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August 6, 2009

Short-Sale Rules Draw Opposition

By Peter Chapman

Trading executives are overwhelmingly opposed to a Securities and Exchange Commission proposal to introduce new short-selling rules, but are willing to abide by one if it is used only in extraordinary circumstances.

With the comment period covering the SEC's plan to amend Regulation SHO with price tests or temporary bans on shorting now ended, all of the major industry organizations and several individual broker-dealers and money managers have weighed in. Most tell the SEC that new restrictions on short sales are unwarranted.

Goldman Sachs, for instance, notes that various SEC efforts of the past year to curb abusive short selling have been successful and are sufficient. "We do not believe that further action to restrict short selling is warranted or will serve the SEC's ultimate goal of restoring investor confidence in our markets," Paul Russo, Goldman's head of U.S. equity trading, said in a letter.

Like many commenters, the Securities Industry and Financial Markets Association says there is no evidence to warrant the imposition of any of the SEC's five proposed rules. Referring to the SEC's goals of restoring investor confidence and facilitating fair and orderly markets, SIFMA stated that it "does not believe there is sufficient evidence that these goals would be promoted or achieved in any measurable sense through new short-sale price-test restrictions."

Like SIFMA, the Managed Funds Association, a lobbying organization that represents hedge funds, petitioned the SEC to conduct a study before passing any new rules. "Rule making should be clearly defined and supported by empirical data," said Stuart Kaswell, the MFA's general counsel.

Traditional money managers weighed in as well. Fidelity Investments recommended the SEC not adopt any of the proposed rules. "The vast majority of the time short selling helps create efficient trading markets without harming the integrity of the markets, investors' confidence or their interests," Fidelity said. Vanguard told the regulator that "any such restrictions must be supported by a cost/benefit analysis based on empirical data."

The Security Traders Association was perhaps the most blunt, claiming that any new rules would be useless. Referring to the SEC's two price-test proposals, it said that "both tests are seriously flawed, and if they are implemented, gaming of these trading restrictions will become rampant. Neither price test would present any appreciable obstacle to abusive short selling in downward spiraling issues and would be ineffective in solving the current quandary."

While most of the industry comments were negative or requested the SEC supply evidence that would support a new rule, many said the SEC should adopt one of its three circuit-breaker rule proposals if it believed it had to do something.

The proposal included three so-called circuit breaker rules that would apply to individual securities rather than the market as a whole. Under the proposals, if a given security fell by 10 percent or so, short selling would become subject to a bid test, tick test or outright ban, depending on the rule.

Most commenters felt a circuit-breaker rule would be the least disruptive and made more sense than either of the two price tests, which cover all securities all of the time. RBC Capital Markets, for instance, believes a circuit breaker combined with a bid test "would have the least impact on the market and, therefore, the smallest risk of adversely impacting market liquidity and/or price discovery."

The SEC could vote on new rules sometime this year.


(For more details on industry endorsement of circuit-breaker rules, see "Circuit Breaker

[Reluctantly] Gets Nod in Short-Sale Debate" on


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