SEC Delivers a Chorus of Misleading Information – April 13, 2005
STOCKGATE TODAY - An online newspaper reporting the issues of Securities Fraud
David Patch
The Securities and Exchange Commission, responsible for the enforcement of the dissemination of accurate information from our publicly traded corporations may have just violated their own standards for clear and accurate dissemination of information. The SEC Division of Market Regulation, best labeled the “Ostrich Gang” for their innate ability to bury their heads in the sand, has tried to spin the fraudulent act of naked shorting abuses on the corporate officers of those complaining about the abuse itself. Forgotten by the SEC is that they admit the fraudulent act occurs in the first place.
The SEC publication came out on April 11, 2005 so let’s grab some of the excerpts and start dissecting truth from fiction.
SEC: Although the vast majority of short sales are legal, abusive short sale practices are illegal.
DP: This would be a simple admission that there are in fact illegal short sale strategies taking place in the markets. Vast Majority does not represent all short sales but only a majority.
SEC: [Re: Naked Shorting] For example, broker-dealers that make a market in a security generally stand ready to buy and sell the security on a regular and continuous basis at a publicly quoted price, even when there are no other buyers or sellers. Thus, market makers must sell a security to a buyer even when there are temporary shortages of that security available in the market. This may occur, for example, if there is a sudden surge in buying interest in that security, or if few investors are selling the security at that time.
DP: So, Market Makers can sell securities naked to make a market when no natural order flow of supply and demand exists? A Market Maker can create a new stock valuation solely independent of what shareholder supply and demand supports and when they do so, they don’t have any responsibility to deliver. And this is good for investors how? Exactly how does the SEC monitor such trading activities to insure “bear raids” and manipulation is not occurring especially in light of the magnitude of pre-existing fails?
SEC: [RE: Grandfathering Under SHO] The grandfathering provisions of Regulation SHO were adopted because the Commission was concerned about creating volatility where there were large pre-existing open positions. The Commission will continue to monitor whether grandfathered open fail positions are being cleaned up under existing delivery and settlement guidelines or whether further action is warranted.
It is important to note that the "grandfathering" clause of the Regulation does not affect the Commission's ability to prosecute violations of law that may involve such securities or violations that may have occurred before the adoption of Regulation SHO or that occurred before the security became a threshold security.
DP: The SEC, in protecting those who generated large failed positions that may or may not be legal positions, elected to “grandfather” all past failures regardless of their legal standing. The fact that the SEC approved this rule change 6-months ahead of the incorporation date, representing plenty of time to slowly close out any large failed positions, seems a concept the SEC cannot grasp. Instead, the SEC concept is to allow a slow matriculation of the short coverings of these illegal trades thus protecting the profits of those who initiated the illegal trades in the first place. A novel concept in investor protection; protect the criminal. Since SHO was incorporated in fact the volatility on “threshold Securities” has increased with a net loss in market capitalization.
As for the SEC’s threat of enforcement on those grandfathered fails, the SEC has zero past enforcement history on the illegal trading associated with naked shorting and settlement failures. ZERO! In fact, Regulation SHO is nearing 3-months into its incorporation period and the SEC has yet to scheduled audits to investigate the system fails. What are they waiting for, the criminals to get away?
SEC: [RE: Naked Shorting Abusive or Illegal] Selling stock short and failing to deliver shares at the time of settlement with the purpose of driving down the security's price. This manipulative activity, in general, would violate various securities laws, including Rule 10b-5 under the Exchange Act. Regulation SHO does not address this issue.
DP: When the SEC proposed SHO they claimed that Naked Shorting provided the seller with additional leverage and could use that leverage to manipulate a stock. The SEC has publicly acknowledged naked shorting as a reality. Why then has the SEC failed to take any enforcement actions against those who committed naked shorting abuses if there are “various securities laws” being violated? Worse, if SHO did not address this because it already pre-existed as a violation, where have the activities been? We did not need SHO to spurn SEC enforcement actions they already had pre-existing laws to utilize.
Is the SEC now claiming that when they drafted SHO, and determined that “large” pre-existing fails existed, that all these fails were of legal standing? They have to have come to that conclusion since they “grandfathered” the fails from mandatory closeout and we are well past that period when the SEC had this evidence and first drafted the document for public comment.
SEC: [RE: Did my Stock Lose Value due to Naked Shorting] There are many reasons why a stock may decline in value….The main factor determining the demand for a stock is the quality of the company itself. If the company is fundamentally strong, that is, if it is generating positive income, its stock is less likely to lose value.
There also may be instances where a company insider or paid promoter provides false and misleading excuses for why a company's stock price has recently decreased. For instance, these individuals may claim that the price decrease is a temporary condition resulting from the activities of naked short sellers. The insiders or promoters may hope to use this misinformation to move the price back up so they can dump their own stock at higher prices.
Naked short selling, however, can have negative effects on the market. Fraudsters may use naked short selling as a tool to manipulate the market. Market manipulation is illegal. The SEC has toughened its rules and is vigilant about taking actions against wrongdoers, but we can't stop every fraud.
DP: This is a long one so I have to break it down into several parts.
First, if a stock is based on supply and demand then why do we have market makers trading a market when there is no supply available at somebody’s demand? Better still, why do you identify that market makers will trade the stock when there is NO supply or demand simply to create the appearance of trading volume?
Now we can delve into the – blame the issuer – routine of the SEC. Of course the SEC highlights all the nefarious acts of those they despise and try to generalize it to all but, can the SEC provide to us the evidence for each that has complained that will show that each does not in fact have large pre-existing fails? The reality is, those corrupt executives and stock promoters are allowed to take on this battle cry due to the shear negligence of the SEC to nip this issue in the butt back in 1999 when the people first publicly protested the fraud during an SEC short sale comment period. I would suggest the SEC immediately disclose to Congress the magnitude of settlement failures, with documented evidence to back it up, for each of the issuers who have voiced concern over the naked shorting abuses. Let Congress decide who is telling the truth.
“But we can’t stop all fraud”. No, but you certainly can “grandfather” the fraud you want to ignore. The fact remains; the SEC has received tens of thousands of complaints, captured audiotapes of broker/dealers being bribed to manipulate a stock [RE: SEC vs. Rhino Advisors] and yet the SEC took no actions against Wall Street. The General Counsel of Bear Stearns, on December 13, 2004, admitted that regulators have told them for years that these strategies of illegally selling were taking place – Yet NO ENFORCEMENT ACTIONS. A hollow threat is not about to scare an industry that is caught daily defrauding the investor.
SEC: [RE: Is it a violation of Law to Fail T+3 Settlement] Because the Commission recognized that there are many reasons why broker-dealers may fail to deliver securities on settlement date, it designed and adopted Rule 15c6-1 to prohibit broker-dealers from contracting to settle transactions later than T+3. However, failure to deliver securities on T+3 does not violate the rule.
DP: This is a joke. The SEC enacted a rule that they have never actively enforced. In fact, in researching the SEC website I could not pull up a single enforcement action pertaining to a Rule 15c6-1 violation. Ironically, an illegal trade [naked short] executed as a short sale, and caused for manipulation is in fact a violation of Rule 15c6-1. Obviously the Selling agent had no intention of meeting the terms of the contract. The very fact that the SEC acknowledges naked shorting abuses is fact that Rule 15c6-1 violations have and still occur without SEC enforcement. Exactly who was the SEC trying to impress here?
First year law students will tell you that to enter into a contract, in which you have no intention of meeting, and doing so under illegal grounds will void the contract. I guess the SEC attorneys missed that first year of law school. Certainly the author of this diatribe did.
SEC: [RE: Does Grandfathering allow the illegal trades to go unaddressed] Regulation SHO does not require close-outs of "grandfathered" fails. As noted above, "grandfathered" status applies where the fail position was established prior to the security becoming a threshold security. However, any new fails in a security on the threshold list are subject to the mandatory close-out provisions.
Any grandfathered position that resulted from illegal activity, such as manipulation, continues to be fully subject to redress by the Commission.
DP: The SEC has not yet taken any audits to review the grandfathered fails and to review the condition behind that fail. How exactly does the SEC plan on redressing this issue if they have not even started, or at least shown an appearance of starting, to care? Without an audit and with all past SEC actions coming against the issuers complaining, where is the credibility behind this statement. The SEC’s own visiting economic scholar drafter a document claiming the fails were strategically placed by the Industry for profit margins.
SEC: [Will Close-Outs drive stock values up] Close-out purchases of stock on threshold securities lists will not necessarily drive up prices of such stocks. One of the primary purposes of Regulation SHO is to clean up open fail positions in threshold securities when they reach a relatively low aggregate level, but not to cause short squeezes. The term "short squeeze" refers to the pressure on short sellers to cover their positions as a result of sharp price increases or difficulty in borrowing the security the sellers are short. The rush by short sellers to cover produces additional upward pressure on the price of the stock, which then can cause an even greater squeeze. Although some short squeezes may occur naturally in the market, a scheme to manipulate the price or availability of stock in order to cause a short squeeze is illegal.
DP: This is where the rubber meets the road. The SEC has been so fixated on preventing any possible short squeezes that they have allowed an equally illegal action to persist. If the SEC had mandated the large pre-existing fails be closed they feared that stock prices would increase due to the shorts being forced to cover. A novel idea but…is the stock artificially low because of the excessive, and illegal, shorts in the first place.
One misunderstanding about short squeezes is the actual price volatilities created. When a stock drops from $10:00/share it has lost 90% of market value and the SEC has willingly let this happen and happen due to illegal naked shorting. Today, the SEC is concerned about a possible squeeze by which the stock runs from a $1.00/share value to $10.00/share. An increase of 1000%. The fact remains, the stock only reached is post manipulation valuation.
Excessive shorting during the dot.com bubble, created by a lack of enforcement on naked shorting, created short squeezes that ran those stocks beyond market valuation means. It was partially the SEC’s fault as they ignored Rule 15c6-1 enforcement and the enforcement of trade settlements. Now they penalize all for their negligence at a time when some stocks are legitimately manipulated down. They continue to drive the market off the victims of fraud.
SEC: [RE: Does the NSCC create counterfeit shares] NSCC's stock borrow program, as approved by the Commission, permits NSCC to borrow securities from its participants for the purpose of completing settlements only if participants have made those securities available to NSCC for this purpose and those securities are on deposit in the participant's account at DTC.
DP: The SEC approved the NSCC stock borrow program as a temporary means to settle hiccups in the settlement system. Through a failure to manage this system the SEC, by their own admissions, are aware that the number of settlement failures have amassed to levels exceeding the entire public float of some companies. These fails have been masked by the NSCC stock borrow program and the continuous distribution of the same share through that system repeatedly. Under the NSCC system the failed trade, while on the books as a failure, has “settled” by DTCC standards because they cleared it using the stock borrow pool.
An example for you would be; Person A buys 100 shares on Monday that fails settlement on Thursday. The DTCC settles the trade through the stock borrow program using shares made available by the members. The shares delivered to person A, in the Name of Broker A, is made on Friday as borrowed shares. Broker A then takes those shares and places them back into the NSCC Stock Pool. Person A then buys another 100 shares the following Monday, the trade fails on Thursday, and the cycle repeats. That same person, over a month bought 400 shares with the same 100 shares being used 4 times. His or her own shares. Is it counterfeiting – for all practical purposes yes.
I conclude that this SEC piece of fiction has a purpose. For some reason the SEC Division of Market Regulation wants to paint a picture of a competence level that does not exist. The “Ostrich Gang” has taken a route that can only question exactly what it is they have to hide. Why deny what they themselves admit exists? Why generalize that it is all about poorly managed companies when it is Wall Street and the Wall street system that trades in naked shorting – not the companies?
Accountability is needed and needed immediately. The SEC can no longer be allowed to deceive the investing public with fiction intended to allow the criminals to get away. Who are these criminals the SEC is so intent on protecting anyway?
A request to the SEC pertaining to the author of this document yielded several conflicting responses. Not expected from an agency rife with conflicts of interest.
To read the entire SEC transcript log on to sec.gov
For more on this issue please visit the Host site at investigatethesec.com .
Copyright 2005 |
