An audit by the SEC’s Office of Inspector General discovered that, despite the tremendous amount of attention the practice of naked short selling has generated in recent years, the Enforcement Division has brought very few actions based on conduct involving abusive or manipulative naked short selling. The OIG also found that Enforcement forwarded few naked short selling complaints to Headquarters or Regional Office enforcement staff for further investigation. None of the forwarded complaints resulted in enforcement actions, though one of the complaints referenced a pending enforcement action involving naked short selling.
The audit also determined that Enforcement’s existing complaint receipt and processing procedures hinder the Division’s ability to respond effectively to naked short selling complaints and referrals. Further, the OIG found that the Center’s policies and procedures do not include specific triage steps for naked short selling complaints, while they do include procedures for the in-depth analysis of several other categories of complaints, such as spam driven manipulations, unregistered online offerings and insider trading. These procedures, OIG believes, have the effect of naked short selling complaints being treated differently than other types of complaints.
Naked short selling has been a controversial practice for several years and, while not illegal per se, abusive or manipulative naked short selling, such as intentionally failing to borrow and deliver shares sold short in order to drive down the stock price, violates the federal securities laws. The Commission initially responded to concerns about abusive naked short selling in 2004 by adopting a short sale regulation, Regulation SHO, that included provisions specifically designed to address naked short selling. The recent financial crisis, including claims that aggressive short selling played a role in the failure of Lehman Brothers in September 2008, renewed the public’s concerns about naked short selling.
The OIG made six specific recommendations to improve the process for tracking and responding to complaints and tips about naked short selling. First, Enforcement should revise its current written policies and procedures to include in-depth triage analysis for naked short selling complaints, similar to the detailed triage steps currently specified for other types of complaints, such as those about spam-driven manipulations and insider trading. Second, the policies must ensure that investor naked short selling complaints based on information obtained from certain types of less sophisticated computer terminals are given a proper level of scrutiny and referred for further investigation where appropriate.
Third, the EnforcementComplaint Center should include naked short selling in the categories of complaints listed on the complaint center page of the SEC’s public website. Fourth, the complaint center should enhance its supervision of the initial screening of complaints to ensure the appropriateness of these important initial decisions about complaints. Fifth, the Enforcement Division should develop uniform written policies and procedures for the complaints and tips program at Headquarters and the Regional Offices and should designate an office or individual at Headquarters to oversee the program on a nationwide basis. In addition, Enforcement should ensure that complaints and tips forwarded to OIE contain complete complaint documentation and that Regional Office senior officials perform monthly reviews, as required by existing policies and procedures. Sixth, Enforcement should make improvements to its existing information technology systems for the receipt and processing of complaints.