The NSCC SBP
Not sure why this program has come to a head this weekend, it is apparently being spammed by touts and conspiracy theorists who are obviously unaware of what or how the program works. Never mind that the idea of being a source of Naked Short Selling has been proven wrong many times over, not just by investigation but also random blind testing of securities. There are multiple ways to skin this cat if you will, the theory is that MMs Naked Short Sell securities and then rely on a borrow from the SBP and never deliver the real shares back to the NSCC and the broker borrowed from. There are multiple theories in just that alone, many claim that the shares are never delivered, ownership issues and the process of Multiplicity, where the same block is shorted again and again by multiple parties.
To answer short and quick about the idea of SBP and Abusive Naked Short Selling, it is not happening, and there is no evidence it has ever happened, and has never been proven to have happened. The SEC and many other external sources have examined this program from every angle and they make it abundantly clear, the SBP does not create Abusive Naked Short Sales. Here is the exact statement from the SEC concerning the SBP and Naked Short Selling:
Question 7.2: Does NSCC's stock borrow program ("SBP") create "counterfeit shares"?
Answer: The SBP was implemented in the late 1970s to allow NSCC to satisfy its members' priority needs for stocks that they do not receive because of fails. It is governed by NSCC rules approved by the Commission. Under the SBP, NSCC uses shares voluntarily made available to the SBP by some of its members to complete deliveries to members that did not receive their securities on settlement day. The SBP moves securities that are actually on deposit at DTC from the lending member to the NSCC member who did not receive securities. NSCC then records the lender's right to receive the same amount of shares that it loaned just as if the lender had purchased securities but not received them (i.e., the member lending the securities replaces the member receiving the loaned securities in the CNS system). The lending and delivery of shares through the SBP, however, does not relieve the member that has failed to deliver from its obligation to deliver securities.
The shares loaned by NSCC members for use in the SBP must be on deposit at DTC and are debited from members' accounts when the securities are used to make delivery. Once a member's shares are used for delivery to another member, the lending member no longer has the right to sell or relend those shares until such time as the shares are returned to its DTC account. Accordingly, NSCC's SBP does not create "counterfeit shares." In fact, the program facilitates the delivery of securities to buyers while maintaining the obligation of the sellers to deliver securities to NSCC. This outcome is consistent with the NSCC's obligation to facilitate the prompt and accurate clearance and settlement of securities transactions and in general to protect investors and the public interest.
So here is a statement posted up by the SEC Concerning their own findings into the matter, some might just say well they didn’t do anything to prove or disprove the SBP and it’s connection to NSS. You would be wrong because a division of the SEC known as the OCIE ran several test over a period of time in random securities and a sample of those that claimed to be experiencing such Abusive NSS, here are the results from their testing of the program:
In addition, in response to media criticism and allegations made by certain issuers and shareholders that NSCC and DTC were facilitating naked short selling through the operation of the Stock Borrow Program, OCIE also incorporated a review of this program into the scope of its 2005 examination. These critics argued that the Stock Borrow Program exacerbated naked short selling by creating and lending shares that are not actually deposited at DTC, thereby, flooding the market with shares that do not exist. As part of their review, OCIE examiners tested transactions in securities that were the subject of the above referenced allegations or had high levels of prolonged FTD. The examination did not find any instances where critics’ claims were validated. However, we did not validate OCIE’s findings
We found that examiners tested stock borrow transactions in securities that were the focus of the above-referenced allegations or had high levels of prolonged FTD to determine if shares loaned through SBP were free and available in the lending participant’s depository account prior to the transaction, and if they were deducted from that participant’s account when the loan was made. The examination did not find any instances where critics’ claims were validated.
So what is the SBP in the first place? Here is the best layman terms description I have ever read and for good reason, it was written for the Senate so they could understand the program, no further explanation needed:
Trade clearance and settlement in the United States operates on a standard 3-day settlement cycle. Due to the volume and value of trading in today’s markets, NSCC nets trades and payments among its participants, using its Continuous Net Settlement System. This is a book entry accounting system, whereby each NSCC participant’s daily purchases and sales of securities, based on trade date, are automatically netted into one long position (right to receive) or one short position (obligation to deliver) for each securities issue purchased or sold.7 The participant’s corresponding payment obligations are, similarly, netted into one obligation to pay or one obligation to receive money.8 For each participant with a short position on settlement date, NSCC instructs the securities depository designated by the participant—typically DTC—to deliver securities from the participant’s account at the depository to the NSCC’s account. NSCC then instructs the depository to deliver those securities from NSCC’s account to participants with net long positions in the security.
If a participant fails to deliver the total number of securities that they owe NSCC on a particular settlement date, NSCC may be unable to meet its delivery obligations, resulting in a fails to receive (FTR) for participants who have net long positions. NSCC uses the automated Stock Borrow Program to borrow shares to meet as many of its delivery obligations as possible. This program allows participants to instruct NSCC on the specific securities from their DTC account that are available for borrowing to cover NSCC’s Continuous Net Settlement System delivery shortfalls. Any shares that NSCC borrows are debited from the lending participant’s DTC account, delivered to NSCC, and, subsequently, delivered to a NSCC participant with a net short position. NSCC creates a right to receive (net long) position for the lender in the Continuous Net Settlement System to show that it is owed securities. Until the securities are returned, the lending participant no longer has ownership rights in them and, therefore, cannot re-lend them. Additionally, any delivery made using the Stock Borrow Program does not relieve the participant who fails to deliver from its delivery obligation to NSCC.
Nothing shocking, shares in the brokers principle account that are excess are lent to brokers who are short because of delivery issues with the securities they sold, they deliver their shares when they customer delivers the shares to the broker. A simple process of accounting called debit and credit nothing crazy about it, rather simple, but some have charged that there isn't a detail transaction chain of custody for the shares borrowed.
Multiplicity is one such theory in which if there were say 100 shares available for example, that the NSCC has no way to know if the same shares were borrowed by 2 other entities at the same time. Meaning instead of 100 shares there are now 300 shares, 100 real and 200 non existing based upon the originating 100 shares. The problem with that, there has to be an existing debit in the account that is to receive and when the shares are pulled from the credit account there is no other means to borrow those shares because they are already removed from the excess account. The same conspiracy shows up concerning regular short interest, if an account has shares available and designated for borrow it can be “daisy chained” by everyone working from the same block of shares to borrow from. It doesn't work that way, once the originating account is debited the shares for the borrow, nobody else can debit the shares to their own account. So then it gets expanded, “well if the shares were borrowed and in a margin account then they can be borrowed against also”, no because they would be designated not available due to not being the actual OWNER of the shares, you can only borrow from an owner.
Firms have actually been busted for not performing a "Hard Locate" and just using a soft locate or a previous locate thinking it was still available.
So where is the supposed problem raised by the conspiracy theorists? The excitement is over a process of clearing known as “Ex Clearing”, whereas the NSCC issue obligation reports to the brokers involved and allows them to settle their transactions on their own and report the settlement with the NSCC after reconciliation. The conspiracy is that Broker “A” contacts Broker “B” and makes an arrangement to ask to forgive their obligation in exchange for reciprocity of the same obligation that Broker “B” maybe seeking on another issue for example.
A brief description of Ex Clearing:
Ex-Clearing is a manual comparison process that is performed by the brokerage firm’s Purchase and Sales Department when the traded security does not meet the eligibility standards of the designated clearing corp.
On settlement date, the firm’s Settlement area will create a Fail Record on the firm’s accounting books and records to represent the open receivable or deliverable. The Settlements area will ‘set-up’ a Fail-to-Deliver for securities sold and a Fail-to-Receive for securities purchased.
The transaction is concluded when the selling firm delivers the sold securities to the buying firm, and the buying firm pays the selling firm for the delivered securities. At such time, the open fail record is removed from the firm’s books and records. The ultimate removal of the open receivable or deliverable is referred to as a "Clean-Up".
One might think well that sounds logical, there is an opening for tom foolery, hijinks, malarkey, schemes and evilness…. Lol… The problem is newer Reg SHO requirements, the FTDs generated are not by manual comparison but in fact electronic comparison. You may have heard of it, it is called CNS (Continuous Net Settlement), it is a completely electronic process of credit and debit for accounts. It is completely automated and almost every security is now in that CNS system. Now here is a Rule that strikes the OTC securities from being Ex Cleared, FINRA Rule 6350A:
6350A. Clearance and Settlement
(a) A Trade Reporting Facility Participant shall clear and settle transactions in designated securities through the facilities of a registered clearing agency that uses a continuous net settlement system. This requirement may be satisfied by direct participation, use of direct clearing services, or by entry into a correspondent clearing arrangement with another member that clears trades through such an agency.
(b) Notwithstanding paragraph (a), transactions in designated securities may be settled "ex-clearing" provided that both parties to the transaction agree.
Now here the Regulator FINRA makes it clearly mandatory to use CNS, the word SHALL cannot be interpreted any other way. The only exception given is if such a security are those securities DESIGNATED, what would be a designated security for Ex Clearing? Those would be the securities that are not in CNS, and are designated Trade for Trade, you might remember this designation it used to be a form of chill the DTCC gave out up until March 2012. Grey Market securities are designated Trade for Trade and are Ex Cleared for example.
You see a daily update at the DTCC that often reflects the FINRA Daily List, the DTCC Notice is called the “UPDATES TO THE LIST OF OTC CLEARED SECURITIES”. You can find them here: http://www.dtcc.com/en/legal/important-notices.aspx?subsidiary=NSCC
Of note at the bottom of each notice you will see the following: ALL SEC 12K SUSPENSIONS WILL BE REMOVED FROM CNS ELIGIBILITY
So after all that we can see that the issue of Naked Short Selling surrounding the SBP is completely FALSE. We also can see that the process of Ex Clearing is not available for those securities designated in the CNS system by FINRA. The final nail in the coffin of the conspiracy of the SBP is this…… Due to the Federal Review Board decisions, NO OTCBB or OTC MARKETS SECURITY are eligible for such a program, the same board that also deems these same securities non marginable. The same reason that OTC Issuers complain about not having access to capital and also why the OTC Markets are referred to as an Illiquid marketplace.
As it has been pointed out thousands of times, brokers and broker dealers do not maintain a balance of these securities in their principal accounts. FINRA has stated this over and over again when trying to get changes in certain reporting because it doesn’t present the same data as listed securities on exchanges. The OTC Markets doesn’t have access to the same liquidity as exchanges therefore certain reporting requirements either are not separated enough or simply do not apply to the market.
Where did all this bullshit start? You can pretty much trace it all back to this singular comment letter from 2009. Some may recognize it all or portions of it that have been bastardized a thousand different ways in various blogs and conspiracy website concerning the markets. How it ever got applied to the OTC markets is beyond me, because if anyone actually read through it’s entirety the would know his whole dialogue is strictly exchange listed securities. As much as I would like to see PUT options here on the OTC, it will never happen….. http://www.sec.gov/comments/4-590/4590-84.pdf
A Wall Street crook agrees to direct order flow to a crooked options MM if he promises to play along with the game plan. The options MM agrees to sell put options to the crooked broker. The options MM is then allowed to “hedge” his position by short selling a corresponding amount of shares. This drives the share price downwards which gives value to the put options that were purchased.
So what is eligible for SBP? Marginable securities are and NON Marginable securities are not… Reporting securities ONLY, that just eliminated every pinksheet and OTCQB out there. Kind of tells you how isolated the OTC markets are from Listed securities. Someone best get the Federal Reserve Board on the line and ask why they will not allow OTC and penny stocks on the list of marginable securities. We already know the answer, it is based upon market protection. The SBPs own requirement of securities above a $1 no matter if they are listed or not also restricts a lot of securities from the program.
Some other things to think about:
SEC and NYSE regulations require a brokerage firm to borrow securities – or attempt to borrow securities – under the following situations:
• SEG Deficit
• Short Sales
The firm’s ability to borrow securities is positively correlated to the number of outstanding shares or bonds of the particular security. The more securities issued the more likely the Stock Loan Department will be able to locate Excess shares to borrow.
Without an accurate OS from a reporting company to the SEC, the borrow cannot accurately be correlated to the OS. Pretty standard stuff. The same reason as to the difference in Threshold for reporting and non reporting companies, the SEC doesn’t recognize non reporting companies/shells due to no currency in their share structure reported directly to the SEC. FINRA has to cover the non reporting companies/shells with their own Rule 4320. If you do not know this already, the SBP is governed under the same rules that standard borrowing complies with from the SEC. Thus why the DTCC had to file a request to the SEC to end the SBP Program. The exact reason for discontinuing the SBP is detailed in the request and comments about the program, it simply is no longer applicable due to other forms of liquidity that have made it obsolete.
Nothing is going to change here in the OTC because of it going away, March 14th will come and go just like any other day. The same conspiracy of NSS will still be there just changed to some other ridiculous idea without any supporting evidence here in the OTC.
GAO Report: http://www.gao.gov/assets/100/95985.pdf
Division of Market Regulation:
Responses to Frequently Asked Questions Concerning Regulation SHO: http://www.sec.gov/divisions/marketreg/mrfaqregsho1204.htm