June 10, 2004
The proposed rule would be appropriate only after the Commission has adopted effective methods to prevent naked short-selling and has devoted sufficient resources to enforcing the prohibitions that the Commission actually adopts to prevent naked short-selling. At this point the Commission has not adopted Exchange Act Release No. 48709 October 28, 2003, 68 FR 62972 November 6, 2003, and it is not clear its proposal to prevent naked short-selling will be effective and, even if effective, will be enforced by the Commission.
Therefore, it is premature to adopt prohibitions on issuer action to avoid the deleterious effect of naked short-selling on public companies and their equity holders. The deleterious effects of naked short-selling are extremely serious, particularly for smaller public companies. The following is a list of the serious harm caused by naked short-sellers:
1. Naked short-sellers depress the price of the stock held by existing investors by artificially increasing the supply of stock offered for sale. The depressed price of the public company stock prevents the public company from raising needed growth capital and undermines equity incentives granted to motivate employees of the public company.
2. By selling shares that do not exist, naked short-sellers undermine the authority of the board of directors under state law to control the number of outstanding shares. State corporate laws typically permit corporations to establish the number of authorized shares in their certificates or articles of incorporation and authorize the board of directors to issue those shares. Naked short-sellers can effectively increase the supply of shares beyond what is authorized by the board of directors and even beyond what is authorized in the certificates or articles of incorporation. Naked short-sellers violate the public policy set forth in the corporate statutes of the various states which permit only the board of directors to control the number of outstanding shares.
3. Naked short-sellers are incentivised to manipulate the price of the stock downward in order to maximize their profits when they cover their short-sale. Unscrupulous naked short-sellers will post false information about the company in Internet chatrooms, spread false rumors and do everything within their power to cause harm to the company. Indeed, the ultimate triumph of a naked short-seller is to drive the company out of business, with the consequence that all of the employees would lose their jobs. The Commission does not have the resources to prevent this type of unscrupulous activity by naked short-sellers.
Although I recognize the need to promote the integrity and efficiency of the U. S. clearance and settlement system, this desirable public policy must be weighed against the evil of permitting the continuation of naked short-selling. Until the Commission develops an effective program to prevent naked short-selling, it should not interfere with the effort of small public companies to attempt to prevent this activity by restricting transfers to or from securities intermediaries.