An Inside Look at How Goldman Lobbies the Senate

"The SEC is holding a public round table Tuesday to explore several issues around securities lending, which has expanded into a big moneymaker for Wall Street firms and pension funds. Regulation hasn’t kept pace, some industry participants contend.Securities lending is central to the practice of short selling, in which investors borrow shares and sell them in a bet that the price will decline. Short sellers later hope to buy back the shares at a lower price and return them to the securities lender, booking a profit. Lending and borrowing also help market makers keep stock trading functioning smoothly."

via SEC Weighs New Rules for Lending of Securities – WSJ.com.

Later on this week I have a story coming out in Rolling Stone that looks at the history of the Bear Stearns and Lehman Brothers collapses. The story ends up being more about naked short-selling and the role it played in those incidents than I had originally planned — when I first started looking at the story months ago, I had some other issues in mind, but it turns out that there’s no way to talk about Bear and Lehman without going into the weeds of naked short-selling, and to do that takes up a lot of magazine inches. So among other things, this issue takes up a lot of space in the upcoming story.

Naked short-selling is a kind of counterfeiting scheme in which short-sellers sell shares of stock they either don’t have or won’t deliver to the buyer. The piece gets into all of this, so I won’t repeat the full description in this space now. But as this week goes on I’m going to be putting up on this site information I had to leave out of the magazine article, as well as some more timely material that I’m only just getting now.

Included in that last category is some of the fallout from this week’s SEC "round table" on the naked short-selling issue.

The real significance of the naked short-selling issue isn’t so much the actual volume of the behavior, i.e. the concrete effect it has on the market and on individual companies — and that has been significant, don’t get me wrong — but the fact that the practice is absurdly widespread and takes place right under the noses of the regulators, and really nothing is ever done about it.

It’s the conspicuousness of the crime that is the issue here, and the degree to which the SEC and the other financial regulators have proven themselves completely incapable of addressing the issue seriously, constantly giving in to the demands of the major banks to pare back (or shelf altogether) planned regulatory actions. There probably isn’t a better example of "regulatory capture," i.e. the phenomenon of regulators being captives of the industry they ostensibly regulate, than this issue.

In that vein, starting tomorrow, the SEC is holding a public "round table" on the naked short-selling issue. What’s interesting about this round table is that virtually none of the invited speakers represent shareholders or companies that might be targets of naked short-selling, or indeed any activists of any kind in favor of tougher rules against the practice. Instead, all of the invitees are either banks, financial firms, or companies that sell stuff to the first two groups.

In particular, there are very few panelists — in fact only one, from what I understand — who are in favor of a simple reform called "pre-borrowing." Pre-borrowing is what it sounds like; it forces short-sellers to actually possess shares before they sell them.

It’s been proven to work, as last summer the SEC, concerned about predatory naked short-selling of big companies in the wake of the Bear Stearns wipeout, instituted a temporary pre-borrow requirement for the shares of 19 fat cat companies (no other companies were worth protecting, apparently). Naked shorting of those firms dropped off almost completely during that time.