The SEC's Campaign Against Naked Shorting: Misguided or Right On?

by: Whitney Tilson

To the extent that the SEC has evidence that naked shorting is going on, then more power to 'em to try to put an end to it (but if so, why limit the new regs to only 17 stocks? Get rid of all of it!). I'm somewhat skeptical, however, that naked shorting is widespread and had much to do with the declines in the stocks of the 17 companies.

This belief is rooted in the fact that not only have we never naked shorted -- our prime broker I'm sure wouldn't allow it, even if we wanted to -- but in nearly ten years in this business, I've never known of or even heard of a case of naked shorting.

But maybe I'm just naive or only hang out with honest people, given that the stocks of these companies have jumped probably an average of 30%+ in the past two days. It was a classic short squeeze, and there are a number of possible explanations for it:

A) I was wrong and there was, in fact, a lot of naked shorting -- and when these people rushed to cover, the stocks soared. If this is true, one friend hypothesized that it might have been the prop desks of the Wall St. firms that were doing the naked shorting, knowing they could always call in the borrow from their hedge fund clients if necessary. I've seen zero evidence for this, but an interesting hypothesis...

B) The SEC's new regs were a major contributor to the big move, but not because there was actually a lot of naked shorting. Rather, because nobody knows how much naked shorting these is, legitimate shorts feared there might be a lot of naked shorts rushing to cover, so rushed to cover ahead of them.

C) The run-up would have happened anyway, even if the SEC hadn't issued the new regs. Financial stocks were oversold, every momentum nitwit (and there are A LOT of them) was long oil and short financials, Wells Fargo had a good report, etc.

My guess: 10% A, 40% B and 50% C.