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SEC Admits to Fraud and Enacts Scheme to Cover-Up – March 30, 2005
David Patch
In the April 2005 publication of Euromoney, the Magazine places it focus squarely on the issue of naked shorting. In three separate articles, European authors Helen Avery and Peter Koh attempt to dig into the US Financial Market scandal to uncover what “Stockgate” is truly about. Their efforts only raise greater doubts about the SEC’s objectivity to this issue.
Case in point.
In June 2004 when the SEC released Regulation SHO they imposed a clause that seemed bizarre. They put a clause in the language that ultimately “grandfathered” all prior open fails from mandatory closeout provisions. If the fails represented illegal trading that was not to be corrected by this reform.
Questioned about this clause by the authors, SEC Asst. Director of Market Regulation James Brigagliano had this to say, “We were concerned about generating volatility where there were large pre-existing open positions, and we wanted to start afresh with new regulation, not re-write history”
Lets analyze this statement.
Since the inception of SHO in January, many stocks have seen huge volatility unseen prior to January 7, 2005 when the first threshold lists were released. Unlike volatility created due to upward buying pressures we have seen volatility swings of 20% or more in “bear raid” like selling tactics. So while upside volatility and short selling profitability has been protected, longs shareholders continue to be abused by the manipulation that has abused them in the past. I guess the SEC underestimated the integrity of the markets. The volatility we see on these stocks, unparallel to the rest of the markets, should certainly be cause for concern.
Mr. Brigagliano also references the existence of “large pre-existing open positions”. I gather Mr. Brigagliano, speaking for the SEC, never considered that those large open positions might be impacting the markets in these stocks? How exactly a large open position is created and how it may not be good for the markets appears to be puzzling to the Asst. Director. Ironically, the Securities Act of 1934 states unequivocally that settlement fails are in fact harmful to the markets and investors. I would almost suggest the Division of Market Regulation may benefit from taking a day and reading the Securities Act once again.
What also must be considered regarding Regulation SHO is that the SEC allowed six months for the industry to prepare for the compliance to the new rules. Rules by the way that mimicked pre-existing SRO rules in place. So I guess the statement of “start fresh” by Mr. Brigagliano meant with respect to recording failures since the rules themselves are actually old. Logically, if these fails were legitimate in the first place six months would be more than ample time to cover the large open positions in these securities. Any that exists after the six months are problem trades that need immediate attention, as there are no legal grounds for fails to persist for six months. Not even with exemptions.
The Congressional agenda of the SEC is to protect all investors. Instead of Investor protection the SEC pardoned the open positions from being closed any time soon. They must have some VERY LARGE open positions to justify such a policy as it goes against every theory of investor protection according to the Securities Act of 1934 (Section 17A).
Mr. Brigagliano followed up his justifications by saying "When you look at some of the complaints from issuers, you have to ask yourself is naked shorting really the problem here? Some of these companies have had serious financial and regulatory issues that may have been the cause for their stock price falling."
Unfortunately this tact of “blame the issuer” only works if there is no large open position on the issuer’s stock. It is an easy out for the SEC to look at a company’s financials and justify a stock valuation because of it. Unfortunately it is not the SEC’s role to review a company’s financials; their role is to make sure the trading on the security has taken place in a legal manner. If there are large open positions, regardless of the financial qualifications of the issuer, the fails must be evaluated for manipulation. Manipulating a financially troubled company is no more legal than manipulating General Electric I don’t think. Maybe I should quiz Mr. Brigagliano on this. I am sure he has a rational justification to pull out of the SEC Q & A handbook. Ultimately the markets are what will dictate stock valuations assuming the markets are traded fairly.
Again, case in point.
In September of 2004 Mr. Brigagliano directed a response to an inquiry by Senator Paul Sarbanes about possible naked shorting abuses. The Senator was specific in his request to the SEC even providing e-mail evidence by Broker/Dealers and the Canadian Depository discussing their inability to settle the trades of a particular “complaining issuer”.
The response from Mr. Brigagliano was simple. The April 2003 Broker/Dealer e-mail acknowledgements of large open positions were to be attributed to a June 2004 corporate action taken by the company. No my dates are not messed up, Mr. Brigagliano tried to blame the fails on a corporate action that happened 14 months after the e-mails were written.
The SEC never did officially review the cause for the fails as they continue placing all the blame on the issuer. As for those fails, they were acknowledged to be real by the Wall Street firms themselves. Those were the “Red Flag” e-mails the SEC promised not to ignore in prior Senate Hearings. Apparently Mr. Brigagliano was sleeping in his office during those hearings and missed the Chairman’s promises not to ignore them again.
So let’s take Mr. Brigagliano to task even further, as he apparently wants to represent the SEC’s position here.
In a December 13, 2004 Bear Stearns Conference Call the General Counsel had this to say about Regulation SHO.
“To give you that brief introduction in Reg SHO, the history how we got to where we are today. For the past several years we have been hearing from many different regulators regarding their concerns about the increase in the level of fails that they are seeing. They believe, and they have stated on numerous occasions, that one of the primary causes of the high level of fails was that various participants in the short sale process, prime brokers, executing brokers, clients, were not following already established rules.”
By this statement the SEC has not only been aware that the large open positions have existed for years, they acknowledge that these large open positions were conducted under trading practices that were not in sync with established laws. Regulators were so brash as to tell firms they were in violation yet did nothing about it.
By protecting these large open positions with Regulation SHO the SEC was in fact protecting the fraudulent actions of the markets. How exactly do the regulators expect credibility over those they regulate if they acknowledge securities fraud yet take no action? Are these the open positions James Brigagliano was defending?
Finally, before I let Mr. Brigagliano off the hook we can review a report that came out of a visiting economic scholar at the SEC. The report by visiting University of New Mexico Professor Leslie Boni was referenced as a key document used in the determination of Regulation SHO guidelines. The report by the professor claims that the large open positions are in fact Strategic Fails created by Wall Street for economic purposes. When compliance ran up against margins, margins won and the professor laid it all out for the SEC.
The SEC conducts their own study, determines one of the causes for the fails in the system are financially driven to benefit Wall Street Institutions and the SEC elects to protect these fails. Are these the actions of an Agency looking out for the best interests of the investor? Volatility in forcing an Industry correction to be in compliance would be a bad thing Jimmie?
Okay, so enough with Mr. Brigagliano and his ill-equipped comments. Let’s step over to another SEC Market Regulation Attorney and see how we can analyze her comments.
Again in one of the three Euromoney articles released, the issue as to why the SEC does not publish the fail positions in the reported threshold companies was asked of the SEC. In response, “Susan Petersen, a special counsel in the SEC's division of market regulation, says that it does not make public the exact amount of fails-to-deliver, as it would potentially have negative effects on investors and broker/dealers by revealing trading strategies.”
Ms. Petersen clearly appears confused over who it is the agency is supposed to protect. Investors and Broker/Dealers have no rights to trading strategies if they are the ones generating the excessive fails. To generate a fail means you are not trading real shares and thus trading counterfeit stocks. The only possible trading strategy in this case would be to manipulate the stock with excess supply beyond reasonable and legal means. Is that the strategy the SEC is protecting?
For the record, market makers are given an exemption to conduct bona fide market making but if they are the ones generating “large open positions” I would beg to differ on this being bona fide market making strategies. These exemptions provided to market makers are intended to be short term and to knock down the stock volatility created due to sudden spikes in liquidity. For their positions to grow to the point of large open positions and extended for large durations of time would mean that temporary volatility is no longer the trading strategy of the investing public. If there is that much buying volume that requires large amounts of naked shorting to diffuse growth, the demand is dictating a new stock valuation level is required and does not require excessive market making corrections.
It is clear by the comments of Ms. Petersen that the negative effects of the long investors are not the primary concern of the SEC. The SEC is more concerned about the protection of those market participants that have created this alternate market by trading counterfeit securities to manipulate valuations. Dare I say – Hedge Funds? Who else has enough financial leverage in the markets and political leverage in Washington to trade counterfeit shares in excessive of what exists and is available and never be forced to deliver?
To review the actions of the SEC with regards to naked shorting, the SEC has done the equivalent of erasing the past of all research analysts’ conflicts, all past mutual fund late trading activities, and all prior IPO allocations issues. On those acts of fraud the SEC did not grandfather in the past and start fresh as Mr. Brigagliano put it, they fined Wall Street tens of billions of dollars. They did so because it was right even if it was only a fraction of what was lost. In this case the stakes are higher, premiums will be paid and investor losses would be restored. Not at a fraction of the cost but at full value. The SEC is afraid of imposing such penalties upon Wall Street and thus grandfathered in their fraud.
The ultimate question at the end of the day is simple. What was the SEC thinking in trying to cover-up the fraud of illegal and abusive naked shorting? They have admitted it exists with every reference made to large open positions. With decades of complaints, an environment of public distrust, and dozens of present state and federal lawsuits pending did the SEC really think the data would never be disclosed? The arrogance exposed by these SEC officials in the Euromoney articles continues to highlight the denial the SEC is in. They really still hold down the belief that Wall Street will monitor and correct itself.
Guess again.
For a full expose on the illegal practice watch NBC’s Dateline Sunday April 10, 2005 @ 7:00 EST. Decide for yourself what side of the fence the SEC calls their home.
For more on this issue please visit the Host site at www.investigatethesec.com .
Copyright 2005
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