July 10, 2008
As an investor, I realize the value of both buying a low priced security and hoping for gain due to price appreciation and shorting a high priced security and hoping for a gain due to price declines. I don't engage in short selling, but I do acknowledge its value in orderly markets.
To maintain that each activity is equal, however, is absurd. There is not a great deal of manipulation possible when taking a long position. You purchase a stock, it is delivered, and your brokerage completes the transaction.
Short selling, however, appears to have much room for manipulation. Your data would seem to support that irregularities are occurring with both frequency and volume in some securities. These proposed changes will help in this regard but don't go far enough.
Unless an uptick rule is again established, rumors - quietly spread, posted on popular blogs, or shouted from the windows of Wall Street - will continue to provide increased profit potential for short sellers to drive down the price of a stock. It is easy for a company to issue a denial of a positive rumor, thus eliminating the danger for manipulation on the upside by people holding a long position. Such denials are automatically and quickly believed. What company would talk down its prospects unless the "talk on the street" was really a false rumor?
Although there is technically no upside to how high a price can go, even if driven by rumor, and occasionally there seems to be no rational explanation behind the prices some securities trade at, for the most part the P/E and other guidelines can clearly show that something is manifestly wrong when a price is elevated too far for whatever reason.
In most markets no denials of bad rumors are likely to be believed. The stock price will drop and frequently keep going down for some time after it appears that there was simply a rumor being bandied about. People are wired to worry that there might be a kernel of truth in the rumor. This is exacerbated by naked short selling and no controls for when short selling can occur. How much of the latest Bear Stearns fiasco was due to rumors that could not be disproved?
A side effect of destroying the market cap of stocks is that they may well be moved out of a more select index to a broader index (SP 100 to SP 400 to SP 500 for example) which causes index funds to sell them to stay matched up with the current stocks in a particular index, increasing the downward spiral (and helping some lucky stock that gets to replace them in the next bigger index by market cap).
There needs to be increased protection on the downside (an uptick rule) that simply isn't needed due to market psychology on the upside. Such a rule provided a much needed throttle on profiting from spreading lies and rumors since the big stock market crash, and should be evaluated quickly along with the changes proposed here.
Thank you for your time.