The National Investor Protection Coalition has issued a stunning petition summarizing the root cause of the naked shorting crisis, and breaking down exactly how the SEC's behavior has actively harmed investors, while allowing Wall Street to run rampant through the markets.
Everyone should read this. It can be viewed here.
After you read it, you should seriously consider donating to the cause, and signing up as a member.
The summary is fairly straightforward. The SEC has behaved, as if by royal edict, as though the federal securities laws don't apply when it comes to the settlement cycle, and more specifically when it comes to the issue of security entitlements. What do I mean?
The 1933 Act clearly defines the term "Security" and prohibits the trading of unregistered securities. The only party capable of issuing registered security is the issuer - the company who issues the stock that is then traded, after being registered. Pretty simple - it is the Federal law of the land, and preempts any state laws that conflict with it.
The SEC, however, has decided to use the UCC, the Uniform Commercial Code, and its description of a security entitlement, as a substitute for the federal law once T+3 has come and gone. UCC allows the creation of security entitlements during the settlement cycle, or more specifically, for the three days that brokers have to get the shares that were bought on behalf of their customers. Federal law allows that DURING the 3 day settlement cycle. All good. The problem is that once the shares fail to show up at T+3, the SEC just sort of acts as though the federal securities laws don't hold anymore, and that brokers can sort of ignore them, in favor of the UCC redefined term "security" - even though that definition conflicts with federal law once T+3 has come and gone. That is the current state of affairs.
The only hiccup is that the SEC never passed any rule that authorizes this. No rule was ever proposed, nor does one exist. There's a reason for that. The SEC doesn't have the authority to pass that sort of a rule - federal law preempts state law when the two are in conflict. The SEC can't change that preemption or do anything formal to try to change it, as it would be shot down. So instead, it just sort of acts as though a rule exists, or that it does have the ability to exempt participants from following the federal law of the land, figuring that if nobody challenges it, they can get away with it.
The SEC has just sort of issued statements and proclamations as though a rule had been passed. It sort of acts like one was, and behaves that it has the authority to substitute the UCC for federal law beyond the settlement period it has authority to do so within (through passage of 15c6-1, security entitlements as defined by the UCC are allowed during the 3 day settlement cycle, but there is no federal rule authorizing the extention of that temporary device past the 3 days - that is where the issue lies - no federal rule or law authorizes anyone to ignore the 1933 Act's definition of "security" bast T+3).
The big problem is that the SEC doesn't have that power. It can't just pretend a rule or authority exists to ignore the federal law of the land. The law is the law. 1933 and 1934 Acts are the benchmark, until Congress says they aren't. Federal law preempts conflicting state law.
What the NIPC demands in the petition is a formal rule that addresses this problem with the current scheme, and establishes a formal rule in place of a practice which runs counter to federal law.
If it wants to eliminate the 1933 Act and a host of rules prohibiting deceptive devices by brokers, and exempting them from following federal laws pertaining to delivery, and the settlement cycle, it needs to do it via a formal rule, with a comment period, as required by the APA, and then that rule must be published. There is no rule currently empowering brokers to substitute the federal 1933 Act defined "Securities" with state-defined UCC created "Securities", which conflict with the federal definition once no share has been delivered.
If it wants to behave in accordance to federal law, it must pass a different rule, and stop the de facto application of a de facto non-rule-masquerading-as-a-rule.
Read the petition. It clarifies a lot. Many folks erroneously buy into the SEC's baldfaced falsehood that there are "loopholes" that allow delivery failures to extend past T+3. In reality there are no such loopholes - there is merely a regulator acting as though the loopholes exist, and pretending that it has the power to enable loopholes that allow participants to act in conflict with federal securities law. But there is no rule creating the loophole, nor authorizing participants to violate the law. There is merely an arrogant captured regulator trying to exceed its authority, and figuring that nobody will actually do the heavy lifting to figure out that it never actually authorized what it acts as though it did.
Because, again, it lacks the power to authorize brokers to ignore federal securities law. It could theoretically try to do so via a formal rule, however Congress would probably have a problem with a bureaucracy rewriting federal law to suit its fancy, and thereby authorize brokers to violate a dozen or more federal laws.
Instead, NIPC is petitioning for a correct application of the law, and an appropriate rule creation process of a rule that is harmonious with existing federal law.
Please circulate this petition far and wide. Sign up as a member of NIPC. If you wish, make a donation - it is tax deductible. But do yourself a favor, and read it. No longer will you just nod along with the notion that there are loopholes that allow naked shorting, and perennial delivery failures. There is only a rogue agency behaving in an unauthorized manner, trying to usurp the power reserved for the states.