Dr. Jim has graciously offered up his latest installment in his 40 bullet points on the NSS issue. Here is number thirteen:
13) Although the NSCC division of the DTCC acted as the “Loan intermediary,” and did the actual “pseudo-borrowing” of “shares” from the “Lending pool,” and is directly owed these shares by the clearing firm failing delivery, they contend that they don’t have the power to demand the payment of this IOU owed directly to them as the loan intermediary. This volunteering by DTCC management to act as the intermediary “straight man” or “shill,” (that did the SBP pseudo-borrow and directly holds the resultant IOU - theoretically for “enhanced efficiency” reasons only), which can later claim to be “powerless” to demand the repayment of it from its own bosses/employers (the 11,000 participating b/ds and banks of the DTCC), is held by many securities scholars as nothing short of genius.
Recall from previous chapters that the other parties to the trade and the “borrow” are certainly not going to volunteer to pay back or demand the payment of this debt. Party #1, the DTCC participant clearing firm failing delivery, certainly won’t volunteer because he doesn’t want to go to the open market and cover his naked short position. Party #2, the DTCC participant “lending b/d,” won’t demand the shares back because he’d rather have the cash equivalent of his client’s shares to earn interest off of and to count towards his net capital reserves. This is a lot better than an electronic book entry or a paper certificate gathering dust. Party #3, the buyer’s b/d, also a DTCC participant, that owes a direct duty of care to his client, the purchaser of the borrowed shares, doesn’t even know that his client’s purchase involved a delivery failure because he did get the “pseudo-delivery” of an electronic book entry (which may or may not have any paper-certificated shares held in DTCC vaults to justify its existence). This keeps the buying b/d pacified, and it keeps him from making any proactive efforts to secure delivery of the shares for his client, as per his duty. It’s important to impart plausible deniability to the DTCC participant owing the most direct duty of care, this being the purchasing b/d. Note how his duty of care is conveniently “snuffed out”.
So, who does that leave to demand the payment of this IOU? It leaves Party #4, the NSCC, the holder of the IOU and the creditor of this debt that all of a sudden, out of nowhere, claims to be “powerless” in demanding its payment. Imagine that - a “banking entity”, A Limited Purpose Trust Company, and member of The Federal Reserve, unable to call in its own debts. We should all have the good fortune to be able to borrow money from such a bank. Sorry, you need to be a DTCC Participant to gain access to this very special bank.
I told you way back in Chapter 1 of how truly brilliant this “fraud on the market” really is. The key is to have DTCC management willing to play the “powerless shill” role on behalf of their 11,000 employers. As Dr. Bob Shapiro once said in a research piece, the DTCC goes way out of their way and voluntarily chooses to not buy-in those failed deliveries. In Chapters 43 and 44 we’ll list 18 reasons why the DTCC does indeed have not only the “Power,” but the “Duty” to buy-in those failed deliveries - especially since it acts as an SRO (see definition below) and as a “Qualified” control location as per our old friend 15c3-3 of the ’34 Exchange Act. Recall the definition of a Self-Regulatory Organization (SRO): an entity, such as the NASD, responsible for regulating its members through the adoption and enforcement of rules and regulations governing the business conduct of its members.
Now compare that definition with recent statements made by the DTCC:
1) “Naked short selling, or short selling, is a trading activity. We don’t have any power or legal authority to regulate or stop short selling, naked or otherwise.”
2) “Reg SHO also allows market makers to legally “naked short” shares in the course of their market making responsibilities, and those obviously result in fails. We can’t do anything about them but what we are doing: that is, report all fails of more than 10,000 shares in any issue to the marketplaces and the SEC for their action.”
3) “NSCC and DTC do not exercise regulatory or enforcement powers over their members and participants. They cannot, for example, initiate a buy-in-only brokers can do that. And they cannot compel brokers to initiate buy-ins.”
4) “We also have no power to force member firms to close out or resolve fails to deliver.”
5) “Simply put, DTCC’s subsidiaries are not participants in the marketplace and concerns relating to marketplace activities (such as short selling) should not be confused with the clearance and settlement function”.
(Newsflash: An SRO is mandated to regulate the business conduct of its members. Investors don’t really care if the DTCC “Subsidiaries” had a banner year or not.)
MY SYNOPSIS OF THE DTCC MINDSET: As an SRO we are mandated to regulate our members by enforcing regulations governing their business conduct, BUT WE DON’T HAVE THE “POWER” TO REGULATE OUR MEMBERS BY ENFORCING REGULATIONS GOVERNING THEIR BUSINESS CONDUCT. (Okee-dokee! I wonder why the SEC website claims that the SROs are the first line of defense for maintaining investor protection and market integrity? Let’s review a question from Book #1. Why does this “first line of defense” for investors have their rifles aimed at these investors and why does the SEC through the filing of their “Amicus” briefs in NSS cases not only provide ammunition to the DTCC marksmen but actually run around and remove the combat helmets from investors?)
Since Wall Street is a “Zero sum” game, and all of the DTCC participants that employ DTCC management are left with huge smiles on their faces from failed deliveries bailed out by the SBP, then somebody must be left with a frown. Oh that’s right, it’s on the faces of the investors (owed the fiduciary duty of care by these characters), that watch as their investment dollars fall into the lap of these “Professionals” while the share price of their investment falls out of bed.
Note how the investor’s money first goes to the lending b/d to collateralize the “pseudo-borrow,” and then as the share price drops, the collateralization requirements also drop, and this money is shunted over to the naked short seller’s clearing firm, even though he has failed to cover after an inordinate amount of time and may have no intention whatsoever to ever cover his naked short position.
Note also that if the NSCC DIDN’T generously volunteer to be the “Loan intermediary” (for “enhanced efficiency” reasons, of course), then a clearing firm failing delivery would have to go directly to a lending b/d and be subject to an open market buy-in at any time if the lending b/d needed his shares back.
With the purchasing b/d insanely being allowed to place the “pseudo-borrowed” shares he just bought right back into the lending pool from whence they just came nanoseconds ago, this morning’s “Purchasing b/d” becomes this afternoon’s “Lending b/d” able to convert his client’s shares into the b/d’s cash. Now can you see how these discount brokers charging $7 per trade make their money? They pull in opportunistic investors with their cheap commissions, set them up with a margin account, and rent their investments to the mortal enemy of their investment, the naked short seller, to “Facilitate” the naked short seller in his efforts to dilute the preyed upon company out of existence. So much for fiduciary duties of care! Oh that’s right, the party with the most direct duty of care, the purchasing b/d, had it snuffed out.
This ability to place recently purchased shares right back into the anonymous lending pool (without any identifying markers) allows this particular parcel of shares to be replicated many times over, and to be loaned out to perhaps 10 different naked short selling fraudsters simultaneously, all to those with the intent of bankrupting the invested-in company. The margin agreement that the investor signed said that his shares can be loaned out or hypothecated to others. It didn’t say anything about being replicated 10-fold and then being simultaneously loaned out to 11 b/ds intent on killing the invested-in company.
What would a “Lending pool” with integrity look like? It would mandate the identification of the parcels of shares in the lending pool and the notifying of the owner of any loaned shares that he just lost his voting and dividend rights. This would end the “Self-replenishing” nature of the lending pool. No doubt about it this would mandate a lot of computerized “paper shuffling” with the frenetic pace that Wall Street moves at. This brings us back to the old “Efficiency vs. integrity” trade-off studied in Chapter 5, involving the DTCC’s sacrificing of market integrity and investor protection for their desire to clear trades at supersonic speeds.