Naked Short Selling
July 15th 2008 23:37
Back in August of 2005, I posted about "Naked Short Selling"
14 companies were called before the NY Fed. They included JPMorgan Chase & Co. (JPM), Deutsche Bank AG ( DB), Goldman Sachs Group Inc.(GS), Morgan Stanley (WMD) and Merrill Lynch & Co. (MER). Regulators were smarting over allegations that they gave super hedge funds a free pass regarding “fails to deliver” (FTD).
If you want to sell shares short and profit from a decline you think you see coming, you go to your broker and ask to borrow shares to sell. If you can't borrow the shares, you can't sell short.
If you flaunted the rules and sold shares anyway, your broker would want you to deliver shares into your account to give to the buyer. You have the buyers money, he wants his shares. Technically, there are rules for delivery, just days, and if you fail to deliver (FTD) the shares, you are supposed to be subject to a buyin. Meaning, regardless of the price of the shares, the broker buys back the shares and you have to come up with any additional money.
We found out that for their big clients, like hedge funds, the brokers were not making the buy ins. They were allowing the FTDs to pile up. In fact FTDs were such a problem that some estimated that FTDs amounted to about 1.5% of daily trading or $6 Billion daily.
The SEC passed Regulation SHO which was designed to fix the problem of FTDs, but the insane part of it was the “grandfather clause”. The SEC said all FTDs would have to be settled normally after Jan 3rd 2005, but those FTDs outstanding before Jan 3rd would not have to be settled because it might cause a short squeeze problem.
For example, open fail positions in securities that existed prior to the effective date of Regulation SHO on January 3, 2005 are not required to be closed out under Regulation SHO.
Bloomberg even did a three part video on Naked Short Selling
Why are reading about Naked Short Selling again? Because our government officials today prohibited the practice in shares of GSEs, Fannie Mae and Freddie Mac. That would mean it's still ok, wink wink, in everything else!
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