SEC Proposes New Rules to Monitor Short Squeezes Like GameStop

CategoriesBusiness & Financial News

The Securities and Exchange Commission proposed new rules Friday that would expand reporting of short sale positions. The agency said it aims to gain better insight into market conditions like the January 2021 short squeezes that convulsed the prices of meme stocks like GameStop and Koss .

The agency’s proposals seem intended to balance the interests of investors who bet against a stock’s price by selling short and critics of the practice. Under the proposed rules, money managers would confidentially report to the SEC any short positions that exceed $10 million in value at the close of a day’s trading, or which exceed 2.5% of a company’s shares outstanding. The reports would be due 14 days after the month in which the positions occurred.

After a unanimous vote endorsing the proposal by the SEC’s commissioners, chair Gary Gensler issued a statement supporting the rule. “If adopted, it would strengthen transparency of an important area of our markets that would benefit from greater visibility and oversight,” Gensler said.

The commission will adopt the rules after a 60-day public comment period.

One part of the proposal would establish a new kind of trading order that obliges brokers to note if a purchase order is intended to cover—or close out—a short sale. Besides giving the SEC insight into short squeezes—where traders buy up a highly shorted stock to raise its price and force short sellers to exit their positions—the new short-covering order designation might be an indirect way for the agency to monitor activist short sellers who publish critical reports on stocks. Critics suspect some activists close out their short positions at prices well above the target price advocated in their short reports.

Money managers would have to report their gross short positions in a stock. That seems intended to give the SEC a view that’s not diminished by offsetting long positions in the same stock at multiple brokerage firms. It isn’t clear whether savvy investors would be able to circumvent the new requirement by engaging in swap trades, where brokers hold a short position on behalf of the trader.

An active short seller, who didn’t want to be named for fear of being targeted by short squeezes, notes that swap-style short positions are legally held in the name of an investor’s prime broker, not the money manager. Overall, the short seller says the SEC proposal’s anonymity makes it preferable to the disclosure rules in Europe, where short sellers are publicly named.

The hedge fund industry’s trade group, Managed Funds Association, wasn’t pleased with the SEC’s proposals. In a written statement, the group’s president Bryan Corbett said the rules would impose costly burdens and expose money managers to retaliation from corporate fraudsters. “American financial markets are the envy of the world, so it’s bewildering that the SEC chose to borrow from elements of Europe’s failed short selling policy. The objective of increasing investor transparency is better achieved through other mechanisms. This rule, as proposed, provides no additional protection to investors or markets,” Corbett said.

For small stock issuers whose illiquid stocks trade over the counter, the agency would set a lower reporting threshold of $500,000 for investors’ gross short positions.

The SEC would then anonymize and publicly report aggregate short positions in a stock. Current reporting of aggregate short sales—known as the short interest—are only collected by exchanges and the securities industry self-regulator FINRA, based on shares lent to short sellers by brokers. These existing reports can give an exaggerated impression of true short sales, since brokers will lend and relend shares, as traders sell and resell them. The SEC’s proposal might correct that.

The broad ideas of the proposals sounded sensible to Joshua Mitts, a professor at Columbia Law School who has advised the Justice Department in its investigation of short selling and testified on behalf of companies claiming they’d been victimized by abusive shorts. Mitts hadn’t studied the proposed rules in detail, but said they were “an important step toward improving the SEC’s oversight of short selling.”

Friday’s proposal by the SEC follows a November proposal requiring reports on securities lending. The November proposal drew criticism from large institutions that borrow stock as part of hedging or market-making activities. Market-makers would be exempt from the newly proposed rules. Market-makers would be exempt from the newly proposed rules.

 

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