Naked Shorting Needs to Be Stopped

I read a story that the SEC is going to implement some new rules that are intended to curb naked short selling and I think the SEC should have passed tougher rules long ago.

I believe hedge funds and institutions have been using naked shorting to manipulate stock prices for quite a while, especially among small caps. I think this has gotten more pronounced in the last couple of years.

I don't know how many times I have seen a small cap take a pretty significant drop without any news. It has also become commonplace for small caps to get slaughtered after earnings if they don't report results that blow away expectations. I think naked shorting is a big reason for both of these events.

It wouldn't be hard for a hedge fund to use naked shorting to force down a small cap to make a profit, especially among stocks with low floats. All they would need to do is force down the stock price and induce some panic selling among jittery longs and then cover. While hedge funds may potentially be able to do this with regular shorting, they can put a ton of pressure of stocks with the ability to naked short. Naked shorting gives them a theoretical infinite amount of shares to short.

I believe naked shorting is currently acting as a catalyst for the demise of troubled financial institutions. I don't blame the sell-off of financial institutions on naked shorting, they caused their own problems, but I believe naked shorting is going to force some of these companies into bankruptcy. Hedge funds know these companies are on the ropes and naked shorting gives them the ability to continue to pressure the stock prices of these companies down. I guarantee there are hedge funds and other investors that have sold troubled financial institutions short even though there were no shares actually available to short.

The SEC needs to hurry up and pass much tougher rules against naked shorting. They also need to grow a backbone and actually enforce their rules.

Disclosure: none.

Comments

[glassbox:]

Agree with you Philip. In fact, I take a more conservative stance that shorting should be banned or regulated. Shorting is a derivative - one has got to borrow the shares. Currently, there are no rules to protect shareholders from having their shares lent out e.g. Harbinger did not even know that their Fortescue shares were being lent out (or at least they claimed that they did not know). How could they not know - aren't they earning a return on the stocks lent out? I find it amazing that such things should be allowed - aren't trustees and custodian supposed to be watching out for shareholders on such things?

The way share lending is regulated now is also another joke. Who decides on the price and is that a fair price?

SEC has not addressed the whole issue. In fact, I find it amazing that they have allowed all these threshold securities to go on for so long - where is the enforcement?

2008 Sep 17 08:23 PM

[Ant:]

The SEC has been snoozing for a long time. it's nice to see they are coming out from under their rock. And no one will even question where they've been.

2008 Sep 18 08:24 AM

[bill t:]

you should explain 'naked shorting', vs shorting so your readers understand the difference. thank you.

2008 Sep 18 08:54 AM

[rlxdoc:]

Let's just ban shorting stocks. Then stocks will always go up.

2008 Sep 18 10:46 AM

[johnhaskell:]

I advocate adoption of the Pakistani model, under which trades cannot take place unless they are at a price higher than the previous trade. Under this system, hard working American families who invest in the stock market will be guaranteed a profit, and shorts will be crushed.

2008 Sep 18 11:39 AM

[ObjectiveFu...:]

I am shocked and saddened that you're disriminating against those poor hard working Americans who can't access the stock market because they're too busy and underpaid. Let's just let Congress legislate $500,000 ... no, ONE... MILLION...DOLLAR checks to every deserving working family in America (pinky). Hell, what about everyone on planet Earth?

Then we'll all be living large, right? happily singing "It's A Small World After All" and cavorting through sunny fields like a Viagra ad. Just like those Pakistanis!

2008 Sep 18 03:44 PM

[rogerk2:]

So far, everybody's missed the point. We HAVE rules making naked shorting illegal, passed in 2004. Cox and the SEC have refused to enforce them. His "new" regulation is to give the naked shorters until the settlement date, usually 2-3 days, to come up with the shares they supposedly borrowed. These pirana are in and out in minutes, so the SEC's "new" enforcement of the 2004 law won't even slow them down.

Loaning shares to short sellers is done all the time. Your broker does it; your pension fund does it; your bank does it. They're all trying to squeeze an extra penny of profit out of the shares they hold on your behalf. Do they enjoy loaning out a $10 stock and getting back a $1 stock? Oh well, it's really your money, not theirs.

Your broker can loan out shares in your portfolio without telling you, because there are no real shares there anyway. It's all electronic. As long as your broker pays you when dividends accrue and puts the requisite amount of cash into your account when you sell your electronic shares, that's all anybody cares about. Brokers love naked shorters because they generate huge transaction volume and trading commissions. Naked shorts know they're illegal, so they're in and out quickly, the electronic books get balanced again, the broker collects the extra fees, and nobody's the wiser.

Even CalPERS, the nation's biggest retirement fund, invests in a whole bunch of hedge funds to try to juice up their returns. They just announced that they are going to STOP loaning their shares out to shorters. Gee thanks, guys, but it's a little late to be getting a guilty conscience now.

I agree that what's needed is a return to basics: You can't sell something you don't own. If you buy something, you have to wait for constructive delivery and the cash to change hands before you can sell it again. That's what the SEC requires of me, as an individual investor. I can't trade with the same dollars twice in the same day. I have to wait three days for the last transaction to clear. So why does the SEC let hedge funds and naked shorters do it?

I think we need to require every large block short trade to be listed for the public record. The exchanges and brokers have all the information, it just isn't public. Even post it the following day, or two days later. It would be enough just to make all these gougers publicly admit they're doing it to the rest of us.

2008 Sep 19 06:16 AM