Lawmakers eyes “Naked” Short Selling

4 06 2009

No, naked short selling has nothing to do with the flashy jackets traders wear on trading room floors.  Short selling is basically selling shares that you do not own, for the purpose of buying them back at a lower price.  The difference between the selling price and the buy back price is the trader’s gain.  Short selling comes in two flavors, regular and “naked”.   In a normal short sale, the seller borrows the shares from the owner.  In a “Naked” short sale, the seller doesn’t even borrow the share.  The main problem with short selling is that it artificially drives down the price of shares by increasing the supply of available shares.  Under normal suppy-demand economics, this drives down the price.  With the naked variety, there is the problem with “failure to deliver”, which occures when the stock isn’t delivered to the owner, particularly because the seller never owned it in the first place.  Aggressive short selling was largely blamed for the failure of Lehman Brothers and Bears Sterns.

Over the summer,  the SEC created rules requiring pre-borrowing before a trader can sell shares from certain financial firms.  The Wall Street Journal has an article on recommendations for further regulation.

One idea is to require that traders borrow shares before they try to sell a stock short, known as a preborrow. Last summer, the SEC issued an emergency rule requiring preborrowing for certain financial firms’ shares, but the industry said it was too expensive, and the requirement was abandoned….

The statement came after the Government Accountability Office found that SEC regulations issued earlier this decade only temporarily slowed cases of “failure to deliver,” which occurs when the seller of a security doesn’t deliver the security to the buyer during a required period. These cases can occur for a variety of reasons, including naked short selling.

An SEC spokesman said the SEC appreciates the GAO’s recommendations and is focused on short selling, including examining a preborrow requirement.




Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: