I wonder if the ASX and the key market regulator, ASIC, are watching what the US Securities and Exchange Commission is doing with so-called “naked shorting“: that’s when investors sell shares without owning or possessing them in any way.

The SEC isn’t changing the existing rules on naked shorting (which are ignored in the breach). It’s forcing all traders in the companies involved to possess the shares before a short sale can be made.

Shorting is done here and, in most cases in the US, through stock lending: the seller rents the shares from a custodian or big shareholder who doesn’t needing them, sells the shares and then delivers the stock and the deal is netted out and a fee paid to the stock lender.

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It’s what tripped up margin lender and broker Tricom earlier this year when the shorting in Allco Equity shares went awry and Tricom couldn’t settle on two occasions because the shares involved were tied up elsewhere.

It’s a hugely profitable deal for custodians and others involved in the stock lending. A report in this morning’s Financial Times in London reveals the huge returns made from this dealing:

Conservative fund management firms and custody banks are making billions of dollars from short-selling by lending stocks to facilitate such trades in exchange for lucrative fees.

Even as short-sellers attract blame for driving big falls in financial stocks, financial services firms – including those targeted by short-sellers – are profiting from the investing strategy.

US prime brokerage firms, most of which are owned by big Wall St banks, will reap revenue of $11bn (£5.5bn) this year, according to a recent study by Tabb Group, a research business.

Given that sort of money, it’s no wonder there’s resistance to the SEC move from brokers and others with their noses in the trough. That’s why we have seen reports in the US business media in the past day from some traders in the US share and options exchanges seeking exemptions for market makers from the SEC order, which will be issued over the weekend and start on Monday night, our time.

The SEC is trying to make it harder for traders to illegally drive down stocks of the mortgage buyers and Wall Street firms and prevent another collapse like Bear Stearns Cos.

Market makers on Wall Street say the new rules would make it harder to short shares and would lower liquidity in some stock, but it will in effect cut their revenues from turning a blind eye to traders who were already going through the motions in a charade.

The SEC is also rooting through Wall Street traders of all sizes for details of deals in Bear Stearns and Lehman Brothers and linking those to analysts’ reports and other comments, and examining emails between traders and clients to try and establish if there was an organised attempt to drive down share prices.

If the SEC can make a decision like this and have it start five days after announcing it, why can’t ASIC and the ASX here bring in similar bans here on such short notice?

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Peter Fray
Peter Fray
Editor-in-chief of Crikey
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