April 26, 2007
Eliminate all naked shorting.
With computer access to the ECNs, market makers are not needed for either liquidity or to smooth out volitility. There are plenty of companies that only trade a few thousand shares a day. So what? Even with market makers, if a stock isn't in demand, it doesn't trade at high volume. There are plenty of times when a stock will lose 70% of its value in just minutes (Elan, February 28, 2005 is an example). Having market makers didn't make that day less volitile. The markets can deal with high and low volitility without the intervention of market makers.
The idea that market makers need the ability to naked short a market to smooth out volitility makes no sense. Their ability to naked short a security can increase volitility Take Dendreon, for example. After the FDA's advisory committee recommended approval of their lead drug candidate, Provenge, the company's share price spiked to nineteen dollars. Short sellers naked shorted the stock, drove the share price down to thirteen dollars and Dendreon went onto RegSHO. Over the next week demand for Dendreon's shares overwhelmed the shorts and the share price rose to twenty-five dollars. At that point, unable to short the market any further because Dendreon was on RegSHO, the shorts turned to the options market and bought puts. Puts, in effect, forced the market makers to hedge their exposure to the put contracts that they sold by using their exemption to the RegSHO rule. They naked shorted additional shares to balance out their risk. So it didn't matter that a party could no longer legally naked short Dendreon. Put contracts is a legal way to force market makers to naked short for them.
Prior to the FDA's recommendation for drug approval, around 25 million shares of Dendreon were sold short. That's 30% of the float. Today the short position, despite Dendreon being on RegSHO for weeks, is 34 million shares or 41% of the float.
That is, Dendreon has had its float artificially inflated by 34 million shares, 41% My shares, my voice, my vote in the marketplace -- for which I paid good money -- unfairly diluted because the SEC doesn't enforce laws already on the books against naked shorting.
Think of Judge Roberts and the conservative members of the court -- the mantra is laws should be interpreted according to the original intent of the law makers. The original intent of U.S. Securities laws cannot have been to allow this kind of manipulation of securities prices.
A weird byproduct of naked shorting: companies can be naked shorted to death. When they are, the shorts never have to cover their positions. They keep the money they borrowed when they shorted the stock and never have to declare it as income. They never have to pay taxes on it. This has become a scam through which unscrupulous entities use loopholes in our securities laws to earn millions -- billions -- and never have to pay taxes on those earnings.
These days, naked shorting is not about providing liquidity or stability to the markets. It's about relentlessly manipulating a company's stock price and stealing.
Leslie Mulkey