Corporate Governance

The SEC and the Ban on Short Selling

By J. Robert Brown

We are coming up on the need for the Commission to renew its ban on short selling. Under Section 12(k)(2), emergency orders cannot last more than ten days unless renewed, although they can be renewed at least twice. So, we consider the consequences of the ban. The WSJ reported that the ban on short selling has "effectively shut down much of the convertible-bond market, a crucial area of financing for struggling companies." The significance?

• Convertible securities are essentially bonds that can be exchanged for stock in the future. It's a relatively small market with less than $400 billion in securities outstanding, according to market participants, a fraction of the total for investment-grade bonds. But in times of stress, struggling companies turn to convertibles in order to raise capital when a share price has fallen.
  

The NYTimes ran an article on Sunday noting that short selling may not be so bad after all. The article pointed out the possibility of inefficient pricing as a result of the ban. Shareholders may, therefore, avoid the stocks because, once the ban has been listed, there may be a correction to the price. As the article notes:

That means investors should think twice before buying shares of any companies for which short-selling is now banned, Professor Reed said. In his research, he said, he has found that ?stocks without short-selling not infrequently trade at prices that deviate widely from their true value.

Moreover, despite claims of abusive short selling in the form of ?bear raids,? one academic noted that: ?when academic researchers have looked for bear raids ? even in those areas in which investors suspected that they existed ? they haven?t found them.?

So, harm from the ban and doubt about its benefit, at least for such a broad based ban for so many companies.  What will the Commission do? Renew the ban to appear involved in the efforts to end the turmoil. Instead, it may well contribute to the problem.

Full post as published by The Race to the Bottom on October 01, 2008 (boomark / email).