Naked Shorts Exposed – We lose, they win…

May 18, 2007 1:58 am

I have seen first hand the process of shorts unable to be delivered. Trading firms offer their clients shorts up to , say 10,000 shares on a stock for almost all stocks that trade. Then, when it actually comes to the part about delivery, it never happens. The requirements to short are very clear and at the very essence, is the ability for brokerages to lend “eligible” stocks to the short sellers from other accounts, which also has clear rules that were created by the SEC. (Partial text of the latest Rule)

V. Rule 203 — Locate and Delivery Requirements for Short Sales
A. “Locate” Requirement

We are adopting proposed Rule 203, with some modifications, after considering the comments received.53 As adopted, Rule 203(b) creates a uniform Commission rule requiring a broker-dealer, prior to effecting a short sale in any equity security, to “locate” securities available for borrowing. For covered securities, Rule 203 supplants current overlapping SRO rules. Specifically, the rule prohibits a broker-dealer from accepting a short sale order in any equity security from another person, or effecting a short sale order for the broker-dealer’s own account unless the broker-dealer has (1) borrowed the security, or entered into an arrangement to borrow the security, or (2) has reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due.54 The locate must be made and documented prior to effecting a short sale, regardless of whether the seller’s short position may be closed out by purchasing securities the same day.55 The rule provides for some limited exceptions, including for short sales effected in connection with bona-fide market making.

Therein lies the biggest problem. While Rule SHO attempts to limit the naked shorts, the exemptions cover those that are most likely to participate in the transactions, namely market makers and others with large $$$$ that are moving the markets. Hedge funds can also be considered market makers in some instances, as they may be part of a bigger brokerage operation.

Nasdaq Short Interest

“Naked short selling, however, can have negative effects on the market. Fraudsters may use naked short selling as a tool to manipulate the market. Market manipulation is illegal. The SEC has toughened its rules and is vigilant about taking actions against wrongdoers. Fails to deliver that persist for an extended period of time may result in a significantly large unfulfilled delivery obligation at the clearing agency where trades are settled. Regulation SHO is intended to address these effects by reducing the number of potential failures to deliver, and by limiting the time in which a broker can permit a fail to deliver to persist. For instance, as explained above, Regulation SHO requires brokers and dealers to close-out the open fail-to-deliver positions in “threshold securities” (i.e., securities that have experienced a substantial number of extended delivery failures) that have persisted for 13 consecutive settlement days.”[4]

As always, a rule without consequence is nothing more than a friendly suggestion. We need to stop being so nice….

COMMENTS ARE ENCOURAGED ON THIS… Do you think that there is too much manipulation in today’s markets?

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