Exclusive Online Only ContentSEC Emergency Orders Inhibiting Securities Lending
September 23, 2008
The Securities and Exchange Commission’s recent flurry of emergency orders limiting short sales are testing broker-dealers’ operations departments, and penalties expected to be levied on firms that have failed to deliver securities are disrupting the stock lending market.
Since Sept. 17, the SEC has issued several orders designed to return stability to the market following Lehman Brothers’ bankruptcy, the Bank of America Corp. deal for Merrill Lynch & Co. and the federal bailout of American International Group. Regulators have expressed concern that unbridled short selling, especially by traders selling short without borrowing the security--so-called naked shorts--could bring down more Wall Street titans. However, the mandates were issued without warning, frequently leaving brokers with hours to implement systems changes and no time for testing.
“There’s been no comment period and no opportunity for input from people who actually have the operational experience,” said Peter Allman-Ward, EVP of Wedbush Morgan Securities, a Los Angeles-based clearing firm.
Allman-Ward noted that most broker-dealers test IT systems changes before making them operational, to ensure that there are no adverse effects on other systems or those of their users. But over the last week, the commission has issued order amendments that became effective almost immediately.
In a press statement released the morning of Sept. 17, the SEC announced an emergency rule--subject to a 30-day comment period--requiring short sellers and their broker-dealers to deliver securities by the close of business on the third day after settlement (T+3), and imposing penalties for failing to do so. But the actual rule, issued that evening, imposed on broker-dealers the additional requirement of closing out all failures to deliver to the National Securities Clearing Corp.’s continuous net settlement (CNS) system by T+4, either by buying the stock in the open market--a buy-in--or borrowing it. Until the fail is resolved, firms cannot allow short sales in that stock without a “pre-borrow.”
Allman-Ward called the initial step “positive” because it acknowledges delivery failures as the naked-shorting problem, rather than short selling itself. In the rule, the SEC recognizes that not all fails stem from naked shorts and provides leeway for inadvertent fails. However, since determining the cause of delivery failures may be difficult under a T+4 deadline--Sept. 24 for transactions initiated Sept. 18, the rule’s effective date--securities lending has become far more challenging.
“Wedbush found few counterparties on Monday who were willing to lend, probably so they can retain their securities to reduce their own potential amount of CNS fails” on Sept. 24, Allman-Ward said.
On Thursday afternoon, the SEC issued another order, temporarily prohibiting short sales for 797 financial services stocks--starting at one minute before midnight--until Oct. 2. Later, however, it stated that the ban applies to 799 securities. Allman-Ward said Wedbush’s technology team finished updating their system at 11:00 a.m. on Friday, and “wasted an hour looking for the missing two securities.” Later that day, the Securities Industry & Financial Markets Association issued a clarification, noting that the ban applied to the stocks of firms listed in appendix A of the emergency order.
It became clear, however, that SEC staff had overlooked several financial services firms, and on Sunday it issued an amendment that, effective with Monday’s market opening, gave the exchanges listing the securities the ability to add more names. NYSE Euronext added 30, including General Electric Co., CIT Group and Legg Mason, while Nasdaq added 66, including numerous regional banks.
