Photo: flickr/Ahmad Nawawi
There is something wrong with a system when every shareholder of a company is satisfied with holding those shares yet the stock price can still radically decline because non-shareholder traders decide they want to sell a bunch of shares they don’t own.And where did the non-shareholders get the shares to sell?
They “borrowed” them from you because you happened to have a margin account at a brokerage firm.
That’s right, you did not give your permission to anyone to take your shares to bet against you, you did not get compensated for it, yet the shares were “loaned” from your account to a short seller because the “hypothecation agreement” that you signed is so broad it allows your brokerage to screw you without telling you.
The present system is tantamount to property rights abuse and is killing shareholders. It allows your property to be given to others, to work against your interests, without your specific knowledge, permission or compensation.
How did things get like this? At one time, when we all held our own certificates, this problem could not exist.
None of us would willingly loan our shares to another party to bet against us.
But with the advent of the paperless back office, commingled securities, and electronic clearing houses, we slowly but surely lost control of our certificates and allowed this insane short selling practice to grow beyond all natural proportions.
Unabashed short selling now often causes severe swings in the price of our underlying securities, disrupts the capital markets, and scares many investors out of the market completely.
While the “uptick rule” (a stock could only be shorted on an uptick) once held un-permissioned short sales to a minimum, the removal of that rule just prior to the market crash of 2008, has exacerbated price swings every since.
Volatility today has reached record levels, mostly due to the unleashed short selling practices. It is now easier than ever for traders to sell shares they don’t own, whenever a company or the market shows weakness; shareholder rights be damned!
Obviously we cannot go back to a time when everyone had physical control of his or her certificates but we can replicate those basic shareholder rights electronically. This could be done simply by allowing the shareholder to say “yes or no” when someone wants to take his or her shares out of safekeeping.
It is recommended that the best way to accomplish this would be to:
1.Simplify the hypothecation agreement so that it only allows the brokerage firm to lend shares for collateral purposes (the original intent of the hypothecation agreement).
2.If the brokerage firm wants to loan a customer’s shares to a short seller that brokerage firm must disclose this fact and get the customer’s permission; yes or no.
Bringing the original owner back into the equation will naturally regulate the short selling market. Everyone would still retain the right to buy or sell whatever security they wish, whenever they wish, but the property rights are returned to the rightful owner, and it is up to that owner to decide if he or she will allow their shares to be loaned out to short sellers. Because few shareholders would unwillingly allow their shares to be used against them, equilibrium will be brought back to the markets. Needless to say it would calm market volatility.
We hope the SEC will understand the problem and restore shareholder property rights before shareholders, and their markets, are further abused.
(The author has been in the securities business for over 40 years, run two brokerage firms, and well experienced in short sale uses and abuses).