John Tabacco is a big personality representing the 鈥渓ittle guy鈥�. All American Technologies (aka Locatestock.com), founded by Tabacco, is one of very few companies that allows users to execute securities lending transactions aside from providing pricing data.
Since its inception, Locatestock.com has processed 82 million short sale locate transactions and 380 billion shares for short sale approval without any failed client audits as a result of using its Matador platform.
In this interview with SLT, Tabacco talks about the state of the market, what needs to change and where he sees it going.
SLT: How did you get started in securities lending?
John Tabacco: My goal in life from a young age was to be involved in the world of global finance and after almost 20 years of participating in US capital markets in many different roles, I found myself introduced to the world of securities lending by a great friend and mentor, Anthony Venditti. I joined the securities lending community as an outsider and became a 鈥渇inder鈥�, in every other area of the capital markets, a finder is called a broker, but for some reason in securities lending the term finder became a dirty word. And, while finders provide an important service to the settlement community, in 2003 regulators decided that they were going to declare war on finders and eliminate the opportunity for intermediaries to participate in the lending markets. I saw that potentially my livelihood might be gone.
Regulators had found a few individuals who were breaking the law and brought them to justice. But afterwards, I think they used a sledgehammer instead of a scalpel. Finders are like independents or individuals, smaller companies and, at least in the聽US, it seems that when regulators go after small companies they go in with a very big hammer and when they go after big companies they use a wrist-slap, it is a disproportionate regulatory enforcement policy.
Either way, I asked myself how is it that securities lending is not automated - it is the backbone of every transaction, both long and short. In an era of black box, high frequency, nano second trading, how are people approving short sales when a human being could not possibly act at the speed that these transactions are coming in these days?
I recognised that there will still be a need for a broker, but the regulatory landscape seemed to point towards automation amid calls for transparency. I am an entrepreneur, I have been in different businesses and, though I don鈥檛 have a background in technology, I know a heck of a lot about securities lending.
Securities lending at that time was one of the last bastions of opacity, so why not be the first guy to build technology to meet that demand?
In 2005, RegSHO, which was a fantastic short sale regulation which set some clear guidelines on how broker-dealers and trading firms should allocate and document an audit trail on where securities were located to support the settlement on the short sale transaction, came into effect and we built the technology to match the requirements of that regulation. Locatestock.com was born.
As the landscape continues to grow with electronic securities lending products, which are great, only we can claim to be first to market, we will always have that.
SLT: What surprises you most about what people don鈥檛 understand about the securities lending market?
Tabacco: It鈥檚 that most people don鈥檛 know that pension plans and retirement systems are some of the biggest lenders of securities in the world, and retirees have no idea that the securities that are purchased by their pension plan are also being lent out to short sellers who are betting and applying pressure to stock that they are invested in to go down.
At the end of the day, I don鈥檛 think people realise that if you are long stock and your custodian or clearing firm lends it out under an agreement which was signed unknowingly, they are facilitating short sellers to put pressure on that investment
In other words, the pension plan is lending out shares to facilitate short sales in the very stock it bought with hopes of higher returns and in turn applying selling pressure to a long investment. And the bulk of the revenue that is generated from custodial lending programmes is generated from hard to borrow securities.
So I think retail investors need to be made aware that securities in their portfolio that they purchased on margin can be lent out to short sellers. The tricky part is how. Every person who opens a brokerage account signs a customer agreement and tucked away somewhere is a hypothecation clause which allows custodians to lend out from the portfolio to short sellers.
It is overlooked in most customer agreements and I don鈥檛 think most investors know they are agreeing to that.
SLT: What do you think needs to happen on this front?
Tabacco: The regulation that I think needs to come down the pike is single stock best execution for securities lending transactions. The whole issue brings up the question of fiduciary responsibility: what is the risk-reward ratio? Meaning, how much money are we making from short sellers who are applying downward pressure on our stocks, might it be better to not lend the stock?
SLT: What regulations do you see coming down the wire that the securities lending community should be paying attention to?
Tabacco: Patrick Byrne, the CEO of Overstock.com, has been a one-man wrecking crew to push Washington and regulators to protect investors and eliminate naked short selling. The one thing he is pushing hard on right now, that could clean up the entire problem for pension plans, investors and public issuers, is a mandatory pre-borrower requirement on all short sales. Simple. That would mean, prior to short selling a stock, it would have to be borrowed. Not just a contract entered into with reasonable grounds.
SLT: What are some of the reasons behind this push to eliminate naked short-selling?
Tabacco: Every time a naked short sale happens, shareholder value is diminished. Some retirement system or pension plan, which should have been paid has instead been fleeced, because there is no borrow and there is no securities lend transaction documented.
On July 25 this year, President Barack Obama issued an executive order and declared a national emergency because 鈥渟ignificant transnational criminal organisations have reached such scope and gravity that they threaten the stability of international economic systems鈥� were his words. And this is directly related to naked short selling.
So, the President of the聽United States聽has recognised that foreign transnational criminal organisations have figured out that our settlement system is broken and the place that it is broken is naked short selling. It can be used to destroy US public companies, like our banks and our financial institutions. I think people need to know that our whole economy could be jeopardised by not acting strenuously enough in taking naked short selling seriously.
SLT: What changes to the settlement system would address this?
Tabacco: Our settlement system needs to go in the direction of share-for-share securities lending allocations to short sales. For example, a clearing firm or custody firm has 150,000 shares of a company they want to lend out or can lend out, there are instances where that firm can approve four or five times the amount of short sales than they have securities in the box. Although RegSHO mandates against this, there are still existing loopholes. I think a national defence approach to cleaning up the cracks in our settlement system is important. It isn鈥檛 just a regulatory issue any more,聽according to our own President聽it is a national emergency.
SLT: What are some of the positive developments you see in the industry?
Tabacco: Beneficial owners have overall done a great job of demanding more transparency and price discovery from their custodians. Some regulation that ties a beneficial owner鈥檚 fiduciary responsibility to ensuring transactional best execution pricing on securities lending transactions would give beneficial owners another leg up in making sure that they are getting full value for the securities they are lending
There are also companies like my own and Quadriserv that are bringing transparent, real-time securities lending pricing. The bigger firms can get pricing because they generate a large amount of commission business, so they can get some degree of transparency, but nobody really seems to care about the little guys. The smaller firms and investors do not have access.
We created an electronic solution that gives small to mid-sized firms the tools they need to succeed in the securities lending markets . In my mind, sunlight kills germs. The more transparency, the more daylight, the better. This is especially true for retail investors.
Most people think Quadriserv is competitor because we are both in the business of electronic securities lending.聽I have a tremendous amount of respect for Quadriserv鈥檚 Pasquale Cestaro, and I like to think of us more as compatriots because we both have vested interests in bringing transparency to the securities lending markets.聽According to Quadriserv鈥檚 most recent press release, It seems like the company is gearing up in the direction of facilitating bigger firms聽with a new block transaction platform,聽聽that鈥檚 鈥渁 little cleaner鈥� than their current offering for smaller brokers.
My hope is that we can create products to fill the void for small to mid-sized firms.
SLT: Where is the market headed?
Tabacco: I think every day companies like ours are innovating in the area of electronic tools and platforms to put the power of securities lending in the hands of the actual securities owner. I see it in the聽US聽鈥� retail investors are waking up to the fact that their shares are being lent out and they are not receiving a share of the collected fees.
If there is a fiduciary responsibility on securities lending transactions to get the highest price in the market place, it would deliver higher returns to beneficial owners. There is a tremendous disparity between the split fee that winds up to the lender and the prevailing market rate that an end user paid to borrow those shares. I mean a tremendous gap between those two. I think the tools that our company and others are coming out with are continuing to push regulators and the bulge bracket firms in the direction of narrowing the gap between fees paid to lenders and fees charged to short sellers, and there is a huge spread there. I think we are getting closer to the end user meeting the organic lender.
I also think the future of securities lending is in a fully electronic central counterparty environment.
SLT: What kind of new innovations is All American Technologies working on?
Tabacco: We are introducing a custodial lending programme to help public issuers prevent their stock from being naked short sold.聽I think it will be a revolutionary way for public companies to take control over what many of them feel is a problem that can鈥檛 be solved - which is fighting short sellers.
Our arena, which was fairly empty a few years ago is becoming more crowded and, for a company that has been engaged in providing electronic securities lending platforms for as long as the regulation has been around, every competitor is welcome and every competitor makes us a better company.
We are the only company with聽executable聽electronic securities lending technology that has been profitable since its inception. I think that shows that there is clearly a need for these products, even when it鈥檚 introduced to the market place by a smaller firm which isn鈥檛 affiliated with an institution.聽We aren鈥檛 some developmental think tank that loses money, we are making a profit.
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