An open letter to the SEC, DTC, and FINRA

(in advance of the SECs October 17, 2011 Roundtable on Microcap Stocks)

September 24, 2011

From:   Dean Petkanas

To:       The SEC; DTC; and FINRA

The Chinese Have Our Interesting Times In Excess Reserves

It is rare in sanguine times to have need for a ballast of change. However, as recent history has given us, we are hardly of sanguine times, although they are quite interesting to say the least. Today’s American economic plight is filled with such gravitas as there is great and substantial need for structural change to the way we conduct our commercial affairs at home. For again, not more than two years removed from a devastating GDP crater and fiscal collapse, we are again teetering backwards into negative territory on top of a crater that was formed by our hubris.

For time and again, in memoriam, our great nation did buckle to the repressive illogic of misguided imbalances in civil and labor inequalities. Now, today, we have washed ashore of fiscal imbalances that have obviously occurred by a Federal Reserve hell bent on globalization and taming the shrew of inflation, despite the warning signs of consecutive bubbles ranging from the stock market’s irrational exuberance to the real estate collapse of recent lore. Our regulatory arms of action and congressional leadership along the way were clearly over their proverbial heads as most, if not all, lack the knowledge and alacrity to step in to a fray or worse step on the status quo toes of political and administrative continuity. In this process of extending the ways and means of a broken system built on the architecture of a club called “Too Big To Fail”, our country has succumbed to an inexhaustible pile of debt; a dichotomy of wealth that has lead to vituperative rhetoric over “class warfare” and the most horrible in a parade of horribles, the institution of the black cloud of fear in reprisals.  Fat cats and jet flying lunatics be damned! Ha.

Politics and failed administration be damned. For if it were left to no one’s devices to invent a billion dollar gift left on a street corner, why wouldn’t anyone simply take it?  For the last 20 years, the very policies of a bi-partisan government that has held to its administrative appointments, and the prospect of globalization, has created this voodoo chasm of differences in the proportion of wealth. Now, in its twentieth year of reigning supreme, the mass which continues to absorb, for those well fixed, is a continuous extraction of larger swaths of wealth, even still. Again, don’t blame the fat cats and banks and hedge funds and too big to fail interests. Don’t blame Wall Street either. They’re just taking what the marketplace gives them. The data do tell the story. In the past ten years the accumulation of wealth has had a delta of 23% vs. 9% (the historical average of a percent of each new dollar in wealth created or transferred). 

Furthermore, and most ironically when given the current party line logic that has spurred the “class warfare” comparisons, this velocity of wealth accumulation has been brought on in continuum, by repressive regulations, recessions and recriminations. For the more the saber rattles, the less the wealthy will seek to take risk. Thus, not only have the banks become zombies under the same conditions, but high net worth investors and funds have taken to the high ground of the hibernation caves.

Time to De-regulation Regulation or at Least Regulate It with a Regulator

What has become of America? Do we need a new czar? How about an oligarch who retires as an oligarch that can become the new new czar of the light speed millennium. Can someone find a Secretary of Commerce in America that understands how to address our domestic commercial problems? We have closed our markets in on ourselves in such manner as to suffocate our industrial capacity and our entrepreneurial spirit. We’ve allowed all of this in the name of regulation. It is a strange dichotomy of circumstances. For how could such regulation heretofore mentioned be good for our great nation, but other regulation be so bad?

This economy is dead. I didn’t kill it. Don’t blame me. It was dead just about the time I got here 40 some odd years ago. We just didn’t know it. For even if the Fed does this, and the Dollar does that and the President does the infrastructure thing, the economy would still be dead. You know why? Over indulgence. Political obsolescence. Same old terminologies. Just like Rome was already set to burn before its fateful ending, we too are in the furnace consumed by a fire that ravaged our nation at least since 1998 and gone parabolic in 2000. September 11, 2001 brought on a new wave of insanities compounded by more regulation that did nothing but cordon off competition and let the repeal of Glass-Steagall do its job in creating the to big to fail model of inefficiency. We do remember 2007 through 2009, correct?

We are face to face again with the need for bold and swift action. Not the kind of promises that shift our attention away from the status quo by prestidigitation of hand and tongue and return us to the same bowl of cottage cheese, but the kind of action that relieves the injunction of regulation upon the not big enough to breath. Small business in America is on life support. We were once a perennial first round choice going into the NFL draft. That is all gone now and that strapping college athlete has gotten mononucleosis and has shriveled into the size of a pre-mie (premature baby) needing life support. Regulation and inverted logic from our political leaders seeking re-election riding high on the hump of corporate demagoguery have created a chasm of adverse selection that hardly cripples the “too-bigs”, forms a basis for them to spend on chasing audits versus hiring productivity and causes an impossible hurdle for pre-mies to clear just to stay in the game.

Why Fix What Wasn’t Broken?

In history, despite our unwillingness to be offended by a change to a parade of horribles, be it civil, labor or fiscal inequities (which today is dangerously close to being called the status quo), we nevertheless made way for such impertinences as the Thirteenth and Nineteenth Amendments; the Glass-Steagall Act of 1933; the Securities Act of 1933; the Securities Exchange Act of 1934; the National Labor Relations Act of 1935 and the Civil Rights Act of 1964. How troublesome! We saw fit to change the things that were needed to be changed and to deregulate those that needed to create more open and competitive markets here and abroad. While I, for one, abhor the very nature of big government and over regulation, those described above are time tested canons of American sensibility. But even sensibility needs a hair cut and a trim every now and then. Fixing what isn’t broken by removing that which has brought about sensible commerce or liberty (i.e. – Glass-Steagall vs. the repeal of Glass-Steagall; or just the CRA vs. the CRA on steroids call Affirmative Action) is part of the problem that results in failed governance and why the first order of cross hairs on the game hunt of too big to fail should be pointed squarely at the U.S. Government and collaborative administrative agencies.

It goes by way of a lack of understanding of history. Americans, including the President and Congress, by in large have become myopic and short in memory. It’s as if we’ve become an army of nearsighted carpenter ants with attention deficit disorder and fiscal deficit disorder and GDP deficit disorder and commercial deficit disorder. All in the name of bi-partisan efforts to extend the mountain of big through such incredible troves of regulatory responses such as Regulation ATS; Regulation FD; The Patriot Act; Sarbanes-Oxley; Regulation SHO; Regulation NMS; and Dodd-Frank (collectively “The Sacking of America”). And yet, one article of regulation, Glass-Steagall, which seemed to have it right all along for 65 years, was ripped from the spine of sanity to create the sum and substance of the progeny which had grown to big and has failed.  Yes, its true. We have closed our markets in on ourselves. And yet, in the face of adverse selection formed through a process I will call the Sacking of America, a process which altogether was formulated to “save us from…” We’re saved alright. It has done nothing of the sort. It has merely caught schools of dolphins in tuna nets to save the crown of righteousness in the name of demagoguery, populism, political survival and appointment.

The Securities and Exchange Commission should be roundly ashamed of itself. Shame on the SEC. Yes, shame on them. But not for missing the screaming signals of shiftless accounting conjured up by the robber barons of the new millennium, or even the Madoff styled sociopaths who followed in lock step. But shame on them for pounding more tree pulp into styled pronouncements that now kill everything for the sake of showing its repentance for its own failed missives, but only to preserve its hegemony. The SEC has become a classical contradiction of its own terms, like a dog chasing its tail and they’re doing it in grand new millennium style. They’re breaking their own rules and regulations in the process and worse yet, allowing the too biggest to fail clan of the major investment banks, the Federal Reserve and Depository Trust Corporation to break its rules as well. There’s an old saying. It goes as follows: “You can’t have it both ways.”

More often than not, the knee jerk responses to outliers and anomalistic singularities (the Bernard Ebbers’, Ken Lays’, Bernard Madoffs’ and such other sundry characters and hucksters yet to be born out of reality TV) is what makes matters worse. For instance, adverse selection doesn’t mysteriously appear somewhere. It is causal. In the case of the securities industry, as of recent (last 15 years) it has been produced by a process that includes GAAP accounting loopholes for big companies forged by the impositions of the Tax Reform Act of 1986; the Federal Reserve Act of 1913 and the Sixteenth Amendment (in other words, the need to use a dilapidated and over burdensome tax system); failed oversight (notice oversight has nothing to do with regulation as regulation needs oversight in order for it to have value and order in the first place); idealistic and lavish regulatory responses from the SEC and Congress that has brought small business to its knees. The crooks will still be there even if you quantized, exponentially, the regulatory schemes in the marketplace.

Looking further to regulatory schemes that have backfired, one need not look any further than Regulation ATS which has given birth to ECNs; Dark Pools; High Frequency Trading. Where on earth can one find a day trader with an abacus to compete against such elements? Yet it was born of ATS. And why? Because of an ideal held by one person and his staff to bring about fair access, best execution and price discovery. Beyond the algorithmic value of a Laffer curve of inefficiency or neutrality, there is no fair access, best execution and price discovery when the market participants are terminators equipped with predictive models that make the market timing cases of the early part of the decade look like child’s play. ATS has gone well beyond the point of diminishing returns for its purpose and has found great advocates like Goldman Sachs / Citadel; the NYSE and NASDAQ, all whom enjoy the concomitant relationship of bubble volume in trading equities and other asset classes.

Jobs, Jobs, Jobs… Where is Jobs?

Some say Apple. Well, from apples to oranges, I don’t think I can find any small business owners that are calling this economy a peach of a morning. Check it. Our internal industrial and entrepreneurial failure continues amidst proprietary trading and other zombie banking tricks which prefer the risk free model of burying money in a mattress the size of the U.S. Treasury, swimming in riskless dark pools of filled with high frequency economic algorithms, and other fantastic derivative structures which altogether fly in the face of the SECs mantra of just and equitable principles of trade. To wit, joblessness and the dearth of corporate finance in America has met its number one enemy – a closed market built on the towering inferno of adverse selection supported by a mountain of regulation. It is incendiary at mere sight to gaze upon the mountains of paper that destroyed trees faster than the great fire of 1910 in order to proclaim the mad pronouncements in the Sacking of America.

To Hell With Small Business, Who Needs Them Anyway

How does that saying go again? “You can’t have it both ways.” The SEC has passed regulation time and again that was meant to create a level playing field for Main Street, spur small business finance (through Rule 144 and Regulation D) and has conveniently intervened against its own regulation, siding with DTC, FINRA and congressional leaders who have popularized the broad sweeping attack against Wall Street. The downside is the trickle down effect that assures the bottom run of corporate America, small cap and micro cap companies become the kindling wood for the SECs ash filled ornamental urn of justice.  On September 19, 2011, the SEC announced its Roundtable on Microcap Securities to take place at its offices in Washington, DC on October 17. The Commission claims that it will feature in-depth discussions of key regulatory issues including: anti-money laundering monitoring; compliance challenges; and potential changes to the regulatory framework. Panelists will include representatives from Depository Trust Company (DTC), broker-dealers, and the Financial Industry Regulatory Authority (FINRA). The purpose of the roundtable is to enable Commission staff to gather ideas and request input for regulatory measures surrounding the execution, clearance and settlement of low-priced securities. What an incredible revelation! On that note, I might add that since 9-11, I have never had the pleasure of meeting more American terrorists and money launderers in my entire life. I just so happens to be everyone I meet these days.

Regulation NMS

Regulation NMS, the latest salvo in the arsenal of demagoguery and chaos. It should read Regulation No More Stupidity, please. SEC Regulation has its place as was the case in 1933 and 1934 and a few spots along the way, like the Insider Trading Act of 1988 and thus and so. However, just because it has its hand on the pen and the pen to paper, doesn’t mean all is good in the land of Oz.  They don’t always get it right. That is a fact that has never been admitted to by the SEC and Congress. They never admit when they’ve made regulatory mistakes and worse, have done nothing, nada, zippo to reverse the effects of a train that has run off the tracks.

Regulation NMS is yet another SEC manuscript instituted in 2005. This five hundred page paper tiger addresses three components, arguably vital to small business in America; liquidity in the capital markets and the golden rule… just and equitable principles of trade need be applied. According to the SEC, “In addition to redesignating the nation market system rules previously adopted under Section 11A of the Securities Exchange Act of 1934 (the ‘Exchange Act’), Regulation NMS includes new substantive (emphasis added) rules that are deigned to modernize and strengthen the regulatory structure of the U.S. Equities markets.”

Getting back to the old saying, “You can’t have it both ways.” Well apparently you can, as long as you are a horde of 800lb gorillas in a banana factory. As the regulatory action continued on page one, “First the ‘Order Protection Rule’ requires…”, then “Second, the ‘Access Rule’ requires…”, and finally “Third, the ‘Sub-Penny Rule’ prohibits market participants from accepting, ranking, or displaying orders, quotations, or indications of interest in a pricing increment smaller than a penny, except for orders, quotations, or indications of interest that are priced at less than $1.00 per share.”

Based on my retarded mathematical skills and all of the issues surrounding Regulation ATS and the call for decimalization (European standards), that would make ninety-nine cents look something like $.9900, assuming it was simply 99 pennies stacked in a tower or 99 bottles of beer on the wall. For if there were in fact 100 bottles and one broke in half it would then look like $.9950.  But if it were a fractional shard greater by a factor of 5% of that fractional amount, give or take a mil, it would look like .9975 bottles of beer. I suspect in glass value it probably amounts to about $.9975 in total, no matter how you slice the stock.

Well, then here we are at the end of our tale of woe and as we have traversed the market’s inefficient maze of over-regulation and wonder, we reach the chamber doors of the Kraken. We are now face to face with DTC (aka DTCC) – Depository Trust & Clearing Company. This larger than life, post-trade (emphasis added) financial services company was established in 1999 as a holding company to combine the Depository Trust Company (DTC) and National Securities Clearing Corporation (NSCC), was set up to provide an efficient and safe way for buyers and seller of securities to make their exchange, and thus “clear and settle” transactions.  Oh, and by the way, also provide a central custody of securities (including those that provide another layer of liquidity for big players in the lending and borrowing of securities in street name, better known as CEDE).  DTCC provides custody and asset servicing for 3.5 million securities issues, mostly stocks and bonds, from the United States and 110 other countries and territories, valued at $40 trillion, more than any other depository in the world. In 2007, DTCC settle the vast majority of securities transactions in the United States, more than $1.86 quadrillion in value, a thousand trillions (that’s 10¹⁵ long scale peta or your garden variety 1,000,000,000,000,000). The good news is that at $1.86 quadrillion, it’s only one fifth the way to a full light year in miles.

Accordingly, pursuant to my open letter, kindly accept these panel questions in advance of the roundtable discussions on October 17, 2011. Considering the open letter issues raised and the fact that all securities trading under $3.00 are not eligible for credit towards margin requirements and are not credited to margin buying power under Federal Reserve margin requirements; and considering that a buyer is making complete delivery of payment on trade date (cash) to cover a settlement of T+3, and do so on trade date as is required (cash to cover the trade), my questions are as follows:

PANEL QUESTIONS

1.)                THREE PART QUESTION FOR DTCC TO ANSWER:         

(a.) How is additional margin below $.01 to the sell side justifiable when 100% of the risk is out of the settlement when at the same time, all requisite compliance on Rule 144 and/or registration has been met by the sell side?; (b.) How does this additional margin (a demand by DTCC for that value between the sub-penny market price of a security purchased with cash below $.01 – two decimal points) form just and equitable principles of trade and/or an efficient market?; and (c.) What safe harbor, Constitutional or otherwise, does DTC rely upon to avoid interference with Regulation NMS, the Securities Act, Rule 144, and Sherman-Clayton Federal Anti-Trust Acts?

2.)                TWO PART QUESTION FOR THE SEC TO ANSWER:        

(a.) How does the recent spate of FINRA and political pressure upon Broker-Dealers and Clearing Firms to avoid all sell side transactions by impugning fictional motives upon market participants despite their complete compliance the Securities Act, The Patriot Act and Rule 144?; and (b.) What are you doing to remove such obstacles that avoid compliance with the above referenced?

3.)                TWO PART QUESTION FOR FINRA TO ANSWER:  

Considering that there is a clear and distinct model of adverse selection, even in this sub-penny microcap space (case in point is Client A is a high net worth individual who can not open a prime brokerage account or show billions or hundreds of millions in liquidity, but yet makes an investment in a microcap company on the same basis as a hedge fund – yet the hedge fund with a prime brokerage account can easily liquidate these securities, but for lack of FINRA oversight), (a.) How does it benefit Client A if your regulatory actions in this regard make for UNjust and INequitable principles of trade, adverse selection and/or failure to provide equal protection under the 4^th, 5^th, and 14^th Amendments of the Constitution?; and (b.) How does clamping down on market participants and registered FINRA broker-dealers and agents provide for efficient markets?

4.)               A FOUR PART QUESTION FOR ALL TO ANSWER:     

How does interfering with just and equitable principles of trade, imposing market restrictions beyond the scope and policy of SEC Regulations and Federal Reserve requirements for participants and causing such fear among registered agents and principals as to avoid the process and service of client needs (a.) good for business; (b.) good for commerce; (c.) good for the movement of capital for small business; and/or (d.) good for the creation of jobs and reduction of unemployment?