Proposed SEC disclosure rule could lift the lid on short-selling

Greater transparency within US and global financial markets has long been on the agenda for regulators, especially given the upward trajectory toward a wave of more-involved investors.

In keeping with the emerging trend for transparency, the US Securities and Exchange Commission (SEC) has announced proposals for a new short-selling disclosure rule – a rule that would make detailed short-selling information available to the public for the first time.

What is short-selling?

Short-selling is the act of profiting from stocks that decline in value, as opposed to profiting from those that increase in value. It involves a high level of speculation and an anticipation that there will be a decline in a stock or security’s price.

In essence, short-selling involves borrowing a security and selling it on the open market – with a view to buying it back later at a lower price. The investor profits from the difference in value – after repaying the initial loan. While the process itself is relatively simple, short-selling is notoriously risky and, in recent times, has been the foundation for significant market turbulence.

What would the new short-selling rule do?

The New Exchange Act Rule 13f-2 would oblige investment and money managers to disclose to the SEC within 14 days of any month in which their gross position was either larger than $10 million, or 2.5% of shares outstanding, if smaller. These disclosures would then be processed by the SEC, with the data about shorts being made available to the public, giving them an overview of short-selling activity in the market. The data would be published on aggregate, to retain confidentiality. The extent to which positions had been hedged would also be disclosed and shared.   

Commenting on the proposed rule, SEC Chair Gary Gensler said:

“This would provide the public and market participants with more visibility into the behaviour of large short-sellers. The raw data reported to the Commission on a new Form SHO would help us to better oversee the markets and understand the role short-selling may play in 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.”

Progress of the rule

So far, Rule 13f-2 has received the full support of the SEC and was backed unanimously in a vote. The new rule will now be submitted for a 60 day period public comment before being passed back to the commission, who will vote to adopt the final rule.

CUBE comment

The SEC’s proposed rule will help members of the public better understand what’s going on in the stock markets, and how short sellers are affecting the prices of individual stocks. Not so many moons ago members of the public would have little interest in knowing these things, but such is the shifting tides of financial services, people are now more engaged than ever.

This is something that was made painfully evident in last year’s GameStop event and other so-called ‘Meme Stock’ occurrences since. Not only are individuals interested in what the market is doing, and the influence it is having, they are actively engaging in it.

The digitisation of financial services has brought with it unbridled accessibility to investments. Individuals with little-to-no experience are able to invest freely, at the touch of a button. This activity, combined with the seemingly unlimited flow of information shared on social platforms, poses huge challenges for the stock market, as well as the regulators who are looking to prevent short-selling activity from being overly disruptive.

It is with this backdrop in mind that we see the SEC’s proposed rule – a rule that would open the floor of short-selling (albeit confidentially) to the general public. This rule follows a broader emerging trend for transparency in financial services – not only in stock markets but across the board.

People care more, so regulators are introducing regulations that help the public make educated decisions about their role and choices within financial services – from climate-change disclosure rules to diversity requirements, to short-selling. These are regulations that adapt and grow with a developing society. It’s good to see, but more work for the compliance team.

Disclosure rules are being proposed the world over. While they offer vital protections for consumers, they add a new, complex layer of regulatory obligations for the compliance team. CUBE tracks in-force and emerging regulations, so you can see what’s coming round the corner – and know how to prepare.