Bobo interviewed Dr. Susanne Trimbath, asking a series of no-holds-barred questions about the DTCC, the FTD issue, the mechanics of the clearing and settlement system, the size of the problem, etc. The result is incredible. Send this to everyone you know - it is absolutely essential material.
Here is the first in a series of interview questions posed by Bob O'Brien, and fielded by Dr. Susanne Trimbath - a noted and acknowledged authority on stock clearing and settlement. Bobo's questions are in bold:
1) Tell us a little about your background at the DTCC…
Being an economist is my second career. I have 20 years experience in financial services, from Prudential Insurance, through the Federal Reserve Bank and 3 different depositories. I was with the Pacific Clearing Corporation and the Pacific Securities Depository Trust Company the last 2 years before they shut down (1985-1987). I was in operations there both as an analyst and as a manager. After the shutdown, Depository Trust Company (DTC) moved me to New York as Director of Transfer Agent Services, an industry liaison position. Since the same companies that ran transfer agencies (Chase, US Trust, BoNY, etc.) were also broker/dealer Participants at DTC, I was frequently called on to help them with problems that extended beyond my job description into reorganizations, dividends, proxies and even settlement.
At DTC (now a subsidiary of DTCC), one of my more important accomplishments was to propose and then enhance a service for the direct mail of certificates by agents to shareholders at the request of participants. I also proposed, developed and tested automated direct withdrawals and deposits at custodians. Both programs are complementary services to Direct Registration offered by issuers, which the NYSE is trying to have made a listing requirement. After leaving DTC, and before entering the PhD program at NYU, I worked about a year in Russia helping them build clearing, settlement and depository operations.
2) Some have expressed the sentiment that you are a whistleblower, and that it is high time a whistleblower came forward. Do you consider yourself a whistleblower? And, just for the record, are you being compensated for your statements about NSS?
Legal protection for whistleblowers is largely reserved for those who take on the government. Otherwise, you would at least be employed by the party you are decrying. I wouldn’t meet either of those qualifications. Since I’ve never left a share of stock with a broker (once you’ve seen how the sausage is being made, you never eat it again), I can’t claim to have been individually harmed by the activity. Of course, if DTCC attempts to withhold my pension because I talked about their role in this mess, then I might have a claim to “whistleblower.” We’ll have to wait an undisclosed number of years before I’m eligible to test the matter.
As I described earlier, I am on my second career, working full time as an independent researcher and consultant in economics and finance. Although capital markets and corporate finance are in my research portfolio, I first addressed the specific topic of NSS at the request of paying clients beginning in late 2003. Since that time, I have worked and will continue to work as an advisor and consultant on NSS for a variety of firms. What it comes down to is that someone pays me to give them direct advice on NSS; when I make public statements it’s usually not for hire but rather in the interest of civic education. Part of my marketing strategy is to be sure all the stakeholders in NSS know that I can help them. I apply a similar strategy to my other areas of specialization such as international finance and economic analysis of law.
3) Given your background there, what do you make of the current FTD issue – let’s start with, why does the DTCC keep all the data secret?
As the saying goes, “Macy’s doesn’t tell Gimble’s.” DTCC keeps certain data private so that Shearson won’t figure out Merrill’s business strategies. All the Participants compete with each other, so DTCC is careful about data that might reveal firm-specific holdings or transactions. That said, there is much aggregate data that the DTCC could release that would not reveal any trade secrets but that could reveal the real magnitude of the problem.
4) Some refer to the SBP as a “self-replenishing, anonymous lending pool.” Would you agree with this characterization?
Yes. It is definitely anonymous (unless rules are being broken). And since nothing prevents the buyer who receives a borrowed share for settlement from depositing shares into the lending pool at the Depository, it is self-replenishing.
5) The DTCC takes great pains to make it clear that the SBP doesn’t allow a broker to lend the same share twice via the SBP. My contention is that they certainly allow the same share to be lent by different brokers, thus their rhetoric is disingenuous. Do you agree, or disagree?
It’s a word game. The stock borrow program doesn’t track who lent the share (only who borrowed it). So the stock borrow program doesn’t allow ANY shares to be lent…only borrowed, get it? They play the same word game when they say they don’t make money on the stock borrow program.
What they DO make money on is the stock lending program.
By the way, they also make money on fails to deliver. OK, so the same shares aren’t lent twice by the same broker because the lender’s account is reduced by the number of loaned shares until the loan is repaid. Fine. What they aren’t saying is that the shares are a “fungible mass,” and no one keeps track of which share was used to settle which trade. So, a Participant who receives 100 shares of OSTK at settlement could be getting 50 borrowed shares. And it is those 50 shares that can be loaned a second time since all settlement is considered to be “final.”
6) I believe that most of the current FTD issue is caused by two things – the de-linking of clearing and settling, and the allowing of access to the proceeds from a failed delivery over and above collateralization requirements. Would you agree, or disagree, and care to comment on any other issues you feel are contributors to this?
It depends on what the meaning of “is” is…. No, wait, that was something else.
It depends on how you define “(T)he current FTD issue”. Regarding “the allowing of access to the proceeds from a failed delivery over and above collateralization requirements” this is a very convoluted statement. Are you referring to the release of collateral on borrowed stock as the price of shares is driven into the ground? Are you referring to the fact that the seller gets paid for a failed delivery because of net settlement and the ever present “fungible mass”? I see the FTD issue as additive to the NSS issue and the stock lending issue. In other words, I see the problem as being at least 3 times as big as any one observer is willing to admit.
The over-arching problem actually got much worse when clearing and settlement (in the form of NSCC and DTC) were connected under DTCC. Think blue-suited brokers at NSCC and grey-suited bankers at DTC. NSCC was run by the trading side where net settlement minimized the number of cash and share deliveries to one per day (basically). DTC on the other hand is like a bank for brokers; it’s where they keep the shares they need to effect settlement. DTC’s status as a quasi-bank provided more regulators and more oversight. Both NSCC and DTC had different Boards, populated from different sides of the houses, with different interests. When they brought them together, it appears that the blue suits won and their Wall Street Cowboy mentality is dominating the organization.
That said, I always believed that they should not have been separated at birth. It is my opinion that there were two dominant personalities at the time and each aggressively sought to have their own area of authority. After those guys retired, the door was open to reunite the two sides. Unfortunately, by then they had grown to be very different. Perhaps because of weak understanding on the part of the Federal Reserve and the SEC about what these two do, the clearing side was allowed to dominate and with that, “trust” was no longer the middle name.
7) Do you have any opinion as to how large the “ex-clearing” FTD situation is versus the “in-system” FTDs? A ratio?
The by-the-rules version of market infrastructure dictates that the ex-clearing portion should be very small, maybe 15% of the whole problem. In fact, since the clearing system enables NSS, FTD and stock loan, there’s no reason to go ex-clearing with the dirty deeds. Here’s a simple example of how to engage in money laundering and counterfeiting using the Stock Borrow Program and the “in-system” mechanisms.
In a future response, I’ll show a diagram where the entire operation can be accelerated if there is at least 1 ex-clearing transaction. It basically shows that things move much faster if you can get at least 1/3 of the transactions processed ex-DTCC.
8) Any opinion as to how large the total grandfathered position of FTDs was?
Big enough to give me nightmares
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