SEC proposes new short selling disclosure rule

Hedge funds and other investors could be forced to share more information with regulators and the public about their bets that individual share prices will fall under a new rule proposed by the US Securities and Exchange Commission on Friday.

The rule would require institutional money managers to report short selling to the SEC within 14 days after any month in which their gross position was larger than $10mn, or 2.5 per cent of the shares outstanding if that is smaller.

The SEC would then make public aggregate data about shorts on individual companies and the extent to which those positions are hedged. Brokers would also have to collect and report data on share purchases that are being used to cover shorts.

The proposed rule, which the SEC backed in a unanimous vote, will now be submitted for public comment before it is finalised.

The proposal is part of a larger effort by SEC chair Gary Gensler to reduce the information and power imbalances that have swept US markets in recent years. Under his leadership, the SEC is pushing for increased transparency on everything from stock purchases to private equity strategies.

Concerns about short sales in particular grew during last year’s meme stock frenzy, in which retail investors banded together against short sellers of stocks such as GameStop.

“Given past market events, it’s important for the public and the commission to know more about this important market, especially in times of stress or volatility,” Gensler said in a statement. “The proposed rule would help the commission address future market events, striking a balance between the need for transparency and the price discovery process.”

The issue has been on the SEC’s agenda for more than a decade. Congress included a directive to increase disclosure of short selling positions in the Dodd-Frank financial reform law passed in 2010 in the wake of the financial crisis.

Other markets already have quite detailed disclosure requirements. The EU requires investors to inform regulators privately when a short position exceeds 0.2 per cent of market value and to declare it publicly if it passes 0.5 per cent.

Bryan Corbett, president and chief executive of the Managed Funds Association, which represents big hedge funds, said it was “bewildering that the SEC chose to borrow from elements of Europe’s failed short selling policy. The objective of increasing investor transparency is better achieved through other mechanisms.”

“Hedge funds and other alternative investors are in favour of aggregate public disclosure of short interest by issuer on a weekly basis. This information is already available to regulators without imposing new, costly, and onerous filings,” he added.

Hedge funds, asset managers that lend out stocks that investors use to short, and the banks they both transact with already closely monitor short positions in individual stocks and exchange traded funds. The data is used as a gauge of investor sentiment on thousands of companies and is an important tool for risk managers across Wall Street.

To short a stock, an investor first borrows the share of a security they want to bet against. The investor then immediately sells that share at the current market price. If the stock price falls, the investor will buy the share back at the reduced price, pocketing the difference from the high price at which they sold it and the lower price that they bought it back at. The investor then returns the security to the bank or fund that lent it out, paying a fee for the cost of borrowing the stock.

But if the stock rises in value after the investor borrowed it, they can be left nursing heavy losses. That is how some hedge funds were caught offside last year as beaten-down stocks such as GameStop and cinema operator AMC rallied in value.

When there is high short interest in a stock, an investor who has bet against the security can often struggle to find a seller willing to part with the shares. That can create a so-called short squeeze, where short sellers bid the price of a stock up to ever higher levels as they try to cover their positions.

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