[Congressional Record (Bound Edition), Volume 155 (2009), Part 19]
[Senate]
[Pages 25132-25133]
[From the U.S. Government Publishing Office, www.gpo.gov]




                          NAKED SHORT SELLING

  Mr. KAUFMAN. Mr. President, I rise to applaud the SEC's Enforcement 
Division for recently bringing two actions for insider trading against 
Wall Street actors. While our judicial system must run its course, I am 
nonetheless pleased that the investigators and prosecutors are working 
together to target Wall Street wrongdoing.
  In white-collar crime, securities fraud, and insider trading, 
enforcement is critical to deterrence. In turn, deterrence is critical 
to maintaining the integrity of our capital markets.
  The importance of these cases extends beyond deterring and punishing 
criminal conduct. By identifying, prosecuting, and punishing alleged 
criminals on Wall Street, we are restoring the public's faith in our 
financial markets and the rule of law.
  So while the Enforcement Division is sending a strong signal about 
insider trading, it still has not brought any enforcement actions 
against naked short sellers. This is despite the fact that naked short 
selling is widely acknowledged by many on Wall Street to have helped 
manipulate downward the prices of Lehman Brothers and Bear Stearns in 
their final days. Their resulting failure served as a catalyst for the 
ensuing financial crisis that affected millions of Americans.
  I am pleased the SEC has flashed a red light in front of insider 
trading. But until it brings a case or makes the naked short selling 
that took place last year an investigative priority, the Commission is 
leaving a green light in front of naked short sellers. When you have a 
red light on one road and a green light on another road, everyone knows 
where the cars are going to go.
  This concern is not mine alone. In the words of the Dow Jones Market 
Watch, in a recent article entitled ``SEC Loses Taste for Short Selling 
Fight'':

       More than a year after short sellers allegedly sucked the 
     broader market lower by concentrating negative bets in 
     troubled financial firms, the Nation's securities regulators 
     appear to be backing off curbing the practice.

  In a piece on the naked short-selling debate, Forbes magazine noted:

       We have become a nation that ponders everything without 
     resolution.

  This is critical because the SEC's current rule against naked short 
selling--a reasonable belief standard that the underlying stock would 
be available if it is needed--is widely viewed as unenforceable. The 
market has recently been showing promise in moving upward, but if it 
goes south--and I am sorry to say eventually it will again--the bear 
raiders who destroyed our economy a year ago and made millions in the 
process will strike again.
  If you know you can sell 5,000 umbrellas on a rainy day in New York, 
you are going to be out on the street with 5,000 umbrellas the next 
time it rains. The next time one of our TARP banks or other financial 
institutions looks vulnerable, naked short sellers will seize the 
opportunity to profit again, and this time it could cost the taxpayers 
directly. The SEC will have no ability to stop them or punish them 
after the fact.
  Given what is at stake, why have we not had action? Frankly, it is a 
story emblematic of problems on Wall Street. The story starts in July 
2007, when the SEC decided to remove the uptick rule which forces short 
sellers to wait until a stock ticks up at least once before being 
allowed to sell without putting anything effective in its place.
  When I was at Wharton back in the midsixties, the uptick rule was an 
article of faith. But a couple years ago, the 70-year-old uptick rule 
became another casualty of deregulation, an impediment to market 
liquidity, they said.

[[Page 25133]]

  A little over a year later, two of the Nation's biggest banks--Bear 
Stearns and Lehman Brothers--had collapsed. Lehman's failure alone, 
with $613 billion in debt, was far and away the largest bankruptcy in 
U.S. history. Both banks were victims of their own risky behavior and 
their own poor judgment. Their thinking was clouded by an aura of 
invincibility--willingly taking highly leveraged positions in what 
turned out to be toxic assets.
  But while Bear and Lehman certainly are responsible for their 
actions, naked short selling played a crucial role in accelerating 
their fate.
  I wish to make an important distinction. Short selling is a well-
established market practice. It can enhance market efficiency and price 
discovery. I, myself, have sold stock short on many occasions, but I 
always had to borrow the stock first before I could sell into the 
market.
  Naked short selling is another matter altogether. It occurs when 
someone sells a stock they do not own and have not borrowed. Naked 
short selling creates two risks in the marketplace. The seller may not 
be able to deliver the necessary shares on delivery date and bad actors 
can manipulate stocks downward, repeatedly selling something they do 
not own.
  Naked short selling, without first borrowing or obtaining a so-called 
hard locate of the shares, essentially increases the number of shares 
in the market, which tends to lower the value of the stock.
  It is exactly as if I made three copies of my car's title and then 
sold the title to three different people. By the time I sold my third 
title, it would likely be impossible to deliver the car to the third 
buyer and its value would also have declined.
  When Bear Stearns and Lehman started to crumble, many believed 
manipulative naked short sellers, using a series of large and frequent 
short sales known as bear raids, helped drive both firms into the 
ground. Bear Stearns' stock dropped from $57 to $3 in 3 days. Let me 
repeat. Bear Stearns' stock dropped from $57 to $3 in just 3 days.
  When Lehman collapsed, an astonishing 32.8 million shares in the 
company had been sold short and not delivered on time.
  The SEC has proven incapable of both preventing market manipulation 
from happening and punishing those responsible for it. We cannot allow 
this to continue.
  Since March, a bipartisan group of Senators and I have been calling 
on the Commission to reinstate some form of the uptick rule and put a 
rule in place that the SEC Enforcement Division could use to stop naked 
short sellers dead in their tracks.
  At a recent SEC roundtable, major problems with the current 
regulatory structure were exposed. Even panelists heavily stacked in 
favor of industry admitted that compliance with the requirement is 
widely ignored. Commissioner Elisse Walter acknowledged, prosecuting 
naked short sellers on the reasonable belief standard is a ``very 
difficult case to bring.''
  Because the ``reasonable belief'' standard is unenforceable, abusive 
short sellers are essentially free to engage in criminal activities 
without fear of facing criminal prosecution.
  The SEC's silence speaks volumes. They have given no indication that 
there will ever be action. Nothing--from the SEC's strategic plan to 
various speeches by SEC executives--acknowledges that this is a 
priority. The SEC has taken action on insider trading; it should devote 
the same intensity of purpose to stopping abusive naked short selling.
  I suspect the problem is that our financial institutions, which can 
now trade stocks with previously unimaginable speed and frequency, 
simply are unwilling to support any regulation that will slow down 
their profit- maximizing programs. High-frequency traders balk at the 
suggestion that they wait in line and get their ticket punched--by 
first obtaining a ``hard locate'' of the stock--before selling short. 
If that is the case, then we are letting technological developments on 
Wall Street dictate our regulatory and enforcement destiny rather than 
vice versa. That philosophy is simply unacceptable.
  Clearly, the cost of inaction in this area is too great to ignore. 
Accordingly, I urge my colleagues to join Senators Isakson, Tester, 
Specter, Chambliss, and me as cosponsors of S. 605, which requires the 
SEC to move quickly to address naked short selling by reinstating the 
substance of the prior uptick rule and requiring traders to obtain a 
contractual hard locate before selling short. We need to send a strong 
message to the SEC that the Congress will not tolerate inaction on this 
critical issue.
  Mr. President, I yield the floor.
  The ACTING PRESIDENT pro tempore. The Senator from Arizona, the 
Republican whip.

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