March 23, 2009

More on the Problems Caused by Naked Short Selling

Just a few days after I weighed in on the problems caused by naked short selling, the SEC’s Inspector General issued a report noting that the SEC received 5,000 complaints over a year and a half period about aggressive short selling (of which, 2.5% of those were investigated) and the SEC’s failure to bring any enforcement cases in this area (and Congress may consider legislation restricting short selling ahead of the SEC adopting a new uptick rule). Here is a Bloomberg article.

According to this WSJ article: “In a written response, the SEC’s enforcement staff played down the likelihood of naked short-selling abuses. It noted that most trades settle on time. The SEC staff said the agency needs to “intelligently leverage” its resources and a large number of complaints provide “no support for the allegations.” The SEC said it is looking to improve its handling of tips.”

While I agree that a large number of complaints doesn’t prove anything – and the Staff certainly needs more resources to do it’s job – I sure hope the SEC is taking the problems caused by naked shorts seriously and realize that adopting an uptick rule alone doesn’t do the trick. I strongly urge folks to read Carl Hagberg’s clear explanation of how naked short selling damages the markets and his suggestion for an easy fix.

Another Ten Cents: The Problems of Share Lending

Thanks to the many members who sent me emails last week, agreeing with the sentiments in my naked short selling blog. Below is one of those emails; this one highlights another issue that the SEC should consider:

Thanks for publishing the blog on naked short selling. I completely agree that rules against failing to deliver should be more aggressively enforced. I have had some clients in the past that have come under attacks from shorts, with their issues being listed on the “Reg SHO Threshold List” for months, while being unable to get any regulatory attention through the SEC or FINRA.

Another – admittedly less pressing – issue that needs to be considered is changing the rules governing when brokers are allowed to lend shares held in their accounts. As I understand the current system, brokers can lend shares unless the account holder has specifically asked that this not be allowed. I imagine most people who take a long position in a stock are under the belief that once they’ve bought the shares, they’ve essentially taken those shares out of circulation, which would normally be expected to reduce supply and help push the price up.

By allowing brokerages to lend shares without affirmative consent (e.g., though an “opt in”), these shares remain available to be traded many times over without the consent or even knowledge of the “holder.” By requiring affirmative consent, brokerage firms may also end up choosing to share part of their stock loan revenues with the account holders, which may provide for some modest hedge and result in better pricing for share lending and more accurate price information in the market for short selling in general.

Webcast: “Compensation Arrangements in a Down Market”

Tune in tomorrow for the webcast – “Compensation Arrangements in a Down Market” – to hear Blair Jones of Semler Brossy, Mike Kesner of Deloitte Consulting and James Kim of Frederic W. Cook & Co. discuss how boards are rethinking compensation practices in the wake of the down market.

– Broc Romanek