Here's a comment letter at the SEC site from the options exchanges, which not surprisingly argues for keeping the unfair and 1934 Act violating market maker exemptions - because it doesn't hurt THAT many companies and investors. And hurting some, even many, is OK if it allows the MMs to enjoy cost free hedging for their for-profit options making business.
http://www.sec.gov/comments/s7-12-06/s71206-935.pdf
“The NASD comment letter summarizes an analysis of threshold securities that appeared on NASDAQ’s Threshold List for 40 days or longer between January 10 and August 11, 2005. There were 148 unique securities that met this standard. In our view, the NASD analysis indicates that the options market maker exception is only a minor cause of extended fails to deliver of these threshold securities. Only 5 of these unique issues appear to have been on the list as the result of reliance on the bona fide market maker exception of SEC Rule 203(b)(3)(ii). Another 22 unique issues appear to have been on the list as a result of reliance on either the bona fide market maker exception or the grandfather provision of SEC Rule 203(b)(3)(i) or both. In other words, fewer than 3% of the unique securities on the NASDAQ Threshold List appear to be on the list as a result of reliance on the options market maker exception alone, and, fewer than 20% had any connection at all to the market maker exception in Regulation SHO.”
“The NASD analysis supports our contention that the benefits of narrowing of the options market maker exception would be far outweighed by the costs of doing so. The NASD analysis shows that only a very small number of persistent fails are the result of reliance on the options market maker exception. This small number of persistent fails is not indicative of abusive activity by options market makers but, rather, is the result of the need to hedge options positions acquired during the course of market making. As we explained in our September comment letter, the cost of reducing this small number of persistent fails is likely to be more limited or non-existent options market maker liquidity in all current and future threshold securities. This is the case because options market makers are likely to be very reluctant to make markets on options on threshold securities if they cannot be certain that they will be able to establish and maintain effective hedges. It makes little sense to risk this result in order to eliminate extended fails in a small number of threshold securities.”
Apparently it makes little sense to protect investors in those securities, when the options MMs might have to pay to hedge their plays in them, rather than getting the free lunch at investor expense they currently enjoy. I mean, hundreds of thousands get wiped out annually due to abuse of that exemption? Collateral damage. No big deal.
And guess what? Who besides the MMs care whether it is easy or hard to make an options market in a security that is on the SHO list? I mean, how do I benefit as a stock investor, based upon what speculators in a separate market do or don't do? I don't. This letter argues from an oblivious stance of self-interest, and poses a threat that is nonsense.
Contrast their stance against this new FOIA data from Tommytoyz on the NFI failures, paying particular attention to the period from December of 2006 on, when the interest skyrocketed to over 10% of OS. As one who got hurt during that period, I can truthfully say that I didn't benefit from these shares created from thin air by the options MM, during which time the put options soared. I know many who were wiped out.
If the MM abuses are no big deal and such a small percentage of the total, why are they arguing so hard against changing this so it cannot be abused?
Again, stock investors derive zero benefit from options MMs business activities in their stocks, and are actively harmed by this type of abusive put hedging. So how is it in the SEC's mandate of investor protection to allow it to continue?