30 July 2008

America's SEC fights dirty (Economist)

The Economist has harshly rebuked (subscription required for link) the US capital market regulator, SEC, for restraining naked shorts of certain stocks:
"The SEC’s moves deserve scrutiny. Investment banks must have a dizzying influence over the regulator to win special protection from short-selling, particularly as they act as prime brokers for almost all short-sellers."

Naked shorting occurs when a person has not borrowed stock to deliver his short position at the time of the sale. Today, the SEC renewed the restriction for another fortnight or so. It is disappointing to hear a person of Cox's caliber talking like this:
“The order is designed to protect legitimate short selling in these securities, but helps prevent illegitimate naked short selling and potential ‘distort and short’ manipulation,” said Christopher Cox, SEC chairman."

May I humbly recommend Justice Posner's case of Sullivan v. Scattered 47 F.3d 857 (or some excerpts) for the educative benefit of the SEC.

We in India already have such restrictions in place - no shorting before borrowing. But at least the current position is a progressive step away from "no shorting for institutions" rule which existed till Dec 2007. Though the policy is unclear when it says "Naked short selling shall not be permitted in the Indian securities market and accordingly, all investors would be required to mandatorily honour their obligation of delivering the securities at the time of settlement." One can do naked shorting even though the borrowing is after the sale so as to honour the obligation of delivery. Thus the phrase "Naked short selling shall not be permitted" should be deleted from the policy view of SEBI. And restricting the class of stocks to F&O (those on which futures and options are allowed) stocks are allowed to be shorted, needs to be removed - as it takes away the benefit of short selling from the stocks which most need the benefit of short selling. Shorts can easily puncture manipulators in the small cap and mid cap stocks if permitted to.

PS.: Pl also see my comments on short selling in my previous entry on Ranbaxy.

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