Milestones in naked short-selling history
Retail investors want to clean up capital markets, and they just might be powerful enough to do it now. Here are some of the key events that led to the rise of naked short selling in the capital markets, and fueled the fire for everyday investors to work together to combat it.
First short-selling regulations enacted
The Dutch East India Co protests to the Amsterdam Exchange after short sellers make enormous profits on its stock. That leads to the first-ever regulations on shorting in the following year.
Great Britain bans naked short-selling
In 1733, naked short selling was banned in Britain after the fallout from the South Sea bubble of 1720. The difference between naked short selling and the traditional short sale is that the shares being shorted are never actually borrowed by the short seller.
In the case of the South Sea bubble, speculation arose about the South Sea Company's monopoly on trade. The company took over most of England's national debt, in exchange for exclusive trading rights in the South Sea. This led to a rise in its share prices. Shares rose from nearly £130 to more than one £1,000 at its peak. Then the market collapsed. The company was accused of falsely inflating its prices by spreading false rumors about its success.
Securities Act of 1933
The Securities Act of 1933 is passed, creating the Securities and Exchange Commission (SEC) to regulate the securities markets and protect investors.
Securities Exchange Act of 1934
The Securities Exchange Act of 1934, also known as the "Exchange Act", is passed to further regulate the securities markets and protect investors.
The Uptick Rule
After an inquiry into the effects of concentrated short selling during the market break of 1937, the SEC Commissioner implemented the Uptick Rule. The uptick rule is a trading restriction that states that short selling a stock is allowed only on an uptick. For the rule to be satisfied, the short must be either at a price above the last traded price of the security.
The rule was repealed in 2007.
Investment Company Act
The Investment Company Act is passed and restricts mutual funds from short selling.
Birth of the Modern Hedge Fund
Alfred Winslow Jones, a financial journalist, creates the first modern hedge fund by forming an unregulated fund that buys stocks while shorting others to hedge some of the market risk, and thus was born the “hedge fund.”
The stock market crash of 1987, also known as "Black Monday", leads to a significant decline in stock prices. Congress launched an investigation into short selling following the market crash.
DTCC / NSCC Merger
In 1999, the DTCC is created with the affiliation of The Depository Trust Company (created in response to Wall Street’s “paperwork crisis” brought on by a sharp increase in securities trading and the growing number of trades that failed to settle) and NSCC under the single DTCC corporate umbrella.
At the center of securities trading activity, DTCC has a unique vantage point to anticipate and lead change to protect and shape the future of the capital markets.
The DTCC is a private company owned by Prime Brokers, who form a second critical element of clearing and settling stock trades. They include household name Prime Brokers such as Merrill Lynch. Goldman, Sachs, Morgan Stanley, JP Morgan, UBS and others. This is where your brokerage account is lodged.
It has been alleged in hundreds of lawsuits that the DTCC and its Prime Broker owners have abused their monopoly position to create numerous techniques that allow for the creation of counterfeit shares through naked shorting that facilitate stock manipulation by hedge funds.
On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002, which he characterized as "the most far-reaching reforms of American business practices since the time of Franklin Delano Roosevelt." The Act mandated a number of reforms on the back of multiple corporate financial scandals in the early 2000's, enhancing corporate responsibility, financial disclosures and combating corporate and accounting fraud.
Reg SHO Enacted
The SEC implements Regulation SHO (Reg Sho) a set of rules designed to address concerns about naked short selling and increase transparency in the markets. Reg SHO was the first significant update to short-selling rules since they were first adopted in 1938. Regulation SHO's "locate" standard requires broker-dealers to have a reasonable belief the equity to be shorted can be borrowed and delivered on a specific date before short selling can occur.
Overstock files lawsuit
Overstock.com sues research firm Gradient Analytics Inc and hedge fund Rocker Partners, charging that they worked together to spread negative news about the company and drive down its stock price. In a conference call the day after filing the suit, Overstock President and Chief Executive Officer Patrick Byrne claimed the company was in the midst of a conspiracy orchestrated by a "Sith Lord."
Enron CEO testifies against fellow executives
CEO Ken Lay testifies that short sellers met in 2001 to conspire to attack Enron, ultimately bringing it down.
Repeal of the Uptick Rule
The SEC unanimously repeals the uptick rule in June 2007.
Bear Sterns blames market manipulators
Bear Sterns CEO Alan Schwartz testified in 2008 about short sellers inducing a panic and bringing down the firm before the U.S. Senate’s finance committee.
SEC issues emergency order
The SEC makes an emergency order curbing short selling.
Occupy Wall Street
The Occupy Wall Street movement paved the way for the retail investor, launching it a battle cry to be treated fairly and equally.
Deutsche Bank Fined $1.4M for Reg SHO Violations
The Financial Industry Regulatory Authority (FINRA) fined a Deutsche Bank Securities, Inc. $1.4M for violating Regulation SHO, and other supervisory failures. According to the self-regulatory organization, for more than 10 years, Deutsche Bank improperly included securities positions of a broker-dealer affiliate who isn’t from the US in a number of aggregation unit; Deutsche Bank purportedly did this when trying to figure out the net position of each unit.
Merrill Lynch Professional Clearing Corporation settles with Overstock for $20MM in market manipulation case
Overstock and its CEO, Patrick Byrne, accepts $20M to settle market manipulation case, after 9 years of legal battles accusing both Merrill Pro and Goldman Sachs of driving down their stock.
After being dismissed multiple times, their case was reinstated by the court in 2014 after lawyers for the major banks accidentally leaked e-mails about their clients naked short-selling Overstock stock, and the documents of the banks' naked shorting practices were accidentally entered into public record by the banks lawyers.
Naked Shorting in the Supreme Court
The case, Merrill Lynch v. Greg Manning (CEO of Escala) arises from allegations by individual shareholders in Escala Group Inc., that traders at Merrill Lynch, Knight Equity Markets and UBS Securities. He alleged the defendants' naked short selling of Escala’s stock increased the amount of shares on the public market and drove down its stock price among others, engaged in naked short selling to manipulate the value of the stock.
Dole Foods illustrates problems in shareholder system
Naked shorting is brought to the forefront by the Dole Foods case. In the settlement, 4,662 people and entities claimed 49,164,415 shares at $2.74 per share. There is just one problem: Dole had only 36,793,758 shares outstanding. These are probably not false claims. They go directly to the problems with the share ownership system. The first problem is that the Depository Trust Company sometimes doesn’t keep track of shares.
FINRA Fines Cantor Fitzgerald $2M for Regulation SHO Violations
FINRA fined Cantor Fitzgerald & Co. (Cantor) $2M for Reg SHO violations and supervisory failures spanning a period between January 2013 through December 2017. As part of the settlement, Cantor also agreed to retain an independent consultant to conduct a comprehensive review of the firm’s policies, systems, procedures and training related to Reg SHO.
FINRA Fines Interactive Brokers $5.5 Million for Regulation SHO Violations
FINRA found that from July 2012 through June 2015, Interactive’s supervisory system, including its written supervisory procedures, was not reasonably designed to achieve compliance with the requirements of Regulation SHO.
Also, Interactive repeatedly ignored “red flags,” including internal audit findings, multiple internal warnings from its clearing and compliance personnel, its own annual risk assessments, and FINRA exam findings, indicating that its Regulation SHO supervisory systems and procedures were unreasonable.
Robinhood takes IPO to the masses
Robinhood rewrote the rules for going public in its 2021 direct-listing. This gave retail investors much more of its I.P.O. than is the norm, and brought the power of Robinhood's community of small investors to collectively move share prices into sharp focus.
FINRA Fines UBS Securities $2.5 Million for Regulation SHO Violations and Supervisory Failures
FINRA found that, from 2009 to 2018, UBS did not timely close out at least 5,300 failure to deliver positions and routed or executed more than 73,000 short sales in securities with an unsatisfied close-out requirement without first borrowing or arranging to borrow the shares.
UBS’s violations of Rule 204 of Reg SHO stemmed from several long-running issues, including:
- Using revocable volume weighted average price (VWAP) transactions or limit orders to address buy-in obligations for failures to deliver;
- Considering shares released from segregation in connection with customer long sales available to close out a failure to deliver; and
- Certain order management systems not always restricting short sales in securities with an unsatisfied close-out requirement.
Game Stop Short Squeeze
Retail investors were impacted by a series of scandals, including the infamous GameStop short squeeze, after which new regulations were put in place to protect retail investors from market manipulation.
Citadel Securities and other Wall Street Firms accused of illicit trading tactics
In a lawsuit, Northwest Biotherapeutics Inc. (OTC: NWBO) alleged that the market makers had repeatedly engaged in illegal trading tactic, “spoofing,“ where traders place orders with an intent to fool other investors about a stock’s demand and manipulate the price. The company said it found thousands of spoofing episodes involving tens of millions of “baiting orders” over a five-year span, and was able to identify the market participants, Citadel Securities, Canaccord Genuity Inc, Virtu Americas LLC, and others, using trading data.
CEOBloc is born
A group of public company founders, entrepreneurs, traders, and Wall Street veterans band together to combat abusive trading practices and market manipulation. There’s power in numbers. F*ck the shorts.
CEOBLOC members head to Occupy SEC 2023, a peaceful demonstration outside the SEC headquarters in Washington D.C, along with regional offices around the country. The event was organized by ex-marine and popular stock commentator Mike Mynar to give retail investors a platform to demand regulatory action against naked short selling.
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