Naked Short Sales No More

By Lisa Valentine

The Securities and Exchange Commission (SEC) announced two changes to the rules to protect against “naked” short sales which the Commission calls “abusive.” These “naked” short sales are when a trader sells shares of a stock without borrowing them first.

The first move by the SEC is to make permanent Rule 204T (the T stands for “temporary”) that requires broker-dealers to “promptly purchase or borrow securities to deliver on a short sale.” The rule was passed as an emergency measure last fall and was successful in diminishing market manipulation. Since enacting the bill, the number of fails to deliver decreased by about 57 percent. The temporary rule was set to expire July 31.

(A failure to deliver occurs when an investor or broker-dealer does not deliver shares within T+3, whether the reason for the failure was legitimate such as in processing delays or because the seller could not locate shares.)

No changes have been made from the temporary rule to the permanent rule even though the temporary rule was enacted while many thought, rightfully so, that the financial industry was in dire peril and that naked short selling was pummeling financial stocks. Does the SEC feel that the danger of a repeat crisis is still possible? Probably not. More likely is that the SEC is taking advantage of public and even financial industry sentiment that naked short selling simply can’t be good for the markets. Who is going to oppose the rule and look like a bad guy?

It’s also likely the Chairman Schapiro has so much regulatory reform on her plate that it’s simply easiest to pass the rule as it exists rather than try to tweak it.

The SEC is also trying to make short sale transaction and volume data more readily available to the public (rather than just institutional money managers which is the case today) by posting it on certain self-regulatory organizations (SRO) web sites. This requirement will replace a temporary rule the SEC enacted in the fall of 2008: Rule 10a-3T.

SROs shortly will begin posting daily aggregate short selling volumes in individual equities, a one-month delayed transaction data, and lists of fails to deliver data twice a month.

Said SEC Chairman Mary Schapiro, “Today’s actions demonstrate the Commission’s determination to address short selling abuses while at the same time increasing public disclosure of short selling activities that affect our markets.”

On September 30, the SEC is hosting a public roundtable where the issues of security lending, requiring short sellers to pre-borrow, and additional short sale disclosures such as a short sale indicator will be on the table for discussion.