December 24, 2003
Mr. Jonathan G. Katz
Re: File No. S7-23-03
Dear Mr. Katz,
I am an experienced Series 7 and 63 certified trader and am writing to express my strong opposition to the proposed uniform bid test rule and the market maker exemption within Regulation SHO. I believe that both proposals will only harm the majority of the investing public by reducing liquidity, increasing transaction costs, and increasing the likelihood of another bubble. Further, I believe that allowing independent exchanges and electronic trading networks to establish their own short sale regulations will benefit the market and public more than having the S.E.C. establish a uniform rule.
The proposed bid test rule defeats the stated objective of Regulation SHO, which is to allow unrestricted selling for a stock that is going up, because it prevents investors from hitting high bids. For example, if an investor enters a bid at a price higher than the last print but below the ask price, the stock will by definition be going up if another investor hits that bid; however, under the bid test rule, short sellers would be restricted from hitting the bid, thus preventing them from selling a stock that is going up. By adding an unnecessary obstacle to short selling, this rule increases the likelihood of another harmful bubble by discouraging investors from shorting stocks, even if they think that they are overvalued. Likewise, the proposed rule will also cause investors to pay more than the market price in order to buy stocks by limiting the ability of traders to hit high bids; this causes public investors to assume more risk and pay higher transaction costs than necessary.
Even more threatening to the general public's interests is the proposal to exempt market makers from the bid test rule. This would provide market makers, who already benefit from their knowledge of order flow, with an unfair advantage over the rest of the investing public and thus create an even more unbalanced playing field, which the S.E.C. should be attempting to correct, rather than exacerbate. This exemption is not justified by market makers' "bonafide market making activities" because they rarely engage in such activities; the majority of volume on the NASDAQ trades through ECNs, not the market makers, which means that exempting them from the rule will only allow market makers to take advantage of the general public's orders that are placed through ECNs. And on the N.Y.S.E., specialists already enjoy the exclusive advantage of knowing the entire order flow, not just the partial list of limit order that they place on the "open book." Further, as the recent investigations into questionable specialist practices illustrates and my trading experiences have confirmed, they tend to use any advantages that they have over the rest of the market to make profits for themselves rather than serve the general public's interests in making an orderly and fair market.
I believe that the best way to produce such a fair market is to allow ECNs and other exchanges to compete by setting their own short sale rules. This essentially would put into practice the pilot program that is being proposed in Regulation SHO. Those market participants who want the protection of a short sale rule could enter their orders on exchanges that offer such protection, and those that think that a rule is unnecessary could enter their orders on other exchanges. Under these competitive conditions, volume will flow towards exchanges that produce the best prices. This is the fairest and most democratic way to resolve the debate about a short-sale rule; investors will vote with their order flow.