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Ban On Naked Short-Selling Spurs Stocks

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Ban On Naked Short-Selling Spurs Stocks

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Ban On Naked Short-Selling Spurs Stocks

Ban On Naked Short-Selling Spurs Stocks

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Ever since the Securities and Exchange Commission decided to ban temporarily a practice called naked short-selling last week, the stock market has been rising. Some observers say it underscores how big a menace naked short-selling has become.

ROBERT SIEGEL, host:

This is ALL THINGS CONSIDERED from NPR News. I'm Robert Siegel.

MELISSA BLOCK, host:

And I'm Melissa Block.

We're going to talk now about short selling, naked short selling. First, some background. It's been a bad year for the banking business, but lately there's been a turnaround. Even though yesterday there was a big sell-off in the market, most financial stocks are still much higher than they were a week ago. A lot of people who follow the markets say one reason for the rally was the decision by the Securities and Exchange Commission.

Last week, the SEC temporarily banned the naked short selling of certain financial stocks. And NPR's Jim Zarroli is here to explain. Jim, you're trying to grab our attention on a Friday. Think naked short selling, what is it?

JIM ZARROLI: Well, let me start by explaining ordinary short selling. Let's say that you think a stock is overvalued and is going to fall and you want to make some money, well luckily the financial markets have come up with a way for you to do this. And what you do is borrow the shares from somebody who owns them and sell them. You get some money. It goes into your brokerage account.

Then, later, if your hunch was correct and those shares fall and you go - and you buy new shares, you give them back to the original owner to repay the shares you borrowed, only now you can buy them back cheaper than you sold them for, so you've made a little profit. And that is short selling.

BLOCK: Okay, so that's short selling, what makes it naked?

ZARROLI: Well, remember, when you short a stock, you have to sell it - and this is the important thing to keep in mind. The law says when you sell the shares, you do not have to deliver them to the buyer for three days. So during that period, the shares exist in a kind of limbo. You can buy and sell them again and again.

Now, by law you're only supposed to buy and sell real shares, but the market is huge, regulators have trouble keeping up with this. So if you wanted to, you could buy and sell the same stock hundreds of times. You can buy and sell more shares than exist. It's like creating virtual shares.

BLOCK: Jim, why would somebody want to do that?

ZARROLI: Well, when a stock is already weak, buying and selling it a lot times can cause it to fall even faster, especially when you're dealing with small companies. And that is what you wanted to happen, if you've shorted a stock - you want the price to fall.

Now, companies, especially small companies, have always complained bitterly about this. They say, you know, they come under attack by these naked short sellers who are just out to drive their share price down.

Now, I talked to a man named Paul Metzinger, who is president of a small microelectronics company in Colorado, which was called NanoPierce Technologies. And he went through this, and here's what he had to say.

Mr. PAUL METZINGER (President, NanoPierce Technologies): I have no doubt in my mind, based upon prior records, that we had prepared and obtained that naked short selling certainly occurred in our stock.

BLOCK: And Jim, how did he know?

ZARROLI: Well, he can't know with absolute certainty, but the thing is he says about five or six years ago, after the dot-com bubble burst, his stock was falling. And he began to notice just a huge volume of trading in his shares that just couldn't be explained in any normal way. And he really believes that naked short sellers were at least partly responsible for that. He says it hurt his company, because when the stock fell, it became a lot harder for him to get loans. Here he is again.

Mr. METZINGER: As a result of that, in order to keep the company going, we had to go to our family, our friends, our immediate business colleagues and people like that to get the money to keep the company alive. 'Cause it just effectively shut the doors on going to institutions to try to get money. So, it's a really vicious circle that you can get caught in. It's just like a whirlpool.

ZARROLI: Now, people who study this kind of thing say that naked short selling has really just ballooned in the past decade because we - because of the way hedge funds have grown. And they short stock in huge numbers. Of course, no hedge fund is going to admit that it does this because it amounts to stock manipulation - which, you know, is illegal.

BLOCK: And we mentioned at the start that the SEC has taken some action. What did they do?

ZARROLI: Well, the SEC explicitly banned naked short selling for shares of Fannie Mae and Freddie Mac and some financial stocks. And it focused on them because they have been falling so much lately, and a lot of people thought naked short sellers were pressuring them. Not everybody agrees with that. But the fact is these stocks have come back. There may be other reason for that. There are good earnings reports.

But whatever the reasons, the SEC now says it wants to make naked short selling sort of harder to do across the stock market, and a lot of people stay that's a good thing.

BLOCK: They're making it harder to do - Jim, is it, in fact, illegal all the time to naked short sell?

ZARROLI: You know, it's a complicated issue. It is illegal to trade shares that you do not own, that don't exist. I think the SEC has traditionally viewed this as a kind of a paperwork problem, except when it's used for stock manipulation, and then it becomes a much bigger problem. So I think the - what the SEC now is doing is just kind of taking steps to make this explicitly more illegal than it's been in the past.

BLOCK: Okay. NPR's Jim Zarroli, explaining the ins and outs of naked short selling. Jim, thanks so much.

ZARROLI: You're welcome.

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