When the news about the SEC’s emergency order to stop “naked short selling” started leaking out yesterday, I was on the phone with Muriel (Mickie) Siebert discussing the Short Sale Uptick Rule that was lifted one year ago. I definitely had the right person on the phone at the right time. Siebert, renowned for being the first woman to own a seat on the New York Stock Exchange and also for founding the discount brokerage Siebert Financial Corp., was against the removal of the Uptick Rule last year. She believed then that it stripped companies of protection against short sellers and still believes it should be put back in place. [The Uptick Rule said you could not short a stock until there was an uptick in its price, preventing a free-for-all downward spiral of the stock.]

Although only limited information on the new rule was available as we spoke, at first blush Siebert felt it was equally problematic, but for different reasons.

The emergency order was put into place to protect certain companies from naked short selling, which, because it allows investors to short a stock without first borrowing the stock, can be done very quickly and, in practice, in reaction to market rumors. [Generally, when you short a stock, the investor borrows a stock and then sells it at a certain price, expecting to buy it back at a lower price. The arrangements to borrow the stock are made in advance of the selling of the stock.]

The new rule could specifically protect the market against investors reacting to rumors by shorting the stock of the companies in question, thus fueling the rumors' fire and possibly leading to a domino effect. For example, after a negative report came out about Freddie Mac and Fannie Mae on July 7, their stock plunged 55 percent. Further rumors surrounding the companies’ longevity adversely affected their stock — a perfect opportunity for naked short sellers to pound it even further, and the predominant reason the SEC instituted the emergency rule.

The emergency rule, which is only in place for nine days, applies to 19 companies: Fannie Mae, Freddie Mac, BNP Paribas Securities Corp., Bank of America Corp., Barclays PLC, Citigroup Inc., Credit Suisse Group, Daiwa Securities Group, Deutsche Bank Group AG, Allianz SE, Goldman Sachs Group, Royal Bank ADS, HSBC Holdings PLC ADS, JPMorgan Chase, Lehman Brothers Holdings, Merrill Lynch & Co., Mizuho Financial Group, Morgan Stanley and UBS AG.

Why doesn’t Siebert think it's fair? She explains, “I don’t think it’s fair to apply this to just a few companies and not to all companies. If they do it in one stock they should do it in all of them.” However, Siebert acknowledges that she would have to hear more about the rule to make a judgment.

This is the first time the SEC has acted so quickly to enact a rule. Many have noted that it is unprecedented: More often than not it takes months or years of studies and comment periods before a rule is put into place.

Siebert on the Uptick Rule

And that’s exactly what Siebert believes the SEC should do regarding the Uptick Rule. “The SEC is really the only organization that can study the outcome and act,” she says. Siebert believes the SEC should look at the past year to review the results of removing the Uptick Rule last July, and notes that she would have liked to have seen the SEC do more research before removing the rule then.

Siebert says, “I had heard rumors about Bear Stearns that Friday [referring to March 14, 2008, the day the firm was sold at a record low price to JPMorgan], and I have heard rumors, real nasty ones, about Lehman, and now Fannie Mae and Freddie Mac. These guys [creating the rumors] have one purpose in mind — to make money. And we are in a market where rumors work superbly.” If the Uptick Rule were in place, she suggests, these rumors could have less of an impact on the market.

Same Day Reporting of Short Sales

Another thing Siebert feels passionately about is the need for same-day reporting of short selling. Today the exchanges only report short sales bimonthly. Siebert asserts, “We need more transparency in the markets.” She acknowledges the great strides the market has made with regard to technology and information flow; however, when it comes to information on whether a company’s stock is being shorted, she notes, that information takes two weeks to be made public.

“If you could see the short sales every day, it would have more of a fairness to it, because if you owned the stock or were thinking of buying the stock, you would know the stock is going down because of the amount of short selling — or at least it is one of the reasons for the selling of the stock,” Siebert says. She adds that being alerted to short selling doesn’t mean a holder of that stock is not going to lose money, but having more information arms stockholders to make better decisions. “It changes your thinking,” she says.

Siebert gives an example of how such transparency could change a person's "thinking": Shorting a stock can only be done if there is stock available to be borrowed, and a firm is not allowed to loan a stock out unless the stock is in a margin account. She explains that if a large owner of a stock had 1 million shares in a margin account and then saw the stock being pounded by short sellers, that owner could take the stock out of the margin account and put it into the cash account, making it unavailable to be borrowed and subsequently shorted. This scenario would only be possible if there was daily or intraday reporting of short sales, however.

Siebert adds that the U.K. recently passed a law requiring that if someone shorted more than one-quarter of 1 percent of a stock’s total volume, that person would have to report the short position by 3:30 the next day. “Then you can say the next day that X percent of yesterday’s trading were short sales. If you owned a stock and you saw your stock was being pounded, you would know if the person selling was someone who was long on the stock and had done their research and had a good reason for selling or ... if it was a short seller acting on rumors," Siebert notes.

Finally, Siebert warns against the damage that short selling can do. “If you want to take advantage of a stock and you can borrow enough stock, you can do it. You can influence major companies. You don’t need a thin stock, but if you have a thinly traded stock, you can really do a job on it. You can control the market if you have a good short position," she says.

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