The Grandfather Clause was one of many loopholes in the initial SHO regulations enacted in January 2005. This exemption essentially granted amnesty to counterfeit shares sold prior to 2005. The reason given by the SEC for this provision was they (the SEC) “were concerned about creating volatility through short squeezes.” The SEC offered no empirical or analytic data in support of the grandfather exemption, and did not offer any explanation of why they were essentially granting a safe haven for those who had engaged in the practice of selling unregistered securities (counterfeiting). The number of shares that were grandfathered in is unknown, except to the DTC and the prime brokers, but it was likely in the billions and possibly trillions. The DTC and the securities industry deny that a meaningful number of counterfeit shares were protected by the grandfather clause; investor advocates believe otherwise.
After much public and political pressure, the SEC relented and closed the grandfather clause loophole in mid - 2007. This should have resulted in a tremendous increase in short shares being borrowed or covered triggering increased buying with a resultant increase in prices. Yet the abolition of the grandfather clause barely created a ripple.
The reason for the imperceptible level of buy-ins was because the DTC and broker dealers moved huge numbers of counterfeit shares from the DTC to ex-clearing. This strategy is successful, because the SEC does not enforce the requirements of Reg SHO for ex-clearing shares. Another safe haven for counterfeit shares.
Another loophole that is the repository for millions or billions of counterfeit shares is the DTC - sponsored and SEC - condoned RECATS program. The DTC, as a service to its prime broker - member/owners, notifies the broker when a position is about to become a fail-to-deliver. The broker may send the position out of DTC by transferring it overseas or doing a match trade with another party. The position may be returned to the DTC where the account is marked to market (value) and all of the time requirements of naked shorting are reset. The cycle can be repeated as often as is necessary to keep the positions naked.
With loopholes like these, it is delusional to think that SHO or anything else done to date is going to have a meaningful impact on counterfeiting. It is also denial to think that the promulgation of illogical rules and the non-existent enforcement by the SEC is not aiding and abetting the counterfeiting of massive amounts of stock in U.S. companies.