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I am strongly opposed to the short sell ban enacted last week to protect financial stocks. This is not to say that I do not agree that there have been rampant abuses in the practices used by brokerage firms to manage short selling prior to this. I know of what I speak.

In an early phase of my career I was responsible for managing fail-to-deliver positions for OTC stocks in a major Wall Street bank’s back office. Back then we used paper ledgers and, when a position had not been resolved within 30 days, it would have to be placed into an error account and bought in. A lovely bipolar guy named Sam* who had liquor on his breath by 10AM every morning was responsible for the buy-ins. If a trade had been open long enough without properly settling Sam would come by my desk to let me know that he was going to move the position into an error accounts unless it was resolved by day’s end. That way, short sales that had never been properly borrowed would be flattened by buying shares in the open market keeping everything honest. That was the theory anyway; in practice the other broker’s identity in the ledger could be changed (say, switching the entry from Smith Barney to Merrill Lynch meaning that Merrill would DK the transaction and it would start life all over again as a brand new fail to deliver for 30 more days). In the little under a year I held that job before moving on to bigger things there was one particular position that never seemed to resolve itself, a sale of shares of a small cap stock predating my employment that had been on the books for so long that no one even knew which customer or prop desk had initiated it anymore –meaning that it would go into a departmental error account if it was bought in. It was still bouncing around when I left and I would not be surprised if it is still open and undelivered in the bowels of that bank to this day.

Later in my career, when I was a prop trader at a bank, I was once assured by a slick salesman that covered me that it would be no problem getting a synthetic short position for a hard to borrow stock –he had a buddy that would pick up market maker status on a foreign exchange that had an agreement to trade US stocks and then use his market maker exemption to short without borrow. Once he was short he would then would turn around and sell a total return swap to me (with a hefty commission for the salesman and a fat spread for his buddy of course). I turned him down. I am sure that many, many others did not. I heard later that that sales guy and others like him made a killing arranging short swaps for PIPE investors –essentially letting them take all market risk out at the point they bought into an offering. It was as a very sordid, very lucrative little corner of the business.

Yes, much as it pains me to say this, Pat Byrne was actually on to something in his own crazy way.

The problem is this, none of these abuses necessarily required new regulations –they merely required that the existing regulations be enforced. Since it took a market catastrophe and political witch hunt to cause this problem to be addressed –let’s hope that it does not inhibit legitimate shorting or overall market liquidity.

*(names have been changed to protect the guilty)

Andrew Barber
Director
Research Edge LLC