If you're a beat cop, and things start getting rowdy on your beat, it's only natural to want to make your presence felt before the situation gets out of hand. You show your face, twirl your baton, talk tough and make the usual suspects know you're in no mood for any monkey business.
SEC Chair Mary Jo White seemed to be engaging in something along these lines recently as things got a bit rowdy on her beat when it comes to short selling, that enigmatic practice that is too often vilified way more than it deserves to be.
Shorting stocks, naturally, becomes more successful and popular when markets appear vulnerable to running out of steam, as has been the case in recent months. And the backlash against it, naturally, comes swiftly.
In recent interviews with Bloomberg Television and others, White made it clear she was twirling her baton in the general direction of the shorts. When asked about calls for new rules requiring big investors to disclose short positions, she said the commission was giving the notion "intense scrutiny."
The New York Stock Exchange is one of the interested parties making noise. In October, it petitioned the SEC to require more transparency around the practice, including identifying institutional investors who engage in short selling and requiring they disclose their trading activity and open short positions.
The argument goes that if big investors have to disclose long positions, it's only fair that they disclose their short ones. This is a false equivalency, however. Quick disclosure that an investor has increased its position to 5 percent or more of a company's stock is required, and that makes sense because it raises questions about the investor's intentions. Disclosing all long positions each quarter is beneficial to stakeholders who want to keep tabs on the people managing their mutual or pension funds, even though many fund managers would surely prefer a bit more privacy.
But who, exactly, is pounding the table for short positions to be made public? It's doubtful that most investors in long-short or short-only funds favor it. However, it is highly likely that companies whose short interest has swelled are in favor of it, and perhaps you can't blame them for that: bloodhound lawyers need a scent to chase, after all. It's also likely that the NYSE has received an earful about the issue from Big Board-listed companies in that category and needs to show that it has their back.
Transparency advocates who believe all transparency is good transparency are also in favor and have been pushing for more disclosure for years. One of their arguments is that it will allow markets to operate more efficiently if short cards are laid out on the table. This is debatable, however.
First of all, the biggest damage to stock prices is almost always caused by the shorts who voice their thesis -- those known as activist shorts. Bill Ackman was not exactly shy about broadcasting his case against Herbalife, for example. David Einhorn publicly laid out the problems he saw with Lehman Brothers months before its collapse. Jim Chanos made no secret of his issues with Enron. The resulting damage to share prices likely wasn't from short bets themselves but rather the issues these investors brought to the public's attention. And simply publicizing a thesis doesn't guarantee success. Shares of Herbalife, which denies Ackman's contention that it is a pyramid scheme, have rallied 43 percent this year.
Additionally, the crusade for more transparency begs the question about the size of shorts that need to be disclosed? Borrowing shares from a brokerage and selling them is a risky proposition because potential profits are capped at 100 percent while potential losses could theoretically be much higher than 100 percent. Plus the cost of the loans goes up quickly as demand from shorts grows. So it's likely going to be somewhat rare for short bets from individual firms to ever register a high percentage of a company's stock.
If the bar is set too low, investors will comb through the data to track down where bets are being placed by short sellers with a good track record. What then? Do you force shorts to disclose their thesis? Because what if the bet is not that a company is going under but simply part of a pair trade where the shares are sold to finance the purchase of stock in a company the investor believes will outperform it?
The truth is, if a company can essentially be taken out of business through a campaign by a short seller, something most likely is gravely wrong. Blaming shorts for their demise was what Ken Lay did at Enron and what Dick Fuld did at Lehman Brothers and what Jimmy Cayne did at Bear Stearns. In retrospect, does anyone believe that these firms would still be around if it weren't for those rapscallion short sellers?
It's a good time to remind everyone to stop treating shorts like villains and treat them like what they really are -- investors just trying to make a buck through fundamental research.
And for the proverbial average mom-and-pop 401(k)-style investors who may be influenced by all the vilification of short sellers, consider this: they are receiving a great benefit from the shorts and may not even realize it. Even companies with angelic reputations like Vanguard lend shares to short sellers in exchange for interest payments. In return, they get a nice little stream of revenue that helps them keep the cost of managing their nest eggs as low as possible.
As White said, the SEC has prosecuted and will continue to prosecute those who spread falsehoods to benefit a short bet, just as they prosecute those who promulgate falsehoods to benefit a pump-and-dump long bet.
It's prudent for her to twirl her baton from time to time. When it comes time to cracking skulls with it, however, she's going to need to make sure she has the right targets in her sights, and not just the usual suspects.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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Michael P. Regan in New York at firstname.lastname@example.org
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