Open letter to the SEC re naked shorting
100 F Street, NE
Washington, DC 20549-1090
Dear Sirs:
The United States stock markets currently find themselves in serious turmoil. Although part of that turmoil is undoubtedly due to the rapid fluctuation of oil and energy prices, and part is due to the fall out from the Collaterized Debt Obligations fallout, a very large and significant portion of the turmoil is directly due to the abysmal failure of the SEC to protect market order and to enforce the regulations they already have.
There are several aspects of the SEC’s failure.
1. On July 26, 2007, the SEC arbitrarily and without discussion with market participants chose to eliminate the ‘uptick rule’, that required an increase in share price before a person or institution could short that security. The ‘uptick rule’ was instituted by the Securities Exchange Act of 1934 in the aftermath of the 1929 market crash in order “to avoid the perpetration of a financial crime known as a ‘bear raid’, i.e. to prevent short-sellers from adding to the downward momentum when the price of a security is already experiencing sharp declines” and it had worked well for over 70 years. If a ‘bear raid’ was a financial crime in 1934, does the removal of the ‘uptick rule’ mean that such a bear raid is not longer a financial crime? Please reinstate the ‘uptick rule’ at once.
2. In 2004, the SEC issued “Regulation SHO”. It is my understanding, from reading your own publication that “… short sales effected to manipulate the price of a security are prohibited. …” As I understand the situation, it is currently illegal to naked short a security, that is to say, to short a security without first borrowing that security. Yet this activity happens continually throughout each and every trading day. An example: Apple Computer (AAPL) was trading at 181+ recently. I saw large sell orders being placed at more than $1.00 less than the bid price. A normal seller of the stock would sell “at market” in order to get the maximum amount for his shares, so the only reason to offer shares significantly below the bid is to manipulate the share price down.
Why does the SEC not enforce their regulation? And why does the SEC arbitrarily decide to announce they will enforce their own regulation ONLY in the case of 19 selected financial stocks, and ONLY on a temporary basis? Regulation SHO should be enforced across the board, for all stocks. Make Regulation SHO permanent. I would suggest a fine of not less than 20% of the share price for the first infraction, not less than 50% for the second infraction, and a total trading ban plus appropriate penalties for a third infraction.
3. Why does the SEC not enforce the regulations for “Fail to Deliver”. Under the current system when a short seller sells a security without borrowing that security first, we frequently see situations where millions of shares of shorted stock has been classed as “Fail to Deliver”. The Office of Economic Analysis reports that in the time period from 5/1/07 to 1/31/08, $30.87 TRILLION dollars of trades was classed as “Fail to Deliver”. If I sell my house or my car to someone, and fail to deliver it, I can go to jail. Why do you not prosecute the traders who fail to deliver the stocks they sold? Once again, I suggest enforcement with strong punitive measures: for a first offense, 50% of the value of the price received plus delivery of the stock; for a second offense, 100% plus a one year ban on trading of any kind, or imprisonment.
Your egregious failure to enforce the regulations of your own agency, your arbitrary removal of long-time market safeguards, and your self-serving attempt to salvage a few financial stocks at the expense of the overall market constitute grounds, in my opinion, for prosecution of you, the SEC, for criminal negligence and possibly culpability in financial fraud. Not only have your actions and inactions severely undermined public trust in our markets and corporations, but your actions have exposed the United States free market system to the possibility of manipulation and extortion by any organization or country with extensive financial resources which might be unfriendly to the US.
Sincerely,
(centex)
cf: Senator Kay Bailey Hutchison
Senator John Cornyn
Congressman Chet Edwards
techstock2000 @ August 1, 2008
Centex - you continue to impress! You and others (plasticdoor44/Mpaq for example) have shared outstanding arguments that should be reinforced with the SEC. I possess neither the background nor knowledge base to articulate these arguments so persuasively. Is it possible for us to put your letter, or a combination of letters, in the form of a petition that could be signed by all of us and circulated (perhaps placed on the Best of AAPLot) and sent to the SEC?
Centex,
An amazing letter and absolutely perfect that you copied your representatives in congress. I will post below, what I posted in a PM to obxfun, who suggested a petition:
obxfun,
A petition won’t do as much good as numbers of comments. Think about it, it’s all political. They count comments as votes, and the more negative comments about what they are doing at the SEC translates - to them at least - as the more votes against this (Republican) administration. That may or may not actually be true - personally, I think people think of the SEC as something other than part of the Republican administration, sort of independent like the FED, but because they really are political - they think like politicians. A petition would be counted as one negative comment, but if we had the hundreds of members of the hundreds of stock message boards all send comments to the SEC, they would have to pay attention. It would be a groundswell of grassroots sentiment, and it could not be ignored. I know it’s a longshot - but I keep trying to put it out there. Certainly, if no one does anything, the SEC will go about their merry way favoring Goldman Sachs and the big investment houses.
With Centex’s permission, I suggest that we copy his letter and send it under our own names so that it gets counted many times, rather than only once. The SEC actually extended the date of the deadline for comments, so they must be under some pressure from congress to at least look as if they are listening. If we can get huge numbers of comments posted, maybe we could even get the media to comment on those numbers. But first, we need the numbers.
I am pleased you like my letter. Any and all are welcome to use it in toto, or in part as they choose.
Since I wrote it, I think I prefer “Brooklyn Bridge” to “my house or my car”, since that more accurately describes the intent of short sellers who fail to deliver. And because that has been tested in our courts as fraud.
There are a couple of other items — a run-on sentence, the use of fallout twice in the same sentence, that could/should be ‘upgraded’.
Smith Barney Veep: letter to the SEC about reg. SHO
posted on the SEC site:
Subject: File No. S7-19-07
From: Gary D Markoff
Affiliation: Senior Vice President Citi/Smith Barney
July 29, 2008
Dear Sirs,
I’ve been participating in the financial markets for nearly 30 years advising clients on both the long and short sides of the market. I’m deeply concerned over the imbalances created since the ‘uptick rule’ was removed 12 months ago,the subsequent explosion of short interest and the Bear Market that has followed.
It’s either unusually coincidental or more probably causal with the broader market meltdown we’ve been experiencing since the rule change. I have no objection with shorting, but I do have an objection to hedge funds (or anyone else) manipulating the process and the price of securities by selling shares that haven’t at least been borrowed first and then slamming the bid with short sales on rapid downticks. I am not allowed to do that for clients at my firm, and can’t understand why anyone else should be allowed. Returning to the Uptick rule and requiring prior authorization on a Borrow need to appply and be enforced for ALL publicly traded companies and not just FRE, FNM and the primary dealers.
The ability to sell ‘market on close’ for a short seller is major unintended consequence of the ‘uptick’ removal, especially in smaller cap (say under $5 bill but more significantly on market caps below $1 billion). This has enabled shorts to dominate the end of day trading and ‘mark’ the closing price (daily, weekly, monthly, quarterly) which is illegal for both shorts and long side players. The difference is that longs must identify themselves in filings to the SEC at least once per quarter and anytime positions go up or down thru 5, 10 or 15% thresholds. Short sellers DO NOT have this requirement and because of this ability to be anonymous, the SEC does not have effective control of surveillance nor do the shareholders and the company itself know who is short.
My request and recommendation is that for transparency purposes, ALL positions both long and short be filed equally and size restrictions be implemented on shorts the way they are on longs. As a shareholder, I should be able to know in the proxy statements who the short sellers are that are short more than 5% of a company just the same way I can see who is long greater than 5%.
I also can’t understand why stocks that are showing up on the Reg SHO lists aren’t subject to immediate buy-ins after a minimum grace period. It’s the SEC’s job to enforce this and hasn’t. Why have a rule if it is not going to be enforced?
I also take issue with short interest getting up to over 50% in some companies. Again, without transparency as to WHO is short, it’s possible that one player can corner the market (short) in a declining environment. Position limits apply in commodities for a reason, they should apply in equities,too.
All of these factors have gone on to raise the cost of capital for companies unnecessarily, and to bring about a broad disengagement from public participation. It’s time to turn those factors around before we create another Depression.
Thank you for your consideration, Gary Markoff
Senior Vice President, Smith Barney- Boston