From NCANS: Why Isn't The Reg SHO List Working As It's Supposed To?
Here is a theory as to why SHO has not worked, and will not work, until regulators take control of market making and specialist Bear raids.
First, here is some verbiage pulled from the NYSE's website:
From time to time, upon application from a NYSE specialist to continue to fulfill its obligation to maintain a fair and orderly market pursuant to NYSE Rule 104, a temporary exemption from the close out and/or borrowing requirements of Regulation SHO, 17CFR 242.203 (b)(3), may be recommended by the New York Stock Exchange and granted to the NYSE specialist in the security, by the Securities and Exchange Commission. The temporary exemption would normally last no longer than 30 days but may be renewed, depending upon the particular circumstances. The fact that a NYSE specialist has been granted an exemption will remain confidential to protect the NYSE specialist's position in the subject security.
Now absorb that. Reflect upon that. A secret waiver from having to observe any of the SHO provisions.
Now to the topic at hand.
Many observers to date can not figure out how or why "threshold
securities" are doing nothing. There are two reasons.
The SEC grandfathered in all of the past Fail To Delivers prior to a company going on to the threshold list. This was a given, as has been addressed many times in the past. It can easily be deduced that the SEC created a "grandfather clause to fraud" because of the implications to the market in forcing the abusers or Wall Street to correct them. As one SEC official told me "there are more unsettled shares than shares to settle with".
That should have been our first clue the SEC was not on our side – the investor's side.
The market makers and specialists retain their rights to raid our stocks with impunity and thus, sell side pressure by market makers and specialists are being used as a trading strategy to draw investors out of their stock in order to cover the fails.
It is this second approach I want to dig deeper into.
Observers to some of the more heavily shorted securities are seeing each trading day start with sell side liquidity. These securities may move into positive ground but quickly fall back on sell side pressures. It is the intent of the sell side pressure that draws investors out. As more sell side pressure is created, fear in the stock increases and more investors are drawn out. The market participants (specialist and market maker) use the investors' sell off to cover their fails as well as stock that they were selling short to create the fear itself.
Lets take Krispy Kreme (NYSE: KKD) as an example:
KKD Reported Institutional and Mutual Fund Ownership
68% of Float
KKD Reported Short Position (January)
48.3% of Float
KKD Daily Trading Volume (3 Month Avg)
4.1% of Float
KKD Daily Trading Volume (10 day average)
7.8% of Float
In the past 14 trading days Krispy Kreme has had a complete turnover of its shares. One hundred percent of the float has traded hands. Within this same period in time, the stock traded with daily spreads of 10% or more closing down on 9 of the 14 days, up 4 of the days and neutral 1 day. Each day being heavy volume days with the worse volume days being sell side volumes.
In theory, day traders would have difficulty in this stock because it would be risky to buy in to a stock moving down. They would also be limited in their ability to engage in sell-side day trading as this stock is a threshold security with short selling restriction. So then who is creating the volatility and volume?
With 68% reported Institutional and mutual fund ownership, these long holdings should be taken off the traded float as the reported shares remain relatively stable (reduced 3% from last quarter). This recalculates the daily trading volume to approx 25% of the float (reduced to 18M shares) with 72% of the float trading yesterday on its largest single loss percentage over the past 14 trading days.
So who is creating such volatile liquidity in a threshold security, with presumed buy-in demands, such that the stock lost 30% market capitalization over the past 14 trade days and 50% since SHO was implemented? Easy - Wall Street. The specialists and market makers.
When a stock is held in an institutional holding it is generally a marginable share. When the owner of a margined share, out on loan, sells that loaned share, it's "called-in" and a buy-in is required. Thus, even if these institutions were dumping shares, their selling would automatically create buy-ins from the called in shares out on loan. These buy-ins are secondary affects only additive to the Reg SHO buy-ins on failed trades. But the institutional ownership is not changing. If it doesn't change the volumes are irrational -if they are changing the buying associated with call-ins on loaned shares should be generating buy-ins. So in either case there should be increases, not decreases, in PPS.
Since KKD is showing absolutely no evidence of mandatory buying pressure a mechanism has been created whereby the buying is done under an umbrella of involuntary selling into their needs. We are back to the Bear Raids of Wall Street driven by the specialist and the market makers, covering the "fail to delivers" from the shares shaken loose from the small investor, and giving the hedge funds and brokerages on the hook a deep discount on the covering. This is illegal market manipulation to benefit the brokerages with huge contingent liabilities from the fails. It is predatory, prohibited, and no one has picked up on it until now. Discovery in a law suit brought against the exchanges would easily confirm this, and the liability of the "free lunch" would shift to the specialist firms and the MM's who were trying to do their friends at the big houses and the hedge funds a favor.
Krispy Kreme could be considered a bad example due to their financial difficulties but it actually becomes the perfect example for the same reason. Under the protection of short selling restrictions the raid on this stock should have been tempered. It was not. The sellers far out-controlled the buyers at a time that the industry is in a forced buying mode. This scenario has been played over dozens of times with similar threshold securities.
Wall Street market making and specialist practices are driving long shareholders out of their investments in order to cover the fails they initially created and are now responsible for. They are doing this slowly and meticulously over time because the SEC gave them the grandfather clause, and the special exemption. It is for this reason that the most abused on this list remain there after more than 2 months of excessive fails.
ps. Don't be a victim. Fight back.