SEC's Short-Selling Decision Nears

Traders Magazine, June 2009

Nina Mehta

In two weeks, the comment period covering the Securities and Exchange Commission's proposal to reintroduce restrictions around short selling will end. The SEC, as part of a rewrite of Regulation SHO, sought input from the industry, issuers and the general public. Opinions are all over the place, and there is no shortage of handicappers.

On the table are five separate proposals. One involves bringing back Rule 10a-1, or the New York Stock Exchange's "uptick" rule, rescinded by the SEC in 2007. Another would introduce a price test using the national best bid as the reference price. Three others involve a circuit breaker that would trigger a trading restriction around short sales if a stock's price declines by a certain amount.

While some in the industry are advocating that the SEC do nothing, far more are betting that the Commission will take action. If so, the choice for the SEC appears to be between a bid test and a circuit breaker that leads to a bid test. The uptick option has been condemned by exchanges and broker-dealers as irrelevant in a fast-paced decimal environment.

 The SEC has also said that bids are more accurate reflections of current prices than ticks, which have 90 seconds to print to the tape. Issuers generally advocate the bid test, while the trading industry would settle for a circuit breaker that leads to a bid test.

For the SEC, the issue isn't easy. The two current Republican commissioners are on record questioning whether any SEC action to curtail short selling is necessary. The SEC's Office of Economic Analysis, whose data and studies, along with those from outside academics, led to the Commission's elimination of all price tests for short sales, is believed to be against a change. The SEC staff is also rumored to be against new restrictions.

But the SEC is under pressure from both Capitol Hill and Main Street. Roel Campos, a former SEC commissioner who left the agency in 2007, predicts that the Commission will "probably decide on some version of the price or bid [test], but I don't know that they'll choose a circuit breaker." Campos, now a partner at Cooley Godward Kronish, spoke at a Security Traders Association conference last month. Tom Gira, executive vice president of the Financial Industry Regulatory Authority, said at another conference that a stock-specific circuit breaker that leads to a ban on shorts is the likelier outcome.

Short selling became a fraught, politically charged issue in the wake of last fall's unprecedented stock market declines. Politicians, the media and investors blamed short sellers for hammering down stock prices. John Nagel, deputy general counsel at Citadel Group, questioned this reaction at an SEC roundtable last month. "The silence is deafening" when it comes to searching for data supporting assertions that short selling was the culprit behind last fall's market problems, he said. He advised the SEC to "carefully evaluate calls for a price test or circuit breaker in light of empirical data."

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