The SEC has implemented rules prohibiting “naked” short selling in an attempt to curb the decline in stock prices and reduce turmoil in securities markets. Naked short selling means selling a security without owning or borrowing it and then failing to deliver it to the buyer; this practice tends to drive prices down as demand for a security falls when short sellers do not make purchases to cover their sales. The new rules became effective yesterday, September 18, 2008, and cover equity securities of public companies trading in U.S. markets.1
Naked Short Selling Prohibition
Under the new rules, short sellers and their broker-dealers (including options market makers) must deliver securities by the close of business on the settlement date (three days after the sale transaction, or T+3). If delivery is not made, the broker-dealer will be prohibited from short selling the same security for any customer unless the securities are located and pre-borrowed. The SEC staff has issued suggestions to broker-dealers on avoiding failures to deliver, including
- borrowing or obtaining control of securities before settlement;
- earmarking specific securities for each arrangement to borrow;
- maintaining adequate inventories of securities in which the firm frequently executes short sales; and
- documenting the source of customers’ borrowings and taking adequate measures to ensure that customer arrangements are valid.
In addition, a new anti-fraud rule prohibits sellers of securities from deceiving purchasers or broker-dealers about their intention or ability to deliver securities by T+3.
Related Disclosure and Enforcement Measures
The SEC is considering a new rule requiring disclosure of daily short positions by hedge funds and other investors managing more than US$100 million in securities.2 Furthermore, the SEC’s Enforcement Division and New York’s Attorney General are in the process of investigating manipulative trading practices.