April 20, 2007
While I realize that naked shorting may be necessary for market makers to legitimately maintain orderly markets, it is also clear that the privilege is being abused. At a minimum this abuse undermines faith in our markets. At a maximum it destroys the markets as a tool for the growth of our economy, the financing of new companies and encouraging the solution of national and world problems.
While I don't know all solutions that may be possible, I think the SEC should consider, again, at a minimum, first, withholding the naked shorting exemption to market makers in foreign markets unless the company expressly agrees to have their securities traded in those markets and expressly agrees to have named market makers make those foreign markets.
Second, deny the naked stock shorting privilege to market makers in options markets. The market makers privilege is frequently "borrowed" by large traders by buying puts thereby forcing the option market makers to short the stock to hedge their position. This is not a legitimate use, in my opinion, of the market makers privilege.
Third, separate the functions of "option" market maker from "stock" market maker. Only the stock market maker should have the privilege of naked shorting. If an option market maker needs to hedge his position, he or she should be required to enter the underlying market and make a legitimate purchase or short sale with a legitimate borrow.
Fourth, if anyone other than a certified market maker in the particular stock, should want to short the stock, he or she should be required to have a verified borrow.
Fifth, once a security appears on the SHO list there should be a time limit by which the security should come off the list. The SEC should have a method of verifying that the shares were repurchased and that there are no more naked shorts.
Finally, there should be a method to electronically specify which shares were borrowed for a particular sale, and, once shorted once, the SEC should consider not allowing those shares to be shorted again. This would eliminate the multiplier effect of having a small number of shares shorted repeatedly.
By doing these things, the SEC could begin to restore confidence in the securities markets.