SEC permanently changes rules related to “naked” short selling

In a much anticipated move, the Securities and Exchange Commission (SEC) made permanent a rule that it hopes will curb abusive “naked” short selling practices in the securities markets.

Short selling is the practice of selling a security that a person does not own. In essence, the person (the “short seller”) “borrows” the security from their broker (or another third party) and sells it to a buyer. This strategy is implemented where the short seller anticipates that the value of the security will drop. As the value of the security goes down, the short seller makes money. Conversely, if the value of the security increases, the short seller loses money. At some point in the future, the short seller will purchase an amount of shares equal to the amount borrowed. This is referred to as “covering” the short position. Often the short seller has to pay a fee to borrow the securities and has to pay interest on the value of the securities until the short position is covered.

The new rule (Rule 204T) requires broker-dealers to promptly purchase or borrow securities to deliver on a short sale. In addition, the SEC is working with self-regulatory organizations to make public information related to short sale volume. Lastly, the SEC is planning to hold a public roundtable on September 30 to discuss securities lending, pre-borrowing, and possible additional short sale disclosures. According to the SEC’s press release, “the roundtable will consider, among other topics, the potential impact of a program requiring short sellers to pre-borrow their securities, possibly on a pilot basis, and adding a short sale indicator to the tapes to which transactions are reported for exchange-listed securities.”

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