If you’re gonna set somebody up, it’s gotta be a surprise, you got that?
- Chili Palmer, “Get Shorty”
What a surprise!
It isn’t every day we get to praise securities regulators, so let us not let pass this opportunity to congratulate SEC Chair Mary Schapiro on the announcement of new initiatives on short selling. The high points of SEC Release 2009-172 (27 July, “SEC Takes Steps To Curtail Abusive Short Sales And Increase Market Transparency”) are: a requirement to deliver stock, and enhanced transparency by making short interest data more widely available.
In addition, there are significant political offerings. These include “a public roundtable… to discuss securities lending, pre-borrowing, and possible additional short sale disclosures…”, and assurance that the Commission is “continuing to actively consider proposals on short sale price test and circuit breaker restrictions.”
The SEC’s brief is market integrity, and investor protection. Anyone who ever earned their living selling anything to anybody will tell you that the incidence of truly informed consumers is statistically insignificant. Therefore, the best any market regulator can possibly do is require maximum market transparency. Added to that, it would be helpful if every brokerage account statement came with a warning similar to those displayed on Canadian cigarette packages, which feature large full-color photographs of gangrenous limbs and active cancer tumors.
Chairman Schapiro has not always contented herself with hoping for the best. She has acted affirmatively in the public interest before. While at the NASD she oversaw the creation of the Investor Education program – you may remember the silly photos from the NASD website, like the pudgy gent wearing a tiny hat under the caption “Small Cap”. The pictures were goofy but memorable, and they were right there on the NASD’s home page under a header that shouted INVESTOR EDUCATION. If you got as far as typing in NASDR.COM you couldn’t miss it.
Of course, even Mary Schapiro could not force you to read the material – but until she came along, no one else had even bothered to publicize it.
We now get to watch Chairman Schapiro as she joins the cast of Get Shorty, where people who are harder working, more focused, and better informed than average investors get punished for being… well… harder working, more focused, and better informed. This has been true of hedge funds, and its latest targets are the High Frequency / Low Latency traders. But there has always been a special place in the hearts of the American public – and legislators – for the Shorts.
Chairman Schapiro, herself no stranger to the Politics of Politics – to coin a phrase – has neatly thrown the short sellers into the briar patch by calling for a roundtable and promising “ongoing” and “active” consideration of other proposals. With any luck, the political process – the septic interface where Hill and Street meet – will slow this debate down to a 16 RPM screaming match that will drag on until nature takes its course: either speculative frenzy will overtake the markets and no one will care about silly things like short sellers and hedge funds, or we will forget about short sales as we queue up to swap our dollars for Yuan, meanwhile hoarding water, bread and bullets.
It would be nonsensical to make a type of transaction illegal. Cocaine is illegal and is distributed through a sales network. Would it be a stretch to think the way to halt the widespread use of cocaine was to introduce legislation making it a crime to buy something? (We may regret suggesting that – please don’t forward this to anyone in Washington!)
No politician will defend short selling against all the nonsense coming down the pike – that would make them look like they were in the pocket of the hedge funds. But we note the issues Chairman Schapiro chooses to avoid.
It is well and good to make delivery mandatory. We expect there to be a few high-visibility and hard-hitting cases brought in short order, where firms will be punished for not making timely delivery. Thus will the SEC show the press it Means Business.
Our market, large and complex as it is, runs on certain presuppositions. At any given time, there is not enough stock available for borrowing in the marketplace to support all the short sales that are done on any given day. Active traders in a volatile market may recycle a short multiple times in one day, shorting, covering and re-shorting stock against the same locate. Would a “hard borrow” require them to make multiple deliveries, even if their position is flat at the close of business? (Don’t send that to Washington either…)
We all know that the Easy To Borrow lists make unrealistic quantities of stock available for shorting, and that at any given moment there are phantom shares in the marketplace as a result of aggregate short sales that exceed prime broker Easy To Borrow lists. But the probability is that not all these shares will be required for delivery at the same time. To introduce a hard locate, or pre-borrow and deliver requirement would be to clamp down on volume and liquidity in the market so drastically, the US would no longer be the marketplace of choice for equity traders. Talk about reneging on your handshake.
This aspect of the market appears to be here to stay. If you had any doubts, footnote 29 of the Release quotes several Exchange Act Releases regarding issuers’ attempts to protect their shares from naked shorting. Issuers have tried issuing shares that are only available in physical certificate and can not be “held” electronically, or simply withdrawing from the industry-wide DTC clearinghouse, making their securities no longer available for book-entry transfer. “Withdrawing securities from DTC or requiring custody-only transfers would undermine the goal of a national clearance and settlement system designed to reduce the physical movement of certificates in the trading markets.” Translation: self-help is not available to issuers. Liquidity of the markets is more important than the woes of individual issuers; short selling is here to stay.
Even the absolute delivery requirement, which reads great in the press, is not absolutely absolute. We note that the expression “ex clearing” does not appear in the SEC document. What does appear is an immediate close-out and deliver position “if a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency…”
Outside of the registered clearinghouses, there appears to be no record of how many trades remain uncompared at any given time. Thus, there seems to be no clear way to challenge those corporate executives who rant in public about collusion between firms to run up and maintain invisible short positions in their stock. If the SEC were serious about rooting out naked shorting and other abuses, they would require firms to record ex clearing contracts, to mark them to market, and charge them against regulatory capital.
Thus, the new short selling release accomplishes a measurable increase in transparency – a good thing. Outside of that, it makes permanent a prohibition against naked short selling – no one will argue there. For the rest, as one market participant said, this monumental exercise appears to be “a fix in search of a problem.”
Or, to put it another way: this is the way the markets work. You got a problem with that?