Hoop De Do

Sen. Ted Kaufman, D-Del., in his first bill proposal since being sworn in to Congress in mid-January, submitted to the Securities and Exchange Commission on Monday a bipartisan legislation that aims to reinstate the so-called “uptick rule” that prohibited short sales from the Depression era until its repeal in mid-2007. “Abusive short selling is tantamount to fraud and market manipulation and must be stopped – now,” Kaufman said on the Senate floor late Monday. “The uptick rule should have never been repealed. To permit people to sell shares they don’t have and won’t be able to deliver turns investment into pure speculation. The time has come for this practice to stop.”

He was joined in the effort by Sen. Johnny Isakson, R-Ga., who announced Tuesday his co-sponsorship of the bill and who said he has since last fall been calling for reinstatement of the rule.

“Senator Kaufman has introduced a piece of legislation that is right for America, it is right for America’s investors, and it is right for our stock market as it still languishes today somewhere down near what we hope is the bottom,” Isakson said during a speech on the Senate floor. “One way to ensure that bottom exists is to stop rewarding those who would feed off of it and instead reinstate good discipline that ensures good practices and allows the market to restore itself back to a good equilibrium.”

That’s bi-partisanship, baby!

One issue. Consider this quote from above "To permit people to sell shares they don’t have and won’t be able to deliver turns investment into pure speculation. The time has come for this practice to stop." That’s actually naked short selling. Which is in fact illegal already. Comforting to know our illustrious leaders from both sides of the aisle don’t know the difference.

Next up? The Dynamic Duo promises to pass legislation condemning England for using Australia as a penal colony.

Anyway, Eric Oberg has been on top of this whole issue over at Real Money Silver.

With these levered short portfolios, they are in theory shorting the shares of the underlying portfolio. They would need to wait for an uptick on each share, which would be incredibly unwieldy. In reality, these funds hold swaps as their assets rather than maintain a series of individual stock shorts (although somewhere the
swap counterparty is holding short positions and the market makers will hedge their positions by establishing shorts). So this is where we get into "form vs. substance."

If the SEC is just trying to put out a toothless rule to appease the politicians and the public, they may well exempt these ETFs from the uptick rule because of the "form" of shorts being established. In that case, everyone will just use these ETFs to front for their avoidance of the rule. But if the SEC is actually behind the intent and spirit of the rule and cares about "substance" rather than form, these vehicles will not be exempted and their viability will be in question. Expect a major lobbying effort here –the dollars are too large for the purveyors of these products.

If these vehicles are no longer viable, expect a wind-down, maybe all in one day or maybe over a few days or weeks, and holders will get the proceeds. For a holder, this may effect your capital gain/loss position based on your holding period and entry point. Yes, this mucks up the tax efficiency a little bit, but remember many of these funds paid out huge capital gains late last year — unexpected for many investors and not based on their own actions. So I guess these didn’t quite act like a traditional ETF anyways.

My guess is you will see some of the bearish money redirected to the options market and traditional forms of shorting, forms that comply with the margin rules. Some of the "pile on" shorts will simply go away, lending credence to the "easier margin terms will bring in more uninformed traders" theory. (Taking a glance at the message boards for some of these products, you realize how many folks do not understand how they work…. Hmm, not understanding the levered derivative product that one purchases — does that sound at all familiar to anyone?)

While I don’t necessarily agree with the need to go crazy on shorting, (and don’t want them to take away SKF and FAZ, they’re the best trading vehicles going) I do agree with his concept of a solution. Again, IF you think we need a solution. Just changing the uptick rule back to 2007 would accomplish literally nothing. There’s a reason they got rid of it, and that reason was not to appease some Short Cabal that ignored it or worked around it anyway. It had become outmoded. And the rise of Inverse Leveraged Monsters since then make the rule even more useless. So you’d really need a comprehensive solution if you want to "solve" the problem of Bear Raiding. And in a world of Decimals, ECN’s, et. al., not sure how you go about that.