SEC Looks To Close Gaps In 2004 Short-Sale Rules
By Judith Burns Of DOW JONES NEWSWIRES WASHINGTON -(Dow Jones)- The Securities and Exchange Commission is looking to close some of the gaps left open by a package of short-sale reforms adopted in 2004.
At an open meeting Wednesday, the SEC will consider three modifications to its Regulation SHO, which loosened some short-selling rules while cracking down on abuses such as "naked" short selling. The changes being considered would tighten the 2004 rule by eliminating a "grandfather" exception for some hard-to-borrow stocks, according to individuals familiar with the matter.
Short sellers sell borrowed stocks, profiting when stock prices decline and shares can be replaced at a lower price. In "naked" short sales, the seller doesn't borrow or replace shares sold short, a practice Regulation SHO sought to curb by requiring brokers to locate shares to borrow before executing customer short sales. The SEC imposed stricter requirements for hard-to-borrow "threshold" securities, but exempted previously existing short positions, which the SEC said would avoid potentially volatile trading that might disrupt markets.
Market data suggest that a big chunk of delivery failures in borrowed stocks are in positions shielded by the SEC's "grandfather" provision, prompting the SEC to rethink its stance. Since the volume of shares covered by the "grandfather" clause is tiny compared with the overall market, "we're comfortable that this can be done without causing dislocations," said SEC Commissioner Annette Nazareth.
At Wednesday's meeting, the SEC will vote to seek comment on a plan to eliminate the "grandfather" protections and bring previously existing short positions under the stock-locate requirements of Regulation SHO. The SEC will propose that pre-existing delivery failures be closed out within 35 days after the rule change takes effect, which will require a second vote by the commission, likely later this year. Individuals familiar with the plan said it should put brokers and other market participants on notice now to borrow shares or close out naked short positions in "grandfathered" stocks.
At the same meeting, the SEC will consider two other changes to Regulation SHO. One would tighten an exception from the rule for market makers in stock options, requiring them to close out short sales that hedge an options position with 13 days after the option expiration date - the same deadline imposed by Regulation SHO for hard-to-borrow "threshold" stocks. Individuals familiar with the proposal said the exception for options market makers has been another source of stock-delivery failures and that tightening it should help reduce such failures.
A third change the SEC will propose is a minor one that targets an exception from short-selling restrictions for unwinding net short index-arbitrage positions, which is available provided the market hasn't declined by 2% or more from the prior day's close. Individuals familiar with the plan said the SEC will consider whether to change the market-decline index used to limit the exception from the Dow Jones Industrial Average to the New York Composite Index.
- By Judith Burns, Dow Jones Newswires, 202-862-6692; Judith.Burns@dowjones.com
