Who Guarantees Settlement of Stock Trades?
















          








































           
NIPC Comment Letter Dec 18, 2008



    Further Improvements on the federal level


    Amend SEC rule 15c3-3
    The biggest problem with shorting is that even legal shorting is not market neutral, but depressive, under
    current regulation. These regulations allow a broker to borrow securities from a customer without his
    permission (for the purpose of lending them to short sellers) up to a market value of 140% of total margin
    debit in the customer's account.

    Apart from the 140% figure enabling excessive margin power to short sellers (it should be 100% to ensure
    that short selling is market-neutral) the wording of the regulation fails to anticipate that accounts can contain
    more than one type of security. Thus a broker is empowered to apply ALL of the margin debit to a minor
    position in the account and thereby lend all the shares - even if the shares in that position were not providing
    any collateral against margin debit.

    In addition, the SEC, in order release no. Release No. 47683  (2003) allowed broker-dealers to substitute
    Mortgage Backed Securities in place of cash collateral for borrowers when borrowing customers' equity
    securities for lending to short sellers. The SEC needs to be forced to reverse this idiotic policy.

    Basically, the SEC should be forced to

    a) Ensure that short and long margin power are about equal
    b) Ensure that investor cash and securities are not taken illegally and by misrepresenting the assets held for
    the accounts. Cash is cash and not questionable MBS securities, etc....
    c) A new federal statute should be passed that makes it illegal for broker-dealers to credit more securities to
    investor accounts after settlement date, than broker-dealers actually have. They should also be forced to
    debit securities from investor accounts if they fail to settle or are borrowed or removed fro any reason.
    d) Broker-dealers should pass on 50% of the lending income the lent securities earn, with the investors from
    whom the securities were "borrowed".    

    Re-instate the Uptick Rule (10a-1)
    The uptick rule was in effect from 1938 until 2007. Since the rule was eliminated, index prices in equities have
    lost 50% of their value. The rule was instituted to put the breaks on unbridled short selling and the price
    destruction that comes with it.

    Bring Back the Glass- Steagall Act  of June 1933
    The Banking system must be separated and divorced from the securities industry as it was from 1933-1999.
    Combining the two in 1999 has been lethal to the entire US financial system and economy. Thanks to Phil
    Gramm of Texas and Jim Leach of Iowa, the Glass Steagall Act was repealed in 1999 with a veto proof
    majority.

    Regulate all Derivatives
    All derivatives must be defined, registered, valued and regulated by requiring minimum reserve requirements
    when holding, issuing or trading derivatives. Before a new type or class of derivatives can be traded, it must
    first be registered, defined and valued. Fails to deliver and fails to receive would fall under this category.
    Basically all types of securities and derivatives traded between institutions that are registered should only be
    permitted to hold or trade securities that are regulated in this way. These derivative securities should also be
    handled through clearing and settlement agent, just like equity securities. Trading in unregistered derivatives
    among registered institutions or offered to customers should be prohibited.

    Limit Short Selling
    Right now, there is no limit to the amount of legal short selling that can occur in any security. This is because
    the same security can be lent and relent over and over again with out decrementing the pool of lendable
    shares to short sellers and because lent shares are not debited from accounts from which they are taken.
    This leads to the ability to sell short in unlimited amounts and incorrectly credits more securities to investors
    than actually exist. To bring reality to the markets and away from fantasy and misleading data and reporting,
    we suggest the following:

    a) When securities are borrowed, they should be debited from the accounts from where they are borrowed
    from
    b) The short interest in any security should be limited to 50% of issued or outstanding shares of any issuer


    Nobody.


The simple answer is that there are no settlement agents in the USA securities industry. Nobody guarantees
that securities will be delivered as contracted to the buyers. In 1934, The U.S. Congress recognized that not
only was it essential to have a settlement facility, but to link the settlement facility with clearing:

17A of the 1934 Securities Exchange Act

The Commission is directed, ......

     
       2. to facilitate the establishment of linked or coordinated facilities for clearance and
    settlement of transactions in securities, securities options, contracts of sale for future
    delivery and options thereon, and commodity options;

But the SEC has done nothing to establish a settlement facility, much less link it with the clearing facility in place.
The DTCC is not a settlement agent and does not guarantee settlement or delivery of securities as contracted.
They merely process settlement information and transfer securities as ordered. They facilitate settlement, but
are not a settlement agent nor guarantee anything in that regard.

Solution
Pass legislation, that adds the function of settlement agent to all clearing agents. That is, if any entity wants to
clear trades, they also have to settle trades and bear the full responsibility and liability for delivering securities
as contracted to buyers. This would need to be accompanied by the authorization and obligation to buy-in all
sales that are not delivered as contracted - that is buying in all "fails to deliver". Finally, it should also include a
provision that prohibits trades to leave the settlement and clearing agent once it is in their system. This is to
stop "fails" obligations from being pushed elsewhere outside the system and turned into an unaccountable "ex-
clearing" fail obligation.

This would satisfy 17A once and for all and not allow any fails to fester in the settlement system.