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February 1, 2004

Putting Squeeze on the Shorties

By Gregory Bresiger

The SEC, closely studying the hot topic for the past four years, is pressing ahead with far-reaching reforms on short selling.

But these measures do not sit well with all trading officials.

The fears surrounding short selling are "largely unfounded," according to Samuel Lek, chief executive of Lek Securities, an options and equities trading brokerage firm.

The proposed SEC rule, regulation SHO, also attracted criticism from the Security Traders Association. The STA praises the SEC's initiative but considers the roughly two-month period permitted by the agency for comment not long enough. The STA also supports the SEC's proposed pilot, which could suspend operation of a proposed uniform bid test of proposed rule 201 for specified securities. But the STA said the two-year pilot period is too long and it wants more securities covered.

"Moreover, the industry and the SEC already possessed information concerning the trading of Nasdaq securities unrestricted by a short sale since a number of markets and ECNs permitted such conduct over the last year," the STA said in a comment letter to the SEC.

The SEC has a package of reforms that would require short sellers to have the securities before they could trade them and impose new penalties on sellers who failed to deliver the securities. It also includes the new uniform bid test allowing short sales to be completed at one cent above the consolidated best bid. This test would apply to all exchange-listed securities and Nasdaq National Market Systems Securities (NMS), wherever traded. Lek says there is a simpler way to reform the tick test - abolish it because "traders who want to evade it, have been able to do it for years." He also argues that the failure to deliver securities is not "a pervasive problem for the market." It is also not a problem, he contends, that is caused by naked short selling.

The STA, in its comment letter, also took aim at the one-cent bid test plan, saying it would cause an unnecessary burden. It also describes the proposed elimination of the market maker exemption as a "grave error and could result in significant harm to public investors by reducing liquidity, speed of execution, and the ability of market makers to test liquidity and engage in price discovery for the purposes of providing better executions to customer orders."