September 27, 2006
Nancy M. Morris, Secretary
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
September 27, 2006
Dear Secretary,
I am disappointed that you have allowed the securities industry comment letters to be posted after the comment period has ended. It was clearly stated that all comment letters were to be received by September 19, 2006.
By allowing the letters submitted by security industry participants to be publicly posted even though the SEC received these letters well after the September 19 deadline, the SEC is again giving these parties special treatment.
So I fully expect this letter to be posted as well.
REG SHO is a failure
Data from a Freedom of Information Act (FOIA) request for the total number of failed deliveries on the NYSE shows that on Reg SHOs commencement date, January 03, 2005, there were 65 million shares of failed deliveries in NYSE issues, with a total of 552 total issues on the Reg SHO threshold list.
On the last date for which data was provided, May 31, 2006, there were 65 million shares of failed deliveries in NYSE issues, and there were 590 total issues on the Reg SHO threshold list.
During the period that Reg SHO was in effect, the number of issues hit a high of 929 total issues on the Reg SHO threshold list (on June 22, 2005), with a peak of 172 million failed trades (January 31, 2006), and lower peaks of 134 million shares of failed deliveries (November 16, 2005), and 91 million shares (May 4, 2005). Simply put, Reg SHO has had no appreciable result in limiting either the number of failed deliveries, nor the number of issues affected, judging by the NYSE data - in fact, the number of issues has increased, while the sheer number of delivery failures has fluctuated both lower and dramatically higher, ending at the same number as when the rule went into effect.
The data clearly shows that REG SHO has had no effect on improving delivery failures in NYSE issues, nor the number of total issues on the threshold list.
This data suggests that Reg SHO has failed in its essential purpose. The DTCC and SECs lopsided representations resulting from careful data mining and filtering aside, the delivery failure problem at the end of the provided data period is as bad as on Reg SHOs start date, and the number of total issues has grown.
The SECs proposals represent fine-tuning of this largely ineffective rule, in an effort to introduce improvement in its efficacy – yet analysis of the last round of rule making reveals a marked inability to craft reforms that will protect investors, or limit participant misconduct.
Options Market Maker Exception:
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 markets interests at the expense of the investing public.
It is the job of market makers to math buyers and sellers, not to lay off hedge and trade expenses onto unsuspecting investors.
The comment letter by the options market makers is a beg for the continuation of making equity investors pay for the expenses incurred in a different security in a different market. How crazy is that? The SEC has no authority to allow this as it harms equity investors. The exemptive authority of the SEC is limited :
to the extent that such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors
Allowing option market makers to hedge their option securities via delivery failures in equity securities harms equity investors.
And why is it that in foreign markets, this is all done differently and derivative and equity markets work just fine? One would think from the industry comment letters that there is no other way. But there are other ways and foreign markets prove this.
Selling more securities than are issued by issuers:
How is it possible for there to be more securities in investor accounts, even factoring out all securities purchased within 3 days awaiting delivery, than there are securities issued by the issuer? Does this open up broker-dealers, who are issuing these extra securities to liabilities?
What happens for instance, if a buyers in aggregate buy up more of these "securities" than the issuer has issued and then buy out the company at a premium or demand dividends? This is a systemic risk I think the broker-dealers and the SEC hasn't contemplated. If the SEC and broker-dealers woke up to this risk, the current practice of selling more securities than are issued by issuers would stop.
1934 and 1933 Security Acts
It's time for the SEC to finally enforce the 1933 and 1934 Security Acts. It's either the industry does it, or it'll be done for them. But the status quo is not an option.
Quoted from Harvey L. Pitt, former SEC Chairman :
"The securities industry and clearing agencies don't seem to recognize that it's only a matter of time before these problems catch up with them and kill off the goose that is, at present, laying very golden eggs. The securities industry needs to seize control and propose effective remedies to increase transparency in stock lending and borrowing."
"Securities and clearing firms need to act quickly. Or else they, to paraphrase Will Rogers, will have to be content to live with even more government than they're already paying for. "
I think the former chairman was understating the negative effects quite a bit.