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U.S. Securities and Exchange Commission

Speech by SEC Commissioner:
Remarks on Proposed Amendments to Reg SHO


Commissioner Roel C. Campos

U.S. Securities and Exchange Commission

SEC Open Meeting
Washington, D.C.
July 12, 2006

I too would like to thank the staff for its efforts on today's proposal. Short sale regulation has been, is, and will continue to be an issue where agreement is difficult to find. All experts, including our own economists, are convinced that short selling provides the marketplace with liquidity and pricing efficiency. However, it must be realized that shorting can be misused for manipulative conduct, as with any trading strategy. However, I believe that the true nature of the problems that are frequently described in the press may be the underlying intent to manipulate the stock. Fraudulent stock manipulation comes in many forms, including long strategies of pumping the stock, as well as shorting strategies. Like other situations when investors appear to be victims of fraud, I support the prompt investigation of such cases. Discovery needs to be instituted and all our legal tools should be brought to bear to protect investors. Indeed, it was to lessen the opportunities for manipulative trading that we adopted Reg SHO.

However, in crafting regulatory change, we must consider the universe of the problem. Today's proposal closes two more gaps in the "failure to deliver" component of the short sale rules. Fails to cover short sales amount to 1% by dollar value of all trades, including equity, debt, and municipal securities on an average day. Thus, in fine-tuning Reg SHO, our efforts are targeted at protecting a small universe of thinly-capitalized securities from abusive trading wherein the level of fails to deliver can harm the market for the security. Again, I won't repeat the numbers that you have already heard but, preliminary data indicate that the locate and deliver rules of Reg SHO are providing considerable protection against naked shorting. But there is room for improvement.

As promised when we adopted Reg SHO, we have studied the ongoing results of Reg SHO and found additional avenues to minimize opportunities for manipulative trading without interfering with the market's ability to police itself. Today's proposal to eliminate the grandfather exemption and assign a close-out period to the options market maker exemption bring us further down the road to modernizing the short sale rules. The potential benefits from limiting outstanding fails accrue not only to the markets and the affected issuer but also to the investor who may have been deprived of the benefits of share ownership. I encourage the staff to consider narrowing other gaps in the current regulatory framework that may allow for abusive short sales, particularly as they may impact the offering process. I note that the Commission has brought a number of enforcement actions under Rule 105 and that rule may need to be tightened. Plus, the staff has been studying the issue of overvoting shares and I look forward to their thoughts and recommendations on that issue in the near future too.

Speaking of the larger picture of short sale modernization, I am eager to evaluate the results of the pilot program. Despite the potentially limited arena for abusive activity, there is no question the existing short sale rules provide for disparate short sale regulation, depending on where the securities are trading. This disparity may lend itself to regulatory arbitrage regardless of the capitalization of the security. Data from the pilot program should enable us to make an informed decision on the proper approach to eliminating this disparity, whether it be dispensing with the short sale rule for all or a particular class of securities or applying a uniform rule — such as the proposed uniform bid rule — to all or a particular class of securities. To that end, I look forward to the upcoming Reg SHO academic roundtable and the thoughts of our participants.

As I said before, today's proposal is but a piece of the puzzle. We must continue to look at short sale regulation from all angles. I encourage your comments, and I support the recommendation.


Modified: 07/12/2006