The DTCC’s CNS naked short selling residue
December 2nd, 2008
by Patrick Byrne
In a previous post I named various places where unsettled trades can accumulate: in the desks of brokers, in the act of pre-netting betwixt brokers, in the Continuous Net Settlement system, in the Stock Borrow Program, through ex-clearing, and in delivery mechanisms from offshore exchanges. For all I know, these represent just a subset of the cracks in the system. The great unanswered question is, How much financial toxic waste has naked short selling and its various equvalents left scattered throughout these cracks?
The answer is: I don’t know. And, more frighteningly, I believe that no one knows. I do not think that any one agent has the full picture of what is going on across all of these cracks. In fact, I suspect that some of these cracks are so obscure no one has a clear picture of what is going on in them individually, let alone collectively.
To some degree this is knowable a priori. We have a system that is shielded from scrutiny of every type. State regulators cannot subpoena it (as various state regulators have told me). The Feds do not understand it (as a former DTCC employee and various Feds have told me). Sometimes Feds get to look inside the system, at which time DTCC officials shine them on (as a former DTCC official tells me and a former SEC official confirms). Sometimes Feds simply are rebuffed, and are helpless to assert themselves (as a high-level SEC official told some colleagues of mine). In fact, four years ago when I began this quest, the first thing I tried to do was to find out who regulated it, and quickly discovered that, other than a brief mention in an obscure GAO report, even the Feds weren’t sure who or if they regulated it. And yet, the treasure of the ages passes through this opaque system every week. That is a recipe for disaster.
To a lesser degree this is knowable a posteriori, simply because getting data about the system from the system is an exercise in Kafkaesque futility. There are various anecdotes of trades that won’t settle, of course. There is also the vague information provided by the Reg SHO list as well. There are various FOIA responses which the unhinged and obsessed (myself and friends included) have pried from the SEC. And for the true afficianados, there is, lately, data files that the SEC periodically releases to the public regarding failures in one of the cracks mentioned, the CNS. Making use of these files is impractical for any members of the general public who do not employ economists, stattisticians, and database experts to work the data.
Fortunately, DeepCapture employs an economist, a statistician, and a database expert to work the data. In the following series of posts I am going to reveal their output, stressing again that the failures I will be disclosing are not the totality of failures, but simply, those residing in one of the cracks (the CNS) into which our federal regulator is permitted to peer (which is some unknown fraction of the total).
Here is a chart showing the CNS failures from 2004, the year Reg SHO was adopted, through Q1, 2008:
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