July 17, 2008
Naked shorting opens the system up to fraud and manipulation, undermining faith in the markets and faith in SEC enforcement.
Because so much fraud can be funneled through naked shorting, the markets lose their sense of logic and orientation. No one knows if a stock is heading down due to bad news pending or simply fraudulent operators trying to sway market sentiment. It is not only discouraging, but it cheats many unsuspecting retail investors out of their due profits, etc. On these points, I think most sincere observers agree.
While classic shorting, where one goes out and actually borrows real, tangible shares, is considered a time honored practice, naked shorting is a horrid caricature of classic shorting. There appears to be no limit on the amount of imaginary shares that can be introduced to the float of shares available for trading, and due to the laws of supply and demand, prices will undeniably fall if the number of shares balloons, even if only for a short period. We cannot grant any loophole for these people trying to manipulate sentiment, not a single day of grace period. Whatever loophole is left, they will use to the ultra-max, as is the history on Wall St. That means no exceptions for options market makers, no exceptions for foreign market makers, enforcement of abuses abroad on stocks listed in the U.S., no grace period for locating stock to borrow, no borrowing the same stock multiple times over, etc. The morally challenged faction on Wall St will abuse any and all exceptions given them. There is clearly no need to compromise with people who are in the fraud business.
Give them no room to avoid prosecution. if the language of any statute or ruling is ambiguous enough, enforcement will become very difficult, which is clearly what the cheaters count upon. There is no need to compromise with people who prey upon unsuspecting investors, none.
This week Chairman Cox implemented an emergency rule for 19 large institutions which effectively protects them from naked shorting.
While I understand the intent and the context, this is unfair to the rest of the equity market and corporations not on that list. Heck, I suspect many on that list actually perpetrate naked shorting themselves. Why should an institution be allowed to naked short, but they, themselves, be protected from the practice regarding their own stock? That's blatantly unfair. It's highly un-American to give privilege to the rich and powerful at the expense of the unsuspecting public. Bankers are the consummate insiders. They need extra protection like I need a hole in my head. No, what is needed is blanket protection for all, equal protection for all. The rules just announced to protect the 19 financial firms are likely to work (witness the 17% bounce in the banking index the day after the rule was announced...simply amazing), and they should be extended in every facet to protect the whole stock market.
Do not listen to those saying we are eliminating necessary tools from market traders, etc. Shorting will still continue, but the fraudulent, manipulative shorting will not, to a large extent. People on the other side don't want to see the gravy train end, because it's pretty easy to scam investors by dumping a huge, unknown quantity of shares on the market in order to dissuade anyone from buying. It's no different than a new secondary offering, only the company receives no benefit of cash infusion. The naked shares can be hugely dilutive, if only for a few key days. All it takes is for a large hedge fund to slam a stock at a key technical level in order to crash a stock. I suspect it is happening daily. This is destructive capitalism.
In summary, I hope the commission takes the high road and sends these scamsters a message that naked shorting is not tolerated in the U.S. Such a move will increase faith in U.S. markets and in the S.E.C. itself. Good faith goes a long way, a lot longer than many understand.
Richard Depp, M.D.