SEC Sets the Dress Code: No Naked Shorting

By Neetal Parekh on July 30, 2009 | Last updated on March 21, 2019

The Securities and Exchange Commission (SEC) turned its temporary rule banning abusive "naked" short selling of securities permanent earlier this week, just days before it was due to expire on July 31st.  But not everyone is breaking out the champagne. 

Naked shorting, as the invidious practice is called, is selling stocks short without borrowing them first.  Sellers then look to cover positions after the sale.  The temporary rule was put in place as a stopgap measure last year at the time Lehman Brothers and Bear Stearns were stumbling to demise.  It requires that the broker-dealer, rather than the seller, be responsible for ensuring for delivery within three days after the trade.

However, some lawmakers are less than satisfied with the rule.  They are concerned that though the rule penalizes naked shorting, it stops short of compelling coverage before the sale.  Senator Ted Kaufman and others call on the SEC to institute a pre-borrow requirement to compel sellers to formally arrange borrowing of shares or even "pre borrowing" before initiating a short sale. 

Their calls for action are not falling on deaf ears as the SEC plans to discuss a pre-borrow requirement and other measures to prevent naked shorting in an upcoming public roundtable discussion.  Kaufman and others are looking to the SEC to introduce a pilot program to test whether pre-borrowing would eliminate the naked shorting practice.

The SEC's naked shorting roundtable is set for September 30th...shirt and shoes required.


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