How The SEC Has Violated Its Statutory Duty and Betrayed The Public Trust

November 8, 2008

The 3 below commentaries tell all:  

How the SEC has violated its statutory duty and betrayed the public trust by blatantly failing to enforce laws on the books– and by further enabling massive market manipulation and fraud that has enriched Wall Street predators at the expense of everybody else– and brought the entire world to its knees.


The coup de grace is the announcement by the Depository Trust Company, subsidiary of the odious Wall Street  owned and operated Depository Trust and Clearing Corporation, that subject to SEC approval, they are moving forward with plans to enable unlimited stock counterfeiting by eliminating all paper stock certificates– the only real evidence of the delivery of real shares.   No stock certificates, no paper trail– no way to ever know whether you ever got what you paid for– or merely an IOU from some naked short seller counterfeiter. 

Too bad we don’t have an honest, free financial press anymore to question the calculated criminal looting of America’s market integrity and economic well being.   What a country.  


“Crisis of Convenience for Roiling SEC – October 30, 2008   by David Patch

“Settlement failures by June 2008 had now reached a daily average value of over $10 Billion”

To say that support for the Securities and Exchange Commission is at an all time low would be an understatement. With Congressional Investigations into the agencies handling of critical investigations and recent reports out of the Office of Inspector General, investors are left guessing as to what exactly the agency is doing to police our markets. Heck, even a presidential candidate has suggested that the SEC Chairman should be fired and it was his party that hired him.

What most want to understand is, has the SEC gone rogue in actually aiding the white collar criminals that lurk out there?

With claims by the OIG that the SEC’s Director of Enforcement was engaged in inappropriate communications regarding an insider trading investigation into the politically connected CEO of Morgan Stanley, and has likewise been accused of having inappropriate communications with the General Counsel of JP Morgan regarding a Bear Stearns investigation it is not a far stretch to think something is remiss.

Question is, how deep does it go? How far have some within the agency gone to protect wealthy and powerful individuals?

Consider this decade old issue of abusive short selling. I say decade old because it was 1998 that the SEC first presented a concept release on short sale reforms whereby nearly 3000 comment letters suggested an abuse existed in the short sale process.

A decade later, the issue is temporarily resolved in what has become a crisis of convenience for the SEC. What do I mean by that? Let’s look at the facts and begin with a picture worth a 1000 words.  [chart omitted]

This chart illustrates the level of threshold companies on the Regulation SHO Threshold security list since inception in January 2005.

Anybody see a trend? A correlation?

What we can timeline together since 1998 is that in October of 2003 the SEC proposed Regulation SHO where the Division of Market Regulation admits that abusive short selling [naked shorts] could be used to generate market leverage necessary to manipulate our markets. They put this right in the language of the proposal. These naked shorts as they are now identified would show up in the markets as failures to deliver within the continuous net settlement system.

By December 2004, as the first reforms were coming into play, we also catch wind of a conference call that was held by the now deceased Bear Stearns in which the General Counsel of Bear Stearns admitted that regulators had been approaching them for years voicing concern over the increased level of failures in the market. According to the General Counsel these fails were being attributed to “prime brokers, executing brokers and clients not following already established rules [in the short sale process]”.

To address the surmounting level of fails in the system the SEC did not merely create reforms but created loopholes to protect those that were not following already established rules. The first identifiable loophole in regulation SHO was the grandfather clause.

According to a document by the SEC’s Division of Market Regulations, and in response to an inquiry by Congressman John Tierney, “SHO does not require the close-out of fails to deliver that existed before a stock became a threshold security (known as “grandfathered” securities) because the Commission was concerned about creating volatility through short squeezes if existing positions had to be closed out quickly. “

So by the illustrated chart, not only did the grandfather clause not require the closeouts of pre-existing fails to deliver, the grandfather clause became a tool used to increase the market levels of fails to deliver in the system. And to whose benefit did this become; those that would have suffered had the agency demanded that these trades settle.

With the market still chugging along, the agency was under attack as the fails to deliver grew exponentially from an average daily dollar value in January 2005 of $3 Billion to over $8.5 Billion by March 2008.

March 2008 was the month Bear Stearns skirted bankruptcy through an emergency sale to an opportunistic JP Morgan. It was this opportunistic sale, in the midst of inappropriate communications between the SEC and JP Morgan General Counsel regarding an on-going Bear Stearns investigation that has again questioned the integrity and alliances of SEC director Linda Thomsen. Again with Bear Stearns.

By November 2007 the Agency had removed the grandfather clause from the short sale policies but by then the levels had accumulated to dangerous levels representing severe liabilities to the market place. And with the short sellers moving to the next loophole of opportunity, the options market and the options market making exemption, the SEC witnessed little relief from the abusive trading patterns. Settlement failures by June 2008 had now reached a daily average value of over $10 Billion.

What the SEC needed now that the pressure was on was a crisis. A means in which the trend could be turned and the unhealthy fails settled.

Open curtain, scene 3, the crash of 2008.

The Bankruptcy of Lehman, the near fall of Morgan Stanley, and a precipitous drop of the Dow Jones to near 8000 and a federal bailout as panic overcame the markets. What a distraction.

As the dust settles and the smoke dissipates few have noticed the playfield in the back right corner of this stage. The playfield of those who carried this tremendous burden of failed deliveries.

As the chart illustrates, the peak level of securities on the threshold security list happened to coincide with the day the SEC first enacted an emergency order that restricted the short selling in 17 financial institutions along with Freddie Mac and Fannie Mae.

Since the June 2008 temporary ban was put into place, as the market went into a free fall so too did the level of threshold securities. It only started to rise again when Morgan Stanley was under attack in September but a second ban again turned that trend around. Then again, the market turned as well.

Ultimately this economic crisis has become a crisis of convenience for the SEC. The failed trades they have tried so desperately to eradicate from the markets have temporarily disappeared. These trades can easily cover quickly since failed trades in a free falling market can always be covered efficiently for a profit. It is only when a trade that should not have been executed can’t be covered for a profit that creates the market inefficiencies.

But what does that say about our market rules, our market regulators, and the possibility of collusion amongst market participants? Why does it take a market crisis to clean up failed trades and what happens when the crisis subsides?

Shouldn’t the market run this efficiently during normalized times or can we expect more ‘crisis of convenience’ events to transpire over the years in order to periodically cleanse away the sins of those that have been allowed to get away with theft?

Now I am not saying that the SEC orchestrated this crisis, although the OIG found cause to think they had the opportunity to thwart it long ago. That opportunity would have come with an SEC investigation into the accounting of assets by —you guessed it— Bear Stearns.

I am finding it rather peculiar however that while the SEC was willing to allow this abuse to accumulate in order to prevent appreciation in the markets to the very advantage of every shareholder, that the SEC did very little to prevent the abuses that drove our markets down in a frenzied panic. Abuses such as short and distort schemes, rumor mongering, and bear raids.

For those interested, Linda Thomsen will be speaking November 6, 2008 at Fordam Law School in New York City. In the advertisements for her speech Ms. Thomsen is quoted as saying “Abusive short-selling, market manipulation and false rumor-mongering for profit by any entity cuts to the heart of investor confidence in our markets. Such behavior will not be tolerated. We will root it out, expose it, and subject guilty parties to the full force of the law.”

I can only laugh at such hypocrisy as I lay witness to the decade of abuse that has taken place where the SEC’s Division of Enforcement has done nothing but protect those that engaged in the very abuses she speaks of. Ms. Thomsen herself a central figure in two OIG Investigations where one has already concluded seeking some form of discipline against the Director.

Maybe somebody in the audience will challenge her on the agencies performance to date and challenge her on the profits reaped under this crisis by those abusive short sellers and rumor mongers she has failed to take actions against.”  Copyright 2008


Physical Certificates Take a Step Closer to Extinction via Depository Trust Company 


Dematerializing Assets

On November 5th, 2008 LibBerte says:
[From DeepCpature Blog Comments — Unreal! Says:
November 5th, 2008 at 9:16 am ]…

Good idea! Let’s take away the only means available for an investor to make sure that what he bought did indeed get delivered and explain it away as increasing “efficiencies” in the system. You had to know this was coming after the SEC admitted that there were so many delivery failures in the system that they couldn’t be bought-in en masse without “market volatility” issues and therefore they needed to be “grandfathered in”. After “grandfathering in” didn’t work out due to the public backlash then burying the bodies in the desert becomes the next best cover up. This cannot be allowed to happen until after all preexisting archaic delivery failures are purged from the system.

Physical Certificates Take a Step Closer to Extinction
by Edward C. Kelleher
The Depository Trust Company, (DTC), a DTCC subsidiary, has announced it will no longer issue physical certificates for withdrawals-by-transfer (WTs) for more than 5,500 issues beginning January 1, 2009.

DTC plans to eliminate WTs of physical certificates for all issues that participate in DTC’s Direct Registration System (DRS). Instead, DTC will process these WTs in DRS statement form. This change is pending approval by the Securities and Exchange Commission (SEC). (About 1,550 additional issues are eligible for, but not participating in, DRS and do not offer the investor the opportunity to receive a DRS statement.)

If permitted by an issuer, investors may take their DRS statement to their transfer agent and exchange it for a physical certificate.

Electronic ownership
DTC’s DRS is a book-entry system that enables investors to register their shares electronically with the issuing company or its transfer agents. Instead of a paper certificate, investors receive a statement of their holdings. In 2008, all the major and regional exchanges in the United States mandated that DRS become a listing requirement for all issues. (DTC is the only registered clearing agency operating a DRS.)

“Eliminating the issuance of physical certificates by DTC in withdrawals-by transfer transactions is part of our overall dematerialization effort aimed at eliminating all paper certificates [evidence] in the securities industry,” said Patrick Kirby, DTCC managing director, Asset Services.

“With the exception of equity securities, virtually all investment instruments in the U.S. including municipal bonds, options and futures and U.S. treasury and agency securities have adopted the book-entry format, helping to eliminate paper and dematerialize the securities industry,” said Kirby.

Paper costs
Both the industry and the government continue to encourage dematerialization. The SEC has recognized that paper certificates are “inefficient” and increase “risk.” According to a 2008 survey by the Securities Industry and Financial Markets Association (SIFMA), more than 1.2 million certificates are reported lost, destroyed or stolen annually, costing the industry about $65 million to replace.

Today, there are more than 7,500 issues eligible for DRS and more than 375 of these issues no longer offer the option of a physical certificate. DRS-eligible issues now account for 88% of all WTs submitted to DTC, and more and more investors are choosing book-entry ownership as opposed to physical certificates.

Ready to dematerialize
“DTC’s customers are committed to going paperless,” said Kirby. “In July 2008, for example, more than 44% of all WTs were processed as DRS statements rather than as physical certificates. That compares with just 20% processed as DRS statements a year ago.

Cost is a driving factor in the move to DRS statements. Today, a WT that calls for a physical certificate costs approximately $125 more than a WT in a DRS statement, which costs about $6. In keeping with the plan established by DTCC’s Board of Directors and its Operating Committee, fees for processing physical certificates will continue to increase in coming years.

Non-participating issuers
For issues that are DRS-eligible but not yet participating, DTC plans to eliminate certificate withdrawals for these issues as of July 1, 2009. “We’ll continue to work with these issuers and encourage them to begin participating in DRS, but we’ll also work with the exchanges and regulators to strengthen the exchange listing requirements mandating that listed issues actively participate in DRS,” said Kirby.
For the small number of issues that have not converted by July 1, 2009, WTs will be processed through DTC’s Exception/Rush WT process.

“With these steps, we believe that WT volume should drop to fewer than 150 certificate transactions per day by the second half of 2009. Over time, this will also lead to a sharp drop in deposits of physical certificates. As that decline takes hold, we will move to curtail remaining services that support processing physical securities,” Kirby said.



 “Wall Street was ripping off investors and the Division of Trading and Markets deceived the public so as to aid the Division of Enforcement in not taking up appropriate cases against those that willfully violated the securities laws.”

As sent to the SEC, Members of the Media, and aides to several key Congressmen. by David Patch


According to a link on the SEC’s Website that directs you to “Key Points about Regulation SHO” the SEC presents to the public this theory:

3. Do all failures to deliver reflect improper activity that should be closed out?
A “fail to deliver” occurs when a broker-dealer fails to deliver securities to the party on the other side of the transaction on settlement date. There are many justifiable reasons why broker-dealers do not or cannot deliver securities on settlement date. A broker-dealer may experience a problem that is either unanticipated or is out of its control, such as (1) delays in customers delivering their shares to a broker-dealer, (2) the inability to obtain borrowed shares in time for settlement, (3) issues related to the physical transfer of securities, or (4) the failure of a broker-dealer to receive shares it had purchased to fulfill its delivery obligations. Fails to deliver can result from both long and short sales.
Regulation SHO was designed to target potentially problematic failures to deliver. Prevention of fails is the goal of the locate requirement. Regulation SHO requires broker-dealers to identify a source of borrowable stock before executing a short sale in any equity security with the goal of reducing the number of situations where stock is unavailable for settlement. But, because the locate is usually done three days before settlement, the stock may not be available from the source at the time of settlement, possibly resulting in a fail.
Regulation SHO also requires some fail positions to be closed out. When a broker-dealer has a fail position in a “threshold security,” and that fail position has persisted for 13 consecutive settlement days, the broker-dealer must take immediate steps to close-out the fail by purchasing securities of like kind and quantity. Even market makers that have such persistent fails in threshold securities must close-out their positions.

I point out the use of the term “justifiable” in the initial paragraph in rationalizing why a fail to deliver exists.

Now between the period of January 2005 to June 2008 the markets experienced a continuous rise in fails to deliver with very little response by the market regulators. Utilizing excuses 1 – 4 above the regulators rationalized that failures to deliver were simply justified difficulties attributed to such problems as lost certificates by granny or delays in delivering shares by legitimate clients. Between January 2005 and June 2008 the dollar value of fails to deliver shares increased 3-fold ($3 Billion to Over $10 Billion) as calculated mark-to-market in daily aggregate fails to deliver.

But then came June 2008 and the economic market crash. There also came that emergency ban of short sales on a paltry 19 publicly traded securities; few if any being qualified as Regulation SHO securities. June 2008 became the turning point for Regulation SHO. Suddenly, as if by miracle, those lost certificates no longer became lost, granny found every last one of them. The inability for a client to deliver securities on time diminished. And Borrowed shares available for settlement could suddenly be found.

With no new regulations between June 2008 and October 2008 investors must ask why the sudden and rapid decline in the number of issuers on the Reg SHO list? What suddenly changed in the market systems to suddenly make settlement an efficient process in which excuses 1-4 no longer seem to be of concern? (Ref: Reg SHO Threshold Security Performance Chart )

The answer is simple, nothing beyond the fact that the market completely crashed between June 2008 and present allowing those massive Fails to deliver to be closed out at a significant profit. Consider that the Dow Jones rand in near 13,000 in June 2008 but fell to Near 8,000 in October. The very period in time when an equally significant decline in fails to deliver were settled.

Had the excuses 1-4 been real, the fails to deliver in a declining market would have been just as significant as that in a flat or bull market. Lost certificates are lost certificates and delays by clients in delivering shares are delays in any market. Without any regulations that altered the short sale process relative to stock locates and unavailable shares to borrow even that excuse would have existed in a declining market but, as if by miracle, none of this happened. Failed trades were easily settled after failure if necessary because the buy-ins could be executed at or below the value executed at the time of trade. So long as a trade could be settled for profit it was settled and when a market collapses settling short sales that failed was as easy as the trade itself.

This type of evidence supports the long standing contention that the ONLY reason fails to deliver persisted for such long and persistent periods of time is purely based on economics. It was not cost effective for these failed trades to be settled and so they were not. That my friends is fraud under no uncertain terms. Failing to comply with securities laws because a profit can not be made is collusion by the industry and is intent to manipulate.

I urge the Commission to address this specific issue publicly and explain how the markets could suddenly become efficient in settling trades when nothing changed except a bear raid. The public has demanded a turnaround in the settlement problems since 2005 and nothing happened until our markets crashed. Are we to believe this is purely by coincidence that the day the market started to crash was likewise the day that stocks could suddenly settle more efficiently? Where are those lost certificates that were highly touted as cause for threshold companies before this market crash?

Ultimately, I believe that this document published on the SEC Website was a blatant attempt at deceiving the investing public as to the truth behind this problem. Wall Street was ripping off investors and the Division of Trading and Markets deceived the public so as to aid the Division of Enforcement in not taking up appropriate cases against those that willfully violated the securities laws. This diversion from the truth delayed the public outcry over where the enforcement cases were.

The language is the SEC’s and the evidence is for all the public to see as Regulation SHO threshold lists are published daily.

David Patch