Originally posted on 8/30/2009 by Judd Bagley
I’m usually a real optimist. Sometimes to a fault, according to my more balanced wife. But when it comes to financial market reform, I’ve devolved into a deeply cynical pessimist.
Too many stinging disappointments, I suppose.
Too many instances of people behaving badly, to be certain.
But as they say, there’s some value in expecting the worst…you’ll never be disappointed.
And so it was with today’s second and concluding session of the SEC’s roundtable on securities lending and short selling: I expected the absolute worst, but in the end was pleasantly surprised to find that it wasn’t quite as bad as I feared.
That’s not the same as proclaiming it a good thing, because it was not. Indeed, I stick by yesterday’s characterization of the event as farce with a pre-determined outcome.
Having said that, I was deeply impressed by two surprises I clearly had not anticipated. And I’ll get to those in a moment.
But first, an overview.
There were two panels. The first examined proposed pre-borrow and hard locate requirements — keys to closing two of the most dangerous remaining loopholes in the US stock settlement system. The second panel examined proposals requiring enhanced disclosure of short selling data — a good idea but ultimately one that would be much less necessary were the proposals discussed in the first panel enacted.
I’ll start with the second panel, which surprised me by coming down overwhelmingly in favor of more transparency in short selling.
Georgetown University Professor James Angel pointed out that greater disclosure would essentially be doing legitimate short sellers a favor, by vindicating them in cases when they are incorrectly accused of manipulation in response to stocks dropping in value.
David Carruthers, of short selling analytics firm Data Explorers, supported greater transparency in short selling where the goal was to “prevent market abuse and prevent the development of a false market, or to prevent situations where market participants take advantage of a vulnerable company.”
Richard Gates, founder of short selling hedge fund TFS Capital, denied that shorting exacerbated the onset of the current financial crisis, but went on to concede that there should be greater disclosure parity on the short and long sides of market activity.
Michael Gitlin of investment manager T. Rowe Price echoed the position of Professor Angel in saying real time reporting of short versus long sales would result in the “demystification of short selling,” adding, “The ongoing debate of what caused an individual security to decline would largely disappear with this added level of transparency.”
As the lone issuer represented on the panel, Jesse Greene, Vice President of Financial Management at IBM, was enthusiastically in favor of a general overhaul of the SEC’s short selling regulatory framework, including public disclosure of short positions, in order to “improve market stability and restore investor confidence.”
Joseph Mecane, Executive VP at NYSE, noted that market fragmentation has made it more difficult to detect manipulation, requiring regulators have access to more short selling data in order to better conduct market surveillance.
In other words, the second panel was a slam dunk in the right direction.
The first and ultimately more meaningful panel, on the other hand, was the Yin to the second panel’s Yang.
Appropriately enough, Managing Director of the Equities Division at Goldman Sachs (NYSE:GS) William Conley kicked things off, lamenting that “both the pre-borrow and hard locate requirement would require significant infrastructure builds on the part of the industry as well as its participants.”
By “infrastructure builds”, Conley is referring to the development of new software able to track down real shares for short sellers to borrow. He seems to have forgotten three things:
1. When there’s money to be made, Goldman Sachs has a rare talent for developing extremely complicated software. Could it be that Conley never met former co-worker Sergey Aleynikov?
2. LocateStock.com, then a bootstrapping startup, developed software that accomplishes precisely the same task Conley regards as so burdensome, on a shoestring budget.
3. If Goldman Sachs has enough cash on hand to spend nearly $12-billion in employee bonuses this year, it can probably set a couple hundred thousand aside to write some crumby software.
As I predicted yesterday, much of the balance of Conley’s mic time was spent echoing the anti-reform talking points currently being circulated on Capitol Hill by his employer’s army of lobbyists — in some cases, verbatim.
William Hodash, Managing Director at DTCC, took us on a trip to his organization’s mindset circa 2005 by pointing out that fails to deliver are not necessarily evidence of naked short selling. With one foot remaining firmly in 2005, another in 2009 and a third in a pile of his own illogic, Hodash then said that the reduction in fails observed before and after the SEC’s implementation of Rule 204 “may be relevant to the discussion of whether naked short selling remains a problem.”
No, you didn’t miss anything. That’s what he said, with all remaining panelists basically pleading some variation of the on his and Conley’s approaches.
With one very prominent exception: Dennis Nixon, Chairman of International BancShares Corporation (NASDAQ:IBCA).
Looking at the program, I had assumed that IBCA’s role on the panel was that of a broker or other market intermediary. Well I was very wrong. IBCA was there in the role of an issuer targeted by naked short sellers, and Nixon very poignantly expressed the anguish of someone in his position, after a 45-day long bear raid removed $1.2-billion in IBCA shareholder value.
“And I think it was all attributed to this predator-type short selling that goes on in this market today that’s uncontrolled. It’s unbelievable,” Nixon said.
That was the first surprise.
The second surprise came from an even less likely source: Commissioner Elisse Walter.
Mostly silent throughout the previous day’s panels, today Walter made it clear that she’s not buying the excuses offered by industry representatives insisting this problem is too much for them to tackle.
“I’m sort of surprised that the industry hasn’t come up with a solution, particularly as this controversy has continued to swirl and does not go away,” Walter said, adding that by failing to address the issue, the industry is essentially passing the cost of non-compliance on to the SEC’s own Division of Enforcement.
I think she’d make a stronger case had the Enforcement Division brought more than two cases against naked short sellers in its entire history, but that’s a topic for another post.
The bottom line is, this panel was undeniably stacked against any additional meaningful steps to limit illegal naked short selling, but the contributions of Dennis Nixon and Elisse Walter were as welcomed as they were unanticipated.
The entire affair could have been much better, but also could have been much worse.