Shorting a stock? How to prevent it?

Posted by The Otter Way on January 31, 2010 (12:19PM)

As a owner of several shares in various stock symbols, I must assume that I really don't own these positions (long) unless I ask for a stock certificate.  I also must assume there really is no action on my part that can prevent my shares from being shorted except for the physical certificate of ownership... and in saying this... I'm not even sure of that...

I raise these questions because I believe from a retail investor standpoint... that shorting is not an event that enhances my position in a particular symbol.  I derive no benefit directly from someone taking an opposite position, using my shares, and selling them, and promising to pay back those shares at a later time... It truly allows someone else to profit from my undeclared long position (certificate)...  It also seems funny that I must ask for a certificate as well as pay for a certificate.

If someone, without my permission, utilizes my position and trades on those... why am I not entitled to share in the profit from this event... there must be some small print in the sign up pages allowing or telling an investor that your shares are not really your shares...

I truly believe this is one area where reform needs to take place... Shorting without direct consent is allowing the house to have better odds at the expense of the player...

Does anyone within TK know of a way to prevent shorting outside of the certificate?

Posted by AlphaKing on February 01, 2010 (02:46AM)

If you signed the Margin Agreement, then you've granted TradeKing the right to re-hypothecate your shares.  See section--Loan or Hypothecation of Securities--on page 4 of the Margin Agreement.

http://content.tradeking.com/wiki/download/attachments/1819/Margin+Agreement.pdf

Such re-hypothecation is a source of revenue for the broker-dealer (BD).  Per regulatory guidelines, BD can re-hypothecate (lend) eligible securities to third parties in exchange for 'collateral.'  In the process, both parties will incur margin expenses and the borrower (short seller) may pay an additional 'hard to borrow' fee. Assuming retail investors, institutional or proprietary parties would be a different story. 



For further reading, reference SEC Rule 15c3-3.  Some particular sections of interest are the following:

a-5: Defines Excess Margin Securities to be those with market value in excess of 140% of one's debit balance.

b-1: Requires that BD obtain and maintain physical possession or control of all 'fully paid' and 'excess margin' securities. 

Per a-5 and b-1, those securities that represent up to 140% of one's debit balance may not be 'maintained' by the BD.  The BD could, at its discretion, lend such securities to a third party in exchange for collateral.  Hence, one would receive 'payments in lieu of dividends' as opposed to 'dividends' for these securities because what you really own isn't 'securities', but rather 'collateral in lieu of securities'.

b-3iv: Stipulates that SIPC protections may not apply to securities hypothecated  by the BD.  The collateral may be the only source of satisfaction for the lender in event of BD's failure to deliver.

http://www.law.uc.edu/CCL/34ActRls/rule15c3-3.html



Note, TradeKing is merely the 'introducing broker' while Legent Clearing LLC is the 'clearing firm.'  Of interest might be Legent's most recent 'Statement of Financial Condition', which can be found here:

http://www.legentclearing.com/pdf/SFC_6-09_audited.pdf

Particularly, take a look at Section 3: Receivable From and Payable to Brokers, Dealers, and Clearing Organizations.

Posted by incubus on February 01, 2010 (01:16PM)

If you're confident on your stock and another party chooses to play it the other way, all the better for you when the other party covers as it rises, the cover moves the price up even more.
Some strategies incorporate buying stocks with high short interest for that reason, short squeezes are frequently violent and often trigger a trend reversal to the upside for the stock itself, much of the rally since March is attributed to shorts covering when many were convinced it was doomsday and went short at the bottom.

Posted by AlphaKing on February 02, 2010 (12:27AM)

The short answer to your question is: a cash-only account.  Albeit, your securities will still be held 'in street name' and 'comingled' with others.  As a retail investor, one can't escape counter party risk!

Posted by PRDinvestments on February 02, 2010 (02:18AM)

Maybe the reason these brokerage fees are as low as they are is because we allow them to short our shares (if we have margin accounts like  alphaking pointed out)
So maybe we are being reimbursed for them using our shares to short by having our transaction costs lower.

I'm assuming margin rates would be  worse if we opted out of allowing them to short our shares. 


So maybe you aren't getting direct benefit, but we are getting a multitude of indirect benefits.

Posted by BeretDude on February 02, 2010 (04:12AM)

Who cares?    LOL


Happy Trading...with your shares or someone else's   /:)

Posted by AlphaKing on February 02, 2010 (04:40AM)

I should expand on the final section, concerning Legent.  Citing SEC Rule 15c3-3:

k-2ii: Stipulates that the aforementioned regulations do not apply to the 'introducing broker' [TradeKing].  The 'clearing firm' [Legent] is the party responsible for compliance with all applicable regulations.


One can research Legent's 'regulatory event' history with FINRA here:

http://brokercheck.finra.org/Search/Search.aspx

Select 'Brokerage Firm' and enter 'Legent' - any of the three variants found represent the same entity, select one.  Then select 'Get Detailed Report' to view the report.

Additional information forthcoming...

Owl001_thumb Brokerage Account

Posted by Owl on February 02, 2010 (03:16PM)

Ditto on what Incubus said. Also, I doubt that any of us own large enough quantities of stock that preventing the lending of our individual shares would actually make a noticeable impact on the market.

Short selling is good for the market. It keeps prices realistic, preventing them from getting too high. It enables the market to include the opinions of both bears and bulls in the current prices.

Posted by dieuwer on February 02, 2010 (07:50PM)

Have a cash account. Legally, stock held in a cash account cannot be borrowed by the brokerage to lend to short.

A trick to be able to short stocks yourself, while making sure that other people cannot short your stocks, is to have TWO brokerage accounts:

1) cash account holding stocks
2) margin account holding just cash

Posted by jb77 on February 03, 2010 (02:36AM)

First, I'll admit, shorting does little good for long-term investors(beyond reality checks, most of which, permabulls hate). With small caps, whole different story.. manipulation is perhaps too easy. Anyway, shorts must eventually cover, so there will be some rebound- if the company is strong fundamentally. Who chickens out first(long or short?), who holds too long due to their stubborn-ness, etc. is all part of the game.

From a practical standpoint- it exists, deal with it. My suggestion- set an arbitrarily high limit to sell, just as an example, $700 for GOOG. TK won't lend out your shares- why bother when the short seller will have to cover in 3ish days if your order fills soon? Perhaps the bigger issue would be finding more shares to borrow.. always easier to borrow from TK accounts(as opposed to going to a competing broker to borrow- the short shares MUST be possessed by TK by the time the short settles). It's not 100% foolproof but your shares will be last in line to be shorted if they have a sell limit. ---My rationale: I've read this in several forums online, can't seem to find any absolute confirmation.. but this is as close as you'll get to "protecting" your shares.

Flipside to shorting: if your stocks are looking weak, maybe sell some off and buy back at a lower price.. you're not shorting but you're limiting exposure to losses.

And lastly, there's no way to prevent naked shorting, It'll happen, incidentally or accidentally.



Posted by The Otter Way on February 03, 2010 (11:06AM)

Thank you all for your opines... Shorting does add a way of keeping prices in check; yet I find it so distasteful helping others by providing the very same ones who profit from shorting a stock with my shares....

I see by regulation my idea of preventing a short on my existing stocks to be mute...

Posted by OldFart on February 07, 2010 (01:40PM)

Interesting paper on how short sellers gain an informational advantage

  • Abnormal short selling predicts lower future returns, with the effect largely concentrated around news releases (and perhaps insignificant in the absence of news). In other words, consistent with the interpretation that short sellers are good information processors, the most informative short sales are in response to news.
  • Any systematic elevation in the ratio of short volume to total volume occurs after news stories (there is no evidence of anticipation of adverse news). On average, short sellers appear to trade on publicly available information.
  • The most profitable short sales are not by market makers, but by speculators (other traders).
  • The ability of short sellers to predict returns concentrates in six news categories: divestitures or asset sales; earnings; earnings projections; management issues; new products and services; and, stock ownership. For these categories, short sellers tend to trade relatively late, confirming a reliance on public information.
Paper - http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1535337

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