NASD RULE CHANGE EFFECTIVE 2/20/2004
Publication Date: February 7, 2004
For years, management of many small-cap and micro-cap publicly-traded companies that have either traded on the Nasdaq SmallCap market, or on the Nasdaq run OTC Bulletin Board have complained about short selling, particularly the practice known as "naked shorting." Naked shorting occurs when the investor is not required to borrow stock before selling the stock short.
Many were skeptical that either the National Association of Securities Dealers (NASD), or the Securities and Exchange Commission would ever take action to correct what they believed was a major abuse in the over-the-counter trading system.
In a move that surprised most Wall Street insiders, the NASD has significantly tightened one of its rules governing short selling.
Named by the NASD as "affirmative determination," the new NASD rule requires that brokers and dealers engaged in a short sale transaction ensure that the shares can be delivered within the three day settlement period.
Until this rule change, foreign brokers, specialists and other investors who weren't members of the NASD weren't covered under the existing "affirmative determination" rule. What that meant was that these short sellers had no requirement to represent to the broker-dealer through whom they were executing transactions that they would be able to deliver the securities by the settlement date.
This new NASD rule, which has recently been approved by the Securities and Exchange Commission, will have the greatest impact on short sales executed by or through foreign brokers. Many believe that much of the naked short selling has been conducted through Canadian brokers. Particularly vulnerable to naked short selling have been shares of companies traded on the OTC Bulletin Board.
Much of the abuse in short selling has taken place because it's been very difficult, if not impossible to "borrow" the shares of companies traded on the OTC Bulletin Board. As a result, individual investors, and institutional investors including many hedge funds looking to take a "negative bid" on what they have seen as over-valued OTC Bulletin Board stocks have executed their trades through Canadian brokers, where it's not required to borrow a stock before selling it. The NASD action closes this opportunity.
The NASD rule doesn't apply to Canadian brokers, who are not members of the NASD, but does affect them. This is because the Canadian brokers must execute their transactions through US brokers who are members of the NASD. The rule change makes it the responsibility of the US NASD member broker to ensure that their Canadian "customers" are in fact able to settle transactions within the settlement period.
Many investors and hedge funds have taken the position that short sellers provide a needed service to the market. But, many Wall Street insiders and management of public companies themselves have called for the complete abolition of short selling citing the significant downward pressure it puts on the shares of publicly-traded companies.
This new NASD affirmative determination rule is scheduled to take effect on February 20th.
Author: Jeffrey Friedland |
