WSJ: "Shorting IPOs is destabilizing," says Bill Singer, a lawyer who represents
day traders through his firm Singer Frumento LLP in New York. "It's not
bona fide or honest trading, and you shouldn't have this kind of garbage
going on," he says.
. "You have people who are saying,
'[Forget] the rules. It's only for the day,' " argues Chris Doubek, president
of Terra Nova Trading, the parent of MBTrading, a brokerage firm
whose clients are day traders."
Aggressive Day Traders Try
Short Selling Some IPOs
By SUSAN PULLIAM
Staff Reporter of THE WALL STREET JOURNAL
It sometimes seems easy to make money buying initial public offerings in a
sizzling stock market. Now, a small band of aggressive day traders are
trying to profit from cooler waters.
The bold strategy: making bearish bets -- or "short sales" -- on IPOs.
That's when investors sell borrowed stock in hopes of repaying the loan
with cheaper shares after the stock falls.
Among the daring devotees is Mark Miller, a
33-year-old electrical engineer turned day
trader who says he has been shorting IPOs
through Van Buren Securities, a small Chicago
brokerage firm. Day traders such as Mr. Miller routinely close out their
trading positions each day.
In the past two months, Mr. Miller says he has made about $20,000
shorting IPOs in their first few days of trading, including shares of
MP3.com, an online-music concern that sold shares to the public on July
21. On the day of its IPO, MP3.com rocketed to 105 from its initial
offering price of 28, but fell to slightly above 63 by the close. Tuesday, it
closed at 34 7/8, down 15/16, on the Nasdaq Stock Market.
"I was constantly shorting and covering MP3 all day long," Mr. Miller says.
"I did 10 to 15 trades on MP3 alone that day," he says. His net profit:
about $8,000.
Shorting any stock is risky, of course. If the stock's price rises, investor
losses can mount quickly, particularly in a rapidly moving market. But
shares of IPOs -- especially Internet issues -- are particularly
unpredictable; they can zigzag wildly in minutes. So, it's not surprising that
shorting IPOs isn't popular.
There's another
factor. Such
sales typically
are prohibited
by a National
Association of
Securities
Dealers rule
that requires
brokers to
make certain
they can
physically
obtain the shares before allowing customers to enter a short sale. In an
IPO, that is hard to do in the first days of trading, because the stock
certificates haven't yet been distributed to investors.
Moreover, the U.S. Securities and Exchange Commission makes shorting
IPOs difficult under a rule that prevents brokerage firms in the underwriting
syndicate from "extending credit," or making loans, on IPO shares for 30
days. (These loans typically are made through margin accounts.)
Despite the restrictions, some brokerage firms that cater to aggressive day
traders have allowed their customers to short IPOs.
Jeffrey Wolfson, chairman of Pax Clearing in Chicago, and a part owner of
Van Buren Securities, says in an interview he wasn't aware that Van Buren
customers have been allowed to short IPOs. "If this is happening, it will be
stopped," Mr. Wolfson says. "When a trader shorts a stock, they should
be able to borrow it."
Van Buren's president, Vito Sisto, says shorting IPOs immediately after the
offering violates the firm's guidelines, and he is unaware of it happening.
"We do our best to insure that that never happens. But the policy is that
before 30 days, traders cannot short an IPO."
However, Mr. Miller, who invests through Van Buren, maintains that he
received a call last week from Pax, Van Buren's clearing agent, saying that
Van Buren members can "no longer short IPOs." Mr. Sisto says he can't
recall any such notification. Nor can Mr. Wolfson, Pax's chairman.
To be sure, a short sale on an IPO doesn't necessarily run afoul of
regulatory rules. Investors are allowed, for instance, to short IPOs if the
broker is able to locate shares to lend through the firm's clearing agent. In
many cases, Wall Street firms make shares of a newly minted IPO
available for shorting to smaller brokerage houses by buying the shares in
the open market and making them available for borrowing to customers in
short sales.
But some brokerage executives contend that some firms catering to day
traders are allowing their customers to short IPOs without making certain
the shares are available for borrowing. "You have people who are saying,
'[Forget] the rules. It's only for the day,' " argues Chris Doubek, president
of Terra Nova Trading, the parent of MBTrading, a brokerage firm
whose clients are day traders.
The SEC declined to comment on the practice.
Indeed, Mr. Doubek says it's not just IPOs that are being targeted for
short sales by day traders. He contends that some day traders routinely
short already public stocks that are hard to borrow. "They call it being
short for the day," Mr. Doubek says.
In effect, he says, customers are being allowed to short shares that aren't
otherwise available for borrowing on the theory that the customer will close
out the sale before the end of trading. This eliminates the possibility the
trade will be "called in" by a broker. In that case, the customer would be
forced to scramble to buy shares, possibly in a rising market.
The trend by fast-action day traders could be helping to exaggerate the
downdraft on new issues. In the past week or so, IPOs have begun to be
cut back in size and price as investor demand has waned. Indeed, as the
IPO market has faltered in recent days, day-trading chat rooms have been
alive with talk from day traders of successful bearish bets against IPOs.
"Shorting IPOs is destabilizing," says Bill Singer, a lawyer who represents
day traders through his firm Singer Frumento LLP in New York. "It's not
bona fide or honest trading, and you shouldn't have this kind of garbage
going on," he says.
But the popularity of the trading strategy shows how some day traders
have taken on even greater levels of risk to stay in the game as Internet
stocks have swooned. Many Net stocks are down 50% or more since
mid-April, when the group's meteoric rise sputtered. The upshot: Some
day traders are "doubling down" by taking on supercharged risks through
IPO shorts.
Although bearish bets on IPOs certainly would have paid off last week, an
investor who sold short shares of Red Hat, which soared from its IPO
price of 40 to a high of 90 11/16 on its first day of trading would have
been hammered.
Some day traders aren't put off by the risks, however. "You can easily get
wiped out," concedes Mr. Miller. But, he adds: "The whole reason I went
with Van Buren [his Chicago-based broker for the short sales] was
because of their extended short list." That's the list of stocks offered for
short sales through Van Buren. On average, says Mr. Miller, he has made
$500 to $1,000 on his IPO short sales of such new issues as
Musicmaker.com and DrKoop.com. Some of his bigger winners, in
addition to MP3.com, have included drugstore.com, he says. His total
day-trading portfolio is valued at about $80,000, he says.
He says he has had a few losers. These include a short sale of Ramp
Networks on the day of its IPO in June; he lost $4,000 on the bet. Says
Mr. Miller: "I jumped in too early."
Some firms that have been offering short sales on IPOs to their clients are
members of the Philadelphia Stock Exchange, which currently lacks a
requirement like that of the NASD preventing member firms from allowing
short sales without first locating the shares to borrow. Members of the
Philadelphia exchange are not subject to NASD regulations.
Last week, the Philadelphia exchange moved to close the loophole by
drafting a rule change that would bring its regulations in line with that of the
NASD. "The only place that our rules deviate from Nasdaq is in the area
of [short sales]," says Meyer Frucher, the exchange's chairman and chief
executive officer.
The rule change, he says, was made after a query from The Wall Street
Journal. "I looked at it and decided there was a hole," Mr. Frucher says.
"We're looking to find our deficiencies and close them as quickly as we
can."
The rule draft will be voted on by the exchange's board by the end of
September, he says, though final adoption of the rule would be about two
months away. This week, he says, the exchange has sent a notice to its
members asking them to voluntarily comply with the proposed rule.
"We are sending out notices to registered firms to see if they engage in this
practice," he says. "And we are asking them to voluntarily desist until the
rule change is affected."
...think a crackdown isn't on the way? |
