Excellent description in this article of naked short selling.
"Naked Shorting In The Uber IPO: It Couldn't Happen On A Blockchain"
https://www.forbes.com/sites/caitlinlong/2019...890d604737
(I know that you are aware AlanC but others need to read this.)
from the article:
"...How Is Naked Shorting Even Legal?
The fact that naked shorting of stocks is legal at all is a vestige of history--of outdated US laws, which themselves simply codified a market structure for US equity markets that has also become outdated.
It once made sense for securities to be owned indirectly (instead of in the owner’s name), just as it once made sense to insert layers of intermediaries into settlement processes to minimize the quantity of transactions that firms settled with each other (today, firms add up debits and credits, net the amount, and settle only the difference). Technology limitations once dictated this market structure--and precluded same-day settlement of securities trades.
These technology limitations have long ago been solved. Yet, the old market structure remains.
If we were re-designing equity markets from scratch, they would look nothing like they do today--and they would be much more investor-friendly.
If the SEC doesn't address the problem, there’s another group that could--and on this front there’s good news. The Uniform Law Commission, which coordinates Uniform Commercial Code drafting, has formed a joint study commission to review the impact of emerging technologies on the UCC and possibly draft amendments or revisions to it. As currently drafted, UCC Article 8 enables naked short selling. Consequently, the joint study commission has an opportunity to fix the problem at its origin.
Naked shorting was enabled legally by UCC Article 8 in 1994, owing to a combination of two features: (1) indirect ownership of publicly-traded securities and (2) a special exemption that obviates the normal requirement that the seller prove in advance that it actually owns the property it is selling to a buyer.
Regarding the indirect ownership feature, most of us believe we own securities in our brokerage accounts but that’s not the case. What we actually own is an IOU from our broker-dealer--a contractual right to the shares instead of the real thing. Your broker, in certain circumstances, has the right to conjure and sell you IOUs to more shares than actually exist.
That’s where the second point comes in. Before buying a house or a car, for example, the seller must prove to you that it owns valid title. But that’s not true for securities, which have a special exemption from this requirement. Section 8-501 of the UCC allows securities intermediaries to credit “security entitlements” to a customer’s account without regard to whether the securities firm actually holds the securities. In other words, yes, it’s legal under the UCC for your broker to sell you something it doesn’t own. Section 8-504 attempts to mitigate the dangers of “overissue” of securities by requiring securities firms to hold a sufficient quantity of securities to satisfy all customer claims--but buried in SEC rules are myriad loopholes that enable securities firms to “overissue” securities (such as naked shorting of IPOs, operational shorting by ETF market-makers, rehypothecation, failures-to-deliver, the Customer Protection Rule enabling debits not always to equal credits, and other examples).
Regarding the "overissue" problem, securities settlement expert DC Donald aptly wrote, “Imposing strict standards on intermediaries can reduce this problem, but not ultimately eliminate it. The problem is a price the market pays for making claims against a number of different intermediaries’ holdings negotiable.”
In other words, the US legal system made a policy decision to favor liquidity over solvency--to favor negotiability of securities over keeping accurate and timely records of who really owns what.
The problem, as Uber investors have just learned the hard way, is that “overissue” of securities suppresses market prices. This is one of many subtle ways that value is skimmed from Mom and Pop investors in securities markets.
To be sure, naked short-selling has been controversial for years and the SEC has made huge strides in shutting the practice down since beginning to tackle it in 2005. But in 2015 the SEC explicitly left a large loophole for banks to engage in naked-shorting of IPOs. This has shifted the upside/downside odds for IPOs in the banks’ favor. It’s not a healthy dynamic for the IPO market, nor for fair capital markets generally.
"Naked Shorting In The Uber IPO: It Couldn't Happen On A Blockchain"
https://www.forbes.com/sites/caitlinlong/2019...890d604737
(I know that you are aware AlanC but others need to read this.)
from the article:
"...How Is Naked Shorting Even Legal?
The fact that naked shorting of stocks is legal at all is a vestige of history--of outdated US laws, which themselves simply codified a market structure for US equity markets that has also become outdated.
It once made sense for securities to be owned indirectly (instead of in the owner’s name), just as it once made sense to insert layers of intermediaries into settlement processes to minimize the quantity of transactions that firms settled with each other (today, firms add up debits and credits, net the amount, and settle only the difference). Technology limitations once dictated this market structure--and precluded same-day settlement of securities trades.
These technology limitations have long ago been solved. Yet, the old market structure remains.
If we were re-designing equity markets from scratch, they would look nothing like they do today--and they would be much more investor-friendly.
If the SEC doesn't address the problem, there’s another group that could--and on this front there’s good news. The Uniform Law Commission, which coordinates Uniform Commercial Code drafting, has formed a joint study commission to review the impact of emerging technologies on the UCC and possibly draft amendments or revisions to it. As currently drafted, UCC Article 8 enables naked short selling. Consequently, the joint study commission has an opportunity to fix the problem at its origin.
Naked shorting was enabled legally by UCC Article 8 in 1994, owing to a combination of two features: (1) indirect ownership of publicly-traded securities and (2) a special exemption that obviates the normal requirement that the seller prove in advance that it actually owns the property it is selling to a buyer.
Regarding the indirect ownership feature, most of us believe we own securities in our brokerage accounts but that’s not the case. What we actually own is an IOU from our broker-dealer--a contractual right to the shares instead of the real thing. Your broker, in certain circumstances, has the right to conjure and sell you IOUs to more shares than actually exist.
That’s where the second point comes in. Before buying a house or a car, for example, the seller must prove to you that it owns valid title. But that’s not true for securities, which have a special exemption from this requirement. Section 8-501 of the UCC allows securities intermediaries to credit “security entitlements” to a customer’s account without regard to whether the securities firm actually holds the securities. In other words, yes, it’s legal under the UCC for your broker to sell you something it doesn’t own. Section 8-504 attempts to mitigate the dangers of “overissue” of securities by requiring securities firms to hold a sufficient quantity of securities to satisfy all customer claims--but buried in SEC rules are myriad loopholes that enable securities firms to “overissue” securities (such as naked shorting of IPOs, operational shorting by ETF market-makers, rehypothecation, failures-to-deliver, the Customer Protection Rule enabling debits not always to equal credits, and other examples).
Regarding the "overissue" problem, securities settlement expert DC Donald aptly wrote, “Imposing strict standards on intermediaries can reduce this problem, but not ultimately eliminate it. The problem is a price the market pays for making claims against a number of different intermediaries’ holdings negotiable.”
In other words, the US legal system made a policy decision to favor liquidity over solvency--to favor negotiability of securities over keeping accurate and timely records of who really owns what.
The problem, as Uber investors have just learned the hard way, is that “overissue” of securities suppresses market prices. This is one of many subtle ways that value is skimmed from Mom and Pop investors in securities markets.
To be sure, naked short-selling has been controversial for years and the SEC has made huge strides in shutting the practice down since beginning to tackle it in 2005. But in 2015 the SEC explicitly left a large loophole for banks to engage in naked-shorting of IPOs. This has shifted the upside/downside odds for IPOs in the banks’ favor. It’s not a healthy dynamic for the IPO market, nor for fair capital markets generally.
3
