Naked Shorting Rule Means Time To Buy Stocks

The SEC yesterday extended its naked short selling rule to all stocks, and made it near permanent on an "interim final basis." The SEC will allow for a 30 day comment period, but clearly prefers to make this a permanent rule of law. Folks, I cannot understate the importance of this. It's a significant positive catalyst, and may help near-term lows mark the new market bottom.

This naked shorting decision by the Securities and Exchange Commission, slated to take effect on Thursday in the early AM, should add much support to stocks by eliminating significant existing pressure against the market. The emergency rule that had been established for specific stocks in the financial sector expired on August 12, but the related pressure upon the shares of many companies, especially those in the financial sector, has helped to force several securities sharply lower and some firms out of business since. Thus, the SEC saw need to extend the rule to all stocks.

The rule makes perfect sense also, since equilibrium is restored to markets. There cannot now be an imbalance in theory; you should not be able to sell short on shares you do not own, or borrow against them, even when a broker is willing to cover for you. Thus, argument against naked shorting was well-founded. That reality made the existing situation clearly faulty, and this change is late in coming.

Hedge Fund Repercussions

Hedge funds are a whole lot less sexy as of today. Long/short investment strategies will be less efficient, and those portfolio managers will have much less flexibility. Portfolio risk/return opportunity will be severely damaged for the pure long/short equity gamers. Arbitrage opportunities are always limited, and this game had its day as well. The best and brightest managers will still produce returns, but the means will change. That said, I would look toward reducing weighting in long/short pure play funds now.

The specifics of the new rule are as such:

1. As of 12:01 a.m. ET on September 18, 2008, commission actions previously applied to only securities of financial firms with access to the Federal Reserve's Primary Dealer Credit Facility will now be extended to the securities of all publicly traded firms.
2. Short sellers and their brokers must now deliver securities by the close of business on the settlement date. Penalties will be imposed for failure to do so.
3. Violations will result in the broker being restricted from further short-sales in the specific security, unless the shares are located and pre-borrowed (meaning you have to deposit the shares before you short sell if your client screws up, and you can't cover for him).
4. Options market-makers will be treated equally, according to the new rule, whereas under the emergency restriction they were given exemption.
5. Violation of the new short-selling rule is a violation of law and will be penalized as such.
    

Comments

[Roger C. Wren:]

But are they really going to enforce it? A hedge fund sees a chance to make a 30 million dollar quick profit but realises that the result MAY be a 25,000 dollar fine four years later. What does a typical hedge fund do?

2008 Sep 18 04:49 AM

[john s. gordon:]

next step required - reinstitute the uptick rule.
> jack

2008 Sep 18 07:58 AM

[monday1929:]

None of this will prevent the New Great Depression, but it will let regulators recall what it feels like to actually enforce the regulations.
Let us restore the uptick rule so it can be eliminated during the next mania and then restored after the next crash....................

2008 Sep 18 08:18 AM

[Mr.G:]

I agree with monday1929 - the fundamentals are just to bearish when looking at the big picture to jump back in and pick a bottom -its a fools bet to think the bottom is near when nothing has changed the underlying fundamentals - the economy is headed south -home prices are headed south -retail sales are headed south - construction is still headed south - banks refuse to reset asset prices on their books lower -consumer spending is headed south - defaults will continue to rise - cedit cards defaults are headed north- unemployment is headed north - you want to invest just because they have found a way to slow the hemmoraging ? no way

2008 Sep 18 08:45 AM

[8 Alpha-Zulu:]

On the battlefield (Wall Street qualifies as one; by the way), the medic does what he/she might to stabilize the wounded until med-evac (a chopper) shows up to transport the him/her to the care of real surgeons. This naked short rule change is merely a tourniquet instigated in the field of battle. yes, it will slow the hemorrhage, but those legs are gonna have to come off in back in triage, i'm afraid.... and i cant even hear the choppers yet. we must re-Institute the uptick rule now.

2008 Sep 18 10:21 AM

[williambanzai7:]

Sympathy for the Shortseller
(Lyrics by WilliamBanzai7)

Please allow me to introduce myself
Im a man of wealth and taste
Ive been around for a long, long year
Stole many a mans nest egg and faith
And I was round when Livermore
Had his moment of doubt and pain
Made damn sure that Milken
Washed his hands and sealed his fate
Pleased to meet you
Hope you guess my name
But whats puzzling you
Is the nature of my game
I stuck around AIG
When I saw it was a time for a change
Fired the CEO and his SVPs
While Bernanke screamed in vain
I killed a bank
Was best friends with Hank
When the markets raged
And the cold Pizzas stank
Pleased to meet you
Hope you guess my name, oh yeah
Ah, whats puzzling you
Is the nature of my game, oh yeah
I watched with glee
While your investment banks bleed
Fought for ten decades
For the junk paper they made
I shouted out,
Who killed LTCM and the SEC?
When after all
It was you and me
Let me please introduce myself
Im a man of wealth and taste
And I laid traps for bond traders
Who get fired before they reach Mumbai
Pleased to meet you
Hope you guessed my name, oh yeah
But whats puzzling you
Is the nature of my game, oh yeah, get down, baby
Pleased to meet you
Hope you guessed my name, oh yeah
But whats confusing you
Is just the nature of my game
Just as every banker is a criminal
And all the investors saints
As heads is tails
Just call me Merrill, Bear, Drexel, Lehman, Kidder & Chase
cause Im in need of some restraint
So if you meet me
Have some courtesy
Have some sympathy, and some taste
Use all your well-learned risk controls
Or Ill lay your trading book to waste, um yeah
Pleased to meet you
Hope you guessed my name, um yeah
But whats puzzling you
Is the nature of my game, um mean it, get down
Woo, who
Oh yeah, get on down
Oh yeah
Oh yeah!
Tell me baby, whats my name

2008 Sep 18 01:20 PM

[oldgoldbug:]

Hmm, guess the market missed the all out buy signal.

2008 Sep 29 04:38 PM