New US SEC rules to shine a light on short selling

By Douglas Gillison and Chris Prentice

(Reuters) -The U.S. Securities and Exchange Commission on Friday agreed to roll out new rules aimed at boosting transparency of short selling, the controversial practice of betting against stocks that drew new scrutiny amid the GameStop (NYSE:) saga.

First proposed in late 2021 and early 2022, the rules will require investors to report their short positions to the agency, and companies that lend out shares to report that activity to the Financial Industry Regulatory Authority (FINRA), a self-regulatory body that polices brokers.

Short selling involves borrowing a stock to sell it in the expectation the price will fall, then repurchasing the shares and pocketing the difference. Should the price rise, the seller can be exposed to potentially unlimited losses.

Short interest in the U.S. market totaled $927 billion as of Thursday, according to analytics firm S3 Partners. The practice has long been divisive, with critics accusing short sellers of trying to hurt companies, and short sellers arguing they help root out fraud and corporate misconduct.

Short selling drew renewed scrutiny from Congress in 2021 when retail investors drove up the price of shares in retailer GameStop, causing heavy losses for hedge funds that had shorted the company. In the wake of the saga, SEC chair Gary Gensler told lawmakers he would increase the transparency of the market.

“Given past market events, it’s important for the (SEC) and the public to know more about short sale activity in the equity markets, especially in times of stress or volatility,” Gensler said in a statement on Friday.

The new rules require institutional investors to report their gross short positions to the SEC monthly and certain “net” short activity for individual dates on which trades settle. The SEC plans to then publish aggregate stock-specific data on a delayed basis.

Such data makes regulators and the public “better positioned to prevent or respond to … destabilizing events,” said Stephen Hall of Better Markets, which advocates for tougher financial rules.

FINRA already publishes short interest reports collected from broker-dealers, but the new rule will apply to institutional investment managers too, offering a fuller picture of market-wide short bets. The new data will also include a daily net activity on each settlement, data not currently available with FINRA or the exchanges.

But hedged funds represented by the Managed Funds Association said on Friday the rules could expose investors’ strategies. “Investment advisers will face more risk when selling short, which will harm investors, market participants, and market efficiency,” said its CEO Bryan Corbett.

ACTIVIST SHORTS

In addition to GameStop, the rise of activist short-sellers who publish negative research on companies in the hopes of depressing the share price has also drawn regulatory scrutiny.

Since at least 2021, the Justice Department and the SEC have also been investigating potential manipulation by short sellers and hedge funds around the publication of negative research reports.

SEC officials said the new rules, which the commission agreed upon in a 3-2 vote, support the agency’s efforts to police the practice.

In separate 3-2 vote, the SEC also adopted a rule requiring institutional investors and other companies involved in lending stock as well as certain broker-dealers who borrow stocks to report information about the loans, such as the name and volume of the stock, collateral, loan dates and termination dates to FINRA.

FINRA will then publish most of this data on an aggregate anonymized basis the following day. In a concession to industry, the final rule would see FINRA delay release of loan amounts by 20 business days.

The rules will be effective 60 days after being publishing in the federal government’s register.