Market Sentiment Drives Fails
March 10, 2008
Data released by the Securities and Exchange Commission on borrowed securities with fails-to-deliver in August and September suggests that, though a substantial percentage of the overall stock market, the fails were not driven by parties selling stocks short without securing shares for delivery--naked shorting.
In analyzing Aug. 15 delivery failures, Concord, Mass.-based research firm Vodia Group found that most occurred in securities experiencing sudden demand. Critics of the current securities lending market claim perpetrators of naked shorts repeatedly sell stocks without delivering the securities, usually to drive down the price.
Such a strategy tends to result in repeated fails and the stock ending up on the exchanges' threshold lists. Threshold securities are defined under Regulation SHO as equities with fails-to-deliver of five consecutive days of at least 10,000 shares where fails equal 0.5 percent of the issue's total shares outstanding.
Vodia, in a research note issued on Feb. 26, said threshold securities accounted for just 6.7 percent of the total market capitalization of stocks with fails, and 22.9 percent of overall fails by dollar value. The firm compared those fails to its database of borrowing rates, which reflect demand to borrow the securities over time. Only 3 percent of those securities had rebates of 5 percent or less--indicative of naked shorting--meaning that most of the stocks were not chronically hard to borrow.
"Most of these fails are occurring in securities where the fails are not systematic and will be cleaned out of the system in a few days," said Alexander Tallett, an analyst at Vodia.
Citing an average put-to-call ratio of 1.43 for securities on the list--compared to 0.89 for the market as a whole--Vodia said investors had suddenly gone sour on those stocks, ratcheting up short demand and the need to borrow. "We're seeing significant correlation between negative sentiment and a large number of fails," Tallett said.
The data, which was released in December and only includes fail positions of more than 10,000 shares, marks the first such disclosure by the SEC. The most recent raw data, for October and November, was posted to its Web site last week.
Vodia also noted that the largest 500 equities by market capitalization represented 28 percent of fails and 92 percent of total market cap; the smallest 500 made up 41 percent of fails and 1 percent of total market cap.
