Short Sale Roundtable Remarks

By Lisa Valentine

The Securities and Exchange Commission has wrapped up a two day roundtable to discuss securities lending and short sales. SEC Chairman Mary Schapiro told those gathered that “I have made it a priority to evaluate the issue of short selling regulation.”

Day one’s discussions focused on securities lending; day two focused on short sales, particularly “naked” short sales.

The SEC invited issuers, financial services firms, self-regulatory organizations, investors and the academic community to debate topics such as whether the SEC should move forward with a pre-borrow or “hard locate” requirement to eliminate abusive “naked” short selling and persistent fails to deliver. Schapiro mentioned that the SEC has heard plenty of comments supporting the SEC requiring that anyone effecting a short sell must borrow or arrange to borrow the securities prior to making the short sale.

In the area of securities lending, Irving Klubeck, managing director, Pershing, made the case that the securities lending market is pretty well regulated except for one area: finders who bring together buyers and sellers. Klubeck believes finders should be regulated, stating, “If finders are going to be brought into the mainstream of securities lending I believe they should be registered, capitalized, have standard guidelines and oversight as exists today with finders in the government fixed income markets.”

Mark Faulkner, with Data Explorers, agreed with Klubeck, saying that securities lending balances are 50% off their peak in May, 2008, indicating that the industry is able to self-adjust. He does warn that cash collateral and the subsequent cash re-investment needs to be evaluated.

John Nagle, managing director, Citadel Investment Group, called for centralized collection and dissemination of loan pricing data, saying that “central counterparties could reduce bilateral credit risk and foster rigorous and consistent credit risk management practices.”

Several speakers, including Leslie S. Nelson, managing director of Global Securities Lending, Goldman Sachs, called for changes to the Prime Brokerage No-Action Letter to require that prime brokers report any instances of clients’’ incorrect order marking (marking an order short when it really is long, and vice versa) and non-compliance with locate requirements to the executing broker.

On the issue of pre-borrow or hard locate, William Conley, managing director of Goldman, Sachs says the reforms are not needed since 99.9% of U.S. equity transactions clear and settle within the standard three day settlement period. He also mentioned that less than 5% of all locates result in the need to borrow.

At a time when liquidity is important, pre-borrows could lessen liquidity needlessly while increasing costs for market participants. The SEC should seriously consider these issues before implementing regulation that does more harm than good.