One senior executive of a market making operation that is now out of business once identified how they viewed bona fide market making naked shorts. This executive stated, during the period in which SHO was up for public comment, that there was no way his firm would ever close out a bona fide naked short at a loss. His firm would carry the fail until such time as the fail came in-the-money before a closeout transpired.
If you consider such a business model, these firms making a bad bet on the temporary influx of volume could create a substantial allotment of fails that were out-of-money. If they have no intent on settling these trades at a loss then the accumulation becomes substantial and damaging to the market. Unless the firms engage in further manipulation of the security by driving investors out any upside appreciation to their "liabilities" could become crippling.
The SEC has protected against such financial liabilities to member firms by creating the grandfather clause in 2004 in what has been presented as direct contradiction to Congressional authorities.
The investor advocate would have the intuition to investigate how bona fide market making naked shorts are being covered in a marketplace. Should such investigations take place the SEC would most likely see that through the net settlement system, market makers engage in sell side market activities to drive investors out during a covering period.
While this is activity is clearly illegal, it is a venue the SEC has and will continue to protect.
With all this talk of short squeezes, the SEC has always stereotyped investor efforts as one where the mission has been to create nothing but a short squeeze across the marketplace. This bias without investigation is harmful and damaging. The efforts of the investor are simply to obtain fair and equal markets. We cannot induce a short squeeze because we do not hold the power to do so. A short squeeze is an event that is precipitated by an activity and in this case can only be precipitated by the covering of an excess and crippling level of fails in the system. Long investors did not create the fails they only purchased into a company they believed and from a seller who never had anything to sell.
In many cases the fails could easily be covered without a squeeze due to the volume trading in the stocks. The fails however would be covered at a loss to the member firm and that is precisely what prevented the members from covering. It was not about a squeeze, it was about pure profits. Investors have no such protection like what the SEC provided the members. The squeeze would only take place on those companies most abused by settlement failures to levels far exceeding normal daily volumes. That in itself should be a red flag.
I would urge that the next time the SEC elects to stereotype the investing public as greed infested dolts, the Commission look squarely across the table at those that aide them in coming to such conclusions and drafting such laws against the public interests. Certainly those lawyers and executives of Wall Street, each making tens of millions in annual compensation, have much more to lose in profit and loss than we ever had to gain.
The investors want a level playing field and that is all. Wall Street wants a captured regulator who will protect the revenues and compensation packages of an industry capable of handing out near $30 Billion in bonuses in 2006 alone. To date the investing public has witnessed a very compliant agency who has done everything it can to protect just that income.
As a sign of investor sentiment towards the recent SEC actions, the web site www.investigatethesec.com witnessed a spike in hits and signatures the day following the SEC's open public hearing. The investing public continues to sound off that trust in this federal agency is lacking and that a formal investigation into the legalities of their actions is being requested. Will members of Congress finally see the light and begin this long overdue investigation?
For more on this issue please visit the Host site at www.investigatethesec.com (posted with permission)
Copyright 2007