Short Squeezes Could Get Much Easier Under This New Rule

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A new proposed rule by the Securities and Exchange Commission could make creating short squeezes much easier.

The proposed rule would require reporting of large short positions. From The National Law Review:

Under Proposed Rule 13f-2, managers would be required to report on a monthly basis — for equity securities in which the manager holds certain minimum short positions — the manager’s end of month gross short position and certain daily short-selling activity affecting the growth short position.

This data will be made public, letting traders see which firms own large short positions in certain stocks. Those traders can then target a firm specifically, buying up those shares:

As the SEC notes, if market participants can ascertain which short positions belong to only one manager — something the SEC estimates may occur in as many as 32% of the stocks for which there would be reporting under Proposed Rule 13f-2 — traders may seek to orchestrate a short squeeze targeting that particular manager.

And if that weren’t bad enough, the SEC plans to use this data to increase enforcement against short sellers:

From an enforcement perspective, the submissions required by Proposed Rule 13f-2 will be used by the SEC to more efficiently police fraud related to short selling activity. In its justification for Proposed Rule 13f-2, the SEC emphasized that data collected under the new rule could help detect and deter fraud.

Short sellers lose twice: first to other traders who target their positions, and again if regulators crack down. Indeed, this rule could be a powerful tool in the DOJ’s ongoing investigation of fraud by short sellers.

I expect to see both hedge funds and individual traders carefully combing these reports. Once they find a firm that’s overexposed, they could target its entire book of short positions.

Such an attack could take down a short selling firm, fast.

I’ll be eagerly watching the SEC to see if this new proposed rule becomes law. It could change markets forever.

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More on markets:

FBI Raids Short Sellers

How DTCC Makes Fails to Deliver Disappear

Melvin Capital Under Federal Investigation

Photo: Prominent short seller Gabriel Plotkin

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