Re: 8/11/06 - Forbes: Utah Governor Caves On Shorts
Utah Governor Caves On Shorts
Liz Moyer, 08.11.06, 5:10 PM ET
After a strong show of support for a new law designed to crack down on abusive stock trading, the state of Utah has caved to Wall Street's demands not to enforce it.
On Friday, the director of Utah's Division of Securities reached an agreement with the Securities Industry Association not to enforce its new law until June 1, 2007. It had been scheduled to go into effect Oct. 1, 2006.
That gives the two sides time to reach a broader compromise while also giving the SIA time to lobby the state legislature to repeal it. In court papers, the two sides said the compromise will allow them more time to study brokerage-industry complaints that the law was too onerous and will free the brokers to focus on the reform of short-selling rules proposed by the U.S. Securities and Exchange Commission.
Still, the SIA reserved the right to resurrect a lawsuit it filed in Utah federal court seeking to overturn the law on grounds of federal preemption.
"We are very pleased to resolve this issue so expeditiously, and we look forward to working with the state of Utah to address their concerns," said Marc Lackritz, president of the SIA.
The state law would require Utah-licensed brokers to report to the Utah Division of Securities within 24 hours any trades in shares of Utah companies that fail to deliver. Noncompliant firms would risk having to pay the issuer companies either $10,000 or an amount equal to the market value of the shares that failed that day. Stock transactions settle in three days, with money and shares being exchanged. If the shares aren't delivered within three days, they are deemed "failed to deliver."
Friday's agreement is a surprising about-face for Gov. Jon Huntsman, who enthusiastically signed the law in May after it was passed in a special legislative session.
The law was generally viewed to have been written with Salt Lake City-based Overstock.com (nasdaq: OSTK - news - people ) in mind. Overstock's Chief Executive Patrick Byrne has been waging what he calls a "crusade" against abusive stock trading, including what's known as naked short-selling.
"Utah passed a bill in favor of the rule of law, and our governor promised to ride tall in the saddle in its defense," Byrne said Friday. "Since then, the SIA has been out here lobbying night and day against the rule of law. They won."
The law was crafted as a response to increasing concerns about stock market manipulation--particularly the practice of short-selling. In this type of trade, a stock is borrowed and sold with the goal of buying it back later at a profit. Then there is naked short-selling, which doesn't involve actually borrowing the shares and is illegal.
Some naked short-selling is unintentional and occurs in the course of maintaining markets, but some is deliberate. A trader's temptation to do a naked short sale goes up with the price to borrow a particular stock; the harder a stock is to borrow, the more expensive it is to borrow, and heavily shorted stocks tend to be hard to borrow.
Several academic studies have found that brokers allow some deliberate, or "strategic," fails to conform to industry convention--they don't force delivery, because they know they'll be on the other end someday.
But the Securities and Exchange Commission says high incidences of fails in a stock might indicate some naked short-selling is happening.
And indeed, aggressive short-selling in a particular stock compounds the problem by creating a cascade of fails in the system.
The agency is trying to fix loopholes in a 2004 regulation, known as Reg SHO, that was designed to curb this type of aggressive short-selling. The SEC already has more than 120 comment letters on the amendments posted on its Web site, most of them from investors who say they have been hurt by aggressive short-selling.
Reg SHO was supposed to make it harder for a trader to make a naked short sale by imposing trade closeout requirements on stocks that persistently fail, among other things. But critics have argued that exemptions for preexisting failures and for certain market makers weaken the regulation.
Some even argue that the daily SHO lists function as trading road maps for aggressive short-sellers. Overstock.com shares have appeared on the Nasdaq SHO list nearly since its start. Other stocks routinely among the SHO stocks reported by the Big Board and Nasdaq include Netflix (nasdaq: NFLX - news - people ), Martha Stewart Living Omnimedia (nyse: MSO - news - people ), Fairfax Financial Holdings (nyse: FFH - news - people ) and Krispy Kreme (nyse: KKD - news - people ).
"We continue to observe a small number of threshold securities with substantial and persistent fail-to-deliver positions that are not being closed out under existing delivery and settlement guidelines," the SEC says in its proposed amendment. "They can be indicative of manipulative naked short-selling."
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