Re: Proposed Regulation SHO
I have read the proposal to replace Rules 3b-3, 10a-1, and 10a-2 and amend Rule 105 of Regulation M. The proposed Regulation SHO would, among other things, require short sellers in all equity securities to locate securities to borrow before selling, and would also impose strict delivery requirements on securities where many sellers have failed to deliver the securities.
I would like to make the following comments.
The Security and Exchange Commission is rightly concerned with protecting investors from fraudulent or deceptive trading practices. Of particular concern are types of trades that are permissible under current regulations, but which in practice create disturbances in the market prices of traded securities.
The SEC is proposing this change in regulations to address such a concern. The perception is that "naked" short selling causes the market price of certain issues to fall artificially, thus unfairly damaging the financial interest of parties who hold long positions in these shares.
I submit that an empirical analysis of the facts will dispute this contention. In fact, virtually are the damage to investors is created by the artificial run-up of stock prices followed by the inevitable collapse as the prices return to levels consistent with the intrinsic value of the shares. Naked short selling serves as a mitigating counterbalance against these pump-and-dump schemes and is thus favorable to the small investor.
The following table lists a group of stocks that were subject to high levels of short selling during the years 2000-2001. Presumably a portion of the short sale positions would not have been permitted under proposed Regulation SHO.
Column A - Security Trading Symbol
Column B - Date on which Stock value had run-up due to pump-and-dump promotions
Column C - Stock Price as of Date in Column B
Column D - Stock Price 90 Days Later
Column E - Percentage Change in Stock Price in 90-Day Period
Column F - Stock Price as of September 30, 2003
Column G- Percentage Change in Stock Price between Date in Column B and present time
While this is not a comprehensive sample, it does illustrate an important point. The damage done to the individual retail investor was not caused by naked short selling, but by overly inflated stock prices. If anything, the shorting interest in these securities benefited the very investors the SEC is seeking to protect. By creating a downward counterbalance, short selling dampened the efforts of unscrupulous promoters to take advantage of penny stock players. The buyers of shares in penny stocks may think that the "bashers" are working against them, but the opposite is true. Short selling activities under existing regulations serve to release air from speculative bubbles, provide liquidity during volume spikes and reduce the long-term losses suffered by those who believe the hype of the pump-and-dump promoters.