SEC Halts the Practice of Naked Short Selling
Monday, July 28, 2008
by Michael Peron
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The Securities and Exchange Commission (SEC) announced today an emergency order that will halt “naked” short selling of the securities of Fannie Mae, Freddie Mac, and 17 other companies.
According to the SEC press statement the new emergency measure will require that “anyone effecting a short sale in these securities arrange beforehand to borrow the securities and deliver them at settlement.” This measure will ensure that a naked short sale is not occurring.
Short selling occurs when traders believe that the price of a stock will soon decline and try to make money off this belief by borrowing stock from investment firms, or other parties, and promptly selling it. Once market prices have gone down, these traders rebuy the stock, pocketing the difference and returning the stock to the parties they borrowed it from originally. “Naked” short selling occurs when traders “sell” stock that they have not borrowed and do not actually own. These traders rely on loopholes between paper and electronic trading systems to not catch the practice until they have already made a profit. Naked short sales are hard to track and are only suspected to have taken place once the three-day stock settlement period is over and a high number of trades have failed to be delivered from the seller to the buyer. Traders who engage in “naked” short selling are purposely trying to manipulate the market to drive prices down so they can make a profit from buying a stock while it is low.
“The SEC's mission to protect investors, maintain orderly markets, and promote capital formation is more important now than it has ever been,” said SEC Chairman Christopher Cox. “Today's Commission action aims to stop unlawful manipulation through 'naked' short selling that threatens the stability of financial institutions. We will continue our vigorous commitment to investors by working within the SEC and in close cooperation with our regulatory counterparts to promote the continued health and vibrancy of our markets.”
According to the order, the SEC intends to prevent false rumors from influencing the market and affecting the viability of companies, particularly Fannie Mae and Freddie Mac, the way they feel it negatively affected The Bear Stearns Companies Inc. According to the order, “during the week of March 10, 2008, rumors spread about liquidity problems at Bear Stearns, which eroded investor confidence in the firm. As Bear Stearns' stock price fell, its counterparties became concerned, and a crisis of confidence occurred late in the week. In particular, counterparties to Bear Stearns were unwilling to make secured funding available to Bear Stearns on customary terms.”
In conclusion, the order stated that the SEC “intends these and similar actions to provide powerful disincentives to those who might otherwise engage in illegal market manipulation through the dissemination of false rumors and thereby over time to diminish the effect of these activities on our markets.”
The Commission's emergency order will take effect this coming Monday, July 21, at 12:01 a.m. ET and will terminate on July 29, 11:59 p.m. ET, 2008.
To read the SEC's emergency order in full, click here.
According to the SEC press statement the new emergency measure will require that “anyone effecting a short sale in these securities arrange beforehand to borrow the securities and deliver them at settlement.” This measure will ensure that a naked short sale is not occurring.
Short selling occurs when traders believe that the price of a stock will soon decline and try to make money off this belief by borrowing stock from investment firms, or other parties, and promptly selling it. Once market prices have gone down, these traders rebuy the stock, pocketing the difference and returning the stock to the parties they borrowed it from originally. “Naked” short selling occurs when traders “sell” stock that they have not borrowed and do not actually own. These traders rely on loopholes between paper and electronic trading systems to not catch the practice until they have already made a profit. Naked short sales are hard to track and are only suspected to have taken place once the three-day stock settlement period is over and a high number of trades have failed to be delivered from the seller to the buyer. Traders who engage in “naked” short selling are purposely trying to manipulate the market to drive prices down so they can make a profit from buying a stock while it is low.
“The SEC's mission to protect investors, maintain orderly markets, and promote capital formation is more important now than it has ever been,” said SEC Chairman Christopher Cox. “Today's Commission action aims to stop unlawful manipulation through 'naked' short selling that threatens the stability of financial institutions. We will continue our vigorous commitment to investors by working within the SEC and in close cooperation with our regulatory counterparts to promote the continued health and vibrancy of our markets.”
According to the order, the SEC intends to prevent false rumors from influencing the market and affecting the viability of companies, particularly Fannie Mae and Freddie Mac, the way they feel it negatively affected The Bear Stearns Companies Inc. According to the order, “during the week of March 10, 2008, rumors spread about liquidity problems at Bear Stearns, which eroded investor confidence in the firm. As Bear Stearns' stock price fell, its counterparties became concerned, and a crisis of confidence occurred late in the week. In particular, counterparties to Bear Stearns were unwilling to make secured funding available to Bear Stearns on customary terms.”
In conclusion, the order stated that the SEC “intends these and similar actions to provide powerful disincentives to those who might otherwise engage in illegal market manipulation through the dissemination of false rumors and thereby over time to diminish the effect of these activities on our markets.”
The Commission's emergency order will take effect this coming Monday, July 21, at 12:01 a.m. ET and will terminate on July 29, 11:59 p.m. ET, 2008.
To read the SEC's emergency order in full, click here.
Rachel Daniels | 07.16.08
