In deference to SEC Chairman Christopher Cox, his October 19, 2008 “Swapping Secrecy for Transparency” Op-Ed opinion does address issues of concern as they relate to the credit-default-swap markets. Let’s hope he is a little more successful with this initial statement of intent than he was with respect to the public dissemination of short positions of larger hedge fund and investment concerns. A portion of his most recent editorial statement follows:
“Congress needs to fill this regulatory hole by passing legislation that would not only make credit-default swaps more transparent but also give regulators the power to rein in fraudulent or manipulative trading practices and help everyone better assess the risks involved.
Congress could require that dealers in over-the-counter credit-default swaps publicly report both their trades and the value of those trades. This would make the market more transparent, and make it easier for everyone engaged in credit-default swaps to assess their value. It would also provide regulators with the information they need to uncover unfair or fraudulent practices and to monitor risk.
Then, the Securities and Exchange Commission should be given explicit authority to issue rules against fraudulent, deceptive or manipulative acts and practices in credit-default swaps.
Finally, Congress could provide support for federal regulators to mandate the use of one or more central counterparties — financially stable clearance and settlement organizations — and exchange-like trading platforms for the credit-default swaps market. As it is now, it is often impossible even to know who stands on the other side of a swap contract, and this increases the risk involved. We at the S.E.C. are already working with the Federal Reserve, the Commodity Futures Trading Commission and industry participants to accomplish these goals on a voluntary basis, using the authority we currently have.
Because of the truly global nature of the over-the-counter derivatives market, we will need to work closely with governments in other major markets. The climate for such cooperation is good, because the cross-border impacts of the current market problems are obvious to all.
Transparency is a powerful antidote for what ails our capital markets. When investors have clear and accurate information, and when they can make informed decisions about where to put their resources, money and credit will begin to flow again. By giving regulators the authority they need to bring the credit derivatives market into the sunshine, we can take a giant step forward in protecting our financial system and the well-being of every American.”
Cox recently had the opportunity to bring the issue of “naked short selling” out of the “darkness” and into the “sunshine” but the opaque curtains that enshroud this illegal practice remain. Selective transparency does not work and suggests that Wall Street brokerages, the DTCC and hedge fund behemoths still call the shots regardless of the initial intentions of the SEC. Like the E.F. Hutton commercial of years gone by, “when the hedge fund consortium talks, the SEC listens.”
On or about the middle of September of 2008 it appeared that Cox was heading in the right direction with his statement suggesting the direct dissemination of information that would reveal short positions at large investment concerns but something got in his way. A review of SEC press releases and statements made over the last month coupled with a correlative analysis of the number of securities on the SHO List and respective closing prices of the DJIA and NSDQ tells the story better than words ever could.
http://www.sec.gov/news/press/2008/2008-209.htm
Chairman Cox’s diatribe began in earnest on September 17, 2008 when, in addition to announcing initiatives to investigate fraud and manipulations in the nation’s securities markets, he included the following paragraphs:
"In order to ensure that hidden manipulation, illegal naked short selling, or illegitimate trading tactics do not drive market behavior and undermine confidence, the SEC today took several actions to address short selling abuses," Chairman Cox continued. "In addition to these initiatives, which will take effect at 12:01 a.m. ET on Thursday, I am asking the Commission to consider on an emergency basis a new disclosure rule that will require hedge funds and other large investors to disclose their short positions. Prepared by the staffs of the Division of Investment Management and the Division of Corporation Finance, the new rule will be designed to ensure transparency in short selling. Managers with more than $100 million invested in securities would be required to promptly begin public reporting of their daily short positions. The managers currently report their long positions to the SEC."
Chairman Cox continued, "Director Thomsen and the Division of Enforcement will also expand their ongoing investigations by undertaking a series of additional enforcement measures against market manipulation. The Enforcement Division will obtain disclosure from significant hedge funds and other institutional traders of their past trading positions in specific securities. Those institutions will also be required immediately to secure all of their communication records in anticipation of subpoenas for these records."
Like many others, we thought this was a promising development that would clearly identify those who perpetrated these frauds bringing transparency to the system for all who were subjected to the naked short selling manipulation. It almost seemed too good to be true and unfortunately, within a short period of time, it was.
http://www.sec.gov/news/press/2008/2008-210.htm
The very next day Cox made another statement, the most important sentence of this release is as follows:
“We announced emergency plans for a rule to ensure public disclosure of short selling positions of hedge funds and other institutional money managers.”
I could not believe what I was reading. The SEC was following through with its recent pronouncement and was going to make “public” the short selling positions of hedge funds and other institutional money managers. Unfortunately, my rekindled enthusiasm and reaffirmation of good versus evil as to who the SEC really protected was to be short lived. Before the markets opened on Monday, September 22nd the investment and hedge fund managers, after what must have been one hell of a weekend country club bridge tournament, regained control of the process as exhibited in a rare Sunday, September 21st press release from the SEC.
http://www.sec.gov/news/press/2008/2008-217.htm
The cracks in the intentions of the SEC armor began to appear as stated:
“In addition to making technical amendments, the revised order also provides that the information disclosed by investment managers on new Form SH will be nonpublic initially, but will be made available to the public via the Commission’s EDGAR website two weeks after it is electronically filed with the Commission.
The amended order will take effect at 12:01 a.m. EDT on Monday, Sept. 22, 2008.
Under the order, covered institutional money managers will be required to report any new short selling in all equity securities, except options, that are admitted for trading on a national securities exchange or quoted on the automated quotation system of a registered securities association. If any new short sales are effected on September 22 through September 27, the managers are required to submit a report on new Form SH to the Commission on Sept. 29, 2008. These managers are already required to report their long positions in these securities on Form 13F.
The Commission may extend the emergency order beyond its current effective period of 10 business days if it deems an extension necessary in the public interest and for the protection of investors, but will not extend the order for more than 30 calendar days in total duration.”
http://www.sec.gov/news/press/2008/2008-235.htm
The winds of change stopped blowing in the direction of public disclosure in early October. The SEC continually modified its language and subsequently the public’s ability to review the required Form SH filings with language as follows:
“The Commission notes that short selling plays an important role in the market for a variety of reasons, including contributing to efficient price discovery, mitigating market bubbles, increasing market liquidity, promoting capital formation, facilitating hedging and other risk management activities, and importantly, limiting upward market manipulations. In addition, there are circumstances in which short selling can be used as a tool to mislead the market. For example, short selling can be used in a downward manipulation whereby a manipulator sells the shares of a company short and then spreads lies about a company's negative prospects. This harms issuers and investors as well as the integrity of the market. This kind of manipulative activity is particularly problematic in the midst of a loss in market confidence.
Specifically, the emergency orders cover the following:
Temporary requirement that institutional money managers report to the SEC their new short sales of certain publicly traded securities. This order will also be extended, to 11:59 p.m. ET on Oct. 17, 2008, but the Commission intends that the order will continue in effect beyond that date without interruption in the form of an interim final rule. The Commission will seek comments on all aspects of the anticipated rulemaking. Disclosure under the emergency order will be made only to the SEC.”
http://www.sec.gov/rules/other/2008/34-58724.pdf
The nails in the coffin of the Form SH disclosure to the public were firmly hammered in on October 2nd with the following language:
“The Commission believes that the nonpublic submission of Form SH may help prevent artificial volatility in securities as well as further downward swings that are caused by short selling, while at the same time providing the Commission with useful information to combat market manipulation that threatens investors and capital markets. Also, the Commission has considered further reasons to maintain the information as nonpublic in the current market environment, and is concerned that publicly available Form SH data could give rise to additional, imitative short selling that was not intended by the Commission’s Order. Accordingly, the Commission has determined that Forms SH filed under the Order, including those that were due on September 29, 2008 will remain nonpublic to the extent permitted by law without the filer needing to submit a confidential treatment request.”
This Order, pursuant to Section 12(k)(2)(C) of the Exchange Act, terminated at 11:59 PM on Friday, October 17, 2008.
The title of this article, “Selective Transparency: Who is the SEC Really Protecting” relates to the action, or inaction as it may be, as it relates to providing critical information to the public. Before concluding with opinion as to why Forms SH remained in the control of the SEC and were never disclosed to the public, take a look at the following chart which illustrates the date and number of securities remaining on the SHO List with recent correlative market closing prices for the DJIA and NSDQ.
Date |
SHO |
DJIA |
NSDQ | |||
9/18/08 |
428 |
11,019.69 |
2,199.10 | |||
9/19/08 |
441 |
11,388.44 |
2,273.90 | |||
9/22/08 |
443 |
11,015.69 |
2,178.98 | |||
9/23/08 |
437 |
10,854.17 |
2,153.34 | |||
9/24/08 |
432 |
10,825.17 |
2,155.68 | |||
9/25/08 |
436 |
11,022.06 |
2,186.57 | |||
9/26/08 |
431 |
11,143.13 |
2,183.34 | |||
9/29/08 |
414 |
10,365.45 |
1,983.73 | |||
9/30/08 |
392 |
10,371.58 |
2,091.88 | |||
10/1/08 |
367 |
10,831.07 |
2,069.40 | |||
10/2/08 |
343 |
10,482.85 |
1,976.72 | |||
10/3/08 |
323 |
10,325.38 |
1,947.39 | |||
10/6/08 |
298 |
9,955.50 |
1,862.96 | |||
10/7/08 |
267 |
9,391.67 |
1,754.88 | |||
10/8/08 |
243 |
9,042.97 |
1,740.33 | |||
10/9/08 |
230 |
8,523.27 |
1,645.12 | |||
10/10/08 |
227 |
8,451.19 |
1,649.51 | |||
10/13/08 |
237 |
9,387.61 |
1,844.25 | |||
10/14/08 |
237 |
9,310.99 |
1,779.01 | |||
10/15/08 |
209 |
8,577.91 |
1,628.33 | |||
10/16/08 |
202 |
8,979.26 |
1,717.71 | |||
10/17/08 |
74 |
8,852.22 |
1,711.29 |
It does not take a rocket scientist to see what transpired between September 17, 2008 and October 17, 2008. Christopher Cox had a pretty good idea when he suggested public disclosure of both the short positions and the entities that controlled those positions that were of a certain size or investment management structure. His proclamation never made it through the weekend before the real powers that be, major Wall Street firms, the DTCC, prime brokers, major hedge funds and institutions, and possibly the investment clients they represent came knocking on his door requesting the public window be closed.
Step back and take a look at the chart. The number of securities on the SHO List has declined dramatically, from a high of 443 on September 22, 2008 to only 74 on October 17, 2008. The DJIA and NSDQ dropped by approximately 20% during this period as well.
Now ask yourself a question; why did the number of securities drop precipitously during this period? Was it because the entities that were naked short securities located bona fide shares to meet the T+3 requirements of their open transactions? I don’t think so. Do you think perhaps, since the stock market and the securities that comprise it essentially crashed, that the entities that employed the illegal manipulative techniques of naked short selling just covered their shares at a huge profit? Yes I think that is exactly what happened.
Remember, this all took place under the watchful eye of the SEC and they knew which hedge fund and investment entities were short which securities. The SEC would have known which hedge fund and investment entities were able to secure legal “locate” numbers versus those that simply closed out their naked shorts in the marketplace. The initial Form SH order was due prior to the markets opening on September 29, 2008. More than 431 securities remained on the SHO List at that time and the markets had not yet begun to crash. Was there coincidence in all that transpired in the markets or was there something more? We have a couple theories that need a few more weeks of development to be completed but it is apparent that someone did not want the public to know the cards they were holding. Thus, transparency was available to privileged few who again, prospered while the public-at-large remained susceptible to their manipulations. In any case, it is obvious that the information that would answer these questions is available and it is time the public was able to access it.
The last thing any of these hedge fund and investment entities wanted, especially at this most critical time, was transparency. The dissemination of this information would have etched a more negative image of this illegal practice of these hedge fund moneyed market participants. It also would have provided a direct conduit for civil legal action against the perpetrators of naked short selling resulting in the DTCC, the prime brokers and other responsible parties being subject to subpoenas that would open up their transaction books to the public. There actually might have been viable platforms created that “redistributed” the privatized wealth, the absolute last thing these Robber Barons of today’s financial markets would ever want to happen. Quite frankly, it is time that it happens. The information is there and it is time to storm the gates of the SEC and get the transparency we all deserve.
There is much more to this story but only so much that anyone reading a blog of this nature has the time to take in and understand. As you have come to know this site, we dig a little deeper than just reporting the news as it relates to the problem. We “connect the dots” and will continue to do so. It was never the fact that securities appeared on the SHO List that created the problem. It was the fact that naked short selling of securities was ever allowed to take place, despite the rules and regulations that prohibited this action that give rise to the list becoming a necessity.
The solution to preventing naked short selling is simple; require a firm “locate” number before being able to enter a short sale. While this may solve the naked short selling problem more issues remain. For example, the exploitation of naked short selling has created a plethora of “phantom” shares that grossly overstate the actual number of shares in existence. How the number of shares in existence is reduced and again accurately relate to the actual number of shares issued and outstanding will be addressed in subsequent articles.
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