March 19, 2008
Restricting the ability to naked short a stock needs to be expanded. The first area is the Market Maker exemption. This is a known area of abuse where both the Market Makers and the naked shorter profit. Essentially the Market Maker (MM) charges a fee for puts sold to the naked seller and the naked seller gets fake shares to dump into the market. An extreme example of this is Dendreon Corporation where 54,000 January 2009 puts, equivalent of 54,000,000 shares were sold by the MMs to the Naked shorters. Dendreon Corporation has approximately 87,000,000 shares outstanding. The above example is just one of many instances of MMs selling puts and manufacturing fake shares for Dendreon. It has been estimated that over 200 million naked (fraudulent) and fake MMs shares exists for Dendreon. An outright ban on MMs exception would be the ideal choice for modification of the rules. A secondary but effective method would be reporting of all MMs fake shares outstanding. Additionally there should be a limit on the total percentage of fakes MM shares allowed in relation to the total outstanding shares.
Another area for rule change has to do with the penalties and restrictions resulting from violations of the rules. As it stands now the shorting rules exist yet are ignored since there is no enforcement and no penalties.
The shorter of shares that end up on the SHO list should be banned from shorting shares on any company in any market regardless of the availability of shares to borrowed. If a drunkard cannot control their drinking and driving then their license is revoked. The same should apply for the naked shorter of shares. Brokerage firms that allow shorting for banded naked shorters should be fined an amount equal to the sale price of the shorted share sold. This fine is should not be refundable once the naked shares are removed from the SHO list. In addition the brokerage firms should be required to buy on the market and replace any naked shorted share within 3 trading days.
All entities that have shorted shares that appear SHO list should be identified by the stock exchange for that stock. This information should be placed on the internet for anyone to easily access. This should happen within one day of appearance on the SHO list. The number of shares naked shorted, what entity naked shorted them, and the dates of these shorting violations should appear. This will identify the criminals, for the firms being shorted, for the investors in the entity conducting the naked shorting, for investors in the stocks being shorted, and for all brokerage firms that may deal with that entity.
These suggestions are by no means comprehensive. They do illustrate many areas that the SEC could proceed to curtail this market and economy damaging practice. Failing to implement strict rules will result erosion of faith in the US markets as fair place to trade equities. If the level of naked shorting becomes known to the general public then a large exit from the market would result. Corruption will always exist in markets and is all but impossible to totally remove but when the corruption goes unchecked it can bring down the largest markets. Other countries that are able to make strict laws and enforce them will then replace the US as the hub for equities trading.