Sears holder Memento expresses concern over short activity in letter to board
Memento, the family office of an investor in Sears Holdings, delivered a letter to Sears' board to express concerns regarding historical patterns of alarming short-selling activity in the company's shares and to ensure the board is taking whatever actions may be required to curb any similar short-selling issues that may arise in the future. "Naked shorting involves selling a stock short without first locating the shares for delivery at settlement. Such a practice is in violation of Regulation SHO, a 2005 SEC rule. Regulation SHO provides that brokerage firms may not accept orders for short sales without having borrowed the stock or having "reasonable grounds" to believe that it can be secured. This is known as the "locate" requirement. The SEC further noted that the practice of naked short selling can be abusive and drive down share prices. We have observed on several occasions that the number of shares of Common Stock outstanding have fallen below short interest activity as measured by real available float. As shown below, short interest in SHLD shares has fluctuated between 12 to 19 million shares in the past two years. In early 2017 we identified that, not taking derivatives into account, there were more stocks lent than the real float, causing a deficit of 3.6 million shares. We observed similar behavior in options activity for SHLD shares. Based on our analysis, it would not be possible for market makers to appropriately hedge their investments and, consequently, deliver the shares of options when exercised. If all of the open put or call contracts were exercised, it would be impossible for market makers to locate and deliver shares for settlement within the legally required time period of three business days. We also note that the lending rate of Sears in 2017 has often reached levels close to 100%, indicating a high borrow cost that creates further incentives for naked short selling. This high interest rate raises the specter that market makers are engaged in naked short selling to avoid the high borrow cost associated with covered short sales. Such behavior would violate the requirements of Regulation SHO. As their only recourse to prevent such an outcome, institutions/brokers would be forced to buy SHLD shares in the open market, which risks causing a spike in the price of SHLD shares, a pattern that would artificially distort the company's value and increase its volatility in the marketplace. The shares of SHLD stock owned by restricted shareholders cannot be borrowed against in the marketplace to cover short sales. Taking this in to account, the real float of Common Stock has fallen below the short interest on several occasions in the past two years. Sears has reason to know this occurs based on the volume of short-selling activity in the marketplace compared to the percentage of outstanding shares restricted from securities lending. It is clear to us based on our own experience in securities lending of SHLD shares and monitoring the company's real float that there have been repeated instances of widespread naked short-selling in the company's shares, with the short interest exceeding total Common Stock outstanding when excluding restricted shares. Naked short selling has the effect of placing immense downward pressure on share price over time, since an unlimited supply of any commodity, including SHLD shares, places downward pressure on its price. At a time when Sears' employees, vendors and customers worry about the company's long-term viability, we believe that the Board must treat this particularly delicate matter with the highest priority. Immediate action is necessary from the company to prevent further destabilization and depression in the price of SHLD shares."