What’s a pre-borrow?

Alistair Barr reports that the SEC is “cautious about imposing a broad pre-borrow requirement as a way of limiting manipulative short selling because the costs could outweigh the benefits”. This confused me: isn’t naked shorting precisely what happens when you short a stock which you haven’t borrowed? And isn’t it illegal? Why all this fuss about a rule which forces shorters to borrow the stock in question first? If they don’t borrow the stock in advance, aren’t they shorting it nakedly?

Turns out, it’s a bit more complicated than that, thanks to the T+3 settlement system. On the day that you short a stock, you don’t need to borrow it, you just need to locate it. That means looking it up on an “easy to borrow” list, or phoning up a dealer and asking for a locate. Once you’ve got a locate, you can then go ahead and put in your sell order, even if you haven’t actually borrowed the stock. In fact you don’t actually borrow the stock until three days later, when the trade settles.

It’s not easy to work this stuff out, amid all the talk of “interim final temporary rules” and the like. But basically the debate comes down to a simple question: do you borrow before you sell, or do you only borrow when you settle? The SEC doesn’t want to force people to borrow stocks before they sell, because they say, and I believe them, that doing so would increase borrowing costs and hurt liquidity — all in the service of addressing a problem (naked shorting, which results in people not providing the shares at settlement) which is not obviously much of a problem at all.

Still, in some real sense nearly all short sales are naked short sales, in that the person doing the sale doesn’t actually have the stock to sell: they only borrow it three days later, at settlement

                          from http://blogs.reuters.com/felix-salmon/2009/06/04/whats-a-pre-borrow/