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Naked short selling: Letters to the editor. DTCC and R J Shapiro

Includes correspondence from Larry Thompson, DTCC and Robert J Shapiro, Washington economist. Response to April 2005's Naked shorting: The curious incident of the shares that didn't exist.

  April's Cover story: The curious incident of the shares that didn't exist


- Larry Thompson: Defending the DTCC

- Robert J Shapiro: A case still to answer


Defending the DTCC


Dear Sir, DTCC has been an integral part of the capital markets system in the US for over 30 years, providing automated post-trade processing for the nation's securities industry. Given our central role in processing securities transactions, we are subject to intensive regulation by federal and state authorities.

All of the rules pursuant to which we operate are subject to approval by the Securities and Exchange Commission. Throughout our history, we have repeatedly demonstrated our resolve to protect the integrity and promote the efficiency of the financial markets.

We place huge value on our reputation for providing the best and most ethical services to all of the financial institutions that constitute our members and participants. Accordingly, we cannot leave unchallenged Euromoney's misleading portrayal of DTCC in the April cover article on naked short selling, in particular, your representation of DTCC's stock borrow programme (SBP).

This article appears to have been based on allegations asserted in various pieces of litigation filed around the US against DTCC and numerous broker dealers.

In repeating the theme of these lawsuits, the article fails to acknowledge that, in reality, only a tiny minority of all deliveries (about 1.6%), and a small minority of delivery failures (0.25%) are filled by shares borrowed through the SBP. This fact would seem to overturn your assertion that short sellers feel: "Who cared if you didn't own what you sold – the DTCC would make good on your delivery."

I am also surprised that you refer to lawsuits filed against DTCC without mentioning that most have been dismissed or withdrawn. In the case of the Sporn litigation in California you refer to, while plaintiffs continue to file amended complaints in an effort to state a  recognizable claim, the federal judge dismissed the second amended complaint in its entirety last month.

The third amended complaint is now subject to another, and hopefully final, round of motions to dismiss.

In addition, could I take the opportunity to correct several factual inaccuracies:

— Euromoney repeatedly refers to the SBP as relying on a "lending pool" maintained by DTCC.  Nothing of the sort exists. Securities remain credited to the independent DTC accounts of lending members until and unless the member informs NSCC on a daily basis that a position is available for the SBP, and NSCC needs the shares to fulfil a delivery obligation that day. All of this is accomplished electronically, through automated systems and procedures.  In any event, there is no "pool" of shares.

— While making much of the fact that brokers don't enforce buy ins, Euromoney never reports that NSCC has no power to compel its member to buy-in open positions. It is up to the broker to determine whether to buy in. NSCC is not a regulator, nor does it exercise enforcement powers. Those powers reside with the federal and market-based regulatory agencies.

— Your example regarding the sale of hypothetical XYZ shares is wrong in asserting that: "Buyer A and Investor B could sell the same company shares as a result of the SBP". Nothing about the SBP enables Investor B to sell shares that it otherwise could not have sold. It is simply untrue that Buyer A and Investor B "could sell the same shares".

— In relation to what information NSCC shares with the public, it does not disclose information regarding open positions (nor do the SEC or the national exchanges) – this is confidential information and, if disclosed, could be used to manipulate the market.

— Much is also made regarding the delivery of physical share certificates. This is wrong. DTC routinely honours requests by its participants (acting on behalf of their customers) to withdraw a paper share certificate. What has not been permitted by the SEC are attempts by certain (micro-cap) issuers: (i) to remove securities that they don't even own from DTC; and (ii) to prevent their publicly held shares from being deposited at DTC.

You will appreciate that it is important for us to set the record straight, as your article raised damaging and erroneous allegations about the integrity and activities of DTCC. 


Larry Thompson

First deputy general counsel, DTCC

A case still to answer

Dear Sir,

As your article The curious incident of the shares that didn't exist (Euromoney, April 2005, page 32) reported, if stock manipulators can carry out large-scale short sales without borrowing and delivering the shares – "naked" short sales – they can manipulate the price of any stock with a modest public float. I am an economist and former US under secretary of commerce, and currently advise three law firms representing companies damaged by such manipulations. My analysis has found that the DTCC process for clearing and settling short sales appears to have played an integral role in many such stock manipulations.

The DTCC acknowledges that the value of undelivered shares on any given day averages $6 billion, equivalent to 7.2% of the daily value of all equity trades on US markets. A recent study has also found that, on an average day, more than 1,500 US stocks have failures-to-deliver totalling 180 million to 300 million shares that have persisted for two months or longer.

In an era in which 97% of securities trades are transacted electronically, how is it possible that every day there are 180 million to 300 million shares worth $6 billion that have gone undelivered for at least two months?

In addition to size, the critical matter here is whether the DTCC's own procedures facilitate this problem. My own analysis is that stock manipulators have targeted stocks with relatively modest public floats for large-scale naked short sales, confident that the DTCC's stock borrow program will potentially clear their transactions by lending the same limited number of available shares potentially multiple times. The DTCC's public statements describe a process in which the DTCC borrows shares from its members to settle naked short sales and credits them to the member to whom the shares were sold – where they apparently are then available to be borrowed again to settle another naked short sale, and again and again to settle a succession of naked short sales. In my opinion, many stock scams that depend on large-scale naked shorts could never be carried out without a settlement system that accommodates long-standing unsettled short positions.

A permissive environment in unsettled trades is even suggested on the DTCC website, which reveals that of the $6 billion in outstanding failures-to-deliver existing on any day, "the Stock Borrow program is able to resolve about $1.1 billion ... or about 20% [18%]." If the stock-borrow program "resolves" 18% of total failures-to-deliver, what happens with the other 82%? Since investors would never tolerate non-delivery for two months of $4.92 billion in securities that they purchased and paid for (82% of the $6 billion in total failures), the statement raises the possibility that the DTCC simply permits naked shorts to persist by crediting the buyers without borrowing anything at all, thereby creating genuine "phantom shares".

Whatever procedures the DTCC uses, the apparent result is that naked short sales effectively inject into the market more shares than are legally registered and issued, diluting the value of shares held by honest, hard-working investors. I can find no other plausible explanation, nor has the DTCC offered one, for scores of stocks with outstanding shorts equal to 40%, 50% and even 80% of their public floats.

The DTCC cannot distance itself by claiming that it has neither the responsibility nor the power to end these extended naked short sales. The DTCC is a trust company with a public duty to ensure the integrity of the settlement and clearance process. Since the extended naked short sales violate the integrity of that process, apparently in some cases in order to manipulate stock prices, the DTCC must have some responsibility to prevent it. And if the DTCC chose to, it could end all extended naked short sales today: before creating the stock-borrow program, the DTCC routinely resolved extended naked shorts by going into the market, buying the shares, and deducting their cost from the account of the member representing the naked short sellers.

Perhaps most indefensible of all, the DTCC says that while it knows how many naked short sales exist for each stock, and for how long, it will not disclose this information even to the issuer of the stock, claiming the information could be used to manipulate the market. The stock exchanges already issue data documenting short sales in every stock, and the additional information on how many of those short sales are naked would not in any way empower manipulators. In my opinion, by withholding this information, the DTCC succeeds only in obscuring its own potential responsibility for damage caused by naked short sales.


Robert J Shapiro