The Wheels Turn So awfully Slowly.But They are moving
SEC Weighs Tougher Stance
On Naked Short-Selling
By KARA SCANNELL
July 12, 2006; Page C3
The Securities and Exchange Commission, responding to criticism that it hasn't done enough to curb naked short-selling, is expected to propose changes to a current rule that would reduce the number of open short positions in stocks.
The proposed amendments to Regulation SHO, a collection of rules on short-selling, come amid heightened attention to the legitimate trading practice of making bearish bets on firms. Short-selling is when a trader borrows shares then sells them with the hope the stock drops, so he can buy it back later at a lower price, locking in a profit. More controversial is naked short-selling, which is when a trader never intends to borrow shares to cover his position. Naked short-selling is illegal in most instances, except when done by a market-maker to maintain liquidity in a stock.
The SEC adopted Reg SHO, in part, to reduce naked short-selling. Since it took effect in January 2005, the number of companies that have open short positions has dropped by some estimates as much as 20%, although critics have said that is insufficient.
Recently, allegations of naked short-selling and manipulative trading have caught the attention of Capitol Hill, where two senators called for stepped-up scrutiny by the Justice Department. Some corporate chiefs have engaged in a public-relations war, railing against short-sellers that have targeted their stock, and the SEC has launched at least one investigation into potential market manipulation involving short-sellers.
Reg SHO requires brokers to locate a security to later borrow to cover the short position. It also established threshold lists of stocks that meet certain conditions, such as more than half of 1% of its shares outstanding haven't been delivered to the counterparty on the date they were due for five consecutive business days. Once a security is on a threshold list, a broker with new short positions needs to close out any failed trades within 13 business days. The idea is to reduce outstanding shorts on those stocks.
The SEC included a grandfather provision that exempted delivery failures that existed before a company became a threshold security, meaning open failed positions that existed before a company made the list remain. At the time, the SEC said it did so out of concern it might create volatility through a short squeeze.
Today at an open meeting, the SEC is expected to vote to amend Reg SHO and eliminate the grandfather clause, which could benefit heavily shorted companies. Eliminating the grandfather clause would force brokers to buy in some positions on threshold-listed securities that were made before the companies made the list. The SEC is also weighing whether to change a provision that allows market makers to have naked short positions. If the changes to the rule are voted, as expected, they will go out for public comment for at least 30 days.
Write to Kara Scannell at kara.scannell@wsj.com
