SEC Follow Up Exhibits Part C SEC_OEA_FCIC_001760-2501

The perceived inability of short sellers to borrow securities for settlement is one of the
primary reasons cited by others for constraints on short selling in IPOs. We test whether short
sellers are avoiding regulatory constraints on locating and borrowing shares for shorting (i.e.
engaging in “naked” short selling) by examining whether IPOs with greater short selling are also
more likely to have failures to deliver. While we document that most IPOs have failures to
deliver on the first settlement date and approximately 30% of IPOs in the sample qualify for the
Regulation SHO threshold list on the first possible date, our findings do not indicate that the
level of short selling on the offer date is related to fails to deliver or to the qualification for the
threshold list. In fact, the factors that are correlated with increased short selling are uncorrelated
with fails to deliver.
Instead, we argue that fails to deliver are potentially related to underwriter price support
activities and present evidence that the level of failures to deliver are related to a variable
indicating a high probability of underwriter price support. Thus, we conclude that the observed
short selling is not due to an avoidance of short selling constraints and therefore, short selling
constraints might not be as onerous as presumed.
Prior literature has documented a significant role of market makers in the aftermarket trading
of IPOs. Using the “exempt” indicator on the short sale transaction as a proxy for potential
market making activity, we test whether our results may be due to the presence of market makers
and find no evidence that market makers are the primary driver of our findings.
Finally, we present evidence that the magnitude of short selling (after removing market
maker activity) on the offer day has a weakly negative statistical relation to subsequent price
movements. Once loan fees are considered, however, there is no relation between short selling
and profitability. While it appears that a small fraction of short sellers make substantial profits,
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SEC_OEA_FCIC_002483