Ocean Financial - Australian Government, The Treasury

Ocean Financial Group Pty Limited
ABN 29 116 173 705
Level 14, 470 Collins Street, MELBOURNE Vic 3000
Telephone: +61-3-9620 0722
Facsimile: +61-3-9629 9100
Mobile: 0418 145 915
Email: [email protected]
__________________________________________________________________
Attn: Mr. Stephen Powell
Corporations Amendment (Short Selling) Bill 2008
Corporations and Financial Services Division
The Treasury
Langton Crescent
PARKES ACT 2600
Sent by Email: [email protected]
Dear Sir
The abusive nature of short selling is now starting to be reveiled in overseas jurisdictions. In particular
the co-relationship between “failed trades and drop in share prices – enough to account for 30 to 70
percent of the declines in Bear Sterns and Lehman and other stocks last year” 1 . This is only the tip of the
ice-berg.
When short-sellers manipulate the market, even the strongest companies can collapse. By
creating a false impression of investor uncertainty, short-sellers can drive a stock lower and
lower until the company itself is destroyed.
According to the smart people who talk to me on TV, most short-sellers are not criminals.
But whether or not they play by the rules, all short-sellers are inherently positioned against
the health of our economic system. At best, short-sellers are rooting for a stock to go down;
at worst, they are engaged in activity that unfairly drives down market prices and destroys
small- and mid-sized companies.
With so many investors pumping money into public companies, they say, it’s useful to have
someone on the other side selling securities and driving overinflated stock down. Short
selling, they say, is a positive consequence of the free market at work.
The benefits of short selling are very real, but the costs are much higher. While it’s doubtful
the collapse of AIG and Lehman Brothers was tied directly to market manipulation by short
sellers, such manipulation has driven and will continue to drive strong companies out of
business. Our economic system should be run by people who are invested in its success, not
by people who cheer when stock prices go down.
Unlike both the US and the UK which changed their regulatory regime at the top of the market in July
2007, the Australia regime was still very much in place when the market started to fall. This included: the
“uptick” rule, the 10% cap on positions in short selling and with regard to fail trades the electronic script
settlement system known as “CHESS”. In you analysed the existing law and the ASX Rules together, you
would have said that Australia was meeting if not exceeding on the four principles currently being put
forward by the IOSCO.
So why did it fail?
1
“Naked Short Sales Hint Fraud in Bringing Down Lehman”, Bloomberg 23 March 2009
The reason can only be the lack of enforcement by the regulators. It is so easy to blame the fall of share
price in Australia on events occurring elsewhere in the world. However, given the fact that there was
suppose to be a much harsher regime in Australia, then in the US and the UK then the fact that Australia
fell harder and faster than overseas jurisdictions can only be attribute to the fact that the Australian regime
was not be enforced.
I will address the rest of this paper in the order requested. But I query why this needs to be changed, if it
had been enforced correctly. Even whose if the new regime is to be enforced by the ASX what
assurances is the government giving that this situation will not happen in the future. In otherwords is the
ASX prepared to spend the necessary enforcement dollars, something they have been reluctant to do in
recent times
In my opinion, the old regime stood the test of time in the 1980’s and 90’s, and only failed due to a
dubious legal opinion, that should have been reviewed by the regulators well before it was needed in the
marketplace. 2
A.
POSITIONAL REPORTING
Up until 19 November 2008, Australia did have a Positional Reporting Regime as opposed to having a
Transaction Reporting Regime. This was through ASX Business Rule 19.6.1.
From that time the rule became a Transactional Rule. The new Rule 19.6.1:
2
Securities Lending of Equity Securities in Australia, John C King, Mallesons Stephen Jacques, 1999, Fourth
Edition, pXXVII
Over the years, I have been a supporter of the Positional Rule and believed that it operated effectively
until about 2002 (ie the time of the demerger of the ASX). The procedures accompanying the rule
required ASX brokers to report their net short positions by 9:00am:
However, it appears that the Positional Reporting Regime failed, not because of the lack of systems, but
rather ASX’s inability to enforce it or even worse it’s desire due to the added liquidity no to enforce it.
Part of the problem that we are current facing stems from the legal opinion that a “covered short sale”
was not a short sale and therefore did not need to reported. I have always been firmly of the opinion that
this was not the case. I also believe that over 80% of the financial community would have the same belief.
It is clear from the new ASX Business Rule 19.1.6, which came into existence on 19 November 2008, that
the ASX has now formed the opinion that a “covered short sale” should be treated as a short sale.
Having formed this opinion, the ASX, should have know that the only way to enforce the short selling
regime was by both a Positional and Transactional information being made available to it as the regulator
and the transparency of the short selling to the market by Positional Reporting.
It must be remembered that the short selling regime is currently regarding against a number of specific
abuses that were discovered due the Rae Royal Commission in 1974 and are extensive covered it the
Committee’s Report. In particular the report was damning on the ASX brokers who undertook short
selling in Antimony Nickel, whereby seven of the top ten leading brokers were short the stock. The
Committee recommended the introduction of the prohibition in short selling section 54(3) of the
Securities Industry Act (NSW) of 1975, the forerunner of Sections 849(3)(a) - (d) of the Corporations Law
now section 1020 of the Corporation Act.
The prohibition was relented to allow short trading on the ASX, subject to very strict ASX enforcing a
fair, orderly and efficient market through its rules in regard to:
⇒
The type of stock that could be short sold. ASX Business Rule 19.7.1
Only certain type and size of company’s should be short sold whereby the added liquidity of
supplied, the price efficiency achieved and enhanced market depth achieved by allowing short
selling overrides the dangers of accelerated decline in prices, the creation of false markets from the
lack of disclosure, the treat of default on delivery being detrimental to market efficiency and the
developed of unfunded speculation due to the lack of margins being imposed.
⇒
The total amount of short selling. ASX Business Rule 19.3.8 and 19.5.1.
The ASX therefore has the power to limit the total value of short selling to a defined amount. The
ASX states this amount in Procedure 19.5.1.
Therefore the ASX in its wisdom has determined that securities should not be short sold greater
than 10% of the company as the dangers of short selling greater number of share than that defeats
the benefits that could be achieved.
⇒
The actions of the short sellers. ASX Business Rule 19.3.7
This rule is designed so that the actions of the short seller is not forcing the share price of a security
lower, but rather the short sellers are adding to the liquidity and stability of the market. In a
number of other jurisdictions it is also known as the zero-tick or up-tick rule. Whilst the SEC in
the US dropped this rule in July 2007 (just at the time the biggest, ugliest, toughest bear market was
about to rip the throat out of the global stock markets) 3 , there has now been an outcry and it
appears according to John Nester the rule maybe reinstated. 4
3
4
Business Speculator Commentary, 21 November 2008
SEC May Weigh Reviving Uptick Rule to Bolster Markets, Jesse Westbrook, 10 March 2009
⇒
Disclosure of short sales. ASX Business Rule 19.3.9
There must be transparency in the market. If there is a lack of transparency, it leads to market
manipulation or at the very less the perception of it, which can undermine the integrity of the
marketplace and cause participants to withdraw. This is what we are currently seeing. Short sales
generally increase the total number of securities owned beneficially by investors, of which some
maybe need to reported. In the case of Antimony Nickel 51% was held by directors and 44% held
by Gordon Barton. This lead to a situation whereby the short seller could not settle their short
trades. Short selling also gives a misleading signal about supply to the market. Any expansion in
the supply of a particular asset would according to Keynesian theory would normal drive prices
down, unless there is perfect elasticity in the demand of the asset. Historically short selling
accelerates a price decline and therefore increase the volatility in the market.
⇒
Client to inform Broker of Short Selling. ASX Business Rule 19.8.1
Historically, this involved marking the order and the contract note as a short sale. By the client
informing their broker that the trade is short sale allows the broker to fulfil their obligation to the
ASX with regard to the disclosure of the sale and the consolidation of short sales into their
reporting to the ASX, but more importantly, the short sale was also marked in the SEATS screen as
a short sale.
The mechanism of reporting through SEATS allowed the ASX to monitor in real time the short
sales so there was no abuse of the zero-tick or up-tick rule. In addition the reporting of the short
sale to the broker, allowed the broker to report to the ASX, so that there was no breach of the 10%
limitation.
In essence this is the current Transaction Reporting Regime, except the trade is no longer marked
as a short trade.
In my opinion, under the current regime I do not see how, the ASX can enforce its rule in regard to
Short Sale Volume and in regard to Consecutive Trades (zero-tick rule). Even worse from my own
examination I have found that everyone of the top20 ASX companies has over the last 12 months
have breached the 10% limitation in regard to Short Sale Volume. I will discuss these breaches by
the ASX later.
⇒
Appropriate mechanism to ensure the short seller can fulfil the contract should the market gone
against the short seller. This done by way of imposing a Margining Regime. ASX Business Rule
19.8.2
This rule requires the short seller to lodge a margin of 20% of the sale value as collateral with the
broker at the time of the short sale. It was this area that is critical in the ?? case, as the script
borrower was also the broker and did not hold the 20% collateral cover.
⇒
Transparency of Short Sales.
This historical has been done by the ASX
supplying the current level of short sales
as a percentage of the 10% allowable to
information vendor via one of it’s
information signals. This information
supplier sell the information through
their system. An example from Iress is
show below.
In summation, I believe that it is important to
have both Positional and Transactional
reporting, as without both it is impossible to
accurate monitor and enforce short selling.
B.
RBA DISCLOSURE
In my opinion the disclosure regime of the RBA
will shed significant light upon the abuses that
have been occurring in the Australia market. As you have rightly stated stock can be lent for other
reasons, however, in the downward part of the cycle very little to no stock are lent for those reasons. This
argument has been a fur fee by the short sellers. If this was the case, have the reasons disclosed and stop
the debate.
I am still very disappointed that we are having the argument about delayed disclosure when the integrity
of the market is at stake. I will give you an example. Suppose both shareholder A and B each owned
40% of a company and the remaining 20% was held in mum and dads hands (not unusual on the ASX
were by small groups control companies). A is currently in financial difficult and script lends his shares of
which 15% is borrowed by C to facilitate a short trade. B acquires the shares from C as he is planning to
launce a takeover for the rest of the company. B lodges his disclosure document showing that he now
controls 55% of the company. The market is now perplex because they known that between A and B,
95% of the company is controlled, and all B needs to do is persuade A to sell and B would then be at
compulsory acquisition stage. So therefore they believe that there is very little upside premium over the
current price. But this would be totally wrong, as the fact that A does own 40%, but has lent 15% to a
short seller who has sold tem to B, means that between A and B they still only hold 80% and 20% is still
held by mum and dads. So a good premium should be possible to mop them up.
Therefore in summary, I welcome the RBA reporting regime and believe that there should be no lag as it
would confuse the market.
C.
INVESTOR DISCLOSURE
I strongly support the notation that investor must disclose their short position. Whether it is reportable to
their broker or to the ASX and even to ASIC, is immaterial so long as there is appropriate enforcement to
ensure that abuses are stopped.
It must also be remembered that if it is not reported to the broker then how can the zero-tick rule be
enforced (see above).
It is going to be interesting now for the SEC if it re-established the zero-tick rule, as to how it expects the
Exchanges to enforce it.
D.
BROKER ACCESS TO INFORMATION
I believe that brokers since November 2008 have now put in appropriate mechanisms to capture this
information. A lot of them already had procedures for this under the old ASX 19.6.1 regime (see above).
Brokers would be unhappy if the money for these systems were wasted. Particularly those that have put
in new systems like Etrade.
The issue of an investor using multiple brokers only becomes an issue if there is a threshold imposed on
reporting. If it was at the broker level and no threshold was imposed, then all trades that were reported to
Broker would be reported to the ASX, subject to the client reporting them.
If the client chooses not to inform the broker that it is a short sale, they are more than like also not going
to inform the exchange. In this regard it is an enforcement action that has to be taken up. It is better that
it done by the regulatory body rather than the broker.
However, if no enforcement happens than the market abuse will still continue, as the client will not tell
the broker it is a short trade will sell it on the market as normal sale and more than like will breach the
zero-tick rule and therefore the market has already suffered the abuse.
The concept of a client splitting trades across multiple brokers is not unusual to cover a market abuses.
For example, see ASIC v Nomura in which I was the principal expert witness for ASIC. Nomura used 10
brokers to facilitate this market manipulation.
It is therefore important that the ASX has an independent mechanism to compare the reporting of the
trades against i.e RBA number, without this it is impossible to have any enforcement.
E.
ENFORCING DISCLOSURE REQUIREMENTS
Offshore entities imposes major issues for any enforcement action. However, they are possible and
should be perused for the integrity of the market. Civil penalty orders similar to Nomura is a good
starting point. It the allows the lead regulatory in the home jurisdiction to use it for other orders.
F.
DESSIMATION OF INFORMATION
It is important that one regulator controls all the short selling reports, including the RBA. But it is more
important, that the regulator spends appropriate dollars on enforcement. We don’t want to be here again
in a another 20 -30 years revisting the same old issue due to lack of enforcement.
Why do I say it is a lack of enforcement? The ASX found itself in a predictament mid last year, when
it was realised that “covered short selling” should be treated exactly the same as a short sale. Up until
then investors through their brokers (who had legal opinion that a “covered short sale” was not a short
sale) had not reported to the ASX, these as short sales. This explains why the ASX short sale numbers
desimminated through information vendors like Iress appeared to be well understated. What is quite
surprising is that a lot of short sales were reported. This means that these people (like myself and people I
had discussed this with) did not believe the weight of the legal opinion.
To my shock, having formed the view that a “covered short sale” was a short sale and imposing the new
rule 19.6.1 and 19.1.6 (see above), the ASX did not enforce those people that had previously been
breaching the rule. Even worst, the ASX did not known the full extent of short selling and therefore
could not be enforcing it Rule 19.5.1. I am of the opinion, that the ASX has turned a blind eye to this and
still does not know the extent of the short selling that has occurred. This would not have been a difficult
exercise as can be seen from the RBA requirement. The result was the markets integrity was at risk, and
the ASX did nothing.
Even worse the ban by the government into short selling and even now into short selling in financial
stocks did not stop the short selling. Rather it sent it underground via the option, future and CFD
markets.
Each of these markets are run by specialist known as arbitrageurs. Arbitrageurs do not take risk on
market direction, they principally make their money out of the bid-ask spread in the market and hedging
their direction risk in stock. For example:
•
In CFD’s if a person wanted to obtained a short exposure to one of the banks, they could sell a
CFD. This means that if the share price went down in the bank, they would benefit from the
position. The arbitrageur would buy the CFD and to eliminate the risk sell borrowed stock.
They would now report this to the ASX as a short sale. That’s why we are seeing short sales in
banks still occurring.
The ASX should be adding together the current day short sales with the previous days accumulation to
come to a total short sale position. Once 10% was reached no further short sales could occur. The issue
was the ASX had no starting point because of the previous unreported “covered short sales”. So
therefore we now have the Transactional Regime rather than Positional Regime imposed by ASX Rule
19.6.1.
In additional, whilst a person cannot sell a security down due to the zero-tick rule (19.3.7), arbitrageurs in
the mistaken belief, believe they are not breaching this rule. Even worst the ASX has no mechanism to
monitor for breaches of this rule.
It is my opinion that the ASX has left itself wide open for a class action to be launched from disgruntled
investors, for its failure to enforce its own rules. The motivation for the ASX was increased turnover for
its markets.
In summation, I believe that the ASX has now failed twice, once in 1971 and now to enforce the rules on
short selling and therefore should not be allowed to continue in any enforcement role.
G.
REPORTING THRESHOLD
The issue here is if other jurisdictions re-impose the uptick rule, then how is the ASX proposing to
enforce it, without the broker being aware that the trade is short at the time of the entry into SEATS. In
this regard there is no mechanism in place for the ASX to know at the time of the trade and therefore no
real-time enforcement.
If the objective is too align the Australian regime with the US and the UK regime, and to drop the current
restriction in short selling of 10% and to drop the “up-tick” rule and replace it with this regime, I would
be totally opposed. I am of the firm belief that those regime will revert back to their old regimes.
If the objective is too inform the regulator who are the biggest short sellers, then I would totally support
it. It is this ambiguity that is intriguing. As previous discussed above, under the current old regime the
ASX was informed of the level of short selling from brokers and this was passed to information vendor to
enable transparency to the market.
As clearly stated in Treasury’s Consultation Paper (page 2) it would clearly understate the actual level of
short selling. It would then create a misinformed or confused market, particular, if the RBA numbers are
also dessiminated to the general public.
As highlighted on Page 2 of Treasury’s Consultation Paper, the aggregate short sale position of a given
stock is a very useful indicator of the riskiness of entering a short sale. The level of aggregate short sales
and the transparency of it, is no different to the disclosure of open position in future, options and CFD’s
or even the unlisted options that director’s and associated may have over the shares of the company.
Each of these imposes a risk on the investor when investing in the security.
H.
EXCLUDED REPORTING
Only the very large top six brokers would have a reporting issue and potentially around the top 40 funds
managers even at the 0.25%. The level of off-shore reporting obligation is more uncertain. With regard
even to the 0.25% level we would have no reporting obligation.
I.
FREQUENCY OF REPORTING
The frequency of reporting needs to be linked to the other transparency in the marketplace. It is very
difficult for an investor to line up the short selling position against what was occurring in the market one
week yet alone two weeks before. In my opinion the level of transparency here is as important as the
reporting of substantial shareholders. I therefore believe that the reporting needs to be done on a daily
basis.
During my time in the 1980’s I worked as an arbitrage / option specialist. As such we regularly held short
selling positions. In this type of environment it is extremely import to know the open position and the
market value of the position, as such major short sellers have complicated system to manage this risk.
Therefore the report of individual stock levels should not be difficult.
J.
BANDED REPORTING
If the banded report is to be only used by the regulator, then banded reporting should be similar to
overseas regime. If however, it is be used as the transparency level of short sales, then I am not in
support of it and would require any change to be reported.
K.
DELAY IN REPORTING
As stated above any delay in reporting the level of short selling in confusing for investors.
L.
AGGREGATE V DISAGGREGATE BASIS
The reporting regime in the US was no different to that was adopted by the ASX up until 19 November
(the old ASX Rule 19.6.1), were brokers aggregated the total short position of their clients and reported in
to the ASX on an aggregated basis. I am of the opinion that this is the type of information that needs to
be disclosed to the general public as it disclose the level and therefore the risks attached to short selling in
the market, without giving away any intellectual property of an individual short seller.
However, I also believe that the regulators need to understand the big players in the industry and what
drives them. So therefore at this level I would support a disaggregated basis.
I am of the opinion that the two regimes can work side by side.
M.
AGGREGATED BEING MISLEADING
I am of the opinion that if the only transparency to the level of short selling is to be an aggregated
reporting regime with a threshold, there is no way to value judge the true level of short selling, therefore it
would create a high level of confusion in the market as different level of short selling would be reported
based upon key assumptions. It also maybe even more confusion, particular with size and timing if it is
compared to the RBA regime.
N.
PUBLIC DISCLSOURE OF MAJOR SHORT SELLERS
If the only transparency to the market is to be threshold major short selling at 0.25% with 0.1% moves,
then I am of the opinion that they should be then disclosed at the individual level. From this information
and a few key assumptions a reasonable level of actual short selling could be predicted.
If however, the general public was offered a reasonably accurate and timely (daily) reporting of level of
short sales in a security, then I believe individual short sellers should only be known to the regulators.
O.
DISCLOSURE OF TRANSACTION REPORTING
The current Transactional Reporting Regime, is only reporting “gross short sales” and not “net short
sales” (ASX Rule 19.6.1). The consequences is that only new short sales are reported we no need to
report the closing out of a short position. In this regard there is no way of actually predicting the level
that a stock is short sold. This is most important position that a client needs. Not that yesterday that
60+% of the sales were short sales. This could be done by subtracting from the previous days position.
The current regime has been more misinforming than having almost nothing, as it favours the existing
short selling as new short sales are shown everyday. What keeps markets down is the fear and press
dessiminating the new shorting.
P.
IMPROVING TRANSACTIONAL REPORTING
Transactional Reporting needs to be on a net basis.
Q.
POSITIONAL REPORTING MANATORY
Depends on the type of Positional Reporting and what is disclosed as the level on net short sales on a
daily basis. For all the reasons above.
R.
DELAY IN REPORTING
I am of the opinion that there should be no delay in reporting. Any delay will reduce the usefulness of the
information and decreases the market integrity as information is misread.
S.
DAMAGING CONSEQUENCES
I am not aware of any instances where this has occurred and I am of the opinion that a breach of this
nature would be a breach of the Privacy legislation and should be protected in that way.
T.
DAMAGING CONSEQUENCES
Yes, people who were use to the old regime whereby the net regime were reported and then accumulated
by the ASX into a short sold position report believed that this was still occurring. Other investors did not
realize that covering of short sales were not reportable.
W.
COST FOR BROKERS
Up until November 2008, even broker was required to report net sales, ie both opening new sales by
selling and closing an existing short sale by buying. What we did was to use the exactly same system, but
turned off the buying. So the cost for any broker should have been minor. Ongoing costs should also be
minor and mainly involve the man-hours in having clients understand the changing regime. The investing
public do not like changes.
Switch back to the old regime should be minor, and having the ASX to turn back on the short selling on
SEATS should also be minor so that you could have a Transaction Regime that consolidates in a Position
Regime.
AA.
ALL STAKEHOLDERS
Costs having mainly occur on a regime that was not broken. Hopefully this will not occur in the future
under the new regime from the lack of enforcement.