The steep fall in prices of several US investment banks and financial institutions, such as Bear Stearns, Fannie Mae and Freddie Mac have been attributed to false rumours leading to panic selling, which has been further exacerbated by “naked” short selling. This has necessitated emergency action on the part of the Federal Reserve to rescue these institutions.
“The measures are the S.E.C.’s second attempt in less than a week to combat market manipulation, and they will make it harder to short the stocks of 19 financial institutions, including brokerage firms like Lehman Brothers and Morgan Stanley.
Short sellers borrow shares from brokers or institutional investors and sell them, hoping to buy them back later at a lower price and profit from the difference. The order aims at so-called naked short-selling, or selling shares short without first borrowing the shares or ensuring that they can be borrowed. The commission’s 30-day emergency measure aims to make abusive naked shorting harder by holding the brokers — or anyone involved in processing a short sale — responsible for any failure to deliver the borrowed shares within a mandated three-day period.”
Short selling was introduced in India a few months ago, as we had discussed in detail in an earlier post on this blog (which also sets out the various concepts involved in short selling). It is interesting to note that the Indian regulations on short selling are somewhat more conservative compared to the position in the US. In India, SEBI permits short selling only when transactions are settled through delivery of shares; in other words, naked short sales are prohibited to begin with. Such a cautious approach of the Indian regulators may aid in such situations where instruments such as “naked” short sales are used by market participants to benefit from fall in prices induced by rumours and false information.