June 12, 2009
Mrs. Elizabeth Murphy
Secretary, Securities and Exchange Commission
100 F Street, NE
Washington DC, 20549-1090
File Number S7-08-09
Dear Madam:
I am writing in reference to rule change S7-08-09 to Regulation SHO under the Securities Exchange act of 1934.
During my 11 years of trading experience, there have been many rule changes and modifications which have all been proposed with the best of intentions. I understand that these intentions are to protect the interests of investors and to increase liquidity and transparency in the market place. Unfortunately, many of these rule changes and modifications have instead resulted in decreases in liquidity and transparency, and have thus reduced investor confidence.
I fear that proposed rule change S7-08-09 will, once again, result in another example of a change with good intentions, which will backfire with undesired results.
I would like to address the idea of circuit breakers in individual stocks at certain price levels. Such an idea sounds good on the surface, as this would potentially slow down sharp declines in stocks with bad news or rumors by restricting short selling after a certain percentage decline in price is reached. More likely, though, this will lead to the undesired effect of sharply increasing the amount of short selling during the decline leading up to the circuit breaker, thus decreasing liquidity to investors who are long the security and wish to sell. The result: little to no liquidity for long sellers until the stock reaches an artificial level where new short sales are prohibited. This can only lead to investor panic and selling at the bottom of these new sharper declines.
So, while the circuit breaker may help stocks from going down as sharply after they have dropped the first "X" percent, it will wildly accelerate the drop and reduce liquidity to long sellers until the circuit breaker is reached by enticing short sellers to get in before it is too late. Since stocks naturally make up and down moves based on order flow, earnings, and other news, and rarely make such drastic moves that would result in a circuit breaker, this proposal will only end up increasing the volatility in stocks natural up and down movement, decrease liquidity in downward moves up until the circuit breaker is met, and thus reduce investor confidence even further by exaggerating down moves which might not otherwise have been as drastic without the rush of short sellers to get short ahead of the circuit breaker.
In closing, I would like to commend the Securities and Exchange Commission in their attempts to find a solution to the drop in investor confidence which resulted from the sub-prime mortgage crisis. However, I find the solution of restricting short selling as a short sighted solution, which probably wouldn't have made any difference during the sub-prime crisis. I think that this type of legislation is too little to late, and that efforts should be concentrated on regulating banks and other entities which were responsible for facilitating these unsecured loans. Stocks will behave better if left alone. Had the sub-prime crisis not occurred, such proposed short sale restriction changes probably would never have been voiced, since up to the point of the crisis liquidity increased and volatility decreased as a result of the rule change to abolish the downtick rule.
I can't think of a worse way to destroy investor confidence than to go back on a rule change which was working quite well, and to further complicate the rule by adding confusing circuit breakers which have no basis for decreasing volatility.
Let us move forwards, not backwards with regulation. There is nothing wrong with the short sale rules, so leave well enough alone.
Sincerely,
David Lazarus
Senior Vice President of Trading