Tuesday, May 19, 2009

Short Sale Saga

Hard to believe after the last five years of seemingly endless debate and commentary on Regulation SHO, but the SEC has again floated out rule changes for public comment. The SEC head, Mary Shapiro, is making short sale regulations a priority after abusive short-selling exacerbated the downward spire of Lehman Brothers and Bear Stearns.

The SEC proposes two approaches to short selling restrictions. One is a price test that would apply market wide. The other is a “circuit breaker” that would apply to individual stocks experiencing severe market declines. Two tests are proposed for each of the two proposed approaches.

The two tests proposed for the market wide restriction are most likely to draw criticism. One test would be based on the national best bid and the second would be based on the last sale price.

You have until June 19, 2009, to weigh in on the issue. Hundreds of comments have already been posted to the SEC web site, mostly from individuals calling for the reinstatement of the so-called “uptick rule.” The uptick rule prevented a short-sale after a decrease in the stock price, thereby preventing short-sellers from driving down the stock price. The rule was eliminated in June 2008, and many believe the extraordinary volatility that was experienced beginning in July 2008, can be attributed to unfettered short-selling.

We may not get the uptick rule back, but it is more likely than not that short-selling will be curtailed in some manner before the end of 2009. That is just as well, in my view. Short-sales are a legitimate investment position when based on valid fundamental or technical analysis. However, the deceptive and manipulative practices often practiced by short-sellers to fulfill their investment strategy - half truths leaked to the press, pressure on analysts to reduce estimates, green mail to management, etc. - suggest short-sellers need to be kep on a "short leash."

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