July 23, 2008
While the goal of reducing naked and illegal shorting is a good one, the temporary new SEC restriction affects ALL market participants that want to short the affected stocks by requiring them to pre-borrow shares before placing a short order. As a result, the participant is subject to considerable additional costs leading to fewer market participants trading and providing liquidity for the affected stocks.
As a professional trader and liquidity provider for NYSE stocks, I buy and sell hundreds of stocks on a daily basis. My market activity is a stabilizing force in the stocks I trade, as I sell (or short) rallies, and buy (or cover) on stock declines.
The preborrow requirement (as opposed to the locate requirement) has severely restricted my activity in the affected stocks this week. Today, for example, the pre-borrow cost was 6 cents per share for Goldman Sachs stock. This cost would be need to be expended before the market open, just in case I might want to short into a rally on that stock during the day. In many cases, I might not short a single share of the stock during the day, but would be required to pay the daily fee, just to reserve that option. The added, and often excessive, costs associated with the temporary restrictions prevent my abilities to provide liquidity, reducing my trading volume in the affected stocks (long and short) by over 90% this week.
Please note that I have never initiated naked short positions, nor has this been facilitated by the broker dealer through which I trade. However, as a result of the temporary SEC restrictions, my trading volume in the affected stocks has been sharply reduced, as the added cost and difficulty of working within the new restrictions were not worth the effort to conduct my normal, liquidity-providing market activity in these stocks.
While the temporary restrictions may have provided a short-term upward bias to stock prices by reducing all shorting (legal and illegal), the associated reduction in liquidity for the affected stocks will lead to higher costs by the overall public in the form of increased average slippage on their orders, and a bias towards wider bid/ask spreads.
Meanwhile, the exemptions granted to market-makers enable them to increase profits from the temporary restrictions, benefiting from the reduced liquidity and profiting at the expense of the investing public as they take market share from their liquidity providing competitors that have been effectively restricted from the marketplace.
In an effort to eliminate 'naked shorting' by the few, the temporary restrictions unnecessarily penalize the majority of market participants (such as myself) who would otherwise choose to legally trade the affected stocks. If the intent is to eliminate naked and predatory shorting (as measured by FTD's, for example), then I believe these desirable goals would be better controlled by other means (forced and immediate buy-ins for all FTD's, for example).