Utah Governor Signs Bill That Cracks Down on Naked Short Selling With State Fines for Brokers

May 26, 2006 – Over the objection of Wall Street firms, Gov. Jon Huntsman signed a bill Friday that cracks down on naked short selling with state fines for brokers who accumulate too many unsettled trades in any company’s shares.

The bill was written for Utah-based Internet retailer Overstock.com Inc., which complains it has been a target of a practice that traders dismiss as a tiny aberration in the markets.

“This bill is good for business, particularly small- and mid-sized cap companies,” Huntsman’s deputy chief of staff, Mike Mower, said Friday.

Tony Taggart, who handles litigation for the Securities Industry Association, had promised a lawsuit if Huntsman signed the bill, saying of the threat: “It’s not a risk – it will happen.”

Taggart said the measure approved by the Utah Legislature late Wednesday caught the industry by surprise. He did not immediately return calls Friday.

“We dropped the ball, all the brokerage firms,” said a financial adviser for a major Wall Street firm with operations in Salt Lake City, who insisted on anonymity because he was ordered by the company not to speak about the matter to reporters.

The bill’s sponsor, Sen. Curtis Bramble, R-Orem, said Overstock.com was “the poster child” for victims of trading abuse. He said the bill could help other emerging companies that can be vulnerable to short selling.

Short sellers borrow stock hoping the share price declines so they can return it to brokers and pocket the difference. Overstock.com contends it has been a target of naked short selling, where brokers send IOUs they can’t honor through a stock clearinghouse when they run out of shares to lend for short selling.

Overstock.com CEO Patrick Byrne says many brokers never settle these trades, allowing short sellers to profit without having to assume risk. The practice tends to lower a company’s share price by artificially creating more sellers than buyers.

Bramble said brokerage houses never spoke up against the bill in the months it has been languishing at the Utah Capitol. It finally passed Wednesday during a special session with little debate.

The Utah law requires brokers to regularly disclose trades that fail to settle, adding to paperwork they say is bothersome. Fines for violations start at $10,000 a day and can increase to cover the sum total of all unsettled trades.

Utah Securities Director Wayne Klein said he was prepared to start enforcing the law July 1 and was looking into allegations of abusive short selling.

Klein said his investigation would go beyond Overstock.com’s complaints to the lending of shares by brokers without the knowledge of a share’s owner, which is allowed under standard customer contracts at brokerage firms.

Klein said it can result in two people voting on proxy proposals or for a company’s directors when only one person is the legal share owner. He said some companies adjust for the problem by “prorating” extra votes to shares, but “if that happened in an election for political office, we’d all cry foul.”

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