Spongetech Delivery Systems, Inc. (fka SPNGQ)

[pj333]

Someone, (I'm sorry I can't remember who, but would wish to thank them), sent me info on rule 10b-21 regarding MM's and short selling.

I've copied a section I found interesting, and my question is this. Does anyone think that option #3 has been used to the extent that the new Reg Sho threshold triggers are signalling a breakdown of the MM's system of covering each others fails within the time frame needed to keep them off the list, or is this more easily explainable?

I leave it to those who know much more than I. Just looking for an answer.
pj

Entire text here
http://www.sec.gov/comments/s7-08-08/s70808-231.pdf

BrokerDealers
are many times fully aware of the potential failures by their preferred clients. These firms take such risk because of the revenues generated by such clientele. Consider that, to date, violations in the short sale process have been treated as simple compliance violations netting trivial fines of $10K, $20,K or even $30K. When calculating risk, the BD will calculate the potential lost revenues vs. the potential sanctions if caught and will trade make that illegal trade 99 out of 100 times.
BrokerDealers
additionally collude with other member firms once such a trade is executed and that fail is in the marketplace. Proof lies with the response to the failed trade itself.
In a failed trade the liability of the fail rests with the BrokerDealer
and not the client. In fact the buy side and sell side broker dealer must put up capital to cover the potential of the failed trade. In an illegal trade the BD can act in several different ways.
1.
If the error was based on the client’s misrepresentations the BD can buy in the trade on behalf of the client to settle the trade. The client would then be billed for any costs associated with such a transaction. The client misrepresented the parameters of the trade. In taking this approach the BD is without liability and the client pays for their misrepresentations.
2.
The BD can buy in the trade from the house account and lend out the share for settlement. This allows the client to maintain their short, and pay the lending fee to the BD leaving the BD long the stock. This likewise would eliminate any liability on the books of the firm and would insure safe and prompt delivery to the buy side BD representing the long shareholder.
3.
The BD can take no steps leaving the illegal trade to remain on the books of the firm.
Option 3 is typically what takes place. Both the buy side and sell side BD agree to hold this open as a fail, and set aside net capital to cover the fail, because it is financially beneficial to do so. Both owe each other shares and both have shares owed to them and thus participating parties excuse the cost liability of a buyin.
The fact that the receiving firm has failed to act in the best interest of their client is evidence of the collusion between firms since, as a standalone
transaction, the failed trade is neither in their best
interest or that of their client.