A consortium of groups representing the hedge fund industry and other investment companies has filed a lawsuit against the U.S. Securities and Exchange Commission (SEC) over recently implemented regulations that mandate the disclosure of information concerning securities short sales and lending practices.
The Effect of Short Sales
Short selling is a securities transaction that involves an investor borrowing shares of a company and subsequently selling them on the open market, with the expectation that the share price will decline. Profit is made if the investor can repurchase the shares at a lower price and repay the loan.
Challenging the Rules
The lawsuit argues that the new rules will discourage short selling by exposing confidential trading strategies. It is believed that market participants may imitate or trade against funds that employ short-selling strategies if they have access to this information.
“The rules will impair market efficiency and price discovery, thus harming market participants and investors,” stated Jack Inglis, CEO of the Alternative Investment Management Association. This organization, along with the National Association of Private Fund Managers and the Managed Funds Association, is part of the group suing the SEC.
The Approved Rules
In October, the SEC approved two rules as part of these regulations. The first rule mandates certain fund managers to report their short sales to the SEC within 14 days at the end of each month. The agency will then aggregate and publish this data on a delayed basis while keeping fund manager information confidential.
These new rules have sparked controversy within the hedge fund industry and have raised concerns about their potential impact on market efficiency and price discovery. The outcome of the lawsuit will be instrumental in determining the future of these regulations.
Transparency in Short Selling: A Critical Issue for the Markets
The contradictory approach to disclosure rules surrounding short selling has recently sparked a lawsuit. One rule acknowledges the potential harm that frequent and detailed disclosures about short sale activity can have on markets, while the other requires daily public disclosure of individual transaction information. This conflicting stance creates confusion and raises concerns among market participants.
The lack of transparency regarding short selling played a significant role in the meme-stock craze of 2021. Stocks such as GameStop Corp. (GME) and AMC Entertainment Holdings Inc. (AMC) experienced unprecedented surges detached from their fundamental company performance. Traders focused on data that revealed heavy shorting by institutional investors, with GameStop reaching a peak where 140% of all outstanding shares were shorted. This led to allegations of illegal “naked” short selling, where brokers lend shares they don’t actually own.
According to short selling specialist Moshe Hurwitz, while naked short selling is mostly banned in the U.S., some brokers find ways to circumvent the rules to capitalize on the lucrative securities lending business. This practice poses a significant concern as it can distort market dynamics and undermine fair play.
Furthermore, the issue of naked short selling has received increased attention this year as numerous small-cap companies expressed worries that their share prices were artificially suppressed by illegal trading activity.
The need for comprehensive reform in short selling regulations has become evident. Striking the right balance between transparency and protecting market integrity is crucial to ensure a level playing field for all investors. Addressing these concerns will undoubtedly contribute to the overall health and stability of today’s public markets.
For more insights on this pressing issue, refer to: Small-cap companies are going after naked short sellers in growing numbers: ‘It’s the biggest risk to the health of today’s public markets’
