Restrictions on Executing Transactions Begin Friday; Egg Firm to Hog Spotlight By HENNY SENDER Staff Reporter of THE WALL STREET JOURNAL January 27, 2005
Cal-Maine Foods Inc. isn't a household name, but the obscure egg company, a favorite among short sellers, is being carefully watched by fund managers concerned about new Securities and Exchange Commission rules governing certain short sales.
Short sellers borrow shares and then sell the shares. They bet the share price will decline and they can then purchase the shares at lower prices to repay the loan. But sometimes shorts sell shares they haven't actually borrowed, a practice called "naked short selling."
Since these short sales stem from nonexistent shares, the trades don't settle. The SEC's rules are aimed at curtailing potentially abusive or manipulative naked short selling by tracking the number of unsettled trades and then imposing limits on trading these shares.
SEC officials say previous rules work most of the time. But when market participants enter into naked short sales on a massive scale, they could have an endless supply of shares and "could drive down the price in an abusive or manipulative way," says James Brigagliano, assistant director in the SEC's Division of Market Regulation.
The new rules, which took effect Jan. 3, are complex. If at least 10,000 shares and 0.5% of the total shares outstanding of any company fail to be delivered for five trading days, they become "threshold securities." If 13 more trading days pass and the situation isn't corrected, then brokers can't execute any short sales for clients until they are certain of having the borrowed shares to sell. The first possible day such restrictions can come into effect is Friday, at which time, the exchanges are expected to place as many as 600 companies on their lists of companies that have short-sale restrictions. The exchanges are required to make the lists of such "threshold securities" public.
These lists would highlight shares in which short sellers are highly active. That, in turn, could prompt other investors to snap up shares of these companies, potentially causing a short squeeze. A squeeze occurs when buying pressure forces shorts to purchase and repay borrowed shares at higher and higher prices.