Regulation SHO Threshold List Gets Confuser and Confuser As Listings 'Disappear'
Jan 18, 2005 (financialwire.net via COMTEX) -- (FinancialWire) Is it a bird, or a plane? Regulation SHO seems anything but Superman as it is confusingly played out at the NASDAQ (NDAQ) trader site, whose latest oddity is the sudden and inexplicable disappearance of all but one Pink Sheets listed Company, MPTV Inc (MPTT), and all but nine companies listed on the OTC Bulletin Board on its widely publicized "threshold list."
Some companies, such as Isonics (ISON) and Taser International (TASR) might have expected to be listed on the now almost decimated list of only 110 securities, but the sudden disappearances are surprising, especially as most observers of naked short selling expected the list to be many times what it has been so far, and have no idea what happened to companies representing the largest trading platforms, widely expected to contain hundreds if not thousands of "failed trades."
Some detractors have just thrown up their hands, calling the whole thing a "charade," planned from the beginning, especially since the original listings just ignored the claimed millions of over-the-threshold "fails" that pre-existed.
"The pre-existing fails were just so far out of control to be beyond comprehension," said one, "perhaps enough to bankrupt the entire financial industry, so it is not surprising the regulators just 'grandfathered' those into the system, in effect wiping them out and starting fresh."
Others believe the lists and everything associated with them should have been and should be fully transparent. David Simon, chair of Smart Chip Technologies (SCTN) said his company's appearance, before it was among those that mysteriously vanished, on the threshold list, was "expected" but wanted to know how the company could "find out the amount of naked shorts outstanding?"
" Trading securities without ever settling is the selling of counterfeit stocks," said David Patch, editor of Stockgate Today electronic newsletter. "General Electric's (GE) CNBC reporter Ron Insana called this manipulation on his Friday Street Signs show."
According to Patch, Regulation SHO requires the release of "threshold securities" by each market center based on a simple calculation. Failed trades are calculated as a percentage of totals outstanding and if the percentage exceeded .5% of the outstanding for 5 consecutive trading days your company was required to be listed. The list, by SHO, is required to be published daily and those companies on the list would remain there until such time as the fails are brought below abusive levels for a similar 5 consecutive trading days. The data used to create the list comes from the industries central settlement system itself the National Securities Clearing Corporation (NSCC).
The threshold list has been published since January 10, and there have been questions about the list since it began. Hundreds of companies that were listed on FinancialWire after they claimed over the past year or two that their trading reflected patterns suspected of being illegal naked short sales, and none of the companies sued by the O'Quinn law firm that has sued the Depository Trust Corporation (DTCC).
According to Patch, the listings so far have been unsatisfactory and even not believable. For instance, pink sheets companies that were non-reporting were supposed to be omitted from the list, but he said as many as six that had been delisted by the SEC for failing to maintain proper finings, such as Infotopia and Dr. Koop, were mysteriously included. So were companies that had ceased trading altogether.
Says Patch: "When the SEC de-listed Infotopia, Dr. Koop, and some 80 other Pink Sheet Companies over these past few months they were notified of the possibility that these companies were driven into financial ruins by illegal trading of counterfeit securities. Wall Street was overselling these securities and driving the stocks into oblivion. They oversold without and cause or concern for settling trades because the SEC was going to assist them by shutting these companies down. Wall Street was ignoring their obligations, under the Securities Acts of 1933 and 1934 to properly seek out and obtain a certified share for the investor and the de-listings would create the virtual impossibility to settle the trades. The data would be captured forever that illegal shares were sold. With the recent publication of the NASDAQ's list, the NASDAQ disclosed the fraud."
Patch also wants to know if the companies with extended fails that persisted prior to the implementation of Regulation SHO will ever have to be settled. "For how long will the SEC allow these fails to stay on the books because the members refuse to seek out real shares in the open market to settle what they sold?"
Prior to the mysterious vanishings, the list at http://www.nasdaqtrader.com/aspx/regsho.aspx , initially included 374 stocks on the NASDAQ list, including 96 on the exchange, 29 OTCBB and 254 on the Pink Sheets.
General Electric's (GE) "Dateline" is said to be on the verge of a major expose that will reportedly touch on possible collusion between brokerages that are purportedly impossibly behind in their fails to deliver certificates, the Depository Trust Corporation, whose "Stock Borrow Program" reportedly garners it almost a billion dollars a year in fees for what detractors call "counterfeit trades," and even the vaunted U.S. Securities and Exchange Commission itself, which makes a fee on every stock transaction, whether legitimate or not.
The recent Securities Industry of America symposium on Regulation SHO, which was supposed to curtail illegal naked short selling, only further deepened the U.S. Securities and Exchange Commission divide as a dramatic ' some say startling ' new 22-page working paper, "Strategic Delivery Failures in U.S. Equity Markets," was published.
The referenced working paper by University of New Mexico Professor Leslie Boni was initiated while the author was visiting financial economist at the SEC.
She termed the "failures to deliver," which litigants have called "counterfeiting," as being "pervasive."
The professor said that a whopping 42% of listed stocks at the New York Stock Exchange, NASDAQ and AMEX, and 47% of unlisted stocks in the OTCBB and Pink Sheets had persistent fails of 5 days or more with 4% being above the SEC's threshold limits for failures.
The economist pointed to a study conducted by Evans, Geczy, Musto, and Reed in 2003 that provided evidence that while the SRO's have buy-in requirements, such buy-ins almost never occur. She noted that an audit of one market maker showed that all or a portion of shares in 69,063 transactions during 1998-1999 were "fails to deliver."
"The market maker was bought-in on only 86 of these positions," she stated.
Dave Patch, editor of "Stockgate Today," said that his own review of the Securities Acts of 1933 and 1934 finds no reference to "strategic failures." In fact, he said, Section 17a of the 1934 act "mandates prompt and accurate clearance and settlement of trades, and the admission of Strategic Failures is also in direct violation of Rule 15c6-1."
Rule 15c6-1 defines the settlement cycle for trades executed and states that no Broker Dealer may enter into a contract for the sale of a security whereby the payment for that security and the delivery of that security is greater than 3 business days. For market making activities there is a slight exemption from the delivery in a Bona Fide Market Making activity but as the SEC and SRO's have repeatedly stated, Bona Fide Market making is not simply supporting the best offer in a naked short sale without also representing the best bid or near best bid in a long trade. They must be actively making a market on both sides of trading to use the exemption, noted Patch.
Robert Shapiro, chair of Sonecon LLC, an economic advisory firm and former Under Secretary of Commerce from 1998 to 2001 and principal economic advisor to President William Clinton in his 1992 campaign, has expressed "serious concerns about the impact of the final version of Regulation SHO regarding short sales on the equity and transparency of our equity markets."
Shapiro holds a Ph.D. from Harvard University and has been a Fellow of the National Bureau
of Economic Research, the Brookings Institution, and Harvard University.
Shapiro said the SEC is correct to broaden the terms of regulation of short sales, and applauded the section directing broker dealers to mark all equity orders as "long," "short" or "short exempt." More important, he said, the new "locate and delivery" requirements could substantially reduce stock manipulation carried out through naked short sales -- but only if those requirements are
widely applied and strictly enforced.
"Unfortunately, Regulation SHO does not meet either of these two standards. The troubling result is that the Regulation, in effect, establishes an official level of tolerance for unsettled or naked short sales," Shapiro charged.
Shapiro said he strongly concurs with the comments of the North American Securities Administrators Association (NASAA) on the draft rule, which said NASAA was "unable to determine why the Commission proposes to permit significant settlement failures at all. While there are instances when settlement may be legitimately delayed, existing regulations provide for extensions for settlement. If the Commission continues to allow settlement failures, it may well facilitate the harm that the proposal is designed to remedy."
"Until Regulation SHO, this economic counterfeiting has been facilitated by electronic record keeping and the apparent practice of the DTCC and its subsidiary National Securities Clearing Corporation (NSCC) of often disregarding persistent unsettled short positions. With Regulation SHO, the SEC has provided its implicit imprimatur for the same practice in cases covering the vast majority of public companies and billions of dollars."
Shapiro urged the SEC to "reconsider the provisions of Regulations SHO and, at a minimum, apply the 'locate and delivery' requirements for threshold securities to all short sale transactions, and adopt a zero-tolerance policy for significant settlement failures. American investors should feel confident that the SEC will ensure the integrity of every equity transaction they undertake and fully protect their right to receive what they have paid for."
Twenty civil cases have now been filed by O'Quinn, Laminack & Pirtle, Christian Smith & Jewell, and Heard, Robins, Cloud, Lubel & Greenwood, LLP, all of Houston, Texas. The consortium of law firms, famed for the giant awards they obtained suing tobacco companies. The group recently brought suit against the Depository Trust and Clearing Corp. for allegedly participating in the short-selling conspiracy through its "stock borrow" program which the attorneys say is nothing more than an illegal electronic printing press for stock certificates.
Lead counsel John O'Quinn said: "We are committed to the relentless pursuit of justice."
In comments to the U.S. Securities and Exchange Commission, C. Austin Burrell, who is providing litigation support and research for the law firms, said that StockGate is more massive than anyone may have imagined. "Illegal Naked Short Selling has stripped hundreds of billions, if not TRILLIONS, of dollars from American investors," and have resulted in over 7,000 public companies having been "shorted out of existence over the past six years." Burrell said some experts believe as much as $1 trillion to $3 trillion has been lost to this practice.
He stated that the restrictions on short selling were deliberately put into the Securities Acts of 1933 and 1934 because of the first-hand evidence then available that the "sheer scale of the crashes was a direct result of intentional manipulation of US markets through abusive short selling by a massive conspiracy."
Burrell noted that the 65-lawyer team presided over by lead lawyers Wes Christian and John O'Quinn has uncovered more than 1,200 hedge fund and offshore accounts working through more than 150 broker-dealers and market makers in a joint cooperative effort to strip small and medium size public companies of their value.
According to lawyer Christian, et.al., the DTC is at the very heart of the problem, and has almost a billion dollars a year at stake in keeping the problem.
The Depository Trust Company (DTC) is a member of the U.S. Federal Reserve System, a limited-purpose trust company under New York State banking law and a registered clearing agency with the SEC. The depository supposedly brings efficiency to the securities industry by retaining custody of some 2 million securities issues, effectively "dematerializing" most of them so that they exist only as electronic files rather than as countless pieces of paper. The depository also provides the services necessary for the maintenance of the securities it has in "custody."
According to the suit, the DTCC has an enormous pecuniary and conflicted interest in the entire short selling scandal through the huge income stream they were realizing from it every day. They have made literally billions of dollars lending individual real shares, in most cases over and over, getting a fee each time they made a journal entry in the "Stock Borrow Program."
The Stock Borrow Program was purportedly set up to facilitate expedited clearance of stock trades. Somewhere along the line, the DTCC became aware that if it could lend a single share an unlimited number of times, it could collect a fee each time, according to Burrell. "There are numerous cases of a single share being lent ten or many more times," giving rise to the complaint that the DTCC has been electronically counterfeiting just as was done via printed certificates before the Crash.
"Such re-hypothecation has in effect made the potential 'float' in a single company's shares virtually unlimited and the term 'float' meaningless. Shares could be electronically created/counterfeited/kited without a registration statement being filed, and without the underlying company having any knowledge such shares are being sold or even in existence." Burrell said the Christian/O'Quinn lawsuits will seek to show that the "counterfeiting/creation of unregistered shares is a specific violation of the Securities Act of 1933, barring the 'Sale of Unregistered Securities'."
One lawsuit alleges that the DTC has a colossal disincentive to stop the "stock borrow" program, booking revenues from services of $425,416,000 and similarly, the NSCC deriving revenues of $293,133,000.
Further, the suit alleges that "open positions" resulting from this activity at the close of business on December 31, 2003, "approximated $3,025,467,000" due to NSCC, and $2,303,717,000 due by NSCC, and unsettled positions of $721,750,000 for securities borrowed through the NSCC's "Stock Borrow Program." The largely unregulated DTC has become something of a defacto Czar presiding over the entire U.S. markets system, wielding more day-to-day influence and control than the SEC, the NASD and NASDAQ combined.
The Depository Trust and Clearing Corp.'s two preferred shareholders are the New York Stock Exchange and the NASD, a regulatory agency that also owns the NASDAQ (NDAQ) and the embattled American Stock Exchange.
In their comments to the SEC regarding Regulation SHO in January, 2004, the 50 state regulators, through their association, the North American Association of Securities Administrators (NASAA) issued what many consider to be a strong warning that if the DTC is not dealt with in the final regulations, state regulators such as New York State Attorney General Eliot Spitzer may step to the plate.
In what many considered to have been explosive comments, Ralph Lambiase, NASAA president and Director of the Connecticut Division of Securities, warned "NASAA urges the Commission to reconsider its stance regarding the role of the Depository Trust and Clearing Corporation (the DTC). As a threshold matter, NASAA believes that the Commission should explicitly prohibit the DTC from lending more shares of a security than it actually holds. The ability of the overall proposed rule would be severely impared unless the Commission undertakes to implement such a prohibition."
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