The SEC and Short Selling: The First Extension

As predicted, the SEC extended its ban on short sales using its emergency authority under Rule 12(k)(2).  The ban will remain in place until the third business day after enactment of the bailout legislation which, if it passes on Friday, will mean 11:59 on Wednesday.  Thepress release announcing the extension, as usual, had no real justification for the extension. The heart of the statement was this:

• The Commission notes that short selling plays an important role in the market for a variety of reasons, including contributing to efficient price discovery, mitigating market bubbles, increasing market liquidity, promoting capital formation, facilitating hedging and other risk management activities, and importantly, limiting upward market manipulations. In addition, there are circumstances in which short selling can be used as a tool to mislead the market. For example, short selling can be used in a downward manipulation whereby a manipulator sells the shares of a company short and then spreads lies about a company's negative prospects. This harms issuers and investors as well as the integrity of the market. This kind of manipulative activity is particularly problematic in the midst of a loss in market confidence. For example, in the context of a credit crisis where financial institutions face liquidity challenges, but are otherwise solvent, a decrease in their share price induced by short selling may lead to further credit tightening for these entities, possibly resulting in loss of confidence in these institutions.

In other words, the best the SEC can do is assert, with no specific example, that short sellers sometimes spread rumors and, as a result, put downward pressure on share prices. For an ageny investigating this practice, it would seem that it could offer greater specificity.

In fact, the SEC is continuing the ban, as we predicted, not because there is any proven connection to the current turmoil but because the agency wants to appear involved. Ending the ban would make it seem like the agency thought the crisis was over. In truth, the ban should have been ended because it wasn't appropriate in the first instance.