Posted by Debbie on Nov 9th, 2008

We have no idea who Giovanni Spagnolo is. We don’t know whether he is a professional trader, a small investor, a fund manager or anything else.

But what we do know is the Australian Securities & Investment Commission (ASIC) has taken him to court for short selling. To be more precise, for naked short selling. You see, what Mr Spagnolo did was sell shares that he did not own. Furthermore, he didn’t borrow the stock from anyone in order to deliver it on settlement. That is what makes it a naked short sell.

We don’t know the full details of the case other than what is on the ASIC website:

“ASIC alleges that between 28 May and 24 October 2007, Mr Spagnolo sold shares and options that he did not own, contrary to Section 1020B(2) of the Corporations Act, in a practice known as ‘short selling’… Mr Spagnolo applied for shares and options in capital raisings by the companies. Before they were issued, he agreed to sell them on the stock exchange. Mr Spagnolo failed to deliver the shares and options on the due date for settlement.”

The problem as we see it is that Mr Spagnolo appears to have done exactly what large institutions do as a matter of course. The main difference is that the institutions are permitted to do so while the private investor is not.

The underwriter of a share issue can short sell stock in advance in order to reduce their exposure if they are left holding stock from a public offering or a placement. Yet it appears that private investors cannot do the same thing.

We wonder if this is the best way to tighten up the rules on short selling. We don’t think it is. There is a much simpler solution that could be easily implemented.

ASIC and the ASX should just follow the same system that operates in Hong Kong.

In Hong Kong investors must deliver stock to the exchange on the settlement day otherwise it triggers a ‘buy-in.’ That means if you want to short sell you must borrow the stock and deliver it to the exchange. If you don’t then the exchange automatically buys the stock back for you, thus closing out the trade.

It is a simple and effective way to almost eradicate naked short selling. It would not be difficult for the ASX to do the same here. It is just a case of whether they have the will to do so.

Are You Scared Yet?

Do you have kids? If yes, you would know all about the perils of any car journey longer than 20 minutes. Before long the question “Are we there yet?” begins and is repeated ad nauseum at regular intervals.

We could ask the same question to the stock market on whether it has bottomed out yet. And we could also ask a variant of the question to investors – “Are you scared yet?”

In what has become a bit of a cliche, Warren Buffett tells us to be “greedy when others are fearful.” In other words, start buying up stocks when the prices have slumped and most investors are running for the exits. As we write, the S&P/ASX200 is down nearly 140 points.

But how fearful do you want others to be? At the moment they are looking pretty fearful to us. Perhaps they can get even more so. Or maybe things will start to get better from here.

The main thing to remember is that markets tend to over-react on the upside and the downside. There is a lot of negativity in the media about recessions and job losses and companies going bankrupt. So surely all of this is already priced into the market, plus a bit extra for good measure.

Even so, it takes a big set of courage to run against the crowd. We have been bearish on the market for the last couple of years. Until a few weeks ago that is. Now, even though everything around us is looking bleak we can’t help but think that the market is offering up some pretty good bargains at the moment.

We are so confident of it, that we are planning to launch a new investment newsletter that will search for the best bargains across the whole market, not just the small caps. Look out for more details in the next few weeks.

This article is written by Kris Sayce from Money Morning. Money morning is a website that aims to give you intelligent and enjoyable commentary on the most important financial stories of the day, and tell you how to profit from them.