Terror Attack on US Financials? Details of SEC Short Ban

Last night, we discussed the absurdity of banning all short sales. The details of the SEC action have been released (see below). The specifics are a "temporary halt in short selling in 799 financial institutions" until October 2nd. 

I have been trying to contextualize this, and I keep coming back to what seemed like a wild theory yesterday that seems a whole lot less wild today. During the day, I had an interesting phone conversation with Joe Besecker of Emerald Asset Management. (We used to do schtick together on Power Lunch, and made for an amusing financial comedy team). 

But Joe is a good money manager, a great stock picker, and a thoughtful guy. He raised an intriguing issue: None of the many hedgies he knew were pressing their bets recently. The bear raids on the banks and brokers were NOT a case of piling on by US based hedge funds. And from what he was seeing and hearing about in terms of order flow, the vast majority of the financial short selling the past week or so were being done overseas. It appears that the lion’s share of shorting was coming out of overseas bourses such as London and Dubai.It may not be a coincidence that the financial short selling ban is both here and in London.

Then there is another coincidence: The huge increase in shorting of the financials occurred on the anniversary of 9/11. And on top of that, the same institutions attacked on 9/11/01 were the ones suffering in recent days.

Joe asked the question: Is anyone investigating whether this is a case of financial terrorism? He wanted to know if someone was at least looking into this question (Joe is buds with Jim Cramer, and mentioned it to him, who then omitted to cite in his column that this was Joe’s theory, not his own). 

Anyway, its an interesting theory, one that seemed kinda out there — until last night’s emergency action. Nothing else really explains the insanity of banning short sales — except for Joe Besecker’s questions. I can think of only 3 other possibilities that explain this insane action:

1) Extreme idiocy and incompetence — not unthinkable ftom the gang that couldn’t shoot  straight in DC these days;

2) Following the impetuous Fannie/Freddie rescue, the timing of this certainly has political overtones. We will see if it gets extended a month from October 2nd to November 5th. 

3) Some other factor, possibly financial terrorism.

I can think of no other explanations for the dismantling of the free operations of trading markets.

~~~

The grand irony of all this is that Naked Shorting has been very profitable for the big broker dealers, like Morgan And Goldman and Merrill and Lehman. They have looked the other way for years, and the SEC has been AWOL on this issue.

Short sales require a locate (shares to borrow) and then a subsequent delivery. It should take less than 3 days to deliver the borrowed shares, but instead, delivery is often delayed indefinitely. Failure to deliver leads to a margin charge, which can be as high as 9-15%.

If you want to know who to blame for the past 5 years of naked shorting, you only have two places to look: The Financial brokers themselves, and the nonfeasance of a feckless SEC.

Previously:
SEC: Ban All Short Selling  (September 18, 2008)
http://bigpicture.typepad.com/comments/2008/09/sec-ban-all-sho.html

Sources:
SEC Halts Short Selling of Financial Stocks to Protect Investors and Markets
SEC Chairman Christopher Cox
FOR IMMEDIATE RELEASE 2008-211
http://www.sec.gov/news/press/2008/2008-211.htm

SEC Halts Short Selling of Financial Stocks to Protect Investors and Markets

FOR IMMEDIATE RELEASE 2008-211

Commission Also Takes Steps to Increase Market Transparency and Liquidity

Washington, D.C., Sept. 19, 2008 — The Securities and Exchange Commission, acting in concert with the U.K. Financial Services Authority, today took temporary emergency action to prohibit short selling in financial companies to protect the integrity and quality of the securities market and strengthen investor confidence.  The U.K. FSA took similar action yesterday.

The Commission’s action will apply to the securities of 799 financial companies.   The action is immediately effective.

SEC Chairman Christopher Cox said, “The Commission is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets.  The emergency order temporarily banning short selling of financial stocks will restore equilibrium to markets.  This action, which would not be necessary in a well-functioning market, is temporary in nature and part of the comprehensive set of steps being taken by the Federal Reserve, the Treasury, and the Congress.”

Today’s decisive SEC action calls a time-out to aggressive short selling in financial institution stocks, because of the essential link between their stock price and confidence in the institution.  The Commission will continue to consider measures to address short selling concerns in other publicly traded companies. 

Under normal market conditions, short selling contributes to price efficiency and adds liquidity to the markets.  At present, it appears that unbridled short selling is contributing to the recent, sudden price declines in the securities of financial institutions unrelated to true price valuation.  Financial institutions are particularly vulnerable to this crisis of confidence and panic selling because they depend on the confidence of their trading counterparties in the conduct of their core business. 

Given the importance of confidence in financial markets, today’s action halts short selling in 799 financial institutions.  The SEC’s emergency order, pursuant to its authority in Section 12(k)(2) of the Securities Exchange Act of 1934, will be immediately effective and will terminate at 11:59 p.m. ET on October 2, 2008.  The Commission may extend the order beyond 10 days if it deems an extension necessary in the public interest and for the protection of investors, but will not extend the order for more than 30 calendar days in total duration.

The Commission notes today’s similar announcement by the U.K. FSA.  The SEC and FSA are consulting on an ongoing basis with regard to short selling matters and will continue to cooperate in carrying out regulatory actions.

The Commission also has taken the following steps to address the recent market conditions:

• Temporarily requiring that institutional money managers report their new short sales of certain publicly traded securities.  These money managers are already required to report their long positions in these securities.
• Temporarily easing restrictions on the ability of securities issuers to re-purchase their securities.  This change will give issuers more flexibility to buy back their securities, and help restore liquidity during this period of unusual and extraordinary market volatility.

http://www.sec.gov/news/press/2008/2008-211.htm