As part of the Barney Frank proposed Manager's Amendment, which will accompany HR4173, the "Wall Street Reform and Consumer Protection Act of 2009", are three little-noticed rules that, if adopted, will make shorting stocks if not impossible, then extremely problematic and difficult. It is obvious why these rules would end up in an amendment: the outcry from retail and institutional traders would have been huge had these proposals made the full text of the proper Bill, and into the full view of the Mainstream Media. So why bother with these - simple. As everyone is aware, Ponzi schemes only work when constantly growing, as otherwise they blow up, implode under their own weight, once price discovery is attempted by all. Case in point: when Madoff's securities was unable to find another greater fool in the face of collapsing asset values, the jig was up overnight, and the value of the pyramid went from $50+ billion to $0 instantaneously.
In this manner, Ponzies are like sharks - they need to swim to live: any deviation from the norm threatens their very survival. By comparison, shorting has always been the most traditional way to force price discovery: as idiot money pension funds tend to be long-only, selling only occurs in times when book gains have to be realized, and facilitates a rising market without any natural checks and balances. If this amendment passes, the entire equity market will have become Madoff securities to the dot. It will continue going up, until market values are a reflection of no underlying fundamentals, but simply the latest pension fund long-only dumb terminal willing to throw managed capital into the bonfire of an inevitable future stock market collapse. And, to borrow another page from the Madoff analogy, when the inevitable correction does occur, it would not be 10% or 20%: the entire worth of the Ponzi would be gutted.
What are these rules? We focus on Section 7422, 24 (a) in the attached Manager's Amendment.
The first one states the following:
‘‘(2)(A) Every institutional investment manager that effects a short sale of an equity security shall also file a report on a daily basis with the Commission in such form as the Commission, by rule, may prescribe. Such report shall include, as applicable, the name of the institution, the name of the institutional investment manager and the title, class, CUSIP number, number of shares or principal amount, aggregate fair market value of each security, and any additional information requested by the Commission. For purposes of section 552 of title 5, United States Code, this subparagraph shall be considered a statute described in subsection (b)(3)(B) of such section.
‘‘(B) The Commission shall prescribe rules providing for the public disclosure of the name of the issuer and the title, class, CUSIP number, aggregate amount of the number of short sales of each security, and any additional information determined by the Commission following the end of the reporting period. At a minimum, such public disclosure shall occur every month.’’.
What this means is that just like with 13-F and 13-G filings for long positions, investors over a certain threshold will be forced to provide to the SEC a listing of all their short positions, which in turn will decide whether or not to publicly disclose all the details about any and all indicated short positions. Of course, any such disclosure will make shorting very problematic for managers who up to this point have been able to tout their long-exposure in certain names without disclosing hedged or shorted counterpositions, with the hope that they will be able to short even more names to witless followers who merely replicate given hedge fund portfolios (yes, hedge fund portfolio cloning is nothing new, and hedge funds are all too aware of how to take advantage of gullible trend seekers). Furthermore, this would likely make hedging particularly difficult for a vast array of hedge funds who do not share the administration's, and CNBC's, fervor that all is good in both the economy and the market.The scariest component of this rule is the latitude that the SEC is given in determining broad policy. As is widely realized by now, the SEC is merely a lapdog for the biggest monied interests, and as such will merely end up doing whatever is in the best interest of such firms as Goldman Sachs which have gotten the concept of regulatory capture down to an art.
The second proposed rule is even more peculiar: the SEC will prohibit anything it deems is a "manipulative" short sale, with the definition of said manipulation left entire up to the SEC's intellectually and reputationally (if not financially) challenged executives:
‘‘(d) TRANSACTIONS RELATING TO SHORT SALES OF SECURITIES.—It shall be unlawful for any person, directly or indirectly, by the use of the mails or any means or instrumentality of interstate commerce, or of any facility of any national securities exchange, or for any member of a national securities exchange to effect, alone or with one or more other persons, a manipulative short sale of any security. The Commission shall issue such other rules as are necessary or appropriate to ensure that the appropriate enforcement options and remedies are available for violations of this subsection in the public interest or for the protection of investors.’’.
Just like the anti-terrorist act allowed virtually any citizen to be stripped of his rights with no questions asked, if the powers that be determined he or she posed a terrorist threat, so potentially any short sale will have legal ramifications, if the SEC so decides. For example, Mary Schapiro can come out tomorrow and tell you shorting Citi is now verboten. That's precisely what rule two envisions.
The last rule is the most peculiar, as it will mandate broker-dealers to instruct clients they have the right and ability to refuse to lend out their stock to short-sellers. In a time when it is next to impossible to find borrow in a plethora of financial stocks, this will simply further eliminate the pool of shortable collateral. As a result, look for (or rather don't) an ever increasing number of shares that will hit broker HTB (hard to borrow) lists, which as a result have huge repo rates and/or are simply unavailable.
NOTICES TO CUSTOMERS REGARDING SECURITIES LENDING.—Every registered broker or dealer shall provide notice to its customers that they may elect not to allow their fully paid securities to be used in connection with short sales. If a broker or dealer uses a customer’s securities in connection with short sales, the broker or dealer shall provide notice to its customer that the broker or dealer may receive compensation in connection with lending the customer’s securities. The Commission, by rule, as it deems necessary or appropriate in the public interest and for the protection of investors, may prescribe the form, content, time, and manner of delivery of any notice required under this paragraph.’’
The combination of these three rules, when passed, will make shorting practically impossible within equities, and with CDS demonized beyond compare, virtually all options (except puts, although we are confident Barney Frank will see to that rather shortly as well) to express a bearish bias in securities will be taken away from investors.
And as if that wasn't enough, the SEC is now expected to adopt a modified uptick rule. The proposal for an "alternate uptick rule" would require traders who wish to short, to post offers at least 1 cent above the best bid, with hitting bid through shorting becoming illegal. What is unknown currently is whether this rule would be effected in combination with a "circuit breaker" rule, whereby the alternate uptick would be enforced only if a stock were to drop by 10% or more in a given session.
Whether or not a circuit breaker is adopted, the combination of all these rules will affect numerous algorithms, further making the computer and algo trading bias (the dominant market force over the past 4 months) to the purchasing side.
Again, the motive behind all these changes is all too obvious: with the fate of the administration, consumer confidence, and the US economy itself tied in to every tick of the market, the regulators and lawmakers of the US will do anything to destroy any semblance of an efficient market if it makes price drops more difficult. Of course, any deviations from fair value are always be temporary, and the ultimate collapse, when it does occur, will be that much more violent. However, as we have gotten to a point when every single up day in the market counts so that Obama can boast to a naive TV audience what a great job he has done in any given day courtesy of the Dow being up another few points, it appears nobody really cares about an efficient market any longer.
The irony is that these regulations will likely push out numerous retail and institutional investors away from open exchanges, and force investors to trade either in unregulated dark pools and other ATS or simply move to foreign domiciled exchanges. At the end of the day, should this Manager's Amendment pass, it will mark the true beginning of the end for America's once effective, and relevant, market structure.