DOCSLIB.ORG

National Coalition Against Naked Short Selling - Failing to Deliver Securities

Total Page：16

File Type：pdf, Size：1020Kb

Download full-text PDF Read full-text
National Coalition Against Naked Short Selling - Failing to Deliver Securities National Coalition Against Naked Short Selling - Failing to Deliver Securities Nancy M. Morris, Secretary September 5, 2006 Securities and Exchange Commission 100 F Street, NE Washington, DC 20549-0609 RE : Amendments to REG SHO Release No.: 34-54154, File No.: S7-12-06 Ladies and Gentlemen: Thank you for providing an opportunity for concerned investors to comment on the proposed amendments for Regulation SHO. NCANS – Who We Are NCANS is a grassroots organization born of necessity. We are supported by and composed of investors on the receiving end of the negative consequences of naked short selling, long-term unsettled trades, and failed securities entitlements. In addition to investors and participants, our members include corporate executives concerned about the deleterious effect these practices have on their companies, employees and investors, and their negative impact on corporate governance issues like shareholder votes. We endorse Section 9 of the 1934 Securities Exchange Act, which makes it unlawful to effect any securities transaction which involves no change in beneficial ownership, and Section 17A, which stresses the need for the linking of all clearance and settlement facilities, and stipulates the prompt clearance and settlement of securities transactions, including the transfer of record ownership. We further endorse U.C.C. Article 8, which requires that security entitlements be supported by bona fide securities on a one-for-one basis, for as long as the security entitlement is held - a prudent and common-sense requirement to prevent abuse at the security entitlement level. And we particularly appreciate Section 36 of the 1934 Act, which allows the SEC to create exceptions to the 1934 Act, “…to the extent that such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors…” (emphasis added). NCANS’ position is that Reg SHO in its current form fails to satisfy the essential requirements described in those sections and articles, and therefore fails to have due regard for the public interest, the protection of investors, the safeguarding of securities and funds, and the maintenance of fair competition among brokers and dealers, clearing agencies, and transfer agents. Scope of the Problem Between 700 Million and 1.5 Billion (known via in-clearing data from the DTCC, obtained through FOIA requests) undelivered equity securities are outstanding on any given day in the U.S. equities markets, not including “ex-clearing” failures. This is the minimum (and likely substantially low) number, given that there is strong evidence that netting eliminates the need for settlement in the vast majority of transactions. Those are a lot of undelivered securities - for which investors have paid, and commissions and fees have been collected. For the sake of market integrity, investor protection, and the reputation of U.S. markets, SEC rules need to align with the requirements of the 1934 Securities Exchange Act, U.C.C. Article 8, state securities laws, and international securities exchange standards. We believe the U.S. equities markets cannot function properly unless the SEC’s rules are consistent with their fundamental principles: namely, for the prompt delivery of genuine securities in all cases; for even application of rules and law across all investor and participant types; for a one-for-one ratio of genuine securities to securities entitlements; for transparency; and for meaningful penalties when violations occur. The SEC must stop allowing one subset of investors/participants to profit at the expense of others. Example: Derivatives (options) market makers lay off their hedging expense and risk exposure on the equities markets by failing to deliver equity securities in “put” option hedging scenarios. This benefits the derivatives market and its participants, at the expense of equity investors and issuers. Derivatives market liquidity cannot be supplied via delivery failures (and resultant investor harm) in the equities market. This abuse of one class of investors for the benefit of derivatives market participants must end. Nowhere is the SEC empowered to favor one business or market’s interests at the expense of the investing public. The theme that runs through this comment letter is that the SEC must hold investor protection, transparency, and the operation of a fair and equitable market system, above the interests of market participants. Those interests include liquidity at the cost of market integrity, opacity rather than transparency, and exceptions from rules designed to protect investors. We believe delivery failures will continue harming investors until the SEC takes comprehensive and decisive action, and implements basic market principles comprised of universal locate and universal delivery requirements, in tandem with universal buy-in requirements - without exceptions for any class of participants. In addition to equity securities, Reg SHO and these universal requirements should also cover security entitlements, ensuring prompt delivery of genuine securities for all credited security entitlements. Otherwise, Reg SHO and any amendments will be easily circumvented by effecting naked short sales using failed security entitlements – crediting customer accounts with security entitlements for which no bona fide securities exist, and failing to cancel those entitlements when the underlying securities fail to materialize. While the SEC and the DTCC argue that the scope of the delivery failure problem is inconsequential, they do so in oblique, statistical terms; as percentages of all trades, or number of transactions, or mark-to-market value of only “in-system” delivery failures (omitting “ex- clearing” failures as outside of the regulatory and reporting framework), rather than in a straight- forward manner that would allow verification and significant analysis. The SEC has often taken the position that meaningful reporting of delivery failures to investors and issuers would violate “trade secrets” or “proprietary trading strategies” – again holding the interests of certain participants as superior to those of investors. In the SEC’s request for comments, it indicates that any response to its questions about delivery failures should contain data to substantiate proposals – ignoring that the DTCC and the SEC make virtually no meaningful data available. There is a spectacular opacity to the workings of the clearing and settlement system, and that lack of transparency benefits nobody but those abusing the system. The lack of material reporting must end, and investors and issuers must be able to get timely, current data on short selling and delivery failures – or the regulatory bodies are shielding participants at the expense of investors and issuers. The equities markets can no longer tolerate large numbers of delivery failures, nor failures to obtain securities for security entitlements credited to investor accounts. The double standard for participants and market makers has resulted in a growing tide of resentment among issuers and investors, and the aforementioned inequities are denigrating the reputation of the system. With U.S. markets slipping from 48% to 41% of total investor world capital, and the reduction of IPO activity in the U.S. (as issuers seek more hospitable venues for their public debuts), NCANS believes the slide will accelerate as the U.S. market reputation weakens, and the delivery failure issue gains visibility. As an interesting historical footnote, when one looks up the history of the NYSE, the chronology reads, “February 1, 1832 – Buying in for non-delivery authorized.” The concept that delivery failures can’t be tolerated in a fair market, and must be made good via buy-ins, is nothing new. 175 years ago the exchange and participants knew this essential and obvious truth. It is therefore troubling to NCANS’ members that a discussion about prompt delivery rules is taking place in 2006, and amendments to delivery rules are being contemplated that still contain exceptions for certain classes of participants, as well as lack any concrete requirement to buy-in failed deliveries. NCANS Not Anti-Short Selling To be clear, NCANS is not against short selling, as we believe that short selling can be a beneficial investment strategy, and can enhance investor returns. Neither is NCANS against short-term delivery failures resulting from lost certificates, or mundane and reasonable occurrences. NCANS is against the practice of offering a product for sale, taking investors’ money, and refusing to deliver the product sold in anything approaching a prompt manner – i.e., failure to deliver as a trading strategy. It is against this manipulative and predatory practice that NCANS has marshaled its efforts, and it is this destructive practice that we believe the SEC should eliminate from our market system. How Much Fraud For Liquidity? The SEC’s concern with liquidity should not lead it to conclude that liquidity requires exempted delivery failures, and certainly not by having one market (derivatives) dependent on delivery failures in another market (equities). Aside from the obvious damage to investors and issuers unchecked delivery failures cause, the folly in this assumption can be demonstrated by studying foreign derivatives, options, futures and equities markets that all work harmoniously without permitting wholesale delivery failures in their equities markets. The Tokyo, Frankfurt, London, Australian and Euronext exchanges have strict delivery requirements in one
Load more

Recommended publications
  • Japan to Normalize Short-Selling Regulations
    lakyara vol.164 Japan to normalize short-selling regulations Sadakazu Osaki 10. May. 2013 Japan to normalize short-selling regulations vol.164 Executive Summary Japan's Financial Services Agency has unveiled plans to rescind the emergency short-selling restrictions imposed during the 2008 financial crisis and replace them with revised permanent regulations. Its proposed revisions are timely and sensible. They should help to improve market liquidity and price formation. Sadakazu Osaki Head of Research Center for Strategic Management and Innovation Emergency short-selling restrictions have remained in effect in Japan In March 2013, Japan's Financial Services Agency (FSA) released a draft of revised short-selling regulations. In Japan, short-selling restrictions were tightened as an emergency measure in response to the market turmoil triggered by Lehman Brothers' September 2008 collapse. These emergency restrictions are still in effect, having been extended 12 times. With the recently released revised regulations slated to take effect in November, regulation of short-selling in Japanese markets is set to finally return to normal. Short selling is an investment technique whereby an investor borrows from a third party securities that he does not currently own and sells them in the aim of repurchasing them later at a lower price. When a security is sold short, its market price reflects the investment opinion of investors that do not own the security in the cash market. Short selling also enhances market liquidity by increasing sell orders. It thus fulfills a legitimate economic function but it can also trigger steep price declines if certain stocks are heavily sold short within a short timeframe.
    [Show full text]
  • Characteristics Which Predict Naked Short Selling
    Journal of Finance and Accountancy Volume 21 Over-the-counter delivery failures: Characteristics which predict naked short selling Paul Ziegler University of Mary Hardin-Baylor Chris Neuenschwander Anderson University ABSTRACT This research deals with the impact of naked short selling on small firms whose stock is traded “over the counter”. Virtually all research into naked short selling has been conducted using data taken exclusively from the major exchanges. Existing research continues to focus on major exchanges even as regulators stress that small firms, in particular those trading over-the- counter, are the most vulnerable to manipulation. Using publically available information, this study has found that several variables including the average daily trading volume, the number of shares in float, and a firm’s market capitalization can be used to identify firms which might be subject to a higher level of naked short selling as identified by post-trade delivery failures. Keywords: Naked short selling, delivery failure, Over-the-Counter Copyright statement: Authors retain the copyright to the manuscripts published in AABRI journals. Please see the AABRI Copyright Policy at http://www.aabri.com/copyright.html Over the counter, Page 1 Journal of Finance and Accountancy Volume 21 INTRODUCTION This research was conducted to discover if directly observable firm characteristics for stocks which trade over-the-counter can be used to predict the level of naked short selling. Generally speaking, stock traded directly between broker/dealers rather than via a formal exchange are termed “over-the-counter” or OTC. Often these firms are small and do not meet the listing requirements of a formal exchange, such as trading volume, market capitalization, or meeting required reporting standards.
    [Show full text]
  • The Global Dilemma in Short Selling Regulation: IOSCO's Information Disclosure Proposals and the Potential for Regulatory Arbitrage Eleanora Zlotnikova
    Brooklyn Journal of International Law Volume 35 Issue 3 SYMPOSIUM: New Paradigms for Financial Article 12 Regulation in the United States and the European Union 2010 The Global Dilemma in Short Selling Regulation: IOSCO's Information Disclosure Proposals and the Potential for Regulatory Arbitrage Eleanora Zlotnikova Follow this and additional works at: https://brooklynworks.brooklaw.edu/bjil Recommended Citation Eleanora Zlotnikova, The Global Dilemma in Short Selling Regulation: IOSCO's Information Disclosure Proposals and the Potential for Regulatory Arbitrage, 35 Brook. J. Int'l L. (2010). Available at: https://brooklynworks.brooklaw.edu/bjil/vol35/iss3/12 This Note is brought to you for free and open access by the Law Journals at BrooklynWorks. It has been accepted for inclusion in Brooklyn Journal of International Law by an authorized editor of BrooklynWorks. THE GLOBAL DILEMMA IN SHORT SELLING REGULATION: IOSCO’S INFORMATION DISCLOSURE PROPOSALS AND THE POTENTIAL FOR REGULATORY ARBITRAGE INTRODUCTION he tumultuous events leading up to the financial crisis in the fall of T2008 resulted in the rapid enactment of global securities rules and regulations that were designed to limit, curb, or outright ban short selling activity. Undoubtedly, Credit Default Swaps1 played a critical role in corroding the global economy by providing insurance on risky mortgage bonds and encouraging reckless behavior during the housing bubble.2 However, according to many regulatory authorities, short sellers greatly exacerbated global economic turmoil, driving
    [Show full text]
  • The Naked Truth: Examining Prevailing Practices in Short Sales and the Resultant Voter Disenfranchisement
    The Naked Truth: Examining Prevailing Practices in Short Sales and the Resultant Voter Disenfranchisement ROBE R T BR OOKS AND CLAY M. MOFFETT FORMAT ANY ROBE R T BR OOKS iterature on short-selling activity due to the costs associated with shorting is Wallace D. Malone, Jr. is a common topic for financial, stocks, thusIN leaving only optimistic investors Endowed Chair of Finan- economic, accounting, and legal and the resulting inflated asset prices; and cial Management in the Department of Finance, authors and has been since the very second, that there are a number of short sales Lfirst journals were established (De la Vega constraints that reduce or limit the number of University of Alabama in Tuscaloosa, AL. [1688]). Short sales occur when a shareholder short sellers. These constraints include: [email protected] sells a share of stock he does not own (by bor-ARTICLE rowing shares), and only later acquires them, • Borrowing costs. The shorter has to be CLAY M. MOFFETT which then closes out the transaction. In so able to borrow and provide securities to is an assistant professor in the Department of doing, there may be various borrowingTHIS costs the purchaser of shares. The proceeds Finance, University of associated with the transaction. The short are then retained by the broker serving North Carolina, seller profits from the transaction if the share as collateral for the securities lender. Wilmington, NC. price declines more than the all-in costs of The interest that is paid is theoreti- [email protected] the transaction by the time he closes out the cally paid to the lender, who then must transaction.
    [Show full text]
  • Short Sale Position and Transaction Reporting
    Short Sale Position and Transaction Reporting As Required by Section 417 of the Dodd‐Frank Wall Street Reform and Consumer Protection Act This is a report of a study by the Staff of the Division of Economic and Risk Analysis of the U.S. Securities and Exchange Commission. The Commission has expressed no view regarding the analysis, findings, or conclusions contained herein. June 5, 2014 Executive Summary Congressional Mandate The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or “Act”) was signed into law on July 21, 2010.1 Section 417(a)(2) of the Act directs the Division of Risk, Strategy, and Financial Innovation (the “Division” and now called the Division of Economic and Risk Analysis) of the Securities and Exchange Commission (the “Commission”) to conduct a study of the feasibility, benefits, and costs of: (A) requiring the reporting of short sale positions in publicly listed securities in real time, (i) publicly or, in the alternative, (ii) only to the Commission and the Financial Industry Regulatory Authority (“FINRA”), and of the feasibility, benefits, and costs of: (B) conducting a voluntary pilot program in which public companies will agree to have all trades of their shares marked (i) “short” (ii) “market maker short” (iii) “buy” (iv) “buy-to-cover” or (v) “long” and reported as such in real time through the Consolidated Tape.2 This is the report of that study made to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Financial Services of the House of Representatives specified in Section 417(b)(2) of the Act.
    [Show full text]
  • Testimony Concerning the State of the Financial Crisis by Chairman Mary L
    Testimony Concerning the State of the Financial Crisis by Chairman Mary L. Schapiro U.S. Securities and Exchange Commission Before the Financial Crisis Inquiry Commission January 14, 2010 I. INTRODUCTION Chairman Angelides, Vice Chairman Thomas, Members of the Commission: Thank you for the invitation to share my personal insights as the Chairman of the Securities and Exchange Commission into the causes of the recent financial crisis.1 I believe the work of the Financial Crisis Inquiry Commission (FCIC) is essential to helping policymakers and the public better understand the causes of the recent financial crisis and build a better regulatory structure. Indeed, just over seventy-five years ago, a similar Congressional committee was tasked with investigating the causes of the stock market crash of 1929. The hearings of that committee led by Ferdinand Pecora uncovered widespread fraud and abuse on Wall Street, including self-dealing and market manipulation among investment banks and their securities affiliates. The public airing of this abuse galvanized support for legislation that created the Securities and Exchange Commission in July 1934. Based on lessons learned from the Pecora investigation, Congress passed laws premised on the need to protect investors by requiring disclosure of material information and outlawing deceptive practices in the sale of securities. When I became Chairman of the SEC in late January 2009, the agency and financial markets were still reeling from the events of the fall of 2008. Since that time, the SEC has worked tirelessly to review its policies, improve its operations and address the legal and regulatory gaps – and in some cases, chasms – that came to light during the crisis.
    [Show full text]
  • Naked Short Selling and Market Returns
    Naked Short Selling and Market Returns * Thomas J. Boulton Farmer School of Business, Miami University, Oxford, OH 45056, USA Marcus V. Braga-Alves College of Business Administration, Marquette University, Milwaukee, WI 53201, USA Initial Draft: March, 2009 Current Draft: July, 2009 Running Head: Naked short selling and market returns JEL classification: D02; G14; G28 Keywords: Failures to deliver; naked short selling; stock returns The authors thank Brandon Carl, Terry Nixon, Sarah Peck, Steve Wyatt, and Chad Zutter for valuable comments. Any remaining errors or omissions remain the responsibility of the authors. * Corresponding author. Tel.: + 1-513-529-1563; fax: + 1-513-529-8598. E-mail address: [email protected] (T. Boulton). Naked Short Selling and Market Returns Abstract We examine stock market returns around periods of increased naked short selling with two objectives in mind. First, we study persistent failures to deliver (FTDs) for insight into naked short sellers’ trading strategies and their ability to identify overpriced stocks. We find that naked short sellers are contrarians who target stocks that experience positive abnormal returns. Returns following transactions that result in persistent FTDs provide no evidence that naked short sellers are informed traders. Second, we study the market’s reaction to announcements indicating increased levels of naked short selling. We find that abnormal returns are generally positive following such announcements. JEL classification: D02; G14; G28 Keywords: Failures to deliver; naked short selling; stock returns 2 Naked Short Selling and Market Returns 1. Introduction Critics describe naked short selling (i.e., selling a stock short without first borrowing or arranging to borrow it) as abusive and manipulative, suggesting that naked short selling has negative consequences for the security being sold short.
    [Show full text]
  • Corporations Amendment (Short Selling) Bill 2008
    Parliament of Australia Department of Parliamentary Services Parliamentary Library Information, analysis and advice for the Parliament BILLS DIGEST www.aph.gov.au/library 25 November 2008, no. 65, 2008–09, ISSN 1328-8091 Corporations Amendment (Short Selling) Bill 2008 Kali Sanyal Economics Section PaoYi Tan Law and Bills Digest Section Contents Purpose .............................................................. 2 Background ........................................................... 2 Global financial crisis ................................................. 2 What is short selling? ................................................. 4 Why Short? ....................................................... 6 For speculation .................................................... 6 For hedging ...................................................... 6 Why does short selling reduce share prices? ................................ 6 Current regulation .................................................... 7 Australia’s Response to Short Selling ..................................... 7 Recent Global Regulatory Response ...................................... 8 Committee consideration .............................................. 10 Financial implications .................................................. 10 Key issues ........................................................... 11 Impact of ban on short selling in Australia ................................ 11 Position of significant interest groups/press commentary ...................... 11 Main provisions
    [Show full text]
  • Overstock CEO Comments on SEC's New Rules Against Naked Short Selling
    Overstock CEO Comments on SEC's New Rules Against Naked Short Selling September 17, 2008 'Nerf penalties for financial rapists' declares Byrne SALT LAKE CITY, Sept. 17 /PRNewswire-FirstCall/ -- Overstock.com, Inc. (Nasdaq: OSTK) chairman and CEO Patrick M. Byrne comments on the SEC's September 17, 2008 press release (see http://www.sec.gov/news/press/2008/2008-204.htm) that purports to protect investors against naked short selling. Dr. Byrne commented, "At the core of the SEC announcement is a decision that if a hedge fund naked shorts a stock, its broker isn't supposed to let them naked short again. But guess what: they were not supposed to naked short in the first place. Instead of giving the buyer who receives the fail the right to put it back to the naked short selling participant, the SEC once again opts for nerf penalties for financial rapists. "If the SEC were anything but a hedge fund bootlick," continued Byrne, "it would not have taken the half-measure of a pre-borrow requirement applied only as a penalty for those failing to deliver within T+3, but would have instituted a market-wide pre-borrow requirement (as it did in its July 15, 2008 Emergency Order protecting Upper Caste financial firms), and mandatory buy-ins at T+3. "Some questions for the SEC: 1. How will the SEC determine whether an institution is in compliance with this rule? The only way to determine compliance is through an SEC audit, something that could only occur months after the fact. In the case of a bear raid, that will be too late.
    [Show full text]
  • Credit Default Swaps and Short Selling Written Evidence
    Credit Default Swaps and Short Selling Written evidence Memorandum by Bank of America Merrill Lynch (CDS 1) ................................................................... 1 Memorandum by Mr John Chapman, former Civil Servant and Journalist (CDS 2) ............................ 4 Letter from the Investment Management Association (CDS 3) ........................................................ 10 Letter from the Association for Financial Markets in Europe (AFME), International Securities and Lending Association (ISLA) and International Swaps and Derivatives Association (ISDA) (CDS 4) .... 13 Memorandum by Bank of America Merrill Lynch (CDS 1) 1. How much short selling is there in the sovereign bonds markets? Does this have a significant influence on sovereign bonds? 2. There is no way to measure how much naked short selling occurs in the market. We as market makers and primary dealers in the sovereign bond market are committed to providing bid and offer prices in which counterparties may purchase or sell against us. When accepting a sale trade we have no way of knowing if this takes the client short. From a proprietary perspective we may find ourselves taking a short position but for settlement purposes these are covered by reverse repo after the fact. 3. The ability to trade into a short position is integral to providing liquidity and is a hedging tool to manage risk. 4. What are the risks of naked short sales of sovereign bonds? 5. Naked short selling on the sovereign bond market does not increase risk. Short positions are generally easily covered for settlement as a result of a highly liquid repo market in sovereign bonds. 6. Do credit default swaps (CDSs), both covered and naked, have a significant impact on the price of the underlying sovereign bonds? 7.
    [Show full text]
  • Naked Short Selling: Is It Information-Based Trading?
    Naked Short Selling: Is it Information-Based Trading? Harrison Liu University of Texas at San Antonio [email protected] Sean T. McGuire Texas A&M University [email protected] Edward P. Swanson Texas A&M University [email protected] June 21, 2013 Abstract: Citing a widely held belief that naked short selling is not based on company fundamentals, the SEC (2008) has substantially tightened Reg. SHO close-out regulations in an effort to eliminate naked short selling. Contrary to accepted belief, we find that accounting fundamentals are highly significant in explaining naked short sales. Further, naked short sales contain incremental information about future stock prices: Abnormal returns from a long/short trading strategy that buys (sells short) shares with low (high) short interest are more than seven times larger using naked and covered short interest, compared to returns using only covered short interest (15.2 percent vs. 2.1 percent annualized). Our findings show that recent actions by regulators to eliminate naked short sales are likely to impede informed arbitrage and reduce market efficiency. Keywords: short selling; accounting fundamentals; arbitrage; trading strategies; naked short selling We appreciate helpful comments from Anwer Ahmed, and from participants at the 2013 LoneStar Accounting Conference and the Securities Financing Forum in NYC (sponsored by DataExplorers, a Markit Company, May 22, 2012). We thank DataExplorers for providing the quantity of shares available for lending. Naked Short Selling: Is it Information-Based Trading? 1. Introduction Naked short selling is widely alleged to cause price declines that are not supported by company fundamentals. This belief is held by the SEC (2008) and even by many Wall Street professionals involved in short selling.
    [Show full text]
  • Plainly Stated, I Do Not Support Any Reimplementation of an Uptick Rule
    Plainly stated, I do not support any reimplementation of an uptick rule, but do support enforcement of current regulations that shorted shares not exceed available shares (i.e. no naked shorting except for reasonable exceptions). I am not strongly opposed to the proposed circuit breaker modified uptick rule, but am strongly opposed to a market wide and permanent price test. My stance stems in good part from my agreement with many of the statements in the Proposed Rule Release No. 34- 59748 discussing the benefits and importance of short selling when striving for an efficient market. This sentence on page 9 of the Release in particular states my sentiments well: “The Commission has long held the view that short selling provides the market with important benefits, including market liquidity and pricing efficiency.15” The tone of the proposal suggests that its authors recognize the vital role short selling plays in the equity markets and even suggests a good dose of hesitancy on their part to pass any regulations that might interfere with efficient short selling. Given this, I will not expound on these here, but will rather take it as a given that we all recognize the vital role that short selling plays in our equity markets. After the horrendous decline and loss of wealth that occurred in the equity markets recently, it is only natural for us to scrutinize the events surrounding the decline in order to better understand the various players and mechanisms involved in the hopes of avoiding similar episodes in the future. Unfortunately, it is also human nature to look outside of ourselves as individuals for places to place blame in order to alleviate our own pain.
    [Show full text]