June 12, 2009
Elizabeth M. Murphy
Securities and Exchange Commission
100 F Street, NE
Washington, DC 20549-1090
File Number S7-08-09
Dear Secretary Elizabeth M. Murphy,
This letter is in reference to File Number S7-08-09, and is in opposition to the proposed rule change that seeks to reinstate a short sale price test. Additionally, I oppose the lesser evil of imposing this short sale restriction only when a security has a severe market decline.
Proponents of a price test assert that selling short on a downtick is damaging to the stock market, that it creates fear and destroys value. They complain when stocks decline precipitously, and assume that this must be because of sinister short sellers. However, they are merely scapegoating short sellers, as both data and reason s
how.Let's look at the data. On December 9, 2008, Bloomberg reporters Edgar Ortega and Jesse Westbrook offered the following information:
"When Citigroup plunged 26 percent on Nov. 20, the steepest drop on record for the New York-based bank, downticks represented 7.1 percent of trades, according to exchange data compiled by Bloomberg. On Oct. 9, as both Morgan Stanley and Merrill Lynch & Co. shares had record declines, trades on a downtick represented 16 percent and 11 percent of transactions, respectively."
This report demonstrates that even in the most extreme circumstances, selling on a downtick contributes to only a small fraction of overall selling. It is preposterous that this minority is getting blamed for large price declines. If one person hits the bid to sell 100 shares short, is that really the catalyst behind someone else selling 1000 shares? The answer is no: this relatively small downward pressure cannot reasonably create and sustain a panic. Of course, if people choose not to believe data and logic, and they think that good quality stocks are going down because of some irrational panic, there is an easy solution - they can enter bids and buy.
Since I do not believe that short selling on a downtick is detrimental to the stock market, it therefore follows that I do not support short selling restrictions even when circuit breakers are involved. First of all, it seems bizarre to me that a stock can trade up 200 percent without restricting how people buy, but upon that same security's 20 percent decline (or whatever decline would prompt a circuit breaker), people would not be allowed to short on a downtick, even if shorting on a downtick might result in a bubble being popped more quickly and efficiently. Prolonging bubbles simply entices new investors to buy at overvalued levels, and this is not a worthwhile goal. Additionally, the mere existence of a circuit breaker level might create a rush to sell in advance of that level, and therefore would be a counterproductive measure against panic.
If I am willing to sell at the bid and someone else is willing to buy there, then a free market should allow us to actualize our intentions. Before the eradication of the tick test, it was often maddeningly difficult to get short. A stock might not have been moving, or it might have only trickled down one penny every five minutes; yet because there was a downtick, it would often take me up to 15 minutes to short any amount of stock, let alone the amount I desired. This is not how a free market should work.
A short sale restriction would be an unnecessary wall separating buyers from sellers, which does a disservice to both parties. Curbing a short seller's ability to establish a position serves as a disincentive to trade, and would therefore reduce liquidity in the market. This makes it harder for investors to buy (when the short seller wants to sell) and sell (when the short seller wants to cover). This proposal also makes it harder to hedge positions - a practice that often eliminates inefficiencies.
A short sale restriction is a bad idea. It would introduce regulation for the sake of appearances, and nothing more. Worse yet, it would be detrimental to the efficiency and liquidity of the marketplace. Please do not pass this proposal.
Sincerely,
David Schwarz
Registered Principal