Research

My research focuses on stock lending, naked short selling, SEC Regulation SHO, ETFs, and the political economy of trade settlement regulation.

“Reg SHO at Twenty”

Welborn, John W., Reg SHO at Twenty (2025). Working Paper. Available at SSRN: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5141255.

Abstract

Regulation SHO (“Reg SHO”) was enacted by the Securities and Exchange Commission in 2004 to address concerns regarding so-called naked short selling and large and persistent trade settlement failures. Reg SHO was also designed to bring consistency, transparency, and fairness to short sale rules that varied across the major stock exchanges. This paper is the first comprehensive analysis of the impact and efficacy of Reg SHO at reducing naked short selling and fails-to-deliver (FTDs) over its twenty-year history. I use daily Regulation SHO Threshold Lists and FTD data for the period from the start of Reg SHO in 2005 through the end of 2024, together with academic and proprietary databases, to document the composition and magnitude of high FTD securities. I conclude that the Reg SHO legacy is mixed and further reforms are necessary to ensure investor confidence in markets.

Keywords: Fail-to-deliver; Regulation SHO; short selling; Securities and Exchange Commission; short interest

JEL Classification: G11; G12; G14; G21; G28; K22

“Informed short selling, fails-to-deliver, and abnormal returns”

Stratmann, Thomas and Welborn, John W. Journal of Empirical Finance 38.A (2016): 81-102, ISSN 0927-5398, https://doi.org/10.1016/j.jempfin.2016.05.006.

Abstract

We find that stocks with fails-to-deliver (FTDs) experience negative abnormal returns that are proportional to their FTD levels. These findings come from both an event study and a portfolio returns analysis using Fama-French factors. Using proprietary data on stock borrow costs, we also show that short sellers of low and high FTD stocks obtain positive estimated profits. Our findings support the hypothesis that FTDs reflect nonbinding short sale constraints which do not restrict informed short selling.

Keywords: Abnormal returns, Fail-to-deliver, Fama-French, Event study, Short selling

JEL Classification: G12, G14, G21, G28, K22

“The options market maker exception to SEC Regulation SHO”

Stratmann, Thomas, and Welborn, John W. Journal of Financial Markets 16.2 (2013): 195–226. https://doi.org/10.1016/j.finmar.2012.04.002.

Abstract

Until 2008, options market makers engaged in bona fide market making were exempt from locate and certain close-out requirements for short sales (the “Exception”). This Exception applied only to short sales that qualified as bona fide hedges of options positions that were established before a stock went on the SEC Regulation SHO Threshold List. In this paper we examine the consequences of eliminating this close-out Exception. Specifically, we test the hypothesis that eliminating the Options Market Maker Exception to SEC Regulation SHO reduced the incentive to naked short sell stocks through the options market. We compare data from the second and fourth quarters of 2008. Consistent with our predictions, we find that eliminating the Exception led to fewer fails-to-deliver and higher stock borrow rates for optionable stocks as compared to non-optionable stocks. Further, removing the Exception reduced fails-to-deliver for optionable stocks when the price of borrowing stock was high. Finally, options market trading volume declined after the Exception was eliminated.

Keywords: Options market maker, Naked short selling, Securities lending, Regulation SHO, Securities and Exchange Commission

JEL Classification: G14, G18, G28

“Exchange-Traded Funds, Fails-to-Deliver, and Market Volatility”

Stratmann, Thomas and Welborn, John W. GMU Working Paper in Economics No. 12-59. Available at SSRN: https://ssrn.com/abstract=2183251 or http://dx.doi.org/10.2139/ssrn.2183251. 

Abstract

Exchange-traded fund (ETF) trading volumes have increased over the last decade and so have ETF settlement failures at the clearing corporation. We test the hypothesis that ETF short selling, high stock borrow prices, and options contract expiration contribute to ETF fails-to-deliver (FTDs). We document a positive relationship between net daily ETF settlement failures and daily ETF short sale volume, the cost to borrow ETFs, and quarterly index options expiration dates (so-called “triple witching” dates). These findings are not consistent with the claim that fails are random. Rather, these findings are consistent with the hypothesis that market makers fail to deliver to avoid paying borrowing costs associated with their short sales. Further support for this hypothesis comes from a positive correlation between ETF FTDs and ETF put option open interest. Finally, we show that ETF settlement failures are important for the functioning of markets because they impact market index volatility. We find that positive changes in aggregate ETF FTDs Granger-cause higher market index volatility. We attribute this causality to buying and borrowing of common stock shares by market makers in order to close-out ETF FTD positions by trade date plus six days (“T+6”). We conclude that ETF FTDs are not inconsequential for market stability.

Keywords: exchange-traded funds, short selling, fails-to-deliver, volatility

JEL Classification: G14, G18, G28

“The Phantom Shares’ Menace”

Welborn, John W. Regulation 31:1 (2008), https://www.cato.org/sites/cato.org/files/serials/files/regulation/2008/2/v31n1-7.pdf.