Blue Chips At Risk If SEC Shuts Down Naked Short Selling
Aug 5th, 2008 | By Rick Pendergraft | Category: Featured, Financial NewsMuch has been written about the new drive by the Securities and Exchange Commission (SEC) to eliminate naked short selling of stocks. (Read the Mogambo Guru scathing criticism here.)
Rick Pendergraft in Investor’s Daily Edge has no problem in principle with the clamp down on naked shorting. But it may create more problems than it solves.
If hedge funds and brokerages suddenly have to settle all unsettled short sells, they will have to sell assets to cover their naked shorts. Blue chips with high institutional ownership are most vulnerable…
Last week I wrote about the Gramm-Leach-Bliley Act and how it was at least partially to blame for the current mess in the financial sector. This week I have another idea from the government that scares the hell out of me.
In case you are not versed in this terminology, there is a big difference between short selling and naked short selling. Ordinarily, when someone sells a stock short, they have three days to settle on the transaction. The settlement boils down to the shares being delivered to the buyer. This is usually done by borrowing the stock from another investor, all of which is arranged by a broker.
Individual investors can’t do naked short selling. Only hedge funds and brokerage houses can get away with it. And it is illegal I should point out.
The process has led to many small stocks being unfairly beaten down. In some cases, there are more shares sold short than there are actual shares outstanding. The institutions have created “phantom” shares. By targeting smaller companies without the means to defend themselves from the naked shorts sellers, the stocks fall sharply.
However, the Securities and Exchange Commission recently issued a statement regarding the practice and specifically targeted the stocks of Fannie Mae and Freddie Mac as stocks where they would be paying particular attention. Why did naked short selling get their attention? Because it is government sponsored enterprises that are the targets this time.
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Now that the SEC stepped in to protect Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) from naked short selling, my concern is that they may take too much of an interest in doing away with naked short selling altogether. As is usually the case with the government trying to fix something, they create another problem altogether.
I don’t have a problem with the SEC trying to shut this practice down completely, but if the try to move too fast, there are a number of hedge funds and brokerage firms that are going to be in trouble. If they are forced to settle all of the unsettled short sells all of the sudden, the institutions will be forced to sell assets in order to cover the naked shorts. And the assets aren’t going to be small companies, they will be the big boys with high institutional ownership.
A complete overhaul by the SEC and enforcement of a law that is already on the books could lead to a major meltdown in blue-chip stocks and could lead to a huge rise in those companies listed on the Regulation SHO list here. This is a list of companies that have at least 10,000 shares or 0.5 percent of their total shares, naked shorted.
If the chatter heats up among the political folks in Washington and New York, keep an eye on the Reg SHO list for opportunities and look to sell stocks you own with big institutional ownership.
Any blue chip with better than 70 percent of its shares held by institutions could be vulnerable. You can get the institutional ownership percentages at any number of sites, but I used Yahoo Finance for the numbers in the following table.
Just to give you an idea of the institutional ownership of some of the most widely held stocks in the U.S., I put together this table.
Company Symbol Percentage held by institutions Microsoft MSFT 63% Pfizer PFE 70.20% Bank of America BAC 62% Merrill Lynch MER 79.50% Citigroup C 60.30% Wyeth WYE 81.70% Ford F 81.30% General Electric GE 59.30% Intel INTC 64.70% Cisco Systems CSCO 73.20% Please keep in mind this isn’t a list of my bearish picks, it is simply a list of widely held stocks and their institutional ownership. Should the SEC clamp down on the naked short sellers and force them to settle up this is the information you will want to know about your stocks.
Source: Do You Trust the Government to Take Care of the Naked Short Selling Problem?
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Rick is currently the Editor-in-Chief of The ETF Options Trader and the Triple Wave Investor. At the age of 23, on the third options trade he had ever placed, Rick turned $1,800 into $22,000 in less than a week, when the company he bought became the target of a takeover. He admits it was a stroke of luck, but it was a memorable education as to the leverage that options can provide. He lives near Delray Beach, FL with his wife and three children.
