After 35 years of stockbroking for some of the biggest houses and investors in Australia and the UK, the Secret Broker is regaling Stockhead readers with his colourful war stories — from the trading floor to the dealer’s desk.

We live in a funny world, where major event headlines can take your eyes off of some of the smaller but just as important things. Like last week, when I noticed something (very) important to me, that may have slipped past most of you Stockheads.

On the 22nd of May, ASIC banned an ex-fund manager for three years, after he was caught shorting over $7 million worth of shares on 150 different occasions between 19 January to 27 August 2021.

Now, it wasn’t the matter that he was shorting shares that got him banned but the fact that the way he went about it is 100% prohibited by ASIC.

He was using some of the super powers that only a fully registered broker has. The one in particular he was using was an abuse to ‘trusting markets’ and all of the professional players involved.

You are always going to get a rogue player in every organisation and it’s how compliance duties are policed that warrants how long they can go on for.

In this case, he was ‘naked’ shorting shares in various companies and had nothing to cover them off with.

He was able to do this because all brokers can buy and sell directly on clients’ orders. This is one of the advantages that a ‘real’ broker has over online brokers.

I used to be able to do the same – take and execute orders from clients and trust that they had the stock or cash to cover their instructions.

Things moved so fast and frantically that you were unable to check these facts.

Shoot first, ask questions later was the mantra.

However, if you hold an account with say, Commsec, it is impossible to put on a sell order if they don’t have a record of you holding them. Likewise, it’s impossible to put on a buy order, if you don’t have the cash to cover on deposit with them.

This is what ASIC says about shorting shares:

‘ASIC recognises that covered short selling, when carried out within the legislative and regulative parameters, is a legitimate mechanism for price discovery and liquidity. ASIC does not seek to limit or restrict short selling that is compliant with the legal and regulatory regime.’

Now that is a paragraph that you should cut and paste into any stock forum post, whenever someone uses the term ‘down rampers’ while complaining about someone who is short.

Who’s naked when the tide goes out

So ‘naked’ shorting is when you sell but don’t have the stock to deliver. ‘Covered’ shorting is where you have borrowed the shares and therefore can deliver them to the market.

Shorting ‘naked’ therefore creates more shares in the market than actually exist.

If you short 100,000 shares into the market but don’t have them to deliver, then a company with 10m shares on issue now has 10.1m shares floating around, thanks to you.

If you have borrowed the 100,000 shares and then shorted them into the market, then there will still be 10m floating around.

I used to ‘naked short’ when it was legal but always had it covered off. This we happily did until I got tapped on the shoulder and told to stop.

Here’s how it work – I would buy short dated company issued options and exercise them to cover our stock shorting and both trades were done at the same time.

Buy 100,000 options, sell 100,000 shares naked and then exercise the options, which usually took about two weeks before the certificate arrived.

In the good old days, a company would IPO at, say, 20c a share and offer a free listed five-year 20c option as a sweetener for the deal.

Rule of thumb was, for every one year that the option had to go it was valued at 1c per year.

At 20c per share, that option would trade at 5c, so your total package would be worth 25c and I would sell the shares, get my outlay back and hold the options.

Fast forward four years and nine months and the company was at say, $1.00 a share.

I would sell 100,000 shares ‘naked’, exercise the options at 20c and deliver them two weeks later and pocket the difference.

There were fines to pay when you were not able to deliver your shares and transfer papers in a timely manner… but they were not much.

Buying nickel on the dime

The best one we did this on was Anaconda Nickel, which was Andrew Forrest’s first foray into listing a company. I would happily send him cheques for $20,000 a pop and he would happily have the company secretary, Ian Dennis, happily turn them around pronto for me.

Later, when I was no longer allowed to naked short, we would either still be long of the whole IPO package and sell and exercise, or we would borrow them, short them and then exercise, using the capital from the sale.

Once it had gone through I would deliver the freshly minted share certificate back to the guys who had lent me the shares and everyone would all be square.

The moral of the story?

You can do very well by playing within the rules. And if you do have an advantage that 90% of the others do not, then you do not need to abuse it.

Just ask Nick Leeson.

He knows.


The Secret Broker can be found on Twitter here @SecretBrokerAU or on email at [email protected].

Feel free to contact him with your best stock tips and ideas.