It is conceivable that some of these positions are put on over a period of time and transferred to the client only at a propitious moment to obviate regulatory questions. To market makers, it appears that this advantage is immense. To equalize this advantage and to prevent positioning to facilitate larger short sellers, I would propose that the amount that a broker can carry in his trading account be no larger than twice the size of his daily average trading volume during the previous 12 months, allowing a variable increase in this figure only commensurate with a substantial rise in the level of trading in the issue. Anything in excess of these numbers would be carried in an investment account to be held for at least 30 days. The investment account would therefore be subject to the 50 percent Reg T margin regulations. These changes would take some of the incentive away from the dealer to bend the rules and make him more a facilitator of transactions than a speculator on his own account. Underreporting of short interest is a constant thorn in both the listed and OTC markets. The primary cause of this is merely the designation by the seller of a security long instead of short. Whether foreign or domestic, this seller has made borrowing arrangements in advance, and securities will be delivered on settlement day for a regular way clearance. This practice, potentially unknown to the executing firm, can only be parried successfully by obligating the lender to receive a copy of the transaction and determine its legality. I would propose making the lender responsible for the policing of security regulations, and if a transaction is not marked short a prompt disclosure must be made. I believe that the framers of the 1933 and 1934 acts could not predict the marginability and lendability of OTC securities. If they had, some of the same rules governing transactions in our exchanges would have been made applicable to the nonlisted markets. It is an unquestioned fact that liquidity generally diminishes as capitalization declines and the need to protect our large companies from the bear raids of the past is of some question. It is the emerging company that needs no less than equal treatment in the markets of the 1990's. We have created a scenario that is biased toward the few large players and one that affords little to the minority; maybe in another 300 years. Thank you very much. [The prepared statement of Mr. Spira follows:] in their studies of short selling have agreed that short selling adds to market efficient pricing of securities is it a good idea to slow down this type of input in the Market? We think not. Short selling, because it helps to dampen speculative excesses in the prices of certain securities that are overvalued, actually adds protection to long buyers who may otherwise have purchased at higher prices. We cannot comment on the idea of guidelines for short sales by the market makers as no specifics were advanced, however given the amount of regulations and scrutiny market makers go through, and since to the best of our knowledge there have been no abuses in this area, we question the need for further regulation. Public reporting of material short positions is being disclosed on a monthly basis currently. We don't think it would be cost effective to do it any more frequently. As you know the day to day trading in all stock is closely monitored by the Exchanges and the NASD. So unusual short selling in a certain security would be subject to this scrutiny. We don't see the need for public reporting of short sale volume by principal originating brokers as we do not feel it serves any useful purpose. This proposal seems on the surface to be discriminatory against short selling because we are not aware of any similar regulations in existence for such long buying or selling. The idea of prohibiting short sales by a business competitor seems on the surface entirely discriminatory. Why shouldn't any investor be able to buy or short a stock? There already exists in the regulatory framework rules against manipulative and fraudulent stock transactions. What abuses are you aware of in this area? We are not aware of any. How would you define a business competitor? Would they ever be permitted to sell short? This would seem to create a regulatory nightmare and to what end? We agree that margin customers as a part of their margin agreement should be notified that there may be a circumstance where certain of their securities may be legitimately lent out and therefore they may lose their right to vote. However, since such a small percentage of owners return their proxy votes we doubt whether this situation ever has or ever will occur. Requiring notice on a stock by stock basis however would be extremely costly and time consuming to the brokerage industry. There exist many rules and regulations governing the lending of customer securities and the inherent safegaurds needed in this vital area. The landing of securities is a viable and necessary part of the brokerage industry. On a day to day basis within the context of the existing rules a customer's margin securities may be lent to a short seller or other stock borrowers, placed as collateral in customer bank loan or they may sit idle in the brokers box. To require a broker to notify each of its margin customers every time a particular security is lent out would be extremely costly and time consuming and would be put in place to "cure" a problem that doesn't exist ie margin lending causing a shareholder to lose his ability to vote in corporate matters. since we feel that the existing rules and regulations particularly BEC Rules 15 C3-3 and Section 8(a) of the Exchange Act adequately provide the needed safegaurds to protect customer securities, we feel additional rules in the lending area would only add additional burdens to the brokerage community with no additional benefits to margin customers who already have the right to fully pay for a security if they are concerned about perceived abuses. As we stated earlier, we welcome your looking into the area of short selling. We are very much in favor of eliminating any real abuses in the short selling area as we would be in aliminating abuses in the securities market as a whole. However we feel there is an adequate framework already in place to cover stock manipulation and fraud whether it is on the long or the short side of the market. Short selling serves a very important function in the securities marketplace. It adds liquidity to the marketplace. It helps to provide for price efficiency by assuring that the entire spectrum of market opinion whether positive or negative is represented in the price of a security. It also provides investors with an opportunity to hedge ar arbitrage their other investments. Information short selling, .. it is labeled in the 1986 NASD study (page 12) is as legitimate a form of investing as is value investing or short term trading. It is an area that will occasionally have its abuses much the same as there have been the many well documented abuses on the long side. We feel that the proper regulatory framework and rules and regulations are already in place to prevent manipulation and fraud and to protect shareholders rights. We also would like to share one other insight we have gained into short selling. The individual companies that complain the loudest about short sellers generally have proven to be our most successful investments. Companies such as Commonwealth Savings of Houston, Gruen and Lifeline Medical are examples. The management or promoters of certain companies do not welcome close scrutiny or someone challenging their earnings estimates or accounting methods and they complain about short sellers rather than running their businesses. This concept was also documented in the NASD study (page 67) which looked into eleven different securities on a case study basis. The companies were selected from media articles, complaints from issuers and information concerning potentially manipulative trading patterns. findings of the case study were that while each situation was unique in important respects, it became clear that a valid basis The existed for short selling in most of the selected securities. We hope that our insight into these issues will contribute to the Subcommittee's work. Thank you again for your invitation to speak before you and it is unfortunate we can't attend. Very Truly Yours, Joseph L Feshbach Mr. BARNARD. Mr. Hastert, do you have an opening statement, sir? Mr. HASTERT. Thank you, Mr. Chairman. The practice of short selling of stocks gained considerable attention following the October 1987 stock market crash. While most stock traders were taking it on the chin, the short sellers were having a field day. As in so many business markets, there are often rewards to be found in going against the trend. Although short selling is an established and legitimate brokerage trading practice, it is a practice which bets on the losers. This may be the source of much of the controversy over short selling. Many in the marketplace simply have difficulty in accepting short selling as a normal trading practice and see it, rather, as a convoluted and somewhat sinister mechanism which disturbs the normal operation of the stock market. This leads to some larger questions: What is the normal operation of the stock market? Is it purely and simply a gamble for the participant, or is it a controlled and somewhat protected environment for those wishing to make investments? Can we adequately protect its participants from market manipulation and financial loss? How do we quantify the market manipulations, and what should and should not be allowable? These are difficult questions, and hopefully these hearings will help to provide some of these answers. Mr. Chairman, frankly, I have no predisposition on this issue, but I am quite anxious to learn more about short selling and certainly its effects on those people who deal in the market. Mr. BARNARD. Thank you very much. Mr. Douglas. Mr. DOUGLAS. Just briefly, Mr. Chairman, I think we are all aware that if a company were going to be taken over by someone buying 10, 20, 30 percent of the stock in that company, a whole range of filings would have to occur. What concerns me-and what I'm here to learn about-is, if the reverse occurs, if you're selling off, or don't even own the shares but are selling shares short, 20, 30, 40 percent of a company's outstanding stock, do we have the same regulatory control on that side as we do on the acquisition side. I am just curious about that. That is one of the things that I hope to learn here. And like you and Mr. Hastert, I don't have any preconceived ideas, but I just want to be sure that, if there is an abuse, we come up with some answer to deal with it. Mr. BARNARD. Thank you very much. Mr. Cox, we certainly welcome you here today. I think this is somewhat of a record, to get four Members of Congress, that range from California to New Hampshire and in between, to come to Washington when Congress is in adjournment, to participate in a hearing of this kind. I want to thank you very much for your pres ence. Mr. DOUGLAS. Let the record show three of the four are Republicans, Mr. Chairman. [Laughter.] Mr. BARNARD. Well, some folks might even question that when they look at certain voting records. [Laughter.] I'm not talking about you all. I'm only talking about myself. |