This is an old revision of this page, as edited by Splash (talk | contribs) at 22:35, 1 February 2006 (moved Naked short selling/Workshop to Naked short selling: merging histories (will copy comment on talk manually)). The present address (URL) is a permanent link to this revision, which may differ significantly from the current revision.
Revision as of 22:35, 1 February 2006 by Splash (talk | contribs) (moved Naked short selling/Workshop to Naked short selling: merging histories (will copy comment on talk manually))(diff) ← Previous revision | Latest revision (diff) | Newer revision → (diff)Naked short selling, or naked shorting, is a controversial form of selling shares of securities short. Critics contend that its practice as a wager against share price declines is illegal. However, the U.S. Securities and Exchange Commission, in a rulemaking on the subject, would only say that naked short-selling is "potentially abusive."
The Practice
Short selling is the practice of borrowing stock, then selling it in hopes that the price will go down and it can be bought back at a lower price, generating profit. Naked shorting is attempting to perform this transaction without first borrowing the stock.
Its Effects
The pervasity of naked short-selling, and its impact on the market, is subject to sharp dispute. Critics say that since naked short selling theoretically can be done limitlessly, its effect can be to significantly depress the value of stocks. Suporters of the practice say that naked short selling functions as a mechanism for correcting abuses in the marketplace, particularly in the market for microcap stocks.
Some alleged targets of naked short-selling include Overstock.com and Martha Stewart Living Omnimedia. However, critics maintain that the prices of those shares fell because of other corporate events.
Overstock CEO Patrick Byrne has supported a group that seeks to have existing rules against naked short selling enforced. In essence, these rules require delivery of stock after sale, with forced buy-in the remedy that would be expected.
Smaller companies have claimed damage from the practice. Pet Quarters claims the practice caused their stock to fall from $4 to under 10 cents, which led to the company filing for bankruptcy. Some have filed suit against alleged naked shorts and other parties, but their suits have been almost invariably dismissed.
In an article on TIME.com, Robert Shapiro estimated that naked short selling has cost legitimate investors $100 billion and caused the failure of 1,000 companies. . However, critics of the anti-naked shorting campaign maintain that there is no proof to substantiate these and other allegations of the anti-shorting forces.
One alleged effect of naked short-selling, according to opponents of the practice, is that it results in "counterfeit shares." The SEC has denied that this effect occurs.
In a forum sponsored by the North American Securities Adminatrations Association in November 2005, regulators denied that naked short-selling is a signficant problem.
Cameron Funkhouser, NASD's senior vice president of market regulations, told the forum that NASD had found no evidence of rampant naked short selling. He also noted that although a number of companies have in the past alleged their shares have been manipulated through the listing of their stocks on foreign stock exchanges, he had found no evidence of such activity. "We took (these allegations) very seriously," Funkhouser said. "We have seen not one instance of naked short selling or any abusive short activity" through foreign exchanges.
Controversy
Some investors defend the practice as just another tool of the market, and caution against federal regulation. Naked short-sellers claim that they are enacting market pressure against overpriced and undertraded small-cap stocks. In the bubble of the 1990s, they argue that regulations against short-selling would have caused an even greater boom and bust.
In recent years, however, the SEC has acted against naked shorting in part due to pressure from small-cap companies organizing under the banner of the National Association Against Naked Short-Selling (NAANSS). This campaign has drawn criticism. Financial columnist Floyd Norris of the New York Times observed that "Investors who own shares might do better to try to understand why some think the shares are overvalued, rather than simply rail about unfair short selling."