Oct. 29, 2022
I am reaching out as a concerned international investor in regards to the lazy and negligent approach to short-selling activity reporting suggested by the proposed rule’s current state, and do have some important suggestions for how this rule can be brought in better alignment with the commissions primary priority of investor protection. First and foremost, short selling carries serous real world consequences and so therefore issue pertaining to this, must be dealt with diligently. As the commission has identified the following shortcomings with current data: (1)Fails to distinguish economic short exposure from hedged positions or intraday trading (2) Fails to distinguish the type of trader short selling or identify individual short position, even for regulatory use (3)fails to capture the various ways that short positions can change and the various ways to acquire short exposure. In addition, the Commission explained that “short selling volume and transaction data cannot easily explain changes in short interest, exposing a gap between these two types of existing data”. Furthermore, these data sets are subject to differences in reporting lag, and can misrepresent the amount of short selling due to mismarking. These gaps provide the ability for fraud and abuse to take place without being detected, consequently this has lead to an increase in apparent frequency and seriousness of such abuses, getting so out of hand that in the previous year, the Department of Justice has had to embark on a wide ranging investigation of short selling activity demonstrating that the these data gaps must be closed in order for the commission to continue providing protection to investors and companies and play an important role in assisting the DOJ with its investigation. Now given the threats to the both investors, companies and the capital market themselves, I was horrified to learn that the commission sees fit to deliver the bare minimum in Proposed rule 13f-2. As the proposed rule 13f-2 requires short activity reporting once per month. A reading of section 929X of the DODD-Frank Act reveals that “At a minimum, such public disclosure(of short-selling activity) shall occur every month.” At a minimum. Why is the commission seeking to doing the bare minimum as required by the law, when its job is to ensure the utmost protection, efficiency and equality of investors, companies and the market? This is not in line with the Commission(repeatedly) stated primary priority of investor protection. Reporting must be much more frequent to allow better and more efficient detection of manipulation, fraud and abuse. Greater resolution of public disclosed data would help empower individual investors and companies to protect themselves and each other, and to also assist the commission via whistleblowing. As has been mentioned, reporting must be more frequent. As section 929X clearly and specifically states that short-selling activity should be reported in aggregate, and clearly and specifically empowers the Commission to determine any other information necessary for the protection of investors and the public interest. As this suggest their must be a balance; reporting must be frequent as possible to protect the public and promote its interest, yet also not so frequent that it strains the concept of “aggregate”. Since the Commission has proposed 15-minute aggregate reporting period in Proposed Rule 10c-1, this seems to be a reasonable point. This would allow investors, the commission and the DOJ to review short-selling at a strong resolution, while still preventing moment by moment manager level examination flash crashes, short attacks and the like. If 15 minute aggregation is too much for the commission ability then half a day to a day should be satisfactory. Since I did see that the Commission has proposed to exempt ETF’s from Proposed rule 13f-2, as well as creations and redemptions, I think it is important that the commission must include these ETFs and creations and redemptions onto the report requirements of this proposed rule. This is because shorting via ETF, as of June 2020, constituted 20% of the overall dollar value of short interest in U.S. equity markets. The popularity of shorting via ETF results in some ETFs being shorted at 200%, 400%, all the way over 1000%(1). This consistently huge level of short interest may in fact indicate regular and significant abuse of particular thinly-traded securities included in those ETFs(2) In an examination of synthetic short-selling activity using ETFs, Li and Zhu(3) find that “directional betting, especially synthetic shorting, is an important component of ETF shorting activities”, noting that “hedge funds frequently create synthetic shorting using ETFs, particularly when it is costly or outright impossible” to do so, and “some hedge funds prefer using ETFs to short underlying stocks so that their rivals cannot easily detect their trading strategies.” The authors also found estimates of shorting activity using ETF-based activity “strongly forecasts stock returns, even after controlling for stock-level shorting measures”. Even APs have a significant profit incentive to use operational shorting: if the price declines in the time the AP is waiting to deliver, they earn the bid-ask spread without paying trading costs. This helps illustrate as to why data on ETF-level short activity should be provided as it would grant market participants a more truthful view of the securities they own, increasing market fairness and allowing investors to better protect themselves against potentially malicious and abusive market forces. Because of how common operation shorting via ETFs is, investors need visibility into this source of short activity to gain an accurate understanding of the state, history and ongoing performance on any security in which they would like to invest. During the GFC of 2008, the Commission temporarily banned short sales on 798 securities, yet the ban list did not include any ETFs. Many market participants elected to legally ignore the commission’s order by short selling ETFs instead.(4) In addition to this, ETFs are not and have never been subject to the “uptick rule” designed by the Commission to impede short-selling activities. Synthetic shorting via ETF allows funds and firms to simply walk around short selling rules enacted by the commission. This is unacceptable. Inclusion of ETFs in the proposed regulations will grant the public greater insight into how shorting via ETF allows funds and firms to decline to be regulated by the Commission’s rules. Principally, shorting via ETF was found to be more common in more thinly-traded and/or hard-to-borrow securities. This is the exact same set of situations the commission itself trains its own investigators to focus on as common targets of abusive and manipulative practices(5); “Market manipulations typically involve thinly traded shares of little know or start up companies”, and “with small volume of trading, it is easier to effect the price of the stock” The Commission also notes that “Sophisticated value traders generally cannot sell securities that they cannot borrow. Short selling cannot be covered” Given that ETF short-selling activity is actively used to circumvent regulations and the law, and that it tends to occur within the exact conditions the commission warns investors and its own employees to watch for abuse. The commission itself should include ETF short activity in reporting requirements to in fact watch those conditions for abuse. ETF short selling is clearly used to ignore the Commission’s order and regulations, and it tends to occur in situations the commissions states is ripe for investor abuse and deserving of special focus. Further, operational shorting (creation and redemption) is; (a) Fundamental part of the aforementioned short-selling activity (b) Carries significant profit incentives for Aps (c) Tends to occur in the same abusive situations (d) Represents a source of profound systematic risk which on its own warrants closer observance by the commission So therefore to reiterate, when it comes to the protection of investors, the Commission should not do the bare minimum required by the law, which directly identified at the bare minimum within the law. I compel the Commission to adopt 15 minute aggregation periods, if this is not possible than half a day to a day should be enough. Sincerely A troubled international investor