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Naked shorting of FirstFed flops

August 29, 2008|Tom Petruno | Times Staff Writer

The bears on FirstFed Financial Corp. may have outsmarted themselves: By heavily betting on the stock to drop, they've created a situation where just the opposite is happening.

The Los Angeles-based mortgage lender's shares on Thursday soared $4.03, or 34%, to $16.03 in what looks like a classic "short squeeze."

Here's the setup for that move: The number of shares of FirstFed that were sold "short" rocketed in the first two weeks of August, from 8.7 million to a record 12.6 million, according to New York Stock Exchange data. (In general, such shares are borrowed, usually from brokerages, and then sold in a bet that the share price will decline.)

Yet the number of FirstFed shares outstanding is just 13.6 million.

So the bears, it seems, have borrowed and sold 93% of all FirstFed shares. And if we remove from the outstanding total the shares locked up by company insiders, short sellers have borrowed and sold more shares than actually are available in the market.

Sound strange? This appears to be a gross case of "naked" shorting: Some traders have been selling shares that they didn't actually have in hand.

Naked shorting is what the Securities and Exchange Commission explicitly outlawed in the case of 19 big financial stocks from mid-July to Aug. 12.

The SEC also has said it plans to propose a market-wide rule against naked shorting, which under current rules may or may not be illegal, depending on the circumstances.

But that apparently didn't stop some bearish traders who were confident that FirstFed shares would decline further this month as the company continued to struggle with a large number of loan defaults.

"I think we may have a group of short sellers who aren't too worried about the rules," FirstFed Chief Executive Babette Heimbuch told my colleague, E. Scott Reckard. "I always figured that is why we have so many rumors spread about us."

The goal of a short sale is to sell a stock and buy it back later (to replace the borrowed shares) at a lower price. If the price indeed drops, the short seller's profit is the difference between the sale price and the repurchase price.

But if the stock price rises instead of falls, short sellers lose. That can send them rushing into the market to buy new shares to replace the borrowed stock.

It looks like that's what happened with FirstFed, after analyst Fred Cannon at Keefe, Bruyette & Woods noted the extraordinarily heavy shorting in a report published late Wednesday.

Heimbuch said she wished the SEC would investigate, "but I imagine we are too small for them to worry about."

An SEC spokesman declined to comment.

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tom.petruno@latimes.com

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