The SEC and House Democrats have targeted disclosure of short-sale positions as an area of regulatory focus. Ben Ashwell looks at why it’s a priority – and whether it’s needed
In July this year the US House Financial Services Committee passed a bill on to the main chamber that, if ratified, will drastically reform the information investors are required to report to the SEC.
The Short Sale Transparency and Market Fairness Act would require asset managers responsible for more than $100 mn in assets under management to file ownership reports with the SEC no later than 10 days after the end of each month. The current rules, which were enacted in 1934 and updated in 1979, require asset managers to file 13Fs with the SEC 45 days after the end of each quarter. The bill includes the disclosure of direct or indirect derivative positions or interest as well as equities in 13F filings. It also seeks to activate section 929X of the Dodd-Frank Act, which would require the disclosure of short positions.
The bill was introduced by Representative Maxine Waters, chair of the House Financial Services Committee. During her opening remarks at the hearing, she said: ‘In the late 1970s, Congress directed the SEC to require Wall Street fund managers to disclose their assets quarterly to the markets for several reasons: for companies to know who their shareholders are to better engage with them, for other investors to know where large investors are investing, and for Congress and the SEC to understand the economic power and influence of these funds.
‘Today, even though these large managed funds have become more dominant in the market and transactions occur at the speed of light, information in the 13F filing has not changed. In addition, many large investors now use derivatives as total return swaps or contracts for difference to quickly amass large levels of shares in a company.
'But these positions, which didn’t even exist in 1979, are not required to be disclosed. As a result, the information on a large fund’s 13F form is woefully incomplete.’
Waters’ comments were supported by NIRI, the Society for Corporate Governance, the North American Securities Administrators Association and others. For many, however, the language may sound familiar. Discussion around reform of 13F filings dates back many years: NIRI, the Society for Corporate Governance and NYSE Euronext filed a joint petition for reform in 2013. And, as already mentioned, provisions were made for disclosure of short positions in the Dodd-Frank Act, which was passed back in 2010.
The SEC – under both Democratic and Republican leadership – has decided, up to now, not to use that section of Dodd-Frank. So why did Waters decide to pick up these issues now? And do we really need disclosure of short positions in the US?
Gary LaBranche, NIRI
Timing is everything There’s a line in Ernest Hemingway’s novel The Sun Also Rises where a character is asked how he went bankrupt. ‘Two ways,’ he responds. ‘Gradually, then suddenly.’ This is how lobbying in Washington, DC can feel, according to Gary LaBranche, NIRI’s president and CEO.
He tells IR Magazine that NIRI has been lobbying the SEC and members of Congress across both sides of the aisle on 13F reform for many years – long before he joined the association in 2017. But the last 12 months brought a confluence of events that made 13F reform and disclosure of short positions more attractive as a mainstream proposition.
It all started last summer, when former SEC chair Jay Clayton unveiled a proposed change to 13F filings, but not the one NIRI and others had been asking for. His change would have increased the threshold for 13F filers from $100 mn in assets under management to $3.5 bn – relieving 89 percent of asset managers from disclosing their positions in the US.
As much as the proposed rule change took IR and governance professionals by surprise, the surprise was outweighed by discontent. The SEC received more than 2,200 comment letters opposing the change and only 24 in favor. Clayton subsequently said that if 13Fs are the only way for US issuers to know who their shareholders are, ‘that’s something we [must] address’.
In short, last year’s attempt to reform 13F filings raised the broader issue of shareholder identification in the US, and amplified the voice of IR and governance teams that for years had been calling for greater visibility into who their shareholders are.
Clayton left the SEC on December 23, 2020, and just one month later the meme stock saga exploded into the US consciousness, as GameStop’s share price increased by more than 1,700 percent. The actions of WallStreetBets members and others raised a host of regulatory concerns, from payment for order flow and naked short-selling to clearinghouse rules and disclosure of short positions. Hundreds of Redditors even signed a petition asking the SEC to increase the frequency of 13F filings.
Then, in March 2021, Archegos Capital defaulted on margin calls from several large investment banks, having used total return swaps to hide its activity from the banks. The unwinding of Archegos Capital could ultimately cost lenders between $6 bn and $10 bn, depending on the analyst estimate – and it brought the practice of total return swaps into sharp focus.
‘One thing about being in the advocacy arena is that sometimes you have to dig the ground and plant the seeds for years,’ LaBranche says.
‘It’s a lot of education. Members of Congress and their staff change over time, so it’s important that you’re present and persistent. If you work hard enough at it and have enough people telling the story, the time will eventually be right.
‘We’re making great progress because of the Archegos scandal. These trading problems are showing the foibles in the market, and getting people to focus on a variety of issues. It’s hard to say that we’re lucky in this; we’re an overnight success after 13 years of effort.
'But with the rise of Reddit and WallStreetBets, it was an unusual set of circumstances. They say don’t let a crisis go to waste. Well, don’t let a meme stock go to waste either.’
This confluence of events may have paved the way for the Short Sale Transparency and Market Fairness Act, but a number of interviewees for this article say they’re not confident it will progress through the necessary steps to become a law before the US mid-term elections next year.
The vote in the House Financial Services Committee was along party lines – showing that the bill, and the others it was bundled with, do not have Republican support at this stage.
The role of the SEC But regardless of whether or not the bill passes, perhaps the most compelling action could come from the SEC itself. Commission chair Gary Gensler, who was sworn in on April 17 this year, has directed the SEC to examine a number of the issues contained in the Short Sale Transparency and Market Fairness Act.
At a Congressional hearing in May 2021, he discussed his views on the meme stock saga, saying: ‘At the center of January’s market events was significant short-selling of [several] meme stocks. While FINRA and the exchanges currently publish or make available certain short-sale data, Congress directed the SEC under the Dodd-Frank Act to publish rules on monthly aggregate short-sale disclosures.
‘In addition, Dodd-Frank provided authority to the SEC to increase transparency in the stock loan market. I’ve directed SEC staff to prepare recommendations for the commission’s consideration on these issues.’
The SEC has since cleared the hedge funds caught up in the meme stock saga – including Citron Research and Melvin Capital – of any allegations of naked short-selling, but it hasn’t yet disclosed its perspective on disclosure of short positions.
During the same May 2021 hearing, Gensler also addressed the Archegos Capital crisis, saying: ‘At the core of that story was Archegos’ use of total return swaps based on underlying stocks, and significant exposure that the prime brokers had to the family office. Under Dodd-Frank, Congress gave the SEC rule-making authority to extend beneficial ownership reporting requirements to total return swaps and other security-based swaps.
‘Among other things, I have asked the commission staff to consider recommendations for the SEC about whether or not to include total return swaps and other security-based swaps under new disclosure requirements – and if so, how.’
Disclosure of short positions and securities-based swaps were both included in the SEC’s rule-making agenda in June. But so were 48 other issues – including the pressing focus on climate-related disclosures and reforms to proxy plumbing – raising questions about how much of a priority these issues are for the commission.
Regardless, LaBranche remains optimistic. ‘From our point of view, having the chair of the House Financial Services Committee advocate for this is enormously helpful,’ he says. ‘We’ve had many contacts with SEC commissioners and staff, and hope springs eternal.’
Should short positions be disclosed? While the IR and governance communities are likely to get behind any future efforts to mandate disclosure of short positions, not everyone supports the idea. Representative Ann Wagner summarized much of the opposition when the Short Sale Transparency and Market Fairness Act passed through the House Financial Services Committee.
‘It’s worth noting that since the passage of Dodd-Frank more than 10 years ago, the SEC has had the authority to require aggregated short-sale disclosure, and it’s telling that even under six years of Democrat-led SECs, completing this Dodd-Frank rule-making was not – I underscore – not a priority,’ she said. ‘Could it be that those Democrat SEC chairs believe the benefits of these disclosures were outweighed by the potential cost? After all, shorting a stock plays an important role in price discovery and it often roots out fraudulent companies – like Enron and Luckin Coffee – well before government regulators.’
Lauri Goodwyn, counsel at Seward & Kissel and co-chair of the Hedge Fund Association's (HFA) regulatory committee, tells IR Magazine that any regulation should be considerate of the overbearing financial costs of greater disclosure and unintended costs to market efficiency.
‘The HFA supports free and efficient markets and believes the regulators should have the tools they need to prevent and remedy manipulative practices, including in the area of short-selling,’ she says. ‘We also recognize that reporting comes with financial costs and places burdens on the personnel of industry players, who are already subject to a wide range of regulation, and therefore we hope any new reporting or other requirements will be as narrowly tailored as possible while achieving regulatory goals.’
On the other hand, a 2020 petition on rule-making filed by John Coffee, professor of law at Columbia Law School, and Joshua Mitts, associate professor of law at Columbia Law School, establishes different classes of short-selling activity. The authors note the importance of short-selling in price discovery and uncovering corporate fraud, but also describe a second phenomenon, which they dub ‘negative activism’.
‘The typical negative activist opens a large short position, disseminates sometimes aggressive negative opinion about a public company – often stopping just short of factual falsehoods – on Twitter and elsewhere, which induces a panic and run on the stock price, and rapidly closes that position for a profit, prior to the stock price partially or fully rebounding,’ the authors write.
Coffee and Mitts garnered support from many in the issuer community – and even from former SEC commissioner Robert Jackson – for their description of manipulative short-selling. It remains to be seen, however, whether the SEC will have the resources to include short-seller disclosure and 13F reform into Gensler’s already packed list of priorities, or whether Congressional Democrats will even prioritize the Short Sale Transparency and Market Fairness Act to push it through the legislative process.
Regardless, the issues of shareholder identification and disclosure of trading activities have made it to the foreground of discussion on capital market regulation, and many in the IR community will hope they stay there.
