Short selling has become a lightening rod for controversy. What is a
short sale? Put simply, a short sale is the sale of a stock you do not
own. A short seller must be prepared to buy or borrow those shares at
some future time to cover that short position. People sell short
because they believe that the price of a stock will drop and they will
be able to buy or borrow it at a lower price. If the price drops the
short seller realizes a profit, if it rises, the short seller incurs a
loss.
The ability to deliver shares – in other words, to cover the short – is central to short selling. A naked short sale exists when a short seller does not – or cannot – borrow shares to cover the short position,
Depending upon your perspective, short selling in general, and naked short selling in particular, can be a useful investment tool, an instrument for stock manipulation, or a convenient whipping boy for struggling companies seeking to pass the blame for their own shortcomings. The truth lies somewhere in that mix.
In order to address some of these concerns, the Securities and Exchange Commission adopted Regulation SHO in January 2005. Despite the new rules, some observers remain concerned that illegal short sales are depressing markets, while others continue to claim that such practices are being used to damage or destroy companies. Exactly what aspects of short selling are addressed by Regulation SHO? The statute itself is somewhat opaque – a challenge for non-lawyers to dissect.
Thankfully, the SEC has now provided a series of answers to some of the most frequently asked questions in an April 11, 2005 release called – what else? – Key Points About Regulation SHO. The full text of this release can be found at http://www.sec.gov/spotlight/keyregshoissues.htm.
The SEC explains the distinctions between lawful and unlawful naked short sales. Market makers may be entitled to make naked short sales in order to maintain an orderly market. On the other hand, as might be expected, naked short sales designed to manipulate the market are unlawful – as, of course, is any market manipulation scheme.
The SEC sounds several notes of caution. The commission reminds investors that short selling may not be the reason for a stock's depressed price. Other factors may be responsible for loss of value. Thinly traded speculative stocks that trade on the Pink Sheets are particularly susceptible to plummeting stock prices. These stocks tend to be thinly traded and closely held. More often than not, the companies have few assets, negligible assets and limited operating history. Short sales are the least of their problems.
The SEC also warns investors to be wary of message board posters who speculate about the impact of short sellers. Issuers, promoters, or shareholders sometimes circulate false rumors and unfounded statements about large naked short positions in chat rooms and on message boards in order to stimulate buying interest. This is particularly true when it comes to stocks that trade on the OTCBB or Pink Sheets. These manipulators may encourage investors to buy securities by claiming that there will be an imminent "short squeeze," in which the alleged naked short sellers will be forced to cover open short positions at increasing prices. Often those claims are false.
We urge readers to review the SEC's comments and answers to Frequently Asked Questions about short sales for a succinct, easy to follow explanation. Individual investors who have further questions or complaints should contact the SEC's Office of Investor Education and Assistance at 1-800-SEC-0330 or (202) 942-7040 or http://www.sec.gov/complaint.shtml.
The ability to deliver shares – in other words, to cover the short – is central to short selling. A naked short sale exists when a short seller does not – or cannot – borrow shares to cover the short position,
Depending upon your perspective, short selling in general, and naked short selling in particular, can be a useful investment tool, an instrument for stock manipulation, or a convenient whipping boy for struggling companies seeking to pass the blame for their own shortcomings. The truth lies somewhere in that mix.
In order to address some of these concerns, the Securities and Exchange Commission adopted Regulation SHO in January 2005. Despite the new rules, some observers remain concerned that illegal short sales are depressing markets, while others continue to claim that such practices are being used to damage or destroy companies. Exactly what aspects of short selling are addressed by Regulation SHO? The statute itself is somewhat opaque – a challenge for non-lawyers to dissect.
Thankfully, the SEC has now provided a series of answers to some of the most frequently asked questions in an April 11, 2005 release called – what else? – Key Points About Regulation SHO. The full text of this release can be found at http://www.sec.gov/spotlight/keyregshoissues.htm.
The SEC explains the distinctions between lawful and unlawful naked short sales. Market makers may be entitled to make naked short sales in order to maintain an orderly market. On the other hand, as might be expected, naked short sales designed to manipulate the market are unlawful – as, of course, is any market manipulation scheme.
The SEC sounds several notes of caution. The commission reminds investors that short selling may not be the reason for a stock's depressed price. Other factors may be responsible for loss of value. Thinly traded speculative stocks that trade on the Pink Sheets are particularly susceptible to plummeting stock prices. These stocks tend to be thinly traded and closely held. More often than not, the companies have few assets, negligible assets and limited operating history. Short sales are the least of their problems.
The SEC also warns investors to be wary of message board posters who speculate about the impact of short sellers. Issuers, promoters, or shareholders sometimes circulate false rumors and unfounded statements about large naked short positions in chat rooms and on message boards in order to stimulate buying interest. This is particularly true when it comes to stocks that trade on the OTCBB or Pink Sheets. These manipulators may encourage investors to buy securities by claiming that there will be an imminent "short squeeze," in which the alleged naked short sellers will be forced to cover open short positions at increasing prices. Often those claims are false.
We urge readers to review the SEC's comments and answers to Frequently Asked Questions about short sales for a succinct, easy to follow explanation. Individual investors who have further questions or complaints should contact the SEC's Office of Investor Education and Assistance at 1-800-SEC-0330 or (202) 942-7040 or http://www.sec.gov/complaint.shtml.
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