Securities Lending Technology
SEC's Short-Sale Guidance May Call for IT Adjustments | Amid Legal Clouds, Automated Solutions | EquiLend Rides Growth Curve | Transparency Taking Hold |
Amid Legal Clouds, Automated Solutions
July 10, 2006
Securities lending has become a significant source of income for brokers and custodians, particularly because of the business' importance in facilitating short selling. But increases in short activity are causing a regulatory and legal backlash.
Short selling and its effect on the markets was a major topic at a June 28 Senate Judiciary Committee hearing on hedge funds. Naked short-selling, or the practice of selling shares that a trader does not own, has become a hot-button issue because of the market risks related to failures to deliver stocks due at settlement. And short sellers are often accused of unfairly depressing the prices of certain stocks. Last year, as part of its effort to clamp down on naked short sales, the Securities and Exchange Commission implemented Regulation SHO.
In May, Utah enacted a law that discourages naked shorting by punishing brokers who do not notify the state securities commission within 24 hours of a failed settlement. The law, which takes effect in October, was reportedly backed by Patrick Byrne, CEO of Salt Lake City-based Overstock.com, who has had a long-running public battle with short sellers and some sell-side analysts whom he blames for the weakness in his company's shares.
In addition, lawsuits filed by two New York hedge funds in April alleged that 11 prime brokers are profiting at the expense of their clients who sell short by not delivering the shares being shorted despite charging the hedge funds for delivery. A report by Concord, Mass. research firm Vodia Group says that if the hedge funds' allegations hold up in court, it would mean that prime brokers routinely sanction the practice of naked shorting and thereby increase the likelihood of failed settlements.
The long-term effect of the legal maneuverings is far from clear. But these efforts underscore a demand for greater disclosure by participants in the securities lending market, and this demand is being met by vendors with new technology tools, including fully automated securities lending platforms.
One of the biggest challenges in short
selling is finding a reliable source, or lender, of the shares to
be borrowed, typically called a "locate." The supplier of one
automated platform, Locatestock.com of Jersey City, N.J., addresses
the locate issue by actually delivering the securities at the time
of the trade. This eliminates any ambiguity about whether the
security has been borrowed or not. John Tabacco, CEO of
Locatestock.com, says Utah's move reflects the growing concern over
short selling, and the need for a uniform federal standard. "When
states start to recognize the need to further legislate," he says,
"it's because they feel they're not getting proper treatment at the
federal level, so it's bringing the issue to the forefront." He
advocates technology as a way to improve enforcement of short-sale
rules in a business that is still largely conducted and recorded
manually.
"If your locate and borrow are all electronic," says Tabacco, "there's an electronic trail of that transaction, and it will probably give regulators a much easier path to follow to ensure enforcement." He says Locatestock.com's tool allows a trader considering a short sale to enter a stock's ticker symbol and see immediately whether it can be borrowed. The firm's strategic partners hold inventories of securities; one of those partners is Assent, a Hoboken, N.J. broker-dealer owned by SunGard Data Systems that caters to upward of 2,000 active traders.
