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April 27, 2022

Better Markets Urges SEC to Close Loophole in Short Sale Transparency Proposal

Better Markets filed a comment letter in response to the Securities and Exchange Commission’s proposed reporting requirements for institutional investment managers’ whose short activity is above the proposed thresholds.

Why It Matters.  Short sales are a significant component of the stock market, allowing traders to bet that the value of a stock will go down.  Short selling activity raises unique concerns, as it can involve a heightened risk of significant investor losses, contribute to intense price volatility, and serve as a tool for abuse and manipulation through schemes such as “short-and-distort.”  However, despite these concerns, short positions and short selling activity are actually subject to relatively few regulatory transparency requirements. The risks that are largely hidden by this lack of transparency were on display during the GameStop trading frenzy of January 2021, when regulators and the public lacked insight into the risks that were building up hidden from view and had difficulty responding in real-time to the ongoing turmoil. Also due to that lack of transparency, regulators have had trouble reconstructing what happened, even with the benefit of hindsight. To address these concerns, Congress directed the SEC in the Dodd-Frank Act to issue rules increasing the transparency of short positions and short selling activity.

What We Said. The proposal will help increase transparency into short positions and short selling activity by requiring institutional investment managers to report certain information about their short selling activity on a monthly basis, subject to thresholds, and by ensuring subsequent public dissemination of that information by the SEC in aggregate form.  However, the proposal includes a major loophole, allowing investment managers to exclude derivatives positions that are functionally equivalent to short positions from the calculation of the reporting threshold.  A person who wants to short a stock can often achieve a substantially similar, if not identical, economic effect through a derivatives transaction such as an option or a swap.  If the SEC fails to close this loophole, many managers will simply shift their direct short positions into derivatives positions that pose the same risks and concerns but continue to be hidden from view.  We also urge the SEC to strengthen the proposal by reducing or eliminating the reporting thresholds, to minimize the level of short selling activity that remains hidden from regulators and the markets.

Bottom Line. Better Markets supports the goal of the Commission’s proposal to increase transparency into the short positions and short selling activity of institutional investment managers.  In order to ensure the Proposal actually achieves this goal, the Commission must close the proposed loophole for derivatives that would allow managers to in effect engage in short selling that remains hidden from view.

Read our full Comment Letter here or click the button below.


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