June 10, 2009
June 10, 2009
The Honorable Mary Schapiro Chairman U.S. Securities and Exchange Commission 100 F Street NE Washington, DC 20549
Dear Chairman Schapiro:
Over my 45 years as a private investor in the equity markets including 25 years as a financial professional I have seen several bear markets but the absence of the Uptick Rule I believe has contributed to this markets severity and volatility. To paraphrase the SEC mission statement it is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. In retrospect I can see nothing by the repeal of the Uptick Rule in July, 2007 that did anything to address this mission. It is certainly questionable as to how unrestricted short selling enabled by this repeal did anything to protect public investors or contribute in any way to orderly markets and increased capital formation.
The very nature of short selling when viewed as a stand-alone activity is not particularly conducive to capital formation in that the economic incentive to maximize profit is to drive prices, sometimes through abusive tactics, toward zero. The primary participants in price discovery should be ownership buyers and sellers as is the case in other areas of commerce and these other areas have little difficulty establishing prices for goods and services without the assistance of a short seller. This is not to say that properly regulated short selling using a price test can not play a constructive role in adding to market efficiencies through hedging functions and absorption of excess buying interest.
So whats to be done? Whatever is done needs to be a serious and effective solution, and I would urge the SEC not to allow "what is easiest to do" to be a factor in the decision making. Again, this needs to be serious reform and I offer the following suggestions and comments for your consideration:
1) Re-establish an uptick rule that is market wide and permanently applied based on the last sale price for a price test. I would suggest an increment of perhaps $0.05 above the last sale price for short sale order entry and execution. The uptick rule should not be triggered by a circuit breaker. A circuit breaker trigger would only weaken the application and effectiveness of the price test rules and I would encourage you to strongly oppose this approach.
2) Naked short selling is truly the counterfeiting of corporate currency. Just as the U.S. Treasury aggressively pursues counterfeiters the SEC should aggressively pursue and do all it can to eliminate this pernicious activity. I would suggest starting with strengthening pre-borrow requirements and failure to deliver regulations. There should be a mandatory buy-in on T+4 with any loss charged to the short seller and any profit forfeited. Repeat offenders should be prosecuted and face severe fines and trading suspension.
3) In addition to a market wide and permanently applied uptick rule I believe a circuit breaker halt rule prohibiting any short selling in a security after a 10% decline from the previous days close would be effective to further reduce price volatility. I would suggest a suspension on short selling for the balance of the trading day.
4) I believe a price test rule should be in place during after-hours trading to prohibit a short sale at a price lower than the last sale price on the consolidated tape. The after-hours market should not become a haven for short selling that would have been prohibited during regular trading hours.
5) I would suggest the SEC craft comprehensive regulations for the hedge fund industry and credit default swaps (CDS) which are essentially default insurance contracts and should be treated accordingly. These are areas that need more transparency and oversight. The naked CDS together with unrestricted short selling has provided powerful tools for abusive bear raids on some of our largest institutions. The confluence of these abusive practices most be stopped. I believe a good place to start would be a regulated clearing house for CDS transactions and a prohibition on naked CDS purchases where there is no insurable interest.
6) The multi-levered ETF product needs thorough review. These products appear to circumvent margin requirements and their use in short selling operations should be in question. These products and others engineered over the last several years have only pushed us toward treating securities as commodities instead of the ownership interests they represent, without contributing any benefit to the markets primary purpose which is to provide private capital formation.
In closing, I am hopeful with your new leadership at the SEC that these important issues will be effectively addressed. While listening to all views I would urge the SEC to relegate the special interests of the hedge funds, day traders, and exchanges to the larger national interests of adopting policy to support fully functioning markets that provide the private capital formation required for future growth and markets in which the public investor can have confidence.