Tag Archives: short selling

Campos vs. Asensio: More on Short-Selling and The Uptick Rule

This past Tuesday afternoon, April 7, Bloomberg News featured two prominent figures in the world of finance to discuss and debate the SEC’s proposed reinstatement of the traditional uptick rule, or the imposition of a modified version. It sure was a showdown in the world of market regulation. Here’s the recap and analysis…


In the Blue Corner arguing in favor of the uptick rule, we have Roel “Jor-El” Campos -Former SEC Commissioner, and advocate of more regulation in the area of naked short-selling.

In the Red Corner arguing against the uptick rule (and, it turns out, any and all short-selling restrictions of any kind) we have Manuel “Lex Luthor” Asensio – Managing Director of New York based Hedge fund, Millrock, (and best Lex Luthor look alike I’ve ever seen!)


Slightly resembles Campos, No?

Slightly resembles Campos, No?

Campos does a great job of actually explaining what the uptick rule is and, later in the interview, the difference between legal short-selling and illegal “naked” short-selling. In case you missed it, the uptick rule or uptick “test” would mean “that a short sale [order] cannot be executed [in the market] unless there is some evidence…[by either] a price test or a bid test…as to whether the stock is rising.” Essentially, this means that stocks can only be shorted when they are actually going up at the moment you place the short sale order. He also explains that the uptick rule is a bit of “Chicken soup,” meaning it’ll make the activists and congressional members that have pressured the SEC about it feel a little bit better about the prospect of abusive short-selling being less prevalent in the markets. However, with the markets as computerized as they are today, and with more advancements on the way, it’s still very easy for savvy, sophisticated, investors to “manipulate the tape” – create the appearance that a stock is experiencing buying or selling pressure by placing strategic large orders on the order book – and still get away with the type of dubious activity that the uptick rule is essentially looking to at least hinder. So, Campos actually even concedes to what he also believes as fact, that even restoring the uptick rule or something like it really won’t do much in the way of stopping illegal short-selling activity.

In response, however, Asensio starts off throwing wild accusations at Campos. He references a letter Campos wrote supporting the regulation of short-selling by imposing the uptick rule or some modified version, which was supported by many “main street companies.” Asensio says these companies that Campos represents are “very questionable companies…that should be the targets of the investigations themselves.” He then calls for more deregulation of the markets in regard to short-selling, stating “there is no economic reason why America should cause and force short-sellers to borrow stock.” He tries to make all short-sellers look like they are all some kind of investment superheroes that short stocks purely for the purposes of stopping price manipulation on the upside and to discover true price parity, or the true value of a stock. He even advocates for the legislation of whistleblower protection for members of public companies that are sued by those companies for blowing the whistle, and tries the old guilt-by-association tactic of trying to say Campos “represents” these types of companies. This guy is some piece of work, but if you keep an eye out for the signs and read between the lines, it’s very easy to see the wolf in sheep’s clothing.

Asensios a dead ringer!

Asensio's a dead ringer!

First of all, I’ve been searching for this supposed letter by Campos, which is supported by these “questionable companies,” and I haven’t been able to come up with much. The two that are fairly recent and deal most directly with the issue at hand that I did locate, can be found by clicking the links in this sentence. But neither really mentions nor is endorsed by any public companies…unless Asensio was talking about the companies through which the letters were published? That doesn’t make much sense either though. So, what underhanded, “questionable” organizations is he talking about? To be honest, I don’t even think he knows what companies he’s trying to implicate by saying that. His entire performance is nothing more than the typical cloak and dagger tactics you would expect from a perfidious, villainous, Lex Luthor-ian salesman, especially now, and especially in the finance industry. Is it really a wonder why we are in the mess we are in right now with guys like this running hedge funds?

Secondly, the calmly arrogant demeanor that Asensio maintains throughout the interview is simply an extension of this surreptitiously evil mind trying to maintain this bogus façade of nobility and humility, trying to lure the viewer into seeing it his way, or at least see that he is perhaps much more credible than he obviously is in reality. Saying that short-sellers shouldn’t have to borrow any stock at all and should be able to sell shares at will with absolutely no regard for the downside and the possibility of that trade going against them, is just like saying buyers shouldn’t be forced to actually pay for the stock they buy, and should be able to buy at will. If this were truly allowed to happen, the current economic recession would feel like utopia compared to the economic situation we would be in as a nation if Joe the Plumber and his band of brothers could actually participate in the market without having to actually pay for any trades that went against them. The market would have dropped to 0 if these were the rules for investing, because once the market started to drop from 14,000+ in October 2007, no one would have paid for their trades! Anyone that pretty much bought stock from then through November 20th 2008 – some until March 9th of this year – has been losing money on that trade every day since they bought it! Why the fuck would you pay a trade they were down in by 2, 5, or 10% by settlement, especially if they didn’t have to? NOBODY!

Finally, it’s obvious that borrowing is what got not just us but the entire globe into this trouble in the first place. The fact that on many stocks, mostly very volatile ones, the extent to which you have to “borrow” (to cover for settlement) is as high as 75-80%, is a means of keeping that same type of out of control leverage that was prevalent in other markets and helped get us into this, away from these markets. All trades are based on ifs, and if that trade goes against you, you’ll be glad that the higher requirements saved you from getting crushed on the entire position, because you “were forced to protect” 75-80% of that highly speculative position. Now you’re only getting crushed on 20-25% of it, but at least you’re still in business. It’s tragic when going the wrong way on one trade in Volkswagen could cause a short-seller to take his life, so I’d say this type of protection is critical on all investments, but especially on ones that are tremendously high in speculation.

The uptick rule is like warning labels on cigarette boxes. Shorting, like smoking, is the other side of a 2 sided coin. Buyer’s, like non-smoker’s, and proponents of selling (smoking) restrictions. Non-smoker’s recognize the health risks that smoking poses to the overall community, as buyers recognize that deflating prices, by shorting stocks, brings the overall economy down thereby threatening the economic health of the overall community,  along with the markets. Regardless, shorter’s are gonna short, and smokers and gonna smoke. The uptick rule, like a warning label, simply makes it a little less attractive to do it, and has been proven to have the overall effect of discouraging an action (naked short-selling and smoking) that has proven to at least inject more potential for unhealthy activity.

At the end of the day, it is clear that this was a very poor attempt by Manuel Asensio at trying to maintain the shroud of secrecy around what short-selling actually is and the market manipulation that can and does occur due to abusive naked short-selling. He does great job looking like one of the most diabolically evil genius’ of all comic book history, but is too transparent with his chicanery to truly pull off the full impersonation. In my eyes, Gene Hackman will always be the best Lex Luthor!

The one and only...

The one and only...

A General Explanation of Short Selling, Naked Short Selling, and Illegal Naked Short Selling

What does it mean to sell short?

Selling a stock short is the exact opposite of buying a stock. When you buy stock, it is typically because you think the stock is rising and you will therefore be able to sell that stock at a later date and at a higher price, profiting from the difference between your low purchase price and subsequent high sale price. When selling a stock short, you still profit in this same way, accept the “order of operations” is reversed. Instead of achieving the low purchase price first, by buying, you “open” or begin a short sale transaction by achieving your high sale price first. You do this by selling shares of a stock that you do not actually own. Why would you sell shares of a stock you don’t own? Well instead of believing that this particular stock is going up, you believe the stock is going to go down.

Strictly as a hypothetical: maybe Google (NYSE:GOOG) at $400 per share is too high a price in your eyes. At that point, you would want to sell shares of GOOG while it’s trading at or around $400. If you are correct, and the overall investment community agrees that $400 is a high price for Google, the stock will be sold off, and go down. In order to “close” or end your short sale transaction with profits, you would have to buy shares of GOOG at the lower price, say when Google is at $320 per share, making your profit (the difference between your high sale price and subsequent low purchase price) $80 per share or roughly 20%. (This example reflects no personal bias on the share price of Google now or at $400 per share, and is purely for argument’s sake.)

Image from the Washington Post

Image from the Washington Post

Many people argue that short selling as a whole should be illegal, because in essence you are betting on a stock falling, which of course is never a good sign for the people working at that company and the prospect of their continued progress. As such, making money from a drop in that stock is akin to benefitting from the suffering of other people. Despite the social and moral implications of this view, there’s nothing illegal about it, and at the end of the day, that is how life goes. People profit from the misery of others all the time. Charles Darwin isn’t heralded for being a nice guy that was interested in science. “Survival of the Fittest” plays out in all environments no matter how large or small. Short-selling is simply the opposite side of a two headed coin. At some point, all stocks trade at a market price that is higher than the company’s true valuation. Short-selling is a function of the markets that helps in achieving parity between these two prices when sentiment around a stock and its share price might be inflated or unjustified.


The problem with short-selling, lies within the timeframe allotted for settling a short sale transaction, and failure to do so. When buying equities, the average timeframe between the actual date of your purchase, (Trade Date) and the actual settlement of that purchase transaction, (Settlement Date) is 3 business days. This is denoted as T+3. (*This timeframe can fluctuate depending on the markets in which the equities are purchased or the type of equities in question. Money market mutual funds and options on equities settle T+1) So, when you buy stock, you have 3 days to settle the trade and put the money in your trading account if it’s not already there.

However, when shorting stock, you need to deliver the shares, not cash, to the buyer on the other end of your sale, in order to settle the transaction. Since a short-seller doesn’t own the shares being sold, they need to borrow those shares from a third party, which I will get to very shortly. The borrowed shares will go to the buyer on the other end of the short sale transaction on Settlement Date, (T+3). Although this will settle the short sale, it doesn’t “close,” or end, the short-sellers obligations in this transaction. At a later date, hopefully after the stock has dropped, the short-seller can buy the shares at the lower price, and replace the previously borrowed shares thereby covering or closing the trade, with the short-seller pocketing the difference and having no other obligations.


Because borrowing is inherently involved with any short transaction, all shorting is done using “Margin“, which is a whole other beast in itself. Basically, using “margin” is borrowing – usually from the brokerage firm where your account is held – an amount of money that is up to the equivalent of what you deposited in the account. So, if you have $10,000 cash in an account, you could use margin, and leverage that money 100% to give yourself $20,000 worth of buying power – $10,000 borrowed from the brokerage firm against your $10,000 in collateral.

As an aside, let me just say that in my opinion, no individual investor should ever use margin, ever! It’s the equivalent of buying stock with your credit card, or with a bookie the way you place sports bets, and that’s certainly high on the list of the dumbest things anyone could ever do.

However, since short sellers are using margin, they don’t always have to borrow 100% of the amount of shares they sold short in order to settle, or deliver, on the short sale transaction. 50% could be backed by the investors’ money (and shares that the bank bought backed by that money), while the other 50% could be backed by margin (shares the bank bought with their own money, but lent to you on margin). For example, if you have a total short position of $10,000 worth of stock, $5000 worth of shares must have either already been borrowed, or the cash to make that purchase must be sitting and ready in your account, while the other $5000 worth is paid for with margin against your $5000. This satisfies the average margin requirements, and gives you the full amount of shares being sold short which goes to the buyer on the other end of the transaction, for settlement. However, you still owe the bank “replacement shares” for the shares they borrowed on your behalf to settle the short sale. The time frame you have to essentially “replace” those borrowed shares with the bank is known as the “Days to Cover.”

Covering and Closing

Buyers have 3 days, on average, to come up with the cash as collateral for their purchases. Short-sellers have the same amount of time to deliver borrowed shares as collateral for their sales. How long does a short seller have to replace those borrowed shares that were used as collateral for their short sales? More complications: The timeframe for “covering,” or closing, a short-sale is determined by dividing the average daily volume of a stock, by the amount of short interest on that stock. For example, if there are 20,000,000 shares of XYZ Inc. being sold short, and the average daily volume of XYZ Inc. is 1,000,000, then a short-seller has 20 “days to cover,” (20,000,000/1,000,000.) This is just an example, as short interest and average daily volume can vary dramatically on all stocks, so some stocks afford 40 days to cover, while others only afford 5. It is more important to understand the relationship between the three values. The lower average volume is in comparison to short interest, the more days you will have to cover a short sale. But the more time you have to cover, the more time the stock has to run against you, which would cause a “short squeeze.” So, short-sellers seek to short companies that allow fewer days to cover rather than more.

Naked Short Selling

When an investor sells shares short without borrowing the shares first, it is a “naked” short sale. The seller does not have the collateral, (the shares,) to satisfy the sale, nor does he have any guarantee that the shares will be available by settlement date, and is therefore “naked.” Sometimes there are not a lot of shares available for borrowing, which can happen with illiquid stocks. Other times, there aren’t too many “lenders,” or lending institutions from which you (or more likely your brokerage firm on behalf of you) can borrow the shares. If the shares are not borrowed, or your short sale is not “covered” by settlement date, this would cause a “failure to deliver” (FTD). Failures to deliver occur all the time, on both the buy-side and the sell-side, but aren’t extremely prevalent as a whole. Maybe, in an illiquid market, it took a few more days to locate all of the shares to borrow in order to satisfy your entire position. Maybe it took a little more time overall to locate an institution where borrowing was even available. (*It should also be mentioned that there are various extensions that both buyers and sellers can receive if they do not have sufficient collateral by settlement date. But just like being late with your credit card payments, it is a “red flag” against you if you take an extension, and there is a limited number you are allowed to take before you are “cut off,” and restricted in some way.)

Just because an FTD occurs doesn’t mean that it was due to illegal naked short selling, it doesn’t even mean it was due to selling at all. But, FTD’s can be a sign that there could be a “problem”, a manipulation going on in some way, and yet, aside from it being electronically generated in a “failure to deliver” report that some intern at the SEC most likely glances over or completely overlooks, nothing really happens. The short position remains open and legitimate, as if it actually had been settled, until the time that the short seller actually decides to deliver the shares, or covers the transaction by buying the shares in the market.

So, if I was an underhanded individual looking to profit from illegal naked short-selling, the mindset would be: “What are the chances of this stock dropping, and my being able to cover this short sale without ever borrowing the shares? What if the stock keeps dropping and I keep adding to my short position, thereby increasing short interest, and continually extending the amount of time I have to ‘cover,’ all the while forgetting about ‘delivery on settlement’ altogether? Well then as long as I continue to maintain a good, large-sized short position, and the stock keeps dropping, I can potentially forget about ever having to borrow shares for settlement, and just focus on covering when the stock actually begins to show some sign of life and real upward momentum. The SEC doesn’t even really do anything about FTD’s anyway.”

“Illegal” or “Abusive” Naked Short Selling

Thinking in the manner described above is what leads to the type of naked short-selling that is illegal, where the seller has no intention of ever delivering the shares to the buyer at the time of settlement. The fear is that short-sellers – specifically institutions like hedge funds that specialize in shorting stocks and have enough cash behind them to manipulate, say a low-priced, low volume stock – could continually short a company, no matter how good or even flat the stock may be performing, inundating the tape with sell orders, and driving the stock price down hard and fast. When short sellers fail to deliver, it creates a set of “phantom shares” that are hypothetically being sold, but of course these phantom shares won’t be really sold short until “the money changes hands,” or in this case until the shares change hands, and those transactions actually settle. Until then, the shares being sold short, that haven’t actually been delivered upon settlement, are in a type of market-purgatory where they are neither sold nor bought. (Think of the train station Neo is trapped in at the beginning of the movie, Matrix Revolutions. That is where these shares are.)

Nonetheless, the real perception, which you could get by simply reading the tape of course, or paying attention to the increases you would see in short-interest, is that these phantom shares, are actually being sold! “Sell” orders are going off! That puts real selling pressure on the stock, dropping the price like a text book falling from the Empire State Building. If buyers come in with heavy volume and the stock should happen to rise, bucking the short-selling trend, abusive short-sellers will only add and add to their short positions, and put more selling pressure on the stock, exponentially engorging the lot of phantom shares, with no regard for settlement whatsoever!


The SEC’s dilemma comes in the form of regulating this type of illegal naked short-selling without hindering or penalizing those short-sellers that follow the rules, settle on time, cover on time, and are not abusive. Even if an investor or investment firm had one or two FTD’s on their record, if these infractions were spread throughout a reasonable amount of time, it could be reasonably overlooked with nothing more than a warning. In the technologically advanced world we live in, compared to when these rules were originally conceived, matching an actual short-sale to an actual buyer to then record an actual failure to deliver is very hard, thus conducting this activity illegally while slipping under the radar is much easier. Electronically recording failures to deliver is probably pretty easy, but it still requires human intelligence, desire, and expertise, aside from time and manpower, to comb through that information to see which FTD’s actually came from naked short-selling, and then continue to track, follow up and report progress on, or penalize them as they occur, until the time they all finally settle.

The uptick rule and various other proposals being discussed by Congress and other Financial Authorities right now are the market tools with which we as a society are most familiar with using in the dissuasion of illegal naked short selling. Regardless of what critics of the uptick rule might say, the mechanism can at least temper the downward pressure a stock can experience when being bombarded with heavy short interest. Even with the uptick rule in place, the old adage that stocks “sure drop a lot faster than they rise,” still rings true, so short-sellers should still be able to prosper with some sort of uptick rule or circuit breaker in place, as they did during the 70 years prior to 2007 when the uptick rule was abolished. I would hope that regardless of one’s personal position on the provisions recently adopted by the SEC regarding the uptick rule, that it is easy to see that without such a mechanism in place, acting as sort of a filter for legitimate market activity on the short side, bad practices would be harder to punish and even differentiate from best practices, or just okay practices that follow the rules by the bare minimum.