In some circles, those are fighting words. There are companies that blame all their problems on that kind of trading, which is illegal if it is intended to manipulate the market. There are claims that it has destroyed thousands of public companies, although those making the claims have trouble naming any such companies.
But now, it appears, naked shorting — the practice of selling shares short without borrowing them — is almost gone. The Securities and Exchange Commission’s hurried changes of short-selling rules last fall appear to have all but eliminated the number of companies where such selling seems to be occurring. This appears to be an example of regulation working.
The primary example of the decline in naked short-selling is in the shares of Overstock.com, an Internet retailer whose chief executive, Patrick M. Byrne, has for years been on what he called a “jihad” against such trading. Overstock has sued many Wall Street firms for facilitating such trading, as well as a hedge fund and a research firm that it believes acted illegally in spreading negative information about the company. The suits have not yet gone to trial.
The primary evidence of naked short-selling is a large number of trades where shares were not delivered on time, causing a “fail” in Wall Street jargon. Naked short-selling can save a trader the costs of borrowing shares, or can make it possible to short a stock where borrowing is very difficult because so many others want to sell it short. A large number of fails does not prove naked short-selling, since there are other reasons for trades to fail, but such a number does indicate it is likely.
Critics of naked short-selling often say it produces “counterfeit shares,” but that term is misleading. Any short-seller, naked or not, takes on the same economic risks. If the price rises, the trader will lose money. If it falls, he will profit.
The stock exchanges publish “threshold lists” every day of stocks where there are substantial failures — at least one-half of 1 percent of the outstanding shares. Overstock spent months on the Nasdaq list, and at the height had 3.8 million failures to deliver in one day, a huge figure in comparison to the 22.8 million shares outstanding.
But it has not been on the list since Sept. 2, 2008, a few weeks before the S.E.C. imposed its new rules. On some days this year, there have been virtually no failures to deliver Overstock shares.
Over all, the threshold lists, which once had hundreds of companies on them each day, now list few companies. Of the handful of companies still remaining, few stay on the lists for more than a few days. That indicates that failures, when they occur, are quickly corrected.
So are those who used to bitterly complain about naked shorting praising the S.E.C. for solving the problem?
Not a bit. Dozens of letters blaming naked shorting for the decline in share prices have poured into the S.E.C. in recent weeks, in response to a request by the commission for comment on the possibility of imposing rules to make it harder to sell stocks short when share prices are falling.
“Why has the SEC not addressed the NAKED SHORTING issue?” asked one such letter, from an investor named Edwin J. Jewell. “It has hurt the average investor by this type of manipulation.”
Mr. Byrne told me this week that he thought there were numerous ways for Wall Street to hide failures to deliver. The list he offered ranged from the plausible to the dubious, but the evidence that there are many such failures is not easy to come by. When I asked Jonathan E. Johnson III, Overstock’s president, if he believed there was substantial naked shorting of his company’s shares despite the low number of failed trades, he declined to answer. He said such information was likely to come out in the trial of the suit Overstock filed against the brokerage firms, but there is no date set for that trial.
The S.E.C. rule that seems to have won the war against naked short-selling was one that simply eliminated an exemption previously available for those who made markets in stock options. The fact that fails soon plunged is evidence that that exemption was being abused.
That rule is set to expire July 31, but it seems probable that the commission will make it permanent before that....
more:
http://www.nytimes.com/2009/05/01/business/economy/01norris.html?_r=1&dlbk
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