September 30, 2008
The meaninglessness of the securities delivery requirements under existing practice makes a mockery of this agency. Shareholders and markets would be better protected under state common law than under the joke "market" the SEC enables. Where else can you take payment for something you don't own, and never have to deliver it?
If Hertz didn't have to own or rent the cars it offered to the public, but could lawfully rent phantom cars to unsuspecting travelers without ever requiring possession, what would you model for the market price for auto rentals?
This entry makes the case fairly nicely:
Shorting is a valuable practice to allow, as it enables pessimists to participate in markets as legitimately as optimists. However, failure to enforce delivery requirements has the effect of making it much cheaper to sell short than to buy on margin, and since short-selling promotes market mechanisms that depress prices it's difficult to see a natural curb to short-selling if delivery isn't required.
The solution is simple: require every seller to have identified -- in its own account or in an account where it has obtained permission to borrow the securities in question -- the securities it will deliver. The only way this requirement will have strict meaning is if the identification requirement must be contemporaneous with the transaction: otherwise, intra-day naked shorts will be able to profit from temporary price manipulation in positions that can be closed the same day.
I cannot say I expect enforcement to become meaningful, but I want to make sure this agency understands both what it is doing and the fact that it has made a laughingstock of itself before everyone who pays attention. The ultimate insult to the theory of uniform federal regulation as the solution to national marketplace concerns is warranted by the SEC's failure to enforce the most basic rule of markets: I would prefer state regulation of the market, and would accept cross-border jurisdictional conflict risk as a price.
If one need not deliver what one sells, why bother trying? It's much cheaper to destroy than to build, and the SEC is doing a superb job of assisting the destruction of value in the marketplace.
Christopher D. Lewis, J.D., M.P.H., J.D.