Policy Proposal for Banning Naked Shorting and Overhauling the DTCC

Economy
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I. Introduction

This policy aims to address the longstanding issues related to naked short selling and the operational inefficiencies within the Depository Trust & Clearing Corporation (DTCC), ensuring that all securities transactions reflect actual share ownership, not merely IOUs.

II. Key Provisions

A. Ban on Naked Shorting:

  • Definition: Clearly define naked short selling as the act of selling securities short without first borrowing the securities or ensuring their availability for delivery.

  • Prohibition: Implement an outright ban on naked shorting, with strict penalties for non-compliance, including fines, trading bans, and criminal charges for persistent offenders.

  • Enforcement: Utilize real-time trade monitoring systems to identify and halt naked short sales immediately.

B. Reform of the DTCC:

  • Real Ownership Tracking: Transition from the current system where shares are often represented by IOUs to a system where each share is uniquely identified, ensuring that every transaction involves the actual transfer of ownership. This could be facilitated through blockchain technology or similar immutable ledger systems.

  • Transparency: Mandate that the DTCC publishes real-time data on share ownership, including fails-to-deliver, to foster transparency and accountability.

  • Settlement Efficiency: Revamp settlement processes to ensure same-day settlement for all trades, reducing the window for naked shorting.

  • Audit and Oversight: Establish an independent body to audit the DTCC’s operations regularly, ensuring compliance with the new ownership rules and reporting on any discrepancies.

C. Stock Borrowing and Lending:

  • Regulation: Tighten regulations around stock borrowing and lending to ensure that all short sales are backed by borrowed shares, with clear accountability for lenders who fail to deliver borrowed shares.

  • Tracking: Implement a system where borrowed shares are tracked from origin to return, preventing multiple lending of the same shares.

D. Education and Compliance:

  • Investor Education: Launch campaigns to educate investors on how to verify real share ownership, promoting awareness of the changes in securities trading.

  • Broker-Deal Compliance: Require all broker-dealers to certify that they comply with the new anti-naked shorting rules, subject to random audits.

E. Legal and Structural Changes:

  • Legislative Support: Enact or amend existing securities laws to support these reforms, ensuring that the legal framework aligns with the policy objectives.

  • Global Coordination: Collaborate with international financial regulators to prevent arbitrage through jurisdictions where naked shorting might still be permissible.

III. Implementation Strategy:

  • Phase 1: Legislation: Draft and pass laws banning naked shorting and mandating DTCC reforms.

  • Phase 2: Technology Integration: Develop and integrate the necessary technological infrastructure, possibly using blockchain or similar tech for share tracking.

  • Phase 3: Education and Compliance: Roll out educational programs and ensure all market participants are compliant before full enforcement.

  • Phase 4: Review and Adjust: After a set period, review the effectiveness of the policies, making adjustments based on market feedback and technological advancements.

IV. Conclusion:

This policy proposal, by addressing naked short selling through comprehensive reform of the DTCC and the trading environment, aims to restore investor confidence, promote fair market practices, and ensure that every share traded represents actual ownership. By transitioning to a system where shares are not merely promises but verified assets, this policy seeks to eliminate the opacity that has allowed for manipulative practices, fostering a more transparent, accountable, and equitable financial market. The goal is not only to prevent market abuses but to enhance the integrity of the financial system, encouraging broader participation and trust in securities trading.

V. Expected Outcomes:

  • Increased Market Integrity: By ensuring that each transaction reflects true ownership, the market will operate with greater integrity, reducing the risk of manipulation.

  • Enhanced Investor Confidence: Investors will have confidence that their shares are genuine, potentially leading to increased investment and market liquidity.

  • Regulatory Clarity: Clear rules and enforcement mechanisms will provide regulators with the tools needed to protect the market from detrimental practices.

  • Global Standards: This could set a precedent for international securities markets to adopt similar practices, promoting global financial stability.

VI. Challenges and Considerations:

  • Technological Transition: Implementing new technology for share tracking may require significant resources and time, potentially disrupting market operations temporarily.

  • Market Adaptation: Short sellers and other market participants accustomed to current practices may resist these changes, requiring strong enforcement and possibly facing legal challenges.

  • Global Market Dynamics: Ensuring this policy does not disadvantage U.S. markets by inadvertently pushing practices elsewhere will require international cooperation.

VII. Conclusion:

This policy represents a bold step towards rectifying foundational issues in securities trading. By banning naked shorting and ensuring that the DTCC reflects real share ownership, the policy aims to fundamentally transform how securities are traded, promoting a market where transactions are transparent, fair, and reflective of true ownership. Continuous evaluation and international collaboration will be key to its success and adaptation to the evolving financial landscape.

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I recently used naked short selling as an example of legalized criminality in a public policy presentation for the Natural Law Institute. Your proposal is excellent and addresses the issue clearly.

I’m also interested in discovering how we could address not just naked short selling but other variations of similar legalized criminality with a higher level law that covers all similar types of crimes, even the ones we have not yet thought of. A principle based law from which these specific laws can be derived.

Since naked short selling is “selling something you dont own” we could use that as a basis for a general law covering all similar schemes.

Noah Revoy
Senior Fellow Natural Law Institute

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Thank you for your kind words regarding my proposal on addressing naked short selling. I’m glad to see it resonates with your work at the Natural Law Institute. Your interest in formulating a higher-level, principle-based law to encompass not only naked short selling but other forms of financial manipulation is both visionary and necessary.

To craft such a law, we should consider the core ethical and legal violation at play: the act of profiting from or manipulating markets with assets one does not legitimately possess or control. Here’s a conceptual framework for such a principle-based law:

Proposed Principle-Based Financial Integrity Law:

Section 1. Principle of True Ownership:

  • “No person or entity shall engage in any financial transaction where the asset, security, or derivative in question is not legitimately owned or under direct control of the seller at the time of transaction, unless explicitly allowed by transparent and consensual contractual agreements or regulatory frameworks.”

Section 2. Definition and Scope:

  • “For the purposes of this law, ‘legitimately owned’ refers to having legal title, beneficial interest, or contractual rights that are not contingent on the failure of another party. This principle applies to all forms of financial instruments, including but not limited to stocks, bonds, commodities, digital assets, and derivatives.”

Section 3. Prohibitions:

  • Prohibited Practices: This includes but is not limited to naked short selling, certain types of speculative derivatives trading where no real asset underpins the transaction, and any scheme where gain is predicated on the misrepresentation of ownership or control over an asset.

Section 4. Enforcement and Exceptions:

  • “Exceptions to this law may be permitted under tightly regulated circumstances, where such transactions are deemed necessary for market stability or innovation, provided they are fully transparent, disclosed to all parties, and operate within a framework that ensures no manipulation or undue harm to market integrity or participants.”

Section 5. Penalties and Compliance:

  • “Non-compliance with this law will be met with stringent penalties, including fines, trading bans, restitution to affected parties, and potentially criminal charges where fraud or intent to harm market integrity can be proven. Regulatory bodies are mandated to enforce this law with rigorous oversight and auditing.”

Section 6. Future Adaptability:

  • “This law is designed to evolve with emerging financial practices and technologies. Regulatory bodies are required to periodically review and update the definitions and scope to prevent new forms of financial manipulation.”

This principle-based approach aims to:

  • Prevent Market Manipulation: By ensuring that all financial transactions are based on true ownership or control, it reduces the avenues for manipulation that harm market integrity.

  • Encourage Transparency: Transactions must be clear about what is being bought or sold, reducing hidden risks.

  • Foster Innovation with Integrity: Allows for financial innovation but within a framework that does not compromise ethical standards or market stability.

  • Flexibility: The law is broad enough to adapt to new financial instruments or schemes that might emerge, preventing the need for constant legislative updates.

Implementing such a law would require:

  • Global Cooperation: Given the interconnected nature of financial markets, international standards or treaties might be necessary.

  • Educational Efforts: Both the public and financial professionals would need education on the new legal standards and their implications.

  • Robust Regulatory Frameworks: Ensuring that regulatory bodies have the tools, authority, and resources to enforce these principles effectively.

Your work at the Natural Law Institute could play a pivotal role in advocating for such legal reforms, emphasizing the ethical imperatives that should underpin our financial systems. This principle-based approach not only addresses current issues like naked short selling but also arms the legal system with the foresight to tackle future financial challenges with integrity and fairness at its core.

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Yes. Naked short selling is betting against American companies without any skin in the game. One fundamental issue is the taxpayers are most impacted by SEC regulation but have no influence. I think heads of the SEC need to be elected by the people.

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Absolutely; I address the circular nature of regulators and industry here: Ending the Revolving Door in Regulatory Practices

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Is it true that RFK is actually reading these proposals? Or did I get click baited?