An Open Letter To Mr. Thompson of the DTCC
Dear Mr. Thompson:
I am again writing to you in the hope that you will take a moment to help me understand where I went wrong. It is important to me personally as well as to my organization, the National Coalition Against Naked Short Selling, to apprehend where our reasoning went awry.
In your recent @DTCC “interview” of March 5 you made a number of comments that would lead the reader to believe that the NSCC’s stock borrow program did not allow that subsidiary of the DTCC to lend out more shares than a participant firm held, or that were authorized and registered by the issuing company. The way the answers were worded, one could easily draw the conclusion that you had truthfully and fully addressed the issue.
You had apparently put to rest the nasty rumor that the DTCC created an unauthorized, unregistered float of shares over and above those legally authorized by the company in question – what some would argue convincingly is electronic counterfeiting of stock. In point of fact, in one artfully worded section, you went as far as to denigrate your detractors as either “intentionally misrepresenting” the “SEC approved system” or of being “profoundly ignorant” of the way the process works.
Your words: “Once a loan is made, the lent shares are deducted from the lender’s DTC account and credited to the DTC account of the member to whom the shares are delivered. Only one NSCC member can have the shares credited to its DTC account at any one time.
The assertion that the same shares are lent over and over again with each new recipient acquiring ownership of the same shares is either an intentional misrepresentation of the SEC-approved system, or a profoundly ignorant characterization of this component of the process of clearing and settling transactions.”
Strong language designed to end any idle and erroneous speculations by the dim, or the uninformed, or the dishonest.
This was in conflict with the way that I understood that the system worked, so I sent you an email around April first, requesting clarification, and offering a very specific description of how I believed the process functioned.
I can understand that you might be occupied with many important tasks and obligations, and thus might not have the time to get around to clearing up the issue for the largest entity of its kind, one of your main detractors, a coalition that has run full page advertisements in the Washington Post and has been involved in the only television footage ever aired that described the naked short selling abuse story. But I had hoped that you would seize that opportunity to disabuse us of our misunderstanding, so that we could fold up our tent, apologize for inconveniencing you, and move on to other things.
Because surely we had gotten it all wrong – you literally called us cretins or crooks for our flawed take on the matter.
It seemed reasonable to expect some response, given that you are the spokesperson for this issue that the DTCC has put forward to explain things. So far, nothing, but I have remained hopeful; cautiously optimistic, if you will.
Imagine my surprise today when I read Professor John Finnerty’s March, 2005 abstract titled “Short Selling, Death Spiral Convertibles, and the Profitability of Stock Manipulation” – in which the Professor of as venerated an establishment as Fordham University agreed with my supposedly incorrect understanding! Apparently he is either as intellectually dishonest or as “profoundly ignorant” as the members of NCANS are - not to mention the attorneys that are suing you, and the reporters you castigated at Euromoney.
So now to the problem. Either we are all badly wrong, or you are lying.
Given that you are an officer of the court, an attorney, and the representative of a self-regulatory organization that is dependent upon the investing public’s belief that you are honest in your dealings, I find it disturbing to consider that you might be bald-faced lying, in print - and therefore conclude that we must all have it wrong.
The alternative explanation would be that you are deliberately misleading the American public and mischaracterizing the operations of the NSCC, in an effort to obfuscate the truth. I find it hard to comprehend that you as an individual, as well as the DTCC, could be involved in this type of possibly criminal dishonesty. I’m hoping that you will grace us with the few moments it should take a gentleman of your robust and comprehensive knowledge of the system, and explain how, and where in the process, the professor has this wrong. To save you the time of looking it up, I have taken the liberty of excerpting pages 35 and 36 of his abstract:
"The NSCC was created in 1976 through the merger of three major clearing corporations (NYSE, AMEX, and NASD). NSCC works in conjunction with the DTC to provide centralized clearance and settlement for broker-to-broker stock trades in the United States. The NSCC clears and settles transactions through the Continuous Net Settlement (CNS) system. It guarantees completion of the transactions by assuming (a) the obligation of the buyers to pay for the shares upon delivery and (b) the obligation of the sellers to deliver the shares. During the trading day, the CNS continually nets all trades by its members in each security. The member’s previous trading day’s closing net long or short position is continually updated with the day’s purchases and sales. At the end of the trading day, the member’s updated net long or short position in each stock is communicated to the DTC for overnight processing. Each short position is compared to the member’s DTC account to determine if the member has enough shares on deposit to settle the short position. If so, then the DTC transfers the required number of shares from the member’s DTC account to the NSCC’s DTC account.
Based on instructions from the NSCC, the DTC transfers shares received from members with short positions to the accounts of members with long positions. If the member with a short position does not have enough shares in its account to cover the short position, then the NSCC has five choices. It can wait another day to see whether the seller cures the fail by delivering the shares. Second, if it determines that the open short position is a high-priority obligation, it can attempt to arrange to borrow enough shares through its stock borrowing program to satisfy the open position (NSCC, 2003). If it is unable to borrow the shares, then the DTC has the three remaining choices: (a) it can demand a dealer buy-in (forcing the selling broker-dealer to buy the shares in the open market and deliver them to the DTC), (b) buy the shares itself in the open market and charge the cost of the buy-in to the account of the seller, or (c) as a last resort, demand that the seller break the trade and compensate the buyer for the associated cost.
The NSCC’s stock borrow program permits it to borrow shares from participating members to cover end-of-day open short positions that it deems to be of high priority. Addendum C-1 of the Rules and Procedures of the NSCC (2003) governs the operation of the stock borrow program. Members who wish to participate in the program inform the NSCC each day of the number of shares of each stock in their general un-pledged account at the DTC which they are willing to lend. After the NSCC determines the number of shares it would like to borrow to satisfy all high-priority open positions, it applies a formula to determine from whom it will borrow the shares. The formula favors members who have the lowest stock loans from the NSCC and who pay the most clearing fees to the NSCC. When it borrows shares, the NSCC debits the lending member’s DTC account but also credits that member with a long position in a special CNS sub-account set up specifically for the stock borrow program. The sub-account holds what is tantamount to an undated stock futures contract with the NSCC as the obligor. The NSCC also credits the lending member’s regular CNS account with funds equal to the market value of the borrowed shares, which the lending member may invest overnight in an interest-bearing account.
The DTC credits the borrowed shares to the NSCC’s DTC account, which eliminates its short position, and transfers them to the buyer’s DTC account. The buyer acquires all right, title, and interest in the borrowed shares – just as it would in any cash transaction that settles the regular way – including the right to vote the shares, receive dividends, resell them, or lend them (e.g., back to the NSCC through the stock borrow program).
The NSCC charges a fee to each member with a short position that triggered the NSCC’s need to use the stock borrow program. The NSCC returns the borrowed shares when it receives deliveries against outstanding short positions that exceed the amount of shares it needs to satisfy high-priority open short positions.
The stock borrow program can facilitate naked shorting in two ways.
First, sellers can continue to fail to deliver because the NSCC can borrow the shares it needs to meet its clearing obligations through the stock borrow program. It does not have to force the seller who fails to deliver to buy in shares, nor does it have to go into the market to buy in the shares. It simply borrows them from another member firm to effect the buy-in. Since the NSCC covers the short position, the buyer of the stock also never has to buy them in.
Second, the stock borrow program allows the shares to be recycled. Each stock loan gives rise to another stock futures contract. Any single share could actually be re-lent multiple times, giving rise to multiple futures contracts. Each futures contract credited to a broker-dealer’s sub-account at the DTC continues to be reported on the broker-dealer’s books as a share held either in its proprietary account or in a customer account. In either case, the account holder believes he owns a real share with all the rights attached to it.
Consequently, the stock borrow program effectively creates additional unauthorized shares of the issuer’s stock. These undated stock futures contracts, which the financial press has referred to as phantom shares, inflate the amount of stock that is available fortrading and also increase the amount of stock that is available for lending to short sellers (SEC, 2003b).”
Again: “Consequently, the stock borrow program effectively creates…additional …unauthorized….shares…of…the…issuer’s…stock.”
Now, I am likely a bit provincial, naïve, misinformed, dare I say, “profoundly ignorant.” The good Professor, however, seems to be both worldly as well as erudite, and fluent in the minutiae of the matter.
So please, favor us with a simple, short explanation of precisely where we have this wrong. Feel free to highlight the text from the Professor’s work, and provide a one or two sentence explanation of his error. I’m confident that the few minutes that will take you will pay enormous dividends in terms of ending this pervasive ignorance, which apparently infests the hallowed halls of academia, as well as the unsophisticated streets of Mainstreet USA. Feel free to use small words if you like, so that we all can follow along – let’s not leave anyone behind.
I would encourage anyone that is interested to email this, with my compliments, to Mr. Thompson at Lthompson@DTCC.com - or reach out and touch him at (212) 855-3240 and ask him to please respond. In fact, go ahead and post a comment here if you sent this to him, so that we can keep track of the number of folks he is too busy to respond to. I am a huge believer in giving one every opportunity to demonstrate one’s honesty and integrity. Or giving them enough rope…