STOCKGATE TODAY

STOCKGATE TODAY

An online newspaper reporting the issues of Securities Fraud

NYSE Trivializes More Naked Shorts With Another ‘Excuse Me’ Fine - July 16, 2007

David Patch

Clearly the NYSE Regulatory Division learned nothing from the Dick Grasso debacle. Grasso of course was accused of creating a conflict of interest by having the Exchange and Market Regulation controlled under one roof and one executive. The latter, Market Regulation suffering from the conflicts of interest between developing profits for the firm and thus personal profits and managing the member fraud that impacted millions of investors.

On May 31, 2007 the NYSE again provided insight into their continued poor judgment regarding regulatory enforcement.

On May 31 the NYSE fined Piper Jaffray $150,000 for a litany of short sale violations. While the draft of the hearing board decision insinuates that the compliance lapses transpired in the first months of Regulation SHO and were lapses associated with the new short sale rules the details behind the summary tell a much different story. SHO violations represented a small fraction of the violations involved in the case.

Piper Jaffray was violating decades old short sale laws including the most basic of short sale requirements, the sale of unregistered securities.

For example, "During the Relevant Period (Jan. 3 - May 31, 2005), the Firm's Algorithmic Program Trading division ("APT") effected certain short sale transactions without borrowing shares, arranging to borrow shares, relying on an ‘easy to borrow’ list or obtaining an affirmative determination from customers assuring it that shares were available to borrow."

Affirmative Determination in the act of a short sale is a decades old requirement and in 2004 as an example as to how egregious a violation it is, the NASD fined and barred Hillary Shane for the sale of unregistered securities under the affirmative determination law. The NASD also taking a hard stance back in 1995 when it banned broker John Fiero for affirmative determination violations resulting in the closing of his firm, Fiero Brothers. The NYSE has never taking such a hard stance instead placating investors by dolling out trivial fines.

Clearly, without knowing the shares exist under affirmative determination the shares being sold would in fact be the sale of unregistered or counterfeit shares depending on how you would like to categorize them.

Even more disturbing in the NYSE actions however is that the APT system at Piper was not new as of January 3, 2005. It was a system in place and used by clients long before Regulation SHO became law and long after Affirmative Determination became a legal requirement to a short sale. Thus, the NYSE’s lack of thoroughness in determining the magnitude of the abuses by Piper stems from their decision to limit the “relevant period” to Jan - May 2005 when considering the extent of the violations and thus the penalties sought.

How many such violations does Piper have to their name?

Piper Jaffray failed to respond to a request into how long the APT system has been in service and thus how long the system violated short sale requirements. What we do know is that Piper has been a registered member of the NYSE since 1995 so it could be as long as 10 years worth of short sale violations under their belt.

One of the examples provided by the NYSE as to how egregious the APT trading violations were exposed in the complaint where "on March 31, 2005, the Firm's institutional trading desk effected the short sale of 300,000 shares of XYZ without confirming that the customer had arranged a locate or confirmed internally that the shares were available to borrow."

The NYSE for some reason never identifies the victim [issuer] of the illegal trading in the statement above, instead calling them Company XYZ. What we do know is that a 300,000 short interest being placed into a market of any stock in a single day will most likely have an impact on the market trading for that day. Even for an issuer like GE, which is trading on average 30 Million shares a day; the 300,000 would represent 1% of all trades taking place and could certainly be used to control a market.

Stock manipulation is defined many ways including the control of a market through the use of illegal actions. One can certainly bet that 300,000 illegal shares representing the sell side market in a single day will most definitely control or impact a market and thus manipulate a market.

The NYSE apparently disregarded the market impacts to the trading violations instead focusing myopically on the procedural violations. The 300,000 illegal shares traded counted as merely a single procedural violation and in this case one of an unknown number that took place in a limited period of relevancy. How profitable was that trade to the seller? The NYSE most likely failed to investigate that as well based on enforcement cases seen to date.

Then there is the case of Piper violating rule 15c3-3 of the Exchange Act of 1934.

Under the rule, a firm cannot identify that it has shares in “good control” unless trade settlement has in fact taken place and that share delivery was made. Piper, on one or more occasions allocated shares into “good control” standing when in fact the trade had not only failed settlement but had failed long past the standard 3-days.

Again from the NYSE Ruling: “For instance, on March 31, 2005, the Firm recorded a position of 61,516 shares of EFGH in a good control location despite the fact that delivery had not been made for 22 days.”

Piper counterfeited 61,516 shares of Company EFGH making such shares electronically exist in good standing and became available for future stock lending. The fact that the shares did not in fact exist jeopardizes the integrity of the markets as it creates an imbalance between the records kept at the Depository Trust Clearing Corporation (DTCC) and the those at the firm. Such imbalances risk the future use and future settlement of these non-existent shares.

The NYSE again treated this event as insignificant.

This event is not insignificant however and if the incident happened more than once which is most likely the case, and Piper profited from such lapses in compliance, strong considerations about the firm must be made. Did the NYSE follow through on why Piper incorrectly booked these holdings and why Piper failed to force settlement of the 22-day-old trade failure in good faith to the contract entered into trade under Rule 15c6-1? How many 15c6-1 contracts did Piper fail to enforce when settlement failed?

Again, the extent to which Piper violated this law is unknown because of the limited period under which the NYSE investigated the violations.

The laws violated above were not SHO violations but longstanding short sale and ownership control laws. Compliance to such laws should never be in question and yet clearly are. How a 12 year old firm operated without such compliance procedures for so long is a testament to the poor auditing of the NYSE and the fine thereafter is representative of the wink and nod that comes through the conflicts of interest at the agency.

The fact that significant and frequent violations of basic law were noted in such a short window of inspection should have been a red flag cause for alarm. That Piper is just one of several small fines imposed by the NYSE regarding short sale violations since 2005 is indeed an indication of systemic problems and the insufficient regulatory auditing of short sales over the decades. It took Regulation SHO for the NYSE regulators to look seriously into the trading strategies and subsequently Goldman Sachs, Daiwa Securities, Credit Suisse, Citigroup, and Piper Jaffray have all received miniscule fines for significant violations of long standing short sale regulations along with some more recent changes with SHO.

I contacted the NYSE to understand why such trivial fines were being handed down and as to whether the NYSE understood the implications of the trading that was taking place. Apparently company CEO’s are not the only people who fail to respond to tough questions. NYSE spokesman Brendan Intindola refused to answer questions regarding the concerns above citing my lack of credentials as a member of the media. Apparently a SABEW membership card is the only calling card to be accepted by Intinola. I am therefore left to wonder what it is the NYSE has to hide in this matter as the enforcement docket lacks the transparency of companies impacted and now the NYSE media spokesman feels the need to be selective on who they are willing to respond to.

I got the message Brendan, the NYSE has a lot to learn when it comes to understanding the realities of market manipulation and fraud. The NYSE has failed to learn it's lessons from the Grasso era of lax enforcement as the mistakes continue to add up. The NYSE could take a lesson from the NASD, which is clearly a step ahead in taking a hard stance on fraud by their members.

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