Thursday, September 18, 2008

Ban the automatic loaning of customer long positions to short sellers

I despise short selling as much as any bullish investor, but I think the optimal solution to short-selling abuses (e.g., naked short selling) is for the SEC to ban mutual funds and pension funds and insurance companies from loaning stock to short-sellers and to ban brokerage firms from automatically loaning customer long stock positions to short sellers without their explicit permission. How many mutual fund shareholders or employees represented by pension funds or customers keeping stock in their brokerage accounts are even aware that it is they who are the suppliers of stock that short sellers are selling short??!! Brokerage firms, mutual funds, and pension funds are supposed to be operating with a fiduciary duty to protect the interests of their customers but they are failing to do so. Fix this fiduciary duty problem and short sellers will instantly become a very minor force in the market rather than the tail wagging the dog that they currently are. It really is this simple.

One pragmatic logistical change which would help correct a lot of short selling abuses would be to go to T+0.0 settlement rather than the current T+3 settlement. Rather than giving short sellers a 3-day free ride to come up with borrowed shares, force them to cough up the borrowed shared up-front before the short-sale transaction can even be requested to be executed. T+3 is not needed these days and is a dog's age in today's computerized stock market. Even T+0 settlement (by the end of the trading day) is insufficient to deal with naked short-selling. T+0.0 settlement is needed and it is needed... yesterday.

These two changes would literally solve the current systemic problem with short-selling without preventing short-sellers or the beneficiary owners of long stock positions from engaging in stock loaning and short-selling if they so choose.

I find is horrifying and reprehensible that a brokerage firm is permitted to loan a customer's stock without the customer's explicit, up-front, opt-in permission to short sellers, and without any notice to the customer that it may or has been done. Opt-out would not be sufficient. It needs to be opt-in and without any onerous penalty for refusing to opt in.

Why the silly Democrats are not jumping up and down and loudly proclaiming this need  to get rid of this automatic opt-in and irresponsibly loaning by mutual funds and pension funds and insurance companies is rather baffling, other than simply that, as the saying goes, "they don't get it."

-- Jack Krupansky


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