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Get Shorty (2008)

With short-selling volumes hitting record highs at the major exchanges and with volatile financial markets, many are wondering whether a flurry of manipulation cases will be coming out of the U.S. Securities and Exchange Commission in the near future.

Last week, SEC Chairman Christopher Cox told a Senate panel that the agency was not ignoring speculation that traders colluded to bring down
Bear Stearns

in a swift short-selling raid in mid-March. Without saying the SEC was investigating unusual trading patterns in Bear Stearns stock, Cox said, “The SEC takes seriously its responsibility to investigate allegations of this nature.”

Some want any investigation to be broader. Trading in shares of
Lehman Brothers

has also been unusually active, with the number of shares sold short at the New York Stock Exchange climbing 21% from mid-March to the end of March, to 56.7 million shares, or 10% of its shares outstanding.

Lehman executives have persistently denied the company was having cash problems similar to that of Bear Stearns in its last days, and they have been quite vocal about their successful efforts to raise capital, despite the pressure from short-sellers.

Shorts piled into

as well, with short interest jumping 76%, to 17.1 million shares, in the last two weeks of March. The maneuvering seems very well-timed. On April 1, the Swiss banking giant said it would take a $12 billion first-quarter loss, create a separate “bad bank” to run off some of its mortgage securities book, replace its chairman, and seek $15 billion in new capital in a securities offering.

Friday, Rep. Barney Frank, a Massachusetts Democrat and chairman of the House Financial Services Committee, sent a letter to the SEC asking it to investigate trading in shares of investment banks in the last few weeks to see if anything funny was going on.

Rep. Frank wants the SEC to see if the rumors are being coordinated to drive certain companies, like Bear and other investment banks, out of business.

Regulators are scrambling to respond to the speculation. The Financial Industry Regulatory Authority, which oversees broker-dealers along with the stock exchanges, sent a warning to member companies last week. “Intentionally spreading false rumors or engaging in collusive activity to impact the financial condition of an issuer will not be tolerated and will be vigorously and aggressively investigated,” it said.

Shares of the major broker dealers have swooned since the collapse of Bear Stearns last month. There was a bear raid on Bear Stearns starting March 10 that sent its stock plummeting 60% in the span of five days on trading volume that exceeded its total shares outstanding. In the options market, too, furious trading in well out-of-the-money contracts raised concerns.

Trading in Bear shares was so frantic that many didn’t settle properly, and so Bear Stearns starting showing up on the New York Stock Exchange’s daily list of stocks with high incidences of persistent trade settlement failures. That can be evidence of manipulation, though not always. Bear Stearns has been on the list from March 25 through April 4.

Bear Stearns’ own executives have blamed short-sellers in part for the company’s collapse, saying false rumors sparked a customer flight that ultimately created a liquidity crisis. The complaints have gotten a sympathetic ear on Capitol Hill, where lawmakers have just gotten a proposal by the Treasury Department for a sweeping overhaul of financial market regulation, including the merger of the SEC with the Commodities Futures Trading Commission and the reassignment of many of the SEC’s enforcement duties to the stock exchanges and other self-regulatory agencies.

Short-sellers have trained their sights on financial stocks, and there are plenty of reasons why. Other heavily-shorted companies include
Washington Mutual


Wells Fargo


Countrywide Financial

, all companies with a big exposure to the mortgage markets, and
CIT Group

, a lender which is trying to raise cash and has shut down some of its lending operations.

But there is room for abuse. The SEC has been trying to tackle the issue of naked, or manipulative, short-selling for over two years, tightening some of the rules around trading in heavily shorted stocks, but loosening restrictions in other areas–much to the frustration of critics.

A refresher course: Short-sellers borrow shares and sell them, hoping the stock will drop. They can buy the shares back at the lower price and return them to the original owner, pocketing the difference. To make short-selling faster, there are rules that say all traders need do is “locate” a share of the stock they want to short, meaning they find someone to say they have the shares to lend out to them.

This leaves all sorts of wiggle room, including the possibility that a trader would purposefully lie that he got the “locate” just to get the trade done. This is what the SEC wants to curtail.

Last month, on the Monday after Bear Stearns’ collapse, the SEC proposed a new “naked short-selling anti-fraud rule” that is supposed to rein in manipulative trading by preventing short-sellers from misrepresenting to a broker that they have properly located stock to borrow to sell short.

The proposed rule has attracted more than 250 comments so far, overwhelmingly from investors who are angry that the current rules aren’t being enforced, allowing manipulative naked short-selling to go on under the noses of various regulators. This new anti-fraud rule, they contend, would potentially make it easier for broker dealers to get off the hook.

Part of the problem, according to those who are fighting for stricter short-selling rules, is that brokerages and their stock loan desks aid in naked short-selling by looking the other way or by purposefully misrepresenting the availability of stock to borrow, reaping fees for services they haven’t actually provided.

Another problem, of course, is the elimination of the “up-tick” rule, a controversial SEC rule change last July (well-timed to the beginning of the credit market meltdown) that removed the rule that short-selling could only be done when a stock was rising. Now it can be done when a stock is going up, down or flat.

The up-tick elimination is being blamed for extreme market volatility and for the precipitous fall of Bear Stearns. Traders simply couldn’t have piled on the stock with such effect without it, the reasoning goes.

Lawmakers are at least putting pressure on the SEC to look into it. “Manipulative or collusive short-selling threatens the markets’ integrity,” Rep. Frank said in his letter to the SEC. “Depending on what the Commission finds, this may lead to a broader inquiry into short-selling by the SEC and Congress.”

Source : https://www.forbes.com/2008/04/07/trading-regulation-investing-biz-wall-cx_lm_0407lehman.html?sh=5c434e576bb7