Cell Pathways, Inc.
702 Electronic Drive, Horsham PA 19044
December 28, 1999
Mr. Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street
Washington, D.C. 20549
Re: Release No. 34-42037
File No. S7-24-99
Short Sale Regulations
Dear Mr. Katz:
I am the Secretary and General Counsel of Cell Pathways, Inc. ("CLPA" on the Nasdaq National Market). The experience of my company over the past year suggests that the Commission should first find effective ways to enforce the current short sale rules before considering any loosening of these rules.
Unenforced abuses of the current short sale rules are depriving individual investors of essential investor protections. They are also making it more expensive for companies to raise capital.
In the fall of 1999, the Wall Street Journal published an expose of illegal short selling strategies and tactics. The Commission should first address these illegal activities in a meaningful way.
The experience of Cell Pathways during 1999 has included the following elements:
- Short interest has risen in the period August - December to 5.2 million shares, or 20% of the outstanding 26.1 million shares. Since, for a variety of reasons, half or more of the 26.1 million outstanding shares are not available for trading, the short interest has risen to perhaps half of the available float.
- During the entire time of the rise in short interest, the company has had an unbroken string of positive developments. The company has never before made such advancements in its anti-cancer programs.
- We have been repeatedly advised by street sources that our stock cannot be borrowed; yet short interest continues to rise.
- False and misleading reports about the company have been circulated by sources allied with short-selling interests.
- Various short-selling, capping and buy-high-sell-low strategies have been observed on a daily basis.
The effect of the foregoing has been twofold:
- it has substantially increased the number of shares in circulation and thereby depreciated the stock in the hands of our stockholders;
- it has depressed the price of the company's common stock and cost the company about $5 million in a recent $14 million financing.
With this experience in 1999, it is easy for us to advise the Commission that current short selling practices are operating to print stock certificates in unregulated fashion, thereby undermining two important priorities of our financial markets - protection of the investor and capital formation.
Rather than responding to the several dozen questions posed in the well-written release, we believe it more important to emphasize key considerations. Our recommendations are as follows.
1. Do not abolish short selling. Abolition of short selling would probably have the same effect as abolition of alcohol during Prohibition.
2. Recognize that the Internet has operated to exacerbate the damage done by short selling. Bulletin boards, chat rooms and other forms of instant universal communication have multiplied the tools of market manipulation. Regulatory authorities have not been able to keep pace.
3. Modernize your approach. Join the Internet. Use the Internet to administer and police short selling. Instead of allowing short selling to occur in a hidden fashion at levels of trading where it cannot be understood, require that all short sales be instantly reported on a universal Internet reporting system which simultaneously records the net long position of each account participating in a short sale and flags naked shorting, down-tick shorting and other bear raid shorting.
4. Expand regulation of short sales to all unregulated markets.
5. Recognize that the justifications for short selling are not as compelling as they might appear:
- Allowing market makers to create liquidity on an intra-day basis makes sense up to a point; but public outrage suggests that this point has been stretched a bit too far. So, tighten the rules for the market makers so that only legitimate temporary intra-day needs to maintain an orderly market can serve as an occasion for short selling.
- Fawning over efficient pricing theories must be reined in. Would you permit third parties to sell your house short - on the theory that this might produce more efficient pricing of your house? Of course not. The only persons with an economic interest in your house are you and the potential buyers. Third party kibitzers have no place in setting the price of your house. So, why do we permit third parties with no ownership interest in stock to determine the price of that stock by selling what is not theirs? Their "transactions" may "inform the market of their evaluation," but, as non-owners, their opinion is irrelevant, their "transactions" artificially print stock certificates, and all persons with a direct economic interest in the stock are directly and adversely affected in proportionate manner. Rather than contribute to the "efficient" pricing of a stock, short selling contributes directly to inefficient pricing of stock by artificially enlarging the number of shares available for purchase and sale in the market.
6. Recognize that most of the legitimate investing objectives and strategies sought to be pursued by short selling can be pursued in derivatives markets. While derivatives markets have an effect on equity markets, the effect is not as direct and not as artificial as the artificial effect created by short selling (i.e., the artificial increasing in the number of shares available). Short selling stock is like printing twenty-dollar bills; it depreciates the currency.
7. Develop velocity and volume limits on short trading. A share which has been loaned to permit a short trade should not be eligible for immediate re-lending for a further short sale. Volume limits for aggregate short sales could be established by a combination of time limits for open short positions, volume limits on related accounts, and allocation of the volume limits among short-selling participants.
8. Recognize that our free market love of short selling should not be protected at the expense of the more fundamental interests which our free markets are intended to serve - protection of investors and the capital formation process.
9. Recognize that short selling produces first an artificially depressing effect on stock price, followed by artificial stimulus of stock price when short positions are covered. These two artificial effects operate to harm other investors and harm companies seeking to raise capital.
We appreciate this opportunity to comment on your important work. We urge that there be no loosening of the current rules on short selling. On the contrary, the Commission should require universal immediate Internet reporting of short sales on an individual account basis in order that the regulators of the markets are able to achieve their overriding objectives of investor protection and capital formation.
Richard H. Troy
General Counsel and Secretary