Distort and Short: Naked Short Selling Restrictions
Distort and Short campaigns have been thrust in the spotlight as of late with the American Bankers Association asking that the SEC more heavily regulate the short selling rules. Distort and Short is the name given to a strategy that investors short a stock, that is sell shares with the hopes that the price will fall, and then distort news such that the share prices do fall. Market manipulation is illegal under SEC rules but it’s often difficult to determine what is considered manipulation. Is the act of short selling an act of manipulation?
The reason why the ABA is involved is because the practice has been involving banks lately.
“Bank customers frequently – and incorrectly – equate significant drops in bank stock prices with safety of bank deposits,” Sarah Miller, an ABA senior vice president, said in a letter addressed to the SEC.
As traders short stock, the stock prices fall and bank customers believe their money is in jeopardy. If the IndyMac fiasco was any indication, when customers waited in line for hours to withdraw funds that were perfectly safe, the average customer doesn’t realize that the two are not at all related. However, if the share price sinks and then the bank faces a liquidity crisis because customers demand their funds, it could spiral out of control with the ultimate winner being the short trader.
The specific short selling technique being targeted is naked short selling, when you sell shares you don’t currently own. As of right now, the SEC prevents naked short selling on Fannie Mae, Freddie Mac, and 17 Wall Street firms in order to calm down the markets. That order expires AUgust 12th.