[Image] Regulation SHO: This Could Get Interesting
>
> The OTC Journal archives reveal I have written three editions on the
> subject of illegal naked short selling over the past two years. It is
> a fascinating subject, and one that is back in the news as a new SEC
> regulation goes into effect this week.
>
> If you have an interest in this subject and want to review the past
> editions, here they are: 4/19/03,5/18/03, and 2/4/04.
>
> [Image] Illegal naked short selling has been problematic for microcap
> stocks for many years, but the pendulum began to swing the
> other way in early 2004. Normal short selling requires the seller to
> borrow the shares ahead of executing a sell trade in shares not owned.
> The seller hopes to buy them back later at a lower price and lock in a
> profit.
>
> For many years short sellers have been able to simply sell unlimited
> supplies of small stocks through overseas brokerage firms, even though
> no shares have been borrowed. Thanks to loopholes in the clearing
> system, these sellers are never forced to deliver the shares. In
> essence, short sellers have been able to "counterfeit" supplies of
> stock by avoiding the regulations from offshore.
>
> Small and microcap companies have been particularly vulnerable to this
> practice as there is often little institutional support for the
> stocks. When a stock starts trading poorly, small investors tend to
> panic and sell, forcing prices even lower. Once an enormous short
> position is established, a smear campaign often follows, characterized
> by negative articles from questionable sources and malicious posting
> on message boards with no disclosure. The stock ends up trading so
> poorly the company cannot raise equity capital, and many die a
> premature death.
>
> A high profile example of this kind of practice occurred in the middle
> of December. Sirius Satellite Radio (NASDAQ: SIRI) had been on a tear
> over the past several months. Clearly the stock was richly valued and
> extended, and it was rumored short sellers were getting killed.
> Miraculously a complete hatchet job article appeared in Barron's,
> which sent the stock temporarily plummeting. While indeed, there was a
> strong argument the stock was overvalued, the article was completely
> one sided and gave no credence to the growth argument. A similar
> article in the Wall Street Journal was much more balanced. If you
> think the Barron's article was an accident, and short sellers didn't
> know about it in advance, you are living in LaLa land.
>
> Small companies have been hounding regulators for years to take steps
> to eliminate these oppressive practices. In February of last year the
> NASD one upped the SEC by implementing the Affirmative Determination
> Rule, which required US brokerage firms to affirmatively determine if
> an overseas brokerage firm selling shares through them can actually
> deliver the shares. This made for some exciting moves in heavily
> shorted stocks.
>
> The SEC has finally implemented the long awaited Regulation SHO.
> Regulation SHO went into effect on January 3rd. Beginning January
> 10th, each day a list of securities with excessive open naked short
> positions will be publicly published.
>
> This required list is referred to as the Threshold Securities List.
> Under Regulation SHO, threshold securities are defined by two
> criteria: 1) there are at least 10,000 shares in aggregate failed
> deliveries for the security for five consecutive settlement days and,
> 2) these fails to deliver constitute 0.5% or more of outstanding
> shares.
>
> If the failed deliveries for the stocks on the Threshold List are not
> rectified within 13 trading days, the market maker to whom the shares
> was sold will effect a "buy in" in the open market.
>
> Each exchange is required to maintain a daily Threshold List. I am
> guessing the list will be found at the web site of the exchange; i.e.
> www.nasdaq.com and www.otcbb.com.
>
> It will be interesting to start monitoring the Threshold Lists for
> unusual movements to the upside.
>
> I am not opposed to the practice of short selling. I believe all
> investors should be able to bet on any stock in either direction. I am
> opposed to sophisticated fund managers with offshore accounts using
> loopholes to initiate trades you that you and I cannot execute through
> our regular brokerage accounts. If they can do, we should all be able
> to do it.
>
> The Threshold List could become a favorite resource for locating
> trading ideas on the long side. It might become the sport of hedge
> fund managers. These new regulations are emerging out of down side
> excesses from the the 2000 to 2003 time frame. The pendulum is finally
> swinging back to a level playing field. These actions by the
> regulators will help the OTC Bulletin Board become the incubator it is
> intended to be.
>
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