SEC Makes a Move on Naked Short Selling: Too Little, Too Late for Sirius

Jul.28.09 | About: Sirius XM (SIRI)

By Brandon Matthews

I first began writing about naked short selling more than one year ago, when Sirius XM Radio’s (NASDAQ:SIRI) common stock first came under attack by hedge funds. I am told that I helped to inspire the documentary Stock Shock, in which I not only played a role but inevitably helped co-produce as well. I have reported on the efforts of Senator Ted Kaufman, whom I applaud for the immense strides he has made in bringing the issue of naked short selling to the forefront of Congressional debate. I have also been highly critical of a slow moving Securities And Exchange Commission. With Monday’s press release from the SEC announcing sweeping changes in the regulation of naked short selling, those who have fought this fight with Satwaves and others can stand tall knowing that our efforts have not been in vain.

Nothing can be done at this point to right the wrongs of the past, such as making restitution to investors in Sirius XM Radio, Overstock.com, Lehman Brothers and Bear Sterns, to name only a few of the companies that fell victim to the practice. The SEC’s announcement is nonetheless a major victory. Sirius XM Radio fell victim to nearly 300 million shares of phantom stock shares that were sold short and not delivered in July of 2008 alone, as cries of foul play fell on deaf ears. Those 300 million counterfeit shares turned out to be merely a drop in the bucket.

Now that the damage is done, the SEC for the first time has finally acknowledged that “short selling can be used as a tool to manipulate the market,” and further acknowledges that “naked short selling” is harmful to both investors and companies alike. The agency is now taking long overdue action by making permanent a rule to curtail naked short selling. Rules however are meant to be broken and the SEC has yet to prove that it's capable of enforcing its rules to any realistic extent.

The Commission promises to impose penalties if a clearing firm does not purchase or borrow shares to close-out a “fail to deliver” resulting from a short sale in any equity security "by no later than the beginning of trading, on the day after the fail first occurs (T+4).” This should help to protect the numerous companies that are expected to receive NASDAQ delisting notices in the coming weeks, including Sirius XM Radio, from further abuses.

Falling short in reinstating the uptick rule which would no doubt render front-running (flash) trading programs worthless, the Commission also took steps to increase the transparency of short sales by proposing the daily publication of short sale volume, a monthly delayed disclosure of short sale transaction information, and bimonthly disclosure of failures to deliver.

Defenders of the removal of the uptick rule tend to fall back on the argument that no downtick rule is required to buy a stock. This argument makes no sense, however, because there is no law that allows an investor to buy a stock “short.” Either the person using such an argument is a moron, or that person feels that other people are gullible. It simply makes no sense. Agreeing to sell a security that you do not own is far different than selling one you do.

Satwaves and I are proud to have been a part of this effort, and rest assured we will continue our efforts in protecting individual investors, when the SEC holds a public roundtable on the issues on September 30, 2009.

Positions: Long SIRI