May 5, 2009
Dear Madam Chairman,
Im not telling you anything you havent heard in my assertion today that there are multiple problems in our trading ecosystem. Unlike some of the talking heads on TV today, though, I believe the problems are being addressed in the wrong order. Before listing what I perceive to be a problems though, Id like to state why I believe shorting behavior must be more tightly controlled than it ever has been before.
Some proponents of the current shorting rules assert that this is merely a leveling of the playing field that has been uneven for 70 years. The false assumption underlying many of these arguments is that behaviors and even long and short markets are, somehow, symmetric. Aside from the obvious difference with the downside being bounded by zero, the important asymmetry comes from the humans standing behind each trade.
Compare the emotional response of a human who has a 20% windfall profit to one who has had an unexpected 20% loss. The former individual may be quite happy and a few will be prudently capturing some of the profit by selling all or part of their investment. The latter individual, however, is rarely happy and far too frequently reacts irrationally to the loss. The term panic selling appropriately captures the feelings and behavior of some of these investors. The increased propensity for the loser to trade is a source for further downward pressure whereas the inaction of the winner does nothing to increase volatility. Is there anyone who can honestly say these two are equal forces in the market?
I actually have no problem with short sellingas long as the seller can cover their bet. This means they MUST own the stock or have documented proof that someone who does own the stock is willing to tender it upon demand. I recently heard a broker claim that this is exactly the system we have today. This is blatantly untrue. Aside from the ability with online brokers to short sell merely by stating I can cover the sale, the exception granted to ETFs is a loophole that is unforgivable.
1. Naked shorting should be prohibited in all forms and violations of this rule should be treated as criminal behavior. Brokers who facilitate this behavior should share the fate of the instigating criminals as well.
2. Exemptions to the short covering rules must be eliminated.
3. An uptick rule should be put (back) into place.
However, I dont believe the old uptick rule is truly appropriate in todays market. The speed with which the market operates today is far faster than when the original uptick rule was created. Thus I would suggest adding a delay factor to thwart programmed trading that could game the old rule. Rather than a simple uptick enabling short selling, it would be better to require a multi-minute upward trend instead of a single uptick.
Those who want to bet on the failure of companies may still do so through authorized borrowing of stock to short or through derivatives. These do not give the short-sellers the ability to inappropriately hammer down stocks and steal the value.
If you disagree with my proposals may I take this as your tacit permission to short-sell your primary residence?
Rob Scott