Christopher Cox on Naked Shorting and Regulation.

What the SEC Really Did on Short Selling


Excerpts:


"Who profits from intentionally false information in the marketplace? Those who are in on the scam and positioned to benefit from the predictable response of people who believe the fraudulent information to be true.

The classic "pump and dump" scheme, in which a stock is inflated through false information and then dumped on unsuspecting investors when the perpetrators flee, is one example of how this works. "Distort and short" is the same thing in reverse.

"Naked" short selling can turbocharge these "distort and short" schemes. In an ordinary short sale, one borrows a stock and sells it, with the understanding that the loan must be repaid by buying the stock in the market (hopefully at a lower price). But in an abusive naked short transaction, the seller doesn't actually borrow the stock, and fails to deliver it to the buyer. For this reason, naked shorting can allow manipulators to force prices down far lower than would be possible in legitimate short-selling conditions."



"Although the Commission's order was issued under emergency authority in unusual market conditions, it is based on several years of experience and analysis. In 2004, the SEC adopted Regulation SHO to attack the problem of naked shorting. It requires broker-dealers, before they accept short sale orders or effectuate short sales in their own accounts, to first borrow the security to be shorted, or enter into a contract to borrow it.

But Regulation SHO also offers an alternative to these requirements if the broker has "reasonable grounds" to believe that the security can be borrowed. This could create opportunities for evasion of the rule's purpose.

That has led the commission to consider simply eliminating the "reasonable grounds" alternative altogether. This is essentially what the SEC did for the financial firms for which the American taxpayer is now on the line. It is also what the commission is even now considering for the broader market."


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Good stuff. Very hopeful, and Right On in philosophy.

Key Phrase: "Although the Commission's order was issued under emergency authority in unusual market conditions, it is based on several years of experience and analysis."

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