The SEC must guard against making any short sale regulations exceedingly restrictive and costly to the markets, said SEC Commissioner Troy A. Paredes on May 6. Paredes, speaking at the Securities Traders Association annual conference, said that short selling makes significant contributions to the effective operation of the securities markets, and that regulating the practice may result in losing those benefits.

Paredes noted that short selling benefits market participants and the economy as a whole, including by improving liquidity and price discovery. In addition, short selling is already regulated, said Paredes, noting the steps the SEC took last year to curb "naked" short selling and the effect of Rule 10b-5 on curbing short selling abuses.

Paredes also stated that he was unaware of any empirical link between the market downturn and the repeal of the "uptick" rule or the impact of short selling, and that the economic findings that supported the SEC's decision to repeal the "uptick" rule in 2007 may still be valid in the current economic and financial climate. He also cautioned against asserting investor confidence as a basis for adopting short sale restrictions, noting that any upside of an investor confidence boost is presumably limited, and that any such restrictions may actually erode investor confidence in the long term.

Paredes also warned against targeting regulatory "gaps" in general, noting that "[t]he federal securities laws are replete with well-reasoned and important exclusions that should not be unwound." He specifically noted the exceptions in the Investment Company Act for private investment funds, calling them "reasonable and appropriate, in part because not every fund is subject to them." He stated that hedge funds, private equity funds and venture capital funds are "central to promoting market efficiency and capital formation," and that denying them their current investment flexibility would be "costly."

Paredes' comments came a day after an SEC roundtable to evaluate the approaches to short selling regulation it proposed on April 8. In her opening statement to the roundtable, SEC Chairman Mary Shapiro noted that the issue of short selling had outpaced any other in terms of the number of inquiries, suggestions and expressions of concerns the SEC had received. She gave no indication of the direction in which the SEC was leaning, stating only that she "made it a priority to evaluate the issue of short selling regulation and ensure that any future policies in this area are the result of a deliberate and thoughtful process."

Paredes took the podium following a speech by Rep. Paul Kanjorski (D-Pa.), chair of the US House Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises, who spoke strongly in favor of filling current regulatory gaps. Kanjorski, whose subcommittee hosted a hearing on hedge fund registration the next day (see story above), said that "[a]nybody that's rational realizes" that Congress must fill areas currently devoid of regulation.

White & Case recently released an alert analyzing the expected implications of each of the SEC's proposed approaches to short selling regulation approaches and will continue to monitor these activities and report on further developments.

Paredes speech: available here (HTML)

Schapiro speech: available here (HTML)

Story: Kanjorski and Paredes Give Opposite Views on Addressing Gaps in Financial Regulation, 41 Sec. Reg. L. Rep. 861 (May 11, 2009)

Proposed rule: available here (PDF)

Related alert: available here (PDF)