http://sec.gov/rules/proposed/2011/ia-3145.pdf

This comment is directed at only one very specific issue in the lengthy release best summarized by the fact  that the information requested should and could include naked short sales. Our clients believe this is a unique opportunity to obtain the type of information that has been missing from hedge funds throughout the entire subprime crisis and the entire debate about abusive short selling in spite of Reg. SHO.Short selling may contain the seeds of systemic risk and abusive short selling even more so. We believe that these entities should be asked to report on  their naked short sales even if they are not deliberate. The release specifically says they are interested in leverage and collateral practices that may have systemic implications. It specifically asks whether there are other ways hedge funds could create systemic risk? the release asks about the net counterparty credit exposure of five largest trading counterparties.It could therefore be assumed that net exposure would include short selling but its more complicated then looking at net numbers. Naked short sales would completely corrupt any net analysis. As explained by Professor Branson:

As with the condemnation of “distort and short” manipulations, many market participants condemn the practice of naked short selling. In theory, if short sellers do not have to, or simply do not, deliver shares which they have purported to sell, short interest in a stock can exceed the total number of shares outstanding. On a more realistic scale, when naked short selling takes place, short interest in a stock can mount rapidly, exerting excessive downward pressure on a stock’s price. Combined with the broadcast of false rumors, or an organized distort and short campaign, naked short selling can push a stock’s price so far down that the price level has no connection with underlying economic realities. Buyers of such stocks, deprived of delivery, do not have the right to receive dividends or to vote shares they have purchased. In the view of nearly every market participant, naked short selling, like the spread of false rumors, is a “hit out of bounds,” not considered to be within the boundaries marking a level playing field.³⁹VIRGINIA LAW & BUSINESS REVIEW VOLUME 5 FALL 2010 NUMBER 1, MORE MUSCLE BEHIND REGULATION SHO? SHORT SELLING AND THE REGULATION OF STOCK BORROWING PROGRAMS, Douglas Branson fn 14

Short selling presents the potential for unlimited risk because unlike long sales where you can lose your entire investment, short sales present the possibility of infinite losses. George Soros explains the potential for systemic risk as follows. With the help of this new paradigm, the poisonous nature of CDS can be demonstrated in a three-step argument. The first step is to acknowledge that being long and selling short in the stock market has an asymmetric risk/reward profile. Losing on a long position reduces one's risk exposure, while losing on a short position increases it. As a result, one can be more patient being long and wrong than being short and wrong. This asymmetry discourages short-selling.

H:\reg sho final\soros short sales.mht 
Naked short selling done opportunistically avoids costs and therefore adds an incentive to the systemic risk .Numerous commenters have asked the commission to provide more visibility on naked short selling and Dodd Frank requires a study on real time reporting. But this is an added benefit opportunity where such information is complementary if not fundamental to the main purpose of the request. We have often argued that the current requirement of Reg Sho that mandates a locate but not a borrow will promote opportunistic short selling in a financial panic or terrorist attack. Relatively modest penalties that have been imposed so far would only strengthen the calculation that money is to be made and worst case scenario is the regulators will require a give back years later. Thus the proposed information gathering exercise should be especially sensitive to abusive short sales and try to obtain as much information as possible on them.

The determination of naked shorts should be decipherable through both buy-ins and shorts where no borrowing costs are incurred. Reporting entities can if they choose to distinguish inadvertent naked shorts but an explanation must be provided. If an entity cannot report then it can provide an explanation as to why it cannot do so and inability to do so should be a major concern in risk management. A recent article on the trading of GM naked CDS  confirms Soros concern and suggests that without this type of information the systemic threats risk can be seriously understated.

http://online.wsj.com/article/SB10001424052748704430304576170710897188504.html?mod=WSJ_hp_LEFTWhatsNewsCollection
Lawmakers and regulators have blamed credit derivatives for exacerbating the financial crisis and helping bring down companies like American International Group </public/quotes/main.html?type=djn&symbol=AIG> Inc. and Lehman Brothers Holdings Inc. Investors who bought "naked CDS" to bet on the likelihood of default, rather than to hedge risk from other investments, are credited with worsening the liquidity crisis that gripped those financial powerhouses, prompting calls for tighter regulation of the industry.

While this subject can be debated,the need to know how large these positions are cannot be debated? As Soros concluded:
Taking these three considerations together, it's clear that AIG, Bear Stearns, Lehman Brothers and others were destroyed by bear raids in which the shorting of stocks and buying CDS mutually amplified and reinforced each other. The unlimited shorting of stocks was made possible by the abolition of the uptick rule, which would have hindered bear raids by allowing short selling only when prices were rising. The unlimited shorting of bonds was facilitated by the CDS market. The two made a lethal combination. And AIG failed to understand this.

Peter J.Chepucavage
Executive Director,CFAW
General Counsel
Plexus Consulting LLC
1620 I St. N.W.
Washington,D.C.20006
202-785-8940 ex 108
www.plexusconsulting.com
www.iasbda.com
pchepucavage@plexusconsulting.com

Michael J. Armelin

4530 Warren Street, N.W.

Washington, D.C.  20016-2442

(202) 362-1680 (h) – (202) 355-4185(c)

michael.armelin@gmail.com

 

SUMMARY

Broker-dealer investigator/project manager experienced at conducting on-site examinations of sales, underwriting, trading practices and other compliance reviews regarding broker-dealers and investment advisors.

 

Capabilities include: investigating the financial/operational condition of firms, conducting pre-examination compliance reviews, assisting in responding to regulatory inquiries, investigating customer complaints/terminations for cause and keeping current about regulatory changes. Also, strong analytical skills, experience reviewing systems of internal controls/risk management and identifying significant, novel sales practice and fraud cases. Industry experience includes active Series 7, 24 and Insurance Licenses, along with PC skills and systems knowledge.

 

Professional Experience --Assistant Director, Department of Enforcement, FINRA (1991 – 2010)

 

*Teamed with the Strategic Programs Unit in identifying significant, novel cases which warranted a formal review.

*Responsible for reviewing the initial aftermarket trading and other trading data for Small Cap IPOs to identify activity for further analysis  

  by an advanced team. This program resulted in approximately 50 formal reviews each year and led to multiple actions.

*Completed initial review and developed follow-up plan for identifying and reviewing fee-based accounts maintained by broker-dealers.

  Resulted in appropriate actions against broker-dealers and RRs.

*Primary reviewer of sales practice issues relating to lock-up agreements in IPOs sold by some 30 broker-dealers. 

*Discovered the first analyst case involving  research reports by a broker-dealer.

*Planned and led the review of telemarketing issues involving IPOs by broker-dealers.

*Represented the Department of Enforcement at regular meetings within FINRA, with the SEC and with other regulators to identify and

  address emerging issues in the securities industry.

 

Additional Roles Included:

 

            Assistant Director, Member Regulation, FINRA

*Responsible for managing the Compliance Department’s team of over twenty staff members and administrative staff, who supported the

  examination and sales practice programs carried out in FINRA’s fourteen regional offices.

*Resolved real-time questions from District supervisors relating to on-site reviews.

*Identified new regulations for incorporation into examination modules.

 

            Regional Coordinator, Member Regulation, FINRA

*Planned and conducted on-site reviews of broker-dealers, on a continuing basis, as needed.

*Review responsibility included oversight of the examination programs conducted by my assigned regional offices, along with monitoring

  the financial and operational condition of broker-dealers in the regions.

*Participated in preparing responses to SEC comment letters following an SEC oversight review of examination programs carried out by

  FINRA’s regional offices.

*Responsible for preparing written notification to SIPC detailing the condition of members experiencing financial or operational problems.

 

            Senior Examiner, Member Regulation, FINRA, New York

*Conducted on-site examinations of broker-dealers and promoted to the Senior Examiner position in New York responsible for the

  examination of general securities firms.

*Examined a broker-dealer planning to go public – discovered net capital and operational difficulties and the IPO was withdrawn.

*Investigation disclosed a member co-underwrote an IPO with a non-member resulting in disciplinary action.

 

Education

            Bachelor of Science (Economics) – Mount St. Mary’s University

            Master of Business Administration – American University

Selected Recognition

            FINRA Gold President’s Award, 2003

            FINRA Team Award, 2005

  We have been discussing the SEC's Small Business Forum with the staff and suggesting that they might be more inclusive in their planning and selection of panel members. We have also suggested that the forum might be held in other cities in addition to D.C.The attached NYT 's article does not bode wall for big firms and if true, is deadly for small firms raising capital. Others especially Steven Pearlstein of the Post have made similar points about the decline of the U.S. economy and markets. http://www.washingtonpost.com/wp-dyn/content/article/2011/02/12/AR2011021202503.html  and

http://www.washingtonpost.com/wp-dyn/content/article/2011/02/01/AR2011020106617.html. See also how Michael Lewis describes how the Irish government, press and financial sector conspired to convince themselves that Dublin was the new London. <http://www.vanityfair.com/business/features/2011/03/michael-lewis-ireland-201103> thereby destroying their markets and their economy.

We think there is a need for renewed emphasis on excessive small business regulation especially the issue of finders and business brokers and the need for a robust small business capital markets exchange.

Op-Ed Contributor
Wall Street’s Dead End
By FELIX SALMON
Published: February 13, 2011 Top of Form 1

Bottom of Form 1
THE stock market has been big news in recent days. Last week’s report that Deutsche Börse, a giant German exchange, intends to buy the New York Stock Exchange <

http://dealbook.nytimes.com/2011/02/09/nyse-euronext-and-deutsche-borse-in-merger-talks/?ref=newyorkstockexchange>, creating a company worth some $24 billion, arrived shortly after the Dow broke the 12,000-point barrier for the first time since before the financial crisis.

These developments drew headlines because they seemed to exemplify significant trends in the American economy. But look at America’s stock exchanges more closely, and there’s less to them than meets the eye. In truth, the stock market is becoming increasingly irrelevant - a trend that threatens the core principles of American capitalism.

These days a healthy stock market doesn’t mean a healthy economy, as a glance at the high unemployment rate or the low labor-market participation rate will show. The Tea Party is right about one thing: What’s good for Wall Street isn’t necessarily good for Main Street. And the Germans aren’t buying the New York Stock Exchange for its commoditized, highly competitive and ultra-low-margin stock business, but rather for its lucrative derivatives operations.

The stock market is still huge, of course: the companies listed on American exchanges are valued at more than $17 trillion, and they’re not going to disappear in the foreseeable future.

But the glory days of publicly traded companies dominating the American business landscape may be over. The number of companies listed on the major domestic exchanges peaked in 1997 at more than 7,000, and it has been falling ever since. It’s now down to about 4,000 companies, and given its steep downward trend will surely continue to shrink.

Nor are the remaining stocks an obvious proxy for the health of the American economy. Innovative American companies like Apple and Google may be worth hundreds of billions of dollars, but most of them don’t pay dividends or employ many Americans, and their shares are essentially speculative investments for people making a bet on how we’re going to live in the future.

Put another way, as the number of initial public offerings steadily declines, the stock market is becoming little more than a place for speculators and algorithms to compete over who can trade his way to the most money.

What the market is not doing so well is its core public function: allocating capital efficiently. Apple, for instance, is hugely profitable and sits on an enormous pile of cash; it is thus very unlikely to use its highly rated stock to pay for any acquisitions. It hasn’t used the stock market to raise money since 1981, and there’s a good bet it never will again.

Meanwhile, the companies in which people most want to invest, technology stars like Facebook and Twitter, are managing to avoid the public markets entirely by raising hundreds of millions or even billions of dollars privately. You and I can’t buy into these companies; only very select institutions and well-connected individuals can. And companies prefer it that way.

A private company’s stock isn’t affected by the unpredictable waves of the stock market as a whole. Its chief executive can concentrate on running the company rather than answering endless questions from investors, analysts and the press.

There’s much less pressure to meet quarterly earnings targets. When the stock does trade, the deals can be negotiated quietly, in private markets, rather than fall victim to short-term speculation from the high-frequency traders who populate public markets. And companies love how private markets allow them to avoid much of the regulatory burden of being public.

That burden comes largely from the Securities and Exchange Commission, which was created in the wake of the 1929 stock-market crash to protect small investors. But if the move to private markets continues, small investors aren’t going to need much protection any more: they’ll be able to invest in only a relative handful of companies anyway.

Only the biggest and oldest companies are happy being listed on public markets today. As a result, the stock market as a whole increasingly fails to reflect the vibrancy and heterogeneity of the broader economy. To invest in younger, smaller companies, you increasingly need to be a member of the ultra-rich elite.

At risk, then, is the shareholder democracy that America forged, slowly, over the past 50 years. Civilians, rather than plutocrats, controlled corporate America, and that relationship improved standards of living and usually kept the worst of corporate abuses in check. With America Inc. owned by its citizens, the success of American business translated into large gains in the stock portfolios of anybody who put his savings in the market over most of the postwar period.

Today, however, stock markets, once the bedrock of American capitalism, are slowly becoming a noisy sideshow that churns out increasingly meager returns. The show still gets lots of attention, but the real business of the global economy is inexorably leaving the stock market - and the vast majority of us - behind.

Felix Salmon is the finance blogger at Reuters.

Peter J.Chepucavage
Executive Director,CFAW
General Counsel
Plexus Consulting LLC
1620 I St. N.W.
Washington,D.C.20006
202-785-8940 ex 108
www.plexusconsulting.com
www.iasbda.com
pchepucavage@plexusconsulting.com

Peter J.Chepucavage
Executive Director,CFAW
General Counsel
Plexus Consulting LLC
1620 I St. N.W.
Washington,D.C.20006
202-785-8940 ex 108
www.plexusconsulting.com
www.iasbda.com
pchepucavage@plexusconsulting.com

 -----Original Message-----
From:   Peter Chepucavage 
Sent:   Wednesday, February 09, 2011 12:09 PM
To:     'rule-comments@sec.gov'
Cc:     brad smith; brock
Subject:        File-no.7-04-11 Net Worth standard for accredited investors

The International Association of Small Broker Dealers and Advisors

1620 Eye Street, NW, Suite 210 Washington, DC 20006

202-785-8940 ext. 108

pchepucavage@plexusconsulting.com <mailto:pchepucavage@plexusconsulting.com>

www.iasbda.com

The International Association of Small Broker-Dealers and Advisers,www.iasbda.com submits the following comments on the above referenced amendments. We wish to focus on the sole issue of how to treat debt incurred on a home and assets purchased with that debt or as the release calls it proceeds of debt secured by primary residence incurred to invest in securities. Borrowing on one's house has become an American tradition and needs to be rationalized in this proposal. The release notes the uncertainty over the use of such borrowings to purchase other assets and whether those assets need to be included in the calculation .A person with a home valued for tax purposes at $1,000,000 may have borrowed as much as $750,000 of net equity and its logical to exclude the other 25%  from their net worth. But the release seems to allow the assets purchased by that $750,000 to be included for net worth purposes because of the complexity of tracing the assets.. This arguably seems to encourage the owner to borrow and diversify and thus defeat the intent of the legislation. A more logical reasoning would suggest that the amount of borrowings must also be excluded from net worth to offset their purchases, thereby excluding the entire value of the house as presumably intended. But that may be an excessive restraint . It seems logical that if other assets are to be counted, the loan against the house, must be deducted from net worth to avoid doing indirectly what cannot be done directly.

The release notes and agrees with NASAA'S concern that investors should not be encouraged to borrow on their house to invest in private placements. Such reasoning would seem however to deny the existence of the housing crunch that has occurred in the last two years. It would be perfectly suitable to draw down home equity to diversify into for example a high dividend energy offering. The question therefore is how to treat home equity debt . Congress was correctly concerned about the sensitive nature of home equity and the potential for abuse of it .It seems therefore that the rule must consider it more specifically then the proposal does. If the proceeds were used wisely then deducting the amount of the loan would not create  a barrier. If they were used unwisely then  the underlying home equity should not offset the entire loan. The question is whether equity underlying a home loan should completely offset the loan in the calculation. To do so seems to defy the intent of Congress and encourage liquefying home equity. Perhaps therefore a haircut can be wisely used to insure that the intent of Congress is fulfilled. A "25% of the loan' deduction" might serve that purpose. Private placements are very important to small business and should be encouraged. But Congress has spoken and the Commission should try to arrive at a proposal that fully considers home equity debt without discouraging this vital capital raising regulation. Small business does not gain by encouraging the unwise use of home equity.

An explanatory example might be the use of the above referenced home equity loan to buy a vacation house or a limited partnership. How much of those assets should be added to net worth without deducting the home equity loan that facilitated them? Finally as we have previously noted this exercise reveals the weakness of not having an alternative sophistication test. A finance professor who has a home worth 2 million dollars as a result of wise real estate investments but only $900,000 in other assets is not sophisticated enough to buy a private placement. But a blue collar worker or elderly widow who inherits a significant portfolio or wins the lottery qualifies. This test must be re-examined.

.

Peter J.Chepucavage
Executive Director,CFAW
General Counsel
Plexus Consulting LLC
1620 I St. N.W.
Washington,D.C.20006
202-785-8940 ex 108
www.plexusconsulting.com
www.iasbda.com
pchepucavage@plexusconsulting.com