Subject: Comment Letter for File Number S7-08-22 Short Position and Short Activity Reporting by Institutional Investment Managers
From: Eric Luong
Affiliation:

Oct. 17, 2022



Vanessa A. Countryman
Secretary
U.S. Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C. 205499–1090

rule-comments@sec.gov

Re: Release No. 34–94313; File No. S7–08–22 Short Position and Short
Activity Reporting by Institutional Investment Managers

Ms. Countryman:

We The Investors (“WTI”)1 appreciates the opportunity to comment on
the U.S. Securities and

Exchange Commission’s (the “SEC” or “Commission”) release on proposed Rule 13f-2

(“Proposal”) under the Securities Exchange Act of 1934.

We The Investors have organized around five key principles as laid out
in our Investors’ Bill of Rights2. These include Transparency,
Simplicity and Fairness, Choice and Control, Best Execution and Better
Settlement and Clearing. This comment letter will focus on two of
those principles - Transparency and Choice and Control.

Before making recommendations regarding the Proposal, it is important
to put some context around the shortcomings of the current system and
the Commission’s goals with this proposal in order to evaluate whether
the proposal will be successful.

The Commission has identified the following shortcomings with current
data: “(1) fails to distinguish economic short exposure from hedged
positions or intraday trading, (2) fails to distinguish the type of
trader short selling or identify individual short positions, even for
regulatory use, and (3) fails to capture the various ways that short
positions can change and the various ways to acquire short exposure.”3
In addition, The Commission explained that “short selling volume and
transactions data cannot easily explain changes in short interest,
exposing a gap between these two types of existing data.”4
Furthermore, these data sets are subject to differences in reporting
lag, and can misrepresent the amount of short selling due to
mismarking.

These are significant and material shortcomings in the transparency of
US capital markets, but the Commission neglects to acknowledge the
impact of these shortcomings. The lack of transparency into short
positions has led to deep mistrust in markets for retail investors,
and especially for newer retail investors. The Commission risks
alienating these investors and driving them away from US capital
markets if they do not act to provide transparency and certainty for
them.

We Need Increased Transparency

Despite the pushback from industry firms who face increased compliance
costs, we fully support the Commission in this rulemaking, and urge
the Commission to go further with these disclosures. Our movement is
born from frustration over the many complex and conflicted aspects of
market structure, with a lack of transparency and visibility into the
inner workings around short selling being a primary driver of our
retail investor supporters. The lack of transparency around short
positions, the inability to adequately quantify short interest, and
the ability for firms to skirt regulation through derivative positions
such as options and security-based swaps are making a mockery of our
free and open markets. The inadequate ability to properly measure and
understand economic short exposure leads to supply/demand imbalances
in markets and affects trading prices.

The protests of the industry in terms of the effort required to comply
with the Proposal ring hollow given the Commission’s experience with
interim temporary Rule 10a-3T - firms had no problem complying and the
data provided was useful to the Commission. Indeed, the Proposal is
easier to comply with, given the monthly rather than weekly reporting
of interim temporary Rule 10a-3T.

However, the Proposal does not go far enough. WTI urges the Commission
to provide the same level of disclosures and transparency for short
positions as is currently done with long positions via 13F filings.
None of the arguments for aggregation or lagged reporting are
consistent with the reporting of long positions via 13Fs. Our markets
already have a position disclosure standard, and that standard should
simply be updated with short positions to allow retail and
institutional investors to do the same kind of analysis regarding
short positions as they currently do with long positions.

We often lament the fact that regulators in other jurisdictions have
done more, moved further, and advanced the cause of transparency far
more significantly than we have in the US. As other commentators have
noted, the EU adopted a short sale reporting regime that essentially
requires “immediate public disclosure of large short positions,” by
individual issuers. Despite this onerous disclosure regime that goes
much further than the Proposal, we agree that “a study of the impact
of the EU’s regulation finds no evidence that the disclosure
requirements have resulted in increased coordination or have resulted
in short sellers being targeted for short squeezes.”5 The concerns
from the industry and from the short selling community are simply not
valid.

Harmonizing the Proposal with European standards would provide
significant benefits, both from a transparency perspective and from
the short-selling investment manager’s perspective - it is far easier
to comply with the same rule across multiple jurisdictions than to
manage varying standards and rules from country to country.

It is also important to note, from the perspective of how to set an
appropriate threshold for disclosure that, as the Commission
acknowledges, the European threshold of 0.5% is being gamed, and
therefore setting a threshold substantially higher than that will lead
to even further gaming of the threshold and disclosure avoidance.
There should be little doubt that firms will attempt to game any
threshold that is set, as has happened with 13F long disclosures for
many years. Given the European experience with a very low threshold,
we would argue that it is important to set the threshold as low as
possible to mitigate any effects and impacts from firms attempting to
game the threshold.

Despite the constant concerns expressed in comment letters about
“reverse engineering trading strategies” and the concern voiced in the
proposal that there would be a “risk of retaliation towards short
individual sellers… as well as the ability for market participants to
engage in copy-cat strategies,”6 the same can be said of current 13F
disclosures. Indeed there is an entire industry that follows 13F and
other similar disclosures (e.g., politician trades) and allows for
copy-cat strategies.

The value of transparency and the need for investors, both retail and
institutional, to understand the holdings of investment managers, as
well as to form an accurate picture of short interest and short
trading dynamics should far outweigh these concerns. The Commission
has agreed with this view in crafting 13F policies, the EU has agreed
with this view with their disclosure regime, and the Proposal should
be expanded to include robust public disclosure at the individual
manager level of this information.

Finally, we would further urge the Commission to set a goal to
harmonize reporting timelines for all relevant disclosures, from 13F
long and short disclosures to reporting timelines for FINRA and the
SROs to ensure that data is released consistently, to avoid
misunderstandings and misconceptions.

Choice and Control are Fundamental Investor Rights

Much like the reasoning behind recent proposals from the Commission
around ESG Disclosures7, retail and institutional investors want to
know the composition of the positions of the funds that they are
investing in. While retail investors may not always have access to the
type of funds that accumulate significant short positions, they may
still be in the position of doing business with such firms, and they
deserve to know when such firms are betting against core portfolio
positions that they may be holding and may be very passionate about.

The feedback from the industry has several consistent themes, but
primarily it is focused on disguising short selling activity and
reducing transparency. This is antithetical to the Commission’s
objectives with the Proposal. Investors, both retail and
institutional, cannot properly exercise their right to choose
investments, counterparties and other relationships without visibility
into the firms that they are investing in or doing business with. An
appropriate level of transparency is absolutely required to empower
investors to act in their own best interests in an informed manner.

All Short Exposure Must Be Included

The Proposal as currently crafted has a huge hole that must be
remedied, one that the Commission is well aware of - “an investor
wishing to profit from the decline of a security’s value can also
trade in various derivative contracts, including options and
security-based swaps.”8 The failure to include derivative exposure in
this rule will inevitably result in firms exploiting the loophole and
will drive more and more firms into the less regulated and less
transparent space of derivatives. As the Commission acknowledges in
the proposal, “trading in derivatives frequently leads to related
trading in the stock market as derivatives’ counterparties seek to
hedge their risk.”9 Derivatives have an impact on the market, and can
have a detrimental effect on the price of stocks, as Archegos
demonstrated so clearly. While the positions held by Archegos were not
disclosed anywhere publicly because they had exploited a loophole in
13F disclosures, the impact on the market was material and
overwhelming. Indeed, had these derivative positions been adequately
disclosed, it is likely that institutional broker-dealers would have
had enough information to mitigate the impact of Archegos’ trading,
would have been able to recognize the significant exposure that
resulted from the leverage they extended via total return swaps, and
would have prevented the crisis from developing in the first place.

In much the same way, it is critical for institutional broker-dealers
and for retail and institutional investors to understand the extent to
which individual firms have high levels of short exposure to
individual stocks or ETFs, regardless of whether that exposure is via
equity, through the use of derivatives or through other novel
mechanisms that the Commission has not considered.

Markets are changing and evolving, and as regulators impose new
disclosure requirements on firms, those firms will figure out ways to
game or avoid those disclosures. That’s what Archegos did with swaps,
and that’s what other firms might do with other novel ways of gaining
short exposure. One example of this could be through security tokens
on crypto exchanges. Another could be through the use of fungible or
nearly fungible holdings in foreign affiliates - both equity and
derivatives.

If one of the primary goals that the Commission is seeking to achieve
with the Proposal is to give retail and institutional investors, along
with regulators, better visibility into economic short exposure, it is
imperative that all short exposure is included.

We would also encourage the Commission to include ETF creation and
redemption activities. “ETFs constitute 10% of U.S. equity market
capitalization but over 20% of short interest and 78% of
failures-to-deliver.”10 Authorized participants are incentivized to
“operationally short” ETFs, and often fail to deliver these shares.
This is a potential source of stress on financial markets, and “the
potential source of stress on the financial system appears to have
shifted from common stocks during the pre-crisis period to ETFs during
the post-crisis period.”11 As such, transparency into the ETF creation
and redemption process is more important now than ever before. Whether
that transparency starts strictly with regulatory transparency versus
public disclosure is one that the Commission will have to decide - we
would urge full public disclosure of ETF activities in order for the
public to more accurately and adequately evaluate the risks involved
in trading ETFs, and to better understand the short interest numbers
in ETFs that can vary wildly.12

Hedging Indicator

If the Commission insists on continuing with the aggregated
disclosures, we would offer one suggestion for an important change.
The current proposal for categorizing a position as not hedged,
partially hedged or fully hedged could lead to serious problems and
misrepresentations of actual economic short exposure, which is the
first shortcoming identified by the Commission. Aggregated information
could actually end up being very misleading, by painting an inaccurate
picture of the size of short positions despite the “hedging”
distribution disclosure. “Partial” hedging could be manipulated or
abused to mask true short positions (e.g., by hedging an immaterial
portion of the position to flag it as “partially hedged”), and overall
gross position disclosures could overstate short positions when net
positions are not accounted for. A better solution would be to have
the actual amount of position hedged, which could range from 0% to
100%+ if the manager’s long position is larger than the manager’s
short position. This is similar to one of the alternatives proposed by
the Commission, to report the delta value of hedged positions. This
would be a critically important addition to the Proposal and make it
far more informative if aggregation is the direction the Commission
goes.

Bona Fide Market Making Reporting

We believe it is important that the Proposal’s provision that would
“require CAT reporting firms that are reporting short sales to
indicate whether such reporting firm is asserting use of the bona fide
market making exception under Regulation SHO”13 is included in the
final rule proposal. While we are encouraged by this, as it signals
that surveillance teams and regulators are finally trying to better
understand the use of this exception, we believe it to be an
antiquated exception that is no longer applicable in modern markets,
and which should be eliminated. The bona fide market making exemption
is being abused, as illustrated by recent enforcement actions14, and
provides an unreasonable competitive advantage for firms who do not
have affirmative obligations to make continuous markets on lit
exchanges. As the Commission acknowledges in the proposal, “[f]irms
that do not need to obtain a locate prior to effecting a short sale,
on the basis of the bona fide market making exception, have a
competitive advantage over firms that are required to obtain a locate
because these firms can trade more quickly and more easily adjust to
or take advantage of changing market conditions.”15

It is also possible that market makers are using the bona fide market
making exception to include transactions and arrangements where other
broker-dealers or customers are using the market maker’s exception to
avoid compliance with Regulation SHO. It is important that the SEC and
FINRA have the surveillance tools and data necessary to police
markets, and including this data in CAT should be an easy decision.

While it is outside the scope of the Proposal, we believe that market
structure reform should focus on leveling the playing field, and
fostering more robust and verdant competition in markets. Repealing
regulation that affirmatively advantages certain firms over other
firms is an important step in that direction.

Conclusion

We The Investors appreciate the opportunity to respond to the
Proposal. Thank you for considering our comments and we would be happy
to answer any questions or further explain any of the points.

Sincerely,
Eric Luomg


1 We The Investors is a grassroots advocacy campaign launched in March
2022 built by, and for, retail investors. Our mission is to educate
retail investors in order to empower them to represent themselves on
market structure issues. We are supported by industry firms and over a
hundred thousand retail investors.

2 The Investors’ Bill of Rights can be accessed at:
https://protect2.fireeye.com/v1/url?k=31323334-50bba2bf-3132d782-4544474f5631-0ae520819dec360f&q=1&e=6b65a3ff-d9d1-4195-9ce9-d69e6821b10f&u=https%3A%2F%2Fwww.urvin.finance%2Fadvocacy

3 Proposal at 95

4 Proposal at 110

5 See letter from Stephen W. Hall, Legal Director and Securities
Specialist, Better Markets (Apr. 26, 2022)

6 Proposal at 158

7 See Proposed Rule No. 33-11068 (May 25, 2022) (Environmental,
Social, and Governance Disclosures for Investment Advisers and
Investment Companies).

8 Proposal at 103

9 Proposal at 104

10 Evans, Richard B. and Moussawi, Rabih and Pagano, Michael S. and
Sedunov, John, Operational Shorting and ETF Liquidity Provision
(January, 2018), Available at:
https://jacobslevycenter.wharton.upenn.edu/wp-content/uploads/2018/08/ETF-Short-Interest-and-Failures-to-Deliver.pdf

11 Ibid.

12 The XRT ETF for example often shows short interest in the hundreds
of percent of its shares outstanding, and many other ETFs can be close
to 100% of shares outstanding.

13 Proposal at 62

14 See IMC Chicago, LLC, August 12, 2022 (File No. 3-20961),
Wilson-Davis & Company, Inc., April 26, 2017 (File No. 3-17733) and
others.

15 Proposal at 64