The Securities and Exchange Commission has announced various measures that it says will strengthen investor protection against ‘naked’ short selling and that apply to the securities of all
The Securities and Exchange Commission has announced various measures that it says will strengthen investor protection against ‘naked’ short selling and that apply to the securities of all public companies, including all companies in the financial sector. The measures took effect at one midnight past midnight on Thursday.
‘These actions make it crystal clear that the SEC has zero tolerance for abusive naked short selling,’ says SEC chairman Christopher Cox. ‘The Enforcement Division, the Office of Compliance Inspections and Examinations and the Division of Trading and Markets will now have these weapons in their arsenal in their continuing battle to stop unlawful manipulation.’
In an ordinary short sale, the short seller borrows a stock and sells it, with the understanding that the loan must be repaid by buying the stock in the market, hopefully at a lower price. In what the US regulator describes as an abusive naked short transaction, the seller doesn’t actually borrow the stock, and fails to deliver it to the buyer. Because of this, the SEC says, naked shorting can allow market manipulators to force prices much lower than would be possible in legitimate short-selling transactions.
The SEC’s measures have been taken under the Administrative Procedure Act and go beyond its emergency order in July, which was limited to the securities of financial firms with access to the Federal Reserve’s Primary Dealer Credit Facility. Because the exercise of emergency authority is limited to 30 days, the previous order under Section 12(k)(2) of the Securities Exchange Act of 1934 expired on August 12.
The SEC has now adopted, on an interim final basis, a new rule requiring that short sellers and their broker-dealers deliver securities by the close of business on the settlement date (three days after the sale transaction date, or T+3) and imposing penalties for failure to do so.
If a short sale violates this close-out requirement, any broker-dealer acting on the short seller’s behalf will be prohibited from further short sales in the same security unless the shares are not only located but also pre-borrowed. The prohibition on the broker-dealer applies not only to short sales for the naked short seller but to all short sales for any customer.
Although the rule will be effective immediately, the SEC says it is seeking comment during a period of 30 days on all aspects of the rule and expects to follow further rulemaking procedures at the expiration of the comment period.
The SEC has also approved a final rule to eliminate the options market maker exception from the close-out requirement of Rule 203(b)(3) in Regulation SHO. As a result, options market makers will be treated in the same way as all other market participants, and required to abide by the hard T+3 closeout requirements that effectively ban naked short selling.
In addition, the regulator has adopted Rule 10b-21, which expressly targets fraudulent short selling transactions, covering short sellers that deceive broker-dealers or other market participants. The new rule makes clear that those who lie about their intention or ability to deliver securities in time for settlement are violating the law when they fail to deliver.
