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Revision as of 15:33, 22 February 2006 by Tomstoner (talk | contribs) (taking out incomplete SEC description of naked shorting)(diff) ← Previous revision | Latest revision (diff) | Newer revision → (diff)Naked short selling, or naked shorting, is a controversial form of selling shares of securities short. Some forms of naked short-selling are legal and some are not. The controversy has surrounded naked short-selling aimed at profiting from share price declines. The U.S. Securities and Exchange Commission has issued a regulation seeking to curb naked shorting abuses.
The Practice
Short selling is the practice of borrowing stock, then selling it in hopes that the price will go down and it can be bought back at a lower price, generating profit and allowing one to return like shares for the borrowed ones.
"Naked shorting" refers to "shorting" a stock for sale without first borrowing it. . When one sells short a non-borrowed stock, one is selling something that they do not possess. The risk, that one may not be able to then acquire the shares needed to deliver on the sale, is a contributing factor to the controversy surrounding this practice.
Its Effects
Critics outside the SEC say that abusive naked short selling in order to manipulate the markets is widespread, citing the data from the SEC regarding number of shares that fail to be delivered, as an indicator and .
These claims are vigorously denied by regulators and by the Depository Trust & Clearing Corporation (DTCC). Regulators point out that the vast majority of FTDs are unrelated to abusive naked short-selling, and that shareholders are not disadvantaged when a fail occurs.
Many contend that naked short-selling has been advanced by owners of small public companies as an excuse to divert attention of price declines caused by corporate shortcomings and regulatory problems.
In it's legal brief describing the legality of naked short selling and in their description of it's new short selling rules, called REG SHO, the SEC explains that "Securities Entitlements" are created as a legal substitute for shares, when customers fail to receive their shares and that customers are not harmed by naked short selling. and . The critics of the SEC on the other hand, say that these "Securities Entitlements" are not legal, and rather represent counterfeit shares.
Controversy
Some investors defend the practice as just another tool of the market, and caution against federal regulation. Naked short-sellers claim that they are enacting market pressure against overpriced and undertraded small-cap stocks. In the bubble of the 1990s, they argue that regulations against short-selling would have caused an even greater boom and bust.
Critics contend that the naked shorting is fraud, and that it constitutes "taking a buyer's money and not delivering the product." However, the SEC denies that occurs, saying that a fail to deliver "does not mean that the customer's purchase is not completed."
In recent years, however, the SEC has acted against naked shorting in part due to pressure from a handful of small and microcap companies. This campaign has drawn criticism. Financial columnist Floyd Norris of the New York Times observed that "Investors who own shares might do better to try to understand why some think the shares are overvalued, rather than simply rail about unfair short selling."
Regulators Respond
The allegations of the anti-naked shorting movements are denied by Securities and Exchange Commission and the self-regulatory organizations(SROs) that regulate the U.S. markets.
In a forum sponsored by the North American Securities Adminatrations Association in November 2005, some regulators, including a high official of the National Assn. of Securities Dealers (NASD), denied that naked short-selling is a signficant problem.
Cameron Funkhouser, NASD's senior vice president of market regulations, told the forum that NASD had found no evidence of widespread naked short selling. He decried "this fear mongering that there's this rampant naked shorting that's gone unregulated."
Funkhouser also noted that although a number of companies have in the past alleged their shares have been manipulated through the listing of their stocks on the Berlin stock exchange, he had found no evidence of naked short selling there. "We took (these allegations) very seriously," Funkhouser said. "We have seen not one instance of naked short selling or any abusive short activity" at that exchange.
At the NASAA Forum, the head of the Connecticut Securities Agency and current head of the NASAA, Ralph Lambiase, delcared his disapointmen in how the industry was handling this issue as a whole.