Following not only the letter but the spirit of the law.
On April 22, 2004 Chairman Donaldson of The Securities and Exchange Commission spoke to the Investment Council Association of America. As the Chairman delved into a speech about the important role the ICAA had on the American investors as the Markets were continually being changed he asked for their support. In doing so the Chairman had this to say: "It means that leaders not only live up to the letter of the law, but also internalize and advocate the spirit of these reforms to everyone in their organization". It is funny how easy it is to ask others to do what you yourself, or your controlled operations, fail to do; follow the SPIRIT of our laws.
In my fight against the abuses of naked shorting and the resultant trade settlement failures that dilute our investments I did some research. That research started with going to the Congressional Charter, "The Constitution", that the SEC operates under; The Securities Act of 1934. I read this Act and tried to understand not only the letter of the law identified but also the spirit intended by it's writers. Here is what I came up with along with some Regulatory rebuttals to my views.
Section 17A -- National System for Clearance and Settlement of Securities Transactions
a. Congressional findings; facilitating establishment of system
1. The Congress finds that--
A. The prompt and accurate clearance and settlement of securities transactions, including the transfer of record ownership and the safeguarding of securities and funds related thereto, are necessary for the protection of investors and persons facilitating transactions by and acting on behalf of investors.
B. Inefficient procedures for clearance and settlement impose unnecessary costs on investors and persons facilitating transactions by and acting on behalf of investors.
My Interpretation: Congress is identifying to the Regulators that for the safety and protection of both the investor and the industry members themselves, prompt settlement of trades MUST be achieved.
Regulatory Comments: There is also a part of the Securities Act that addresses what the member firms must do in the event of a settlement failure. The firms must put up net capital reserve to protect the investors in an event of failures in the system.
The Spirit of the Law: Congress is telling the Industry that for the safety of the Industry they should be focused on prompt settlement of trades. If, however, for any reason a trade does fail we will put in place temporary measures to handle such events. The underlying goal is still to settle ALL trades promptly.
It is the Spirit of the Law that has this issue all embroiled in turmoil. A Turmoil that puts the wealth and power of the industry up against the small retail investors and struggling business. Chairman Donaldson and the Regulatory teams of the SEC and SRO's are neglecting the Spirit of the law and the line of command of the laws.
To explain my viewpoint let me use an analogy to help:
When you travel down a major highway there is generally a breakdown lane. It is unlawful to use the breakdown lane for general travel purposes (Section 17A of the Securities Act). However, there will be circumstances that create opportunities where the use of the Breakdown lane is permitted for use on a short-term basis such as accidents or road repairs (Net Capital Reserve). Just because you were provided access to this use the lane today on a short-term basis because of such an event it does not now make it legal to make it the new standard mode of operation. That is where the Industry has taken trade settlement failures and net capital reserves.
What were put in place to address the short-term failures became standard operating procedures and Investors became defrauded. This allegation is only re-affirmed by an Executive VP of Charles Schwab when he informed the SEC in a comment letter that the Industry has a "Behavioral Issue" with settlements that needs to be addressed. The Industry is using the breakdown lane and accidents are happening. Innocent people are being harmed.
As the battle lines continue to develop think of a few oddities in what is transpiring here:
1. Regulation SHO, recently released by the SEC defines a line in the sand for abusive settlement failures. The SEC has not mandated that all trades settle within any specific timelines (T+3, T+3+10, T+3+10+5?..) instead they have accepted settlement failures as a part of standard business. That VIOLATES the letter and the spirit of Section 17A of the securities Act.
2. When settlement failures become abusive, the SEC still does not force the settlement of those trades but instead simply mandates that that client and that firm can no longer short sell the security until they do settle the trades. Why again have they neglected to force immediate settlement?
These same regulators are aware that the criminal elements usually have multiple accounts and multiple aliases.
3. Net Capital Reserves. The Regulators have informed me that it is the Brokerage houses that take on the risk and liability of the settlement failures by locking up their capital until the trade settles. I ask; why would a Broker, representing a buyer put up net capital to cover the unsettled trade because the seller never delivered? The Industry does NOTHING unless it is profitable to them so why would a Brokerage firm put up their money to protect another firm if it was not financially beneficial to them? Why not force the seller to deliver and keep your money liquid?
I believe it is because it is lucrative business as these settlement failures create the market liquidity that creates trade commission revenues.
Presently, the SEC and NASD have publicly stated that there are some issuers who have settlement failures that exceed the entire public float of their companies. These failures are a direct result of the Industry ignoring the letter and the spirit of Section 17A of the Securities Act of 1934. To complicate matters, these same member firms that amassed the liabilities of unforced settlements, at the detriment to the investors, are now taking control of the trading in these securities by imposing their own restriction on these stocks. They are imposing "Sell-Only" restrictions to their clients because of the settlement failure problems.
What do the Regulators have to say about this? They will once again side with the Member firms who impose these restrictions highlighting that it is in YOUR best interest to no longer buy stocks the Industry cannot settle. But if I am a shareholder, and the market is sell-only, what maintains present and future stock pricing? How is my present investment protected?
Who are the buyers if I cannot buy? The answer is, the people who NEED to settle up their trades. The people that created the depressed pricing based on dilution are now the only ones allowed to purchase the stocks back. They force me out and take my shares in a controlled market set-up. This sounds like collusion to me.
The Industry has again taken steps to protect itself from financial ruin and has passed that burden on to the investors. It was not the investors buying the security that created the mess with settlement. The Industry never notified them when they purchased their stock that it was a journal entry settlement failure. No, the Industry took your commission, said thank-you, and allowed the manipulation to continue. Now that they abused the Spirit of the Securities Act, and their financial liability became intolerable, they simply said, I have to go out and buy this stock to start settling so I need to box out other buyers to prevent competition in pricing. You lose, We win. It is Research Fraud, IPO Fraud, Mutual Fund Late-trading all over again. The self-interests of revenues is put above the protection of the investors. If there were no self-interests to the Industry, and their money was already locked-up in capital reserves, why won't they just settle the trades? Ultimately that is the question. Why is every major brokerage firm risking Federal and State Court cases to protect these UNSETTLED trades instead of just settling them? Are they doing this for the goodness of the Investors and companies suing them?
Chairman Donaldson talked about following the spirit of the law. Instead of following his own advice, however, the chairman and his staff created a new reform package that not only violated the spirit of the Securities Act but the letter of the Act as well. Section 17A of the Securities Act is the primary Law with regards to trade settlements. The follow on guidelines that talk about short-term means to address acceptable deviations to that are also law but intended for short-term usage. That was the spirit anyway.
It is time our securities regulators stopped playing lawyers and politicians trying to protect a corrupt Wall Street and focused more on both the Spirit and letter of the laws that are to use to guide them through their days. The SEC is an INVESTOR PROTECTION agency and has NO rights or guidelines to put the protection of a single company above the protection of any investor. Failing to force the Industry to use some of that net-capital set aside to settle our trades is criminal in spirit if not in letter.
If I am mistaken by these assumptions than the SEC and SRO's need to make it clear to me and the millions of others that are viewing this issue in this manner. We read the laws you provide us and if your laws are misleading fix them. We also understand that we purchase a stock in a company we expect that we have become rightful owners in that company.
Retail investors have NEVER been informed that what is in our account statements in no way represents our factual ownership in a company.
Abusive settlement failures has created false ownerships and a dilution in our investments that we need to be informed of as we make our investment decisions. The industry cannot operate under cloak and dagger from both regulators and Industry practices.
Dave Patch
www.investigatethesec.com
