Wall Street’s main regulator is weighing whether to require more transparency of short-selling and the opaque network of stock lending and borrowing that facilitates it, according to people familiar with the matter.
The Securities and Exchange Commission was ordered 11 years ago to impose such rules but never did it. Now, dealing with the fallout from frenetic trading in GameStop shares, the agency under new leadership is considering using its authority to shine more light on the mechanics of the bearish trades.
The 2010 Dodd-Frank financial overhaul law required the SEC to collect information about how much of each public company’s stock has been sold short. The SEC doesn’t gather or disseminate data on such bets by specific investors.
House lawmakers meeting Thursday plan to examine the GameStop trading and discuss the dearth of short-sale data, according to a memorandum issued in advance of the hearing. The memo noted that the SEC hadn’t completed its responsibilities under the Dodd-Frank mandate.
It isn’t clear what specific disclosures the SEC would propose. Any new requirements would have to be issued first for public comment before commissioners could vote to adopt them.
GameStop’s sudden surge last month, from around $20 to over $400, forced hedge funds that had bet against the stock to either put up more margin or buy the stock to close out their positions, which sent the stock soaring higher. Regulators now must piece together data from brokerages to understand which asset managers were most vulnerable to the GameStop short squeeze, which accelerated as many smaller traders gathering on Reddit urged one another to buy the shares.
The SEC has in the past declined to require greater disclosure of short selling, including how much of a stock has been lent out. One provision of Dodd-Frank required the SEC to issue rules within two years that would enhance public information about the lending or borrowing of securities. Another told the agency to publicly report, at least once a month, on how much of a company’s shares have been shorted.
Some SEC officials have in the past expressed concern that if big investors had to disclose short positions, others might be prompted to copy and crowd into such trades, raising the costs for short sellers to borrow stock, one of the people said. The SEC is now under Democratic control and steered by acting chair Allison Herren Lee.
“They have the rule-making authority to do almost anything, but generally they have not done much,” said James Angel, a finance professor at Georgetown University’s McDonough School of Business.
Short sales are typically arranged by brokerages, which allow clients to sell stock they don’t own as long as those shares can be borrowed, often from mutual funds. It is possible for the same shares to be lent out multiple times, which can cause short interest in a stock to approach substantial levels. Short sellers exit the trade and make money if share prices fall below where they were when the stock was borrowed.
Some investors say too much transparency could put a damper on the activity, which can serve a beneficial role by keeping share prices closer to fair value and allowing investors to hedge their risk.
The stock-loan market is a back-office operation typically controlled by brokerages. The SEC could require a new type of “ticker tape” that would publicly report when shares are borrowed for short sales and how much it costs to finance the position, Angel said.
Some SEC officials have acknowledged in conversations with Wall Street executives that it could have been useful during the most recent tempest to have a repository of data to draw on for a fuller picture.
The SEC is now analysing what happened with GameStop and plans to publicly report on the factors that drove the price to rise and then collapse. The agency’s staff will analyse the role of short sellers in the tumult and could recommend policy changes, the people said. SEC officials have discussed the Dodd-Frank mandates that were never completed in conversations with some market participants, the people said.
Nasdaq has endorsed requiring institutional investors to report their bearish bets on periodic forms they file with the SEC. Nasdaq argues the disclosure would help public companies engage with investors who may be working behind the scenes to drive down share prices.
It isn’t clear if having the information would have prevented such a squeeze. But implementing the rules would have given the SEC more visibility into the exact sizes of positions by big investors. It would have allowed them to know, for instance, if just a few hedge funds accounted for the short interest in GameStop, creating a higher likelihood that the stock would skyrocket if they had to buy back the stock and unwind their positions.
Asset managers, hedge funds and other big institutions regularly disclose stock positions each quarter to the SEC. Those reports don’t have to disclose short positions.
This article was published by The Wall Street Journal.