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Naked Short Selling

In an announcement from the Securities and Exchange Commission on July 27, federal regulators confirmed that a permanent rule regarding "naked" short-selling was finalized. Implemented last year at the height of the financial market's crisis, the rule was put into place to curtail abusive short-selling. The rule was set to expire on July 31.

Short-selling is a practice within the markets wherein investors are betting against a stock. A trader borrows a company's shares, sells them, and then later buys them back when the stock's price drops and returns them to the lender. It is here that the trader pockets the difference between the sale price and the purchase price.

As for the term "naked" short-selling, it occurs when a seller does not borrow any shares before selling them and then later looks to cover the position following the sale.

SEC Chairman Mary Schapiro responded to the actions, "Today's actions demonstrate the commission's determination to address short-selling abuses while at the same time increasing public disclosure of short-selling activities that affect our markets."

It was the House Financial Services Committee, chaired by Barney Frank, who pressured the SEC into restricting short-selling after the S&P 500 index plunged more than 38% in 2008.

The SEC has also been considering additional approaches to help curtail an influx in regular short-selling, which in many cases, also leads to drastic declines in the price of stocks. The government agency will hold public hearing on September 30 to discuss stock lending practices related to short-selling and potential new disclosures related to these practices.

"Instead of proposing action today to deal with the problem, the SEC apparently is content to let potential solutions sit on the shelf for another two months," commented Sen. Ted Kaufman (D-Del). "...If the markets were to decline precipitously again and the banks propped up by taxpayer funds were to become vulnerable again, that is not an insignificant risk."

The five SEC commissioners voted back in April to discuss and possibly implement five alternative short-selling plans. One option was the so-called uptick rule, which prevents massive selling sprees that build upon themselves. Looking back, it was those particular actions that helped propel the dramatic losses in the banking industry and financial sector as a whole.

The uptick rule prohibits short sellers from making their trades until a stock ticks at least $0.01 above its previous trading price.

The SEC also revealed that they were in the process of collaborating with the nation's stock exchanges in an effort to make data related to short-selling available through that particular exchange's website.

Elsewhere, France's stock market regulators prolonged their governing measures on short-selling insurance and financial stock until the end of January 2010. The Autorite des Marches Financiers (AMF) in Paris finalized their decision the same day the SEC maintained their short-selling rules, while also supporting the conclusion of the Committee of European Securities Regulators (CESR) to implement new rules forcing hedge funds to report short selling to regulators.

"While welcoming the proposals by CESR of July 8 to create more transparency on short selling, the college wishes to wait for the results of the consultation before deciding what measures to take in France," confirmed a representative from the AMF.

Under France's trading rules, anyone holding 0.25% in one of the fifteen financial companies must report the position to the AMF. Within the CESR's program, short sales of 0.1% of any company's outstanding share capital would then be reported to national regulators for further examination.

Meanwhile, in Japan, the Financial Services Agency will continue their restriction on naked short-selling until October 31 of this year. The agency will now also require investors to disclose short-selling position of more than 0.25% of the total outstanding shares of the stock. Last year, the Nikkei 225 Stock Exchange plummeted more than 42% as credit markets collapsed throughout the world.

- by BetterTrades Financial Analysts