Phantom Shares: A Bloomberg Special Report (2008)
There is a large portion of America’s middle class that turns to investments as a means of retirement. A lot of people like to keep tabs on stock they have invested in, or receive as benefits. Some might receive shares of a stock as an incentive to take care of the company they work for insuring they and the company are profitable. Then one day the moment in the spotlight comes and the company goes public on the market. The glitter quickly fades to gloom as the company you and so many worked so hard for falls in value %15-%35 in the first month continuing the trend over the next year. Someone must be to blame but not who you might think.
Welcome to the realization you have been the target of “naked short sales” of your stock. Small cap companies are at the greatest risk. While there are efforts in place to regulate it, there are still many investors and companies paying the price. To bring you up to speed here is a interesting piece Bloomberg news did on how and why it is happening. So, the DTCC, the company behind all wallstreet transactions processes $1.4 quadrillion in trades per year and by the way here is what that number looks like $1,400,000,000,000,000! The SEC stated that %1.5 of trades per day are not settled now in small amonts %1.5 might seem like a drop in the bucket but when that much money is changing hands it is a more than substantial sum, $6,000,000,000 in trade do not clear every day. But is that really all that does not clear? There is also something called the continuous net settlement system or CNS. To explain it simply let’s say that Morgan has 100,000 shares of IBM that they owe Goldman Sachs, and Goldman Sachs on their side has 96,000 shares of IBM that they owe Morgan. Rather than 100,000 flows from one side and 96,000 flows from the other into the DTCC. The CNS says there is only a difference of 4,000 share that need to trade hands here and that is all that gets sent to the DTCC. The DTCC has said that the continuous net settlement system takes care of 96% of the trades.
There is also what is known as an “ex-clearing”. Say The FTD’s (failure to deliver) between two companies have been outstanding for a long time they can say lets settle it amongst ourselves. This is basically a contract outside the jurisdiction of the DTCC and SEC. If both companies made millions by bankrupting a company who’s to say they don’t just call it default?
One would think there would be some stiff fines and punishment for this sort of thing but the truth of the matter is that if you did it before it made SRO’s threshold securities list you are “grandfathered” or in other words off the hook, don’t take my word see what the SEC says. Even when you are on that list (that dictates FTD’s should be settled in 13 days) you can let it run 400 days no problem. Perhaps the SEC could be a little stiffer on this. Well lets give them some credit they have handed out some fines here and there…
In March 2007, Goldman Sachs was fined $2 million by the SEC for allowing customers to illegally sell shares short prior to secondary public offerings. Please! $2,000,000 to Goldman Sachs is a joke when there is $6,000,000,000 a DAY up for grabs. Not even a slap on the wrist.
In July 2007, Piper Jaffray Cos. was fined $150,000 by the New York Stock Exchange (NYSE). Piper violated securities trading rules from January through May of 2005, selling shares without borrowing them, and also failing to “cover short sales in a timely manner”, according to the NYSE.  At the time of this fine, the NYSE had levied over $1.9 million in fines for naked short sales over seven regulatory actions. They are sweating now… in the cayman islands.
Also in July 2007, the American Stock Exchange fined two options market makers for violations of Regulation SHO. SBA Trading was sanctioned for $5 million, and ALA Trading was fined $3 million, which included disgorgement of profits. Both firms and their principals were suspended from association with the exchange for five years. Hell yea, weak fines and a five year vacation to boot. If they ever get board I’m sure they can find a broker.
In October 2007, the SEC settled charges against New York hedge fund adviser Sandell Asset Management Corp. and three executives of the firm for, among other things, shorting stock without locating shares to borrow. Fines totaling $8 million were imposed, and the firm neither admitted nor denied the charges. $8,000,000 now we got something.
In short you can be sure of one thing, these firms will keep taking fines happily as long as they can go about their business. Meanwhile a lot of hard working people and good companies pay the price. If you ever get to question a political candidate in public, please ask them what they plan to do about this. It will draw some attention to the matter. Why not go the extra mile and tell the people in office before they go up for re-election that if they do not act on this matter you will find a candidate that will and they will get your vote. Without jail time this will continue to happen, help put an end to the legal racketeering on wall street, or a part of it at least.