Short Selling - Part A
There is no doubt in my mind that the removal of the uptick rule by Chairman Cox and the SEC in July 2007 - a rule that had been in existence for over 70 years - has been a major factor in the destabilization of the financial markets. Naked shorting has added another nail in the coffin.
I have nothing against short selling if it is done within the regulations, but the change in regulations by Cox has dealt a blow to market stability and, more importantly, Cox's failure to regulate properly and in a timely fashion has been a factor as well.
To show the extent of potential profits from illegal short selling, I paste in here an entry from an excellent website "Compliance Insights" (www.complianceinsights.com) which reveals the details of a recent SEC action in which two day traders, aided by a collusive brokerage house,
are alleged to have made over $2 billion in illegal profits over a one year period. Two guys, two billion, is just the tip of the iceberg of the illegal activity that plagues the markets. Add to this the increase in short selling because of derivatives, ETFs and futures, and you have a very unsafe market for traditional investors.
SEC Charges Day Traders in Short-Selling Scheme
"The SEC filed a civil injunctive action against 2 day-traders,
Robert Beardsley and George Lindenberg, who allegedly perpetrated
a manipulative short-selling scheme through brokerage accounts at a now defunct
B/D, Redwood Trading. In the complaint, the 2 engaged in a
manipulative scheme by repeatedly shorting securities in violation of the
then-existing "uptick" rule, with the intent to artificially depress
the prices of shares that they had sold short in order to enable them to cover
their positions at favorable prices. In a related civil injunctive
action, the SEC alleges that Dennis McNell, former CEO and COO of
Redwood, aided and abetted their scheme and, in an unrelated fraudulent scheme,
sought to hide substantial trading losses that he had incurred in a Redwood
prop account.
As part of their scheme, Beardsley and Lindenberg also failed to mark their orders as short sales in order to create the false appearance that their orders were long. McNell enabled the scheme by disabling a feature of the trading software that was programmed to prevent violations of the uptick rule. The two allegedly made $2.4bn in illicit gains in less than a year. [SEC Litigation Release 20814, 11/19]"
Had they waited for the suspension of the uptick rule in July 2007, what they did would have been legal.
I rec'd and agree but you might want to edit the huge gap of space out of your blog.
November 21, 2008 11:49 AM | Reply | Permalink
I've never really understood naked short selling.
When I buy shares I can't know from whom I bought them -- although, presumably, my broker does. I expect them to be delivered to my broker "for my account" within 5 days of the purchase.
If the seller -- here, a naked short seller -- never delivers them (a "fail to deliver" occurs), do I own the shares I purchased? Is my transaction nullified? Does my broker step in and deliver on behalf of the short seller?
In other words, how does trading with a naked short seller who fails to deliver effect me?
November 21, 2008 8:50 PM | Reply | Permalink
Delivery of your shares on the fourth day - T(trade date +3, i.e.T/D Monday, S/D(settlement date) Thursday). No, you don't know the seller - your broker expects electronic delivery on s/d through DTC (Depository Trust Co.) If there is a fail, you still own the shares and your account is credited electronically with the shares as the seller's broker delivers to your broker. The seller's broker is thus short the shares, and if that broker has shares available for loan (shares held in a margin account by any customer)he loans them against the seller's acct, and if he doesn't have them he goes to other brokers to borrow them and if there aren't any available for loan he is supposed to "buy in" the seller, which isn't necessarily done. Sometimes weeks can pass with fail positions on a broker's books. In down markets, the short seller can dance around and ultimately buy the shares in the market at a lower price (i.e., the purpose of short selling)thus making a profit accompanied by apologies for the misunderstanding. If the market goes up and money is owed, the short seller may be forced to buy in un-borrowable and undelivered stock stock when the time limit is reached and un-collateralized positions begin to create bookkeeping problems.
None of this, however, affects your position on the other side of the trade, and you aren't even aware if a short seller or long holder sells you the stock you bought.
November 21, 2008 10:35 PM | Reply | Permalink
So, then --
Shouldn't we say that it's the short seller's broker that's perpetrating the fraud?
In other words the seller's broker -- who in the "fail to deliver" situation (no shares in its customer margin accounts and no borrowings from other brokers) -- still taps out the delivery transaction on its keyboard which has the effect of electronically transferring ("fictitious"?) shares to the buyer's broker's account.
When the seller's broker keys in that transfer, isn't it representing, by implication at the least, that it has possession of the shares it is "transferring"?
So, again, isn't it the seller's broker and not the naked short seller that is really the responsible (guilty?) party?
November 21, 2008 11:11 PM | Reply | Permalink
It always takes two to tango. Depending on whom one trades with, individuals have a pre-borrow obligation and systems will prevent trades from going through without a tag specifying that the stock has been borrowed from the selling broker. Institutions, mainly dealing in large blocks, can borrow away from the actual firm doing that particular sale and can represent that the stock loan has been arranged at some other institution, whether it has or hasn't been.
This is about as much as I know.
November 22, 2008 8:51 AM | Reply | Permalink