Short Sellers Got No Reason to Live?

Everyone hates a know-it-all, which may be why the world is ganging up on short sellers right now.

By definition, people who were shorting companies that subsequently crashed were totally right. To dramatically oversimplify: Short sellers are broadcasting signals to the market that the companies they're shorting suck. When they're right and big companies come tumbling down, you'd think everyone would rally 'round and ask, "How did you know? Tell us your secret?" Instead, we blame them for the financial troubles of the less prescient:

Short sellers—not management—defended honesty in the pricing of shares by demanding accountability. Short sellers openly warned about the problems at Enron, Tyco, Fannie Mae and Freddie Mac before their meltdowns. And when it comes to investigating corporate fraud, it's the short sellers who are the detectives, while all too often our regulators practice archaeology.

In fact, in times of financial crisis, short selling has gotten the short end of the stick pretty frequently:

Short selling has been misunderstood and maligned throughout history. In the 1630s, England banned short selling after tulipmania collapsed in the Netherlands to prevent a similar fallout in England. More recently in Malaysia and Pakistan, short sellers have been faulted for stock-market busts.

Right a wrong—go find someone who sold Fannie and Freddie short and give him a hug.

Comments

[brotherben]

ALL HAIL MR. MEISNER!

[cadaver dog]

If Jack and Harry were walking down the street right next to one another, and Harry was shot by a sniper perched on a nearby building, a caveman on the street would think Jack killed him.

That's exactly what we're seeing here: people who don't understand what's really happening assume that proximity equals guilt. Shorters were selling stocks, and the stock markets went down, therefore they must be guilty.

[Episiarch]

go find someone who sold Fannie and Freddie short and give him a hug

I wish I could be hugging myself right now.

What, no link to the Newman video?

[brotherben]

WTF was I talking about?

[EJM]

...the world is ganging up on short sellers right now.

According to a new Bloomberg story, "Germany, France, the Netherlands, Belgium, Australia and Taiwan joined the U.S. and the U.K. to widen a global crackdown on short selling."

(Australia's move apparently involves a total ban on short-selling, which Motley Fool's Morgan Housel calls "one of the most excessive market-intruding actions a free-market economy has seen in recent memory".)

[dunphy]

I trade primarily futures (with stocks, I do more longterm stuff), and I'm happy to report there is still free access to short futures. I use the dow futures mostly (YMZ8)

This won't affect the futes, except to the extent that their underlyings will move differently. Short AWAY!

Although there are some good long values here as well.

[Dagny T.]

I wish I could be hugging myself right now.

No worries. This is just the next stop on the road to full blown insanity, and I hear the Bellevue has very comfy straitjackets.

[That Dude]

It's a little more complicated. Serious people have little problem with long term thoughtful shorts. In times of crisis (i.e. now) very short term shorts can exacerbate downward moves. If a stock gets pounded 50%today because every day trader is shorting it, then large money funds might lose confidence and not roll over, say, a 100 million short term notes coming due.... bankruptcy. Theoretically you shouldn't close the stock market because it's going down but the NYSE has circuit breakers in that stops trading to let everyone cool down for a minute. Why isn't this as much of an affront to financial decency?

[bill]

The problem was NAKED short selling. That is, the ones shorting, sold the stock without actually "borrowing" it first as they are supposed to do. Basically people were selling stock they didn't own. This allows the shorters to artificially manipulate the price to cause it to go even lower.

[Mo]

bill is 100% correct here. The only thing worse than people that don't understand shorts demonizing short sellers are people that don't understand what's going on praising short sellers and looking like fools.

Stop naked short selling, bring back the uptick rule and most of the problems will be fixed.

[J sub D]

I am a dull and simple lad.

But my totally uneducated, simple to a fault understanding of selling short is -

I believe this stock is overvalued and I'll bet my own goddam money that it is.

You financial geniuses can correct me or amplify my definition as necessary.

[Episiarch]

This is just the next stop on the road to full blown insanity, and I hear the Bellevue has very comfy straitjackets

Thorazine "straightjackets" are the most comfortable of all.

Fun note: Bellevue has its own little park with the creepiest fucking animal sculptures. When I first saw it, I was blown away that someone had the balls to do that at a mental hospital.

[Gilbert Martin]

"The problem was NAKED short selling."

Yes that indeed contributes to the problem.

There are multiple regulatory changes that have been made related to short selling.

First the uptick rule was elimnated by the SEC that only allowed short sales on an uptick in the stock price. This has made it easier for momentum oriented short sellers to manipulate stock prices by piling on and driving them down.

Second was the crack down on naked short selling. Naked short sellers do not borrow the stock they are selling short and therefore they are essentially creating new shares of stock out of thin air and diluting the stock ownership of everyone else. Cracking down on this is a good thing.

Third was the outright prohibition of short selling in a specific set of financial companies. That one should not have been done.

Also, the uptick rule should not have been eliminated.

[Warren]

I bet those greedy short sellers that are driving down stock prices, are the same greedy speculators driving up oil prices. The bastards.

[qingl78]

Bill,

I come from the land of naked shorts.

Naked shorting only works if you expect the shares to never get off the mat otherwise you will have to make good on them at some point.

Even now, it isn't really naked shorting but people "kite" shares which is on the verge of legal.

I have to re-iterate. You can't kill a healthy company by shorting naked or otherwise.

Complaints about naked shorting are just "crybaby captialism".

[Mad Max]

"More recently in Malaysia and Pakistan, short sellers have been faulted for stock-market busts."

When I saw that sentence beginning with Malaysia and Pakistan and short-sellers, I thought it would end with something about stonings or beheadings. I apologize to these wonderful countries for daring to stereotype them.

[creech]

And "longs" have been faulted for creating bubbles. The obvious solution is for Congress to appoint a market czar who will, in all his or her wisdom, set the daily price for every stock, commodity, bond, etc. etc. that will be permitted to trade that day. Time to slap the invisible hand and put Eliot Spitzer or Andrew Cuomo in charge.

[Gibert Martin]

"I have to re-iterate. You can't kill a healthy company by shorting naked or otherwise."

Whether naked shorting kills "healthy" company or not isn't the relevant criteria for whether it should be allowed. It is akin to counterfiting money. It is creating something that doesn't legitimately exist.

[qingl78]

If I have a healthy company and someone is shorting me (naked or otherwise) it only effects how I can raise money from share issuance.

This doesn't limit me in my sales or the running of my business if I have a good product. I still sell widgets based on how good my widgets are.

If I am a healthy company and I can prove it then I can start buying back my shares if I am being shorted (either through cash reserves which healthy companies have or through short term loans).

Shorting does affects me if I have to issue shares to pay my employees or rent.

Last message today. Have to work.

[That Dude]

"You can't kill a healthy company by shorting naked or otherwise."

Probably not. But I think you can kill a somewhat troubled company that otherwise might be able to weather the storm and return to succesful, healthy operation.

Maybe it's not very libertarian but I understand the impulse of the gummint to try to make sure companies that fit that description survive.

[Mo]

I have to re-iterate. You can't kill a healthy company by shorting naked or otherwise.

Yeah, but you can temporarily drive the stock price to the ground, completely unrelated to actual company performance, with naked short selling by flooding trading books with short sells. Especially without the uptick rule. By forcing short sellers to actually own the stock, you limit the number of shorts to shares outstanding and give the owners of the shares a say in the value.

Naked short sellers are like house flippers that never own the homes they flip.

[Mo]

Maybe it's not very libertarian but I understand the impulse of the gummint to try to make sure companies that fit that description survive.

I don't see anything unlibertarian about having a rule that you have to own/borrow what you sell.

[qingl78]

Gilbert,

Sorry but I couldn't let this go:

It is akin to counterfiting money. It is creating something that doesn't legitimately exist.

You could say this about the stock market in general. There are literally thousands of OTCBB companies that issue stock without any or any significant assets.

This is the law of the jungle out here. The market isn't for the faint of heart.

I get the feeling like I am Blade telling that woman that the world you live in is just a sugar coating on the real world and you had best toughen up if you want to survive.

Gots to go.

[Fluffy]

The discussion we're having about the merits of short selling makes less sense in the context of the trading of financial stocks in a fiat-currency economy.

In such an economy, "confidence" is a critical ingredient of the solvency of financial institutions.

If a declining share price saps the market of its magical "confidence", financial institutions run into difficulties because counterparties stop doing business with it, leading in short order to "runs" on the affected institutions.

[SugarFree]

It's little unfair to your readership to combine that headline with that image and it not be a story about where you can buy a midget.

Shame on you, Reason! Journalistic fraud, I say!

[Dagny T.]

When I first saw it, I was blown away that someone had the balls to do that at a mental hospital.

Maybe it was outsider art by one of the patients.

Thorazine "straightjackets" are the most comfortable of all.

You have much knowledge of antipsychotics. Helpful in an election year, kind of disturbing any other time.

[Episiarch]

Maybe it was outsider art by one of the patients.

Maybe. I tried to find a picture but failed. However, if you are ever going up 1st Ave. (especially on the bus), make sure you look at the North side of the hospital as you pass. Creepy, creepy, creepy.

Helpful in an election year, kind of disturbing any other time

Helpful at all times! It's a crazy world out there. You never know when someone is going to give you a gorilla mask.

[ChrisH]

1) I may be another starry-eyed free-market fanboy here, but my understanding is that shorting HELPS during a panicked market. If the market only had people in it for the long haul, once it really starts down, you either join the panic -- to get out while you can -- or sit it out until it's hit bottom.

People who are in the process of shorting have an incentive to come in and buy, because they are already making a profit, and because they're panicked in the other direction -- "I gotta unload this thing before it starts back UP!".

This slows a collapse, or at the very least provides liquidity on the way down.

2) I'm too lazy + distracted-trying-to-look-like-I'm-working to look it up, but among the many recent HnR posts was one that addresses the "uptick" rule (regarding McCain babbling into his drool cup in the guise of economic musing). Survey says: it does nothing. Therefore, as long as it is completely irrelevant to solving the problem, if we need reassurance, let's all believe that as long as the Large Hadron Collider is up and running, it is protecting us from the negative effects of downtick-short-selling, because the LHC is waaaay cooler than the SEC.

3) By and large, ditto naked short selling. It sounds slightly nuts to me that you pretend you have something, sell it, buy it back and make money in this process, but the evidence is that this doesn't effect things any differently than... clothed(?) shorting.

4) re the sniper and the caveman: after all those Geico commercials, I kind of feel bad whenever a caveman is used as an example of an ignorant person who can't figure things out.

And if you don't think there are cavemen lurking on HnR...

[Marcvs]

This is the law of the jungle out here. The market isn't for the faint of heart.

You are delusional if you think that the market operates under "the law of the jungle." The entire thing is so distorted by regulations that it is incredibly far from a free market. For instance, if you had to be tough to survive, how come we are seeing a $1 trillion dollar bail out? Spare me your tough guy talk.

[Mo]

qingl,
There's a huge difference between a company issuing stock and two guys with a Bloomberg station. One is by law and ownership standards allowed to do it. Their shareholders can vote them out for diluting their shares. The other group is literally unaccountable to actual shareholders (those that borrow shares can have those shares called at any time by the owner) and diluting the shares.

I liked the analogy someone put up last week. If I got together with the URKOBOLD crew and posted hundreds of sales of the Honus Wagner card on eBay, without owning it. We'd destroy the value of a legitimate product. Naked short sellers are the same way. If you want to gamble, go to Vegas.

Note: I have no problem with real short sellers, just guys like qingl. To call them the lampreys of the financial system would be an insult to lampreys.

[Mo]

ChrisH,

What's your evidence that both the uptick rule and naked short selling do nothing?

[Paul]

Right a wrong-go find someone who sold Fannie and Freddie short and give him a hug.

I don't wanna give him a hug, I want to learn at his hem.

[Dagny T.]

if you are ever going up 1st Ave

I know! The first time I was in New York we were on our way up to Koreatown & forgot what we were approaching. Super creepy.

You never know when someone is going to give you a gorilla mask.

I stupidly missed the first episodes! 🙁 I need to find them somewhere online.

[Gilbert Martin]

"You could say this about the stock market in general. There are literally thousands of OTCBB companies that issue stock without any or any significant assets. "

You COULD say that - but you would be wrong.

There are indeed many worthless stocks out there with no real assets to back them up.

It is incumbent on investors to do due diligence on what they are investing in to determine if the shares have anything to back them up or not.

But that is not at all a valid analogy to naked shorting where some party unrelated to the company itself is essentially creating additional shares of stock out of thin air that dilutes the ownership of everyone else who legitimately owns stock in the compnny.

[Sam Grove]

Maybe it's not very libertarian but I understand the impulse of the gummint to try to make sure companies that fit that description survive.
A government with that power also can kill start ups with an announcement of an impending investigation. Such as the Tucker auto company.

[Paul]

You know, I've heard a lot of technical stuff about short selling, why it's good, why it's bad, but I've heard no one, including people who are for short-selling (as am I) discuss how dangerous short-selling is...for the short seller.

To hear short-sellers maligned, you'd think they were simply printing money by using Malaysian slave labor. As if short-selling were some sort of shortcut to easy profits on the backs of the unfortunate.

Not so. Short selling is an incredibly dangerous and risky move. In essence (and correct me if I'm wrong) your potential losses are open ended. If I buy a stock at X price long, all I can do is lose my entire investment. But if I by a position at X price short, how high can the stock go? Open ended

[perilisk]

"That's exactly what we're seeing here: people who don't understand what's really happening assume that proximity equals guilt. Shorters were selling stocks, and the stock markets went down, therefore they must be guilty."

It's like Wile E. Coyote blaming looking down for his gravity-related problems, instead of blaming walking off the edge of the cliff.

[Episiarch]

I stupidly missed the first episodes! 🙁 I need to find them somewhere online.

They should repeat them on FX. Just be patient 😉

[ChrisH]

Mo | September 22, 2008, 1:16pm | #
ChrisH,
What's your evidence that both the uptick rule and naked short selling do nothing?

OK, I think you missed something. I said "I'm too lazy + distracted-trying-to-look-like-I'm-working to look it up, but among the many recent HnR posts was one that addresses the 'uptick' rule (regarding McCain babbling into his drool cup in the guise of economic musing). Survey says: it does nothing."

By this, I meant to say that I am lazy. I am busy. There have been many posts on HnR recently regarding the mortgage bailouts. One of these talked about the uptick rule. To narrow that down for you a little bit, it was one about McCain speaking about it on the campaign trail. It (the post) described in some detail the history of the SEC's research on the issue of the uptick rule, which showed that it had no effect.

Now, when you ask "what is your evidence", I am confused, 'cause I think I said where my evidence was.

I have an unfortunate tendency to rise to the challenge, so I started looking back through old posts, and couldn't find it. And I used the Search function on HnR. I couldn't find it.

And that was the point when I realized that if you didn't care enough to dig it up in HnR, I didn't care enough to dig it up for you.

But, the Truth is out there...

[Paul]

From Wiki:

Reporting by major media outlets has been mixed. While concern expressed by the regulator has been echoed by journalists, some commentators contend that naked short selling is not harmful and that its prevalence has been exaggerated by corporate officials seeking to blame external forces for their own shortcomings

http://en.wikipedia.org/wiki/Naked_short_selling#cite_note-nudists-15

Referenced from:

http://online.wsj.com/article/SB114480254610823574.html

Naked short selling is explicitly permitted for brokers who serve as "market makers" and stand ready to meet demand for a stock even when they have none in inventory. Do these brokers extend this favor to trading clients who want to sell short? Possibly. But this is more like an acceptable kludge, helping the market work better, than a cesspot of corruption liable to bring down the financial system.

After spending far too long in the corporate world, I'm leaning towards the theory that executives are seeking to blame external forces for their shortcomings.

[Mo]

ChrisH,
I was in that thread. The only evidence provided in that thread was that someone said the SEC said that naked short sells weren't a problem a few months ago. Of course, the SEC also said that Fannie and Freddie were solvent a few months ago.

Not so. Short selling is an incredibly dangerous and risky move. In essence (and correct me if I'm wrong) your potential losses are open ended. If I buy a stock at X price long, all I can do is lose my entire investment. But if I by a position at X price short, how high can the stock go? Open ended

Only if you're too dumb to buy a call to limit your downside.

[fyodor]

I don't see anything unlibertarian about having a rule that you have to own/borrow what you sell.

It's unlibertarian if it gets in the way of willing buyers who are not substantively misled about the nature of the purchase, and if the seller has a right to what he's selling.

Whether it does that or not, and whether it's a good thing regardless, I don't claim to know, but I believe that's the standard to determine if it's "libertarian" or not, FWIW.

[Paul]

Only if you're too dumb to buy a call to limit your downside.

Do short sellers routinely do this? I figure I would if I were a short seller. But for instance, there's controversy over whether stop-losses are a good idea for long positions. I'm a big fan of stop losses, but some traders don't like them.

[bill]

@ChrisH

Maybe you haven't heard. The LHC is broken. LOL.

[P Brooks]

exaggerated by corporate officials seeking to blame external forces for their own shortcomings

See Byrne, Patrick.

And short selling *is* very risky, which is why the people who do it had better know their shit. If the price of a fundamentally sound company falls, for any reason, bargain hunters will buy. If you're short, you'll be sorry.

[P Brooks]

oops.

[Jennifer]

I'm not sure I understand the implications of this, so somebody please correct me if I'm wrong here: if I own a bunch of stock in a certain company, and it's officially worth $40 a share according to the various "check your stock value" newspapers and websites, it is now going to be illegal for me to sell the stock for less than $40?

That can't be right. Can it? What am I missing here?

[kinnath]

What am I missing here?

You check the current price AMCE Fish Nets Inc. and see that's it trading at 40 bucks (which you think is too high).

So you wander down to your favorite broker and borrow 1,000 shares, then turn around and sell them at 40 bucks a piece.

You now wait a week and buy a 1,000 shares at 32 bucks a piece and return the stocks you borrowed from the broker.

You pocket 1,000 times 8 bucks in profit.

Of course if the stock goes up to 50 bucks in a week you lose 1,000 times 10 bucks.

[Jennifer]

Okay, so I can still sell my own stock for less than the market price, but I essentially can't go into the "stock futures" market with the assumption that prices will drop? This still doesn't make a damned bit of sense.

[Brian24]

I don't think the Honus Wagner card example is really a good one, because it's a very, very limited commodity.

How's this for a comparison: say I come to you and say I will sell you 100 bananas at $.50 per banana. You agree and give me $50. Later that day I go down to the grocery and, lo and behold, banana prices have gone down to $.45. I buy the bananas for $45, deliver them to you, and pocket the extra $5.

Now explain to me why it matters whether I had actually borrowed the bananas from the store first, or just waited to later to get them.

[kinnath]

This still doesn't make a damned bit of sense.

An attempt to prevent manipulation of the market (where the medicine is worse than the disease).

Fraud #1) Borrow shit loads of money to buy stock. Release "information" into the market to pump up the price of the stock. Dump the stock at a huge profit. All the other suckers get screwed. {a couple of teens got caught using the internet to pump & dump a couple of years ago}

That's so last year 😉

Fraud #2) Borrow shit loads of stock. Release "information" into the market to dump the price of the stock (that information includes the fact that your selling short -- so it's a self-fulfilling prophesy). Sell it now, buy it back later. Pocket the profit.

If you're really good, you can destroy a company. {at least that's the "rationale" for the current ban on short-selling}

[kinnath]

How's this for a comparison: say I come to you and say I will sell you 100 bananas at $.50 per banana. You agree and give me $50. Later that day I go down to the grocery and, lo and behold, banana prices have gone down to $.45. I buy the bananas for $45, deliver them to you, and pocket the extra $5.

You sold a future delivery of bannanas.

Now explain to me why it matters whether I had actually borrowed the bananas from the store first, or just waited to later to get them.

To sell-short you have to deliver the bannanas at the time I give you the 50 bucks. So you have to go the store first, get the bannanas on credit, sell them to me now, then pay the store later.

[Brian24]

To sell-short you have to deliver the bannanas at the time I give you the 50 bucks.

Not correct. Obviously, in a naked short sale I don't even have possession of the bananas, so I could not possibly provide them at the time of the sale.

[Paul]

Not correct. Obviously, in a naked short sale I don't even have possession of the bananas, so I could not possibly provide them at the time of the sale.

And if the bananas are all sold out or unavailable, they get recorded as a "failed to deliver"

I'm doing some unscientific googling and generally, most opinion are that banning shortselling is just plain stupid.

[kinnath]

Not correct. Obviously, in a naked short sale I don't even have possession of the bananas, so I could not possibly provide them at the time of the sale.

I would agree that a naked short sell is functionally equivalent to selling futures; however, I doubt that they are legally equivalent.

[Paul]

Oh, I've been googling and can't find anything definitive, but can anyone provide a comprehensive link or even list a number of solid, financially sound companies which were destroyed by short-selling?

[ChrisH]

Mo | September 22, 2008, 1:55pm | #
ChrisH,
I was in that thread...

Can you give me the link to it?!?

Geez, does anyone else have the problem of HnR posts just disappearing? If I've just started a hallucinatory episode, I was hoping it would be a lot more interesting than this.

Anyway, best I can "recall" (since I apparently now have memories that don't appear to anyone else in the universe): It was about McCain saying he would fire Christopher Cox. One of McCain's major tizzies was ending the uptick rule. The post went on to describe that the SEC had studied this extensively, by which I mean done statistical analysis of past trading. This showed the uptick rule had no effect. Apparently, like the Large Hadron Collider.

Now, I'm happy to snark along with how the SEC (or [insert gov't agency of your choice]) doesn't know anything, or what they know is wrong. But this was a case of doing statistical anaylsis of historical data, so I tend to believe they can at least do that right.

I think we may still be talking about different posts, though, because the one I'm thinking of didn't say much about the naked short rule. I've read something somewhere (I seem to "recall") about that in the last week, that it doesn't effect things differently than other short selling. And, I believed it because I'm naive about the free market that way.

[Paul]

I would agree that a naked short sell is functionally equivalent to selling futures; however, I doubt that they are legally equivalent.

You're probably correct. However, I would point out that all stock market activity are "futures" transactions. Some are just much more complex than others.

[andy]

wikipedia references to naked short selling are worthless... just ask judd bagley of overstock:

http://antisocialmedia.net/?p=28

the glut of unsettled daily transactions (failure to delivers) is not an overstated risk... it's a $3 billion a day problem. for those who say, "well, they have to deliver the stock at some point so it can't work like you say - they'll get burned at some point." just like refinancing, when you naked short and the stock doesn't crumble like you planned, you borrow more phantom shares from a different party and sell them back to the party you originally borrowed from. this process can continue ad nauseum until the stock is finally destroyed via share inflation and the profit can be raked in.

http://www.deepcapture.com/they-cant-say-he-didnt-warn-them/

http://www.bloomberg.com/avp/avp.htm?clipSRC=mms://media2.bloomberg.com/cache/vIrfhgQPAJ1s.asf

there is nothing libertarian in promoting naked shorting; it's fraud, plain and simple. it completely violates underlying tenements of libertarianism and social contracts. to say that you're not libertarian for wanting to prosecute fraud (i.e. naked shorting) is to paint libertarians as a group with no moral compass or concern with justice.

[Mo]

ChrisH

Heir. There was no link to a study, just an assertion.

The big difference between naked and regular shorting is the cost to borrow the shares. If I borrow money, I expect to pay interest on it. Same goes for borrowed stock. As the short interest rises, the demand for borrowed stock relative to the demand also goes up, making it more expensive to borrow. Naked short sells take out these market indications. It also takes away a big penalty for people manipulating and flooding trading books.

[Paul]

No, no links to any sound, financially secure companies destroyed by short selling?

[andy]

thar be a list, paul!

http://www.nasdaqtrader.com/Trader.aspx?id=RegSHOThreshold

perhaps you've seen the reg sho list? it has such disreputable companies as zion bancorp and panera bread company!

sure, banks with a lot of mortgages on the books (such as a zion, which is a holding company for a few banks) and higher-end chain coffee shoppes are going to be struggling in the economy in general right now. that doesn't mean that they should be completely brought down by naked shorting, but it does mean that people are more likely to believe that these companies crumbled as a result of their own mismanagement and not as a result of naked shorting. the sec even recognizes it as an issue that exists (source: http://www.sec.gov/divisions/marketreg/mrfaqregsho1204.htm):

"Regulation SHO provides a new regulatory framework governing short selling of securities. Regulation SHO is designed, in part, to fulfill several objectives, including (1) establish uniform locate and delivery requirements in order to address problems associated with failures to deliver, including potentially abusive "naked" short selling (i.e., selling short without having borrowed the securities to make delivery) ..."

"... (Rule 203) also imposes additional requirements on broker-dealers for securities in which a substantial amount of failures to deliver have occurred."

the fun part about these rules, if you read on, is that there's really no threat of enforcement or punitive action. then there's a waffling on the sec's part about whether or not naked shorting creates "counterfeit" shares:

"Question 7.1: Do naked short sale transactions create "counterfeit shares?"

Some believe that naked short sale transactions cause the number of shares trading to exceed the number of shares outstanding, which in turn allows broker-dealers to trade shares that don't exist. Others believe that the U.S. clearance and settlement system, and specifically the National Securities Clearing Corporation's ("NSCC") Continuous Net Settlement System ("CNS"), produces "phantom" or "counterfeit" securities by accounting for fails to deliver.

Naked short selling has no effect on an issuer's total shares outstanding."

that last statement is a tautology if you think about it since naked shorting only has an effect on people's perception of total shares outstanding. we all know that more than 100% of anything can't really exist, but that doesn't mean that it can't be perceived by the market when they see trading volume spike. they go on to recognize that, yes, there can be more shares in float and trading volume than exist in the market:

"There is significant confusion relating to the fact that the aggregate number of positions reflected in customer accounts at broker-dealers may in fact be greater than the number of securities issued and outstanding. This is due in part to the fact that securities intermediaries, such as broker-dealers and banks, credit customer accounts prior to delivery of the securities."

eager to hear your points.

[Paul]

perhaps you've seen the reg sho list? it has such disreputable companies as zion bancorp and panera bread company!

I think you misunderstood my post as a snark. First, I never meant to suggest that only "disreputable" companies. I merely wanted to know which perfectly sound, stable companies were taken down in the 'dark of night' -- if you will -- by short selling.

eager to hear your points.

This is a long, complicated list. I'm thinking that if each one were studied carefully, we'd find that there was more to the story. I'm also a little confused. Panera bread company is still in business? What's your definition of 'destroyed'?

[Paul]

Ok, I've been looking at this list. I'm double confused. I understand that this is a list of companies which met the securities threshhold level for SHO rule. Fine.

As defined in Rule 203(c)(6) of Regulation SHO, a "threshold security" is any equity security of any issuer that is registered under Section 12 of the Exchange Act, or that is required to file reports under Section 15(d) of the Exchange Act (commonly referred to as reporting securities), where, for five consecutive settlement days:

There are aggregate fails to deliver at a registered clearing agency of 10,000 shares or more per security;

The level of fails is equal to at least one-half of one percent of the issuer's total shares outstanding; and

The security is included on a list published by a self-regulatory organization (SRO).

A random sampling of these companies shows they're all still in business.

Panera
Canadian Solar, Inc.
POOL Corporation

I was expecting something like, oh *IndyMac-- you know, a company whose doors were shuttered, supposedly due to short selling.

*Opinion is divided on why IndyMac failed. Megan McArdle says it was. IndyMac employees say Charles Schumer destroyed it. And financial analysts say it wasn't a sound operation.