Here Are A Few Rules And Regulations That Issuers Of Securities Would Actually Like To See From The SEC… All Of Them Very Simple Fixes, We Say:

TOTALLY ELIMINATE NAKED SHORT SELLING: We still can’t figure why smart people haven’t been able to understand exactly how naked short sales cheat investors – and how they can and do create cascades of sales to spook legitimate investors into panic selling – so the shorts can lock-in their profits, guaranteed – AND how simple the “fix” to the naked short-selling scandal really is:

Here’s the simple FIX: Every single trade must be settled on T+3, or a mandatory buy-in must be executed by the seller’s agent…No excuses or exceptions allowed; something the SEC is still – shockingly and wrongly allowing.

We’re been equally surprised by the large number of very smart people who think that restoring the “uptick rule” is the solution to the problem. It isn’t – especially since with trades now moving in one-cent increments, any crook in town can create an uptick to sell on, but still fail to deliver, sale after sale, after sale.

Let’s patiently review what should really be SIMPLE LOGIC, about the way securities markets are supposed to work – AND also about the INEXORABLE, BUT BASICALLY SIMPLE LAW OF SUPPLY AND DEMAND:

• First, let’s remember that one of the main reasons the SEC was formed in the first place – and THE main reason that SEC registration of all publicly tradable shares was and is required – is to prevent fraudulent ‘overissuances’ of securities. In other words, if 100 shares of Company-A are registered, and I own 10 of them, the SEC rules and regs are meant to assure that I own one tenth of the company, regardless of whether the shares are $1 each or $10 each.

• Second, let’s note that when shares are “sold short” there is always - by definition - a buyer. That buyer is entitled to have possession of his shares, and ALL the rights pertaining thereto, on T+3…And, under the present system, the buyer’s agent automatically credits him  ith the ownership.

• But thus, please note, it is not enough for a seller to simply “locate shares” or to simply “ascertain that shares are available for lending” as current SEC rules seem to say is sufficient: The “short seller” must literally “borrow” the shares – and literally deliver them to the buyer for cancellation and re-registration; otherwise the issuer is “over-issued”.

• Let’s review: For every single day a short-seller is allowed to go “naked” – i.e. the seller or his agent has failed to deliver the shares sold for cancellation – the issuer is literally “over-issued” by that number of shares.

• In other words, if I sell 10 shares, and the buyer has taken ownership of ten shares…but I haven’t shares ‘floating’ out there in our little example…And, most important to notice; in economic terms, this represents a 10% dilution of the SEC-Registered shares.

• Theoretically, the 10% dilution – and the accompanying economic distortion of the true “equilibrium price” of the stock – is supposed to be immediately corrected by a forced “buy-in” of the undelivered shares, which will automatically bring the price back to a market-based “equilibrium” price.

• But, when the buy-in rule is NOT strictly enforced, as is presently the case, ‘smart’ naked-short-sellers will make as many more naked-short-sales as they possibly can – since allowing shorters to go naked almost guarantees that the shares will continue to fall – which will allow them to “cover” at even lower market prices than if they’d covered on time.

• Please note carefully that allowing “naked shorts” to go uncovered by T+3 creates a “double whammy” in terms of market dynamics AND in terms of the economics: Not only is there a frightening drumbeat of repeated sales – that tends to encourage a barrage of covered-sales too - each “naked sale” dilutes the number of shares that are really outstanding - on a direct share-for-share basis: The BUYERs are always being credited with the shares they’ve bought, but NO shares have been presented for cancellation.

• Please note too, that IF a mandatory buy-in takes place, the “outstanding shares” are immediately brought back to the Registered number of shares –AND the market purchase automatically assures that the PRICE is brought to a market-based “equilibrium number”…which, of course, is the correct number from a market-based perspective.

• Let’s review the math again: If I make a short sale of 10 shares of the 100 shares outstanding on Monday, and don’t deliver on Thursday – and I am not automatically bought-in - as theoretically required, Company-A is over issued by 10%. If I decide to make another naked short sale of 10 shares - and once again fail to deliver, and fail to get bought-in, Company-A is now over-issued by 20%. Make no mistake about it: the SEC is allowing this to happen every single day!

• Let’s review the consequences again: The market - and the market price of the stock - are being inexorably distorted…because in reality, sellers are being allowed to sell something they do not have…or ever PLAN to have – AND, for every day they are allowed to ‘go naked” they have been allowed to sell shares that should no longer truly exist under the Charter and Bylaws of the company - or under SEC rules.

So let’s sum up: There is absolutely nothing wrong with short selling…as long as one ponies-up the shares on settlement date…regardless of whether one owns them outright or borrows them. (If one bets the wrong way, as very often happens, and the shares go UP – and pass the point where the seller “sold short” legitimate short sellers will, of course, have to “cover their bet” at some point, and repay the borrowed shares – either by delivering shares they may now own, or by buying them at the market price, which keeps the price of said shares at the market-based “equilibrium price”).

But NOTE WELL: There IS something that is both immoral and illegal about selling something you DON’T OWN – or where you haven’t actually borrowed the goods to make delivery…and MADE delivery, pursuant to the normal terms of the sale. (And if you sold short with no intention of ever delivering the goods…that’s fraud.)

If one allows the SUPPLY of shares to multiply by 5%, or 10% or more – as naked short sellers actually have done…while the “DEMAND” to buy shares is constant, other things being equal, the PRICE of said shares will definitely FALL. (This is the first law of economics, by the way). And if one adds to the normal desire to sell – by initiating a panic, fueled by sales of shares the one doesn’t own, and doesn’t intend to lay claim to and deliver by the agreed upon date…(i.e. an artificially induced ‘disequilibrium’ between real supply and real demand)…the price will fall even more!

NAKED SHORT SELLING IS NOT A FIGMENT OF SOMEONE’S IMAGINATION: WE KNOW OF LOTS OF COMPANIES THAT DISCOVER AT ANNUAL MEETING TIME THAT THERE SEEM TO BE 50% MORE SHARES OUTSTANDING THAN THEY HAVE OFFICIALLY “REGISTERED” WITH THE SEC…AND YOU CAN FIND SUMMARIES OF UNSETTLED SHORT-SALES IN THE DAILY PAPERS. THE SEC CAN FIX THIS DISGRACEFUL SITUATION WITH THE STROKE OF A PEN!

FIX THE “EMPTY VOTING SCAM”: THIS IS A TRAVESTY, THAT U.S. COMPANIES HAVE BEEN WHISTLEBLOWING ABOUT FOR 5+ YEARS, ALSO TO NO AVAIL: Guess what? If the SEC fixes the naked-short-selling scandal – by insisting on T+3 delivery of sold shares – whether previously owned or ‘borrowed’ – or, failing that, an automatic buy-in on T+3 - they will automatically fix a very big part of the “empty voting” scandal too. (When there’s a naked short sale, as we HOPE you’ve figured out from the above section, the buyer automatically gets the vote…but the party who has not delivered has created an EXTRA vote… since the issuer is now “over-issued’ until the short-sale is covered, and, until then, an “extra” number of votes are still outstanding).

But there IS still some confusion in the securities lending world, and some very bad recordkeeping too, which we believe is defrauding investors when it comes to the “value” of their vote…and which should be fixed pronto:

And this too is very easy to fix: All that is needed is for the SEC…or FINRA, if they prefer to take the lead, to simply DECLARE that votes remain with the LEGAL OWNER of the shares…unless such owner executes an irrevocable proxy, signifying that he has given up the right to vote, in favor of the proxy-holder.

As we’ve mentioned here in earlier columns, there is nothing new about “buying votes” – and there is nothing intrinsically wrong about it either, as long as there’s reasonable disclosure.

But there IS something wrong with selling votes and not giving the proceeds to the OWNER of the vote, as many brokers are clearly doing. And there is also something very wrong with using ‘loopholes’ in the rules, and exploiting deficiencies in the recordkeeping systems to surreptitiously RIG a corporate election - which statistical studies indicate is actually happening with regularity.

ACCESS DEBATE: We’re not entirely sure that the corporate community is ready to face up to this yet, but clearly, the struggle over “proxy access” has been a consistently loosing battle for them to date. As we’ve written at length, the unintended consequences of trying to fight this off – chiefly the move to oust directors anyway, through vote-no campaigns and other ad-hominem attacks – have been far worse than the proposed ‘remedy”… which we believe would be applied only at companies that are in extremis.

Further, as we’ve also pointed out, how is it “good governance” to let the likes of Carl Icahn nominate two directors with only a 5% stake in a company, as he did at Yahoo, and at Motorola - with no commitment to hold onto it - and with, clearly, only his own interests in mind…and often, with no election at all, for at least a year, and sometimes for three?

We say, let’s compromise on a reasonable number – let’s say 10% of the outstanding shares – where a like-minded group with 10% combined would be able to nominate let’s say a minority of the directors standing for re-election at any meeting; so one of three, or five of twelve, with the highest vote-getters taking their seats. We can’t imagine how any savvy group of inflamed investors could possibly fail to reach this threshold – IF they have a point that is. And, since corporations are already being bullied into action by folks with far less than 10% we don’t see how they could possibly complain.

American companies can not really afford to have “too easy access” to the proxy statement…just as activist investors can’t afford to mount a lot of fruitless election campaigns…so let’s get this stupid, time and money wasting distraction behind us.

CONDUCT THE TOP-TO-BOTTOM REVIEW OF THE PROXY DISTRIBUTION AND VOTING SYSTEMS, AND THE NOBO/OBO MUMBO-JUMBO THAT THE ISSUER COMMUNITY HAS BEEN CALLING FOR - FOR 10 YEARS NOW: How can it possibly be considered “good governance” for the SEC NOT to formally review, and put out for bids, a system that affects every public company and every single investor – and that has not been formally revisited, or rebid in 25 years? Any professional manager we know who let a contract run for 25 years without a formal review would – and should – be promptly sacked!

ISSUE THOSE TRANSFER AGENT REGULATIONS… ANOTHER TRULY IMPORTANT INITIATIVE THE SEC HAS BEEN DIDDLING WITH FOR ALMOST 10 YEARS NOW! Here’s yet another instance where the SEC staff has been unwilling to get its “hands” into something that requires a bit of brainpower - and maybe a bit of dirty-duty - and something that definitely requires a bit of hard work. Where else but at the SEC could staffers promise action “soon” for ten full years…and deliver NONE?