Why do some stocks have restrictions when sold short?

Question

What exactly are these restrictions? And how do the exchange know about the stock being shorted when this is only between you and your broker.

Not being able to sell short while the stock is on down tick is a general rule for all stocks.
I think for some stocks you have the obligation to buy them back in some time frame but am not sure nor I want to answer my own question.

Answer 1

First of all, the exchange knows that a stock is sold short because brokers are required to report this to the exchange. While disclosure of short sells to the exchanges does not require the broker to reveal your identity, there are various subpoena and admnistrative rules that allow your personal information to be revealed to appropriate regulatory or law enforcement bodies under certain circumstances. There are many parties who have the right to request information, and who have the right to know, about your securities transactions. These include the exchanges, clearing houses, the SEC, and various police agencies. The broker/client relationship is not privileged as is the doctor/patient or lawyer/client relationship.

On to your question. When you short sell a stock, you still need to make good delivery. In order to do this, you have to borrow the stock from someone who actually owns it. Your broker does this on your behalf, so you are probably unaware that it happens.

There are some truly evil players out there who have figured out how to fool the system into allowing them to short sell without borrowing. This is called a naked short sale. It produces a "fail to deliver", or FTD in the clearance system, which functions like an IOU. Unfortunately, this is a very bad thing: in the past it's been used to beat down the price of a stock. Since the naked short seller wasn't borrowing stock, he could keep hammering the stock until the whole company could be acquired cheaply. This is the equivalent of counterfieting the stock. The practice is sometimes associated with so-called "death spiral financing", where a lender agrees to be repaid in company stock. If the lender then engages in naked short sales, the price of the stock drops, and so they get more shares back in return for their loan.

To control this, the SEC recently put in place Rule SHO. This requires each exchange to post a daily list of stocks which are being hit by an inordinate number of naked shorts, and for brokers not to accept short sell orders against these stocks unless a successful stock locate/borrow is completed before the sale. Here is the Nasdaq list:

http://www.nasdaqtrader.com/aspx/regsho.aspx

Answer 2

First it is between you and your broker. However, your brokers (more specifically the NASD and NYSE) are regulated by certain entities. At any time, they can open the books of your broker and see what has been sold short.

The restrictions on selling short are timuing issues relating to maret upticks and downticks. To get more detailed would be quite arduous.

Answer 3

Your broker is regulated by regulatory body, which requires to follow its rules and guidelines.

See basic description here: http://www.investorguide.com/igu-article-827-stock-strategies-short-selling.html

Another option for selling short some stocks are SSFs which are futures contracts for stocks. There is no uptick rule for them.