Naked shorting: Funds up in arms about short-selling ban
When the US SEC announced in July that it would impose a 30-day ban on illegal naked shorting in 19 stocks, some hedge funds were up in arms.
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They had a right to be confused. The proliferation of illegal naked short selling, whereby stocks sold short are deliberately not bought in and delivered within three days, to allow the seller to take advantage of further drops in price, had largely been played down by the SEC. Punishment for failing to deliver within the timeframe has been posting collateral – not a big enough incentive to prevent the practice. The ban implies therefore that the SEC has either misunderstood the damage that illegal naked shorting can inflict and has been inflicting, and suggests that it admits that the practice is rife in the industry. One trader says he is familiar with a large hedge fund manager that has been shorting large financial companies in the past few months with no intention of locating the actual stocks within the three-day period. His argument is that his firm has sufficient clout with the broker for the broker to turn a blind eye.
The ban has received criticism from hedge fund industry representatives, fearing it might lead to longer-term regulation restricting short selling as a whole. The Managed Funds Association and Coalition of Private Investment Companies wrote a letter of complaint to the SEC. MFA president and chief executive Richard Baker says his firm believes "the difficulties are the result of poor fundamental conditions and not a mysterious conspiracy, or the inadequacy of current rules related to short selling".
Jim Chanos, chairman of the CPIC, argues that restrictions on short sales undermine the integrity of prices because they remove liquidity and healthy sceptism from the marketplace
Shorting stock without physical possession of the stock certainly keeps the market liquid but hedge funds’ arguments that three days are not sufficient to locate stock and deliver it is only proof that the SEC’s failure-to-deliver regulations have been ignored for years.