Please take a moment to read the above statement.  What you see there is not what it says.  SEC Chairman Cox says that they are to maintain stability and prevent securities fraud for the most part.  But what I see here is an admission on their part, that this 74-year old government institution was asleep at the wheel.  But I really can only point my finger at it's Chairman, Christopher Cox.

Appointed by Bush in 2005, the Orange County Republican should have acted quicker.  Often the market, in its herd mentality that so can encompass it at times, will judge it by price action.  A company could have good fundamentals, yet hit a patch of bad news, and the stock could get trounced.  Sometimes this is warranted, say in the case of Enron, and then you have situations where really the market has over done it.  I've seen shares slide at least 10% if a company reports earnings off by a penny by estimations.  It doesn't matter to the short sellers, to them its a reason to sell.

A Quick & Dirty Guide to Short Selling

But who are short sellers, and what is short selling?  Basically, short selling is selling shares of a company first at a high price and (hopefully) buying it back at a cheaper price.  In the end, you hope to pocket the difference between the two prices.  But, as I'm often asked, how can someone sell something they don't own?  Normally, what happens is you issue a sell order with your broker, and they are supposed to find stock sitting either in their own books or that of a client's portfolio.  They loan you the stock to sell, in return you are forced to put up margin.  Margin is, for securities, cash (or a t-note) in excess of the value of the stock you are shorting, normally 150%

Example:

You think GOP Corp is way over priced at $10 a share, you think it's worth $5.  In order to short GOP Corp, you need to have $15 per share that you are going to sell.  So if you short 100 shares of GOP Corp, you will need $1500.  That 150% number may be different with your broker, it could be higher, but I've mainly seen 150% for retail customers.

On top of this, you may be charged an interest rate, because to the broker, it's like loaning you money.  Depending on much business you do with the broker and how credit worthy you seem to them, the rates could be next to nothing to some crazy amount.  But what about that person whose shares you borrowed?  Ah, now we get into some interesting territory. Two things could happen, a bad news and a good news item.

Say some bad news comes out, CEO Rove is indited with embezzlement or something.  The shares now start to plummet, say to $8.  The person whose shares you borrowed wants to sell now. The broker has no choice, unless they have shares in their books to give to that customer, so they make you close out your trade.  Yes, you may have made some money, but you didn't meet your objectives.  But it's the next scenario that's the nightmares of short sellers, the "short squeeze."

Short squeezes occur when a stock has gotten so low, and the short interest so high, that some good news...really anything, causes it to pop up.  Say you shorted 100 shares of Liberal Group at $10, but good news comes out.  Suddenly, Liberal Group is up to $12!  The guy who you borrowed from wants to sell, and you now have to give him back his shares.  You see where this leads?

Now, getting back to the main story.  We get to something call "naked short selling."  Today's big move to make it harder to short a stock by the SEC centers on such a thing.

In a dramatic emergency order, the SEC said it would immediately move to curb improper short selling in the stocks of struggling mortgage giants Fannie Mae and Freddie Mac, as well as those of 17 financial firms, including Goldman Sachs Group Inc., Lehman Brothers Holdings Inc., Morgan Stanley and Merrill Lynch & Co.

- excerpt from "SEC Moves to Curb Short-Selling", WSJ.com

What if I told you, that short selling was being done, but that now shares were being borrowed?  Crazy, not possible.  Oh but it is, well sorta, but folks like you or I can't do this.  No, instead we see folks like the managed funds and other institutional investors doing this.  What we have here is that they are issuing sell orders, that get accepted, yet have not found the shares to borrow.

Let me correct myself.  What happens is, the brokerages who work with the hedge fund types put a little faith on their customers being able to come up with the shares.  I mean you don't expect Goldman Sachs or some other elite trading group not to be able to get some shares.  A second common incident also happens when you see short selling.  The same shares get borrowed again and again.  In an odd way, it would be as if I borrowed a coffee cup from you, then I loaned it to a friend who then lends it to a friend and so on.  Now you want that coffee cup back, now I have to go find it.  Almost the same thing here, you could have a bunch of hedge funds borrowing that same stock, now you get a short squeeze and you end up in a crazy situation.  

It's this amplified effect of borrowing that stock that can cause a stock to drop so fast. The Asks will outnumber the Bids by a huge amount with share orders far larger than the other side.  You could be looking to buy a stock, say you do it online which is easy to do, and on that broker's site you'll see a price.  But is it a good price?  And how do you know if there is selling pressure?  The last thing you need is for the price to drop after you buy the stock!

When you get a chance, I want you all to bookmark a site for me, its from the New York Stock Exchange's Archipelago online exchange.  What I want you to see is what they call "the book."  No, it's not a book with pages, what it is a roster of buyers and sellers.  Everyone should know what "the book" is if they intend to buy a stock.  Now when you go to that site, click on "Open Web Book."  You have a choice of a java or html version, and a popup will happen.  In it put in whatever stock symbol you fancy, like GE or IBM.  The screen is divided up between the Bids and the Asks, basically Buyers and Sellers.  

My apologies, I had intended to use one from Arca, but the markets are closed and what with a family emergency, could not do this piece in one shot but sporatically; once again, sorry.  But the above example actually isn't that bad at all.  It is the book from the Chicago Mercantile Exchange's gold trading.  Yes, I'm aware that the preeminent gold pit is in New York, but they don't give out the book for free. Anyways, as one can see, you have an array of prices for both buyers and sellers.  What you should pay attention to, for right now, is the top prices, this is what you will deal with if you put in a market order.  Those who trade off of the book will try and guage the deph of the market, that is add in several rows of bids and asks.  Looking at that graphic, you see that the first three rows for the Buyers has 12 (5+3+4) and the Sellers has 7 (2+2+3).  For the sake of time and simplification, the bids/Buyers outnumber the asks/Sellers, and thus you have buying pressure.  I hope you can see how the selling pressure could begin to mount.  Now in case you're wondering, those numbers are for contracts, for example "12" represents twelve contracts of gold.  In that link I posted, the numbers would represent shares of 100.

Getting back to Today's announcement

Already, those on "the Street" are saying either it's about time or that the SEC is over stepping its bounds. To call it an "emergency action" which expires in 30 days, is stupid in my opinion.  Franklin Delano Roosevelt created the Securities and Exchange Commission to prevent fraud and market manipulation FROM HAPPENING.  But instead, what we have is the market equivalent of Naomi Klein's Shock Doctrine.  

Chairman Cox should have pounced on the naked short sellers when they abused their priviledges.  For example, Bear Sterns, had the selling pressure been eased more early, do you think JP Morgan Chase would have gotten it for $2 (considering that it was $80 a year or so before)?  And the SEC has to clarify it's rules on naked short selling.  It's either illegal or it isn't.  

Although the vast majority of short sales are legal, abusive short sale practices are illegal. For example, it is prohibited for any person to engage in a series of transactions in order to create actual or apparent active trading in a security or to depress the price of a security for the purpose of inducing the purchase or sale of the security by others. Thus, short sales effected to manipulate the price of a stock are prohibited.

- excerpt from "Division of Market Regulation: Key Points About Regulation SHO", SEC.gov

Naked short selling is not necessarily a violation of the federal securities laws or the Commission's rules.

- - excerpt from "Division of Market Regulation: Key Points About Regulation SHO", SEC.gov

Now I ask you, taking these two tidbits from the Securities & Exchange Commission, would you be a bit confused? From the previous section on short selling, you can see that selling pressure can build.  Short interest, that is the percentage of shorts compared to the shares outstanding, can weigh heavily on a stock. Hedge fund managers who could be holding Put options on a stock (Put Options are contracts that give one the right but not the obligation to sell something at a specific price) could try and slam the stock through naked short selling.  

Though stock manipulation is illegal, in this day and age it still goes on to a certain extent.  A hedge fund could buy Put options on a stock in the US, and have a dummy company registered in Europe short the stock.  I can't think of the name of the company (Bondad or Jerome, help me out here), but that exact same thing recently happened this past decade.  

Short sellers aren't evil, and short selling isn't wrong.  Indeed, it is a necessity sometimes.  But it should be regulated.  Eliminate naked short selling, and bring back the uptick rule.  For the uninitiated, the uptick rule stipulated that one could not short a stock if the last price was down, they had to wait for the stock to inch upwards to sell it.  The uptick rule was developed after the 1987 stock market crash.  Why?  Because short sellers, mainly naked ones, kept pounding the market down further.

I'm glad this government is finally doing something.  Alas, I think they are too late, and have done very little.  This is another example of the Bush Administration's incopetence. And the market knows this, the VIX, or Volatility Index has stayed above 18 for a while know because market makers know we could be heading southward.  This new "authority" they granted only lasts 30 days.  My question is, what will happen to the market after 30 days?