The Long and Short of Shorting

In redirect examination -- where the defense gets to try and refute assertions made during the government's cross-examination -- Kenneth L. Lay testified that his son, Mark, was not short-selling Enron stock as the government argued.

Lay and Jeffrey K. Skilling before him testified that a cabal of short-sellers had conspired to drive down Enron's stock price through 2001, as short-sellers make money off a stock that's in decline.

The prosecution had alleged that even Lay's son was shorting Enron stock, an embarrassment for Lay, who said he didn't know his son was doing that.

But under redirect examination from defense lawyer George "Mac" Secrest, Lay said he reviewed Mark's brokerage account over the past weekend

Lay said his son was indeed trying to sell Enron stock, but not shorting it, and perhaps the broker got "nervous" and shorted the stock to lock in the price for Mark. I don't know what that means and I bet the jury doesn't, either.

By Frank Ahrens |  May 1, 2006; 4:22 PM ET  | Category:  Dispatches
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'Lay said his son was actually trying to buy Enron stock, but perhaps the broker got "nervous" and shorted the stock to lock in the price for Mark.'

This make no sense whatsoever. If the broker wanted to "lock-in" the price, he would buy the stock in anticipiation of it appreciating. A short sale is just the opposite: a customer borrows another customer's shares and sells them on the market, with the hope of buying them back at a lower price (and thus making a profit). Lay's explanation is giberrish.

Posted by: Ken | May 1, 2006 05:07 PM

Hi, Ken. Please note my correction: Lay confirmed his son was actually trying to sell, not buy. That was my bad. Thanks.

Posted by: Frank Ahrens | May 1, 2006 05:15 PM

Thanks for the correction Frank. What I believe Lay meant was referring to is the practice where a long position (someone buying and hoping to sell the stock higher) will short a stock to lock in whatever profit they have made without having to actually sell the stock. If they already show a profit, by initiating the short they now benefit whether the stock increases or decreases, effectively "locking in" their profit. Small players do it to avoid taxes, I would imagine bigger players do it so they do not create a large decrease in share price by issuing such a large ask?

Posted by: Brad | May 1, 2006 05:23 PM

What Brad is describing is "shorting against the box" and since 1981 is not allowed by the IRS although not illegal it is looked at as a constructive sale on the date and price at which the sale takes place with the resulting tax consequences. I have seen "rookie" investors do this to avoid taking a loss or at least stanching the bleeding. In this case as I recall this was done in March before "le deluge" so it most likely was a genuine "short sale". All brokerage statements and confirmations are marked "short sale" if indeed the customer instructed it be such. The easy answer of course is to look at the account at the end of the day of the alleged "short" and either the account is "net long" (owns more shares than are sold short) "even" (owns as many shares as sold short) and in both these cases the customer is "short against the box. Last case the account is "net short" (short or sold more shares than he owns) which is a bet the stock is going to go down. I guess in fairness if he had a few shares laying around at home he could be short at his broker(s) and it would be against the box. Against the box is a silly thing to do in any case, but the Lay men haven't struck me as the brightest bulbs in the business tree.

Posted by: T W Fowler | May 1, 2006 10:25 PM

How many officers are observing Lay and Skilling away from the courtroom? I've seen several blogs that have commented on Lay's technical explanations being greeted by blank stares and his attempts at humor bringing only silence. Maybe Lay will resort to singing. Something like: "Ooh, ooh, take the money and run, ooh, ooh, ooh."

Posted by: Jeff Rambin | May 1, 2006 11:10 PM

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