July 18, 2008
Although the proposed change to Regulation SHO is an improvement, the following topics must also be addressed to properly guard against naked short selling:
(a) A broker-dealer acting on behalf of another entity that is also subject to SHO should not be exempt from assuring delivery. This exemption could shield improper behavior.
(b) Market makers should not be exempt from SHO. If they are behaving legitimately, they will be continually acquiring, not merely selling, securities. They might hold a net short position for a few weeks, but ultimately they should have to deliver.
(c) Shares of ETFs should not be exempt from SHO, nor should trades made on behalf of ETFs.
(d) SHO should mandate that failures to deliver be rectified quickly, say within two days. If this does not occur, SHO should mandate reversal of the transaction at either the original or the current market price, whichever is less advantageous.
(e) Agreements with the regulators of foreign securities exchanges (in Canada, for example) are needed to prevent the bypassing of SHO. Similarly, SHO should be enforced for foreign securities traded, for example, as depository receipts or on the Pink Sheets.
Naked short sales were recently singled out as a reason for the drop in the share prices of various financial institutions. However, naked shorting has previously affected other sectors. This gives the lamentable impression that some sectors enjoy preferential treatment regarding the vigor with which regulations are enforced.
Finally, a comment on Letter "Type C" is in order. Among other things, it proposes transferring securities oversight to the Fed if the SEC doesn't do its job properly. Oh, the irony. Naked shorting is equivalent to counterfeiting, something of which the Fed has no small experience. Giving the Fed jurisdiction over this matter would surely result in shareholders being diluted in the same manner as the holders of US dollars.