Sec Speeches Cryptocurrency Statement on Short Position and Short Activity Reporting by Institutional Investment Managers

Thank you, Chair Gensler. Section 13(f)(2) of the Exchange Act requires the Commission to prescribe rules providing for the public disclosure of the name of the issuer and the title, class, CUSIP number, and aggregate amount of the number of short sales of each security, and any additional information determined by the Commission.[1] Section 13(f)(3) then provides the Commission with authority to exempt any institutional investment manager or security or any class of the foregoing from any or all of the provisions of Section 13(f) or the rules thereunder.[2] Notably, in enacting the Dodd-Frank Act, Congress did not limit the Commission’s exemptive authority under section 13(f)(3) as it did in other areas, such as with respect to certain swaps and derivatives where Congress did specifically curtail Commission authority to issue exemptive relief.

Had the Commission simply implemented the statute by requiring the specific reporting items enumerated by Congress in the Dodd-Frank Act, my views would be very different. But the Commission proceeds to go above and beyond what is required by law by relying on a broad grant of discretionary authority.[3] This grant of authority—which permits the Commission to require the disclosure of “any additional information determined by the Commission”—is so broad that an ambitious regulator could interpret it to permit the Commission to require the disclosure of almost any information imaginable. I believe that such ambitious interpretations are unwise.

In this case, the Commission has exercised it discretionary authority in a manner that could discourage short selling. Short sales can play a vitally important role in setting a fair price for securities, which is perhaps the greatest protection for investors in the market. On the other hand, there are risks that short sales can be employed to abusively manipulate the market and it is necessary to mitigate those risks.

Short selling as a trading strategy can result in economic rewards for conducting research into the value of a security, thereby encouraging such research. Why should anyone make the effort to conduct research if there will no individualized reward for such efforts? This can lead to superior price discovery. If a person determines that a security is underpriced relative to its intrinsic value, they can purchase the security and go “long.” If a person believes that a security is overvalued, then they can sell it if they happen to own it. But if they do not own it, then short selling provides a way to profit from this effort.

By virtue of the efficient market hypothesis, the markets as a whole benefit from these private profit-seeking efforts. A market for securities that has informed investors engaged in fundamental research produces securities prices that are more reliable because they generally incorporate all publicly available information.

The benefits of short selling go beyond improved general price discovery. Short selling often proactively reduces market manipulations that would otherwise occur. For example, in a pump-and-dump scheme where fraudsters spread false, but positive, news about the issuer, informed investors monitoring the market are typically the first to note that a share is rising above its intrinsic value and they can profit by short selling. Thus, short selling works directly against the actions of the upside manipulators by depressing the prices of the now overvalued securities. Another example is identifying companies with potential fraudulent disclosures; short sellers were among the earliest persons to identify potential problems at Enron.

Short selling can be employed to abusively manipulate markets. For example, fraudsters might short sell a security, possibly through so-called “naked short selling,” and then spread negative false information about an issuer before covering their short positions at lowered prices. These activities are already unlawful. In addition, the SEC further regulates short selling through Regulation SHO to ensure that markets remain fair and orderly. None of these concerns are at issue in this rule—just the public reporting of short selling and its potential impact on the market.

One final point: short selling is comparatively risky. For a long position, the most one can lose is what they paid for that security. However, if one goes short, there is no theoretical limit on how much one might lose. Sometimes short sellers are captured in a “short squeeze” as the price keeps rising, their potential losses increase.

Short sellers may be particularly vulnerable if their positions are revealed in real time to the public, or those positions can be inferred from the information made public. Others may mimic their positions and undermine the returns they would otherwise make based on their research activities, which would discourage short selling. Public knowledge of their short positions would render them susceptible to a short squeeze and also reduce the incentives to engage in this beneficial activity. In designing a rule on short sale reporting, one would hope that the Commission would consider—within the bounds of its statutory obligations—ensuring that individual positions are as protected as possible in order to address these vulnerabilities. Unfortunately, this rule fails to do so.

For example, “Table 2” on the reporting form requires that a manager report “net” activity for each reported equity security for each individual settlement date during the calendar month reporting period. The Commission intends to publish the net activity in the reported equity security, as aggregated across all reporting managers, for each reported equity security for each individual settlement date during the calendar month. This goes well beyond anything required by the statute.

The thresholds for reporting and the required timing for both reporting and disclosure could have been better designed to protect against information leakage and to minimize compliance costs. There also appear to be lower cost alternatives that would involve leveraging pre-existing data efforts that might have been employed to fulfill these statutory requirements.

The Economic Analysis summarizes these concerns. It states that “Rule 13f-2 may harm price efficiency by increasing the cost of short selling. Academic studies, both theoretical and empirical, have shown that when short selling becomes more costly, stock prices are less reflective of fundamental information both because costly short selling makes trading on information more difficult, and because costly short selling dissuades investors from collecting information in the first place”. Further, the Economic Analysis concludes that: “Rule 13f-2 increases the costs of short selling in at least four ways: (1) Compliance costs, (2) potentially revealing short sellers’ information that may have been acquired through fundamental research, (3) potentially revealing short sellers’ trading strategies, and (4) increasing the threat of retaliation against Managers by other market participants.”[4]

Finally, I have not received sufficient assurances that the information collected on the short positions of specific managers will be protected against cybersecurity threats. The Commission has either adopted or proposed rules with stringent obligations on public companies, investment advisers and funds, broker-dealers, and other market intermediaries regarding cybersecurity risk management, strategy, and governance. Yet the recommendations today have not been accompanied by any written assurance on cybersecurity to the Commission, even though the EDGAR system historically has been subject to prior breaches by intruders. This appears to be another situation of “rules for thee, but not for me.”

Given the unfortunate, but likely, consequence of discouraging publicly beneficial short selling activity, I am unable to support this rule. I thank the staff in the Divisions of Trading and Markets and Economic and Risk Analysis as well as the Office of General Counsel for their efforts.