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SEC on dangerous ground with short selling rule

Finance Blogger: Anthony Harrington Anthony Harrington

Despite all the evidence pointing to the role of the banks and the mispricing of risk as causal factors in the 2008 credit crunch and financial meltdown, some US politicians still can’t resist playing to public opinion and blaming “wicked short sellers” for the crash.

“It was the speculators that did it,” is a venerable cry of outrage that dates back to US stock crashes over the last century. Unfortunately, with US regulatory institutions now very much under the microscope, the risk of excessive regulation based on emotion rather than fact seems to be mounting. The evidence for this lies in the SEC’s decision to bring in a new rule to restrict short selling when a stock is, in the SEC’s words, “experiencing significant downward pressure,” or, in other words, when it has lost 10% of its value from the prior day’s closing price in any one day.

The SEC claims that its “alternative uptick rule” will stop short selling from driving down the price of a stock because it ensures that long sellers will get to sell their shares before short sellers get their chance, once the “circuit breaker” 10% rule has been breached. The rule would then stay in force for the remainder of the day and for the entire following day.

Introducing the rule, SEC Chairman Mary Shapiro said:

“The rule is designed to preserve investor confidence and promote market efficiency, recognizing short selling can potentially have both a beneficial and a harmful impact on the market. It is important for the Commission and the markets to have in place a measure that creates certainty about how trading restrictions will operate during periods of stress and volatility.”

The SEC’s new rule comes into force 60 days after its publication on February 24, and market participants have a further six months to comply. From any practical standpoint, therefore, the SEC’s edict here is final.

However, the SEC is not home free. Many market watchers do not believe that there is any compelling necessity for such a rule. The Wall Street Journal reported that two dissenting Republican Commissioners, Kathleen Casey and Troy Paredes, had accused the agency of foregoing its reliance on data and analysis in adopting the regulation. Moreover the Wall Street Journal went on to quote a blistering broadside from Jamie Selway, founder of White Cap Trading and a former chief economist at Archipelago Holdings:

“The concern is not so much this decision, which was expected, but the emerging evidence that the SEC is willing to engage in rule-making based on emotion, assertion and speculation, rather than evidence,” Selway said in an interview from New York. “This is not how they’ve historically acted. This is not the standard they’re supposed to be meeting.”

The problem with the ban is that there have been a number of academic studies that show that short selling per se is generally good for the market rather than bad. A number of operators of trading platforms have written to the SEC arguing that restrictions on short selling are not warranted and would not improve the quality of markets for investors. Which brings us back to the fact that this looks like a politically driven decision.

The SEC is due to pronounce on “dark pools” sometime soon. Let us hope that this time Shapiro’s SEC hoe’s a more independent row…

Further reading for short selling



Tags: regulation , SEC , short selling , US
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