By David Rocker
Unfortunately that is exactly what we seem to be doing. Politicians and regulators, sensitive to the fury of investors and voters, too often focus on relieving obvious symptoms rather than addressing the flaws in the underlying structures that created the problems. It is easier to visibly impose new regulations rather than tackle the more politically embarrassing issue of why existing regulations were insufficient or not adequately enforced. As a result, bureaucracy increases, efficiency diminishes, and root causes go unaddressed.
In this respect the SEC, egged on by various members of Congress, has opted for the “round up the usual suspects” approach to the stock collapse and plans to again restrict short selling. This is terrible policy and the opposite of what is needed.
The stated mission of the SEC is to “protect investors, maintain fair, orderly and efficient markets and facilitate capital formation.” Efficient markets can exist only if buyers and sellers are exposed to all views in the marketplace. The SEC is predominantly populated by attorneys, not analysts. As such they provide no early warning system and become involved only after problems become manifest. The only players who have identified major scams in the past have been short sellers, ironically, making them the agency’s natural allies. Regrettably, the SEC has never capitalized on this, partly because it is subject to great political pressure emanating from bullish constituencies which donate heavily to Senate campaigns. Even though the SEC has given lip service to protecting those offering contrary views from harassment, it has failed to follow through. It is time for the SEC to resist reactive new regulations and to commit itself to enforcing existing ones. Every study done by the SEC and other independent parties attest to the stabilizing effect of short selling. Referring to the 2007 elimination of the uptick rule, James Bragagliano, co-director of trading and markets for the SEC, said recently that findings “did not evidence an increase in manipulative short selling after removal of price tests.” Now the SEC is backtracking again. Similarly, the belief that delivery failures were a result of naked shorting by hedge funds has proved illusory. They emanated from market makers, and when they finally lost their privileged exemption last year, the threshold list fell by more than 80%.
Despite generalized accusations in this heated environment, I am unaware of any documented case having been filed against anyone for driving down the shares of any specific financial firm. Rather, the shares of many of these companies collapsed this past fall because of reckless risks earlier undertaken by their managers while regulators sat passively by. The huge losses of capital in the past decade have ensued not as a result of the short sellers disseminating negative stories, but rather in reaction to the vast overvaluations created by unfettered bulls citing the number of eyeballs as a relevant measure for valuing dot-coms and creating assorted toxic financial instruments peddled on the premise that housing prices would only rise.
This is not to say that nothing should change. There are serious structural problems that need to be addressed, and they start with the SEC itself. The SEC needs to be a freestanding regulatory body no longer under the control of the Senate Banking Committee, where senators can exert pressures as to who should or should not be investigated. The embarrassing failure to catch Bernie Madoff despite substantial detailed evidence having been spoon fed to the SEC by Harry Markopolos is just one of many instances of likely meddling. Further, the SEC needs to do everything in its power to induce others to furnish it with evidence of corporate wrongdoing before a company blows up and destroys investor capital. Lawyers are trained to investigate and prosecute those who have done wrong, not to do serious financial analysis. More financial analysts must be hired, and more bounties must be offered to whistleblowers and others who could provide the SEC with valid and timely evidence of wrongdoing, which the SEC should vigorously pursue. Finally, the SEC should encourage and protect short sellers and others offering legitimate critical analyses in the marketplace. Unbalanced regulations should be resisted at all cost. This will take considerable political will.
The near collapse of the financial system should be a wake up call. It would be sad if we didn’t learn something from it to bring a fresh perspective on real, rather than imagined, issues.
David Rocker ran short-biased Rocker Partners for 21 years until he retired in 2007.
