Back in what now seem to be the long-ago days of 2003 through 2007, when the economy seemed to be healthy and stocks were expected to rise as a matter of course, so-called naked short-selling was a subject of great interest to more than a few companies and politicians. The Securities and Exchange Commission responded with a new rule that was supposed to curb the practice.
This week the S.E.C. settled a case against a former options market maker for violating those rules in 2006 and 2007. The trader, Gary S. Bell, will pay $2.1 million to settle the allegations. Most of that is in the form of disgorging illegal profits, which shows, if nothing else, that finding a way around the rule was profitable.
To economists, restrictions on short-selling often seem to be foolish and costly impediments to efficient markets. To companies, and their executives, any short-selling — whether legal or not — can seem pernicious. That is particularly true when market stresses are at their greatest. It can become an article of faith that short-sellers are spreading false rumors aimed at destroying a company.
A short-seller sells shares in a company that he does not own, hoping to repurchase them later at a lower price. Normally, a short-seller borrows the shares from someone who does own them, but when a stock seems especially overvalued such borrowing can become very expensive, if not impossible. Selling a stock that has not been borrowed is called naked shorting. Of course, the shares will not be delivered when the trade settles — that is called a failure to deliver — but the seller still stands to profit if the shares fall in price, and to lose money if they rise.
These days, it is not only the naked shorts that arouse ire. Governments in Europe have imposed bans on selling financial stocks short since the August market turmoil. Those bans have not kept financial stocks from being the worst-performing stocks on the Continent, but of course there is no way to know what would have happened without the ban.
It may or may not be relevant to note that financial shares in the United States, where the S.E.C. has resisted pressures to impose a comparable ban, have done better than their European brethren. But returns have been volatile here too, raising questions about whether shorts deserve blame for manipulating markets.
Historically, short-sellers have tended to be right a surprising amount of the time, at least in cases where the company grew upset enough to publicly complain. In 2004, a Yale professor, Owen Lamont, published a study of 266 companies that had publicly complained about short-selling during the quarter-century ending in 2002. Because some companies grew angry more than once, he studied a total of 327 share-price movements. On average, stocks underperformed the market by about 25 percentage points over the following year after they began to campaign against short-sellers.
Mr. Lamont conceded that such data did not prove the companies had been overvalued. An alternative explanation, favored by company managements, he wrote, “is that short-sellers are actually manipulating prices, driving prices down over long periods of time.”
But he noted that a significant number of the companies turned out to be frauds. “The evidence suggests that short-sellers play an important role in detecting not just overpricing, but fraud,” he wrote. “Policy makers might want to consider making the institutional and legal environment less hostile to short-sellers.”
The data Mr. Lamont used is now, of course, rather old. The S.E.C.’s rule to prevent naked short-selling dates from 2004, and was strengthened in 2008. Is there any evidence that those who violated the rule had similarly identified overpriced stocks?
The Bell case is at least the fourth one filed by the S.E.C. that claims violations of Regulation SHO by options market makers, but only the second one I could find that named actual stocks that were illegally shorted, the other being a 2009 case against traders who operated firms with the delightful names of Rhino Trading and Fat Squirrel Trading. All the cases concerned trading that took place before the rule was strengthened.
Perhaps significantly, many of the stocks that the S.E.C. said were illegally shorted appear never to have shown up on the Regulation SHO lists of stocks that are published by markets. Those lists show stocks in which there have been a large number of failures to deliver shares. Such fails can indicate naked shorting, although they also can result from back-office problems. The fact that there were violations in other stocks could mean violations were more widespread than those lists seemed to indicate.
Article source: http://feeds.nytimes.com/click.phdo?i=b7c43929d5bd82d2e3b891b5eafe0183
Speak Your Mind
You must be logged in to post a comment.