October 18, 2023

Just Short It

Remember the movie Wag the Dog? 

Barry Levinson directs, David Mamet (a genius) writes, Robert DeNiro and Dustin Hoffman act.  It’s about creating a distraction.

Photo 6512338 | Shorting © Farang | Dreamstime.com

It’s human nature. Probably a public company that might miss expectations pumps out a lot of product press releases beforehand.  Somebody will of course figure that out and write an algorithm to short stocks doing that.

Which brings us to the new SEC rule 13f-2

Most of you are likely aware of 13Fs.  In 1975, Congress passed the section 13(f) amendments to the Securities Act, requiring funds exercising discretionary control over assets of $100 million or more to report the stocks they own.  They still do, 48 years later, 45 days after the end of each quarter.

By the way, the average S&P 500 stock trades over 45,000 times daily, or twice per second.  SPY, the big State Street ETF tracking S&P 500 stocks, trades over 500,000 times per day, or 20 times per second.  TSLA trades over 1.2 million times per day, or over 50 times per second.

So how good is 45 days after the end of the calendar quarter?

Anyway, the SEC has decided at last to comply with the Dodd-Frank directive from Congress to create a short-reporting standard.  Voila, Rule 13f-2.

It’s difficult to keep up with all the rulemaking out of the SEC, which appears intent on fostering the same kind of regulatory chaff that now masquerades as trading in the stock market.

I digress. You can see the rules here.  You can see comments on the two rules here.  We have not filed comments as I’d not seen the proposed rules. We’ll do so.

After the Great Gamestop Tulip Bulb Soar and Swoon, the SEC came under intense pressure to “do something.” They issued what I think is a reasonable market-structure dissertation here, on what happened.

Traders were outraged.

Much of the invective was directed at Citadel and its ilk, firms retail traders thought were, using a technical term, hosing them (there’s an even more technical two-syllable term but we’ll omit it here).  You can find it on X (formerly Twitter) if you’re interested.

So two years later, the SEC has disgorged a batch of effluvium aimed at addressing shorting. (Yes, I’m using the marvelous agility of the English language for humor.)

The rules will require institutions to report short positions monthly above certain thresholds, and what the SEC calls “net” positions reflecting shorting and derivatives.  The SEC will then publish aggregate anonymized data.  That’s Rule 13f-2.

The SEC is also amending the so-called CAT, the Consolidated Audit Trail, to require market-makers who short stocks under what’s called – here comes one of the largest mouthfuls of jargon mush ever – the BFMM exception to Reg SHO Rule 203(b)(2)(iii) to state that an order is exempt under bona fide market-making (BFMM) rules.

We’ve talked a lot about this market-making exemption.  It’s the root cause of meme stocks. Brokers can claim that they’re just “making markets” by offering to buy or sell 100 shares of stocks.

Except when they do so, they can just – boom! – create stock.  Digital stock.  It’s really the only way the stock market can function and permit TSLA to trade 50 times per second (sometimes it’s a lot more, like 100 times per second).

That can’t happen if real, actual stock is trading hands.  No, all that stuff is fluff. Chaff. Dust in the wind.

But the dust is what keeps the stock market from going haywire. If literally 50% of the stock market’s volume didn’t come from fake shares – Reg SHO Rule 203(b)(2)(iii) trading exemptions – the market would come apart at the seams.

Reminds me of a fabulous Band of Horses song.  Things start splitting at the seams and now the whole thing’s tumblin’ down.

When that happens, no one’s gonna love you.


Meme stocks happened because “market makers” manufactured stock to fill trades up 1,000%. 

But the SEC requires it.

What these rules don’t do is fix the problem. They just require market-makers to tell the SEC what they’re doing.  Which the SEC already knows because the SEC ordered it.  The SEC requires market-makers to manufacture stock.

Don’t believe me?  Read Roman Numeral II here.

It’s wag the dog.  We’ve done a bunch of things over here where the waving hands are, says the SEC.  Don’t look behind the curtain.

I’m not knocking the SEC.  But why not just require institutions to report monthly long and short positions the day after the end of the month? Publicly.  We called for that in 2011.  Thirteen years ago.

And tell the public, honestly and frankly, that you’re permitting firms like Citadel to manufacture stock because the high-speed, totally automated, algorithmic stock market will fall apart otherwise.

That seems fair.  And if you want to know what your order flow really looks like, public companies, ask us. We know.

Do we fade this move then?  No, we short it.

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