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Post by Franko10 ™ on Mar 26, 2005 11:02:12 GMT -5
The Naked Truth on Illegal Shorting
By Karl Thiel
March 24, 2005
It's amazing how the word "naked" can liven up a discussion. Take naked short selling, for instance. The addition of this saucy little word turns the mundane act of borrowing and selling shares of stock in hopes of buying them back later at a lower price into a raging controversy fraught with conspiracy, secret identities, public recriminations, foreign intrigue, sports team owners, and now some of the top regulators in the land.
How can one word cause so much trouble? While legal short sellers must borrow the shares they sell, naked short sellers sell shares of stock they haven't borrowed, have no intention of borrowing, and that may not even exist. Not surprisingly, this activity is illegal and has been since the Securities and Exchange Act of 1934. But for a number of reasons, regulators have overlooked it in the past.
In response to a rising tide of complaints, however, the SEC recently introduced Regulation SHO, which went into effect Jan. 3. The idea was to put a stop to, or at least help control, abusive short selling practices. Unfortunately, the result of the SEC's effort so far has arguably been to turn rampant abuse into a spectator sport by simply providing a list of stocks being most abused… and doing little else.
Intrigue in the sock drawer
How bad is the problem? Listen to this story: On Feb. 3, a man named Robert Simpson filed a Schedule 13-D with the SEC describing his purchase of 1,158,209 shares of Global Links Corp. (OTCBB: GLKCE), "constituting 100 percent of the issued and outstanding common stock of the Issuer." As described in a story that ran on FinancialWire on March 4, Simpson stuck every single share of the company in his sock drawer -- and then watched as 60 million shares traded hands over the next two days.
In other words, every single outstanding share of the company somehow changed hands nearly 60 times in the course of two days, despite the fact that the company's entire float was located in Simpson's sock drawer. In fact, even as recently as last Friday, 930,872 shares of Global Links still traded hands. If Simpson's claim that he owns all shares is accurate, that is a staggering number of phantom shares being traded around by naked short sellers.
What we have here is a failure to settle
This is just one extreme example of a phenomenon a number of companies have complained about. Patrick Byrne, CEO of Rule Breakers recommendation Overstock.com (Nasdaq: OSTK), for instance, has noted seeing four and five times his company's float rack up in trading volume over the course of a day. Overstock has been on the Nasdaq Threshold Security List for weeks, indicating a consistent pattern of, um, settlement failure.
What exactly are settlement failures? In a legitimate short sale, shares must be delivered within three days of the transaction. If they are not, this is called (excuse the tortured syntax) "fails to deliver." Failure to deliver -- that is, a settlement failure -- could be the result of a bureaucratic snafu or clerical oversight. But consistent failure in large volume would seem to indicate something more nefarious, or at the very least, a major bureaucratic breakdown in desperate need of repair. Failures on the scale experienced by some companies go beyond any innocent explanation.
The Threshold Security List, published daily by Nasdaq, the NYSE, AMEX, and Archipelago (AMEX: AX), is the most visible aspect of Reg SHO. To make the list, more than 10,000 shares in a company or more than 0.5% of a company's total outstanding shares must fail delivery for five consecutive days. When a stock appears on this list, it is like a red flag waving, stating "something is wrong here!" When a hedge fund is actively shorting a number of stocks that just happen to be on the Threshold Security List, it would seem to be good cause for an investigation. To the extent that Reg SHO brings these issues to the attention of companies, investors, and regulators, it's doing a good thing.
By Karl Thiel
March 24, 2005
It's amazing how the word "naked" can liven up a discussion. Take naked short selling, for instance. The addition of this saucy little word turns the mundane act of borrowing and selling shares of stock in hopes of buying them back later at a lower price into a raging controversy fraught with conspiracy, secret identities, public recriminations, foreign intrigue, sports team owners, and now some of the top regulators in the land.
How can one word cause so much trouble? While legal short sellers must borrow the shares they sell, naked short sellers sell shares of stock they haven't borrowed, have no intention of borrowing, and that may not even exist. Not surprisingly, this activity is illegal and has been since the Securities and Exchange Act of 1934. But for a number of reasons, regulators have overlooked it in the past.
In response to a rising tide of complaints, however, the SEC recently introduced Regulation SHO, which went into effect Jan. 3. The idea was to put a stop to, or at least help control, abusive short selling practices. Unfortunately, the result of the SEC's effort so far has arguably been to turn rampant abuse into a spectator sport by simply providing a list of stocks being most abused… and doing little else.
Intrigue in the sock drawer
How bad is the problem? Listen to this story: On Feb. 3, a man named Robert Simpson filed a Schedule 13-D with the SEC describing his purchase of 1,158,209 shares of Global Links Corp. (OTCBB: GLKCE), "constituting 100 percent of the issued and outstanding common stock of the Issuer." As described in a story that ran on FinancialWire on March 4, Simpson stuck every single share of the company in his sock drawer -- and then watched as 60 million shares traded hands over the next two days.
In other words, every single outstanding share of the company somehow changed hands nearly 60 times in the course of two days, despite the fact that the company's entire float was located in Simpson's sock drawer. In fact, even as recently as last Friday, 930,872 shares of Global Links still traded hands. If Simpson's claim that he owns all shares is accurate, that is a staggering number of phantom shares being traded around by naked short sellers.
What we have here is a failure to settle
This is just one extreme example of a phenomenon a number of companies have complained about. Patrick Byrne, CEO of Rule Breakers recommendation Overstock.com (Nasdaq: OSTK), for instance, has noted seeing four and five times his company's float rack up in trading volume over the course of a day. Overstock has been on the Nasdaq Threshold Security List for weeks, indicating a consistent pattern of, um, settlement failure.
What exactly are settlement failures? In a legitimate short sale, shares must be delivered within three days of the transaction. If they are not, this is called (excuse the tortured syntax) "fails to deliver." Failure to deliver -- that is, a settlement failure -- could be the result of a bureaucratic snafu or clerical oversight. But consistent failure in large volume would seem to indicate something more nefarious, or at the very least, a major bureaucratic breakdown in desperate need of repair. Failures on the scale experienced by some companies go beyond any innocent explanation.
The Threshold Security List, published daily by Nasdaq, the NYSE, AMEX, and Archipelago (AMEX: AX), is the most visible aspect of Reg SHO. To make the list, more than 10,000 shares in a company or more than 0.5% of a company's total outstanding shares must fail delivery for five consecutive days. When a stock appears on this list, it is like a red flag waving, stating "something is wrong here!" When a hedge fund is actively shorting a number of stocks that just happen to be on the Threshold Security List, it would seem to be good cause for an investigation. To the extent that Reg SHO brings these issues to the attention of companies, investors, and regulators, it's doing a good thing.
