From: Eric A. McAfee (E-mail) [emcafee@cmcp.com] Sent: Monday, December 01, 2003 1:48 AM To: rule-comments@sec.gov Subject: File No. S7-23-03: Comment on Proposed Regulation SHO Mr. Katz, I am a high technology entrepreneur (founded six companies) and venture capitalist (funded twenty-five companies) based in Cupertino, California. I am currently a director of three OTC-listed public companies with a combined market value of about $500 million. Naked short selling artificially inflates the number of shares outstanding in a given company's stock, thereby increasing the supply of shares without increasing the demand for the shares. As a result, the price of the shares falls as a natural result of the manipulation of the supply/demand equation by naked short sellers. In any other industry, this situation would result in outrage. For example, if a buyer of a building was able to naked short the property, he would be able to artificially decrease the price of the building prior to his purchase, without ever owning any portion of the building prior to his "naked sale" of a portion of the property. Of course, this idea is irrational in the world of real estate, but occurs every day in the stock market. The result of this manipulation of the supply of shares by naked short sellers is the destruction of the stock market as a healthy capital formation mechanism. One of our companies was recently "naked shorted" aggressively, since shares were not readily available for borrowing. The naked short selling caused a $200 million decrease in valuation in a month when the company was completing a private placement. This rapid fall in price directly impacted the price of the offering, decreasing the agreed price of the placement by $60 million in valuation (a 25% fall) -- from $8 per share to $6 per share. These naked short sellers caused our company to raise less money, at a higher price, while the stock fell from $16 to $9.50 in less than a month. The shares have now recovered to $13-$14 per share, but the damage had been done. The company's cost of capital is now much higher, and revenue and employment growth has been slowed. Why doesn't the SEC take aggressive action here? If your house could be naked shorted by the neighbor that wanted to buy it, you would always have to sell at a lower price than your house is worth. Why isn't this obvious to the regulators who are in such a hurry to catch the "criminals" that create the jobs and the economic growth that fuels America's economic and defense strength? Especially vulnerable to naked short sellers are smaller, fast-growing companies. These companies create jobs at a much faster percentage rate than larger companies, but may not yet be listed on NMS, Nasdaq Small Cap, or AMEX. Stock manipulators attack these smaller companies with abandon, without any SEC intervention or apparent interest at all. Recommendations: 1. Strictly Outlaw Naked Short Selling -- both US and Canada: If the shares aren't already owned or haven't clearly been borrowed (and title passed to the borrower), then how can shares be sold? The current system violates Constitutional property rights by extending ownership rights to those who never obtain ownership of shares -- naked short sellers. If you don't own it, you shouldn't be able to sell it. Vague language that allows abuse of this basic concept should be tightened to make the goal clear -- no naked selling of shares by any party at any time. The Canadian government should adopt the same regulations. 2. Personal Liability for Naked Shorting: In addition to a loss of any profits gained, naked short sellers should be personally liable to other shareholders and the company for damages related to any fall in the price of shares caused by illegal naked short selling. 3. Require Specific Acknowledgement of Shares Lent by Shareholders: Currently, brokerage agreements provide for broad discretion by the broker to lend shares to third parties at any time, without compensation to the lending shareholder. However, this arrangement does not provide full disclosure or specific permission to the widows and orphans that deposit shares with brokerage firms. Specifically, if Widow Smith deposits shares at her broker with an intent to sell the shares, shouldn't she specifically authorize her shares to be lent to a short seller? The short seller will sell the shares borrowed from Widow Smith into the market, thereby decreasing the price of the stock by increasing the supply of shares available for sale, ahead of Widow Smith's sale. If she knew that her own shares were being used to drive down the value of her shares, would she specifically agree to such a lending of shares? Absolutely not. However, current law provides Widow Smith with no protection from this blatant downward manipulation of the value of her shares. If Widow Smith desires to lend shares, she would most probably seek payment from the short seller for such a right, since lending shares decreases the value of her holdings when her shares are subsequently sold into the market at ever-lower prices by short sellers. Summary: Those of us who are in the business of creating jobs and building GNP need the SEC's support. From our discussions with SEC enforcement attorneys, they have made it very clear that their career is assisted by catching bad companies, not stock manipulators. The culture of the SEC is to "protect the innocent investor", not to protect the companies that are building America. The SEC has a broader role, that of building better lives by providing jobs for Americans. The SEC can support these companies by allowing them to raise capital free of stock manipulators and naked short sellers. Eric McAfee --------------------------------------- Eric A. McAfee, Managing Director Cagan McAfee Capital Partners, LLC 10600 N. De Anza Blvd, Suite 250 Cupertino, CA 95014 (408) 873-0400 x. 301 Office (408) 873-0550 Fax (408) 390-3275 Mobile emcafee@cmcp.com www.cmcp.com