FAQ

Frequently Asked Questions

What is the solution?
There are several ways the securities industry could be fixed.

a) One solution is for the SEC, the SROs or the states to enforce the existing laws. No new laws are really necessary.
Unfortunately, the securities industry is based on SROs or self regulation. And it is now obvious that self regulation
does not work.
b) Amending the UCC alone would do wonders. It could provide transparency to all transactions and securities and the
prompt return of investor money when contracts are not kept.

Do broker-dealers have a fiduciary duty to their customers?
Yes, they do. FINRA rule IM-2310-2 confirms this relationship. But they sure don't act that way. This duty is not
honored, when customer securities are not obtained or maintained, and customer securities are lent out to short
sellers and accounts are misrepresented as to the securities held for customers.

Do broker account agreements, signed by customers, negate any securities laws or customer rights?
No.

Section 29 of the Securities Exchange Act of 1934 stipulates that:

Every contract made in violation of any provision of this title or of any rule or regulation thereunder, and every

contract (including any contract for listing a security on an exchange) heretofore or hereafter made, the

performance

of which involves the violation of, or the continuance of any relationship or practice in violation of,

any provision of

this title or any rule or regulation thereunder, shall be void..."

Even an express waiver would not make any difference, because,

"Any condition, stipulation, or provision binding any person to waive compliance with any provision of this title or

any rule or regulation thereunder, or of any rule of an exchange required thereby shall be void.

Aren't "fails to deliver" or "fails to receive" allowed?
No, "fails to deliver" are not even defined in any law, much less allowed. "Fails to deliver" are securities issued by
market participants to indicate delivery of the contracted for security has not taken place within the settlement date
delivery requirement. A real security has been contracted and paid for, but that specific security is not delivered by the
contract date. The clearing agent gives the selling (and failing) broker a delivery obligation in the form of an FTD.

"Fails to Receive" are not defined in law either. These are credited to buying brokers and buying customers when
there is no security by the settlement date. These securities have dubious value and do not confer the rights that the
contracted for securities confer onto beneficial owners.

I thought there was a loophole that allows "fails", or an exemption in REG SHO that allows "fails"?
The "loophole" is the deliberate non enforcement by the SEC and SROs of existing laws. By deciding not to enforce
existing laws, the SEC and SROs created a "loophole" that "allows" fails. It is a "de facto" law, adopted in an informal
way, that is adhered to by the SEC, SROs and broker-dealers. But there is no law that authorizes anyone to cause
"fails" of any kind or for any reason, much less to keep "fails" open for long periods of time. There is no "loophole" in
the law. The only laws that officially exist and that are on the books, are the ones that prohibit all fails.

Which laws are not being enforced when "fails" are effected or persist?
The list of violated and unenforced rules and laws is long. The basic ones are:

Rule

15c6-1, the settlement cycle rule

. This is the first line of defense and is the foundation of the market. It

spells

out

the settlement date delivery requirement of securities. As long as the contracted for securities are

delivered

by the

settlement date, all is good and all is as it should be. When delivery does not occur by the

settlement

date, there is a

"fail to deliver".

Rule

15c3-3, the customer protection rule.

This rule requires broker-dealers to promptly obtain and securely

maintain

securities, even in the event that securities are not delivered by the settlement date. Doing nothing is

not an option.

Rule

0b-10, the trade confirmation rule.

This SEC rule requires broker-dealers to confirm the identity,

quantity and

price of securities obtained on behalf of customers. When the brokers receive nothing but "fails to

receive"

rather

than the contracted for securities, the brokers should not confirm the trade and confirm the

quantity of the

contracted for securities, because none have been obtained. When "fails" occur, broker-dealers

confirm the

trade to

customers anyway, creating a false confirmation statement.

Section 9 of the Securities Exchange Act of 1934

. This s

tatute

makes it unlawful to create a false or

misleading

appearance of active

trading in any security registered on a national securities exchange, or to

create a

false or misleading appearance with respect to the market for any such security, and

to effect any

transaction in

registered security which involves no change in the

beneficial ownership. False and misleading

statements are

also

unlawful under this

Section. Trading, confirming, taking money for and crediting fake and

undefined

securities in

place of the real contracted for securities

are violations of this federal statute

Section 6(b)(5) of the Securities Exchange Act of 1934.

This statute limits the authority of the SEC and the

SROs by prohibiting them from regulating and selectively enforcing rules and statutes, in a way that is

discriminatory against equity investors and issuers in favor of others. By "allowing" fails to occur through

selective non enforcement of existing statutes and rules, the SEC and SROs are doing exactly that.

Section 17A of the Securities Exchange Act of 1934

. This statute requires that

settlement and clearing

securities be linked and that they happen promptly and accurately. It also requires that trades effect the transfer

of record ownership of securities. When trades fail and phantom securities are delivered instead, these

requirements are all violated.

Fiduciary duty to customers by broker-dealers

. Among these are FINRA Conduct Rule IM-2310-2. Taking

money

from customers for the purchase of securities (they're supposed to be a broker), but

not

actually

obtaining the

m and misrepresenting this failure to obtain securities by misrepresenting

the identity and quantity

of securities in customer accounts and filing false trade confirmations, is against the interest of the customers

Wall Street and the SEC have said that "fails" are legal
Only Wall Street firms have said that. The SEC however, has only said that certain types of naked short sales are
legal, which is true. But that is entirely different from saying that "fails" are legal. Naked short sales delivered within the
settlement cycle and that do not fail delivery, are legal. As to "fails", there is no law that allows them. Not even when
broker-dealers could have easily dismissed lawsuits against them for failing to deliver securities by quoting the rules or
laws that permit "fails", their defense lawyers were unable to. They were unable to because "fails" are not permitted,
only certain naked short sales are OK, so long as they don't fail to deliver.

Why are "fails" a problem? How do they harm?
"Fails" cause harm on several levels, because the underpinnings of the markets are removed. The goods sold are not
delivered, but the buyer's money is tied up and market participants play with the buyer's money. When basic market
principals are removed like this, the wreckage will be widely disbursed and affect a large swath of people. Whether on
individual securities or the market as a whole or the systemic cracks, the effects are found in almost every corner of
the markets.

1. Market Manipulation of individual securities. By controlling the supply of securities by an issuer and increasing that
supply well above the number that the issuer has issued by selling phantom "fails to deliver" securities to buyers, the
price of the targeted security can easily be manipulated downward to profit from doing so. The more one fails to
deliver, the more profitable it is. This can permanently harm corporations, their investors, employees and customers.

2. The formation of capital is hindered. Companies may be unable to raise capital for expansion to even
recapitalization. Not all companies that fall on hard times should fail. Some investor may want to invest in a
downtrodden company, if they think it can regain footing and prosper. If illegal naked short seller fail to deliver
securities in troubled companies, value investors would not invest in troubled companies. Companies would be barred
from raising equity capital when they need it most and rob value investors the opportunity to participate in a potential
recovery of the company. For instance, at one point, many had written Apple Computer off when it fell on hard times,
but after being able to raise equity capital in 1994, when they needed it most, they were able to recover nicely. In
addition, top talents that corporations hire and need are often compensated via stock options. However, If these are
not viable, the corporation may not be able to attract or keep the talent it needs.

3. Systemic risk. Broker-dealers now hold only a fraction of securities that customers have paid for. The fillers or place
holders for the missing ones are called "fails to receive".This means that broker-dealers still have the liability to deliver
the real ones some day, as "fails to receive" are not the real securities - even though broker-dealers act as if they were
and broker-dealers do not disclose to their customers that they are holding only a fraction of the securities being
credited to their accounts.

If customers were to demand these securities it would bankrupt the broker-dealers instantly. Broker-dealers hold so
many "fails to receive" in place of the real securities now, that it is possible that broker-dealers as a whole, are
insolvent and without the ability to deliver all customer securities. We saw the real deal when Bear Stearns went under
due to customer withdrawals. If enough customers withdraw their securities, the number of securities on hand will not
be enough to meet the withdrawal requests, nor will the broker-dealers have enough capital to buy the missing
customer securities being withdrawn. The number of "fails to receive" is now so large and the fraction of customer
securities held so small, that it is only a matter if time before it all comes tumbling down. When it does, it'll happen very
quickly. All it would take is for a large sovereign wealth fund to make a massive withdrawal of securities out of Wall
Street to another custodian, say to Singapore or Hong Kong, etc....They could even just demand paper certificates,
that wouldn't be pretty.

4. U.S. tax payers may be on the hook. And even non tax payers. If a massive bail out is necessary, it strains the
budget and is inflationary. It is not an options to let the securities markets collapse as the reputational damage to US
capital markets would be too severe. So like in 1929-35, the US treasury would have to be used. All of this so a few
people can make some money by not delivering goods they sell. Not even ebay allows that. Nobody but in the US
capital markets is something like this possible on such a grand scale.

What Should I demand from regulators, politicians, etc...?
That existing laws need to be enforced. That's all. New laws are not needed.

However, new rules or laws can help on the state level and federal level that help enforce existing rules and laws. For
instance penalties can be added for violationing existing rules and laws. Another idea that is self enforcing is to
require all failed trades to be broken immediately and funds returned to buyers in the amount of the purchase price or
the quoted price of the security at the point the trade is broken - which ever is higher.