Thoughts on the SEC's short sale actions

Short selling has been on the receiving end of public scrutiny and outrage for the past few quarters, as many believe hedge funds are to blame for the financial crisis. While hedge funds may have added fuel to the fire, their use of short selling did not cause the problems we are experiencing today. In my view, short selling is extremely useful because it allows market participants more ways to express their views on the value of a security, and thereby profit. It also acts as a counter-balance against the undue optimism sometimes present in a security, and can bring that security's price back to reality.

Whether you are for or against short selling, I think all of us can agree that the SEC's monitoring and regulation of short selling, and in particular naked short selling, has been poor at best. Just to clarify, naked short selling is the act of short selling when you do not have the "borrow" available. It is a particularly pernicious activity because it can allow someone to manipulate the market for a security.

Yesterday, the SEC announced several measures designed to better regulate and disclose the act of short selling (http://www.sec.gov/news/press/2009/2009-172.htm).

The measures are three-fold:

1. Brokers must purchase or borrow securities to deliver on a short sale. While this rule was already in place, it is being made permanent in order to curtail naked short sales.
   
2. A plan for SRO's to publicly disclose price and volume information regarding short sales. They are also continuing to review proposals on short sale price tests and circuit breakers for individual stocks.
   
3. A roundtable will be held on September 30th to discuss new measures including "securities lending, pre-borrowing, possible additional short sale disclosures, the potential impact of a program requiring short sellers to pre-borrow their securities, possibly on a pilot basis, and adding a short sale indicator to the tapes to which transactions are reported for exchange-listed securities".
   

I believe these measures are extremely positive for the market. I do applaud the SEC's efforts in (hopefully) regulating short sales the way they should be regulated, and increasing short sale transparency through more public disclosure. The only real negative to come from all of this is that all of this new regulation requires resources - resources that could be put to better use. In particular, it will increase the costs involved for short sellers - most likely legal and compliance.