May 5, 2009
THE ARCHACIC SHORT SALE
Short sales of equity securities are archaic, destructive and totally unnecessary. Modern equity options can serve the same purpose by allowing a short seller to buy a put or write a call and RIDE the share price down to make a profit, if they are right in their analysis of a companys weakness.
The key term here is RIDE. And thats what it should be. The short sale on the other hand allows the short seller to DRIVE (as opposed to RIDE) the price down, through in effect, what amounts to issuing unregistered, dilutive phantom shares in competition with the underlying company (and its registered shareholders).
Just look at the underlying anatomy of a short sale. Buyer A wants to buy all 100 shares of company XYZ that are issued for $100 and does. Now comes buyer B who wants 100 shares of XYZ also. Under normal circumstances buyer B would have to either go to buyer A to purchase them (a non-dilutive transaction) or directly to the company who can issue more shares AND TAKE IN MORE EQUITY.
Now enter a short seller. Buyer B can now go to a short seller who can, in effect, issue more shares by simply borrowing them from buyer As account. But look what you end up with . . . both buyers A and B with FULL ECONOMIC INTERESTS in 100 shares of XYZ stock each, FOR WHICH THE COMPANY ONLY REGISTERED AND ISSUED 100 SHARES AND RECEIVED $100 IN EQUITY. The other $100 in equity for the unregistered phantom borrowed shares that were created went to the short seller. Now add multiple short sellers, take away the up-tick rule, and they can DRIVE the price of a stock down by issuing more dilutive unregistered phantom shares. If a company needs more capital to cover its obligations, it may then be unable to raise it with its stock price so low. Does any of this sound familiar?
Allowing the short sale of equity securities is like allowing and unlicensed person to DRIVE a car (the car being company XYZ in this case) rather than RIDE it to its ultimate destination. If shares are to get diluted, the company should get the equity for the dilution, not a short seller who can create, in effect, phantom unregistered shares under current SEC rules. Short sellers should be utilizing a security (equity options) that DERIVES its price from the underlying security not one that DRIVES it. We need to stop this practice now. And note, I didnt even get into NAKED SHORT SALES