Utah law may doom naked short selling
By Sara Hansard
June 5, 2006
WASHINGTON - Supporters of a new Utah law, intended to rein in the practice
of "naked short selling," last week predicted that their movement soon would
spread to other states.
The brokerage industry, caught off guard by the enactment of the law,
threatened to take Utah to court to have the law overturned. When investors
sell stock they do not own, the transaction is called naked short selling.
"Utah will be the vanguard of protecting corporate equity, or protecting the
little shareholders from the guys who would want to manipulate the market,"
said Republican state Sen. Curtis Bramble, the chief sponsor of legislation
signed May 26 by Utah Gov. Jon Huntsman.
Other states will "probably look to our state to see what good comes of it,"
commented Republican state Rep. Jim Ferrin, who voted for the legislation.
It was passed overwhelmingly in a special session of the state legislature
May 24. Mr. Ferrin is the owner of Ferrin Capital Advisors, a financial
planning firm in Orem, Utah.
But the Securities Industry Association, of New York and Washington, sent a
letter to the governor May 25, saying that the law could "result in a time
consuming and expensive court challenge." The SIA contends that the law
violates the National Securities Markets Improvement Act, which prohibits
state regulations of national markets if they differ from federal securities
rules.
In its May 25 letter to Mr. Huntsman, the SIA noted that the SEC's 2003
Regulation SHO is the agency's attempt to prevent naked short selling.
Reporting requirement
The law requires brokers doing business in the state to report to the
division of securities sizable short sales for which stock has not been
delivered for more than five trading days.
Regulation SHO took effect in January 2005 and requires clearing agents or
broker-dealers to close out positions they have failed to deliver for an
extended time. The Utah law would put more teeth into it by levying
$10,000-per-day fines to brokerage firms that do not fill their short sales
or report to the state securities regulator their failures to deliver.
In addition, the law gives companies affected by the practice of naked short
selling a private right of action to sue brokers who engage in it.
Traders typically short stocks by borrowing the security in the hope of
selling it later when the price goes down and when it can be bought back at
a lower price. Critics contend the practice is controversial because it has
been used to drive down the price of stocks and, in the process, allegedly
destroy smaller companies. Overstock.com Inc., an online retailer based in
Salt Lake City, campaigned heavily for the law.
Overstock.com chief executive Patrick Byrne claimed that the practice has
contributed to a decline in the stock price of his company, and he has
gained the ear of Sen. Robert Bennett, R-Utah, who queried SEC chairman
Christopher Cox about the practice at an April 25 Senate Banking Committee
hearing.
Mr. Bennett has no plans to introduce similar legislation to the Utah bill
"at this time," said Mary Jane Collipriest, spokeswoman for the senator.
At that hearing, Mr. Cox said the SEC is in the process of finishing
targeted examinations of 45 brokerage firms and 19 clearing firms concerning
the practice. If the results of the exams show that changes are needed, "I
will recommend changes," to Regulation SHO that require monitoring of
significant stock sales that are not delivered in a timely fashion.
"This is something that we would hope that the federal government would take
a look at and fix," said Jonathan Johnson, senior vice president for legal
and corporate affairs for Overstock.com.
The law will affect not just brokerage firms that do business in Utah but
"any individual who lives there who does any short selling, even if they're
doing business with a broker in Chicago or Phoenix," said Yolanda Holtzee,
portfolio manager of Alcap LLP in Newcastle, Wash., a private investment
club where she engages in short sales.
Last week Ms. Holtzee, who has been described as an industry gadfly for her
practice of notifying regulators about perceived wrongdoing, fired off an
e-mail to top officials at the SEC, the SIA and NASD. She raised questions
about Overstock, which is the subject of an SEC subpoena concerning its
accounting practices.
"SEC types, [it's] time to support the SIA a little, ladies and gents. We
sure as hell don't want 50 versions of Regulation SHO out there, do we?" Ms.
Holtzee wrote in her
e-mail. John Nester, spokesman at SEC, declined to comment on the Utah bill.
The new Utah law would impose a large bookkeeping burden on brokers in the
state, who already say they face a large burden from Regulation SHO, said
Mark Pugsley, shareholder of Salt Lake City law firm Ray Quinney & Nebeker
PC and a member of the SIA.
The brokerage industry does not "want a pile-on where every state decides to
pass a similar law and all of a sudden [the brokerage industry has] to
monitor trading for every company on a state-by-state basis," he said. Also,
requirements would likely differ among the states, Mr. Pugsley said. "It
would be hugely burdensome."
The SIA's letter to Mr. Huntsman expressed regret that the association
entered the legislative process late. The bill was introduced last January
and went through committee hearings and unanimous passage in the Senate
without opposition, Mr. Bramble said.
The law could "substantially and adversely impact Utah and Utah-based
companies in the future," noted Steve Judge, senior vice president of
government affairs at SIA. The law could cause brokerage firms to limit
their interaction with Utah companies, and clearing firms may not clear
trades involving Utah companies, he wrote.
There can be justifiable reasons why broker-dealers cannot deliver
securities on a settlement date, Mr. Judge said, and the legislation is
likely to cover lawful activities as well as illegal market manipulation.
"We recognize that there are those [who] are upset by the law," said
Francine Giani, executive director of Utah's Department of Commerce, which
includes the Division of Securities. However, "Naked short selling appears
to be a problem, one that I think the SEC is beginning to recognize is more
of a problem [than it thought]. Perhaps this law being moved forward will
bring the issue to the forefront."
AI
