letter to GAO from Tom Vallarino (NIPC)
Dear Mr. Rick Hillman:
On FEB 26, 2009, the GAO published a summary letter (GAO-09-318R) which includes a description of the SEC’s efforts to ensure the reliability and efficiency of the clearance and settlement system through its examination program for clearing agencies. I am disappointed by how the report paints an inaccurate picture of this, because it omits critical key information.
While the GAO summary letter does describe some of the legal framework of the clearance and settlement system and the SEC's authority and efforts to ensure reliability and efficiency, the letter omits crucial parts of the legal frame work and what the SEC has failed to do. No investigation is needed to determine these omissions as most are clearly obvious to even a casual observer.
First of all, no description of the transfer or immobilization of securities in depositories and through clearing agents is complete without mentioning the role of the Uniform Commercial Code in this area. That is because the transfer of securities and the responsibilities of securities intermediaries including depositories is the sole jurisdiction of state law, explicitly reserved for them. The states have adopted the Uniform Commercial Code (UCC) for this purpose.
While it is true that the SEC is only responsible for regulating federal securities laws, the UCC does fall into their enforcement jurisdiction indirectly because the UCC is part of the governing rules for the SROs which the SEC is responsible for regulating and responsible to ensure that they enforce all governing rules.
However, it is clear that the SEC and the SROs are knowingly not enforcing provisions of the UCC regarding settlement. Among them:
Uniform Commercial Code
§ 8-501. SECURITIES ACCOUNT; ACQUISITION OF SECURITY ENTITLEMENT FROM SECURITIES INTERMEDIARY.
(a) "Securities account" means an account to which a financial asset is or may be credited in accordance with an agreement .." (agreement = Settlement agreement)....(financial asset = security)
This is how the SEC has tries to explain, excuse and justify settlement violations in the court filing that you have investigated, using 8-501 of the UCC as "authority" (my comments are underlined):
Quote SEC:
"It is . . . entirely possible that a securities intermediary might make entries in
a customer’s account reflecting that customer’s acquisition of a certain
security at a time when the securities intermediary did not itself happen to
hold any units of that security (true, but only before settlement date)."
"The person from whom the securities intermediary bought the security might have failed to deliver and it might have taken some time to clear up the problem (that is a possible reason for the fail, but not a legal excuse to treat the account in violation of 8-501 - the cause and the violation are two separate things. The settlement date is part of the agreement and thus crediting "securities entitlements" that reflect unsettled securities rather than settled securities after settlement date is not treating the account as agreed) . . .. U.C.C. 8-501, Official Comment 3"
The first sentence has nothing to do with the second. The 1st sentence also creates the appearance that it is always true, when it is only true in a very limitied way (before settlement) - misleading by ommission. These are typical SEC and Wall Street tactics.
Notice that in the Amicus papers you have investigated, the SEC makes no mention of federal laws that allow settlement failures. That is because there are none. As the SEC starts saying that they deal with enforcement of settlement rules via REG SHO - that too is a misrepresentation because REG SHO deals with settlement failures after they have already happened.
It is of no consequence what the "locate" or "pre-borrow" requirements are for short sales or if some naked short sales are allowed under REG SHO – that is because settlement must always occur as contracted in all cases.
This is reflected in federal rules (15c6-1) and in the UCC (8-501). Any truthful statement on the part of the SEC and SROs would admit that they simply do not enforce settlement rules and laws in any meaningful way and rely on counter party trust and discipline instead. If Settlement rules and laws were enforced, settlement failures wouldn't occur. Even to a casual observer it is clear that:
- Settlement failures are occurring
- Settlement failures happen because the SEC is not enforcing settlement rules
- Settlement failures happen because the SROs are not enforcing settlement rules
- Settlement failures continue to happen because the SEC does no compel the SROs to enforce settlement rules
- There are no exemptions or legal excuses for causing settlement failures
- Settlement failures are possible because settlement and clearing are divorced and not linked
- 17A of the Securities Exchange Act of 1934 mandates the linking of clearance and settlement
- The SEC has not made any rules to ensure that clearance and settlement are linked
- The SROs have not made any rules to ensure that clearance and settlement are linked
- REG SHO does not enforce settlement rules, it only seeks them after the settlement violations have already occurred.
In addition, the SEC does not even know why settlement failures occur because the SEC does not even obtain or maintain that data. The causes for settlement failures are pure speculation on the part of the SEC, as they've admitted in an FOIA responses that they do not have the data.
Thus, in my opinion, the final report should include what has been omitted thus far in the summary letter. Such as:
- Role of the UCC
- Settlement failures are prohibited by both state and federal rules and laws
- The regulatory lapse that allows settlement failures is the lack of enforcement of settlement laws
Describing a road without mentioning the large boulders, potholes, misplaced signs and the cliff ending would be a misleading description of the road.
If there is only one recommendation or question the GAO can make, it would be: Why does the SEC not obtain and maintain "Fails to Receive" (FTR) data? This is one data point that would be proof positive of settlement failures and not mere "Fails to Deliver" (FTD). There is a big difference between an FTD and a settlement failure, the latter of which is only indicated by FTRs. If one knew for certain the number of settlement failures, that would unravel the entire "hide Waldo" game conducted by Wall Street and the SEC. It would show violations to REG T and many other rules and laws. The disinterest or even the complicit nature of the SEC to allow settlement failures, despite rules and laws to the contrary, is indicative by this failure to obtain FTR data that is available merely for the asking on the part of the SEC.
Another question to ask the SEC would be, why settlement failures are not stopped.
Attached is an audit request recently sent to the SEC's Office of Inspector General, which explains these things in detail. Also attached is an FTD chart on Sears. IN August 2008, the fails topped 8 million when the price was around $100. That means that $800 million was siphoned off via fails just in Sears. This is a systemic breakdown. I would be happy to talk with any of the GAOs staff or provide any documentation I may have to support the information contained here or in the audit request and to assist the GAO in any way I can.
Sincerely,
Thomas Vallarino - President, National Investor Protection Coalition |
