An emergency SEC rule that went into effect today prohibits naked short selling of any equity security. This rule expands on the emergency rule issued by the SEC in July, which prohibited naked short selling of 19 financial company securities.
Naked short selling occurs when short sellers and the entities loaning the shares (market makers and brokerages) do not identify whether shares are available to be borrowed. Because actual share certificates do not necessarily change hands, and transactions are settled days after the sale occurs, shares can be shorted without ever being borrowed in the first place. This practice creates opportunities for abuse, and there have been allegations of the same shares being lent to different short sellers resulting in shares being sold that do not exist and more shares shorted than are available in the public float.
The rule will remain in place through October 1, 2008.
Is the rule enough to curb these abusive and manipulative selling activities? Or should the SEC reinstate the “uptick rule,” which was abandoned by the SEC only a year ago after having stood for 70 years? The uptick rule mandated that, subject to certain exceptions, a security could only be sold short at a price above its last sales price. Perhaps a reinstatement of the uptick rule would more effectively protect against naked short selling abuses. After all, by the time the SEC’s emergency rule could be enforced with regard to a particular security, that security may already be in a downward spiral.