Crackdown on naked short-selling intensifies

By Brooke Masters
Financial Times, London
Wednesday, August 5, 2009

Short-selling has come under regulatory scrutiny in the aftermath of the financial crisis, with some critics saying it exacerbated the troubles of weak banks. US, UK, and European Union regulators have all proposed increased disclosure of short positions.

In the US, naked short-selling has drawn particular opprobrium and the SEC recently sought to weed out the practice by reducing the timeframe for locating stock to cover a short trade.

Brokers must now close out positions within four days instead of 13.

"Naked short selling potentially dilutes shareholders influence and potentially creates a misleading impression of the market," said Leslie Kazon, the SEC assistant regional director on the HCM case.

The two cases predate the tighter rules. HCM's trades occurred from 2005 to 2007 and TJM traded in 2007.

In both cases, the SEC said, the traders had become involved with naked short-selling through transactions known as "reverse conversions," in which a trader uses options to replicate a long position while simultaneously hedging himself by selling the same stock short.

Borrowing stock to cover the short position can be expensive and cut into returns.

TJM and HCM claimed to be acting as marketmakers.