Tom Farley, head of the New York Stock Exchange, told Washington lawmakers this week that short-selling feels icky. But what he proposed as a solution should leave anyone who cares about free and fair markets grossed out.
Farley was testifying before a House panel on market structure when he blurted out his feelings about short-sellers -- investors who bet against the shares of individual companies. To be fair, Farley wasn't saying that the actual practice was icky, just that it makes him feel that way. After publicly cleansing himself, Farley said that in fact he was all for short-selling. It's good for the market, he said. (Remember the early warnings on Enron and Lehman Brothers?) Banning it would be bad. All Farley wants, and what he said companies on his exchange have asked for, is for short-sellers to be required to publicly disclose when they are betting against a company.
And Farley is not alone. In early May, the Nasdaq, the other big U.S. exchange, laid out its desires for how regulators could improve public markets. One of the top requests was for short-seller disclosure.
Short-sellers have long been demonized, but the push for disclosure is relatively new. While asking for simple disclosure seems like reasonable middle ground, it's not. It's the same thing as a government that says it's fine with free speech as long as it is constantly able to spy on all of your conversations. It's the same thing as a bully saying, "Say whatever you want as long as you say it to my face." You get the point. It's not a ban, but it's close.
In late 2015, the Nasdaq in a letter signed by the exchange's top lawyer, Edward Knight, petitioned the Securities and Exchange Commission to require short-seller disclosure. The letter is more full of errors than it is logic. (I reached out to Knight and Farley, and both declined to comment through spokespeople.) The letter says when investors buy stocks they are forced to disclose their positions. Short-sellers, though, are not. But that's not true; just ask Bill Ackman. He has 4 percent of his publicly traded Pershing Square fund, roughly $200 million, in a stock, or more likely a derivative tied to one, that he lists only as "Undisclosed Position." He recently said he most likely won't say what it is until after he sells it.
Nasdaq's Knight says the lack of disclosure is "particularly untenable" now that short-sellers are taking "an activist role in corporate policy." But the only way to take an activist role is to disclose a position either publicly or to the company, which many short-sellers do voluntarily. Knight cites Herbalife as a company that was damaged by undisclosed short-selling. But Herbalife was one of the most public shorts in history by Ackman. And it's hard to see how it was damaged. The stock is up 55 percent since Ackman announced his short. (It is, of course, easy to see how Ackman was damaged.)
Knight cites the fact that the European Union adopted disclosure rules in 2012 as reason the U.S. could, too. But at least two studies have shown that the move hasn't helped European markets. Knight actually includes one of them, "Revealing Shorts" by Charles Jones of Columbia Business School, Adam Reed of the University of North Carolina and William Waller of Carnegie Mellon, in a footnote is his letter, but fails to mention the findings of the study, which include that the rules clearly discourage some short-sellers and lead to less-informed stock prices. The study does end in a sort-of tie, concluding "it is not at all clear whether short position disclosure regulation is a net benefit," but that's not the type of language that will ace you in your debate club.
In the end, the main argument of Farley and Knight and the disclosure backers is that if long investors have to disclose, why shouldn't the shorts. The answer is that buying shares in a company is like giving management a high-five. Shorting is like giving management the middle finger. The reaction, and potential legal actions a company will take, will be different. So the protections, if we want a fair market, should be different. Second, and more important, when you buy the shares of most companies you get the right to vote, on board members and other matters. And that can impact that value of the shares of other stockholders, so they have a right to know who their fellow meaningful owners are. No voting rights come with short-selling. No rights, no disclosure.
It's pretty clear why Farley would want to come out against short-sellers. Corporations like their stock to go up. Putting pressure on short-sellers wins points with executives who decide where to list their companies. And right now the NYSE and the Nasdaq are locked in the biggest courting effort in years. Saudi Aramco, potentially the largest IPO of all time, is most likely to go public in the next year and has yet to say where it will list. Seeming C-suite friendly is more important than ever. But while sucking up to CEOs can win listings, Farley has to be careful not to be too unfair to investors. Without investors, the NYSE, and the Nasdaq, become much less attractive places to list.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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