Stuart Z. Goldstein
New York, NY, July 6, 2007 - The Wall Street Journal (WSJ) article "Blame the 'Stock Vault?'" (July 5, 2007) contained a number of omissions and factual errors that misinform readers. DTCC is providing the following information, as it did during lengthy meetings with the reporters, to set the record straight.
1.The WSJ article failed to report DTCC's response to a core premise, i.e., whether we played a role in naked short selling?
As DTCC has explained, short-selling and naked short selling are trading strategies. These trading activities are regulated and policed by the marketplaces/exchanges, the self-regulatory organizations and the SEC. DTCC is involved in post-trade processing, which occurs after a trade is completed. DTCC has no regulatory authority over trading activity or to release information related to trading activity. In fact, as we told the WSJ reporters, we have no power to force the closing of an open fail, no matter what the cause, and we do not have the authority to force a buy-in. And we provided information to the reporters from the SEC, which regulates the clearance and settlement system, so they had the highest credible source on this issue.
While rehashing baseless claims from old lawsuits, the article missed the opportunity to educate readers regarding the role DTCC plays in the capital market system. We process the trading volume from all equity markets in the U.S. (NYSE, Nasdaq, Amex, regional stock exchanges and ECNs), which on a peak trading day can represent over 6 billion shares and $1.5 trillion. Our job is to protect the safety and soundness of the system, by ensuring this trade data is processed, ownership records are changed and financial obligations between trading parties are settled. As for enforcement of the securities laws, however, this is a matter for the governmental regulators and the SROs. DTCC provides the SEC and the markets with data on the results of trading activity, and it is left to them to enforce the law.
As for delivery failures in particular, there are SEC and SRO rules setting forth the responsibilities of brokers. Contrary to the WSJ article, the regulatory authorities do indeed have "mechanisms" to enforce the delivery rules. From the perspective of DTCC, however, in addition to not having enforcement powers, we do not know whether a sale is long or short -- certainly not whether it is "naked."
We can understand that some of our critics and legal adversaries have sought to portray DTCC as a contributor to naked short selling, but as the SEC has said repeatedly on its Web site and in legal filings (http://www.sec.gov/divisions/marketreg/mrfaqregsho1204.htm and http://www.sec.gov/litigation/briefs/nanopiercesecbrief.pdf), we are not responsible for this issue. The WSJ had this information.
2. The WSJ article said: "The naked shorting debate is a product of the revolution that has occurred in stock trading over the past 40 years."
Not true. The development of automated clearing and settlement processes, while indeed revolutionary and key to the development of the U.S. capital markets, did not create naked short selling. Indeed, failure to deliver shares sold short occurs with paper certificates, and always has.
While the term "naked short selling" may be new, the practice of abusive shorting by failing to deliver is as old as trading itself.
DTCC pointed the WSJ to authoritative academic pieces written on short selling by Yale professor Owen Lamont. His extensive research found short sellers were often proved correct in that shorted companies were non-performers with weak balance sheets and growth. Lamont also documented that typical tactics of these companies included citing naked short selling as the cause of the poor stock performance when, in fact, the cause was almost invariably poor business performance. (http://www.mba.yale.edu/faculty/pdf/overpricing.pdf).
3. The WSJ article said: "Some companies with falling stock prices say it (naked short selling) is rampant and blame DTCC as the keepers of the systems where it happens."
This claim that DTCC is responsible for naked short selling has been expressly rejected by the SEC. Further, as we explained to the WSJ, this claim displays a fundamental misunderstanding of our role in the capital markets. It ignores that naked short selling is a trading strategy and has nothing to do with the post-trade clearance and settlement process. It ignores that we do not know the underlying reasons why trades fail, information that is known only to the broker/dealer. It ignores the fact that DTCC is not the "keepers of the systems where it happens," since this implies DTCC has regulatory authority over trading parties, which by federal statute or federal regulation it does not. It ignores that none of these claims articulated in lawsuits has been successful, and no new case has been filed in more than two years. We think that is adequate evidence to reject any assertion that DTCC is to "blame" for NSS. The fact is the story carried by WSJ on July 5, 2007 is old news presented without proper context, and it grossly underplayed the important steps taken by the SEC this year that have addressed this issue of long-standing fails to deliver.
4. The WSJ article said: "About 99% of the time, trades are completed without incident. But about 1% of the shares -- valued at about $2.5 billion on a given day - aren't delivered to the buyer within the requisite three days, for one reason or another."
The 1% figure represented 1% of the dollar value, not 1% of the trades. In fact, the number of trades that fail (both aged and new fails) amount to about one-tenth of 1% of the daily number of trades, and 80% of the total failed positions (which may include a number of trades) are resolved in two business weeks.
Moreover, the story fails to make clear that the $2.5 billion estimate is an aggregate number; it does not represent the value of each day's fails, but the average value of all outstanding fails on any particular day.
What the WSJ omitted is the sizable amount of daily trading, $350 billion on average in 2006, that does clear and settle in the three-day period.
The WSJ also omitted that it would be impossible with the high volume of trading (over 5 billion shares daily) across equity markets to force all trades to complete in three days. Those seeking a solution would force a return to an earlier period in history, akin to a time when paper stock certificates and payments were exchanged on a trade-for-trade basis. Were this line of argument to be successful, it would bring the robust equity markets in the U.S. to a screeching halt, and destroy our competitiveness with other capital markets around the world.
Lastly, the WSJ incorrectly gives equal weight to the reasons for fails, when the SEC in their Q&A on this issue pointed out that trade failures largely occur due to administrative reasons. The SEC states that a failed trade does not automatically mean there is naked short selling. The lack of proper context by the WSJ is misleading to readers.
5. The WSJ article said: "Critics contend DTCC has turned a blind eye to the naked shorting problem."
Untrue. DTCC has met with a variety of groups, including broker / dealers, marketplace regulators, state regulators and academics, and has communicated with concerned companies, the media, as well as plaintiffs and plaintiffs' counsels on this issue. This effort includes seven hours of meetings and conference calls with the WSJ reporters who wrote this story.
We have shared insights and information in an effort to educate those who were unfamiliar with DTCC's role in clearance and settlement and correct misimpressions of our authority and non-involvement in this issue. We have also rightfully called into question excessive claims and the lack of empirical data to support claims, and pointed to the public filings (e.g., 10K documentation) of why many of these companies were losing money and experiencing declining stock prices.
The WSJ was fully briefed on these issues. We also responded directly to assertions being made by lawyers for companies who have sued DTCC (unsuccessfully), but our response to these accusations were not included in the WSJ article.
As the article did note, DTCC submitted a comment letter to the SEC last September proposing there be greater transparency in providing fails data o the public. Moreover, the SEC has recently indicated their support for our recommendation and expressed a willingness to look at releasing this data. Since the data is confidential to the brokerage firms, we cannot release it. Only the SEC has this authority. Since the WSJ had this information and understood how this process works, we're surprised it would repeat such misleading comments.
6. The WSJ article said: "If the stock in a given transaction isn't delivered in the three-day period, the buyer, who paid his money, is routinely given electronic credit for the stock. While the SEC calls for delivery in three days, the agency has no mechanism to enforce that guideline."
This completely misrepresents how failed trades are handled in DTCC's clearance and settlement systems. In fact, the broker for the buyer does not pay the contractual value for the trade to the clearing system until the stock is delivered, although the broker's customer may be given a security entitlement on the broker's records immediately. That security entitlement is what makes it possible for the markets and investors to buy and sell securities freely throughout the day or over several days. If an investor had to wait until stock was delivered and paid for, they'd have to wait several days to trade that stock again. Imagine an investor buying a stock in the morning, then finding market information being announced mid-day that might adversely impact that stock and then being told you can't sell out your position to minimize the potential loss. Freedom to trade is a cornerstone of our equity markets and a fundamental principle in the regulatory schemes that govern the markets. The SEC has flatly rejected the argument that there are such things as phantom shares or credits being created in the market.
A seller's obligation to deliver securities does not go away. And the broker/dealer who acts as a buyer of securities has a regulatory entitlement and the power -- and, in many cases, an affirmative obligation after a period of time -- to execute a buy-in on a failed delivery to force the seller to fulfill its obligations. In a buy-in, the broker/dealer failing to receive the securities essentially purchases the undelivered stock from some other broker, with the selling broker/dealer who failed to deliver having to absorb any difference in price or other costs incurred on the buy-in. And the SEC or applicable market regulator also has the power, under existing appropriate regulations, to force a fail to be closed. (We note that DTCC, in contrast, does not have any such authority.) So the WSJ is wrong in suggesting that there aren't market and regulatory mechanisms available to enforce delivery obligations. Lastly, to include this assertion without talking about the SEC's elimination of the grandfather clause under Reg SHO is to ignore further steps by our regulators to address concerns about closing long-standing failed trades.
7. The WSJ article said: "Denver-based Nanopierce Technologies Inc. contended that DTCC allowed "sellers to maintain significant open fail to deliver" positions of millions of shares of the semiconductor company's stock for extended periods."
While the WSJ makes reference to the Nanopierce litigation in the context of naked short selling, it fails to note that plaintiffs in that case insist that the case is not about naked short selling, but about how DTCC processes transactions through systems that have been expressly approved by the SEC. This case was dismissed by the original trial judge, but the plaintiffs have kept it alive by a series of appeals. If the WSJ was going to reference this lawsuit, it was incumbent upon it to look into the company's business fundamentals and draw its own conclusions as to why it is selling at 40 cents. The WSJ should have simply stuck with the fact that almost all of these naked short selling cases against DTCC have either been dismissed or filed and then not pursued by plaintiffs.
8. The WSJ article said: "The cost of buying and selling stock has fallen to less than 3.5 cents a share, a tenth of paper-era costs."
First, it is the cost of clearing and settling a trade that had fallen to an average of 3.5 cents and it does not, as the article states, represent the cost of trading. This was the cost per transaction, not per share. It doesn't matter if the trade is for 100 shares or 1,000 shares, each transaction costs the same to clear and settle. In 2007, the average cost of clearing and settling a trade is down to 1.7 cents per side. The earlier figure of 3.5 cents is from 2005. The WSJ did not have access to this latest number, but we did point out that DTCC's costs were the lowest in the world.
9. In the DTCC "By the Numbers" section, The WSJ lists the volume of OTC derivatives transactions processed as $2.6 million.
It is 2.6 million transactions. The notional dollar value of transactions has not been tracked by DTCC, but would probably be in the trillions of dollars. DTCC currently confirms 80%+ of all OTC credit default swap trades in this $18 trillion market.
Once again, the narrow focus of this WSJ article ignores DTCC's 30-year track record of bringing automated solutions that have eliminated risk, brought certainty and safety to the equities and fixed income markets, expanded investor choice for a broad array of mutual funds, mitigated potential crises by insulating the clearance and settlement system from the impact of firm failures, and brought certainty to the OTC credit default swap markets by automating and increasing the confirmation of these trades from 15% to 80% in three years, among many other accomplishments that the article chooses to ignore.
The Depository Trust & Clearing Corporation (DTCC), through its subsidiaries, provides clearance, settlement and information services for equities, corporate and municipal bonds, government and mortgage-backed securities and over-the-counter derivatives. In addition, DTCC is a leading processor of mutual funds and insurance transactions, linking funds and carriers with their distribution networks. DTCC's depository provides custody and asset servicing for 2.8 million securities issues from the United States and 100 other countries and territories, valued at $36 trillion. Last year, DTCC settled more than $1.5 quadrillion in securities transactions. DTCC has operating facilities in multiple locations in the United States and overseas. For more information on DTCC, visit www.dtcc.com.
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