So what exactly does this emergency order that Chris Cox announced this afternoon? A lot of people are scratching their heads about the rule because most naked-short selling is already prohibited under the rules. Maybe Cox just thought the markets didn’t have enough uncertainty in them right now.
It’s still unclear but here’s what we’re hearing. First of all, whatever it is it seems that it is broader than Fannie and Freddie. It applies to all primary broker-dealers also. Basically, if Ben Bernanke has recently granted you access to the discount window, it’s going to be much harder to short you.
Second, it’s going to be more than merely stepped up enforcement. We hear from sources who claim their familiar with the thinking (if you want to call it that) at the SEC that there will be new rules in place. What are the new rules? The rules put in place a few years ago allow primary broker-dealers and specialists to place and accept short selling orders from one another without requiring that they borrow shares first. This can be done for liquidity and market-making purposes but critics of naked short selling often say it can be easily abused.
Additionally, it’s been a consistent claim by those who think abusive naked shorting is rampant that short-sellers intentionally misrepresent to broker-dealers that they have legitimately borrowed the stock or that they actually own the shares.
The bottom line is that we’re hearing from sources in Washington that Cox may be looking to curtail one or possibly two of these loopholes. One move may be to require investors to certify in writing that they have located and borrowed the stock. Alternatively, the SEC could require short sellers to borrow, sell and close out their short trades through the same broker, eliminating the portability of short trades. They may also eliminate the broker-dealer exception. It’s not expected that the specialist loophole would be eliminated, since this is still looked at as an important part of the smooth functioning of the market.
What’s short selling? After the jump, we explain it in six sentences. (And then explain “naked shorting” in just five.)
Traders who believe a stock’s price will decline borrow stock through a broker. They immediately sell the borrowed stock. Later, when it comes time to return the stock, they buy it on the market. If the price of the shares has declined since the original borrowing, they profit from the difference. It can be a risky bet, because if the shares go up after they are borrowed and sold off, the short-seller stands to lose money. Since there is no limit to how high a share can climb, short-selling creates a potentially unlimited upside risk. Want more: here’s an in-depth guide to short-selling.
Naked short sellers skip the part where they borrow stocks. They sell shares they don’t own, and only need to locate shares later when the buyer expects delivery. Sometimes they don’t deliver the shares at all, which produces what the market calls a “failure to deliver.” Is that illegal? Well the SEC rules make it very difficult. But you probably won’t got to jail unless you the SEC can show you are attempting to manipulate the market or commit fraud.
In the first paragraph you state “most naked-short selling is already prohibited under the rules.” In the last paragraph you state “naked short selling isn’t illegal in most cases.”
Is this consistent? Is naked short sales somehow prohibited under the rules but not against the law?
“…because most naked-short selling is already prohibited under the rules.”
“Naked short selling isn’t illegal in most cases…”
well, which is it?
“…because most naked-short selling is already prohibited under the rules.”
“Naked short selling isn’t illegal in most cases…”
well, which is it?
It sounds like they will be cracking down on the practice of borrowing one amount of shares and shorting more than the borrow. In the past I think this was done and if the position was closed out same day many PB’s looked the other way.
Why do you have to explain short selling on a financial blog?
@2:51–have you seen the caliber of some of the comments today? I think maybe we should explain the difference between debt and equity.
you kiddies need to read up on reg SHO.
all your answers are there.
but basically if you want to know how it works, hedgefunds traders bullshit salestraders and tell them that their prime borrowed the stock and/or is “easy to locate”.
you know brokers hate commisions so they hardly ever believe the hedgefund traders and refuse to execute the trades. (((rolleyes)))
@ 2:54
That is why their “emergency action” is going to prevent portable borrows. Meaning if you borrow at a B/D you probably will need to execute the trsde there so they can keep tabs on the shares.
“Is that illegal? Well the SEC rules make it very difficult. But you probably won’t got to jail unless you the SEC can show you are attempting to manipulate the market or commit fraud.”
you’re a worse proof reader than me – lol
and regulatory agencies are a funny animal.
they look the other way until the big guys in washington call for heads.
and then spitting on the sidewalk becomes a felony.
you’ll know real soon if they’re serious if you start hear about justice.
or some overzealous state ag gets horny for headlines, but i think ag’s are looking to lay low now, if ya know what i’m saying.
Still don’t understand what the SEC thinks this will accomplish. About a billion shares have changed hands the last 4 trading days. Doubt borrowing the shares can be too difficult.
The current requirement of simply getting a locate on an “easy to borrow” name needs to go too. Multiple brokers can locate the same block of stock at the same lender, but those shares can ultimately only go to one, making the shares sold short a multiple of the actual quantity avaiable to borrow.
Keep it simple: no DTC position, no sale.
Sorry for confusion in original wording. Cleared up now. Well, as clear as it can be given how vague Cox was on this.
@ 3:03
Exactly, if you link the borrow to a DTC position this whole problem of double, triple, quadroople borrowing goes away!
For those of you who’ve read Atlas Shrugged, and what true capitalist hasn’t, those words “emergency order” are interesting. What emergency directives could be next?
It’s real simple. Let people execute any trades they want but have some actual penalties for fails to deliver.
you know a lot of these hedge fund guys have been openly critical of bush and openly supportive of democrats.
they should follow stevie cohens lead and walk around with groucho marx glasses…
but i digress,
i wonder if the white house is going to get a pound of flesh here before they say bye-bye?
Jesus, do we really need to explain what short-selling is?
the least thing that’s going to happen here is that all hedge funds will be required to be registered with the SEC.
no more exemptions.
think martha stewart and that dude from enron who killed himself for worst case scenario.
@ 3:11
Agreed, get draconion, try out the Singapore rules. Those guys do everything but string you up by the nuts on a fail.
One caveat, rule shouldn’t apply when DTC f’s up and delays allocating shares in a corporate action, IPO, etc
We try to keep things friendly for the new kids around here by dropping basic explanations of things like short selling into the discussions. Casual readers can get lost in the discussion, and you’d be surprised at how many guys who work in M&A don’t understand some basic trading concepts after a couple of years spinning pitchbooks and glad-handing executives.
John Carney@3:29pm…
Thank you for this thread and for your “friendly” welcome to those new to DB.
I dropped by yesterday to say hello, and today I’ll add a comment:
Some at DB already know that I don’t like “Wall St”. What I don’t like is not “Wall St” itself, but what “Wall St” has done over the past few years to bring our entire financial system closer to collapse.
Today’s action by the SEC is most welcome and as @2:32 said “is a start”. On this thread I see the typical short-sighted, glib comments from posters who think “business as usual” is a good thing. What you posters seem bent on ignoring is the near certainty of further SEC action. @2:32 summarized it well. This is definitely “a start”.
The Guy from Delaware
I suppose a rule such as this makes it safe to say they view several banks and i-banks having solvency issues.
Guys, the problem is more simplistic.
What the SEC has clearly seen, that we are not privy to, is that the CNS failed trades (end of day net reporting) as reported daily by the DTCC is accumulating. The same happened in Bear Stearns leading into that collapse. In Bear Stearns false accumulated from 19,000 shares to 13 Million shares in a matter of a few trading days. None of this can be directly correlated to daily trade volume because of day trading activities.
What the SEC sees is a net rise but the reality is short sales without a locate and/or borrow are initiated and closed out in the same day keeping off teh net report. They are also attributing this rise as having an impact on the market itself. How wouldn’t it when there are vastly more sellers than buyers and a portion of those sellers can’t even settle the trades.
For the longest time short sellers have been able to take advantage of these loopholes because Broker-Dealers let the fails linger instead of going back into the market and closing them out. The SEC finally recognizes how that can lead to predatory trading strategies and possible market manipulation.
OK – seriously, can someone find me a an academic paper that actually concludes short selling is bad for the market? In my meager research I havent been able to find anything with quantitative evidence against short selling–although i find a hell of a lot arguing for it. This isn’t a tongue in cheeck challenge, if you know of something post it up or email me.
Fails to deliver should be penalized, and the SEC should simply enforce the rules already on its books.
Interesting comments. I think it’s appalling that Chris Cox would provide testimony to Congress on a critical issue and leave the financial community (and everyone else) scratching their heads as to what he meant. I don’t think Cox has bothered to master the concepts of what it is his agency does. I’m sure whoever is left at the SEC who has any brains and the emergency “talent” sent over from other federal agencies are busily scrambling to concoct something that both fits Cox’s Congressional testimony and addresses the problem.
ah yes, an academic paper, now that would prove it!
Oh, and by the way, thank god Cox instituted that rule to clear out the naked shorts.
Didn’t say it would prove anything, but at least it would be a place to start. Somehow anecdotal evidence (rumors?)from CEOs trying to save their own asses doesn’t hold much legitimacy.
Just because your Doritos chip bears a striking resemblance to the Virgin Mary doesnt mean it is the VM–or that she was even a virgin.
But i’d probably tap that if she was.
onetwo– do you work for an hf?
“onetwo– do you work for an hf?”
–the dorito company, duh
I find it amusing that these large brokerages made all this money prior to the housing crash and now beg for protection after they made all these bad loans and advise.
There goes capitalism right out the window.
I don’t get it. Legitimate borrow is easily available in large quantities for both FRE and FNM. It appears unlikely that any naked shorting has or would be likely to occur in these names. This appears to be more of a witch-hunt by regulators that either don’t understand the regulation they are now looking to enforce, or are hoping to distract the public from taking a harder look at the regulators that let financial conditions deteriorate to this point at the institutions they were charged with overseeing.
(link below shows borrow available for FRE)
http://individuals.interactivebrokers.com/en/trading/ViewShortableStocks.php?key=fre&cntry=usa&tag=United+States&ib_entity=llc&ln=
who does number two work for?! who does number two work for?!
onetwo, I’m all for short selling, but for hang’em-by-the-balls-Singapore-style punishment against those who can’t settle. When you short and fail to deliver not only do you perhaps artificially depress a stock’s value, you create a major pain in the ass for those down the line who need to deliver the shares they expected from you… and it goes on.
I don’t think it’s ever been done, but I would love to see a study on the hours spent by back office types haggling over settlement and bitching about buy-ins. The externalities must cost in the hundreds of millions, maybe billions.
@5:12 – the reason you don’t “get it” is because you may be intelligent enough to think for yourself and realize that naked shorting isn’t even close to the culprit people are making it out to be.
Short selling didn’t push the CDS contracts up to record levels (only to fall when the Gov’t said “wait, you know that sentence on the front of every fre/fnm prospectus that says ‘no one but fre/fnm backs these bonds’. Yea, ignore that.”) Short selling didn’t put FRE into a $5bn asset/liability mismatch in the first quarter. Short selling didn’t give them a .45% coverage ratio. Short selling also didn’t lower the GSE capital requirements last year and increase conforming loan regulations.
But, i may be wrong. It probably is the short sellers. We should probably keep these share prices up, so that when they do fail they fall REAL FAST…WEEEEE!
Oh, and i forgot to mention, god FRE was smart for waiting until quarter’s end to raise that $5bn it needed. On the other hand, maybe they saw this coming all along and figured it’d be cheaper to charge Bernanke & Co than the public markets.
@5:20 – I absolutely agree that FTD should be penalized as needed. I don’t know how you draw the distinction between unintentional/operational issues and true naked shorting with no attempt to deliver the securities–but I 100%agree that it should be illegal to sell with no intention of delivery. No one should be able to flood a market with shares.
However, I 100% disagree that you depress the stock price in such a way that the market can’t correct itself.
Think of it this way:
-2% of MFs short
-
What some have said about the middle/back office operations re: short selling makes sense if reality is really as sloppy as some have pointed out. I’ve nary a clue as to the degree of duplicate borrowing, but the fact that its possible seems like a simple “loophole” to fix, if for nothing else than matter of principal behind it. As 1-2, among others have pointed out, the operational aspects of short selling likely have far-less effect on asset prices (net-net) than deteriorations in 1)fundamentals, and 2)expectations about future fundamentals.
Borrows on equity shorts may be available but when trading options borrows are not required as options market makers sell naked into the equity market. I think you need to look for spikes on Puts in the Options Market as short sellers avoid the borrow costs and still get the underlying short and sell side pressures into the equity.
Data and an analysis is available here;
http://sec.gov/comments/s7-19-07/s71907-562.pdf
Carney, nice discussion, but how could you have failed to quote Daniel Drew on short selling?
He Who Sells What Isn’t His’n
Must Buy it Back or Go to Pris’n.
Not Bob
And lest we forget how evil the speculative longs are in commodities!
Let’s face it. Everyone is just trying to look real busy now. Regulators do this every time someone gets in touble, and it generally does more harm than good.
Don’t forget, the S&L scandal both incentivized the securitization process (illegal to buy individual crappy securities and essentially carry them as a bundle on your balance sheet, so you have to buy the bundle up front) and annointed the now demonized ratings firms ultimate arbiters of who can do what. Oh, yea, and told S&Ls that the GSEs were the only companies they could hold on their balance sheets without regard to concentration risk.
How’s that working out for us?
onetwo, what exactly is your points here? Should the SEC ignore the apparent accumulation of fails in a free falling market? Should purchasers of shares that can’t be delivered be satisfied they paid a premium on shares that never get delivered? I hear shares are readily available but short sellers don’t want to borrow them instead opting for the cheaper option of selling without delivery.
@602 – do you even read what I write?
From 5:45
“@5:20 – I absolutely agree that FTD should be penalized as needed. I don’t know how you draw the distinction between unintentional/operational issues and true naked shorting with no attempt to deliver the securities–but I 100%agree that it should be illegal to sell with no intention of delivery. No one should be able to flood a market with shares.”
@6:02…Jesus Christ, read the comments. 1-2 says that he think the SEC should penalize FTD
It would not surprise me if one of the reforms coming from this period is that shorting is only allowed for hedging existing long exposure. Not justifying, just see it as a realistic possibility. Politicians will not see penalizing shorts after the fact as adequate when companies have already kicked the bucket (even if they legitimately deserve to). I think their concern extends beyond FTD.
fuck you for taking down the BL-towel pic
http://tinyurl.com/67h2uk
onetwo: That’s not going to happen for the same reason that Congress isn’t going to deny the Fed the additional power it’s requesting.
No government official, in the history of mankind, has ever come out and admitted that any problem was in any way related to failure to enforce existing regulations or exercise existing powers. No, the problem is ALWAYS that we need MORE rules and they need MORE power.
As usual, this is total bullshit. Intentional failure to deliver is FRAUD. Fraud is already against the law. If you can’t prove intent, then sue the bejeezus out of them and delicense them – a license to trade securities is a privilege, not a right, same as a gaming license or a liquor license. Hell, if a securities trading license was as hard to get as a gaming license or a liquor license, we wouldn’t be having this discussion.
M
@stmarc -
I’m not going to lie, i love your addition to db comment boards. Please don’t confuse my hatred of hypocracy for an actual belief that any of the real actions that should be taken will be taken. No politician will ever take fault for what has happened–nor would it even help in the end. I also completely agree with your assertion that a license as dificult to obtain and retain as caberet licenses existed in the securities market a lot a problems would fade quickly.
But, please keep in mind, that this all ignores the fact that it’s difficult to actually rationalize why fre/fnm should be priced any higher than they are. They shouldn’t be at any lofty valuations at all with their inadequate capital ratios, loosening lending standards, and liquidity penalties. So, while i agree all manipulative naked short-selling ftd is fraud and should be prosecuted, i doubt it would make much of a difference.
@onetwo: I get carried away. You’ll have to get used to me and my little ways, provided they don’t give me the boot. :)
M