Friday, August 12, 2005 8:19:00 AM
August 12, 2005 (FinancialWire) In the naked short selling wars, the shot heard around the world may be fired this morning as Overstock.com (NASDAQ: OSTK) CEO Patrick Byrne hosts a conference call at 8:30 a.m. today to discuss his company's civil lawsuit against notorious short sellers Rocker Partners and Gradient Analytics.
Overstock.com, Netflix (NASDAQ: NFLX), Internet Initiative Japan (NASDAQ: IIJI) and others are among numerous companies identified by TheStreet.com (NASDAQ: TSCM) as targets of illegal stock manipulators. Rocker Partners has been branded by some as having the greatest short position on the New York Stock Exchange alone.
The event will occur at http://www.shareholder.com/overstock , or via the phone at 800-811-8830.
“What if someone passed a law and no one followed it?” asked TheStreet.com senior writer Kevin Kelleher this week, referring to “fails to deliver” for extended periods for Overstock and other leading companies.
The lawsuit has been filed by John O’Quinn, Esq., and his legal team. O’Quinn has also alleged in separate lawsuits a conspiracy in aiding and abetting firms such as Rocker Partnrs by the Depository Trust & Clearing Corp., a unit of NYSE and NASD.
Overstock.com launched its first website through which customers could purchase products in 1999. Its overall business and gross revenues have grown steadily and consistently, at a rate of approximately 100% each year since 2000. Its annual revenues for the year ending December 31, 2004 were approximately $500 million.
The complaint alleges that Gradient Analytics, Inc., an influential company that sells reports and analyses on publicly traded companies to hedge funds, traditional mutual funds, and provides them to financial commentators such as MSNBC, is closely aligned with various stock hedge funds. The complaint alleges that Gradient and Rocker Partners LP, which is owned and controlled by David Rocker and Michael Cohodes, individually and/or through Rocker Offshore or Rocker Management, conspired to denigrate Overstock.com's business so as to reap personal profits for themselves.
Byrne commented: "What's at stake here is innovation and entrepreneurship in America. My company has been attacked and I'm not going to take this lying down. In joining forces with John O'Quinn and his team of lawyers, I think we have what it takes to win. We certainly have what it takes to fight."
also commented: "We have an expression in Texas about the skill of matching the mules. Combining our lawyers and a-level experts with the tenacity, verve and commitment of Overstock.com CEO Dr. Patrick Byrne is a powerful alliance, hitched up for the long haul to win this battle. It is time someone stops these offshore hedge funds from taking advantage of average working Americans and American Public companies. That someone is us."
Attorney Adam Voyles added: "I am speaking for the entire consortium when I say that we are prepared to obtain justice for our client from these Defendants and all others who aided them in these illegal acts. It is time our government authorities and regulators pay attention to the large number of offshore hedge funds that are taking advantage of hard working Americans."
In the actions, filed in Marin County California Superior Court, Overstock.com is represented by the law firms of O'Quinn, Laminack & Pirtle, Christian Smith & Jewell, and Heard, Robins, Cloud, Lubel & Greenwood, LLP, all of Houston, Texas, Woodbury & Kessler, PC of Salt Lake City, Utah, the Siegler Law Group, Inc, of Beverly Hills, California and Koerner Silberberg and Weiner, LLP of New York, New York.
A replay of the webcast will be available on the Internet at http://www.shareholder.com/overstock starting 90 minutes after the live call has ended. A transcript will be posted to the website as soon as it is available. An audio replay of the webcast will be available via telephone starting at 1:30 p.m. Eastern time on August 12, through midnight Eastern Time on Friday, August 19. To listen to the recorded webcast by phone, please dial (888) 203-1112 (passcode: 4199807).
Regulation SHO is “not one of those bizarre, outdated laws you hear about, like in Maine, where people are required to bring shotguns to church, but a brand new law with an entirely sensible goal, like keeping people from selling equities that don't exist,” Kelleher had stated.
“The Securities and Exchange Commission gives broker-dealers a 13-day grace period before they are required to close out those naked-short positions. After 13 days, it's safer to assume there must be at least some abusive shorting going on.”
TheStreet.com said the website, Buyins.com, lists 59 securities that have been on the threshold lists longer than Internet Initiative Japan.
He said unlike some relatively illiquid small caps, there are 10 Nasdaq companies “that have substantial daily volume and market caps between $150 million and $1.1 billion that have been on its threshold list for more than 26 days, twice the allotted grace period after which the positions must be cleared out.”
Besides, Internet Initiative Japan, on the list for 42 days, and Netflix, Given and Taser, others include Cal-Maine Foods (NASDAQ: CALM), 134 days, Global Crossing (NASDAQ: GLBC), 137 days, Navarre Corp. (NASDAQ: NAVR), 77 days, Overstock.com (OTCBB: OSTK), 75 days, Endwave Corp. (NASDAQ: ENWV), 48 days, Antigenics (NASDAQ: AGEN), 36 days, and Turbochef Technologies (NASDAQ: OVEN), 33 days.
“Why aren't broker-dealers cleaning out these naked-short positions?,” asked TheStreet.com.
Asking the watchdogs doesn't offer much insight, it said, noting that John Heine, a spokesman for the Securities and Exchange Commission, says that body doesn't comment on the activities of its enforcement office, which oversees broker-dealer activity.
"There hasn't been a case yet where we've brought enforcement action" regarding Regulation SHO, Heine says. "We're always interested when people have any information about violations of SEC laws."
NASD, which is supported by 5,200 member brokerage firms, is required to gather data on naked short-selling, so it's in the best position to understand why so many stocks are stuck on its threshold list. Yet it seems oddly indifferent, stated Kelleher.
"Isn't that the business of the SEC?" snapped NASD spokesperson Nancy Condon when asked about the lingerers on its threshold list. A second spokesperson called back to point out the SEC's Web page explaining Regulation SHO, but didn't comment any further.”
Why, for example, has it taken more than six months to clear out grandfathered short positions in Taser or Netflix?, inquired TheStreet.com.
"Regulation SHO is toothless," it quotes Overstock CEO Patrick Byrne. "The regulators have decided to give free passes to criminals."
“Data on naked short-selling isn't as transparent as it is on plain old-fashioned short-selling. The SEC doesn't require disclosure of how many shares have failed to deliver, which is too bad, because there's a good deal of disagreement on how widespread naked short-selling is. Some people, including investors at hedge funds, maintain it's all a tempest in a teapot. Others, like Byrne, suggest it's become too big a problem for regulators to rein in,” said Kelleher.
“The SEC could make enforcement of Regulation SHO a lot easier by enlisting the help of the market itself: Why not simply disclose the size of the naked-short position in each stock as well as the broker-dealer responsible for clearing out the position? If the naked-short positions are disarmingly small, investors will know that it is indeed a tempest in a teapot. And if the positions are large, they'll know who to call,” concluded TheStreet.com.
Some 93.89% of the respondents to the Investrend Poll at http://www.investrendinformation.com said that the DTCC should be “punished” for its interferences.
The censorship has since admitted to in a letter posted at http://www.investrend.com/Admin/Topics/Articles/Resources/349_1113403487.pdf .
More than a half dozen highly-ranked Republican and Democratic U.S. Senators have weighed in that the U.S. Securities and Exchange Commission’s much-ballyhooed “Regulation SHO” has highlighted the massive extent of the illegal practice but has done nothing to stop it.
The main lists for Regulation SHO are at http://www.nasdaqtrader.com/aspx/regsho.aspx and http://www.nyse.com/Frameset.html?displayPage=/threshold .
Even the DTCC has admitted its “fails to deliver” is massive, amounting to upwards of $6 billion a day, according to DTCC Deputy General Counsel Larry Thompson.
A former U.S. Under Secretary of Commerce for Economic Affairs, Robert J. Shapiro, now chair of Sonecon, LLC, a private economic advisory firm, accused Thompson of making “inaccurate or misleading” statements. Shapiro, who holds a Ph.D from Harvard University, was the principal economic advisor to former President Bill Clinton in his initial Presidential campaign.
Shapiro currently provides economic analysis to the law firms of O’Quinn, Laminack and Pirtle, Christian, Smith and Jewell, and Heard, Robins, Cloud, Lubel and Greenwood, on issues associated with naked short sales, which he noted includes “matters raised in an interview published by @DTCC with DTCC deputy general counsel Larry Thompson.”
He asserted in his letter that “the extent to which [naked short selling] occurs is in dispute. While this statement may be narrowly correct, objective academic analysis has established that naked short selling has been a widespread practice and one which, when allowed to persist, can pose a threat to the integrity of equity markets. A recent study by Dr. Leslie Boni, then a visiting financial economist at the SEC, analyzed NSCC data and found that on three random days, an average of more than 700 listed stocks had failures-to-deliver of 60 million-to-120 million shares sold short – naked shorts – that had persisted for at least two months. In addition, over 800 unlisted stocks on any day had fails of 120 million-to-180 million shares sold short that also had persisted for at least two months. The total number of naked shorts, including those that had persisted for less than two months, was presumably considerably greater.
“Regarding the extent of naked shorts, Thompson has provided closely-related additional information: ‘fails to deliver and receive amount to about $6 billion daily…including both new fails and aged fails.’ Thompson minimizes this total by comparing it to “just under $400 billion in trades (emphasis added) processed daily by NSCC, or about 1.5% of the dollar volume.” By most people’s standards, a problem involving hundreds of millions of shares valued at $6 billion every day is a very large problem. Moreover, the $6 billion total substantially underestimates the actual value of all failed-to-deliver trades measured when the trades actually occurred. Most of the $6 billion total represents uncovered or naked short sales, many of which have gone undelivered for weeks or months with their market price being marked-to-market every day. As a stock’s price falls, the market price of naked shorts in that stock also declines, reducing the total value of the outstanding failures-to-deliver cited by Thompson.
“In other respects, Thompson’s comparison to the ‘$400 billion in trades processed daily by NSCC’ seems disingenuous and misleading, because that $400 billion total covers not only U.S. equity trades which can involve most of the failures-to-deliver at issue, but many other transactions also processed by the NSCC. The value of all equity transactions on U.S. markets in 2004, for example, averaged $82.3 billion/day. If Thompson is correct that the daily value of fails-to-deliver averages $6 billion, that total is equivalent to 7.2 percent of average daily equity trades or nearly five times the 1.5 percent level suggested by Thompson.
“Furthermore, the DTCC reports on its website that on a peak day, ‘through its Continuous Net Settlement (CNS) system, NSCC eliminated the need to settle 96 percent of total obligations.’ Assuming that CNS nets out the same proportion of trades on other days, $384 billion of the $400 billion in daily trades cited by Thompson are netted out, leaving only $16 billion in daily trades that require the actual delivery of securities. The $6 billion of fails-to-deliver securities existing on any day are equivalent to 37.5 percent of the average daily trades that require the delivery of securities, or 25 times the 1.5 percent level cited by Thompson.
“Thompson tries to explain the large numbers of shares that go undelivered – in most cases arising from naked short sales -- by citing problems with paper certificates, inevitable human error, and the legitimate operations of market makers. This also seems misleading or disingenuous. Regarding problems with paper certificates, the DTCC estimates that 97 percent of all stock certificates are now kept in electronic form. Nor can human error or legitimate market-making operations explain the high levels of failures-to-deliver that persist for months – on any day, an average of 180 million-to-300 million shares have gone undelivered for two months or longer – as documented by Dr. Boni’s analysis of NSCC data.
“Thompson also disparages the attorneys who represent companies that have been damaged or destroyed by massive naked short sales, and their shareholders, by claiming falsely that the cases in this matter have almost all been dismissed or withdrawn. The legal firms that I advise -- O’Quinn, Petrie and Laminack; Christian, Smith and Jewell; and Heard, Robins, Cloud, Lubel and Greenwood – have not lost any motions against the DTCC or its affiliates and currently have one case against the DTCC pending in Nevada and another case against the DTCC pending in Arkansas. In addition, on February 24, 2005, these attorneys were granted an order by the New York Supreme Court ordering the DTCC to produce trading records involving two companies they represent, including records from the Stock Borrow program, which may establish whether large-scale naked short sales were used to manipulate and drive down the stock price of those two companies.
“Thompson also asserts that the plaintiffs suing the DTCC for damages associated with the handling of naked short sales rely on “theories [that] are not an accurate reflection of how the capital market system actually works.” This assertion is inaccurate. There is no dispute about how the capital markets work -- nor any doubt that naked short sales have been used to manipulate and drive down the price of stocks, as seen in numerous death-spiral financing cases. The issue here is the DTCC’s role in allowing or facilitating such stock manipulation through its treatment of extended naked short sales.
“In explaining the DTCC’s role in these matters, Thompson rejects the claim that the NSCC’s Stock Borrow program allows the same shares to be lent over and over again, potentially creating more shares than actually exist or ‘phantom’ shares. By Thompson’s own account, shares borrowed by the NSCC to settle naked short sales are deducted from the lending member’s DTC account and credited to the DTC account of the member to whom the shares have been sold. Therefore, those same shares become available to be re-borrowed to settle another naked short sale and, if that happens, to be re-borrowed again and again to settle a succession of naked short sales. Throughout this process, the actual short sellers may continue to fail-to-deliver the shares to cover their shorts and, as Dr. Boni’s analysis of NSCC data found, the underlying failure can age for months or even years. The process which Thompson describes is one in which shares can be borrowed and lent over and over again, introducing more shares into the market than are legally registered and issued. If any ambiguity remains, Thompson can clarify it by responding to the following query: Once a share that has been borrowed through the NSCC Stock Borrow program is delivered to the purchaser, is that share restricted in any way so it cannot be lent again?
“It is important to note that the Stock Borrow program is used when continuous net settlement cannot locate the shares to settle. As a consequence, Stock Borrow is usually called into play when there are relatively few shares available for borrowing. These are propitious conditions for market manipulation: Unscrupulous short sellers undertake large-scale naked short sales involving stocks for which few shares are available for trading and lending, relying on the Stock Borrow program to borrow the limited available shares, again and again, at sufficient levels to drive down the market price of the shares.
“Thompson notes that of approximately $6 billion in outstanding failures-to-deliver existing on any day, “the Stock Borrow program is able to resolve about $1.1 billion … or about 20% [18 percent] of the total fail obligation.” In this statement, Thompson raises very serious questions about the integrity and operations of the NSCC and DTCC, which he can clarify by responding to the following queries: If the Stock Borrow program “resolves” only 18 percent of total fails, what is the disposition of the remaining 82 percent of outstanding fails? When failures-to-deliver occur that are not resolved through Stock Borrow, does the NSCC credit the undelivered shares to the member representing the buyer, creating genuine “phantom shares”? Finally, how many shares do the borrowing brokers, clearing firms and other participants in the Stock Borrow program owe the NSCC on a typical day, and what is their total value?
“In a related matter, Thompson tries to distance the DTCC from charges that shares held in restricted accounts – for example, cash accounts, retirement accounts and many institutional accounts – are improperly lent through the Stock Borrow program by claiming that responsibility for segregating restricted shares from lendable shares falls to the “broker and bank members” of the DTCC, while responsibility for monitoring or regulating their performance in this matter falls to the stock exchanges and the SEC. As a trust company, the DTCC cannot hold that it has no role, duty or responsibility to ensure the probity of its operations. Thompson could address this issue by responding to the following queries: What procedures does the NSCC have to ensure that shares held in members’ accounts for possible loan through the NSCC Stock Borrow program are unencumbered by regulatory or legal restrictions from being pledged or assigned and eligible to be borrowed? On any given day, how many participants in the Stock Borrow program have lent shares that exceed their lendable shares, in what numbers and of what value?
“Thompson also tries to distance the DTCC as far as possible from the naked short selling that generates most of the extended failures-to-deliver: ‘We don’t have any power or legal authority to regulate or stop short selling, naked or otherwise. We also have no power to force member firms to close out or resolve fails to deliver … we don’t even see whether a sale is short or not.’ In fact, the DTCC chooses to not distinguish short sales from long sales, chooses to not regulate or stop extended naked short sales, and chooses to not force member firms to resolve protracted naked short sales.
“First, Regulation SHO requires that all transactions be clearly marked short or long. If the DTCC and NSCC do not know whether sales are short or long as Thompson contends, they choose to not know. Second, the NSCC has a clear responsibility and adequate means to stop naked short sales of extended duration, with no legal barrier that would prevent them from so doing. As a trust company with an acknowledged duty to provide investors certainty in the settlement and clearance of equity transactions, the DTCC chose to carry out that duty by assuming the role of counterparty to both sides of every equity transaction, through the operations of the NSCC’s CNS system and the Stock Borrow program. By allowing short sellers to fail-to-deliver shares for months or even years, the NSCC clearly fails to provide certainty in settlement to the buyers, sellers and issuers of securities. Since it is widely known that extended naked short sales have been used to manipulate stock prices in cases of death-spiral financing, and the NSCC created the Stock Borrow program to address failures-to-deliver that prominently include naked short sales, the NSCC and DTCC share a responsibility with the SEC and the stock exchanges to protect investors by resolving extended fails.
“Third, the DTCC and NSCC have the clear capacity to force member firms to resolve the extended failures-to-deliver of their customers by purchasing shares on the open market and deducting the cost from the member’s account. A 2003 study by Dr. Richard Evans and others provides evidence that forced buy-ins by any party occur very rarely. They found that a major options market maker who failed to deliver all or a portion of shares sold in 69,063 transactions in 1998-1999 was bought-in only 86 times or barely one-tenth of 1 percent of the fails. Thompson can clarify investors’ understanding of their operations by responding to the following query: What proportion of shares that are persistent fails-to-deliver, of one month or longer, are ever bought in?
“Thompson acknowledges that the DTCC and NSCC know precisely how many failures-to-deliver exist for each stock and the precise duration of each of these fails. Yet, the DTCC refuses to disclose this information even to the issuer of the stock in question, which Thompson justifies by citing ‘NSCC rules’ prohibiting such a release of data based on ‘the obvious reason that the trading data we receive could be used to manipulate the market, as well as reveal trading patterns of individual firms.’
“This response is both disingenuous and revealing. We know now, for the first time, that the DTCC has full knowledge of the extent of protracted, large-scale naked short sales in all particular cases. We also know now that the DTCC has had this information for at least a decade, since Thompson also notes that ‘fails, as a percentage of total trading, hasn’t changed in the last 10 years.’ Yet, based on the DTCC’s own rules, it allowed these abuses to persist and fester. The DTCC and NSCC can change their rules at any time. Moreover, in this case, those rules are unjustified. Data documenting outstanding short sales in each stock are currently issued publicly, so further data on how many of those short sales are naked would not reveal additional information about the trading patterns of individual firms or in any way empower manipulators. In fact, the DTCC could substantially disarm manipulators by both publicly reporting naked short sales in each issue and pledging to force buy-ins of all naked short sales that persist for more than a limited period.
Surely, if large-scale, extended naked short sales have effectively created “phantom” shares, companies have a responsibility to their shareholders and the right to secure this information from the organization which manages the settlement of short sales. At a minimum, the DTCC should respond to requests by issuers for data on extended failures-to-deliver in their own stocks, both in the past and currently, so they can take steps to resist stock manipulators or bring them to account for past manipulation.
Thompson also claims that the DTCC did not create or manage the Stock Borrow program to serve its own financial interest, insisting that the service generates less than $2 million a year in direct fees to the DTCC and that all DTCC services are priced on a “not for profit” basis that seeks to match revenues with expenses. Without further information, these responses beg the question of whose private financial interest has been served by the Stock Borrow program, especially as the DTCC is owned by the stock markets, clearinghouses, brokerage and banking institutions that use its services. Thompson and the DTCC can clarify this serious matter by responding to the following queries: Do DTCC participant/owners receive interest or other payments through or from the Stock Borrow program for lending the shares of their customers and, if so, how much have they received for these activities over the last 10 years? Further, do DTCC participant/owners receive any dividend, interest or other payments or distributions from the DTCC or its subsidiaries?,” Shapiro concluded.
Neither Thompson nor the DTCC have responded to Shapiro’s wide-ranging allegations.
Recently, former SEC Attorney Peter Chepucavage, previously a staffer for the U.S. Securities and Exchange Commission’s Division of Market Regulation, and a key participant in the release of Regulation SHO, has left the SEC and is now challenging his former agency over the regulation’s inability to reign in illegal market manipulations.
Chepucavage has forwarded his comments to the SEC, under File Nunber 265-23:
“I am responding to your Request for Public Comments on Summary of Proposed Committee Agenda. I wish to incorporate and expand upon the comments of Brad Smith regarding a macro or more comprehensive approach to small companies and to use his term small to medium enterprises (SME'S). A more comprehensive approach is necessary and appropriate because there is a need to review not only the small company issuers but also the markets and broker dealers involved in the raising of capital for SME's and the public perception of the regulation of those markets.
“In a recent explanation of the key points of Reg. SHO, the staff stated “Speculative stocks, such as microcap stocks, often have a high probability of declining in value and a low probability of experiencing above average gains." The committee should review the underlying data for this proposition to determine whether it is true for all low priced stocks in general or just those traded on the pink sheets and otcbb with a view to determining whether such stocks could ever be suitable for retail investors or whether they should only be sold to investors qualified by knowledge of these markets.
“In the column Washington Investing, Wash Post 5/23/05 p.1 Jerry Knight refers to the "purgatory of the Pink Sheets, a nearly unregulated neither market for trading stocks.” The committee should evaluate this statement and if necessary recommend increased practical regulation such as short sale reporting and Reg SHO coverage.
“Reg. SHO excluded these stocks from its coverage and the committee should therefore review why the most speculative stocks are not included.
“The SRO short sale reporting rules exclude these stocks from their coverage. See petition of the Pink Sheets to include them as an example of a market seeking more regulation.
“The SRO'S have failed to enforce their locate requirements for short sales thereby encouraging naked shorting in these markets. Except for one case, the penalties imposed over the last 10 years include modest fines probably less than trading profits made. ”These stocks are not eligible for margin or options and thus the loan supply is curtailed enabling naked shorts and the inability to hedge. See Comments of Professor Angle to Reg SHO.
“The Commission is reluctant to provide an arbitrage exemption for short sales which makes the distribution of many small company issues thru Pipes and Wt arbitrage. The committee should review the merits of such an exemption.
“The presidents and CEO'S of small broker -dealers believe they are often held responsible for their employees conduct while those of large broker dealers rarely are . They also believe penalties imposed on small bd's constitute a much larger portion of their net capital and are inherently unfair. This is an old argument but continues to resurface and should be addressed.
“The chairman of the PHLX recently noted that he worried that the Commission staff would be overwhelmed with the NYSE/ARCHIPELAGO and NASDAQ/INSTINET mergers and not have time for the rule filings of other smaller SRO's.
“Small companies are more likely to be referred to as penny stocks, unless like Lucent at $2.50 a share they are listed on the NYSE.
“There may be no reliable evidence that small bd's and small companies create more regulatory issues than the Enrons, Worldcoms, Tycos and other similar large companies that have required significant regulatory resources. The committee should review whether they do in fact create more regulatory issues.
“There is a proliferation of unregistered finders operating in the area of SME'S because of the lack of clear guidance from the Commission. It should also consider studying the role of finders in the process and might consider whether those finders should be registered as investment advisers rather than bd's.
“The Committee should not be reluctant to challenge conventional norms in its approach. The Committee should therefore recommend a special study of the regulation of SME's and small bd's to determine if the regulatory scheme is adequate and consistent and does not impose a greater burden on them especially in light of their job creating value in the U.S. It might also recommend the creation of an independent small business/small bd office at the Commission with a significant increase in staffing. While it is not the Commission's role to encourage small to medium enterprises or bd's, it is their obligation not to hinder them and to pay equal attention to them. This Committee has a rare opportunity to set a future agenda for SME'S in this country .As the markets rapidly consolidate, attention to SMEs and bd's is important whether it results in more or less regulation or more reasonable regulation,” the former SEC attorney concluded.
A controversial audio of a purported conference call conducted by officials of Bear Stearns (NYSE: BSC) contains allegations that the SEC had shared with Bear Stearns the names of hundreds of companies that it had said would be on the threshold lists but which were not on the official lists published, and that regulators had confided to Bear Stearns and others that the regulators are selectively enforcing provisions against “fails to deliver” securities according to a kind of floating set of “interpretations” rather than strictly according to the law.
The blockbuster audio is posted at http://www.investigatethesec.com/Bear080705.wma .
U.S. Senator Elizabeth Dole (R-SC) recently joined U.S. Senators James Talent (R-MO), Richard Shelby (D-AL), Susan Collins (R-ME), Robert Bennett (R-UT) and Richard Durbin (D-IL) in questioning U.S. Securities and Exchange Commission about what they call the “failure” of Regulation SHO to curtail unlawful, predatory securities trading.
The current Senate line-up carries significant heft. Senator Collins is chair of the Homeland Security and Governmental Affairs committee, Senator Shelby is chair of the Senate Banking Committee, Senator Durbin is Assistant Democratic Leader and Senator Bennett is Republican Whip. The Senators’ letters are posted at http://www.americaneedstoknow.com
“Stockgate Today” publisher David Patch said that the Senators have 23 good reasons, citing that many companies, including Martha Stewart Living Omnimedia (NYSE: MSO), Delta Air Lines (NYSE: DAL), Krispy Kreme (NYSE: KKD) and Netflix (NASDAQ: NFLX), that remain “not settled” on the official threshold lists maintained by the New York Stock Exchange and Nasdaq five months later.
“Stockgate Today” is published at http://www.investigatethesec.com . The Senators’ letters to shareholders and the SEC are posted at http://www.americaneedstoknow.com
Patch said that most of the 23 companies hardest-hit by unlawful stock manipulations in full sight of market regulators, including those at the SEC, such as Annette Nazareth, head of market regulation, who belittles complaints as coming from those who “want to see their stock go up,” have had double-digit declines in stock valuations over the 94 days they have been on the highly-public list.
He also noted that in the March, 2005 Euromoney Magazine article on illegal naked short selling, Head of Market Regulation Annette Nazareth’s assistant, James Brigagliano said that prior lawbreakers were “grandfathered” because “we were concerned about generating volatility where there were large pre-existing open positions, and we wanted to start afresh with new regulation, not re-write history.”
“So does Ken Lay, but he can’t,” retorted Patch.
This disputed “grandfathering” has not yet been taken up by Congress, but the 23 companies on the threshhold list for over days are new transgressions, and presumably they can’t be dealt with either because Nazareth and Brigagliano are concerned about “generating volatility.”
Also, in a blockbuster event almost equal to the mysterious “postponement” of “Dateline NBC,” the U.S. Securities and Exchange Commission has inexplicably given the DTC’s National Securities Clearing Corp. “immunity” in the form of limited liability for willful misconduct or violations of Federal securities laws.
The Notice regarding the SEC’s action is at http://www.nscc.com/impnot/notices/notice2005/a6029.pdf
Some legal experts are questioning whether the SEC, without the approval of Congress, has the authority to limit the NSCC’s liability. There have been similar questions about the SEC’s authority to unilaterally “grandfather” securities violations prior to Regulation SHO.
The new regulation is sure to be litigated since the DTCC and the NSCC were the subject of lawsuits claiming their “stock borrow program” is illegal counterfeiting, prior to the rule approval by the SEC.
Also, recently a stock transfer agent, Transfer Online Inc., had asked then-SEC Chair William Donaldson to put a stop to the control the Depository Trust & Clearing Corp. and Automatic Data Processing (NYSE: ADP) are fast gaining over the transfer business, and to demand DTCC transparency.
Excerpts from the letter, posted at http://www.faulkingtruth.com/Articles/LettersToEditor/1012.html , states: “Over the years as the amount of shares held at DTC has increased it has become more and more difficult to determine who owns the shares, who is trading them and if the trading is proper. This trend, and the resulting problems I will detail below, continues to increase because a minority of the total number of shareholders are reflected on the books and records of the corporation, most activity takes place behind the wall of ownership that is designated as Cede & Co. and neither the company nor the transfer agent has any access to the underlying information.
“Furthermore, DTC recently managed to put through a rule change (Release No. 34-50758A; File No.S7-24-04) that prohibits a transfer agent from representing any company who seeks to withdraw from the DTC system. This change effectively leaves companies with no voice or choice in the management of their stock and their ability to have any transparency as to what is actually taking place in the market in regard to their stock.
“I receive calls from companies seeking information as they watch millions of shares trade in a single day, who watch their share price decrease in value and who have no access to information regarding who is behind the trading of these shares, or if in fact the trades are at all legitimate. As the system now operates, most companies have a large percentage of shares on their books registered to Cede & Co.
“Given the importance of shareholder voting and communication one would assume that the same requirements placed on transfer agents as to accuracy and reporting would be placed on ADP and Cede & Co. as they usually hold or service the majority of the shares owned in any given company.
“I have found; however, that when presented with the tabulation reports from ADP the share totals they report sometimes exceed the total number of shares outstanding for the company. Let me restate this because it is a very important part of my concern about a system that is more and more headed in the direction of increased control by DTC. The shares presented by ADP, that are the shares voted by the brokers on behalf of the shareholders for whom they hold accounts, EXCEED when added to the shareholders of record the total number of shares outstanding.
“Where are these extra shares coming from? Why are there no controls on the number of shares held in the nominee name Cede & Co. vs. the ownership on the books and records of the brokers and why is the company not privy to any information unless it pays whatever fees it is told it must pay by the organizations that control the data?
“In fact, as the system is evolving, DTC is de facto becoming the largest transfer agent in the industry even though it is an organization formed by and working for the interests of the brokerage community. If, ultimately, the S.E.C. is in place to protect investors then this issue can not be ignored because in the end when the market is completely under the control of the brokers and the organizations that represent them then the market can neither be transparent nor fair.”
The “Important Notice” from the DTCC regarding the NSCC demonstrates that the entities are a “self-regulatory organization” under the auspices of the SEC, which ramps up the media interference to First Amendment violations.
The DTCC said that the “approved changes create a uniform standard limiting NSCC’s liability to direct losses caused by the NSCC’s gross negligence, willful misconduct, or violation of Federal securities laws for which there is a private right of action.”
In addition, the organization stated, “the changes memorialize an appropriate commercial standard of care that will protect NSCC for undue liability, permit the resources of NSCC to be appropriately utilized for promoting the accurate clearance and settlement of securities, and are consistent with similar rules adopted by other self-regulatory organizations and approved by the Commission.”
The DTCC had asked for the rule December 8, 2004. It is not known how the proposed rule slipped through the cracks on the public and Congressional levels prior to the approval.
The National Coalition Against Naked Shorting stated that the action was sought and approved hastily because “they have been willfully violating securities laws for years, know that it will come out in court, and want to have a piece of paper to fall back on,” adding that it corroborates “the theory that the stock borrow program violates a host of securities laws, that the NSCC knows it, and that they have been counterfeiting stock for years and just now are starting to catch on to the idea that they will get caught.”
In his communication to then-SEC Chair William Donaldson, Sen. Durbin also contested the claim by the Depository Trust and Clearing Corp., a unit ot the New York Stock Exchange and NASD, that it has no responsibilities under Regulation SHO.
Senator Durbin’s letter to Donaldson appears to sharply contest the Depository Trust & Clearing Corp.’s contention that it has no role in Regulation SHO.
“I am writing to request information regarding the August 12, 2004 Securities and Exchange Commission (SEC) short sale regulation, designated Regulation SHO. On March 9, 2005, the Senate Committee on Banking, Housing, and Urban Affairs held a hearing on Regulation SHO, in which Chairman Bennett spoke with you about the regulation’s effects on the illegal practice of naked short selling. I thank you for your testimony and I hope that you can follow up on some of my concerns not fully addressed by the Banking Committee hearings.
“I appreciate the efforts of the Securities and Exchange Commission (SEC) to control abusive short selling practices. As a result of Regulation SHO, the names of firms with large amounts of unsettled shares are published on the Threshold Security List daily. This list assists individual investors in making informed decisions about potential manipulation of the market, and gives regulators and investigators a centralized list of firms with significant numbers of undelivered shares. However, it has come to my attention that Regulation SHO may not be curtailing abusive naked short selling practices.
“Several of my constituents have contacted me since the SEC introduces Regulation SHO. They have raised concerns about potential loopholes in settlement regulations. During your recent testimony before the Banking Committee, Chairman Bennett asked you about the ability of brokerage houses to shuttle unsettled shares every 13 days in order to avoid settling the borrowed shorted shares. Due to time constraints at the hearing, the committee did not receive a complete answer. This issue is worthy of a full response.
“Additionally, my constituents have expressed concern about SEC enforcement of Regulation SHO. While the Threshold Security List publicizes securities that might have been manipulated, I am concerned that some securities repeatedly appear on the list. What steps is the SEC taking to investigate trading practices that result in vast quantities of unsettled shares, and to punish those people who violate SEC naked short selling regulations? What is the SEC doing to ensure that the Depository Trust & Clearing Corporation (DTCC) is complying with Regulation SHO, and what actions does the SEC undertake when the DTCC identifies large quantities of shares that have not been delivered?
“It is important that the SEC identify abuses and prevent manipulative naked short selling practices that undermine faith in the market. Thank you for your attention to this matter. I look forward to your timely response,” Senator Durbin concluded.
Pink Sheets head Cromwell Coulson has asked the SEC to publish short positions on all over the counter and bulletin board stocks, and that request is currently in a comment period.
The request for rulemaking, which Coulson has told companies traded on the Pink Sheets, is needed “to make regulators turn on the lights and protect investors from the menance of hidden short selling in the OTC market,” is at http://sec.gov/rules/petitions.shtml
In an email to Donaldson, Coulson had said “I believe that it is very important to require the disclosure of short positions because the lack of transparency is allowing promoters to defraud investors by blaming all selling on naked market maker short selling. Disclosure and transparency can easily remedy the issue.”
In other news on the naked short-selling front known as “StockGate,” adding to what TheStreet.com founder James Cramer calls the “Hedge Fund Relief Act,” the termination of the Uptick Rule, is the fact that those using illegal naked short selling in the past have been granted a kind of amnesty for acts before the first of 2005. The SEC just “grandfathered” those illegally-begotten gains and resultant counterfeit shares into the system, so these windfall gains are now available to downtick with reckless abandon on downticks.
The “grandfathering” admission is at http://www.sec.gov/spotlight/keyregshoissues.htm
In the same document, the SEC has inexplicably stated that not all forms of illegal naked short selling, the equivalent of counterfeiting shares in public companies, are actually “illegal.”
The DTCC actions in the StockGate mire are the most serious, if not notorious since the agent of two SROs, the New York Stock Exchange and NASD is also peopled by some 21 directors whose companies, such as Merrill Lynch & Co. (NYSE: MER), State Street Corporation (NYSE: STT) and Goldman Sachs (NYSE: GS), are unlikely to support the DTCC in its media censorship.
In a recent editorial, Investrend Information head Gayle Essary questioned whether the board and principal shareholders would “be party to shenanigans that lead to the censorship or disabling of any media” that he says is “un-American activity.”
Essary said that the arrogance the DTCC expressed in its censorship efforts shows that the entity has “become too large, too encompassing, too powerful, too unresponsive to those it serves, primarily the investing public, and too unresponsive to the Congress under whose auspices it should be operating.
“First, it is time to unconflict it, with real public representations on its board,” he said, and second, “it is time to break it up, with its various duties provided by smaller agencies under separate unconflicted boards.”
DTCC board members include Michael C. Bodson, Managing Director, Morgan Stanley (NYSE: MWD); Gary Bullock, Global Head of Logistics, Infrastructure, UBS Investment Bank (NYSE: UBS); Stephen P. Casper, Managing Director and Chief Operating Officer, Fischer Francis Trees & Watts, Inc.; Jill M. Considine,Chairman, President & Chief Executive Officer, The Depository Trust & Clearing Corporation (DTCC);
Also, Paul F. Costello, President, Business Services Group, Wachovia Securities (NYSE: WB); John W. Cummings, Senior Vice President & Head of Global Technology & Services, Merrill Lynch & Co. (NYSE: MER); Donald F. Donahue, Chief Operating Officer, The Depository Trust & Clearing Corporation (DTCC); Norman Eaker, General Partner, Edward Jones; George Hrabovsky, President, Alliance Global Investors Service; Catherine R. Kinney, President and Co-Chief Operating Officer, New York Stock Exchange; Thomas J. McCrossan, Executive Vice President, State Street Corporation (NYSE: STT); Bradley Abelow, Managing Director, Goldman Sachs (NYSE: GS); Jonathan E. Beyman, Chief Information Officer, Lehman Brothers (NYSE: LEH); and Frank J. Bisignano, Chief Administrative Officer and Senior Executive Vice President, Citigroup / Solomon Smith Barney's Corporate Investment Bank (NYSE: C), Eileen K. Murray, Managing Director, Credit Suisse First Boston (NYSE: CSR); James P. Palermo, Vice Chairman, Mellon Financial Corporation (NYSE: MEL); Thomas J. Perna, Senior Executive Vice President, Financial Companies Services Sector of The Bank of New York (NYSE: BNY); Ronald Purpora, Chief Executive Officer, Garban LLC; Douglas Shulman, President, Regulatory Services and Operations, NASD; and Thompson M. Swayne, Executive Vice President, JPMorgan Chase (NYSE: JPM).
For up-to-the-minute news, features and links click on http://www.financialwire.net
Overstock.com, Netflix (NASDAQ: NFLX), Internet Initiative Japan (NASDAQ: IIJI) and others are among numerous companies identified by TheStreet.com (NASDAQ: TSCM) as targets of illegal stock manipulators. Rocker Partners has been branded by some as having the greatest short position on the New York Stock Exchange alone.
The event will occur at http://www.shareholder.com/overstock , or via the phone at 800-811-8830.
“What if someone passed a law and no one followed it?” asked TheStreet.com senior writer Kevin Kelleher this week, referring to “fails to deliver” for extended periods for Overstock and other leading companies.
The lawsuit has been filed by John O’Quinn, Esq., and his legal team. O’Quinn has also alleged in separate lawsuits a conspiracy in aiding and abetting firms such as Rocker Partnrs by the Depository Trust & Clearing Corp., a unit of NYSE and NASD.
Overstock.com launched its first website through which customers could purchase products in 1999. Its overall business and gross revenues have grown steadily and consistently, at a rate of approximately 100% each year since 2000. Its annual revenues for the year ending December 31, 2004 were approximately $500 million.
The complaint alleges that Gradient Analytics, Inc., an influential company that sells reports and analyses on publicly traded companies to hedge funds, traditional mutual funds, and provides them to financial commentators such as MSNBC, is closely aligned with various stock hedge funds. The complaint alleges that Gradient and Rocker Partners LP, which is owned and controlled by David Rocker and Michael Cohodes, individually and/or through Rocker Offshore or Rocker Management, conspired to denigrate Overstock.com's business so as to reap personal profits for themselves.
Byrne commented: "What's at stake here is innovation and entrepreneurship in America. My company has been attacked and I'm not going to take this lying down. In joining forces with John O'Quinn and his team of lawyers, I think we have what it takes to win. We certainly have what it takes to fight."
also commented: "We have an expression in Texas about the skill of matching the mules. Combining our lawyers and a-level experts with the tenacity, verve and commitment of Overstock.com CEO Dr. Patrick Byrne is a powerful alliance, hitched up for the long haul to win this battle. It is time someone stops these offshore hedge funds from taking advantage of average working Americans and American Public companies. That someone is us."
Attorney Adam Voyles added: "I am speaking for the entire consortium when I say that we are prepared to obtain justice for our client from these Defendants and all others who aided them in these illegal acts. It is time our government authorities and regulators pay attention to the large number of offshore hedge funds that are taking advantage of hard working Americans."
In the actions, filed in Marin County California Superior Court, Overstock.com is represented by the law firms of O'Quinn, Laminack & Pirtle, Christian Smith & Jewell, and Heard, Robins, Cloud, Lubel & Greenwood, LLP, all of Houston, Texas, Woodbury & Kessler, PC of Salt Lake City, Utah, the Siegler Law Group, Inc, of Beverly Hills, California and Koerner Silberberg and Weiner, LLP of New York, New York.
A replay of the webcast will be available on the Internet at http://www.shareholder.com/overstock starting 90 minutes after the live call has ended. A transcript will be posted to the website as soon as it is available. An audio replay of the webcast will be available via telephone starting at 1:30 p.m. Eastern time on August 12, through midnight Eastern Time on Friday, August 19. To listen to the recorded webcast by phone, please dial (888) 203-1112 (passcode: 4199807).
Regulation SHO is “not one of those bizarre, outdated laws you hear about, like in Maine, where people are required to bring shotguns to church, but a brand new law with an entirely sensible goal, like keeping people from selling equities that don't exist,” Kelleher had stated.
“The Securities and Exchange Commission gives broker-dealers a 13-day grace period before they are required to close out those naked-short positions. After 13 days, it's safer to assume there must be at least some abusive shorting going on.”
TheStreet.com said the website, Buyins.com, lists 59 securities that have been on the threshold lists longer than Internet Initiative Japan.
He said unlike some relatively illiquid small caps, there are 10 Nasdaq companies “that have substantial daily volume and market caps between $150 million and $1.1 billion that have been on its threshold list for more than 26 days, twice the allotted grace period after which the positions must be cleared out.”
Besides, Internet Initiative Japan, on the list for 42 days, and Netflix, Given and Taser, others include Cal-Maine Foods (NASDAQ: CALM), 134 days, Global Crossing (NASDAQ: GLBC), 137 days, Navarre Corp. (NASDAQ: NAVR), 77 days, Overstock.com (OTCBB: OSTK), 75 days, Endwave Corp. (NASDAQ: ENWV), 48 days, Antigenics (NASDAQ: AGEN), 36 days, and Turbochef Technologies (NASDAQ: OVEN), 33 days.
“Why aren't broker-dealers cleaning out these naked-short positions?,” asked TheStreet.com.
Asking the watchdogs doesn't offer much insight, it said, noting that John Heine, a spokesman for the Securities and Exchange Commission, says that body doesn't comment on the activities of its enforcement office, which oversees broker-dealer activity.
"There hasn't been a case yet where we've brought enforcement action" regarding Regulation SHO, Heine says. "We're always interested when people have any information about violations of SEC laws."
NASD, which is supported by 5,200 member brokerage firms, is required to gather data on naked short-selling, so it's in the best position to understand why so many stocks are stuck on its threshold list. Yet it seems oddly indifferent, stated Kelleher.
"Isn't that the business of the SEC?" snapped NASD spokesperson Nancy Condon when asked about the lingerers on its threshold list. A second spokesperson called back to point out the SEC's Web page explaining Regulation SHO, but didn't comment any further.”
Why, for example, has it taken more than six months to clear out grandfathered short positions in Taser or Netflix?, inquired TheStreet.com.
"Regulation SHO is toothless," it quotes Overstock CEO Patrick Byrne. "The regulators have decided to give free passes to criminals."
“Data on naked short-selling isn't as transparent as it is on plain old-fashioned short-selling. The SEC doesn't require disclosure of how many shares have failed to deliver, which is too bad, because there's a good deal of disagreement on how widespread naked short-selling is. Some people, including investors at hedge funds, maintain it's all a tempest in a teapot. Others, like Byrne, suggest it's become too big a problem for regulators to rein in,” said Kelleher.
“The SEC could make enforcement of Regulation SHO a lot easier by enlisting the help of the market itself: Why not simply disclose the size of the naked-short position in each stock as well as the broker-dealer responsible for clearing out the position? If the naked-short positions are disarmingly small, investors will know that it is indeed a tempest in a teapot. And if the positions are large, they'll know who to call,” concluded TheStreet.com.
Some 93.89% of the respondents to the Investrend Poll at http://www.investrendinformation.com said that the DTCC should be “punished” for its interferences.
The censorship has since admitted to in a letter posted at http://www.investrend.com/Admin/Topics/Articles/Resources/349_1113403487.pdf .
More than a half dozen highly-ranked Republican and Democratic U.S. Senators have weighed in that the U.S. Securities and Exchange Commission’s much-ballyhooed “Regulation SHO” has highlighted the massive extent of the illegal practice but has done nothing to stop it.
The main lists for Regulation SHO are at http://www.nasdaqtrader.com/aspx/regsho.aspx and http://www.nyse.com/Frameset.html?displayPage=/threshold .
Even the DTCC has admitted its “fails to deliver” is massive, amounting to upwards of $6 billion a day, according to DTCC Deputy General Counsel Larry Thompson.
A former U.S. Under Secretary of Commerce for Economic Affairs, Robert J. Shapiro, now chair of Sonecon, LLC, a private economic advisory firm, accused Thompson of making “inaccurate or misleading” statements. Shapiro, who holds a Ph.D from Harvard University, was the principal economic advisor to former President Bill Clinton in his initial Presidential campaign.
Shapiro currently provides economic analysis to the law firms of O’Quinn, Laminack and Pirtle, Christian, Smith and Jewell, and Heard, Robins, Cloud, Lubel and Greenwood, on issues associated with naked short sales, which he noted includes “matters raised in an interview published by @DTCC with DTCC deputy general counsel Larry Thompson.”
He asserted in his letter that “the extent to which [naked short selling] occurs is in dispute. While this statement may be narrowly correct, objective academic analysis has established that naked short selling has been a widespread practice and one which, when allowed to persist, can pose a threat to the integrity of equity markets. A recent study by Dr. Leslie Boni, then a visiting financial economist at the SEC, analyzed NSCC data and found that on three random days, an average of more than 700 listed stocks had failures-to-deliver of 60 million-to-120 million shares sold short – naked shorts – that had persisted for at least two months. In addition, over 800 unlisted stocks on any day had fails of 120 million-to-180 million shares sold short that also had persisted for at least two months. The total number of naked shorts, including those that had persisted for less than two months, was presumably considerably greater.
“Regarding the extent of naked shorts, Thompson has provided closely-related additional information: ‘fails to deliver and receive amount to about $6 billion daily…including both new fails and aged fails.’ Thompson minimizes this total by comparing it to “just under $400 billion in trades (emphasis added) processed daily by NSCC, or about 1.5% of the dollar volume.” By most people’s standards, a problem involving hundreds of millions of shares valued at $6 billion every day is a very large problem. Moreover, the $6 billion total substantially underestimates the actual value of all failed-to-deliver trades measured when the trades actually occurred. Most of the $6 billion total represents uncovered or naked short sales, many of which have gone undelivered for weeks or months with their market price being marked-to-market every day. As a stock’s price falls, the market price of naked shorts in that stock also declines, reducing the total value of the outstanding failures-to-deliver cited by Thompson.
“In other respects, Thompson’s comparison to the ‘$400 billion in trades processed daily by NSCC’ seems disingenuous and misleading, because that $400 billion total covers not only U.S. equity trades which can involve most of the failures-to-deliver at issue, but many other transactions also processed by the NSCC. The value of all equity transactions on U.S. markets in 2004, for example, averaged $82.3 billion/day. If Thompson is correct that the daily value of fails-to-deliver averages $6 billion, that total is equivalent to 7.2 percent of average daily equity trades or nearly five times the 1.5 percent level suggested by Thompson.
“Furthermore, the DTCC reports on its website that on a peak day, ‘through its Continuous Net Settlement (CNS) system, NSCC eliminated the need to settle 96 percent of total obligations.’ Assuming that CNS nets out the same proportion of trades on other days, $384 billion of the $400 billion in daily trades cited by Thompson are netted out, leaving only $16 billion in daily trades that require the actual delivery of securities. The $6 billion of fails-to-deliver securities existing on any day are equivalent to 37.5 percent of the average daily trades that require the delivery of securities, or 25 times the 1.5 percent level cited by Thompson.
“Thompson tries to explain the large numbers of shares that go undelivered – in most cases arising from naked short sales -- by citing problems with paper certificates, inevitable human error, and the legitimate operations of market makers. This also seems misleading or disingenuous. Regarding problems with paper certificates, the DTCC estimates that 97 percent of all stock certificates are now kept in electronic form. Nor can human error or legitimate market-making operations explain the high levels of failures-to-deliver that persist for months – on any day, an average of 180 million-to-300 million shares have gone undelivered for two months or longer – as documented by Dr. Boni’s analysis of NSCC data.
“Thompson also disparages the attorneys who represent companies that have been damaged or destroyed by massive naked short sales, and their shareholders, by claiming falsely that the cases in this matter have almost all been dismissed or withdrawn. The legal firms that I advise -- O’Quinn, Petrie and Laminack; Christian, Smith and Jewell; and Heard, Robins, Cloud, Lubel and Greenwood – have not lost any motions against the DTCC or its affiliates and currently have one case against the DTCC pending in Nevada and another case against the DTCC pending in Arkansas. In addition, on February 24, 2005, these attorneys were granted an order by the New York Supreme Court ordering the DTCC to produce trading records involving two companies they represent, including records from the Stock Borrow program, which may establish whether large-scale naked short sales were used to manipulate and drive down the stock price of those two companies.
“Thompson also asserts that the plaintiffs suing the DTCC for damages associated with the handling of naked short sales rely on “theories [that] are not an accurate reflection of how the capital market system actually works.” This assertion is inaccurate. There is no dispute about how the capital markets work -- nor any doubt that naked short sales have been used to manipulate and drive down the price of stocks, as seen in numerous death-spiral financing cases. The issue here is the DTCC’s role in allowing or facilitating such stock manipulation through its treatment of extended naked short sales.
“In explaining the DTCC’s role in these matters, Thompson rejects the claim that the NSCC’s Stock Borrow program allows the same shares to be lent over and over again, potentially creating more shares than actually exist or ‘phantom’ shares. By Thompson’s own account, shares borrowed by the NSCC to settle naked short sales are deducted from the lending member’s DTC account and credited to the DTC account of the member to whom the shares have been sold. Therefore, those same shares become available to be re-borrowed to settle another naked short sale and, if that happens, to be re-borrowed again and again to settle a succession of naked short sales. Throughout this process, the actual short sellers may continue to fail-to-deliver the shares to cover their shorts and, as Dr. Boni’s analysis of NSCC data found, the underlying failure can age for months or even years. The process which Thompson describes is one in which shares can be borrowed and lent over and over again, introducing more shares into the market than are legally registered and issued. If any ambiguity remains, Thompson can clarify it by responding to the following query: Once a share that has been borrowed through the NSCC Stock Borrow program is delivered to the purchaser, is that share restricted in any way so it cannot be lent again?
“It is important to note that the Stock Borrow program is used when continuous net settlement cannot locate the shares to settle. As a consequence, Stock Borrow is usually called into play when there are relatively few shares available for borrowing. These are propitious conditions for market manipulation: Unscrupulous short sellers undertake large-scale naked short sales involving stocks for which few shares are available for trading and lending, relying on the Stock Borrow program to borrow the limited available shares, again and again, at sufficient levels to drive down the market price of the shares.
“Thompson notes that of approximately $6 billion in outstanding failures-to-deliver existing on any day, “the Stock Borrow program is able to resolve about $1.1 billion … or about 20% [18 percent] of the total fail obligation.” In this statement, Thompson raises very serious questions about the integrity and operations of the NSCC and DTCC, which he can clarify by responding to the following queries: If the Stock Borrow program “resolves” only 18 percent of total fails, what is the disposition of the remaining 82 percent of outstanding fails? When failures-to-deliver occur that are not resolved through Stock Borrow, does the NSCC credit the undelivered shares to the member representing the buyer, creating genuine “phantom shares”? Finally, how many shares do the borrowing brokers, clearing firms and other participants in the Stock Borrow program owe the NSCC on a typical day, and what is their total value?
“In a related matter, Thompson tries to distance the DTCC from charges that shares held in restricted accounts – for example, cash accounts, retirement accounts and many institutional accounts – are improperly lent through the Stock Borrow program by claiming that responsibility for segregating restricted shares from lendable shares falls to the “broker and bank members” of the DTCC, while responsibility for monitoring or regulating their performance in this matter falls to the stock exchanges and the SEC. As a trust company, the DTCC cannot hold that it has no role, duty or responsibility to ensure the probity of its operations. Thompson could address this issue by responding to the following queries: What procedures does the NSCC have to ensure that shares held in members’ accounts for possible loan through the NSCC Stock Borrow program are unencumbered by regulatory or legal restrictions from being pledged or assigned and eligible to be borrowed? On any given day, how many participants in the Stock Borrow program have lent shares that exceed their lendable shares, in what numbers and of what value?
“Thompson also tries to distance the DTCC as far as possible from the naked short selling that generates most of the extended failures-to-deliver: ‘We don’t have any power or legal authority to regulate or stop short selling, naked or otherwise. We also have no power to force member firms to close out or resolve fails to deliver … we don’t even see whether a sale is short or not.’ In fact, the DTCC chooses to not distinguish short sales from long sales, chooses to not regulate or stop extended naked short sales, and chooses to not force member firms to resolve protracted naked short sales.
“First, Regulation SHO requires that all transactions be clearly marked short or long. If the DTCC and NSCC do not know whether sales are short or long as Thompson contends, they choose to not know. Second, the NSCC has a clear responsibility and adequate means to stop naked short sales of extended duration, with no legal barrier that would prevent them from so doing. As a trust company with an acknowledged duty to provide investors certainty in the settlement and clearance of equity transactions, the DTCC chose to carry out that duty by assuming the role of counterparty to both sides of every equity transaction, through the operations of the NSCC’s CNS system and the Stock Borrow program. By allowing short sellers to fail-to-deliver shares for months or even years, the NSCC clearly fails to provide certainty in settlement to the buyers, sellers and issuers of securities. Since it is widely known that extended naked short sales have been used to manipulate stock prices in cases of death-spiral financing, and the NSCC created the Stock Borrow program to address failures-to-deliver that prominently include naked short sales, the NSCC and DTCC share a responsibility with the SEC and the stock exchanges to protect investors by resolving extended fails.
“Third, the DTCC and NSCC have the clear capacity to force member firms to resolve the extended failures-to-deliver of their customers by purchasing shares on the open market and deducting the cost from the member’s account. A 2003 study by Dr. Richard Evans and others provides evidence that forced buy-ins by any party occur very rarely. They found that a major options market maker who failed to deliver all or a portion of shares sold in 69,063 transactions in 1998-1999 was bought-in only 86 times or barely one-tenth of 1 percent of the fails. Thompson can clarify investors’ understanding of their operations by responding to the following query: What proportion of shares that are persistent fails-to-deliver, of one month or longer, are ever bought in?
“Thompson acknowledges that the DTCC and NSCC know precisely how many failures-to-deliver exist for each stock and the precise duration of each of these fails. Yet, the DTCC refuses to disclose this information even to the issuer of the stock in question, which Thompson justifies by citing ‘NSCC rules’ prohibiting such a release of data based on ‘the obvious reason that the trading data we receive could be used to manipulate the market, as well as reveal trading patterns of individual firms.’
“This response is both disingenuous and revealing. We know now, for the first time, that the DTCC has full knowledge of the extent of protracted, large-scale naked short sales in all particular cases. We also know now that the DTCC has had this information for at least a decade, since Thompson also notes that ‘fails, as a percentage of total trading, hasn’t changed in the last 10 years.’ Yet, based on the DTCC’s own rules, it allowed these abuses to persist and fester. The DTCC and NSCC can change their rules at any time. Moreover, in this case, those rules are unjustified. Data documenting outstanding short sales in each stock are currently issued publicly, so further data on how many of those short sales are naked would not reveal additional information about the trading patterns of individual firms or in any way empower manipulators. In fact, the DTCC could substantially disarm manipulators by both publicly reporting naked short sales in each issue and pledging to force buy-ins of all naked short sales that persist for more than a limited period.
Surely, if large-scale, extended naked short sales have effectively created “phantom” shares, companies have a responsibility to their shareholders and the right to secure this information from the organization which manages the settlement of short sales. At a minimum, the DTCC should respond to requests by issuers for data on extended failures-to-deliver in their own stocks, both in the past and currently, so they can take steps to resist stock manipulators or bring them to account for past manipulation.
Thompson also claims that the DTCC did not create or manage the Stock Borrow program to serve its own financial interest, insisting that the service generates less than $2 million a year in direct fees to the DTCC and that all DTCC services are priced on a “not for profit” basis that seeks to match revenues with expenses. Without further information, these responses beg the question of whose private financial interest has been served by the Stock Borrow program, especially as the DTCC is owned by the stock markets, clearinghouses, brokerage and banking institutions that use its services. Thompson and the DTCC can clarify this serious matter by responding to the following queries: Do DTCC participant/owners receive interest or other payments through or from the Stock Borrow program for lending the shares of their customers and, if so, how much have they received for these activities over the last 10 years? Further, do DTCC participant/owners receive any dividend, interest or other payments or distributions from the DTCC or its subsidiaries?,” Shapiro concluded.
Neither Thompson nor the DTCC have responded to Shapiro’s wide-ranging allegations.
Recently, former SEC Attorney Peter Chepucavage, previously a staffer for the U.S. Securities and Exchange Commission’s Division of Market Regulation, and a key participant in the release of Regulation SHO, has left the SEC and is now challenging his former agency over the regulation’s inability to reign in illegal market manipulations.
Chepucavage has forwarded his comments to the SEC, under File Nunber 265-23:
“I am responding to your Request for Public Comments on Summary of Proposed Committee Agenda. I wish to incorporate and expand upon the comments of Brad Smith regarding a macro or more comprehensive approach to small companies and to use his term small to medium enterprises (SME'S). A more comprehensive approach is necessary and appropriate because there is a need to review not only the small company issuers but also the markets and broker dealers involved in the raising of capital for SME's and the public perception of the regulation of those markets.
“In a recent explanation of the key points of Reg. SHO, the staff stated “Speculative stocks, such as microcap stocks, often have a high probability of declining in value and a low probability of experiencing above average gains." The committee should review the underlying data for this proposition to determine whether it is true for all low priced stocks in general or just those traded on the pink sheets and otcbb with a view to determining whether such stocks could ever be suitable for retail investors or whether they should only be sold to investors qualified by knowledge of these markets.
“In the column Washington Investing, Wash Post 5/23/05 p.1 Jerry Knight refers to the "purgatory of the Pink Sheets, a nearly unregulated neither market for trading stocks.” The committee should evaluate this statement and if necessary recommend increased practical regulation such as short sale reporting and Reg SHO coverage.
“Reg. SHO excluded these stocks from its coverage and the committee should therefore review why the most speculative stocks are not included.
“The SRO short sale reporting rules exclude these stocks from their coverage. See petition of the Pink Sheets to include them as an example of a market seeking more regulation.
“The SRO'S have failed to enforce their locate requirements for short sales thereby encouraging naked shorting in these markets. Except for one case, the penalties imposed over the last 10 years include modest fines probably less than trading profits made. ”These stocks are not eligible for margin or options and thus the loan supply is curtailed enabling naked shorts and the inability to hedge. See Comments of Professor Angle to Reg SHO.
“The Commission is reluctant to provide an arbitrage exemption for short sales which makes the distribution of many small company issues thru Pipes and Wt arbitrage. The committee should review the merits of such an exemption.
“The presidents and CEO'S of small broker -dealers believe they are often held responsible for their employees conduct while those of large broker dealers rarely are . They also believe penalties imposed on small bd's constitute a much larger portion of their net capital and are inherently unfair. This is an old argument but continues to resurface and should be addressed.
“The chairman of the PHLX recently noted that he worried that the Commission staff would be overwhelmed with the NYSE/ARCHIPELAGO and NASDAQ/INSTINET mergers and not have time for the rule filings of other smaller SRO's.
“Small companies are more likely to be referred to as penny stocks, unless like Lucent at $2.50 a share they are listed on the NYSE.
“There may be no reliable evidence that small bd's and small companies create more regulatory issues than the Enrons, Worldcoms, Tycos and other similar large companies that have required significant regulatory resources. The committee should review whether they do in fact create more regulatory issues.
“There is a proliferation of unregistered finders operating in the area of SME'S because of the lack of clear guidance from the Commission. It should also consider studying the role of finders in the process and might consider whether those finders should be registered as investment advisers rather than bd's.
“The Committee should not be reluctant to challenge conventional norms in its approach. The Committee should therefore recommend a special study of the regulation of SME's and small bd's to determine if the regulatory scheme is adequate and consistent and does not impose a greater burden on them especially in light of their job creating value in the U.S. It might also recommend the creation of an independent small business/small bd office at the Commission with a significant increase in staffing. While it is not the Commission's role to encourage small to medium enterprises or bd's, it is their obligation not to hinder them and to pay equal attention to them. This Committee has a rare opportunity to set a future agenda for SME'S in this country .As the markets rapidly consolidate, attention to SMEs and bd's is important whether it results in more or less regulation or more reasonable regulation,” the former SEC attorney concluded.
A controversial audio of a purported conference call conducted by officials of Bear Stearns (NYSE: BSC) contains allegations that the SEC had shared with Bear Stearns the names of hundreds of companies that it had said would be on the threshold lists but which were not on the official lists published, and that regulators had confided to Bear Stearns and others that the regulators are selectively enforcing provisions against “fails to deliver” securities according to a kind of floating set of “interpretations” rather than strictly according to the law.
The blockbuster audio is posted at http://www.investigatethesec.com/Bear080705.wma .
U.S. Senator Elizabeth Dole (R-SC) recently joined U.S. Senators James Talent (R-MO), Richard Shelby (D-AL), Susan Collins (R-ME), Robert Bennett (R-UT) and Richard Durbin (D-IL) in questioning U.S. Securities and Exchange Commission about what they call the “failure” of Regulation SHO to curtail unlawful, predatory securities trading.
The current Senate line-up carries significant heft. Senator Collins is chair of the Homeland Security and Governmental Affairs committee, Senator Shelby is chair of the Senate Banking Committee, Senator Durbin is Assistant Democratic Leader and Senator Bennett is Republican Whip. The Senators’ letters are posted at http://www.americaneedstoknow.com
“Stockgate Today” publisher David Patch said that the Senators have 23 good reasons, citing that many companies, including Martha Stewart Living Omnimedia (NYSE: MSO), Delta Air Lines (NYSE: DAL), Krispy Kreme (NYSE: KKD) and Netflix (NASDAQ: NFLX), that remain “not settled” on the official threshold lists maintained by the New York Stock Exchange and Nasdaq five months later.
“Stockgate Today” is published at http://www.investigatethesec.com . The Senators’ letters to shareholders and the SEC are posted at http://www.americaneedstoknow.com
Patch said that most of the 23 companies hardest-hit by unlawful stock manipulations in full sight of market regulators, including those at the SEC, such as Annette Nazareth, head of market regulation, who belittles complaints as coming from those who “want to see their stock go up,” have had double-digit declines in stock valuations over the 94 days they have been on the highly-public list.
He also noted that in the March, 2005 Euromoney Magazine article on illegal naked short selling, Head of Market Regulation Annette Nazareth’s assistant, James Brigagliano said that prior lawbreakers were “grandfathered” because “we were concerned about generating volatility where there were large pre-existing open positions, and we wanted to start afresh with new regulation, not re-write history.”
“So does Ken Lay, but he can’t,” retorted Patch.
This disputed “grandfathering” has not yet been taken up by Congress, but the 23 companies on the threshhold list for over days are new transgressions, and presumably they can’t be dealt with either because Nazareth and Brigagliano are concerned about “generating volatility.”
Also, in a blockbuster event almost equal to the mysterious “postponement” of “Dateline NBC,” the U.S. Securities and Exchange Commission has inexplicably given the DTC’s National Securities Clearing Corp. “immunity” in the form of limited liability for willful misconduct or violations of Federal securities laws.
The Notice regarding the SEC’s action is at http://www.nscc.com/impnot/notices/notice2005/a6029.pdf
Some legal experts are questioning whether the SEC, without the approval of Congress, has the authority to limit the NSCC’s liability. There have been similar questions about the SEC’s authority to unilaterally “grandfather” securities violations prior to Regulation SHO.
The new regulation is sure to be litigated since the DTCC and the NSCC were the subject of lawsuits claiming their “stock borrow program” is illegal counterfeiting, prior to the rule approval by the SEC.
Also, recently a stock transfer agent, Transfer Online Inc., had asked then-SEC Chair William Donaldson to put a stop to the control the Depository Trust & Clearing Corp. and Automatic Data Processing (NYSE: ADP) are fast gaining over the transfer business, and to demand DTCC transparency.
Excerpts from the letter, posted at http://www.faulkingtruth.com/Articles/LettersToEditor/1012.html , states: “Over the years as the amount of shares held at DTC has increased it has become more and more difficult to determine who owns the shares, who is trading them and if the trading is proper. This trend, and the resulting problems I will detail below, continues to increase because a minority of the total number of shareholders are reflected on the books and records of the corporation, most activity takes place behind the wall of ownership that is designated as Cede & Co. and neither the company nor the transfer agent has any access to the underlying information.
“Furthermore, DTC recently managed to put through a rule change (Release No. 34-50758A; File No.S7-24-04) that prohibits a transfer agent from representing any company who seeks to withdraw from the DTC system. This change effectively leaves companies with no voice or choice in the management of their stock and their ability to have any transparency as to what is actually taking place in the market in regard to their stock.
“I receive calls from companies seeking information as they watch millions of shares trade in a single day, who watch their share price decrease in value and who have no access to information regarding who is behind the trading of these shares, or if in fact the trades are at all legitimate. As the system now operates, most companies have a large percentage of shares on their books registered to Cede & Co.
“Given the importance of shareholder voting and communication one would assume that the same requirements placed on transfer agents as to accuracy and reporting would be placed on ADP and Cede & Co. as they usually hold or service the majority of the shares owned in any given company.
“I have found; however, that when presented with the tabulation reports from ADP the share totals they report sometimes exceed the total number of shares outstanding for the company. Let me restate this because it is a very important part of my concern about a system that is more and more headed in the direction of increased control by DTC. The shares presented by ADP, that are the shares voted by the brokers on behalf of the shareholders for whom they hold accounts, EXCEED when added to the shareholders of record the total number of shares outstanding.
“Where are these extra shares coming from? Why are there no controls on the number of shares held in the nominee name Cede & Co. vs. the ownership on the books and records of the brokers and why is the company not privy to any information unless it pays whatever fees it is told it must pay by the organizations that control the data?
“In fact, as the system is evolving, DTC is de facto becoming the largest transfer agent in the industry even though it is an organization formed by and working for the interests of the brokerage community. If, ultimately, the S.E.C. is in place to protect investors then this issue can not be ignored because in the end when the market is completely under the control of the brokers and the organizations that represent them then the market can neither be transparent nor fair.”
The “Important Notice” from the DTCC regarding the NSCC demonstrates that the entities are a “self-regulatory organization” under the auspices of the SEC, which ramps up the media interference to First Amendment violations.
The DTCC said that the “approved changes create a uniform standard limiting NSCC’s liability to direct losses caused by the NSCC’s gross negligence, willful misconduct, or violation of Federal securities laws for which there is a private right of action.”
In addition, the organization stated, “the changes memorialize an appropriate commercial standard of care that will protect NSCC for undue liability, permit the resources of NSCC to be appropriately utilized for promoting the accurate clearance and settlement of securities, and are consistent with similar rules adopted by other self-regulatory organizations and approved by the Commission.”
The DTCC had asked for the rule December 8, 2004. It is not known how the proposed rule slipped through the cracks on the public and Congressional levels prior to the approval.
The National Coalition Against Naked Shorting stated that the action was sought and approved hastily because “they have been willfully violating securities laws for years, know that it will come out in court, and want to have a piece of paper to fall back on,” adding that it corroborates “the theory that the stock borrow program violates a host of securities laws, that the NSCC knows it, and that they have been counterfeiting stock for years and just now are starting to catch on to the idea that they will get caught.”
In his communication to then-SEC Chair William Donaldson, Sen. Durbin also contested the claim by the Depository Trust and Clearing Corp., a unit ot the New York Stock Exchange and NASD, that it has no responsibilities under Regulation SHO.
Senator Durbin’s letter to Donaldson appears to sharply contest the Depository Trust & Clearing Corp.’s contention that it has no role in Regulation SHO.
“I am writing to request information regarding the August 12, 2004 Securities and Exchange Commission (SEC) short sale regulation, designated Regulation SHO. On March 9, 2005, the Senate Committee on Banking, Housing, and Urban Affairs held a hearing on Regulation SHO, in which Chairman Bennett spoke with you about the regulation’s effects on the illegal practice of naked short selling. I thank you for your testimony and I hope that you can follow up on some of my concerns not fully addressed by the Banking Committee hearings.
“I appreciate the efforts of the Securities and Exchange Commission (SEC) to control abusive short selling practices. As a result of Regulation SHO, the names of firms with large amounts of unsettled shares are published on the Threshold Security List daily. This list assists individual investors in making informed decisions about potential manipulation of the market, and gives regulators and investigators a centralized list of firms with significant numbers of undelivered shares. However, it has come to my attention that Regulation SHO may not be curtailing abusive naked short selling practices.
“Several of my constituents have contacted me since the SEC introduces Regulation SHO. They have raised concerns about potential loopholes in settlement regulations. During your recent testimony before the Banking Committee, Chairman Bennett asked you about the ability of brokerage houses to shuttle unsettled shares every 13 days in order to avoid settling the borrowed shorted shares. Due to time constraints at the hearing, the committee did not receive a complete answer. This issue is worthy of a full response.
“Additionally, my constituents have expressed concern about SEC enforcement of Regulation SHO. While the Threshold Security List publicizes securities that might have been manipulated, I am concerned that some securities repeatedly appear on the list. What steps is the SEC taking to investigate trading practices that result in vast quantities of unsettled shares, and to punish those people who violate SEC naked short selling regulations? What is the SEC doing to ensure that the Depository Trust & Clearing Corporation (DTCC) is complying with Regulation SHO, and what actions does the SEC undertake when the DTCC identifies large quantities of shares that have not been delivered?
“It is important that the SEC identify abuses and prevent manipulative naked short selling practices that undermine faith in the market. Thank you for your attention to this matter. I look forward to your timely response,” Senator Durbin concluded.
Pink Sheets head Cromwell Coulson has asked the SEC to publish short positions on all over the counter and bulletin board stocks, and that request is currently in a comment period.
The request for rulemaking, which Coulson has told companies traded on the Pink Sheets, is needed “to make regulators turn on the lights and protect investors from the menance of hidden short selling in the OTC market,” is at http://sec.gov/rules/petitions.shtml
In an email to Donaldson, Coulson had said “I believe that it is very important to require the disclosure of short positions because the lack of transparency is allowing promoters to defraud investors by blaming all selling on naked market maker short selling. Disclosure and transparency can easily remedy the issue.”
In other news on the naked short-selling front known as “StockGate,” adding to what TheStreet.com founder James Cramer calls the “Hedge Fund Relief Act,” the termination of the Uptick Rule, is the fact that those using illegal naked short selling in the past have been granted a kind of amnesty for acts before the first of 2005. The SEC just “grandfathered” those illegally-begotten gains and resultant counterfeit shares into the system, so these windfall gains are now available to downtick with reckless abandon on downticks.
The “grandfathering” admission is at http://www.sec.gov/spotlight/keyregshoissues.htm
In the same document, the SEC has inexplicably stated that not all forms of illegal naked short selling, the equivalent of counterfeiting shares in public companies, are actually “illegal.”
The DTCC actions in the StockGate mire are the most serious, if not notorious since the agent of two SROs, the New York Stock Exchange and NASD is also peopled by some 21 directors whose companies, such as Merrill Lynch & Co. (NYSE: MER), State Street Corporation (NYSE: STT) and Goldman Sachs (NYSE: GS), are unlikely to support the DTCC in its media censorship.
In a recent editorial, Investrend Information head Gayle Essary questioned whether the board and principal shareholders would “be party to shenanigans that lead to the censorship or disabling of any media” that he says is “un-American activity.”
Essary said that the arrogance the DTCC expressed in its censorship efforts shows that the entity has “become too large, too encompassing, too powerful, too unresponsive to those it serves, primarily the investing public, and too unresponsive to the Congress under whose auspices it should be operating.
“First, it is time to unconflict it, with real public representations on its board,” he said, and second, “it is time to break it up, with its various duties provided by smaller agencies under separate unconflicted boards.”
DTCC board members include Michael C. Bodson, Managing Director, Morgan Stanley (NYSE: MWD); Gary Bullock, Global Head of Logistics, Infrastructure, UBS Investment Bank (NYSE: UBS); Stephen P. Casper, Managing Director and Chief Operating Officer, Fischer Francis Trees & Watts, Inc.; Jill M. Considine,Chairman, President & Chief Executive Officer, The Depository Trust & Clearing Corporation (DTCC);
Also, Paul F. Costello, President, Business Services Group, Wachovia Securities (NYSE: WB); John W. Cummings, Senior Vice President & Head of Global Technology & Services, Merrill Lynch & Co. (NYSE: MER); Donald F. Donahue, Chief Operating Officer, The Depository Trust & Clearing Corporation (DTCC); Norman Eaker, General Partner, Edward Jones; George Hrabovsky, President, Alliance Global Investors Service; Catherine R. Kinney, President and Co-Chief Operating Officer, New York Stock Exchange; Thomas J. McCrossan, Executive Vice President, State Street Corporation (NYSE: STT); Bradley Abelow, Managing Director, Goldman Sachs (NYSE: GS); Jonathan E. Beyman, Chief Information Officer, Lehman Brothers (NYSE: LEH); and Frank J. Bisignano, Chief Administrative Officer and Senior Executive Vice President, Citigroup / Solomon Smith Barney's Corporate Investment Bank (NYSE: C), Eileen K. Murray, Managing Director, Credit Suisse First Boston (NYSE: CSR); James P. Palermo, Vice Chairman, Mellon Financial Corporation (NYSE: MEL); Thomas J. Perna, Senior Executive Vice President, Financial Companies Services Sector of The Bank of New York (NYSE: BNY); Ronald Purpora, Chief Executive Officer, Garban LLC; Douglas Shulman, President, Regulatory Services and Operations, NASD; and Thompson M. Swayne, Executive Vice President, JPMorgan Chase (NYSE: JPM).
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