CFAW ANNUAL DINNER Dinner with Bob Pozen, Author of "Too Big To Save?"

Events Update March 04, 2010    Bob Pozen, Author of Too Big to Save? How to Fix the U.S. Financial System Wednesday, April 14, 2010: 12Noon - 2pm Location: Arnold & Porter LLP (555 12th Street, NW)  (Metro Lines: Red/Blue/Orange - MetroCenter)  Member/NonMember Cost        Lunch ONLY: $30/$40        Lunch & Pre-Ordered Copy of Book: $50/$60  Join us for lunch with Bob Pozen, chairman of MFS Investment Management and author of Too Big to Save?  How to Fix the U.S. Financial System.   Mr. Pozen will discuss his new book, which analyzes the multiple factors that caused the financial crisis of 2008-2009, evaluates the government response so far, and presents non-partisan policy prescriptions to rebuild the global financial system.  Speaker Bio: Mr. Pozen is Chairman of MFS Investment Management, which manages over $150 billion in assets for individual and institutional investors. In 2002 and 2003 he was the John Olin Visiting Professor at Harvard Law School. In 2003 he served as Secretary of Economic Affairs for Massachusetts Governor Mitt Romney.  Mr. Pozen also served on President Bush's Commission to Strengthen Social Security.  Mr. Pozen was formerly vice chairman of Fidelity Investments and president of Fidelity Management & Research Company.  He has published a broad variety of articles in the Wall Street Journal, the New York Times, and the Financial Times.   Click here to see a full bio.  Mr. Pozen will be autographing his book after the presentation.  Onsite purchases will be available; however, pre-orders are being taken through our registration. Future CFA Washington Events  Annual Dinner at the Newseum, Speaker: Russell Napier, Wednesday, March 24, 2010     Women in Fund Management: Presentation and Networking Reception - Wednesday, April 21, 2010 Ed Altman: Revisiting Default Expectations for Industrial Enterprises: The Z-Metrics Approach - Monday, May 24, 2010 Back to Top Please visit www.cfawashington.org for registration and information regarding the events.  Cancellations must be made 72 hours in advance of the event for a full refund. Volunteer Opportunities  To express interest or for more details about specific opportunities check out our website or email This e-mail address is being protected from spam bots, you need JavaScript enabled to view it .  For general volunteer inquiries, please contact  This e-mail address is being protected from spam bots, you need JavaScript enabled to view it   CFAW Brochure CFAW was founded in 1953 as the Washington Society of Investment Analysts. Today, this organization has grown to more than 1,600 members plus some 250 student members, making it one of the largest CFA societies in the United States. Quick Links Join the CFAW LinkedIn Group CFAW Homepage Event Calendar Sponsorship Opportunities Support CFA Washington and further your business and marketing objectives. Corporate sponsorship opportunities are available, as well as event sponsorship for our professional education and networking events. In This Issue

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SEC ADOPTS ALTERNATIVE TICK RULE 3-2

PLEXUS CONSULTING

We attended the open meeting today where the commission adopted a rule that imposes an alternative tick test when a stock drops 10% from its close. The tick is then in place for the remainder of the trading day and the following day. The idea emphasized was that when that occurs it will only be longs selling because shorts must pay more. We know this is true only if there is vigorous enforcement and we hope the release will warn about counter parties agreeing to sell above the bid with a kick back to the purchaser. Experience shows that determined counter parties can agree on a price no matter what the market is doing. The release is 330 pages with 90 pages of cost/benefit anlysis.It was stated that only about 1.3% of stocks ever drop 10%. But we think lots of stocks will drop that much in a terrorist attack yet there was no discussion of that possibility. Most interesting was the dissent's emphasis on the concept of investor confidence .They suggested that there is no evidence of how short selling restrictions affect such confidence-no evidence except the 4300 letters and 5000 signature petition. We would have made the argument that without comments on a hard borrow or pre-borrow this step is the equivalent of a non alcoholic beer, all form and no substance except in a serious crisis. The investor confidence argument suggests that writing comment letters is a waste of time as the dissenting commissioners know better. The DTM director and head of risk respectfully pointed out that they might mean something. This rule will not become effective until year end . The dissent also projected significant compliance costs and that is probably the better argument given the small number of affected stocks. The following statement by two senators is a good analysis of the work done today;

FOR RELEASE: Feb. 24, 2010
CONTACT: Amy Dudley (Kaufman), 202-224-5042
Sheridan Watson (Saxon), 202-224-7777

Kaufman,  Isakson Say SEC Action a “Step Forward” But Fails to Solve Naked Short Selling Concerns
Delaware, Georgia Senators dismayed SEC never sought comments on “hard locate” requirement

WASHINGTON, D.C. - Senators Ted Kaufman (D-DE) and Johnny Isakson (R-GA) released the following statement after the Securities and Exchange Commission voted 3-2 Wednesday to require short sellers - if a company’s shares fall 10 percent in one day - to exceed the prevailing “bid” for the remainder of the trading day and the following day in short sales of that security.

“We are encouraged that three of the Commissioners finally took some action to protect investors from manipulative short selling. This circuit-breaker/bid test rule is a step forward. But in our view it will be of limited use, helping only in the worst-case scenarios that could occur during a terrorist attack or financial crisis. The uptick rule worked for 70 years as a systemic check on predatory bear raids; this approach will not provide investors with the same protections as an ‘always-on’ bid test.

“Moreover, the real problem is that the SEC does not have an enforceable rule to punish those who undertake market manipulation through abusive naked short selling and rumor-mongering. To this point, the SEC has not yet brought a single enforcement case in the 2008 naked short selling incidents that helped take down Bear Stearns and Lehman Brothers. Today’s new rule does not address that glaring problem.

“We are also dismayed that the Commission has never sought comments on a ‘hard locate’ requirement for short sellers, even after eight senators pointedly made this suggestion last July and seven senators have co-sponsored a bill calling for this. The Commission still failed to seek comments even after the SEC acknowledged in a September roundtable that the naked short selling rule did indeed pose enforcement difficulties. What would have been the downside to proposing a firm requirement that before stocks can be sold short, the short-seller must have a legally enforceable right - and obligation - to deliver the stock at the time of settlement? Just by proposing that type of rule, the Commission would have been in a position today to adopt a pre-trade hard-locate requirement, or a circuit-breaker approach combined with a hard-locate requirement, instead of a bid test, for example.

“Unfortunately, in our view, the partial action taken by the Commission today will not provide investors with the same protections as the uptick rule, nor does it address the enforcement issues surrounding the current naked short selling rule.”

BACKGROUND:

- On March 16, Sens. Kaufman, Isakson and Jon Tester (D-MT) introduced a bill (S.605) that calls for the following: “Not later than 60 days after the date of enactment of this Act, the Commission shall issue regulations prohibiting any person from selling securities short, unless that person demonstrates, at the time of the sale, that such person possesses, at the time of the sale, a demonstrable, legally enforceable right to deliver the securities at the required delivery date.” Co-sponsors: Sens. Robert Bennett (R-UT), Saxby Chambliss (R-GA), Orrin Hatch (R-UT), Arlen Specter (D-PA).

- In a June 24 letter to SEC Chair Mary Schapiro, Sens. Kaufman, Isakson, Jon Tester (D-MT) and Rep. Carolyn Maloney (D-NY) wrote, “Focusing on the uptick rule alone, however, puts too narrow a frame on the problems associated with naked short selling. The problem at its root may be that the current rules against naked short selling are both inadequate and impossible to enforce.”

- In a July 22 letter to Schapiro, Sens. Kaufman and Isakson and five other senators suggested a pilot program as proposed by the Depository Trust & Clearing Corporation (DTCC) to prohibit short sales that do not first acquire a “hard locate.” Sens. Kaufman, Isakson, Carl Levin (D-MI), Jon Tester (D-MT), Sherrod Brown (D-OH), Orrin Hatch (R-UT) and Robert Menendez (D-NJ) wrote: “This centralized ‘hard locate’ system seems to offer a viable way to eliminate ‘over selling’ of stock inventories, in that there would no longer be multiple locates on the same shares of a security. … The DTCC proposal could standardize requirements across the industry, can be configured in a way that will not disrupt markets, would streamline locate documentation requirements, and can be overseen directly by the SEC to ensure regulatory compliance.” Sen. Arlen Specter (D-PA) later wrote to say he concurred in that letter.

###

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
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The useless U-5

1. It should never be used for performance related issues.
2. It should never be public until a regulator has made a finding of violation.
3. It should never reduce complicated employment issues to a word or phrase.
4. The employer should provide the facts to the regulator without making any judgments and the employee should respond to those facts. The regulator should make the judgment.

   
   

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Regulatory Notice 09-69-Payments to Unregistered Persons

The International Association of Small Broker-Dealers and Advisers  www.iasbda.com submits the following comment on one general aspect of this proposal.For the last 30 years the SEC and FINRA have been dealing with the general question of finders. See ABA report on this subject included below.Each year at the SEC'S Small Business forum it is one of the chief recommendations to help small business.This year's draft recommendation is as follows;

1. Promote the Commission's twin missions of enhancing small business capital formation and protecting investors. These objectives can be met by bringing more unregulated or ineffectively-regulated activity into an appropriate regulatory environment that emphasizes disclosure and education in the area of private placement broker involvement. Action may be accelerated by the appointment of an advisory committee or designation of a working group involving the staff of the Office of Chief Counsel of the Division of Trading and Markets and the Division' of Corporation Finance's Small Business Office.

2. The Commission should adopt rules as recommended by the American Bar Association in its Report and Recommendations of the Task Force on Private Placement Broker-Dealers, dated June 20, 2005.  Background: This recommendation appeared in the 2006 Final Report of the Advisory Committee on Smaller Public Companies, and was recommended by the SEC Government-Business Forum Final Reports issued in 2006, 2007 and 2008.The report is included below

3. Allow "private placement brokers" to raise capital through private placements of issuers' securities offered solely to "accredited investors" in amounts per issuer of up to 10% of the investor's net worth (excluding his or her primary residence), with full written disclosure of the broker's compensation and any relationship that would require disclosure under Item 404 of Regulation S-K, in aggregate amounts of up to $20 million per issuer.  Background: This recommendation is specifically highlighted from those found in the ABA Report and Recommendations of the Task Force on Private Placement Broker-Dealers, dated June 20, 2005.

Despite this long history of debate,this rule filing regarding unregisterd finders is going forward without any substantive recognition of the complexity of this issue and can only be confusing to  large numbers of business intermediaries currently acting as finders both for members and issuers.We recommend that in forwarding the rule to the commission Finra ask that the commission clarify its position including the numerous no-action letters issued over the last 30 years.If the commission did so in seeking comments on FINRA'S rule, it would help the investment community understand the current status of the issue and may inform the commission as to how widespread a problem exists.The current economic emphasis on small business job creation demands that this issue be taken seriously at this time.We believe the ABA report is a good starting point but there may be other creative ways to clarify this issue including allowing the states to deal with it in regards to small offerings.FINRA would do a great service by engaing this issue at this time

http://www.finra.org/web/groups/industry/@ip/@reg/@notice/documents/notices/p120480.pdf

ABA Report and Recommendations

of theTask Force on

Private Placement

Broker-dealers
http://www.praxiis.com/files/SjoquistJune22005ABATaskForceReport.doc

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
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FINRA Regulatory Notice 10-03 Proposed Rule 4330(a)

This proposed rule 4330(a),http://www.finra.org/web/groups/industry/@ip/@reg/@notice/documents/notices/p120691.pdf  requires firms to obtain a written authorization from customers before their margin securities may be loaned out. However after years of debate about short selling and stock loan practices surely the disclosure could and should cover the most opaque parts of this transaction. These include the fact that only the broker -dealer will make money on this transaction and that the securities most likely will be used for short selling. Thus the customer who pays margin interest receives no compensation and his own securities are used to short his own stock. While this has been common practice for many years it can easily be included in the required disclosure. While legitimate debate about short selling continues there is no debate that retail customers receive little benefit when their securities are used and are not likely to understand they are conspiring against their own position.We suggest therefore that the broker explain the rebate he receives and the fact that the resulting short sale may be against their own interest and perhaps that other more powerful customers may indeed participate in these stock loan profits.

The following more colorfully describes the arguably inherent unfairness of this limited disclosure and suggests an appropriate disclosure at the end. We can substitute Dendreon as the real world example of the hypothetical Acme Pharmaceutical.While the language here may be exaggerated its message is not.;

WALL STREET VERSUS MAIN STREET AND THE USE OF MARGIN ACCOUNTS by Dr. Jim Decosta

Let’s assume “Buyer Bob B.” has $10,000 to invest and he wants to buy shares of Acme Pharmaceutical which has a new cancer cure.  Bob is an immunologist and very familiar with the efficacy of Acme’s new breakthrough drug.  Bob places an order for $10,000 worth of Acme and his broker informs him that he could actually buy $20,000 worth of Acme if he would just open up a margin account.  Bob may not be able to afford to lose $20,000 half of which is borrowed but knowing of the potential for the new drug he takes the bait and opens up a margin a/c and buys $20,000 worth of Acme.  Bob can afford to buy “X” amount of Acme but he ends up buying “2X” worth but it was his choice.  After all, to an immunologist like Bob Acme’s chances for an FDA approval is a no-brainer. 

Bob’s brokerage firm’s clearing firm earns a fee for the “banking” business it provided to Bob and the full “2X” amount of shares serves as the collateral for that $10,000 loan. Bob’s brokerage firm incurs veritably no risk for default on this loan with 200% collateral because they can easily sell these shares out from underneath Bob should the price drop.  Let’s assume that the shares that Bob bought were short sold from a short seller.  This “2X” amount of shares were originally bought by an investor across town named "Buyer Bob A."  They too were bought in a margin a/c; that’s why they were available for lending to the short seller.

After processing Bob B.’s $20,000 purchase order his broker now becomes the “legal owner” of that particular parcel of 2X amount of shares unknowingly “co-beneficially owned” by Bob A. and Bob B.  Being the new “legal owner” of that 2X parcel of Acme shares Bob B.’s broker has all of the right in the world to rent them to yet another short seller who then sells them to yet another Bob, “Buyer Bob C.”  There are now 3 “co-beneficial owners” of that one parcel of impossible to identify shares.  The most recent purchaser is referred to as the “legal owner” and all previous purchasers of that same parcel of shares are referred to as “security entitlement holders”.  This parcel of shares is impossible to identify because of the NSCC’s insistence on holding “street name” shares in an “anonymously pooled” format and because of the circa 1970 “dematerialization” of tough to counterfeit paper-certificated shares into easy to counterfeit electronic book entry shares.

All “security entitlement holders” are allowed by UCC Article 8 to sell that which they purchased at any time they so choose.  After a year or so let’s assume that through the magic of theoretically “legal” short selling there are now 11 “co-beneficial owners” and one “legal owner” of that one impossible to identify parcel of Acme shares.  Keep in mind that this is just one of many, many “daisy chains” of bogus Acme "shares" possible.

Picture Acme Pharmaceutical as a small tree attempting to grow into a big Pharmaceutical company via the introduction of their new breakthrough cancer cure.  Every single time a short sale of Acme shares occurred a readily sellable unregistered share price depressing “security entitlement” was essentially “issued”.  Due to their being treated as being readily sellable they add to the “supply” or “float” of Acme shares which must be treated as being readily sellable.  Each “borrow” associated with each short sale damaged Acme’s share price similar to an ax chopping away at the young “Acme tree’s” trunk.

As Acme’s share price dropped from all of this wonderful “liquidity” being injected by these 12 different short sellers the 12 purchasers of the very same parcel of Acme shares through their margin accounts started to get margin calls.  Since they already bought 2 times as much Acme as they could afford they were not able to meet these margin calls with cash.  Therefore their brokers had to sell some of their Acme shares to meet these margin calls.  This put yet further pressure on Acme’s share price which resulted in yet more margin calls which in turn put yet further pressure on Acme’s share price ad infinitum. Acme's share price is now into what is referred to as a self-sustaining "death spiral".

A self-propelling negative feedback loop has been established and Acme’s share price went to zero as they lost any ability to raise money to advance any further through the lengthy and expensive FDA approval process.  Acme had become an “easy prey” due to the nature of the business they were in, the nature of margin accounts and the DTCC’s refusal to bring transparency to shares being held in “street name”.  Perhaps none of those 12 investors would have invested in Acme shares if they had visibility of the immense number of share price depressing "security entitlements" poisoning the share structure of Acme.

During all of this “liquidity injecting” short selling the Wall Street “securities intermediaries” made an absolute fortune.  The margin a/c hosts were making banking fees right and left, the lending agents were making lending fees, the prime brokers were going to town, the executing brokers were going to town and the short selling hedge fund manager and his investors absolutely cleaned up while raking in all of the money the 12 investors lost.  In fact, 12 different brokerage firms were earning rental fees while renting out the very same parcel of impossible to identify shares in 12 different directions simultaneously.

In slow motion what just happened here.  An investor unaware of how margin accounts and short selling “DTCC style” operates got talked into buying twice the amount of Acme shares that he could afford; shame on him.  His margin a/c “host” took the shares purchased, both the “X” amount of shares that the investor could afford and the “X” amount of shares that he couldn’t afford and rented both parcels to a short seller whose goal it was to bankrupt Acme.  In order to effect that goal the short seller needs shares to borrow and the brokerage firms earning commissions from the sale and banking income from the loan were more than happy to earn rental income from those trying to bankrupt the invested in company.  One might ask what happened to the ’34 Exchange Act’s forbidding of conflicts of interest between brokerage firms and their commission paying clients.

This loan to short sellers started a “daisy chain” involving an inherent “counterfeiting/replicating” phenomenon associated with how our DTCC-administered clearance and settlement system is “rigged” in favor of the Wall Street “securities intermediaries” that own it over the Main Street investors in the Acme’s of the world.  It wouldn't’t take two seconds to put an identifier onto parcels of shares to block this “counterfeiting/replicating” process but those Wall Street insiders in favor of the corrupt status quo claim that it would be too expensive, it would decrease “market efficiency”, the technology is not there yet, pricing efficiency would be lost, etc. 

At the end of the day we have witnessed a very predictable “transfer of wealth” from Main Street to Wall Street because the NSCC insists on holding “street name” securities in an “anonymously pooled” format enabling this “counterfeiting/replicating” phenomenon to occur and be abused.  Even though these are theoretically “borrows” occurring in short sales the key to this fraud is to craftily transfer “legal ownership” to the new purchasers of these “borrowed” shares.  Why?  Because nobody can stop the new “legal owner” of shares to rent them out to anybody he so chooses.  But shouldn't’t the previous purchaser of the borrowed shares be identified and told that he lost his “legal ownership” and therefore can no longer sell that which he purchased?  That’s the trick; you can’t identify the original purchaser of those shares when shares are held in an “anonymously pooled” format and if you can’t identify him you can’t inform him that he lost his ability to sell that which he purchased.  Besides, not being able to sell that which one purchased wouldn’t go over too well with him anyways and nobody would opt to use margin accounts.  All of that extra banking and rental income would be lost.  Thus you can see the need to characterize what is clearly a “sale” as a “borrow”.

The key to this totally corrupt concept of holding shares in an “anonymously pooled” format is firstly the inability to keep the original purchaser of a specific parcel of shares from reselling that which he purchased after his shares were loaned out from underneath him and secondly you can’t prove that 12 investors bought and now “co-beneficially own” the very same parcel of shares and thirdly you can’t prove that 12 brokerage firms are earning rental proceeds from the simultaneous renting out of the very same parcel of shares in 12 different directions.  Pretty slick, huh? 

The victims of these thefts on Main Street refer to this phenomenon as the “counterfeiting of securities” that needs to be done away with.  Technically what is being “counterfeited” is not a “share” of a corporation as there are a fixed amount of those “outstanding” at any given time and this number doesn’t get altered during abusive short selling.  What are being “counterfeited” are the “units” on Wall Street that contribute to the “supply” of that which must be treated as being readily sellable.  These “units” include legitimate registered shares and the unregistered “security entitlements” issued during each otherwise legal “pre-borrow”, each and every NSCC SBP “borrow” and each failure to deliver that is yet to be bought-in.

Abusive Wall Street insiders will argue that there is no such thing as “phantom shares” being created during short selling as the number of “shares outstanding” does not increase.  What they (not so mysteriously) forget to mention is that the number of “shares outstanding” is not the only component of the “supply” variable that interacts with the “demand” variable to determine share prices.  The other component is the number of “security entitlements” that are issued.  I think that you in Congress can appreciate the reason why the DTCC management needs to make these intentional misrepresentations i.e. the aforementioned “iceberg” that nobody except for U.S. "long" investors and U.S. corporations are in a hurry to address.

The beneficiaries of these thefts inhabiting Wall Street refer to this blatant “counterfeiting” process as the “injection of liquidity” and the enhancement of “market and pricing efficiencies” which they lobby aggressively to maintain as the status quo.  Although mere “security entitlements” are not technically “shares” of a corporation they are indeed “securities” as any “evidence of indebtedness” qualifies as a “security”.  Thus the “counterfeiting” of securities phraseology is quite accurate but technically perhaps “the abusive inducing of the issuance of readily sellable share price depressing “security entitlements” with the intent to defraud the purchasers of nonexistent shares for one’s own financial gain” would be more accurate.

Theoretically “anonymous pooling” is used to enhance “market efficiency” and “streamline” the clearance and settlement process.  In the case of abusive short selling, however, what is really being “streamlined” is the flow of investor funds into the wallets of abusive short sellers and those that act as “securities intermediaries” in the short selling process.  At the recent SEC “roundtable” we saw the Wall Street insiders aggressively lobby to maintain the corrupt “status quo” and all of the standard malarkey about the theoretical benefits of short selling were cited.

In the example cited above the Main Streeters using margin accounts lost not only that which they could afford to lose but twice that amount and those extra shares they purchased “on credit” actually provided the leverage to augment, via the triggering of unable to meet margin calls, the already inherent “counterfeiting/replicating” phenomenon associated with otherwise legal short selling.  Margin accounts clearly need a “black box warning” that unsophisticated investors can read and understand.  Encouraging U.S. “long” investors to “double down” on their investments only to use the shares bought on credit as leverage against the entire amount of the “double down” is a very dirty trick especially when all of the “securities intermediaries” on Wall Street are heavily financially incentivized to assist in the defrauding process.

Didn’t we just witness the exact same modus operandi in the housing industry wherein Main Streeters were encouraged by Wall Street “banksters” to “leverage up” and get in over their heads so that the “banksters” could make tons of money in loan processing fees, commissions, banking income, rental income, etc.  Doesn’t that seem like a bit of a dirty trick to facilitate the “doubling down” by client’s owed a fiduciary duty of care only to take that double amount of shares that were purchased to facilitate the destruction of the investment made all while raking in income that was otherwise unattainable if the client did not double down?

Can you see in the above example how the more an investor knew about the company he was investing in the more he would be tempted to buy on margin which paradoxically made it more probable that those that knew absolutely nothing about this new medical breakthrough would end up predictably siphoning his investment funds into their wallet?  Abusive short sellers refer to this as the enhanced “market efficiency” they wouldn’t want any new regulations to do away with.

Should margin accounts have a “black box warning” similar to this? Warning:  There is a significant chance that the shares you are purchasing partially on credit will act as a “seed” to propagate the formation of an unlimited amount of  readily sellable share price depressing “security entitlements”  that can be used to loan to short sellers to aid them in their attempts to bring down the corporation you chose not only to invest in but to actually double down on your investment bet. 

The shares you purchased plus all of their “offspring” will be used to predictably manipulate the share price of the "invested in company" downwards.  This may likely result in you receiving “margin calls” which if you cannot answer with cash will result in a portion of your shares and those of other margin a/c holders to be forcefully sold which will exacerbate this downward movement in share prices which may lead to yet more margin calls. 

This is due to how shares held in “street name” are currently held in an impossible to identify “anonymously pooled” format that provides enough opacity to allow abusive DTCC “participants” and their hedge fund “guests” to systematically use the shares you purchased in your margin a/c to augment your own brokerage firm’s well-compensated efforts to route your investment funds into their wallets aided by an inherent “counterfeiting/replicating” phenomenon naturally present in any system using “anonymous pooling”.  The brokerage firm you paid a commission to and are paying banking fees and interest to will be handsomely rewarded via banking fees, commissions, rental income, enhanced order flow from the hedge funds they are aiding and abetting, etc. for their efforts rendered on behalf of the financial interests of those trying to bankrupt your invested in corporation.

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
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Gadinis: The SEC and the Financial Industry: Evidence from Enforcement against Broker-Dealers

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1333717

The SEC and the Financial Industry: Evidence from Enforcement against Broker-Dealers

Stavros Gadinis
Harvard University - Harvard Law School

August 11, 2009

Harvard Law and Economics Discussion Paper No. 27

Abstract:     
Recent financial collapses have focused policymakers' attention on the financial industry. To date, empirical studies have concentrated on corporate issuer activity, such as securities offerings and class actions. This paper makes a first step in studying SEC enforcement against investment banks and brokerage houses. This study suggests that the SEC favors defendants associated with big firms compared to defendants associated with smaller firms in three ways.First, SEC actions against big firms are more likely to involve exclusively corporate liability, with no individuals subject to any regulatory action. Second, the SEC is more likely to choose administrative rather than court proceedings for big-firm defendants, controlling for types of violation and levels of harm to investors. Third, within administrative proceedings, big-firm employees are likely to receive lower sanctions, notably temporary or permanent bars from the industry. To explain this gap, the paper first investigates whether big-firm violations are qualitatively different from small firms' violations, but finds no support for this. This paper next explores two hypotheses that could explain a systematic bias in enforcement patterns: that constraints in bureaucratic resources weaken the SEC's negotiating position towards big firms, and that SEC officials favor prospective employers

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BrokeAndBroker.com: The Fiduciary Standard Battle

We recommend the excellent discussions below but also believe there is a fundamental confusion about bd advice and ia advice.Bd's should only be subject to the fiduciary standard when they become advisers and it is not useful to suggest that they always do the same thing. A bd that sells 100 shares of GE to a client does not take on the duty of overseeing that client's entire financial affairs. But a bd who claims to be a financial advisor certainly should.We have experienced personally, older clients who are certain that their brokers are financial advisors but the brokers are equally certain that they have no duty to oversee their financial affairs that include especially planning for health/custodial care in old age including the use of reverse mortgages.The bd who recommended a portfolio of blue chips to a couple in their 40's does not necessarily think he has the duty to change that portfolio as they age into their 80's and the suitability requirement is rarely if ever used in that context.This is especially true if the account has become inactive following a buy and hold strategy.Yet its precisely in their 80's when these clients need independent holistic financial advice as that is when their savings are drawn down for health and custodial care.We have also experienced senior citizens demanding a certain equities return to maintain a life style.If an adviser has examined their entire picture and concluded that they know exactly what they want ,then we believe he has done his job.A bd who does the same thing may protect himself on the suitability issue but may well have crossed the line on being an adviser.See presentation sponsored by the Research Foundation of the CFA Institute on Life Cycle Saving and Investing for statistics in these areas.

http://www1.cchwallstreet.com/ws-portal/content/news/container.jsp?fn=04-09-07

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Comments on the SEC'S draft strategic plan.

We write to address one general concern about the draft plan http://sec.gov/about/secstratplan1015.pdf  that affects many of our clients including the International Association of Small Broker-Dealers and Advisers,www.iasbda.com. We do not believe the plan pays enough, if  any, attention to small broker-dealers, advisors or issuers. Indeed a word search finds the word small used 7 times in very general ways, with no specific discussion of small firm substantive issues. While the mission of the commission is protection of small investors we believe it underestimates who takes care of those small investors. In numerous areas the commission is focused on the problems of wall street but in very few areas the problems of the small firms that make up the largest percentage of brokers, advisers and issuers. We would have expected by now a significant portion of the plan devoted to the challenges of the smaller players in the capital markets. We will outline a number of areas for review along with proposed solutions as follows:

1) Abusive short selling primarily affects small issuers.-We recommend that the Commission establish an office of  Abusive Short Selling that would also include the Division of Trading and Markets staff that oversees the clearing agencies. This office would be the go to place for complaints in this area and would formulate suggested policies on a continuing basis as opposed to intermittent rulemaking. The plan should also discuss the need to obtain formal comment on a pre-borrow requirement as part of any analysis of abusive short selling. Any further rule making without comments on a pre borrow requirement would in our view violate the APA.

2) Sarbanes Oxley-The challenges confronting small issuers including SOX audits and finders have been hanging for many years and we believe the SEC'S Small Business Office should be significantly upgraded with staff and classified as an advocacy office. If the current legislation to exempt small issuers does not pass, the commission should continue to assess the cost benefit analysis of these audits.

3) State sharing of IA regulation We believe that the small investment advisers and hedge funds should be examined by the states with the commission staff focusing on the larger advisers and funds. We think that the smaller advisers, mostly located in one state, will be able to develop productive relationships with their home states while the SEC pays more attention to multi-state large advisers. These states will also be more informed about their own state customer base.

4) Uneven playing field. We believe that smaller broker-dealers are still playing on an uneven playing field when it comes to examinations and compliance. We think the SEC should leave that work to FINRA but increase its oversight of FINRA to insure that small bd's are not abused in this process. In this regard it should bring the OCIE inspectors back into the Divisions to enhance the SRO oversight.

5) Discretionary accounts for bd's We believe that the Commission should continue to allow discretionary accounts for bd's with very strict guidance as to when that business becomes an IA business. These accounts are valuable to small brokers and retail investors who do not want to pay an advisory fee and are very happy with these arrangements.

6) Meeting privately with big firms We believe that the commission should review its practice of meeting privately with big firms on proposed rules and bring those meetings into the public sphere. Recording such meetings might be one step but the best of all alternatives would be to do them in a public roundtable format. We also believe that small firm representatives need to be included in advisory committees and roundtables. The recent Reg SHO roundtable had an 8-1 ratio of big firms to small firms discussing the pre-borrow requirement.

7) Suitability/fiduciary duty We believe that the suitability/fiduciary duty concern can be made less difficult by imposing the suitability requirement on unsolicited bd trades except for internet trades. In particular the impact of imposing a fiduciary duty on small brokers should be carefully addressed especially if they receive no special compensation for advice.

8) Sanctioning senior management of big firms  The Commission must reexamine its policy of never sanctioning senior management of big firms while often doing so for small firms. This has been noted by Judge Rakoff and has been a scandal for at least the last 35 years. Judge Rakoff has described such a policy as  a “contrivance” that would allow the SEC to appear to be enforcing the law and protecting shareholders while allowing the management  to make an embarrassing situation disappear. The Commission and FINRA need to answer this common belief by analyzing those cases in which senior management have been named to determine whether the belief is well founded. A specific section of the strategic plan should be devoted to this issue. While promises of a review of small firm abuse have been made in the past, we do not believe the results have ever been made public.

9) SRO rule filing process We believe that the sro rule filing process can be simplified by many of the suggestions enumerated in the Katz report. http://www.uschamber.com/assets/ccmc/090211ccmc_sec_speed.pdf .We also believe that it should contain a certification that small firms are not disproportionately affected by the proposed rule under review or an explanation if they are. 

10) Enforcement orientation Finally we believe that as also enumerated in the Katz report the SEC should be less enforcement oriented and more surveillance oriented. As the head of enforcement recently noted its too late when an enforcement action is needed." stopping misconduct before it happens is infinitely better than prosecuting it after the fact".

'http://www.iimagazine.com/regulation/Articles/2333948/Mary-Schapiro-Puts-SEC-Back-in-Business.html
Small firms' CEO'S  are often targeted for actions that big firms escape and the IG report on the Aguirre matter noted the staff's recognition of this problem. Small firms are often the target of racking up numbers to show tough enforcement statistics while large firms often escape with only monetary fines. A modest $20,000 fine for a large firm may be the death knell for a small firm .

11) Accepted research favoritism and front running-certain big firms have acknowledged that research is provided to favored clients before publicly distributed and that trading occurs based on orders being shopped at their trading desks. This conflict between the broker's roles and their duty to all customers needs to be reviewed as part of any strategic analysis. As Senator Kaufman has admirably noted every very investor deserves a level playing field as does every small firm. Whatever this means it needs to be part of the strategic study and the commission should act as quickly as it has on flash orders and dark pools to insure a level playing field.

12) Diversity measurement-The draft plan states that diversity is important but in its performance metrics it fails to adopt the most logical metric ie an increase in minorities especially at the senior management level.pp 44-45.We have witnessed an entire replacement of senior staff without much evidence of a diversity goal even in terms of geography. We believe that there are experienced securities professionals out side of the New York- Washington corridor. But if you consider small firm experience as part of diversity you would look very hard to find any senior management with that experience. Indeed you would look hard to find any small firm experienced staff. Finally if you were looking for industry experience outside of law firms and other regulators or law enforcement it would not be easy to find, a fact noted by some of the prescient commenter on recent regulatory failures. This is not intended in any way to disparage current staff but if the plan chooses to focus on diversity it cannot ignore the obvious and better metrics should be considered for minorities and past experience

13) Qualification exams- The sro's have raised the issue of allowing individuals not currently employed in the industry to take qualification exams in order to enhance their prospects of entering the industry or to maintain those qualifications when they leave the industry in the same way that lawyers, doctors and accountants do. The commission should consider this policy especially in a time of high unemployment in financial services. Today we have colleagues wishing to reenter the industry who cannot take the principal's or other supervisory exams because they are not employed. This policy is truly counterproductive in terms of increasing regulatory sophistication and somewhat hypocritical when not applied to regulators themselves. It affects the small firm community which cannot hire and train its employees but must have them come aboard as immediate producers. Thus its most important that the commission do everything within its power to help those who have lost jobs in the current crisis.

Peter J.Chepucavage
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

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Plexus Retained By The Chartered Financial Analyst Society of Washington,D.C.

• • • • • • • • • • • • • • • • •     Contact:

                                      

                                  Heidi Schneider

                            Phone: 202.785.8940

                                Fax: 202.785.8949

                      Email: This e-mail address is being protected from spam bots, you need JavaScript enabled to view it

PLEXUS provides management services to the Chartered Financial Analyst Society of Washington D.C.

Washington, DC- 9 November 2009- The Chartered Financial Analyst Society of Washington D.C. has retained Plexus Consulting Group, LLC (Plexus) to provide management services. Plexus is headed by Steven Worth, and Peter Chepucavage its General Counsel will serveas Executive Director of CFAW. CFAW has over 1600 local members and an additional 300 student members. Its vision and mission statements are as follows: 

Vision: 

 “The CFA Society of Washington and its members are influential leaders in the global investment community who are respected for their knowledge, professionalism and integrity.”

Mission Statement: 

“Advance members’ professional success and the interests of the Washington, DC financial community.”

John Escario the President of its Board stated that it intends to become a leading voice in the Washington D.C area for the values that the CFA Institute stands for. Those values encompass ethics, training and helping its membership secure employment in the corporate, government and non-profit sector. Steve Worth, the President of Plexus, noted that the CFAW will implement a major membership drive with Plexus and seeks to work with employers in the area to further that goal.

(MORE)

About Plexus Consulting Group, LLC

Plexus Consulting Group is a management-consulting firm that provides marketing, management, and strategic planning services to association, for-profit, and governmental entities in North America, Europe, Latin America, and Asia. Plexus’s network of affiliate offices covers all these markets. The firm is headed by Steven Worth-a 25-year consulting veteran whose former professional titles include: Director of International Public Affairs and Communications, Deloitte, Touche, Tohmatsu; Managing Director of Hill and Knowlton Brussels, and Press Liaison for the U.S. Senate Majority Leader’s office.

For more information, visit the firm’s website atwww.plexusconsulting.com <http://www.plexusconsulting.com>.

-END-

Peter J.Chepucavage
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

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File No. S7-21-09. Flash Orders

The International Association of Small Broker Dealers and Advisors

1620 Eye Street, NW, Suite 210

Washington, DC 20006

202-785-8940 ext. 108

This e-mail address is being protected from spam bots, you need JavaScript enabled to view it

www.iasbda.com

The International Association of Small Broker-Dealers and Advisers www.iasbda.com supports the Commission's proposal to ban flash orders. We are particularly impressed with the speed in which the Commission has addressed this problem.We have not seen the Commission encourage commenters to respond within the comment period as it has on p.33 noting its intent to act quickly. However we are more interested in the statement at page 16 of the release that "its clear responsibility is to uphold the interests of long term investors" when there is a conflict with professional short term traders. We contrast this with the following commentary from a well respected financial news editor:

"Despite a few arcane rules that the SEC may eventually impose, steroidal trading is likely to continue unabated. Hyperkinetic traders will defend their frenzied trading by opining that it adds liquidity, which is good for everyone. (Sure, and if you believe that, let me sell you some auction rate securities.)

The truth is, for average people, Wall Street's trading arenas are like Times Square in the raunchy days before Disneyfication: A glittery, dangerous place that becomes more exciting and iconic the farther you are from the actual tawdry mess.

All this trading benefits no one but traders, the exchanges - which are now for-profit businesses - and computer salespeople. Sure, as a nation, we should invest in more productive (and boring) things like faster railroads and better cell phones. On the other hand, if the financial markets didn't waste capital on faster trading, they'd probably waste it on leveraged buyouts, which do more damage." http://www.investmentnews.com/apps/pbcs.dll/article?AID=/20091014/FREE/910149991/1094/INDaily01

The Commission must focus on this common perception. We have yet to see the preference for long term investors applied in 10 years of Reg Sho considerations or with respect to trading ahead of research or customer orders or in the selection of participants for roundtables and advisory committees. Indeed we rarely have seen this principle elucidated as it is in this context. Rather we see it as an idealistic goal proffered to the masses while professional traders and mutual funds go the opposite way.The Commission notes on p.20 the strong incentive for markets to maximize their executed volume and that flash orders provide a competitive advantage.We do not think that the fairness of those markets often outweighs this competitive mandate especially since they became for profit businesses.The Commission must ask whether a for profit business can put fsirness ahead of profits?

We agree with Senator Kaufman and others that this fundamental principle of our capital markets needs to be subject to a modern Pecora study SeeFinancial Times,Preventing a horror movie ending in the US marketsBy Edward E. Kaufman 10/16/02

"Many on Wall Street assure us there is nothing to worry about. In their view, the dramatic proliferation of competing markets and the extraordinary rise in high velocity trading have had only beneficial results: greater liquidity, narrowed spreads and lower transaction costs for all investors.

Lost in this reflexive defense against meaningful government review, however, is a more overarching concern: the integrity of our capital markets, which are now too frag mented, too opaque and well beyond the effective surveillance of the Securities and Exchange Commission.

That’s why I have urged the SEC to undertake a comprehensive “ground up” review of a broad range of market structure issues before more piecemeal changes occur. We have seen this horror movie before, and only timely regulatory examination can best prevent a sequel: When markets develop rapidly and are not transparent, effectively regulated or fair, the movie’s ending scene can be one of tragedy affecting millions of people.

The facts speak for themselves. We’ve gone from too few stock markets to too many; from an era dominated by a duopoly of the New York Stock Exchange and Nasdaq to a highly fragmented market of more than 60 trading centres.

In competing for market share, those trading centres encourage or permit a variety of questionable practices. Dark pools, for example, which allow confidential trading that takes place away from the public eye, have flourished: Five years ago, there were 18 dark pools comprising 1.5 per cent of the market’s volume; today, over 50 dark pools execute over 12 per cent of market trades. And the total percentage of trades taking place in dark pools or internally at broker dealers, another source of private trading outside public markets, now approaches one quarter. For strictly retail investor orders, it may be twice that amount.

And when the average investor loses confidence in the integrity of our markets, when he or she believes that the price at which they are able to buy 100 shares of IBM is higher than it should be, even if only marginally, because of high frequency gaming strategies, then the reputation of our capital markets for basic fairness is significantly tarnished.

The SEC’s review should be all-encompassing, reviving old ideas and examining new ones: should markets be centralised or decentralised; should we separate the markets based on investor types; what should be the role of market makers; what role might there be for real time risk management?

At a minimum, a few simple themes should guide us to a regulatory framework that permits vigorous competition while substantially reducing the possibility of a two-tiered trading network, where long-term investors are vulnerable to powerful trading companies that exist not to value or invest in the underlying companies, but to feed everywhere on small but statistically significant price differentials. "

In addition we believe the issue of long term investing should be addressed in every rule proposal. We also disagree with the notion that liquidity is today's guiding principle for our capital markets. Fairness is the guiding principle but too often many documents and statements issued by regulators emphasize liquidity much more frequently than fairness. How did that come about? It came about because in the last 25 years technology coupled with deregulation has become the answer to all problems on wall street. Is it a pure coincidence that scandals in the last 25 years have been far more prevalent than in the previous 25 year period? See testimony of Mark Cooper of  the  Consumer  Federation of America.http://judiciary.house.gov/hearings/pdf/Cooper090317.pdf  where he contrasts market fundamentalism with fairness. See also<http://www.consumerfed.org/pdfs/FinancialMarketReformReport.pdf>discussing specific reforms in financial services. We therefore applaud the Commission's action on flash orders but believe that the priority of long term investing has been the victim of market fundamentalism.As Captain Sullenberger says about the airline industry,"economics is linked to safety"while in financial services profits are linked to fairness.

Peter J.Chepucavage
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

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Abusive Short Selling Update.

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Matt Taibbi Rolling Stone.pdf(2491 KB)

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File no.4-590 Roundtable on stock loan and short sales.

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

202-785-8940 ext. 108

This e-mail address is being protected from spam bots, you need JavaScript enabled to view it www.iasbda.com

The International Association of Small Broker-Dealers and Advisors www.iasbda.com submits the following comments on the  pending  alternative tick test  proposal  and roundtables . We are concerned that this additional request for comments has been instituted prior to a roundtable on September 30th that includes specifically a pre-borrow requirement. We fear that putting the tick test ahead of the pre-borrow consideration will result in the tick test being the exclusive pre-trade remedy without proper consideration of other options. We note that many economists including commission staff such as professor Larry Harris have stated that tick tests are not effective while no one to our knowledge has indicated that a pre-borrow is not effective. Criticism of a pre trade/ pre borrow centers around increased costs resulting in less liquidity. Stated another way-if we really need to borrow its not as profitable. The commission's own economist Dr. Leslie Boni has noted the concept of opportunistic short selling to avoid the borrowing costs. This problem has arisen because of the Commission's reluctance over the multiple comment requests to seek formal comment on a pre-borrow requirement. Thus the various tick and circuit breaker proposals are being considered in a vacuum without the alternative of a more effective pre-trade remedy. This will  raise for some commenters the question of whether we need both and whether the systems costs are becoming unmanageable. If a pilot is the desired course will we have two pilots after the roundtable.

We therefore believe that whatever results from these comments, the commission should move aggressively to ask whether the pre-borrow alternative is more cost benefit effective than the tick /circuit breaker alternatives? Dr. Robert Shapiro has provided strong evidence that it is and numerous former commissioners and legislators have agreed. Yet we are now considering it in a roundtable 9 days after the end of the second comment period on a tick test and we still have no indication from the regulators as to whether the Bear and Lehman demises were the result of abusive short selling. We noted in our comments to the original proposal to reinstitute the tick test that it would be a diversion from the consideration of other more effective remedies. Our worst fears have come to pass as we now have triangulated various remedies with no consensus on the right one.Furthermore we are 18 months and 12 months respectively beyond the demise of Bear Stearns and Lehman without any indication of whether abusive short selling was involved. We are almost 5 years beyond the effective date of Reg Sho with only one case brought under it. We are very fortunate that our markets have been rising since March but another financial or terrorist crisis leaves investors with no real pre-trade protection against abusive short selling.

Much has been made of the hard close post trade remedy that has reduced the threshold list significantly. We have noticed with frustration the Commission's recent actions' confirmation of a change from pre-trade regulation to post trade regulation of abusive short selling. The essence of our argument is found in a recent courageous Dow Jones article by Joe Checkler .<http://compliancex.typepad.com/compliancex/2009/08/even-with-new-rules-naked-short-violations-hard-to-enforce.html> These arguments were also reinforced by CEO Neiderhauer of the NYSE who recently stated;

"But even if we get that done, your second part of your question is the important part. What was really broken in this country was not the trading rules. It was the borrowing, lending and delivery rules. They were not being enforced. People were not borrowing stock and had no intention of borrowing stock when they shorted. And that was our big issue with the SEC in the previous administration. Enforce the rules.

Settlement's supposed to be T-plus-three in this country, not T-plus-100. And there were a lot more aged fails than people thought. So I think tightening up those rules has made a big difference and has dramatically reduced the amount of naked short selling.

Lastly, Steve, the intraday activity we're never going to be able to stop. You're not going to be able to stop it. I'm not going to be able to stop it, even as the biggest exchange. If someone wants to short a stock in the morning and cover it in the afternoon, that's called day-trading, I'm not sure there's much we can do about that. So I don't really think that's naked short-selling the way the media talks about it. I think that was short-selling where the customer had no intention of borrowing and delivering that stock."

We believe this interpretation of day trading is incorrect in light of the Ko securities case specifically highlighted in fn. 55 of the Reg SHO adopting release, but Neiderhauer's general point is valid. Short term abusive short selling has been given a no-action letter. If the trade can be settled its legal.We think this is wrong and note the destruction of Bear Stearns in one week. The commission has promised a roundtable on September 30th to address pre-borrowing and other remedies. However we do not believe such roundtables can be productive in the near term as we think the tick test debate will crowd it out. We see no estimated specific date for the reinstitution of a tick test and can foresee how the current market surge could justify a decision by the Commission to declare victory and go home on this issue. The pre-trade and post trade analysis is historically instructive.

The tick test was a pre-trade remedy but was eliminated in favor of an allegedly aggressive Reg SHO with its strongest element the post trade threshold list with exceptions. The commission's current posture is that the post trade close out has cured all problems because settlement is insured. But that settlement occurs with another naked short which must be hard closed in another three days. If you don't borrow the stock pre-trade you create the equivalent of a stock loan ponzi/madoff scheme. But because the initial trade settles the commisssion seems pleased. This is why a pre-borrow is arguably more effective then a tick test or hard close. No stock-no trade. But if you limit the trades than you limit liquidity.Is it liquidity or is it leverage we are limiting? Note how much nicer the former word sounds today after the leverage of the sub prime crisis.? So what price are we willing to pay for liquidity? Or as Chairman Donaldson stated how much fraud will we accept for liquidity. We are willing to pay the price of eliminating pre-trade restrictions and allowing unfettered leverage on both sides. We are told that its accepted practice now for Lenders to provide 5 locates for each stock they own. In view of the recent enforcement activity short sellers can calculate that the most that will happen with an abusive sale is a fine five years later. We believe therefore that immediately after the roundtable the commission should move quickly to impose some combination of tick test, circuit breaker and pre-borrow requirement and it should state whether abusive short selling was one of the causes of Bear and Lehman's demise.

Peter J.Chepucavage
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

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A sea change in the regulation of short selling.

We have noticed with frustration the Commission's recent actions' confirmation of a change from pre-trade regulation to post trade regulation of abusive short selling.Its an affirmation of the wisdom of unsafe sex if it can be fixed later.The essence of our argument is found in a recent courageous dow jones article by Joe Checkler .http://compliancex.typepad.com/compliancex/2009/08/even-with-new-rules-naked-short-violations-hard-to-enforce.html  These arguments were also reinforced by CEO Neiderhauer of the NYSE who recently stated;

"But even if we get that done, your second part of your question is the important part. What was really broken in this country was not the trading rules. It was the borrowing, lending and delivery rules. They were not being enforced. People were not borrowing stock and had no intention of borrowing stock when they shorted. And that was our big issue with the SEC in the previous administration. Enforce the rules.

Settlement's supposed to be T-plus-three in this country, not T-plus-100. And there were a lot more aged fails than people thought. So I think tightening up those rules has made a big difference and has dramatically reduced the amount of naked short selling.

Lastly, Steve, the intraday activity we're never going to be able to stop. You're not going to be able to stop it. I'm not going to be able to stop it, even as the biggest exchange. If someone wants to short a stock in the morning and cover it in the afternoon, that's called day-trading, I'm not sure there's much we can do about that. So I don't really think that's naked short-selling the way the media talks about it. I think that was short-selling where the customer had no intention of borrowing and delivering that stock."

We believe this interpretation of day trading is incorrect in light of the Ko securities case specifically highlighted in fn. 55 of the Reg SHO adopting release, but Neiderhauer's general point is valid.Short term abusive short selling has been given a no-action letter.If the trade can be settled its ok.We think this is wrong and note the destruction of Bear Stearns in one week.The commission has promised a roundtable on September 30th to address pre-borrrowing and other remedies.However we do not believe such roundtables can be productive in the near term.We see no estimated date for the reinstitution of a tick test and can foresee how the current market surge could justify a decision by the Commission to declare victory and go home on this issue.The pre-trade and post trade analysis is historically instructive.

The tick test was a pre-trade remedy but was eliminated in favor of a allegedly aggressive reg SHO with its strongest element the post trade threshold list with exceptions.Our current posture is that the post trade close out has cured all problems because settlemet is insured. But that settlement occurs with another naked short which must be hard closed in another three days.If you don't borrow the stock pre-trade you create the equivalent of a stock loan ponzi/madoff scheme.But because the initial trade settles the Gods are pleased.This is why a pre-borow limits the amount of rollovers that can occur.No stock-no trade.But if you limit the trades than you limit the big dawg-LIQUIDITY.Is it liquidity or is it leverage? Note how much nicer the former word sounds today? So what price are we willing to pay for liquidity? We are willing to pay the price of eliminating pre-trade restrictions and allowing unfettered leverage on both sides. Lenders providing 5 locates for each stock and short sellers calculating that the most that will happen with an abusive sale is a fine five years later. Its the difference between certain religions emphasizing forgiveness while others emphasize prohibitions. Extremism is defense of liquidity is no vice while pre-trade limitations in favor of fair markets is no virtue. We see this regulatory change in other areas such as flash trades and derivatives regulation. Perhaps the logical extension of this thinking is to change the basis of self regulation to conduct inconsistent with just and equitable principles of liquidity?

Peter J.Chepucavage
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

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amendments to reg sho.File No.: S7-08-09

The International Association of Small Broker Dealers and Advisors

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

202-785-8940 ext. 108

This e-mail address is being protected from spam bots, you need JavaScript enabled to view it

www.iasbda.com

The International Association of Small Broker-Dealers and Advisers www.iasbda.com submits the following supplement to our comments dated April 21,2009. http://sec.gov/comments/s7-08-09/s70809-180.pdf .We continue to believe that this proposal has diverted the commission from the most effective remedy, a pre-borrow or hard borrow requirement and that position was confirmed by the recent GAO report.http://levin.senate.gov/newsroom/supporting/2009/report.GAO.060309.pdf . However recent statements by the Commission staff to the GAO require that  the Commission clarify who is responsible for enforcing Reg SHO and any new uptick or circuit breaker rules. This is particularly important because any uptick rule is subject to evasion which is why most economists do not believe it can fix the problem. The use of married puts both legally and illegally is a traditional means of evading the uptick barrier. Therefore if a new tick test is imposed enforcement/surveillance responsibility must be clear.We argue hereafter that the locate requirement together with the staff's enforcement uncertainty need to be rectified before any new rules can be truly effective.

Most recently the staff told the GAO that they did not bring any cases because the self regulators were primarily responsible for the enforcement of Reg SHO due to the operational nature of the rule. Report at pp 52-53.  Previously  the staff told the Inspector General that since few sro referrals were made, the problem was not serious.http://www.sec-oig.gov/Reports/AuditsInspections/2009/450.pdf . The news media has reported that senior staff had suggested that those concerned about naked short selling were whiners or bozos.At the commission's open meeting on the proposal of Rule 10b-21 senior staff told the commission they were not aware of many complaints of rumor-mongering. By the summer of '08 they became very aware. As far back as 1991 the staff was criticized when it told Congress that it relied heavily on short sellers for information about enforcement cases. SHORT-SELLING ACTIVITY IN THE STOCK MARKET: MARKET EFFECTS AND THE NEED FOR REGULATION (PART 1)Committee Reports,102d Congress, House Rept. 102-414,102 H. Rpt. 414,DATE: December 6, 1991.Excerpts from this report are included below. During the 10 year period beginning in the early 90's the NASD now FINRA settled close to 80 cases involving its version of the locate rule but with minimum fines except in one case.Reg. SHO was adopted precisely because the staff believed that SRO enforcement was not adequate. 

Former commissioner Campos in his comment letter on the final interim hard close rule dated March 25,2009 noted the difficulty in bringing Reg SHO cases without a preborrow requirement. http://sec.gov/comments/s7-30-08/s73008-108.pdf

"Regulation SHO currently allows a short seller to execute a short sale if he has a "reasonable belief' that he will be able to locate the stock in the future. This "reasonable belief' standard allows gamesmanship and, in an enforcement action, it is very difficult to show the trader's required scienter (mental state) necessary for proving a violation of Regulation SHO A recent SEC Inspector General Report demonstrates clearly that the Enforcement Division's attitude toward naked short selling has been to completely ignore complaints of such activity. 12 The report's findings are not surprising considering the difficulty under the current rules to show the requisite scienter. Requiring traders to pre-borrow shares, or to have a legally enforceable right to deliver the shares to be shorted prior to executing the short sale, will

(1) stop naked short selling, and (2) make enforcement easier, and thus more effective, as there will be a clear and trackable rule"

.
The recent GAO report noted that GAO staff did not understand how the locate requirement could be enforced or complied with absent a decrementing requirement.

Another potentially important aspect of any SEC determination regarding whether to continue to rely on the current locate and close-out requirements for mitigating manipulative short selling will be an evaluation of the effectiveness of the current locate requirement in reducing FTD and the potential for market manipulation, with a particular focus on the reliability of easy-to-borrow lists--that is, these lists must represent securities that are available for borrowing. Regulation SHO lacks specific criteria regarding what constitutes an easy-to-borrow security, but SEC found that a few firms have not followed industry best practices, which call for decrementing their inventory as locates are provided. We note that unless firms follow such best practices, it is not clear how they can ensure that they are providing locates only on their available supply of securities and limiting the potential for FTD. However, because following industry practice is voluntary, the magnitude of firms overlocating or including securities that are not easy to borrow on the list is currently unclear.

Reg SHO itself was enacted because of commission concern that the SRO's were not enforcing their rules. Yet the staff's uncertain ambivalence was noted in a 2008 interview where a very senior staffer explained;

"As to naked short selling, and more generally market manipulation generally (sic), it is an area we are focused on. We have seen fewer cases in that arena because, often times, this is not necessarily with respect to naked shorts, but shorting or market manipulation more generally, because often the components of something that might look to be manipulative are all legal trades as you point out. So it's a hard case to bring, which is not to say that it isn't something that we don't investigate, because we do. So I.. hear and understand the frustration of many on the subject of short selling generally. When we hear complaints about short selling-and, frankly, it is both short and naked short, it is a combination of both-we routinely hear from companies who've come in, who worry that they're being shorted in an illegal way. We routinely take all that information in and look into it. And often times, as I think many defense counsel would be happy to tell you, when we dig in, what we find is that some of the information that has caused people to be shorting is actually true as to the company, and we may very well be confronted with two issues, one on the company and its disclosure side as well as on the trading side. But they're very difficult cases, which is not to say that we aren't focused on them and interested in them and indeed this new focus that we have on some smaller companies and smaller issuers will wrap some of those concerns into their focus as well."

This logic of moral equivalence between the abusive short seller and the issuer has a long history and was criticized in the above referenced 1991 congressional report;

"The committees concern regarding this aspect of the SECs enforcement program is further heightened by the prepared testimony of ------ the SECs Division of Enforcement. In explaining why the SEC has not found it practical to bring enforcement cases against short sellers in most instances, he stated:

Finally, many of the complaints we receive about alleged illegal short selling come from companies and corporate officers who are themselves under investigation by the Commission or others for possible violations of the securities and other laws. When there is an obvious economic justification for short sales, it is extremely difficult to prove: .  .  . (ii) the material false statement/omission and fraudulent intent requirements of Rule 10b-5. This is particularly true in those situations where, for example, our investigation tends to show that at the time when short sellers were allegedly disseminating false rumors, in fact, the issuer was disseminating materially false financial statements.

This statement by Mr. ---- has the appearance of a de facto "no-action" assurance to short sellers concerning any actions they may take to disseminate false rumors about companies that are the object of SEC fraud investigations. Moreover, since the SEC does not bring formal charges against the company in many of the cases where it initiates an investigation, this statement represents a policy of ignoring possible cases of abuse by short sellers on the basis of unproven and potentially untrue suppositions about company behavior. The committee finds this policy very disturbing."

This history including the additional 1991 report excerpts below suggest that the commission needs to clearly delineate for the staff the responsibility and accountability and desire for robust enforcement.These statements do not "venture from the realm of economics to the realm of psychology" as noted in a recent letter regarding investor confidence.Investors can only read these statements in one way. Its not enough for  Chairpersons to speak of aggressive enforcement, that message must be embraced and co-ordinated with the staff of both the SEC and FINRA. We suggest the following joint SEC/FINRA outline of surveillance and enforcement;

• FINRA/NYSE Regulation should have primary responsibility for surveillance and enforcement except for those cases against non bd short sellers and those cases where the subpoena of third parties is demanded.
• SEC staff should focus on insuring that the sro's do their job instead of trying to compete for cases with the sro's
• FINRA should insist that its members determine who is failing on short sales and dispel the myth that it cannot be done because of NSCC'S settlement process.
• The Commission should demand that its staff make a clear and unequivocal commitment to the enforcement of Reg SHO and any new uptick or circuit breaker rules and that the staff should not opine that the hard close rule has fixed everything. The commission should provide the staff with a pre-borrow rule to work with by quickly proposing a pilot pre-borrow. We understand there are arguments against a pre-borrow but we do not understand why the Commission has never sought formal comment on it which it can easily and quickly do.
• Finally as noted above sometimes the shorts are correct-but being correct can never justify abusive shorting and this point must be embraced by the commission and the staff. There is no moral equivalence when laws are broken by both sides. The rapist is not innocent because the victim also committed a crime.

Excerpts from the 1991 Congressional report.:

III. Abuse and Manipulation By Short Sellers
 A. Credibility of Abuse Allegations
The subcommittees investigation of short selling has included extensive review of the allegations of short-seller abuse offered by affected issuers and investors or reported in the press. In addition to the widespread press reports, allegations of abuse were reported by witnesses in the subcommittees hearings, by issuers who responded to the subcommittees questionnaire, and by other issuers and investors in numerous unsolicited off-the-record contacts with the subcommittee. The subcommittee did not, however, attempt independent verification of their accuracy through field investigation.

Because of the lack of independent investigation and verification, the committee has not made any findings that certain of these allegations were conclusively demonstrated to be true. The committee cannot, therefore, report documentation of specific incidents of abuse by short sellers.

The committee has found, however, that many of the reports of rumor-spreading abuse are entirely credible and are strongly suggestive of abuse. Moreover, the widespread nature of these reports and the high degree of similarity among them constitute a highly consistent pattern. The committee finds, therefore, that a pattern of abusive and destructive rumormongering, targeted specifically at companies in the equity securities of which some short-selling investors have established major short positions, appears to be occurring.

Other reports have alleged direct price manipulation or other trading abuses by short sellers in the trading of target companies shares. Many of these reports have alleged that certain parties were engaging in naked short selling, presumably with the cooperation of a major broker or dealer.

None of the reports of naked short selling were supported with direct evidence, and in its evaluation of these reports the subcommittee found the circumstantial evidence offered to be inconclusive. The charges of naked short selling do raise important questions of the proper functioning of the markets, however, and the subcommittee has therefore initiated a study of clearing and settlement delays and their relationship to short selling, as reported previously.

This study has not been completed, but the evidence examined so far suggests that naked short selling or its functional equivalent does occur in large volume in some equity issues. The committee does tentatively conclude, therefore, that the reports of naked short selling offered by issuers and other investors, while lacking direct supporting evidence, may nevertheless be true in some instances.

Other allegations of direct price manipulation by short sellers have appeared to the subcommittee to lack substance. For this reason the committee has concluded that, aside from the reports of spreading false rumors and engaging in naked short selling, many of the complaints about short-seller abuse are not soundly based and may reflect a misunderstanding of the short-selling process.

b. the psychological environment
The committees principal concern in its evaluation of short-selling issues has been broader than just whether specific abuses and violations have occurred and are being regulated. The committee is particularly concerned with whether:

 a. The equity market functions fairly for investors who invest in the shares of companies that are actively sold short by other investors; and

 b. Whether the equity market prices such stocks efficiently and appropriately so that these companies will continue to have access to the market for new capital on a sound and fair competitive basis.

The committee has found, in this connection, that the fairness and efficiency of the equity market for stocks that are actively targeted by short sellers suffer from serious disturbances that cannot be attributed solely to specific instances of short-seller abuse.

The pricing and trading of individual equity issues are highly dependent on subjective elements of psychology and perception among investors generally, and the committee finds that many investors and issuers have a perception that short sellers have great manipulative power over stocks.  Moreover, the committee finds a widespread perception, expressed in many ways to the subcommittee, that the SEC is indifferent to the manipulative activities of the short sellers and assists them indirectly by their attitude of indifference.

The psychological environment is further affected by the fact that major short-selling investors function entirely anonymously. Under present reporting rules it cannot be known, except through a special investigation by the SEC, the exchanges, or the NASD, who is holding the major short positions in a particular stock.

The committee finds a strong undercurrent of disillusionment with the public equity markets and with the SEC in the viewpoints expressed by many investors and issuers whose shares are targeted by short sellers. Among these investors and issuers there appears to be a sense of being victimized by powerful but unknown abusers who do their will without restraint from any regulators. If these were isolated views, they might not be significant, but the committee finds them sufficiently prevalent to constitute a troubling pattern.

In some instances, as reported previously, the targets of short selling appear to have drawn conclusions about the manipulative power of short sellers without a solid factual basis, but this tendency of many investors to draw such unfounded conclusions is the fundamental reason for concern about the psychological climate.

The fact is that some short-selling partnerships possess very substantial financial resources and a capacity, financially speaking, to influence heavily or even dominate the trading activity in a small capitalization issue of stock over an extended period of time. When this general fact is combined in the minds of company executives and shareholders with the information that some unknown but presumably powerful party or parties is or are actively short selling a particular stock and when these executives and shareholders also share a conviction that the SEC ignores abusive practices by the short sellers and does not ensure a fair market it is readily understandable that these executives and shareholders of the affected issuer may reach exaggerated and ill-founded conclusions about the short-selling "threat." When such exaggerated reactions to active short selling become frequent and persistent, as the committee believes they have in many stock issues, then pricing efficiency and market fairness suffer.

Moreover, the impairment of pricing efficiency affects not just the immediate targets of short sellers but the entire class of firms, many of them small but some large as well, that are viewed in the investing community as potentially vulnerable to short-seller abuse. Given the perceived power of anonymous short sellers to manipulate the market, it is only ordinary prudence to many investors to avoid such issues altogether, which in turn unjustifiably depresses the pricing of such issues relative to others perceived as less vulnerable.

This analysis of pricing inefficiency would not be valid if short sellers do in fact possess the great capacity to manipulate prices and hurt companies that is widely attributed to them. That is, if these investor evaluations of the short-selling threat are soundly based and relatively accurate on average (i.e., statistically unbiased), then the resulting effects on pricing could be compatible with efficient market functioning.  The foundation of this analysis of probable pricing inefficiency is that, on the contrary, the psychological environment surrounding short selling has led investors to systematically overestimate the manipulative power of short sellers. Although there appear to have been some cases of serious abuse with a potential for significant price distortions on individual issues, the committee does not believe, as a general matter, that short sellers possess the extraordinary manipulative power that is widely attributed to them.

This is precisely the environment in which improved public information is clearly needed. While not necessarily providing a complete solution, better public information is the natural first remedy for such difficulties. By injecting factual clarity, it reduces the scope for fear based on imaginative speculations and unfounded assumptions. The issue of improved public information is discussed in Sections IV and V below.

 C. The American Stock Exchange Surveillance Report
In 1987 the American Stock Exchange received complaints from three companies that holders of short positions were engaged in downside manipulation of the companys stock. Each company reported that it was the target of malicious negative rumors which, it felt, were being spread by the short sellers as part of a scheme to depress the price of its stock. In addition, many negative press stories had appeared about these companies, notably in Barrons.

The American Exchanges Surveillance Department conducted investigations into the short selling of each companys stock. It compiled detailed trading data on these companies stocks for certain study periods that ranged from 3 to 12 weeks and attempted to determine whether any of the short sellers had engaged in price manipulation in their trading during the study periods.

The trading data compiled in the investigation and the Exchanges findings were reported to the SEC. In each case, the Exchange concluded that none of the information it gathered revealed evidence of manipulation by short sellers. However, it stated that it could not determine whether certain principal short sellers had acted in concert. Moreover, since most of the principal short sellers were not members of the Exchange and therefore not subject to the Exchanges jurisdiction, it stated that the Exchange could not do a thorough investigation of the short-sellers activities. It submitted the report to the SEC with a recommendation that the SEC should further investigate the activities of the short sellers to determine whether the short sellers had acted in concert to depress the stock prices.

The Exchange also made a limited attempt to evaluate the companies claims of false rumors, but this work did not represent a thorough investigation.  In its report the Exchange concluded that the charges of false rumors were a subject for the SEC to deal with. In particular, it recommended that the SEC should determine whether there had been any improper contact between the short sellers and the press.

The SEC did some additional investigation after it received the surveillance report. This included contacting the companies and the stock analysts that followed the companies, as well as searching various databases for negative articles or other information about the companies.  Although it found negative articles from its database searches, the SEC said it did not find any articles which contained materially false information about the companies. In describing its response to the American Exchanges recommendation for further investigation, the SEC stated to the subcommittee that it found no indication of illegal activity by the short sellers in these cases and, moreover, that the SEC had brought action against one of the companies involved for improper accounting methods.

The subcommittee found, on close study of the Exchanges surveillance report, that the report contained both statistical discrepancies and unexplained information gaps. When questioned, the Exchange attributed the statistical discrepancies to human error but was unable to explain why certain information requested from one broker was never received. More importantly, the study periods selected by the Exchange for the three stocks did not correspond to the months when the reported short interest for these stocks was highest, or to the build-up of the short interest figures to their highest levels. Moreover, in the case of two stocks, high volume trading days occurred in the week immediately prior or subsequent to the study periods but were excluded from the study periods.

Finally, the Exchanges evaluation of the extensive trading data that was assembled lacked focus. It was never clearly stated what pattern they were looking for or what pattern would have raised concerns about manipulation.  For this reason and because of the inadequacies cited above, the committee, while acknowledging the extensive effort of the Exchange, questions the effectiveness of its surveillance examination.

Moreover, the inadequacies found by the subcommittee should have been evident to the SEC but apparently were never detected. The committee finds, therefore, that the SECs response and followup to the American Exchange surveillance report were superficial and did not represent a serious effort to investigate the company charges of manipulation by short sellers.

D. The Role of the SEC
The Securities and Exchange Commission is responsible for enforcing the antifraud and antimanipulation provisions of the securities laws, and agency witnesses testified in the subcommittees hearings that the agency performs this responsibility vigorously when evidence of illegal behavior by short sellers is brought to their attention. In support of this the agency testimony cited certain enforcement cases brought by the Commission where the behavior of short sellers was challenged.

Other witnesses questioned the adequacy of the SECs efforts to control short-seller abuses, however. Moreover, several company officials have told privately of bringing complaints of short-seller abuse to the SEC without any apparent SEC action resulting. Some company officials even reported to the subcommittee that, after they brought their complaints to the SEC, the SEC turned around and investigated their own companies groundlessly for suspected accounting fraud, public disclosure violations, or other matters, without ever bringing formal charges.

The SEC has never, as far as the committee is aware, brought an enforcement case or even sought seriously to investigate a case in which the central allegation of abuse was the malicious dissemination of false or unverifiable negative reports about a public company, its officers, its products, or other matters that, if true or believed by investors, would be likely to influence negatively the trading price of the companys stock.

For this reason, the committee finds substantial basis for concern that the SECs policing of the fairness of the markets in this respect may not be adequate.

The committees concern regarding this aspect of the SECs enforcement program is further heightened by the prepared testimony of ------ the SECs Division of Enforcement. In explaining why the SEC has not found it practical to bring enforcement cases against short sellers in most instances, he stated:

 Finally, many of the complaints we receive about alleged illegal short selling come from companies and corporate officers who are themselves under investigation by the Commission or others for possible violations of the securities and other laws. When there is an obvious economic justification for short sales, it is extremely difficult to prove: .  .  . (ii) the material false statement/omission and fraudulent intent requirements of Rule 10b-5. This is particularly true in those situations where, for example, our investigation tends to show that at the time when short sellers were allegedly disseminating false rumors, in fact, the issuer was disseminating materially false financial statements.

This statement by Mr. ---- has the appearance of a de facto "no-action" assurance to short sellers concerning any actions they may take to disseminate false rumors about companies that are the object of SEC fraud investigations. Moreover, since the SEC does not bring formal charges against the company in many of the cases where it initiates an investigation, this statement represents a policy of ignoring possible cases of abuse by short sellers on the basis of unproven and potentially untrue suppositions about company behavior. The committee finds this policy very disturbing.

Finally, the committee finds that there has been an uncomfortably close direct working relationship between certain unknown short sellers and the SEC enforcement staff. Mr.----- acknowledged in the subcommittee hearing that the SEC staff "listen" when short sellers make allegations that a company is doing something wrong, because the short-sellers information is often accurate. Short sellers, in other words, frequently provide useful enforcement tips to the SEC staff.

 That the SEC staff does frequently act on the tips provided by short sellers may also be inferred from a statistical survey the subcommittee staff conducted, with SEC cooperation, of SEC investigations of NASDAQ companies for accounting fraud or other fraudulent public disclosures during the period March 1989 through March 1990. During this period 24 percent of the formal were investigations targeted at companies in which the reported short interest in the company stock immediately prior to the opening of the investigation was at least 5 percent of the public float in that company’s stock. That is, substantial percentages of all SEC investigations of NASDAQ companies during this period were investigations of short-seller targets.

The subcommittee does not find anything inherently improper in this pattern of enforcement investigations by the SEC. This pattern does, nevertheless, raise a troubling question. The question is whether the SECs selection of investigation targets is biased in a manner that provides unwarranted assistance to the short sellers

The knowledge in the market that a company is the object of an SEC investigation for possible fraud is generally expected to disappoint or alarm investors and to directly cause a decline in the companys stock price. The opening of such SEC investigations after short sellers have established substantial short positions in the target companies securities is therefore very beneficial to the short sellers. For this reason the SEC needs to exercise extreme caution in opening investigations of short-seller target companies, especially on the basis of tips from the short sellers, in order to guard against any appearance of bias favoring the short sellers.

Regardless of the appropriateness, from an enforcement perspective, of the investigations opened regarding possible fraud by short-seller target companies, the de facto working relationship between short sellers and the SEC enforcement staff has the effect of providing bounties to the short sellers for their enforcement tips when the enforcement investigations become known in the market. In this context, the committee finds it highly improper that the SEC staff should also exempt from any enforcement scrutiny the behavior of the short sellers whose tips they determine to act on, as Mr.  testified investigations opened involving NASDAQ companies, and 17 percent of the informal investigations opened involving NASDAQ companies,.

Peter J.Chepucavage
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

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Regulatory Notice 09-25 Suitability and Know Your Customer

The International Association of Small Broker Dealers and Advisors

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

202-785-8940 ext. 108

This e-mail address is being protected from spam bots, you need JavaScript enabled to view it

www.iasbda.com

The International Association of Small Broker-Dealers and Advisers,www.iasbda.com submits the following comments on the above referenced proposal. The proposal comes in the middle of a larger debate over whether all financial advisers should have a fiduciary duty to their customers and we do not understand the value of considering these changes outside of this broader context.

See http://registeredrep.com/newsletters/wealthmanagement/fiduciary_sifma_fpa_ici_standard_of_care0411/
Furthermore we believe that the recommendation aspect of suitability has lost its meaning in the context of modern investing and communications technology. We believe the notice should at least ask for comment on this aspect of the rule especially in view of the fiduciary duty debate. We wish to make the following observations in this regard.

Retail investing through the internet should not be subject to any suitability test because of the objective absence of a recommendation.

Retail investing that occurs through a communication between an rr and customer has an implied recommendation because most customers believe their rep has a fiduciary duty. Unlike the waiver proposal for institutional customers, few firms are willing to ask their retail customers for such a waiver or to tell them that they take no responsibility for the trades discussed. There is no public interest served in having a debate over whether a trade was the firm's idea or the customer's idea or a combination resulting from an honest inquiry.. Our experience has been that there are very few big suitability cases brought but this discussion would be informed by discussing those brought over the last 15 years. The public interest will be served when an rr questions an unsolicited trade and in some cases refuses to execute it precisely because he knows the customer.The best demographic example is the 85 year old investor who likes to trade his account when the rep knows from the know your customer rule that he has limited assets and limited time with probable large health costs ahead of him. We believe that suitability must apply regardless of whether a recommendation occurs unless the trade is an internet trade. But we also believe that firms especially small firms need protection from unscrupulous customers and overly aggressive regulators. The SEC sets out an investment adviser's fiduciary duty as follows:

As an investment adviser, you are a “fiduciary” to your advisory clients. This means that you have a fundamental obligation to act in the best interests of your clients and to provide investment advice in your clients’ best interests. You owe your clients a duty of undivided loyalty and utmost good faith. You should not engage in any activity in conflict with the interest of any client, and you should take steps reasonably necessary to fulfill your obligations. You must employ reasonable care to avoid misleading clients and you must provide full and fair disclosure of all material facts to your clients and prospective clients. Generally, facts are “material” if a reasonable investor would consider them to be important. You must eliminate, or at least disclose, all conflicts of interest that might incline you - consciously or unconsciously - to render advice that is not disinterested. If you do not avoid a conflict of interest that could impact the impartiality of your advice, you must make full and frank disclosure of the conflict. You cannot use your clients’ assets for your own benefit or the benefit of other clients, at least without client consent. Departure from this fiduciary standard may constitute “fraud” upon your clients. As an investment adviser, you are a “fiduciary” to your advisory clients. This means that you have a fundamental obligation to act in the best interests of your clients and to provide investment advice in your clients’ best interests. You owe your clients a duty of undivided loyalty and utmost good faith. You should not engage in any activity in conflict with the interest of any client, and you should take steps reasonably necessary to fulfill your obligations. You must employ reasonable care to avoid misleading clients and you must provide full and fair disclosure of all material facts to your clients and prospective clients. Generally, facts are “material” if a reasonable investor would consider them to be important. You must eliminate, or at least disclose, all conflicts of interest that might incline you - consciously or unconsciously - to render advice that is not disinterested. If you do not avoid a conflict of interest that could impact the impartiality of your advice, you must make full and frank disclosure of the conflict. You cannot use your clients’ assets for your own benefit or the benefit of other clients, at least without client consent. Departure from this fiduciary standard may constitute “fraud” upon your clients (under Section 206 </cgi-bin/goodbye.cgi?www4.law.cornell.edu/uscode/html/uscode15/usc_sec_15_00000080---b006-.html> of the Advisers Act).

We believe that most brokers already believe that they meet this standard and are proud to do so. But there may be some unknown implications when this standard is applied to brokers who are not registered investment advisers. Therefore we believe that this standard would be most closely duplicated by eliminating the recommendation requirement for suitability as discussed above, once a broker enters into a conversation with a client for whom he has performed a know your customer analysis as he is required to do. While this would be a significant change from current practices it could be phased in for smaller investors defined as those with less than $100,000 at the firm. These customers do not generate significant income for the firm but are arguably the most vulnerable to unsuitable investments. These customers are also often referred to a call center by the large firms where a robust suitability analysis may not take place. By insisting that the firms know these customers from the onset of contact,Finra may place them in a vulnerable situation by continuing the recommendation aspect of the suitability analysis. It essentially says that no matter how dangerous or ill-advised the investment is, the firm is free to execute it. Thats not a consumer protection policy the industry needs to continue or be proud of.

Peter J.Chepucavage
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

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File No.S7-09-09 IA custody rules

The International Association of Small Broker Dealers and Advisors

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

202-785-8940 ext. 108

This e-mail address is being protected from spam bots, you need JavaScript enabled to view it ,www.iasbda.com

The International Association of Small Broker-Dealers and Advisors,www.iasbda.com submits the following limited comment on the above referenced proposal .We believe that the costs assumed for this surprise audit may be unrealistic and unfair to small to medium advisors.The staff assumes an average cost of $8,128 for over 9000 advisors. Release at p 47 with a $250,000 cost for those firms needing an internal control report. Id at p.48.Average numbers are always problematic for those at the far ends of the spectrum.But more importantly we do not believe the number takes into account the potential liability for these surprise audits and how that must be factored into any cost  estimate beyond the actual hours needed for the work We note that the profits for investment advice rise slowly with the accumulation of assets.Thus the firm with 30 million aum does not make a significant amount more than one with $60 million aum.Yet the additional accounts resulting in that extra $30 million may add significantly to the cost of the audit especially including the potential liability.In other words we think the added cost is disproportionate to the added compensation,a fact often present inone size fits all regulation.This proposal also comes at a time when the staff has begun sending client letters to individual IA clients which is certain to raise the compliance costs.The net effect here is the privatization of IA regulatory surveillance because of the Madoff case which occurred for the most part in a broker-dealer.

We have stated before that an alternative approach would be to raise the aum level for state regulation of IA's to 75-100   million  aum.We were advised by a former senior official of NASSA that the states could handle regulation of 100 million aum.We think they could especially do so if these advisors were charged a modest fee to avoid the costs of the private audit  While the commission may learn more from the comments of auditors themselves,we believe that the state alternative must be carefully examined and should have been included for comment .

Peter J.Chepucavage
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

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Consumer protection at the SEC

The news media have reported widely that there are discussions about transferring some of the SEC'S consumer protection responsibility to a new commission. The chairman of the SEC and various former staffers and commissioners have rejected that approach. The argument unfortunately appears to be the SEC doesn't have enough resources but does not want to give up any responsibility

Shapiro to question any shifting of powers away from SEC <http://r.smartbrief.com/resp/pRqgjCsufjafptCibTfHCicNoBni?format=standard>
The Obama administration's ideas about shifting some powers out of the Securities and Exchange Commission drew a swift response from SEC Chairwoman Mary Schapiro. "I will question pretty profoundly any model that would try to move investor-protection functions out of the Securities and Exchange Commission," she said. Schapiro said investor protection is "welded" into the SEC.The Washington Post <http://r.smartbrief.com/resp/pRqgjCsufjafptCibTfHCicNoBni?format=standard> (5/21),The Wall Street Journal <http://r.smartbrief.com/resp/pRqgjCsufjafpuCibTfHCicNyZsh?format=standard> (5/21),BusinessWeek/The Associated Press <http://r.smartbrief.com/resp/pRqgjCsufjafpvCibTfHCicNKREK?format=standard> (5/20)

But isn't the real issue whether the SEC has devalued retail consumer protection in order to concentrate on the bigger issues. Lets be honest the entire industry has abandoned the individual consumer with less than $100,000 in investment funds. That segment is also not likely to provide a comfortable career for staffers when they choose to leave their government service. Given the choice between working on a big firm derivatives case or suitability for the 85 year old stock genius its clear that genre will not take you from the Merlot to the Bordeaux. But it doesn't have to be that way and the consumer protection strike force can be developed within the SEC and its comrades in the States and FINRA. The function just needs to be valued up as has recently happened to the inspector general's office and the risk office. The commission gets the type of regulation that it values. For years enforcement had that cachet but lately they have been in a slump.

The current Office of Investor Education and Advocacy(OIEA) should take this role and be lawyered up to the levels of other offices and divisions. It should be recognized that protecting the small investor is a different job then much of what the rest of the Commission does. Just as regulating the small issuers is very different then regulating the large companies. With appropriate resources and lines of authority/communication to the States and FINRA, this office could reach the level of independence and expertise that is suggested for the new agency. There are lawyers dedicated to this work even though they know that Wall Street or K street is not likely to embrace them. There are two cultures in America and we believe one may be in decline while the other may be on the rise. One culture is fast money and short term profits while the other is long term investing and capital formation. The SEC'S OIEA should focus on the latter and leave the former to the other parts of the commission. Consumer protection may be a neglected stepchild of the SEC but it doesn't have to be forced into adoption. We have seen in the evolution of the SEC's regulatory responsibility that certain areas lose priority while others gain it because of limited staff available.But if you value up an area as FINRA did with senior citizen investing then you can regain the initiative. Thus instead of moving this responsibility out of the commission it should be reborn within the commission.

Peter J.Chepucavage
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

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File No.S7-08-09 uptick rule reinstatement proposals.

The International Association of Small Broker Dealers and Advisors

1620 Eye Street, NW, Suite 210

  Washington, DC 20006

202-785-8940 ext. 108

This e-mail address is being protected from spam bots, you need JavaScript enabled to view it

www.iasbda.com

The elimination of the tick test is perhaps the most significant deregulation move in memory and should be done cautiously especially for the the smaller issuers and in light of the acknowledged current weaknesses of Reg. SHO --IASBDA COMMENT LETTER 12/19/06

The Commission has proposed a reinstitution of the uptick and or circuit breaker rule 10 years from the date it first sought comments on eliminating the rule in its 1999 concept release and 2 years after it eliminated it. These rules are generally referred to as price tests. It is understandable why public pressure brings about this reversal, but we wish to focus on the uncertainty of price tests vs. the absolute certainty of a pre-borrow rule as explained in former Commissioner Campos letter of March 25,2009.The history of price tests shows that in good markets they are orphans but in bad markets they have many parents. We previously warned that the total removal of the tick test was neither required nor justified but our warnings were summarily rejected because in our view the policy was fixed in advance of the comments. In addition neither  our comments or Amex's are  referenced in the current release so we are compelled to reference them.

In response to IASBDA’s comment regarding allowing issuers to have a choice as to whether or not they want their stock to be subject to a price test, we have determined not to take such action at this time. A primary goal of the amendments is to bring uniformity to, and simplify, short sale regulation. To allow issuers to have a choice as to whether or not their stock is subject to a price test would undermine this primary objective. In addition, we note that in the Proposing Release we specifically requested comment from issuers regarding their views of the impact of the proposed amendments on their securities.62 We did not, however, receive any comments from issuers.63

 
In addition, with respect to IASBDA’s comment regarding the universe of securities subject to the Pilot and, in particular, that the Pilot did not include securities quoted on the OTCBB, we note that the Pilot did not include this class of securities because securities quoted on the OTCBB are not currently subject to any price test restrictions.

 
Both the IASBDA and Amex suggested removing price tests from larger securities first to allow time to study the impact of the permanent removal of price test restrictions before such action is taken for smaller securities. We do not believe that such an approach would provide new results relevant to smaller securities. ⁶⁴ As we noted in the Proposing Release, while there is some evidence supporting the application of price test restrictions to smaller securities, the evidence is not strong enough to warrant the continuation of current price test restrictions to any subset of securities.65 Such continuation would also undermine a primary goal of these amendments of providing greater uniformity and simplicity to short sale regulation.

Release No. 34-55970; File No. S7-21-06 at pp 18-19

We would first note that with respect to the otcbb,while there was no price test the Commission decided there could never be one for the sake of uniformity .We believe history has shown that uniformity of short sale restrictions prevented the SRO's from acting when it became clear that price tests might be more reasonable than the commission thought. Uniformity was also rejected with the emergency orders as was issuer choice when some firms voluntarily placed themselves outside the emergency orders. See AMEX REG 2008-44 SEC Emergency Order prohibiting short sales in financial firms covered securities for September 25, 2008 -  Companies included on the list may choose to opt out of the application of the short sale prohibition by informing the Amex of that determination by email to This e-mail address is being protected from spam bots, you need JavaScript enabled to view it or by phone to 212-306-1331.

We believe therefore that uniformity is not important but timeliness, consistency and effectiveness are. We are gratified to see that the current release asks for comment on  otcbb restrictions and we belive they should be included.

More importantly we believe as Commissioner Campos does that a reinstatement does no harm but that it is not the complete or most advisable solution. What has not been explained is that there was a quid pro quo for its removal and that was a robust enforcement of Reg Sho. As indicated in the recent Inspector General's report that did not take place. We worry that the imposition of a tick test will be an excuse for not aggressively enforcing Reg.SHO. We believe that any tick test must be accompanied by a pre-borrow requirement with significant consequences such as treble damages based on the profits made. Price tests and circuit breakers are by their very nature  temporary defenses because as prices moderate a short selling raid can begin again and again. Price tests similarly interfere with dynamic hedging. The STA letter makes a number of these points very well in addition to their argument that price tests are ineffective in today's fast markets. A pre-borrow test is more permanent as it limits the amount of short sales to the amount of borrowable stock and will not interfere with legitimate dynamic hedging. It is simpler and everyone admits that it works.Indeed its already in Reg Sho as the remedy for the threshold list. The only debate is how much fraud you are willing to accept for maximum liquidity? Together with a hard close and a price test you would have the first really substantive arsenal against abusive short selling. However if the commission decides to maintain the locate requirement it should make clear that its a continuing requirement. The understanding today is that once you get the locate there is no further obligation if it fails. That makes no sense and encourages soft locates as a means of opportunistic sales and commission kickbacks. See Dr. Leslie Boni's study while working at the commission.

We understand that the staff has tried to separate price tests from naked short sales and we worry that the end result is to minimize the seriousness of fails because a price test is implemented. Yet from the very beginning of Reg SHO  it was assumed that both are serious issues and are intertwined. Thus they can only be attacked jointly. The release takes an abstract approach by focusing solely on volatility as opposed to illegality. Yet the tick test was originally imposed to stem illegal bear raids. Volatility down is a new  justification for regulation and begs the question of why only volatility down? See David C.Worley,The Regulation of Short Sales; The Long and Short of It,55 Brook L.Rev.1255(1989-1990) which explains that the regulation grew from illegality not volatility. The assumptions in the media are that this is a political response and using volatility to justify it only encourages that assumption. We can live with volatility but we cannot live with illegality. Finally the release heavily emphasizes the need for data or extant empirical data and analysis. But that data is really only accessible by the Commission itself at NSCC.Numerous commentators have noted the need for real time seller identifiable statistics to prove the presence of abusive short selling. The burden here is on the regulators to prove it does not exist and numerous statements on current investigations have suggested they would do this. Yet this release would have us believe its a volatility issue .This is not responsive to the six senators letter which specifically mentioned both pre-borrowing and concern about the IG report.

We believe the Commission has not adequately examined the pre-borrrow requirement as an alternative to these proposals and is required by law to do so especially if it is truly interested in a cost-benefit analysis. Indeed it has not even examined a continue to locate requirement such that if the locate fails the seller must keep trying to find the stock. Since the initiation of the short sale review in 1999 ,the commission has asked only once about the pre-borrow-without proposing it- in its proposed amendments regarding the grandfather and market maker exceptions. In its 2006 proposed amendments it asked:

       Should we impose a mandatory “pre-borrow” requirement i.e., that would prohibit a participant of a registered clearing agency, or any broker-dealer for which it clears transactions, from accepting any short sale order or effecting further short sales in the particular threshold security without borrowing, or entering into a bona-fide arrangement to borrow, the security) for all firms whenever there are extended fails in a threshold security regardless of whether that particular firm has an extended fail position in that security? If so, how should we identify such securities? What criteria should be used to identify an extended fail? Should this alternative apply to all threshold securities? What are the costs and benefits of imposing such a mandatory pre-borrow requirement? What percentage of these pre-borrowed shares would eventually be required for delivery? Release No. 34-54154; File No. S7-12-06 Dated: July 14, 2006

But it never returned to this subject until summarily imposing it in the emergency orders of the summer of 08.Thereafter it again abandoned the concept such that there is no analysis of its impact or effectiveness or its popularity?Now  years later after being asked by numerous commenters including six senators to consider it ,the Commission has again ignored the consideration of what was apparently useful and worthy of comment  in 2006, important in the summer of 08 and important to the senate.Clearly its the third rail of short sales regulation even though in the past its been sought by the industry for dividend rolls and its done today for hard to locate stocks and as the threshold list penalty.Its apparently legitimate after failing for 13 days but a big obstacle before the sale?The Commisssion needs both comments and data on this alternative in order to do a incisive cost benefit analysis.

 The Commission refers often to the fact that abusive short sales or even legal short sales have not been proven to be responsible for the recent demise of Wall Street. But its the commission's duty to prove the alternative i.e. that short sales legal or illegal are not a problem when so many ceo's and former regulators believe it is a problem. The markets would regain confidence if the commission confirmed that they have thoroughly investigated and found no problems. But that's not what this release says. This release tells the public, which is without subpoena power or regulatory authority, to prove the problem does not exist. It also does not consider the pre-borrow or "continue to locate" even worthy of soliciting comments. This rationale does not inspire confidence but instead suggests foot-dragging at best or undue industry influence at worst. Finally we note that there is an urgency to this matter and the commission should not study it until the markets makes it less relevant. If a tick test/circuit breaker is deemed needed it should be imposed quickly as an interim temporary rule and the current interim rules made final along with a pre-borrow requirement. If needed the pre-borrow can be implemented on a pilot basis to determine if it works with the other remedies. But most importantly the pre-borrow requires a serious proposal because its as serious as anything else that has been proposed.

EXHIBIT A-PREVIOUS.COMMENT LETTER ON REMOVAL OF TICK TEST.




The International Association of Small Broker Dealers and Advisors

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

202-785-8940 ext. 108

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www.iasbda.com

The International Association of Small Broker-Dealers and Advisors submits the following comments on the above referenced amendments.The Staff makes a compelling case for the removal of the tick test for the Russell 3000 securities. However it fails to address whether the issuers of other securities should have some choice in whether they want their stock subject to the test.By insisting that it must be all or none the staff may unnecessarily force small issuers to accept an environment which is most unkind to their securities.While the studies seem to have found little evidence of small stock detriment, the universe did not include the otcbb stocks and may not have been inclusive of other small stocks. The Russell 3000 is a broad based index index in terms of capitalization but there are roughly 9000 stocks in the publicly reporting universe.The Russell 3000 Index offers investors access to the broad U.S. equity universe representing approximately 98% of the U.S. market,but roughly 33% of individual stocks.The SEC's Advisory Committee Report on Small Public Companies Final report concluded there were 9,428 companies listed including the otcbb. Report at p.5 Therefore there may be an argument for phasing in the elimination by starting with the larger stocks and concluding with the otcbb and other small stock segments of the market. The proposal acknowledges at p.25 some evidence supporting the application of price test restrictions to smaller companies but (concludes) its not strong enough. For whatever reason, issuer comments have been significantly underrepresented(non-existent?) in the various short sale rule proposals. Under a phase in arrangement those issuers might focus more on the subject and eventually make a compelling argument that its not necessary to have all or none elimination. The commission might also learn something from its observance of the large stocks without a tick test. After so many years there is no compelling reason to force small companies into this environment when a phase in period has no downside.This is especially true when the commission has acknowledged that Reg SHO needs to be strengthened with additional amendments.The elimination of the tick test is perhaps the most significant deregulation move in memory and should be done cautiously especially for the the smaller issuers and in light of the acknowledged current weaknesses of Reg. SHO.

.

Peter J.Chepucavage
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

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IASBDA/Plexus quoted in Pipewire.

SEC to Propose Uptick Restoration, Price Tests For Short Selling
Posted April 08, 2009 6:21PM PST
The Securities and Exchange Commission voted unanimously today to propose two possible rules to combat abusive short selling.

The first approach under consideration is to bring back an old rule, most likely in a modified form, that allowed short sellers to sell only after a stock price had increased. This rule has been known as the "uptick rule" or "tick test."

The new tick test may either not allow a short sale below the last sale price – similarly to the old uptick rule that was repealed in 2007 – or not allow a short sale below the national best bid. The national best bid standard was recommended by the major U.S. stock exchanges in a statement they jointly released in March.

The second proposed approach to curb stock manipulation is to implement a "circuit breaker" for all stocks, where after a "severe" decline in the price of a stock during a single trading day, a tick test would be imposed or short selling would be banned for the day in that stock.

The proposals fall short of some recommendation made by critics of the commission's past approach to abusive short selling. Those include six U.S. senators who recently signed a letter to the SEC, as well as former SEC commissioner Roel Campos. The senators and Campos both called for a requirement that a short seller should have to borrow a stock before selling it short.

Peter Chepucavage, an attorney and former fellow at the SEC who helped develop short-selling regulations, said he was disappointed that the commission did not address the pre-borrow issue.

It's likely that hedge funds and bankers that profit from unregulated short selling found these proposals more acceptable than a pre-borrow requirement and that they have the ear of the commission, Chepucavage said.

"My own view is that the industry has told them in private meetings that 'we can live with an uptick rule, a circuit breaker or a price test, but we can't live with a pre-borrow,'" Chepucavage said.

Annette Nazareth, a former commissioner who left the SEC in January 2008, is now on the board of directors of the Managed Funds Association, the main lobbying group representing hedge funds. Nazareth did not immediately respond to a request for comment.

The proposals will be open for comment from the public for 60 days after they're published.
Source:SEC Release <http://www.sec.gov/news/press/2009/2009-76.htm>

Peter J.Chepucavage
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

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plexus/iasbda Bloomberg interview.

Sling - More Perspective - Restoring the "Uptick" Rule? - Video ... <http://beta.sling.com/video/show/140146/51/More-Perspective---Restoring-the-%22U>

Bloomberg. More Perspective - Restoring the "U.. ... with Former SEC Counsel Peter Chepucavage: "Locate" Requirement Mother of Loopholes; ... on Sling.com. Watch along: http://sling.com/t/140146/51 ... 2009 Sling Media. All Rights Reserved.
beta.sling.com/video/show/140146/51/More-Perspective---Restoring-the-%22U - 14 hours ago - Similar pages </search?hl=en&q=related:beta.sling.com/video/show/140146/51/More-Perspective---Restoring-the-%2522U>

Peter J.Chepucavage
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

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