The US Securities and Exchange Commission is weighing multiple rules to dictate when traders can bet shares will fall, after lawmakers and business groups said short-sellers fueled the financial crisis by targeting banks.
One option the SEC staff proposed on Wednesday is a measure similar to the so-called uptick rule, which House Financial Services Committee Chairman Barney Frank urged the agency to reinstate. The agency will also seek feedback from investors, brokerages and companies on a plan to temporarily ban short- selling of stocks that have fallen at least 10 per cent.
“The practice of short-selling has both strong supporters and detractors,” SEC Chairman Mary Schapiro said at a public meeting in Washington. The agency is initiating “what will be a thoughtful and deliberative process to determine what is in the best interest of investors.”
The 5-0 vote by Schapiro and the SEC’s four commissioners moves the agency a step closer to imposing new constraints on bets against stocks after the Standard & Poor’s 500 Index fell 40 per cent in the past year. Morgan Stanley Chief Executive Officer John Mack and former Lehman Brothers Holdings Inc CEO Richard Fuld said short-sellers attacked their firms.
Hedge-fund managers oppose trading restrictions, arguing that banks’ excessive risk-taking and over-concentration in mortgage securities drove down share prices. Financial companies worldwide have reported more than $1.2 trillion of writedowns and credit losses since 2007.
“I think it’s a horrible mistake to impose any restriction on short-selling,” Manuel Asensio, a money manager at New York- based Mill Rock LLC, said in a Bloomberg Television interview. “This is one case where deregulation would be good for the markets.”
The proposal resembling the uptick rule would bar short- selling of a stock until it brings a price at least one penny higher than the preceding trade.
The SEC scrapped the almost 70-year-old provision in July 2007 after studies determined the rule wasn’t relevant in markets dominated by fast-paced electronic trading.
Schapiro said the SEC isn’t aware of any “empirical evidence” that shows the elimination of the uptick rule contributed to falling U.S. stock prices. Still, “many members of the public have come to associate short-selling with that volatility and with a loss of investor confidence,” she said.
An alternative that SEC commissioners considered would allow short-sales only at prices exceeding the best bid. A bid represents the price investors are willing to pay for a stock.
A third option is similar to a proposal made March 24 by NYSE Euronext, Nasdaq OMX Group Inc., Bats Exchange Inc. and National Stock Exchange Inc., which together handle about 80 percent of the shares traded in the U.S.
Circuit Breaker
Under the plan, known as a circuit breaker, the SEC would limit short-selling only after a stock has fallen a certain amount. Once triggered, a bid or last-trade restriction would take effect.
The agency also considered a circuit breaker that goes further than the exchanges proposed. If a stock fell 10 percent, then short-selling would be prohibited for the rest of the day, according to the proposal.
In a short-sale, traders borrow stock and then sell it, aiming to profit by repurchasing shares at a lower price, returning the borrowed shares and pocketing the difference.
‘Political Exercise’
SEC Commissioner Kathleen Casey, a Republican, questioned whether the agency was pushing forward “merely in a political exercise.” If the SEC fails to justify its actions, the agency risked having any rule challenged and shot down by a federal court, she said.
“Empirical evidence must guide regulatory decisions,” said Casey, who voted in favor of soliciting public comment on the proposals. “If the commission forgets this principle, the D.C. Circuit stands ready to provide a reminder.”
The SEC will seek comment for 60 days. Then the staff will determine whether to make changes before commissioners vote to make any of the regulations binding.
Should that happen, an SEC official said the agency plans to give brokerages and exchanges 90 days to implement the new short-selling restrictions.
Market Makers
The SEC doesn’t plan to exempt market makers from any of the rule proposals. Market makers, who account for about 40 percent of trades, are obliged to quote prices at which they’ll buy and sell securities so investors are able to complete trades.
Former SEC Commissioner Roel Campos said it’s inevitable that the agency will make at least one of its proposals binding, because “that decision has” already “been made by congressional people” who want to curtail short-selling.
Campos, now a partner at law firm Cooley Godward Kronish LLP in Washington, represents companies that want the SEC to impose more restrictions on so-called naked short-selling.
Naked short-sellers make bearish bets without borrowing and delivering shares. Overstock.com Inc. and other firms argue it’s a form of manipulation that traders use to drive down stock prices by flooding the market with sell orders.
Erik Sirri, who heads the SEC division of trading and markets, said the agency is working on a regulation that would subject traders and brokers to penalties if they failed to deliver borrowed shares. A temporary SEC rule that expires in July has contributed to a steep decline in shares that aren’t delivered to buyers.
