September 20, 2009
To: Securities and Exchange Commission (SEC)
From: James L. Rothenberg
Summary: This Amended Proposal for Comment and the Original Proposal for Comment are admissions of regulatory failure. The Notices for Comment state that legitimate trading may be foreclosed by any of these proposals. In an effort to prevent fraudulent and/or manipulative trading, the remedy prescibed in these Proposals are a scheme of price regulation. Price regulation is outside of the Congressional mandate. The SEC has acknowledged repeatedly that price regulation is contrary to the national policy of free and open markets determining prices.
The SEC hearings on Regulation SHO and short selling should have focused on specific short selling strategies in order to determine which strategies are manipulative either in intent or effect. A Rule Proposal could have been drafted for Comment that complied with the intent of Congress when it directed the SEC to draft regulations to prevent fraudulent and/or manipulative trading.
The economic analyses of the Short Selling bans on financial securities cited by other commentators uniformly conclude that the prohibitions were an abject failure. The hastily created Rules produced unintended dislocations of securities prices from futures and option prices. Market declines of financial securities reflected the enormous losses incurred by those entities. Short sellers who anticipated those losses covered their short positions as the financial securities declined in price. Political and public pressure to do something to retard the decline led inevitably to misguided regulation.
Short Selling is precluded for many retail investors either by the FINRA Suitability Rule or by stated customer investment objectives. Many institutions are precluded from short selling either by state law or by their disclosed investment objectives. Short selling is typically conducted by market professionals either for their own accounts or for institutional accounts that disclose the risk of short selling or hedging strategies that include short selling. Accordingly, short selling which provides liquidity and depth to markets, as noted in the Proposals for Comment, has to be evaluated solely on its potential for illegal intent or effect.
Two specific short selling prohibitions are appropriate consistent with congressional intent. First, ban "death spiral" short selling, either directly or by brokers working with the financing entity, where a greater long position is created by lower pricing caused by the short selling. Second, ban short selling where derivative products benefit from lower prices caused by short selling. Neither example cited above is exempt arbitrage because the profit is created by short selling at lower prices not by existing differentials. Both examples cited above have the intent and/or the effect of manipulation because of the absence of investment or trading objectives.
Specific Comment Request
Renewal of Comment Request
1. None. Pricing regulation imposed by the "alternative uptick rule" impedes legitimate short selling but does not directly impact manipulative or abusive conduct. Short selling is a vital and valuable part of securities pricing in all market conditions except rapidly declining markets. When securities markets rapidly decline, option and futures markets sell at a discount rather than a premium. Immediate exercise of options and futures conversions at a discount to the cash market permit an unlimited amount of synthetic "long" stock to be sold for an legal arbitrage profit. Securities markets will continue to decline until sufficient buyers are attracted or circuit breakers are triggered.
2. The Brady Report and the SEC Study of the 1987 market decline emphasize the unitary nature of securities, options and futures. The absence of any tick regulation in futures and options destroys any theoretical value of tick regulation in securities.
3. Technical progammers inside and outside of the investment community are the persons best qualified to respond to trading and surveilllance systems costs.
The "Alternative Tick Rule" which is proposed for "administrative simplicity" is not an acceptable option for the reasons set forth above. Instead, the primary market, wherever located, should be the pricing point for short sales. Market professionals understand that secondary markets price off of the primary market and lay off their imbalances in the primary market. In the absence of any meaningful self-regulation of electronic exchanges, alternative trading systems and dark pools" where orders can be placed in microseconds, the statutory congressional mandate has been and continues to be ignored because of regulatory policy in favor of "competition." Neither FINRA nor the SEC has announced any enforcement or regulatory action to address this outrageous flouting of congressional intent.
4. Policies and procedures manuals are not an acceptable alternative to mandated self-regulation and enforcement proceedings in the absence of meaningful self-regulation.
5. System wide circuit breakers are already in place. Stock specific circuit breakers ignore the fact that company announcements and filings frequently cause dramatic percentage declines. Market efficient pricing, based upon revised forecasting of value, is consistent with basic economic theory.
Supplemental Comment Request:
Please refer to my prior comment letter. I have the following additional comments.
1-3. Investor confidence restoration is dependent on free and open markets and specific regulation targeted at known manipulative conduct. The 'Alternative Tick Rule," because it is over-inclusive and precludes valuable depth and liquidity by short sellers, has the direct effect of increasing trading in overseas markets.