Can someone with an understanding of canadian stock trading help me understand this question

[BigToque]

I'm taking the Canadian Securities course and there are a number of practice questions for every chapter of the course.

here is one of the questions that I don't understand the answer to.

"On January 12, Miss Prudence purchases 1,000 shares of Rock Solid Manufacturing Inc. (RSM) through Dr. Trade, an IA at Sultan Securities. On Monday, February 10, Mr. Knows, another client of the same IA places an order to sell short 1,000 shares of RSM. A few minutes later a third client, Professor Smart places an order to buy 1,000 shares of RSM. On February 14 RSM releases its annual report and also declares a $0.25 per share dividend to shareholders of record at the close of business February 24, payable on March 15. Who is required to pay the dividend?"

The answer to the question was that "Rock Solid Manufacturing is of course required to pay the dividend. Mr. Knows is also required to pay the dividend, because he has sold the shares short."

This doesn't make any sense to me,

On Feb. 10, Mr. Knows puts his 1000 shares up for sale.
On Feb. 10, Professor Smart places an order to buy 1,000 shares.
The settlement should occur by Feb. 13.

By the time RSM declares it's dividends (Feb. 14) they will already have a record of Professor Smart owning his 1000 shares.

This means that RSM will have to pay both Miss Prudence and Professor Smart the dividend.

By Feb. 14, what does Mr. Knows have anything to with RSM? And for what reason would he be paying any kind of dividend?

There is a very long explanation with only this part that sticks out:

"The short seller is liable for any dividends or other benefits paid during the period the account is short"

But there were no dividends paid during the time Mr. Knows account was in short... Right? Or is this where I am wrong?

 

[DaveSimmons]

Selling short is not the same as selling - wiki

 

[BigToque]

Originally posted by: DaveSimmons

Selling short is not the same as selling - wiki

I understand that. I just don't understand why Mr. Knows is paying for a dividend, and who is he paying the dividend to?

Both Miss Prudence and Professor Smart receiving dividends from RSM in this example right?

Or does RSM only pay Miss Prudence, and Mr. Knows is responsible for paying the dividend to Professor Smart (that would have come from RSM had Mr. Knows not sold short)?

I'll look at the Wiki to see if it answers my question.

 

[kranky]

I don't know the mechanism by which the dividend gets from Mr. Knows to the rightful owner, but he's surely liable to pay it. He owned no shares, he sold short. So he in effect borrowed 1,000 shares from an existing stockholder and sold them. The stockholder whose shares were borrowed is entitled to the dividend and Mr. Knows is liable for paying it.

Note there is no mention of Mr. Knows covering his short position by purchasing the 1,000 shares he sold short.

If you sold short 1,000 and your broker borrowed the shares from DaveSimmons's account to process your short sale, and a dividend was declared and paid before you covered your short position, DaveSimmons can't get his dividend from the company because his shares were sold. He's still entitled to it, so you have to pay it.

 

[BigToque]

Originally posted by: kranky
I don't know the mechanism by which the dividend gets from Mr. Knows to the rightful owner, but he's surely liable to pay it. He owned no shares, he sold short. So he in effect borrowed 1,000 shares from an existing stockholder and sold them. The stockholder whose shares were borrowed is entitled to the dividend and Mr. Knows is liable for paying it.

Note there is no mention of Mr. Knows covering his short position by purchasing the 1,000 shares he sold short.

If you sold short 1,000 and your broker borrowed the shares from DaveSimmons's account to process your short sale, and a dividend was declared and paid before you covered your short position, DaveSimmons can't get his dividend from the company because his shares were sold. He's still entitled to it, so you have to pay it.

Ahhh... that makes a lot of sense.

Thanks kranky.

 

[altonb1]

Originally posted by: kranky
I don't know the mechanism by which the dividend gets from Mr. Knows to the rightful owner, but he's surely liable to pay it. He owned no shares, he sold short. So he in effect borrowed 1,000 shares from an existing stockholder and sold them. The stockholder whose shares were borrowed is entitled to the dividend and Mr. Knows is liable for paying it.

Note there is no mention of Mr. Knows covering his short position by purchasing the 1,000 shares he sold short.

If you sold short 1,000 and your broker borrowed the shares from DaveSimmons's account to process your short sale, and a dividend was declared and paid before you covered your short position, DaveSimmons can't get his dividend from the company because his shares were sold. He's still entitled to it, so you have to pay it.

That's the way I was seeing it, too. The short seller has not covered his position, so he has to pay the dividend. How it gets from his account to the owner's account, I'm not sure, either. The company has to pay the dividend to all stockholders on record at the time the dividend is processed.