We are starting to get more information out of the Securities and Exchange Commission on how it plans to go after some of the abuses which have been prevalent in short selling. Keep in mind that this is pursuing the abuse of short selling, not the use of short selling. The SEC issued a release today outlining several actions meant to protect against abusive short sales and to make more short sale information available to the public.
First, the SEC made permanent an interim final temporary rule to reduce the potential for abusive “naked” short selling in the securities market. The new rule requires broker-dealers to promptly purchase or borrow securities to deliver on a short sale.
Second, the SEC is working with several self-regulatory organizations to make short sale volume and transaction data available through the SRO Web sites to result in a substantial increase over the amount of information presently required by another temporary rule.
THE SEC is continuing to actively consider proposals on a short sale price test and circuit breaker restrictions.
The SEC also intends to hold a public roundtable on September 30 to discuss securities lending, pre-borrowing, and possible additional short sale disclosures to consider the potential impact of a program requiring short sellers to pre-borrow their securities and adding a short sale indicator to the tapes to which transactions are reported for exchange-listed securities.
As the SEC notes, “short selling often can play an important role in the market for a variety of reasons….” Those reasons are listed as:
- efficient price discovery,
- mitigating market bubbles,
- increasing market liquidity,
- promoting capital formation,
- hedging and other risk management activities,
- and limiting upward market manipulations.
But the SEC also noted circumstances where short selling can be used as a tool to manipulate the market.
- “Naked” Short Sales.. just selling without a borrow. Such a transaction is permitted because there is no legal requirement that a short seller actually borrow the shares before effecting a short sale. The new rule requires that the broker-dealer rather than the seller must locate an entity that the broker reasonably believes can deliver the shares within three days after the trade in the same “T+3 settlement period. There is still some room for play here though, as this noted “a broker-dealer may rely on a short seller’s assurance that the short seller has located his or her own lender that can deliver shares in time for settlement.”
- “Fails-to-deliver”.. no shares have been delivered nor located for delivery in the T+3. The SEC noted that this can occur for legitimate reasons, such as mechanical errors or processing delays.
THE SEC adopted Regulation SHO effective since 2005 includes two major exceptions: the so-called “grandfather” and “options market maker” exceptions. Both of these exceptions provided that certain “fails to deliver” in threshold securities never had to be closed out.
The SEC is increasing transparency around short sales. In 2008, it adopted a short sale reporting interim rule requiring certain market participants to provide short sale and short position information to the SEC so that it could evaluate whether the benefits from the data justified the costs associated with the rule. Instead of renewing the rule, the SEC is working with parties to increase the public availability of short sale-related information through a series of other actions. This could include:
- Daily Publication of Short Sale Volume Information.
- Disclosure of Short Sale Transaction Information.
- Twice Monthly Disclosure of Fails Data.
The SEC is examining whether additional measures are needed to further enhance market quality and transparency and intends to hold a public roundtable on September 30, 2009 that will focus on issues related to securities lending, pre-borrowing, and possible additional short sale disclosures.
We have chopped down the details here to offer more of an overview. You can read the full details here at the SEC site.
Jon C. Ogg
July 27, 2009
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