Short Selling: Others Want Protection Too

As is now well known, this week the SEC announced that it plans to tighten short-selling rules on Monday for 19 financial companies, essentially limiting naked short selling by now requiring short-sellers to actually borrow the shares they plan to sell before shorting. The new restrictions were loosened a little on Friday when the SEC said market makers wouldn't have to pre-borrow the stock, but would still need to deliver them within three days. Market makers had complained that the new rules would prevent them from providing the necessary liquidity for making an efficient market.

Upon first hearing of the rule change (or enforcement), in particular the listing of the gang of 19, I wondered in a post whether some companies on the list would prefer to not be included, given the attached stigma of needing Government intervention to prop up their shares. After all, the rule is effectively an SEC induced short-squeeze. Of course, that was 3 days and +20% ago. Now other companies are wondering why they were not included. After all, they like +20% moves as well.

As mentioned in a recent WSJ article, the Financial Services Roundtable, who represents 100 of the largest U.S. financial companies, wants the SEC to extend the order to include companies they represent as well. Companies like Wachovia (WB), reporting next week, are not currently included. Apparently they are either not big enough to fail, or are not yet in poor enough shape to fail. Given the recent investigation of Wachovia, and speculation about poor numbers next week, that may soon change.

If history is any indication, and it usually is - it is rarely different this time - then companies may want to be careful what they wish for. Research by Professor Charles Jones at Columbia Business School has found that similar moves by the SEC have some unhappy precedents. As mentioned in the WSJ article:

 

In 1932, the New York Stock Exchange announced that, effective April 1, brokers would need written authorization before lending an investor's shares. "This wreaked havoc on the securities lending market, but the effect was completely temporary," he [Jones] said, because the move only added extra hoops, and didn't prevent people from taking bearish positions if they wanted.

 

More regulation, and temporary results. Not necessarily what we need long-term, but what we will probably get regardless. Maybe with less next quarter, short-term, results-generated management, by both investors and the government, we would not need additional layers of regulation.

 

Comments

[apppro]

Very true on this short term thinking mentality. However, we really do need to do something about the 'trader' mentality that has been spawned by CNBC and a few others. SELL..SELL..SELL on every uptick is also poor financial judgement.

[adan]

the less unfairness applied by the govt to our everyday lives, the better the long term prognosis - but both govt application and thinking long term appear to be challenges in themselves :-)

[adan]

the less unfairness applied by the govt to our everyday lives, the better the long term prognosis - but both govt application and thinking long term appear to be challenges in themselves :-)

[williambanzai7]

With the panoply of available derivatives, any savy trader will be able to put a bear trade on these stocks.

[kabab]

<p>
Re the WSJ quote:
</p><p><...
..but the effect was completely temporary," he [Jones] said, because the move only added extra hoops, and didn't prevent people from taking bearish positions if they wanted.
</i></p>&l...
So right! In fact I decided to blog about a way I discovered last week to cover my LEH short w/o losing my ability to short again. Though this must be old news to seasoned traders, I couldn't find much written about it on the web.
</p>

[jwt]

I view naked short selling like counterfieting and should be treated as same shorts can sell a call or write a put these would limit their down side risk but would cost a premimum which is generally not a big deal personally i plan on instructing my brokerage house i want my shares kept in a cash account and not loaned out you go long a stock and the damn broker lends your shares to someone else to sell (short), thereby creating a false supply which in turn puts downward pressure on your long position shorting is just another cash generating feature for the brokerage house they already have any cash balance in the account they can loan out at high interest rates greed has no limits

[Lilliana]

JWT
You are so correct. NAKED SHORTING IS AN ABOMINATION
Naked short selling is nothing more IOHO ...the all time scam.
Unfortunatly many of the large funds are using custmers equity ( without express sanction)to lend stock...which in turn debases the overall value of the market..This is both morally and legally wrong..and wont go unpunished.
They are diging their own financial disaster.

[packotruths]

Can one actually instruct a broker not to lend one's shares? I know one can ask the broker to send the share certs to the individual who owns the shares thus effectively stopping any lending since the owner rather than the broker physically holds the certificate in the owner's name. But without actually holding the share certificates, how can one rpevent the broker from loaning shares held in "street name?"